**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

**x**                                 ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGEACT OF 1934

**For the fiscal year ended March 31, 2006**

**o**                                   TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESACT OF 1934

**For the transition period from                  to                **

**Commission File Number 1-8533**

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****

**DRSTechnologies, Inc.**

(Exactname of registrant as specified in charter)

| **Delaware**                                                     | **13-2632319**                            |
|------------------------------------------------------------------|-------------------------------------------|
| (State  or other jurisdiction of  incorporation or organization) | (I.R.S.  Employer  Identification Number) |
| **5 Sylvan Way, Parsippany, New  Jersey**                        | **07054**                                 |
| (Address  of principal executive offices)                        | (Zip  Code)                               |

 

**(973) 898-1500**

(TelephoneNo.)

**Securities registered pursuant to Section 12(b) of the Act:**

|                               | ** ** | **Name of  Each Exchange** |
|-------------------------------|------------|----------------------------|
| **Title of  Each Class**      | ** ** | **on which  Registered**   |
| Common  Stock, $.01 par value |       | New  York Stock Exchange   |

 

**Securitiesregistered pursuant to Section 12(g) of the Act: None**

Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act. Yes x  No o

Indicate by check mark if the registrantin not required to file reports pursuant to Section 13 of Section 15(d) ofthe Act. Yes o  No x

Indicate by check mark whether theregistrant (1) has filed all reports required to be filed bysection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x  No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. x

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act.

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

Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes o  No x

The market value of shares ofcommon stock held by non-affiliates as of the last business day of theregistrants most recently completed second fiscal quarter was$1,370.9 million. The number of shares of common stock outstanding as of June 7,2006 was 39,930,367.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portions of thedefinitive proxy statement for the Annual Meeting of Stockholders to be heldAugust 3, 2006 have been incorporated herein by reference into Part IIIof this Form 10-K.

 

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**Table ofContents**
|               | ** ** |                                                                                                                          | ** ** | **Page** |
|---------------|------------|--------------------------------------------------------------------------------------------------------------------------|------------|----------|
| PART I   |
| Item  1.      |       | Business                                                                                                                 |       | 3        |   |
| Item 1A.      |       | Risk Factors                                                                                                             |       | 14       |   |
| Item  1B.     |       | Unresolved Staff  Comments                                                                                               |       | 24       |   |
| Item 2.       |       | Properties                                                                                                               |       | 25       |   |
| Item 3.       |       | Legal  Proceedings                                                                                                       |       | 27       |   |
| Item 4.       |       | Submission  of Matters to a Vote of Security Holders                                                                     |       | 29       |   |
| PART II  |
| Item 5.       |       | Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities |       | 30       |   |
| Item 6.       |       | Selected  Financial Data                                                                                                 |       | 31       |   |
| Item 7.       |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |       | 34       |   |
| Item 7A.      |       | Quantitative  and Qualitative Disclosures About Market Risk                                                              |       | 61       |   |
| Item 8.       |       | Financial  Statements and Supplementary Data                                                                             |       | 63       |   |
| Item 9.       |       | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                                    |       | 128      |   |
| Item 9A.      |       | Controls  and Procedures                                                                                                 |       | 128      |   |
| Item 9B.      |       | Other  Information                                                                                                       |       | 130      |   |
| PART III |
| Item 10.      |       | Directors and Executive Officers of the Registrant                                                                       |       | 130      |   |
| Item 11.      |       | Executive Compensation                                                                                                   |       | 130      |   |
| Item 12.      |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholders Matters                         |       | 130      |   |
| Item 13.      |       | Certain Relationships and Related Transactions                                                                           |       | 130      |   |
| Item 14.      |       | Principal Accountant Fees and Services                                                                                   |       | 130      |   |
| PART IV  |
| Item 15.      |       | Exhibits,  Financial Statement Schedules                                                                                 |       | 131      |   |
| Signatures    |       | 132                                                                                                                      |       |

 

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**Item 1.**                    Business

References in this Annual Reporton Form 10-K to “DRS Technologies,” “DRS,” “the Company,” “we,” “our”and “us” refer to DRS Technologies, Inc., its wholly-ownedsubsidiaries and majority-owned partnership.

**General**

DRS is a leading supplier of defense electronicproducts and systems and military support services. We provide high-technology products andservices to all branches of the U.S. military, major aerospace and defenseprime contractors, government intelligence agencies, international militaryforces and industrial markets. We focus on several key areas ofimportance to the U.S. Department of Defense (DoD), such as intelligence,surveillance, reconnaissance, power management, advanced communications andnetwork systems. Incorporated in 1968, we have served the defense industry forover 37 years. We are a leading provider of thermal imaging devices, combatdisplay workstations, electronic sensor systems, power systems, battlefielddigitization systems, air combat training systems, mission recorders,deployable flight incident recorders, environmental and telecommunicationsystems, aircraft loaders, military trailers and shelters, and integratedlogistics support services. Our products are deployed on a wide range of high-profile military platforms,such as DDG-51 Aegis destroyers, M1A2Abrams Main Battle Tanks, M2A3 Bradley Fighting Vehicles, OH-58D Kiowa Warrior helicopters,AH-64 Apache helicopters, F/A-18E/F Super Hornet and F-16 Fighting Falcon jetfighters, F-15 Eagle tactical fighters, C-17 Globemaster II and C-130 Hercules cargo aircraft, Ohio,Los Angeles and Virginia class submarines, and on several otherplatforms for military and non-military applications. We alsohave contracts that support future military platforms, such as the CVN-78 next generation aircraftcarrier, Littoral Combat Ship and Future Combat System. In addition, as aresult of our recent acquisition of Engineered Support Systems, Inc. DRSprovides sustainment products that support military forces, such asenvironmental control systems, power generators, water and fuel distributionsystems, chemical/biological decontamination shelters and heavy equipmenttransport systems. We also provide support services to the military, includingsecurity and asset protection system services, telecommunication andinformation technology services, training and logistics support services forall branches of the U.S. armed forces and certain foreign militaries, homelandsecurity forces, and selected government and intelligence agencies.

**Available Information**

The address of our principal executive office is 5Sylvan Way, Parsippany, New Jersey 07054, and our telephone number is (973) 898-1500.Our web address is *http://www.drs.com.*We are subject to the informational requirements of the Securities Exchange Actof 1934 and, in accordance therewith, file reports and other information withthe Securities and Exchange Commission (SEC). Such reports and otherinformation can be inspected and copied at the Public Reference Room ofthe SEC, located at 100 F Street N.E., Washington D.C. 20549. Copies of suchmaterial can be obtained from the Public Reference Room of the SEC atprescribed rates. You may obtain information on the operation of the PublicReference Room by calling the SEC at 1-800-SEC-0330.Such material also may be accessed electronically by means of the SEC’s home page onthe Internet at http://www.sec.gov or at www.drs.com.

We provide free of charge on our web site, under theheading “Investor Info,” our annual report on Form 10-K, quarterlyreports on Form 10-Q, current reports on Form 8-K andamendments to reports filed or furnished, pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934, as amended, as soon asreasonably practicable after we file such material with, or furnish it to, theU.S. Securities and Exchange Commission.

The corporate governanceinformation in our web site includes our Code of Ethics and Code of BusinessConduct for all employees of DRS, including senior financial personnel and ourBoard 

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of Directors. Inaddition, amendments to and waivers granted to our directors and executiveofficers under our Code of Ethics, if any, will be posted in this area of ourweb site. These corporate governance documents can be accessed by visiting ourweb site and clicking on the “Corporate Info” link followed by the “EthicsProgram” link. You can request a copy of our Code of Ethics at no cost bycontacting Investor Relations at (973) 898-1500.

**Company Organization**

We operate in three principal operating segments onthe basis of products and services offered. Each operating segment is comprisedof separate and distinct businesses. Our segments are: the Command, Control,Communications, Computers and Intelligence (C4I) Group, the Surveillance &Reconnaissance (SR) Group and the Sustainment Systems & Services (S3)Group. All other operations, primarily our Corporate Headquarters, are groupedin Other.

On January 31, 2006, we acquired all of theoutstanding stock of Engineered Support Systems, Inc. (ESSI) forming our thirdoperating segment, the S3 Group. The total transaction value was approximately$1.93 billion. The acquisition is more fully described in Fiscal 2006Acquisitions below.

On March 10, 2005, we completed the sale of twoof our operating units, DRS Weather Systems, Inc. (DRS Weather) and DRSBroadcast Technology (DRS Broadcast). The operating units were acquired inconnection with our fiscal 2004 acquisition of Integrated Defense Technologies, Inc.(IDT). The results of operations of DRS Weather and DRS Broadcast for thefiscal year ended March 31, 2005 and for the period from the date ofacquisition through March 31, 2004 are included in the ConsolidatedStatements of Earnings as “Earnings from discontinued operations” whichincludes the gain on their sale. The cash flows of the discontinued operationsalso are presented separately in the Consolidated Statements of Cash Flows forthe years ended March 31, 2005 and 2004.

A summary of the operating results of the discontinuedoperations for the years ended March 31, 2005 and 2004 is more fullydescribed under Note 1.A., in our Consolidated Financial Statements forthe year ended March 31, 2006.

Financial information on our reportablebusiness segments is presented in Note 14 to our Consolidated FinancialStatements, which are included in this Form 10-K. See Item 8.Financial Statements and Supplementary Data. Additional financial data andcommentary on the results of operations for the operating segments are includedin Management’s Discussion and Analysis of Financial Condition and Results ofOperations, which also is included in this Form 10-K. See Item 7.Management’s Discussion and Analysis of Financial Condition and Results ofOperations. The data and comments should be referred to in conjunction with thesummary description of our operating segments, which follows.

**C4I Group**

The C4I Group is comprised of the following businessareas: Command, Control and Communications (C3), which includes naval displaysystems, ship communications systems, radar systems, technical support,electronic manufacturing and system integration services, and secure voice anddata communications; Power Systems, which includes naval and industrial powergeneration, conversion, propulsion, distribution and control systems;Intelligence Technologies, which includes signals intelligence, communicationsintelligence, data collection, processing and dissemination equipment; andTactical Systems, which includes battle management tactical computer systemsand peripherals.

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**Surveillance & Reconnaissance Group**

The SR Group is comprised of thefollowing business areas: Reconnaissance, Surveillance & Target Acquisition(RSTA), which develops and produces electro-optical sighting, targetingand weapon sensor systems, high-speed digital data and imaging systems,aircraft weapons alignment systems, mission and flight recorders and imageintensification (I2)night vision, combat identification and laser aimers/illuminator products, andprovides electronic manufacturing services; Training & Control Systems,which develops and produces air combat training, and unmanned vehicles, electronicwarfare and network systems; and Test & Energy Management, whichdevelops and produces electronic test, diagnostics and vehicle electronics.

**Sustainment Systems &Services Group**

The S3 Group is comprised of the following businessareas: Sustainment Systems, which designs, engineers and manufacturesintegrated military electronics and other military support equipment, primarilyfor the DoD, as well as related heat transfer and air handling equipment andpower generation and distribution equipment for domestic commercial andindustrial users; and Support Services, which 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.

**Other.****  **“Other” includes the activities ofDRS Corporate Headquarters and certain of our non-operating subsidiaries.

**Industry Background**

The U.S. military has worked to meet the changingthreats that have evolved since the mid-1980s with a focus on lighter,faster and more intelligent weapons and an emphasis on intelligence,surveillance and reconnaissance. This change in focus, the end of the Cold Warand the subsequent reduction in defense spending led to consolidation in thedefense industry. Today, we believe the industry is dominated by five domesticprime contractors and a few large European defense companies with an increasingpresence in the U.S. markets. These large prime contractors have shifted theirbusiness strategies to focus on platforms and systems integration andconsequently subcontract the development of many systems and subsystems.

Events of the last five years, including the global war on terrorism,Operation Enduring Freedom and Operation Iraqi Freedom, have altered thedefense and homeland security environment of the United States. We believe theseevents will likely continue to have a significant impact on the markets fordefense and advanced technology products for the next several years. The DoDcontinues to focus on both supporting ongoing operations and transforming ourmilitary to confront future threats. We believe that the current business,political and global environments will create new opportunities for mid-tierdefense companies like DRS to develop strategic relationships with thegovernment and prime contractors. Through these relationships, we believe wecan provide new systems and subsystems, which are capable of meeting themilitary’s evolving requirements.

**Business Strategy**

Our goal is tocontinually improve our position as a leading supplier of defense electronicsproducts and systems. Our strategies to achieve our objectives include:

·       ***Leverage Incumbent Relationships.  ***Weintend to leverage our relationships with government and industry decision-makersby continuing to deliver high levels of performance on our existing contracts.Our experience has shown that strong performance on existing contracts enhancesour ability to obtain additional business with our existing 

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customer base. Toaccomplish this, we intend to continue to position ourselves as a “best value”provider for our customers. “Best value” is a DoD contracting theme whichfocuses supplier selection on a variety of criteria, including supplier’s pastperformance, instead of solely on lowest price.

·       ***Develop and Expand ExistingTechnologies.  ***Through a combination of customer-fundedresearch and development and our own internal research and development efforts,we intend to continue to focus on the development of our technology. Customer-fundeddevelopment contracts enable us to work with our customers to design andmanufacture new systems and components, while decreasing our financial risk.

·       ***Leverage Combination of Service and ProductCapabilities to Better Serve Customers.  ***We intend toleverage the combination our product portfolio and service capabilities tobetter serve our military customers. As our S3 Group becomes fully integratedinto DRS, our new contract bidding efforts will emphasize the benefits of anintegrated products and services offering to our customers.

·       ***Continue to React Quickly to theChanging Defense Environment.***    In addition to being wellpositioned for conventional warfare roles, we intend to continue to adapt ourproducts, such as thermal imaging, ruggedization and communication products, toaddress evolving military requirements, such as rapid deployment and containmentof non-conventional threats including terrorism.

·       ***Capitalize on the Department ofDefense’s Emphasis on Transformation and Modernization.***   TheDoD has emphasized its goal to transform the U.S. military into a nimble, lightand network-centric force. We believe our expertise in electro-optics,power management, training and test, signals intelligence, rugged computers,advanced communications, network systems and sustainment systems and servicesfits well into the DoD’s technological focus. We also intend to continue tosupply upgrades for force modernization of the current force through back fitand forward fit initiatives.

·       ***Pursue Strategic Acquisitions.***    Weplan to continue our participation in the ongoing consolidation of theaerospace and defense industry. Through selective acquisitions, we aim tobroaden our existing product base, build on our existing customer relationshipsand enhance our ability to enter new markets.

**Fiscal 2006 Acquisitions**

On January 31, 2006, we completed our acquisitionof Engineered Support Systems, Inc. (ESSI). In the transaction, a wholly-ownedsubsidiary of DRS was merged with ESSI, with the ESSI operating units formingDRS’s third operating segment—the S3 Group.

ESSI, headquartered in St. Louis, Missouri, is asupplier of integrated military electronics, support equipment and technicalservices focused on advanced sustainment and logistics support solutions forall branches of the U.S. armed services, major prime defense contractors, certaininternational militaries, homeland security forces and selected government andintelligence agencies. ESSI also produces specialized equipment and systems forcommercial and industrial applications. We believe ESSI will contribute asignificant base of systems, products and services focused on military forcesustainment, technical and logistics support, integrated military electronicsand field support equipment. The results of ESSI have been included in ourfinancial statements since the date of acquisition.

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The purchase price was $43.00 per share of ESSI commonstock, which was comprised of $30.10 in cash and a fraction of a share of DRScommon stock valued at $12.90. The stock component of the consideration included11.7 million shares of DRS common stock and was valued using the average stockprice of DRS common stock on the measurement date of the merger, January 27,2006, and two days before and after the measurement date, which approximated$587.3 million. Total consideration for the acquisition was $2.0 billion, andthe assumption of approximately $78.5 million of ESSI’s debt at closing. Inaddition to the purchase price, the estimated costs related to the acquisitionapproximated $25.5 million.

We financed the cash portion of the acquisition byutilizing existing cash on hand, revolving credit borrowings, $275.0 million interm debt and $900 million of new debt securities, including $350 millionaggregate principal amount of 65¤8% senior notesdue 2016, $250 million aggregate principal amount of 75¤8% seniorsubordinated notes due 2018 and $300 million aggregate principal amount of 2.0%convertible senior notes due 2026 (with a 20% conversion premium).

On June 27, 2005, we acquired WalkAbout ComputerSystems, Inc. (WalkAbout) in a stock purchase transaction for approximately$13.8 million in cash, with additional consideration payable of up to $5.0million upon achievement of certain revenue targets for a period of two and ahalf years. Approximately $0.2 million ofadditional consideration was accrued in the fourth quarter of fiscal 2006, as aresult of achieving certain revenue targets. In addition to the purchaseprice, we recorded approximately $0.2million for acquisition-related costs. The results of WalkAbout have beenincluded in our financial statements since the date of acquisition.

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

On April 15, 2005, we acquired Codem Systems, Inc.(Codem) in a stock purchase transaction for approximately $31.6 million incash, with additional consideration payable of up to $5.0 million uponachievement of certain annual bookings targets for a period of three years. Approximately $0.3 million of additional consideration was accrued in the fourthquarter of fiscal 2006, as a result of achieving certain bookings targets. Inaddition to the purchase price, we recorded approximately $0.3 million foracquisition-related costs. The results of Codem’s operations have been includedin our financial statements since the date of acquisition.

Codem, located in Merrimack, NewHampshire, is a provider of signals intelligence (SIGINT) systems, networkinterface modules and high-performance antenna control systems. Managementbelieves that the addition of Codem has enhanced our existing intelligenceproduct base. Codem is being managed as a part of our C4I Group.

**Customers**

We sell a significant portion ofour products to agencies of the U.S. government, primarily the DoD, tointernational government agencies and to prime contractors and theirsubcontractors. Approximately 87%, 84% and 85% of total consolidated revenuesfor fiscal 2006, 2005 and 2004, respectively, were derived directly orindirectly from defense contracts for end use by the U.S. government and itsagencies. Export sales accounted for approximately 10%, 14% and 12% of totalconsolidated revenues in the fiscal years ended March 31, 2006, 2005 and2004, respectively.

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**Backlog**

The following table sets forth our backlog by majorproduct group (including enhancements, modifications and related logisticssupport) at the dates indicated. “Backlog” refers to the aggregate revenuesremaining to be earned at a specified date under contracts held by us,including U.S. government contracts, to the extent the funded amounts undersuch a contract have been appropriated by Congress and allotted to the contractby the procuring government agency. Our backlog does not include the full valueof contract awards nor does it include the sales value of unexercised optionsthat may be exercised in the future. Backlog also includes all firm orders forcommercial products. Fluctuations in backlog generally relate to the timing andamount of defense contract awards.

| ** **          | ** ** | **March 31,**      | ** ** |
|---------------------|------------|-------------------------|------------|
| ** **          | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **          | ** ** | **(in thousands)** | ** ** |
| U.S. government     |       | $                       | 2,101,446  |   | $ | 1,096,275 |   | $ | 917,630 |   |
| Foreign governments |       | 240,976                 |       | 171,880 |   | 227,980 |   |
|                | ** ** | 2,342,422               |       | 1,268,155 |   | 1,145,610 |   |
| Commercial products |       | 53,640                  |       | 46,623 |   | 50,436 |   |
|                |       | $                       | 2,396,062  |   | $ | 1,314,778 |   | $ | 1,196,046 |   |

 

We expect to record as revenuesapproximately 74% of our funded backlog as of March 31, 2006 during fiscal2007. However, there can be no assurance that our entire funded backlog willbecome revenues in future periods.

**Research and Development**

We conduct research and development programs tomaintain and advance our technology base. Our research and development effortsare funded by both internal sources and by part of customer-fundeddevelopment contracts.

We recorded revenues for customer-sponsoredresearch and development of approximately $106.1 million,$93.1 million and $74.4 million for fiscal 2006, 2005 and 2004,respectively. Such customer-sponsored activities are primarily the resultof contracts directly or indirectly with the U.S. government. We also invest ininternal research and development. Expenditures for internal research anddevelopment amounted to approximately $47.6 million, $38.9 millionand $27.4 million for fiscal 2006, 2005 and 2004, respectively.

**Contracts**

A significant portion of our revenue is derived fromlong-term programs and from programs for which we are the incumbent supplier orhave been the sole or dual supplier for many years. A large percentage of ourrevenue is derived from programs that are in the production phase.

No single program represented more than 10% ofrevenues for the years ended March 31, 2006, 2005 and 2004. We have adiverse business mix with limited dependence on any single program.

The percentagesof revenues during fiscal 2006, 2005 and 2004 attributable to our contracts bycontract type were as follows:

| ** **  | ** ** | **March 31,** | ** ** |
|-------------|------------|--------------------|------------|
| ** **  | ** ** | **2006**           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Fixed-price |       |               | 83         | % |   |   | 81 | % |   |   | 82 | % |   |
| Cost-type   |       |               | 17         | % |   |   | 19 | % |   |   | 18 | % |   |

 

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Our contracts are normally for production, services ordevelopment. Production contracts are typically of the fixed-pricevariety with development contracts of the cost-type variety. We believe continuedpredominance of fixed-price contracts is reflective of the fact thatproduction contracts comprise a significant portion of our U.S. governmentcontract portfolio. Fixed-price contracts may provide for a fixed priceor they may be fixed-price incentive contracts. Under the fixed-pricecontracts, we agree to perform for an agreed-upon price. Accordingly, we derivebenefits from cost savings, but bear the risk of cost overruns. Under the fixed-priceincentive contracts, if actual costs incurred in the performance of thecontracts are less than estimated costs for the contracts, the savings areapportioned between the customer and us. If actual costs under such a contractexceed estimated costs, however, excess costs are apportioned between thecustomer and us, up to a ceiling. We bear all costs that exceed the ceiling, ifany.

Cost-type contracts typically provide forreimbursement of allowable costs incurred plus a fee (profit). Unlike fixed-pricecontracts in which we are committed to deliver without regard to cost,cost-type contracts normally obligate us to use our best efforts to accomplishthe scope of work within a specified time and a stated contract dollarlimitation. In addition, U.S. government procurement regulations mandate lowerprofits for cost-type contracts because of our reduced risk. Undercost-plus-incentive-fee contracts, the incentive may be based on cost orperformance. When the incentive is based on cost, the contract specifies thatwe are reimbursed for allowable incurred costs plus a fee adjusted by a formulabased on the ratio of total allowable costs to target cost. Target cost, targetfee, minimum and maximum fee and adjustment formulae are agreed upon when thecontract is negotiated. In the case of performance-based incentives, weare reimbursed for allowable incurred costs plus an incentive, contingent uponmeeting or surpassing stated performance targets. The contract provides forincreases in the fee to the extent that such targets are surpassed and fordecreases to the extent that such targets are not met. In some instances, incentivecontracts also may include a combination of both cost and performanceincentives. Under cost-plus-fixed-fee contracts, we are reimbursed for costsand receive a fixed fee, which is negotiated and specified in the contract.Such fees have statutory limits.

We negotiate for and generally receive progresspayments from our customers of between 75-90% of allowable costs incurredon the previously described contracts. Included in our reported revenues arecertain amounts, which we have not billed to customers. These amounts consistof costs and related profits, if any, in excess of progress payments forcontracts on which revenues are recognized on a percentage-of-completion basis.

Under generally accepted accounting principles in theUnited States (GAAP), contract costs, including applicable general andadministrative expenses on certain long-term government contracts, are chargedto work-in-progress inventory and are written off to costs and expenses asrevenues are recognized. The Federal Acquisition Regulations, incorporated byreference in U.S. government contracts, provide that internal research anddevelopment costs are allowable general and administrative expenses. To theextent that general and administrative expenses are included in inventory, researchand development costs also are included. Unallowable costs, pursuant to theFederal Acquisition Regulations, are excluded from costs accumulated on U.S.government contracts. Work-in-process inventory includes general andadministrative costs (which include internal research and development costs,and bid and proposal costs) of $63.9 million and $47.4 million at March 31,2006 and 2005, respectively.

Our defense contracts and subcontracts are subject toaudit, various profit and cost controls, and standard provisions fortermination at the convenience of the customer. The Defense Contract AuditAgency (DCAA) performs these audits on behalf of the U.S. government. The DCAAhas the right to perform audits on our incurred costs on all contracts on a yearlybasis. Approval of an incurred cost submission can take from one to three yearsfrom the date of the submission of the contract cost.

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Under the Truth in Negotiations Act of 1962(Negotiations Act), the U.S. government has the right for three years afterfinal payment on certain negotiated contracts, subcontracts and modifications,to determine whether DRS furnished the U.S. government with complete, accurateand current cost or pricing data as defined by the Negotiations Act. If DRSfails to satisfy this requirement, the U.S. government has the right to adjusta contract or subcontract price by the amount of any overstatement, as definedby the Negotiations Act.

U.S. government contracts are, by their terms, subjectto termination by the U.S. government for either convenience or default by thecontractor. Fixed-price contracts provide for payment upon terminationfor items delivered to and accepted by the U.S. government and, if thetermination is for convenience, for payment of fair compensation of workperformed plus the costs of settling and paying claims by terminatedsubcontractors, other settlement expenses and a reasonable profit on the costsincurred. Cost-plus contracts provide that, upon termination, the contractor isentitled to reimbursement of its allowable costs and, if the termination is forconvenience, a total fee proportionate to the percentage of the work completedunder the contract. If a contract termination is for default, however, thecontractor is paid an amount agreed upon for completed and partially completedproducts and services accepted by the U.S. government. In these circumstances,the U.S. government is not liable for excess costs incurred by us in procuringundelivered items from another source.

In addition to the right of theU.S. government to terminate, U.S. government contracts are conditioned uponthe continuing availability of Congressional appropriations. Congress usuallyappropriates funds for a given program on a September 30 fiscal yearbasis, even though contract performance may take many years. Consequently, atthe outset of a major program, the contract usually is funded partially, andadditional monies normally are committed to the contract by the procuringagency only as appropriations are made by Congress for future fiscal years.

**Competition**

Our products are sold inmarkets in which several of our competitors are substantially larger than weare, devote substantially greater resources to research and development, and,generally, have greater financial resources. We face a variety of competitors,including BAE Systems PLC, Raytheon Company and L-3 CommunicationsHoldings, Inc. Certain competitors are also our customers and suppliers.The extent of competition for any single project generally varies according tothe complexity of the product and the dollar value of the anticipated award. Webelieve that we compete on the basis of:

·       Theperformance, flexibility and price of our products;

·       Reputationfor prompt and responsive contract performance;

·       Accumulatedtechnical knowledge and expertise; and

·       Breadthof our product lines.

Our future success will depend in large part upon ourability to improve existing product lines and to develop new products andtechnologies in the same or related fields.

In the military sector, we compete with large andmid-tier defense contractors on the basis of product performance, cost, overallvalue, delivery and reputation. As a number of consolidations and mergers ofdefense suppliers has occurred, the number of participants in the defenseindustry has decreased in recent years. We expect this consolidation trend tocontinue. As the industry consolidates, the large defense contractors arenarrowing their supplier base, awarding increasing portions of projects tostrategic mid- and lower-tier suppliers, and, in the process, are becomingoriented more toward systems integration and assembly. We believe that we havebenefited from this defense industry trend.

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In addition to the military sector,we compete with a large number of suppliers to commercial and industrial airhandling customers on the basis of both performance and price.

**Patents and Licenses**

We have patents on certain of our commercial and datarecording products, semiconductor devices, rugged computer related items,electro-optical and focal plane array products, in addition to otherproducts. We and our subsidiaries have certain registered trademarks, none ofwhich are considered material to our current operations. We believe our patentposition and intellectual property portfolio in the aggregate are valuable toour operations. We do not believe that the conduct of our business as a wholeis materially dependent on any single patent, trademark or copyright.

When we work on U.S. governmentcontracts, the U.S. government may have contractual rights to data for our “core”technologies, source codes and other developments associated with suchgovernment contracts. Records of our data rights are maintained in order toclaim these rights as our proprietary technology, but it may not always bepossible to delineate our proprietary developments from those developed underU.S. government contracts. The protection of our data from use by other U.S.government contractors is subject to negotiation from time to time between usand the U.S. government. The extent of the government’s data rights in anyparticular product generally depends upon whether the product was developedunder a government contract and the degree of government funding for thedevelopment of such product.

**Manufacturing and Supplies**

Our manufacturing processes for most of our productsinclude the assembly of purchased components and testing of products at variousstages in the assembly process. Purchased components include integratedcircuits, circuit boards, sheet metal fabricated into cabinets, resistors,capacitors, semiconductors, silicon wafers and other conductive materials andinsulated wire and cables. In addition, many of our products use machinecastings and housings, motors, and recording and reproducing heads.

Many of the purchased components are fabricated to ourdesigns and specifications. The manufacturing process for certain of our opticproducts includes the grinding, polishing and coating of various opticalmaterials and the machining of metal components.

Although materials and purchasedcomponents generally are available from a number of different suppliers,several suppliers are our sole source of certain components. If a suppliershould cease to deliver such components, other sources probably would beavailable; however, added cost and manufacturing delays might result. We havenot experienced significant production delays attributable to supply shortages,but occasionally experience quality and other related problems with respect tocertain components, such as semiconductors and connectors. In addition, withrespect to our optical products, certain materials, such as germanium, zincsulfide and cobalt, may not always be readily available.

**International Operationsand Export Sales**

We currently sell several of our products and servicesinternationally, such as to Canada, the United Kingdom, Israel, Spain andAustralia, as well as other countries. International sales of DRS’s U.S.products and services are subject to export licenses granted on a case-by-casebasis by the U.S. Department of State and Department of Commerce. In addition,the U.S. government prohibits or restricts the export of some of DRS’sproducts. Our international contracts generally are payable in U.S. dollars.Export sales accounted for approximately 10%, 14% and 12% of total revenues inthe fiscal years ended March 31, 2006, 2005 and 2004, respectively.

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There are two principal contracting methods used byDRS for export sales: Direct Foreign Sales (DFS) and the U.S. government’sForeign Military Sales (FMS). In a DFS transaction, the contractor sellsdirectly to the foreign country and assumes all the risks in the transaction.In a FMS transaction, the sale is funded by, contracted by and made to the U.S.government, which in turn sells the product to the foreign country.

We currently operate in Canada through our C4I Group,SR Group and S3 Group and in the United Kingdom through our C4I Group.

Our international operations involveadditional risks for us, such as exposure to currency fluctuations, futureinvestment obligations and changes in international economic and politicalenvironments. In addition, international transactions frequently involveincreased financial and legal risks arising from stringent contractual termsand conditions and widely different legal systems, customs and practices inforeign countries.

**Seasonality**

No material portion of ourbusiness is considered to be seasonal. Various factors can affect thedistribution of our revenue between accounting periods, including the timing ofgovernment awards, the availability of government funding, product deliveriesand customer acceptance.

**Environmental Matters**

The Company’s operations includethe use, generation and disposal of hazardous materials. The Company is subjectto various U.S. federal, state, local and foreign laws and regulations relatingto the protection of the environment, including those governing the dischargeof pollutants into the air and water, the management and disposal of hazardoussubstances and wastes, the clean up of contaminated sites and the maintenanceof a safe workplace. Except as described under Item 3, Legal Proceedings, we believethat we have been and are in material compliance with environmental laws andregulations and that we have no liabilities under environmental requirementsthat would be expected to have a material adverse effect on our business,results of operations or financial condition.

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**EXECUTIVE OFFICERS ANDCERTAIN OTHER OFFICERS OF THE REGISTRANT**

**Executive Officers**

The names of our executive officers, their positionsand offices with us, and their ages are set forth below:
| Name                                        | ** ** | ** ** | ** ** | **Age**                                                      | ** ** | **Position** |
|---------------------------------------------|------------|------------|------------|--------------------------------------------------------------|------------|--------------|
| Mark  S. Newman                             |       | 56         |       | Chairman of the Board, President and Chief Executive Officer |
| Vice  Admiral Michael L. Bowman, USN (Ret.) |       | 62         |       | Executive Vice President, Washington Operations              |
| Nina  Laserson Dunn                         |       | 59         |       | Executive Vice President, General Counsel and Secretary      |
| Robert  F. Mehmel                           |       | 43         |       | Executive Vice President, Chief Operating Officer            |
| Richard  A. Schneider                       |       | 53         |       | Executive Vice President, Chief Financial Officer            |

 

***Mark S. Newman***is Chairman of the Board, President and Chief Executive Officer. He joined usin 1973, four years after our founding, and became President and CEO in 1994,after serving many years as our Chief Financial Officer. He was named adirector in 1988, and in 1995, was elected Chairman of the Board. He is activewith many important professional organizations. He is a member of the Board ofGovernors of the Aerospace Industries Association and is a director on theboards of Business Executives for National Security, the Commerce and IndustryAssociation of New Jersey and the New Jersey Technology Council. He also servesas a member of the Navy League of the United States, the National DefenseIndustrial Association, the Association of the U.S. Army and the Surface NavyAssociation, among other professional affiliations. He is a past chairman ofthe American Electronics Association. He is also a director of CongoleumCorporation, Refac Optical Group and EFJ, Inc.

***Vice Admiral Michael L.Bowman, USN (Ret.)***has been our Executive VicePresident, Washington Operations since June 2005. He served as our SeniorVice President, Washington Operations from the time he joined us inMarch 2001 until June 2005. Prior to that, he served for35 years with the U.S. Navy, including a number of assignments in theWashington, D.C. area involving Congressional relations in support of Navy andMarine Corps defense issues. Initially heading the Senate Liaison Office of theSecretary of the Navy, he later was appointed Chief of Legislative Affairs,responsible for the coordination of all Department of the Navy issues in theU.S. House of Representatives and the Senate.

***Nina Laserson Dunn***joinedus as Executive Vice President, General Counsel and Secretary inJuly 1997. Prior to joining DRS, Ms. Dunn was a Director in thecorporate law department of Hannoch Weisman, a Professional Corporation, whereshe served as our outside legal counsel. Ms. Dunn is admitted to practicelaw in New York and New Jersey and is a member of the American, New York Stateand New Jersey State Bar Associations.

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***Robert F. Mehmel******is Executive Vice President, ChiefOperating Officer since May 11, 2006. He***joined usas Executive Vice President, Business Operations and Strategy in January 2001.Before joining DRS, he was Director, Corporate Development, at Jabil Circuit, Inc.Prior to that, he was Vice President, Planning, at L-3 CommunicationsCorporation from its inception in April 1997 until June 2000.Earlier, Mr. Mehmel held various positions in divisional and corporatefinancial management with Lockheed Martin Corporation, Loral Corporation andLear Siegler, Inc. He is also a member of the Board of Directors of UnitedIndustrial Corporation.

***Richard A. Schneider***joinedus in 1999 as Executive Vice President and Chief Financial Officer. He alsoserved as our Treasurer until November 20, 2002. He held similar positionsat NAI Technologies, Inc. (NAI) and was a member of its board ofdirectors prior to its acquisition by us in February 1999. Mr. Schneiderhas over 30 years of experience in corporate financial management.

**Employees**

As of March 31, 2006, we had approximately 9,800employees, approximately 9,400 of whom are located in the United States. Thereis a continuing demand for qualified technical personnel, and we believe thatour future growth and success will depend upon our ability to attract, trainand retain such personnel. Approximately 92 of our employees at DRS Power &Control Technologies are represented by a labor union and are covered by acollective bargaining agreement through March 2009. Two DRS Power &Control Technologies employees are represented by a separate labor union andare covered by a collective bargaining agreement through October 2006.Approximately 130 employees from DRS Test & Energy Management, Inc.are represented by a union and are covered by a collective bargaining agreementthat expires in May 2009. Approximately 304 of our employees at DRSSystems & Electronics are covered under a collective bargainingagreement that expires in March 2008. We believe that our relations withour employees generally are good.

**Item 1A.   RiskFactors**

The Company’s financial position, results ofoperations and cash flows are subject to various risks, many of which are notexclusively within the Company’s control that may cause actual performance todiffer materially from historical or projected future performance. Informationin this Form 10-K should be considered carefully by investors in lightof the risk factors described below.

**Our revenues depend on our ability to maintain ourlevel of government business. The loss of our contracts withdomestic and non-U.S. government agencies could adversely affect our revenues.**

We derivethe substantial majority of our revenues from contracts or subcontracts withdomestic and non-U.S. government agencies. A significant reduction in thepurchase of our products by these agencies would have a material adverse effectour business. For the fiscal years ended March 31, 2006, 2005 and 2004,approximately 87%, 84% and 85%, respectively, of our revenues were deriveddirectly or indirectly from defense-industry contracts with the U.S.government and its agencies. In addition, for the fiscal years ended March 31,2006, 2005 and 2004, approximately 9%, 12% and 10% of our revenues were deriveddirectly or indirectly from sales to foreign governments, respectively.Therefore, the development of our business in the future will depend upon thecontinued willingness of the U.S. government and its prime contractors tocommit substantial resources to defense programs and, in particular, upon thecontinued purchase of our products, and other products which incorporate ourproducts, by the U.S. government. In particular, the current funding demands onthe U.S. government combined 

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with a potential reduction of forces in Iraq, may leadto lower levels of government defense spending.

The risk that governmental purchases of our productsmay decline stems from the nature of our business with the U.S. government, inwhich the U.S. government may:

·       terminatecontracts at its convenience;

·       terminate,reduce or modify contracts or subcontracts if its requirements or budgetaryconstraints change;

·       cancelmulti-year contracts and related orders if funds become unavailable;

·       shiftits spending priorities;

·       adjustcontract costs and fees on the basis of audits done by its agencies; and

·       inquireabout and investigate business practices and audit compliance with applicable rules andregulations.

In addition, as defense businesses, we are subject tothe following risks in connection with government contracts:

·       thefrequent need to bid on programs prior to completing the necessary design,which may result in unforeseen technological difficulties and/or cost overruns;

·       thedifficulty in forecasting long-term costs and schedules and the potentialobsolescence of products related to long-term fixed-price contracts;

·       therisk of fluctuations or a decline in government expenditures due to any changesin the DoD budget or appropriation of funds;

·       whenwe act as a subcontractor, the failure or inability of the prime contractor toperform its prime contract may result in an inability to obtain payment of feesand contract costs;

·       restrictionor potential prohibition on the export of products based on licensingrequirements; and

·       governmentcontract wins can be contested by other contractors.

**Our revenues will be adversely affected if we fail toreceive renewal or follow-on contracts.**

Renewal and follow-on contracts are important becauseour contracts are for fixed terms. These terms vary from shorter than one yearto over five years, particularly for contracts with options. The typical termof our contracts with the U.S. government is between one and three years. Theloss of revenues from our possible failure to obtain renewal or follow-oncontracts may be significant because our U.S. government contracts account fora substantial portion of our revenues.

**Our operating results may fluctuate.**

Our results of operations have fluctuated in the pastand may continue to fluctuate in the future as a result of a number of factors,many of which are beyond our control. These factors include:

·       thetermination of a key government contract;

·       thesize and timing of new contract awards to replace completed or expiredcontracts; and

·       changesin DoD policies, budgetary priorities and allocation of funding.

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**We may not be successful in implementing our growthstrategy if we are unable to identify, acquire and financesuitable acquisition targets.**

Finding and consummating acquisitions is an importantcomponent of our growth strategy. Our continued ability to grow by acquisitionis dependent upon the availability of acquisition candidates at reasonableprices and our ability to obtain additional acquisition financing on acceptableterms. We experience competition in making acquisitions from larger companieswith significantly greater resources. We are likely to use significant amountsof cash, issue additional equity securities or incur additional debt inconnection with future acquisitions, each of which could have a materialadverse effect on our business. There can be no assurance that we will be ableto procure the necessary funds to effectuate our acquisition strategy oncommercially reasonable terms, or at all. In addition, as our revenue growthhas been historically attributable largely to our successful acquisitionstrategy, failure to identify, consummate or integrate suitable acquisitions couldlead to a reduced rate of revenue growth, operating income and net earnings inthe future.

**Integration of the operations of recent acquisitionswill be complex, time-consuming and expensiveand may adversely affect the results of our operations after the acquisition.**

The anticipated benefits of our acquisitions willdepend in part on whether we can integrate our operations in an efficient,timely and effective manner. Integrating our acquisitions will be a complex,time-consuming and expensive process. Our acquisition of Engineered SupportSystems, Inc. (ESSI) on January 31, 2006 represents our largest and mostsignificant acquisition to date. Successful integration will require, amongother things, combining the companies’:

·       businessdevelopment efforts;

·       keypersonnel;

·       geographicallyseparate facilities; and

·       businessprocesses and cultures.

We may not accomplish this integration successfullyand may not realize the benefits contemplated by combining the operations ofboth companies. In the course of our due diligence investigation of ESSI, wedetermined that ESSI and various of its subsidiaries may not have adequateexport authorizations. Accordingly, we may be required to make disclosures togovernmental agencies and may be subject to fines and penalties as a result ofESSI’s actions or inaction prior to the acquisition. We expect to make changesto ESSI’s export compliance program, and we may be required to alter thebusiness practices of ESSI in order to comply with our business practices andstandards or applicable federal, state, local and foreign laws. Any remedialefforts that we take may require significant management attention and resourcesand may delay production or require modification to existing products andprograms. The diversion of our attention to the integration effort and anydifficulty encountered in combining operations could cause the interruption of,or a loss of momentum in, the activities of our business.

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**If we are unable to successfully integrate ESSI andother companies we acquire into our operations on a timelybasis, our profitability could be negatively affected.**

We expect that our acquisition of ESSI will result incertain business opportunities and growth prospects. We, however, may neverrealize these expected business opportunities and growth prospects. We mayexperience increased competition that limits our ability to expand ourbusiness. Our assumptions underlying estimates of expected cost savings may beinaccurate, or general industry and business conditions may deteriorate.Acquisitions involve numerous risks, including, but not limited to:

·       difficultiesin assimilating and integrating the operations, technologies and productsacquired;

·       thediversion of our management’s attention from other business concerns;

·       currentoperating and financial systems and controls may be inadequate to deal with ourgrowth;

·       therisk that we will be unable to maintain or renew any of the governmentcontracts of businesses we acquire;

·       therisks of entering markets in which we have limited or no prior experience; and

·       theloss of key employees.

If thesefactors limit our ability to integrate the operations of our acquisitions,including ESSI, successfully or on a timely basis, our expectations of futureresults of operations may not be met. In addition, our growth and operatingstrategies for businesses we acquire, including ESSI, may be different from thestrategies that such business currently is pursuing. If our strategies are notthe proper strategies for a company we acquire, it could have a materialadverse effect on our business, financial condition and results of operations.Further, there can be no assurance that we will be able to maintain or enhancethe profitability of any acquired business or consolidate the operations of anyacquired business to achieve cost savings.

In addition, there may be liabilities that we fail orare unable to discover in the course of performing due diligence investigationson each company or business we have already acquired or may acquire in thefuture. Such liabilities could include those arising from employee benefitscontribution obligations of a prior owner or non-compliance with or liabilitypursuant to applicable federal, state or local environmental requirements byprior owners for which we, as a successor owner, may be responsible. Inaddition, there may be additional costs relating to acquisitions, including,but not limited to, possible purchase price adjustments. We cannot assure youthat rights to indemnification by sellers of assets to us, even if obtained,will be enforceable, collectible or sufficient in amount, scope or duration tofully offset the possible liabilities associated with the business or propertyacquired. Any such liabilities, individually or in the aggregate, could have amaterial adverse effect on our business.

**Failure to anticipate technical problems, estimatecosts accurately or control costs during performance of a fixed-pricecontract may reduce our profit or cause a loss.**

We provideour services primarily through two types of contracts: fixed-price andcost-type contracts. Approximately 83%, 81% and 82% of our total revenues forthe fiscal years ended March 31, 2006, 2005 and 2004, respectively, werederived from fixed-price contracts, which require us to perform servicesunder a contract at a stipulated price. We derived approximately 17%, 19% and18% of our revenues for the fiscal years ended March 31, 2006, 2005 and2004, respectively, from cost-type contracts by which we are reimbursed forincurred costs and receive a 

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fee that, depending on the contract, is eitherdependent on cost savings and/or performance or is a fixed fee which isnegotiated but limited by statutes.

We assume greater financial risk on fixed-pricecontracts than on cost-type contracts. Failure to anticipate technicalproblems, estimate costs accurately or control costs during performance of afixed-price contract will reduce our profit or cause a loss. In particular,because of their inherent uncertainties and consequent cost overruns,development contracts have historically been less profitable than productioncontracts. Although we believe that adequate provision for our costs ofperformance is reflected in our consolidated financial statements, we can giveno assurance that this provision is adequate or that losses on fixed-priceand cost-type contracts will not occur in the future. We also cannot assure youthat current cost-type contracts will not be changed to fixed-pricecontracts.

**We may experience production delays if suppliers failto deliver materials to us.**

Ourmanufacturing process for certain products consists primarily of the assemblyof purchased components and testing of the product at various stages in theassembly process.

Although we can obtain materials and purchasecomponents for these products from a number of different suppliers, severalsuppliers are our sole source of certain components. If a supplier should ceaseto deliver such components, we believe that we would probably find othersources; however, this could result in added cost and manufacturing delays. Wehave not experienced significant production delays attributable to supplyshortages, but we occasionally experience procurement problems with respect tocertain components, such as semiconductors and connectors. In addition, withrespect to our electro-optical products, certain materials, such as germanium,zinc sulfide and cobalt, may not always be readily available.

**Our backlog is subject to reduction and cancellation,which could negatively impact our revenues and results ofoperations.**

Backlog represents products or services that ourcustomers have committed by contract to purchase from us. Our total fundedbacklog as of March 31, 2006 was approximately $2.4 billion. Backlogis subject to fluctuations and is not necessarily indicative of future sales.Moreover, cancellations of purchase orders or reductions of product quantitiesin existing contracts could substantially and materially reduce backlog and,consequently, future revenues. Our failure to replace canceled or reducedbacklog could negatively impact our revenues and results of operations.

**Our international operations expose us to risks oflosses.**

Approximately 9%, 12% and 10% of our revenues for thefiscal years ended March 31, 2006, 2005 and 2004, respectively, werederived from sales to foreign governments. We are exploring the possibility ofexpansion into additional international markets, and our acquisition of ESSImay provide entry into additional international markets. We cannot assure youthat we will maintain significant operations internationally or that any suchoperations will be successful. Any international operations we establish willbe subject to risks similar to those affecting our U.S. operations in additionto a number of other risks, including:

·       politicaland economic instability in foreign markets;

·       inconsistentproduct regulation by foreign agencies or governments;

·       impositionof product tariffs and burdens;

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·       costof complying with a wide variety of international and U.S. export laws andregulatory requirements, including the Foreign Corrupt Practices Act, theExport Administration Act and the Arms Export Control Act (and the regulationspromulgated thereunder);

·       lackof local business experience;

·       foreigncurrency fluctuations;

·       difficultyin enforcing intellectual property rights; and

·       languageand other cultural barriers.

**We face competition in the military electronics and servicesindustries.**

The militaryelectronics and services industries in which we participate are highlycompetitive and characterized by rapid technological change. Our potentialinability to improve existing product lines and develop new products and technologiescould have a material adverse effect on our business. In addition, ourcompetitors could introduce new products with greater capabilities, which couldhave a material adverse effect on our business. We also compete with theseentities with respect to identifying targets and consummating our acquisitionstrategy.

There aremany competitors in the markets in which we sell our products. Many of thesecompetitors are substantially larger than us, devote substantially greaterresources to research and development, and generally have greater financial andother resources. Consequently, these competitors may be better positioned totake advantage of economies of scale and develop new technologies. Some ofthese competitors are also our suppliers and customers.

In the military sector, we compete with many large andmid-tier defense contractors on the basis of performance, cost, overall value,delivery and reputation. As U.S. defense spending decreased in the early 1990s,the industry experienced substantial consolidation, increasing the market shareof certain companies.

**We are dependent in part upon our relationships andalliances with industry participants in order to generate revenue.**

We rely onthe strength of our relationships with military industry organizations to formstrategic alliances. Some of our industry partners assist us in the developmentof some of our products through teaming arrangements. Under these teamingarrangements, our industry partners usually have borne a portion of theexpenses associated with our research and development of new and existingproducts, which are the subject of such agreements. We cannot assure you thatour industry partners will continue to bear these expenses in the future. Ifany of our existing relationships with our industry partners were impaired orterminated, we could experience significant delays in the development of ournew products ourselves, and we would incur additional development costs. Wewould need to fund these costs internally or identify new industry partners.

Some of our likely industry partners are alsopotential competitors, which may impair the viability of new strategicrelationships. While we must compete effectively in the marketplace, our futurealliances may depend on our industry partners’ perception of us. Our ability towin new and/or follow-on contracts may be dependent upon our relationshipswithin the military industry.

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**The U.S. government’s right to use technologydeveloped by us limits our intellectual property rights.**

We seek to protect the competitive benefits we derivefrom our patents, proprietary information and other intellectual property.However, we do not have the right to prohibit the U.S. government from usingcertain technologies developed by us or to prohibit third party companies,including our competitors, from using those technologies in providing productsand services to the U.S. government. The U.S. government has the right toroyalty-free use of technologies that we have developed under U.S. governmentcontracts. We are free to commercially exploit those government fundedtechnologies and may assert our intellectual property rights to seek to blockother non-government users thereof, but we cannot assure you we couldsuccessfully do so.

**We are subject to government regulation, which mayrequire us to obtain additional licenses and could limit our abilityto sell our products outside the United States.**

The sale ofcertain of our products outside the United States is subject to compliance withthe United States Export Administration Regulations and the InternationalTraffic in Arms Regulations. Our failure to obtain the requisite licenses, meetregistration standards or comply with other government export regulations, mayaffect our ability to export such products or to generate revenues from thesale of our products outside the United States, which could have a materialadverse effect on our business, financial condition and results of operations.Compliance with government regulations also may subject us to additional feesand costs. The absence of comparable restrictions on competitors in othercountries may adversely affect our competitive position.

In order to sell our products in European Unioncountries, we must satisfy certain registrations and technical requirements. Ifwe were unable to comply with those requirements with respect to a significantquantity of our products, our sales in Europe could be restricted, which couldhave a material adverse effect on our business.

**We are subject to environmental laws and regulations,and our ongoing operations may expose us to environmentalliabilities.**

Our operations, like those of other companies engagedin similar businesses, are subject to federal, state, foreign and localenvironmental and health and safety laws and regulations. As a result, we havebeen involved from time to time in administrative or legal proceedings relatingto environmental matters. We cannot assure you that the aggregate amount offuture clean-up costs and other environmental liabilities will not be material.We can be subject to potentially significant fines or penalties, includingcriminal sanctions, if we fail to comply with these requirements. We have madeand will continue to make capital and other expenditures in order to complywith these laws and regulations. However, the requirements of these laws andregulations are complex, change frequently and could become more stringent inthe future. We cannot predict what environmental legislation or regulationswill be enacted in the future, how existing or future laws or regulations willbe administered or interpreted or what environmental conditions may be found toexist. Also, in the future, contamination may be found to exist at our currentor former facilities or at off-site locations to which we or certain companiesthat we have acquired may have sent waste, including the Orphan Mine site inthe Grand Canyon National Park, Arizona, which is currently subject to agovernment investigation. We could be held liable for such contamination. Theremediation of such contamination, or the enactment of more stringent laws orregulations or more strict interpretation of existing laws and regulations mayrequire us to make additional expenditures, some of which could be material.

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**ESSI currently is subject to investigations by theEnforcement Division of the SEC and the Office of the U.S. Attorney for theEastern District of Missouri, each of which could require significantmanagement attention and legal resources and could have a material adverse effecton the Company.**

In December 2004, ESSI, prior to its acquisition byus, was notified by the Enforcement Division of the SEC of the issuance of aformal order directing a private investigation captioned *In the Matter of Engineered Support Systems, Inc.*, and in September 2005, ESSIreceived notice that the SEC staff had expanded the scope of its investigationto include ESSI’s disclosure of a November 2004 stop-work order relating toESSI’s Deployable Power Generation and Distribution Systems program (“DPGDS”).In connection with the investigation, ESSI and certain of its directors andofficers have received subpoenas and provided information and testimony to theSEC and one former director, officer and consultant has received a so-calledWells notice. ESSI continues to furnish information required by the SEC andotherwise to cooperate in connection with the investigation.

In January 2006, ESSI was informed that the Office ofthe U.S. Attorney for the Eastern District of Missouri was initiating aninvestigation into ESSI’s disclosure of the DPGDS stop-work order and intotrading in ESSI stock by ESSI insiders which preceded such disclosure. The U.S.Attorney’s office advised ESSI that although it considered it to be a subjectof its investigation, ESSI was not a target. In connection with this investigation, the U.S. Attorney’s office issuedESSI a subpoena requesting specified information, which ESSI continues tofurnish.

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 we acquired it. Although ESSI continues to be a subject of the U.S. Attorney’s office’sinvestigation, the U.S. Attorney’s office has advised us that ESSI is not atarget.  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 the Company to be awitness, not a subject or target of its investigation.

The Company is committed to full cooperation withregard to the foregoing investigations. We are unable to determine at this time either the timing of theinvestigations or the impact, if any, which the investigations could have onthe Company. See Item 3. “Legal Proceedings.”

**A failure to attract and retain technical and otherkey personnel could reduce our revenues and our operationaleffectiveness.**

There is a continuing demand for qualified technicaland other key personnel, and we believe that our future growth and success willdepend upon our ability to attract, train and retain such personnel.Competition for personnel in the military industry is intense, and there is alimited number of persons with knowledge of and experience in this industry.Although we currently experience relatively low rates of turnover for ourtechnical personnel, the rate of turnover may increase in the future. Aninability to attract or maintain a sufficient number of technical and other keypersonnel could have a material adverse effect on our contract performance oron our ability to capitalize on market opportunities.

**Our operations involve rapidly evolving products andtechnological change.**

The rapid change of technology is a key feature of themarket for our defense applications. To succeed, we will need to design,develop, manufacture, assemble, test, market and support new products andenhancements on a timely and cost-effective basis. Historically, our technologyhas been developed through customer-sponsored research and development, as wellas from 

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internally funded research anddevelopment. We cannot guarantee that we will continue to maintain comparablelevels of research and development. In the past, we have allocated substantialfunds to capital expenditures, and we intend to continue to do so in thefuture. Even so, we cannot assure you that we will successfully identify newopportunities and continue to have the needed financial resources to developnew products in a timely or cost-effective manner. At the same time, productsand technologies developed by others may render our products and systemsobsolete or non-competitive.

**Our level of indebtedness could limit cash flowavailable for our operations and could adversely affect ourability to service our debt or obtain additional financing, if necessary. Wemay incur substantial additional indebtedness in the future.**

Our total debt outstanding as of March 31, 2006was approximately $1.8 billion. Our level of indebtedness could restrictour operations and make it more difficult for us to satisfy our obligations.For example, our levels of indebtedness could, among other things:

·       limitour ability to obtain additional financing for working capital, capitalexpenditures, acquisitions and general corporate purposes or make suchfinancing more costly;

·       requireus to dedicate all or a substantial portion of our cash flow to service ourdebt, which will reduce funds available for other business purposes, such ascapital expenditures, research and development, dividends or acquisitions;

·       limitour flexibility in planning for or reacting to changes in the markets in whichwe compete;

·       placeus at a competitive disadvantage relative to our competitors with lessindebtedness;

·       renderus more vulnerable to general adverse economic and industry conditions; and

·       makeit more difficult for us to satisfy our financial obligations.

In addition, the indentures governing the Senior Notesand the Senior Subordinated Notes, our amended and restated senior securedcredit facility and the terms of the agreements governing our other outstandingindebtedness contain or will contain financial and other restrictive covenantsthat will limit our ability to engage in activities that may be in ourlong-term best interests. Our failure to comply with those covenants couldresult in an event of default which, if not cured or waived, could result inthe acceleration of all of our debts.

**Despite current indebtedness levels, we and oursubsidiaries still may be able to incur substantially more debt. Thiscould further exacerbate the risks associated with our substantial leverage.**

We and our subsidiaries may be able to incursubstantial additional indebtedness in the future. The terms of the indenturesgoverning our notes do not fully prohibit us or our subsidiaries from doing so.Our amended and restated senior secured credit facility permits additionalborrowing under such facility.

**Our ability to service our debt and meet our cashrequirements depends on many factors, some of which are beyondour control.**

Although there can be no assurances, we believe thatthe level of borrowings available to us, combined with cash provided by ouroperations, will be sufficient to provide for our cash requirements for theforeseeable future. However, our ability to satisfy our obligations will dependon our future operating performance and financial results, which will besubject, in part, to factors beyond our control, including interest rates andgeneral economic, financial and 

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business conditions. If we areunable to generate sufficient cash flow to service our debt, we may be requiredto:

·       refinanceall or a portion of our debt;

·       obtainadditional financing;

·       sellsome of our assets or operations;

·       reduceor delay capital expenditures and/or acquisitions; or

·       reviseor delay our strategic plans.

If we are required to take any of these actions, itcould have a material adverse effect on our business, financial condition,results of operations and liquidity. In addition, we cannot assure you that wewould be able to take any of these actions, that these actions would enable usto continue to satisfy our capital requirements or that these actions would bepermitted under the terms of our various debt instruments, including ouramended and restated senior secured credit facility and the indenturesgoverning our notes.

**The covenants in our amended and restated seniorsecured credit facility and the indentures governing our notes imposerestrictions that may limit our ability and the ability of most of our subsidiariesto take certain actions.**

The covenants in our amended and restated seniorsecured credit facility and the indentures governing our notes restrict ourability and the ability of our restricted subsidiaries to, among other things:

·       incuradditional debt;

·       paydividends and make other restricted payments;

·       makecertain investments, loans and advances;

·       createor permit certain liens;

·       issueor sell capital stock of restricted subsidiaries;

·       usethe proceeds from sales of assets and subsidiary stock;

·       createor permit restrictions on the ability of our restricted subsidiaries to paydividends or make other distributions to us;

·       enterinto transactions with affiliates;

·       enterinto sale and leaseback transactions;

·       engagein certain business activities; and

·       consolidateor merge or sell all or substantially all of our assets.

Our amendedand restated senior secured credit facility contains other covenants customaryfor credit facilities of this nature, including requiring us to meet specifiedfinancial ratios and financial tests. Our ability to borrow under our amendedand restated senior secured credit facility will depend upon satisfaction ofthese covenants. Events beyond our control can affect our ability to meet thosecovenants.

If we are unable to meet the terms of our financialcovenants, or if we break any of these covenants, a default could occur underone or more of these agreements. A default, if not waived by our lenders, couldresult in the acceleration of our outstanding indebtedness and cause our debtto become immediately due and payable. If acceleration occurs, we would not be 

23

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able to repay our debt, and it isunlikely that we would be able to borrow sufficient funds to refinance ourdebt. Even if new financing is made available to us, it may not be on termsacceptable to us.

**Some of our debt, including borrowings under ouramended and restated senior secured credit facility, is basedon variable rates of interest, which could result in higher interest expensesin the event of an increase in interest rates.**

As of March 31, 2006, 18% of our total debt isexposed to fluctuations in variable interest rates. This increases our exposureto fluctuations in market interest rates. If we borrow additional amounts underthe revolving portion of our amended and restated senior secured creditfacility, the interest rates on those borrowings may vary depending on the primerate, federal funds rate or Eurodollar Rate (LIBOR). If these interest ratesrise, the interest rate on our variable rate debt also may increase. Therefore,an increase in these interest rates may increase our interest paymentobligations and have a negative effect on our cash flow and financial position.

**Item 1B    UnresolvedStaff Comments**

None

24

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**Item 2.     Properties**

The tablebelow provides information about our significant facilities and properties atMarch 31, 2006.

We leased thefollowing properties:
| Location                            | ** ** | ** **                                           | ** ** | **Activities** | ** ** | **Operating   Segment** | ** ** | **Approximate   Square Footage** | ** ** | **Lease   Expiration** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|----------------|------------|-------------------------|------------|---------------------------------------|------------|------------------------|------------|
| Parsippany,  New Jersey             |       | Corporate Headquarters                               |       |           | Corporate  |                    |       |                                  | 50,800     |                   |       | Fiscal 2013 |   |
| Arlington, Virginia                 |       | Administrative                                       |       |           | Corporate  |                    |       |                                  | 4,300      |                   |       | Month to month |   |
| Washington, D.C.                    |       | Administrative                                       |       |           | Corporate  |                    |       |                                  | 3,400      |                   |       | Fiscal 2008 |   |
| Allendale, NJ.                      |       | Administrative                                       |       |           | Corporate  |                    |       |                                  | 5,200      |                   |       | Fiscal 2011 |   |
| Gaithersburg,  Maryland             |       | Administrative, Engineering and                      |       |           |       |                    |       |                                  |       |                   |       |   |   |
|                                     |       | Product Development                                  |       |           | C4I        |                    |       |                                  | 42,500     |                   |       | Month to month |   |
|                                     |       | Administrative, Engineering and  Product Development |       |           | C4I        |                    |       |                                  | 21,800     |                   |       | Fiscal 2010 |   |
| Chesapeake, Virginia.               |       | Field Service and Engineering  Support               |       |           | C4I        |                    |       |                                  | 19,600     |                   |       | Fiscal 2010 |   |
| San Diego, California               |       | Engineering Support Services                         |       |           | C4I        |                    |       |                                  | 7,200      |                   |       | Fiscal 2010 |   |
| Johnstown,  Pennsylvania            |       | Administrative and Manufacturing                     |       |           | C4I        |                    |       |                                  | 130,000    |                   |       | Fiscal 2011 |   |
| Farnham, Surrey, United Kingdom     |       | Administrative, Engineering and                      |       |           |       |                    |       |                                  |       |                   |       |   |   |
|                                     |       | Manufacturing                                        |       |           | C4I        |                    |       |                                  | 26,000     |                   |       | Fiscal 2015 |   |
| Colorado Springs, Colorado          |       | Administrative, Engineering and                      |       |           |       |                    |       |                                  |       |                   |       |   |   |
|                                |       | Manufacturing                                        |       |           | C4I        |                    |       |                                  | 21,600     |                   |       | Fiscal 2012 |   |
| Columbia, Maryland                  |       | Administrative and Manufacturing                     |       |           | C4I        |                    |       |                                  | 11,600     |                   |       | Fiscal 2007 |   |
|                                     |       | Administrative                                       |       |           | C4I        |                    |       |                                  | 2,700      |                   |       | Fiscal 2012 |   |
| Danbury, Connecticut                |       | Administrative, Engineering and                      |       |           |       |                    |       |                                  |       |                   |       |   |   |
|                                |       | Manufacturing                                        |       |           | C4I        |                    |       |                                  | 21,000     |                   |       | Fiscal 2007 |   |
| Dayton, Ohio                        |       | Administrative, Manufacturing and  Field Service     |       |           | C4I        |                    |       |                                  | 20,100     |                   |       | Fiscal 2009 |   |
|                                     |       | Administrative and Manufacturing                     |       |           | C4I        |                    |       |                                  | 16,100     |                   |       | Fiscal 2010 |   |
| Fitchburg,  Massachusetts           |       | Administrative and Engineering                       |       |           | C4I        |                    |       |                                  | 64,000     |                   |       | Month to month |   |
|                                |       | Administrative, Engineering and  Manufacturing       |       |           | C4I        |                    |       |                                  | 22,000     |                   |       | Fiscal 2021 |   |
| Kanata, Ontario,  Canada            |       | Administrative and Engineering                       |       |           | C4I        |                    |       |                                  | 62,900     |                   |       | Fiscal 2012 |   |
| Morgan Hill,  California            |       | Engineering, Manufacturing and                       |       |           |       |                    |       |                                  |       |                   |       |   |   |
|                                |       | Research                                             |       |           | C4I        |                    |       |                                  | 52,100     |                   |       | Fiscal 2007 |   |
| Merrimack, New Hampshire  |       | Administrative and Marketing                         |       |           | C4I        |                    |       |                                  | 20,800     |                   |       | Fiscal 2010 |   |
|                                     |       | Administrative and Marketing                         |       |           | C4I        |                    |       |                                  | 22,000     |                   |       | Fiscal 2011 |   |
| Wyndmoor,  Pennsylvania             |       | Administrative and Manufacturing                     |       |           | C4I        |                    |       |                                  | 92,000     |                   |       | Fiscal 2008 |   |
| Melbourne, Florida                  |       | Administrative and Marketing                         |       |           | C4I        |                    |       |                                  | 105,300    |                   |       | Fiscal 2016 |   |
| West Palm Beach,  Florida           |       | Administrative and Marketing                         |       |           | C4I        |                    |       |                                  | 19,900     |                   |       | Fiscal 2007 |   |
| Oakland, New Jersey                 |       | Administrative, Engineering and  Manufacturing       |       |           | SR         |                    |       |                                  | 61,300     |                   |       | Fiscal 2008 |   |
| Palm Bay, Florida                   |       | Administrative, Engineering and  Manufacturing       |       |           | SR         |                    |       |                                  | 93,400     |                   |       | Fiscal 2011 |   |
| Melbourne, Florida                  |       | Administrative, Engineering and  Manufacturing       |       |           | SR         |                    |       |                                  | 141,300    |                   |       | Fiscal 2011 |   |

 

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| **Location**                        | ** ** | ** **                                                          | ** ** | **Activities** | ** ** | **Operating   Segment** | ** ** | **Approximate   Square Footage** | ** ** | **Lease   Expiration** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------------------|------------|----------------|------------|-------------------------|------------|---------------------------------------|------------|------------------------|------------|
| Irvine, California                  |       | Administrative, Engineering and  Manufacturing                      |       |           | SR         |                    |       |                                  | 40,100     |                   |       | Fiscal 2010 |   |
| Mineral Wells, Texas                |       | Administrative, Engineering,  Manufacturing and Product Development |       |           | SR         |                    |       |                                  | 42,000     |                   |       | Fiscal 2008 |   |
| Dallas, Texas                       |       | Administrative, Engineering and  Manufacturing                      |       |           | SR         |                    |       |                                  | 119,600    |                   |       | Fiscal 2008 |   |
| Huntsville, Alabama                 |       | Administrative, Manufacturing Warehouse                             |       |           | SR         |                    |       |                                  | 215,500    |                   |       | Fiscal 2014 |   |
|                                |       | Administrative                                                      |       |           | SR         |                    |       |                                  | 2,000      |                   |       | Fiscal 2008 |   |
| Buffalo, New York                   |       | Engineering, Manufacturing and Research                             |       |           | SR         |                    |       |                                  | 224,000    |                   |       | Fiscal 2007 |   |
| Kanata, Ontario, Canada             |       | Engineering and Manufacturing                                       |       |           | SR         |                    |       |                                  | 11,000     |                   |       | Fiscal 2008 |   |
| Allentown, Pennsylvania             |       | Administration and Manufacturing                                    |       |           | SR         |                    |       |                                  | 7,400      |                   |       | Fiscal 2010 |   |
| Prescott Valley, Arizona            |       | Research, Development and Production                                |       |           | SR         |                    |       |                                  | 11,900     |                   |       | Fiscal 2010 |   |
|                                |       | Administrative                                                      |       |           | SR         |                    |       |                                  | 1,200      |                   |       | Fiscal 2007 |   |
| Cypress, California                 |       | Administrative, Engineering and  Manufacturing                      |       |           | SR         |                    |       |                                  | 91,500     |                   |       | Fiscal 2016 |   |
| Cincinnati, Ohio                    |       | Manufacturing/Administrative                                        |       |           | S3         |                    |       |                                  | 19,000     |                   |       | Fiscal 2009 |   |
|                                |       | Manufacturing/Administrative                                        |       |           | S3         |                    |       |                                  | 11,700     |                   |       | Fiscal 2014 |   |
|                                |       | Manufacturing/Administrative                                        |       |           | S3         |                    |       |                                  | 88,000     |                   |       | Fiscal 2018 |   |
| Bridgeport, Connecticut             |       | Manufacturing/Warehouse                                             |       |           | S3         |                    |       |                                  | 34,400     |                   |       | Fiscal 2007 |   |
|                                |       | Manufacturing                                                       |       |           | S3         |                    |       |                                  | 11,400     |                   |       | Fiscal 2009 |   |
| Alexandria, Virginia                |       | Administrative                                                      |       |           | S3         |                    |       |                                  | 42,000     |                   |       | Fiscal 2008 |   |
| Elizabeth City, North Carolina |       | Manufacturing/Administrative                                        |       |           | S3         |                    |       |                                  | 11,000     |                   |       | Fiscal 2007 |   |
|                                |       | Administrative                                                      |       |           | S3         |                    |       |                                  | 8,000      |                   |       | Fiscal 2009 |   |
| Polson, Montana                     |       | Manufacturing/Administrative                                        |       |           | S3         |                    |       |                                  | 10,000     |                   |       | Fiscal 2007 |   |
| Troy, Michigan                      |       | Administrative                                                      |       |           | S3         |                    |       |                                  | 20,000     |                   |       | Fiscal 2010 |   |
| Calverton, Maryland                 |       | Administrative                                                      |       |           | S3         |                    |       |                                  | 26,000     |                   |       | Fiscal 2010 |   |
| Chantilly, Virginia                 |       | Manufacturing/Administrative                                        |       |           | S3         |                    |       |                                  | 16,000     |                   |       | Fiscal 2010 |   |
| Melbourne, Florida                  |       | Manufacturing/Administrative                                        |       |           | S3         |                    |       |                                  | 15,000     |                   |       | Fiscal 2009 |   |
| Tinton Falls, New Jersey       |       | Manufacturing/Administrative                                        |       |           | S3         |                    |       |                                  | 15,000     |                   |       | Fiscal 2008 |   |
| Dulles, Virginia                    |       | Administrative                                                      |       |           | S3         |                    |       |                                  | 25,000     |                   |       | Fiscal 2010 |   |
| St. Louis County,  Missouri    |       | Warehouse                                                           |       |           | S3         |                    |       |                                  | 13,000     |                   |       | Fiscal 2008 |   |
| Warner Robins, Georgia              |       | Administrative                                                      |       |           | S3         |                    |       |                                  | 13,000     |                   |       | Month to month |   |
|                                |       | Manufacturing/Administrative                                        |       |           | S3         |                    |       |                                  | 11,000     |                   |       | Fiscal 2007 |   |
| Fairborn, Ohio                      |       | Administrative                                                      |       |           | S3         |                    |       |                                  | 13,000     |                   |       | Fiscal 2007 |   |
| West Plains, Missouri               |       | Warehouse                                                           |       |           | S3         |                    |       |                                  | 13,000     |                   |       | Month to month |   |
| Willoughby, Ohio                    |       | Administrative                                                      |       |           | S3         |                    |       |                                  | 12,000     |                   |       | Month to month |   |
| Bridgeton, Missouri                 |       | Manufacturing/Administrative                                        |       |           | S3         |                    |       |                                  | 11,000     |                   |       | Fiscal 2007 |   |
| Lorton, Virginia                    |       | Administrative                                                      |       |           | S3         |                    |       |                                  | 12,000     |                   |       | Fiscal 2009 |   |

 

We own the following properties:

| Location              | ** ** | ** **                           | ** ** | **Activities** | ** ** | **Operating   Segment** | ** ** | **Approximate   Square Footage** | ** ** |
|-----------------------|------------|--------------------------------------|------------|----------------|------------|-------------------------|------------|---------------------------------------|------------|
| Largo, Florida        |       | Administrative and Manufacturing     |       |           | C4I        |                    |       |                                  | 120,000    |   |   |
| Hudson, Massachusetts |       | Administrative, Engineering, Product |       |           |       |                    |       |                                  |       |   |   |
|                  |       | Development and Manufacturing        |       |           | C4I        |                    |       |                                  | 54,000     |   |   |
| Danbury, Connecticut  |       | Administrative, Engineering and      |       |           |       |                    |       |                                  |       |   |   |
|                       |       | Manufacturing                        |       |           | C4I        |                    |       |                                  | 72,700     |   |   |

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| Milwaukee, Wisconsin               |   | Administrative, Engineering, Field Service, |   |   |   |   |   |   |    |   |   |
|------------------------------------|--------|---------------------------------------------|--------|--------|--------|--------|--------|--------|---------|--------|--------|
|                               |   | Product Development and Manufacturing       |   |   | C4I    |   |   |   | 615,000 |   |   |
| Carleton Place, Ontario, Canada    |   | Administrative and Manufacturing            |   |   | C4I    |   |   |   | 128,500 |   |   |
| Gaithersburg, Maryland             |   | Engineering, Manufacturing and              |   |   |   |   |   |   |    |   |   |
|                                    |   | Research                                    |   |   | SR     |   |   |   | 170,000 |   |   |
| Palm Bay, Florida                  |   | Administrative, Manufacturing and           |   |   |   |   |   |   |    |   |   |
|                                    |   | Engineering                                 |   |   | SR     |   |   |   | 54,000  |   |   |
| Fort Walton Beach, FL              |   | Engineering, Manufacturing and Research     |   |   | SR     |   |   |   | 260,300 |   |   |
| West Plains, Missouri              |   | Manufacturing/Administrative                |   |   | S3     |   |   |   | 391,000 |   |   |
| Florence, Kentucky                 |   | Manufacturing/Administrative                |   |   | S3     |   |   |   | 265,000 |   |   |
| St. Louis County, Missouri    |   | Subassembly/Administrative                  |   |   | S3     |   |   |   | 263,000 |   |   |
| High Ridge, Missouri               |   | Manufacturing/Administrative                |   |   | S3     |   |   |   | 214,000 |   |   |
| Bridgeport, Connecticut            |   | Manufacturing/Administrative                |   |   | S3     |   |   |   | 135,000 |   |   |
| Elizabeth City, North  Carolina    |   | Hangar                                      |   |   | S3     |   |   |   | 80,000  |   |   |
| Halifax, Nova Scotia, Canada  |   | Manufacturing/Administrative                |   |   | S3     |   |   |   | 40,000  |   |   |
| Cincinnati, Ohio                   |   | Manufacturing/Administrative                |   |   | S3     |   |   |   | 27,000  |   |   |
| Warner Robins, Georgia             |   | Administrative                              |   |   | S3     |   |   |   | 11,000  |   |   |

 

We believe that all of our facilities are in goodcondition, adequate for our intended use and sufficient for our immediateneeds. It is not certain whether we will negotiate new leases as existingleases expire. Such determinations will be made as existing leases approachexpiration and will be based on an assessment of our requirements at that time.Further, we believe that we can obtain additional space, if necessary, based onprior experience and current real estate market conditions.

The Company has a mortgage notepayable that is secured by a lien on its facility in Palm Bay, Florida.

**Item 3.     LegalProceedings**

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

Various legal actions, claims, assessments and othercontingencies arising in the normal course of our business, including certain mattersdescribed below, are pending against us and certain of our subsidiaries. Thesematters are subject to many uncertainties, and it is possible that some ofthese matters could be ultimately decided, resolved or settled adversely. Wehave recorded accruals totaling $4.5 million and $10.3 million atMarch 31, 2006 and March 31, 2005, respectively, for losses relatedto those matters that we consider to be probable and that can be reasonablyestimated (certain legal and environmental matters are discussed in detailbelow). Although the ultimate amount of liability at March 31, 2006 thatmay result from those matters for which we have recorded accruals is notascertainable, we believe that any amounts exceeding our recorded accrualsshould not materially affect our financial condition or liquidity. It ispossible, however, that the ultimate resolution of those matters could resultin a material adverse effect on our results of operations for a particularreporting period.

Some environmental laws, such as the ComprehensiveEnvironmental Response, Compensation and Liability Act of 1980 (also known asCERCLA or the Superfund law) and similar state statutes, can impose liabilityfor the entire cost of the clean up of contaminated sites upon any of thecurrent or former site owners or operators (or upon parties who send waste tothese sites), regardless of the lawfulness of the original activities that ledto the contamination. In July 2000, prior to its acquisition by IDT, andprior to our acquisition of IDT, Tech-Sym Corporation received aSection 104(e) Request for Information from the National Park Service

27

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(NPS), pursuant to CERCLA,regarding a site known as the Orphan Mine site in the Grand Canyon NationalPark, Arizona, which is the subject of an NPS investigation regarding thepresence of residual radioactive materials and contamination. A corporation ofwhich Tech-Sym is an alleged successor operated this uranium mine from 1956 to1967. In 1962, the land was sold to the U.S. government and the allegedpredecessor of Tech-Sym was given a 25-year mining lease. In 1967, themining rights were transferred to a third party by a trustee in bankruptcy, andwe believe that the mine was operated by such third party until approximately1969. We understand that there are other companies in the chain of title to themining rights subsequent to Tech-Sym’s alleged predecessor, and, accordingly, thatthere are other potentially responsible parties (PRPs) for the environmentalconditions at the site, including the U.S. government as owner, operator andarranger at the site. During its period of ownership, IDT retained a technicalconsultant in connection with this matter, who conducted a limited, preliminaryreview of site conditions and communicated with the NPS regarding actions thatmay be required at the site by all of the PRPs. On February 6, 2005, theNPS sent us an Engineering Evaluation/Cost Analysis Work Plan (the “NPS EE/CA”)under CERCLA (the ‘‘CERCLA Letter’’) with regards to Operable Unit 1 of theOrphan Mine site. In our view, the NPS EE/CA included additional clean up notcovered by CERCLA. The CERCLA Letter also requested (a) payment of $0.5million for costs incurred by the NPS related to the Orphan Mine, and(b) a ‘‘good faith offer’’ to conduct the response activity outlined bythe NPS and to reimburse the NPS for future costs. The NPS advised that asimilar letter has been sent to another PRP. We initiated discussions with theother PRP and with NPS, and engaged a technical consultant to evaluate theexisting documentation and the site in depth. As a result, onSeptember 29, 2005, the technical consultant submitted to the NPS, onbehalf of us and the other PRP, an alternative Engineering Evaluation/CostAnalysis Work Plan (the “alternative EE/CA”) with regards to Operating Units 1and 2 of the Orphan Mine Site.

On December 6, 2005, the PRPs and NPS met todiscuss the alternative EE/CA. The meeting focused on the technical merits ofthe alternative EE/CA and certain differences between the alternative EE/CA andthe NPS EE/CA provided with the CERCLA Letter. The differences included analternative sampling technique and the inclusion of Operable Unit 2 (the lower minearea) in the alternative EE/CA. Since that meeting in late 2005, the partieshave also discussed certain legal issues relating to the process forimplementing the alternative EE/CA and entering into a Settlement Agreementthat would memorialize the parties’ intent The potential liability associated with implementation of an EE/CA canchange substantially due to such factors as additional information on thenature 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 the ESSI acquisition, we have beenmade aware of certain legal actions, claims, assessments and other contingencies,certain of which are described below.

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

On or about September 23, 2005, the SEC staff advisedESSI’s counsel that it had issued a subpoena directed to ESSI and expanded itsinvestigation to include ESSI’s disclosure of a November 2004 stop work orderrelating to ESSI’s Deployable Power Generation and Distribution 

28

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Systems (“DPGDS”) program for theU.S. Air Force, and relating to trading in ESSI stock by certain individualsassociated 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 that one of ESSI’s former directors and officers, andsubsequently a consultant to ESSI, had been issued a so-called Wells noticeinforming him that the staff of the SEC was considering recommending that theSEC bring a civil injunctive action against him in connection with the SEC’sinvestigation into trading in ESSI common stock in 2003. A Wells noticeprovides prospective defendants with an opportunity to respond to the SEC staffmembers before the staff makes a formal recommendation on whether the SECshould pursue disciplinary action against them. ESSI, itself, has not receiveda Wells notice and continues to cooperate with the investigation.

In January 2006, ESSI was informed that the Office ofthe U.S. Attorney for the Eastern District of Missouri was initiating aninvestigation into ESSI’s disclosure of the DPGDS stop-work order and intotrading in ESSI stock by ESSI insiders which preceded such disclosure. The U.S.Attorney’s office advised ESSI that although it considered it to be a subjectof its investigation, ESSI was not a target. In connection with this investigation, the U.S. Attorney’s office issuedESSI a subpoena requesting specified information, which ESSI continues tofurnish. 

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 we acquired it. Although ESSI continues to be a subject of the U.S. Attorney’s office’sinvestigation, the U.S. Attorney’s office has advised us that ESSI is not atarget.  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 us to be a witness,not a subject or target of its investigation. 

We are committed to fullcooperation with regard to the foregoing investigations.  We are unable to determine at this timeeither the timing of the SEC or U.S. Attorney’s office investigations or theimpact, if any, which the investigations could have on us.

**Item 4.     Submission of Matters to a Vote of SecurityHolders**

On January 30, 2006, we held a Special Meeting ofStockholders at our Corporate Offices at 5 Sylvan Way, Parsippany, NJ 07054. Thefollowing matters were submitted to a vote of stockholders:

i.                  Toapprove the issuance of shares of DRS common stock pursuant to the Agreementand Plan of Merger, dated as of September 21, 2005, by and among DRSTechnologies, Inc., Maxco, Inc. a wholly-owned subsidiary of DRSTechnologies, Inc., and Engineered Support Systems, Inc.

ii.              To approve theamendment to our certificate of incorporation to increase the number ofauthorized shares of common stock from 50,000,000 shares to 100,000,000 shares.

| ** **     | ** ** | **For**    | ** ** | **Abstain** | ** ** | **Against** | ** ** |
|----------------|------------|------------|------------|-------------|------------|-------------|------------|
| Proposal (i):  |       | 23,196,561 |       | 79,452      |       | 73,948      |       |
| Proposal (ii): |       | 23,365,288 |       | 34,592      |       | 2,358,006   |       |

 

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**PART II**

**Item 5.**                    Marketfor Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities

On May 11, 2006, the Board of Directors declareda quarterly cash dividend of $0.03 per share on our common stock. The dividendis payable on June 30, 2006 to stockholders of record as of the close ofbusiness on June 15, 2006. Our credit facility was amended to allow thepayment of dividends or make other distributions on our common stock. Anyfuture declaration of dividends will be subject to the discretion of our Boardof Directors. The timing, amount and form of any future dividends will depend,among other things, on our results of operations, financial condition, cashrequirements, plans for expansion, limitations imposed by our amended and restatedcredit agreement and indentures governing our notes and other factors deemedrelevant by our Board of Directors.

The following table shows the highand low sale prices per share of our common stock and dividends paid duringfiscal 2006 and 2005, as reported on the NYSE.

| ** **                                                    | ** ** | ** ** | ** ** | **Dividends**        | ** ** |
|---------------------------------------------------------------|------------|------------|------------|----------------------|------------|
| **Fiscal Year Ended March 31, 2006** | ** ** | ** ** | ** ** | **Fiscal 2006** | ** ** | **Paid** | ** ** |
| First Quarter                                                 | ** ** | **$**      | **51.80**  | ** **           | **$**      | **42.65** |   |   | $ | 0.03 |   |   |
| Second Quarter                                                | ** ** | **$**      | **53.90**  | ** **           | **$**      | **45.55** |   |   | $ | 0.03 |   |   |
| Third Quarter                                                 | ** ** | **$**      | **53.10**  | ** **           | **$**      | **46.68** |   |   | $ | 0.03 |   |   |
| Fourth Quarter                                                | ** ** | **$**      | **57.76**  | ** **           | **$**      | **47.41** |   |   | $ | 0.03 |   |   |
|                                                               |            |            |            |                      |            |  |  |  |  |  |  |  |  |  |

 

| ** **                                                    | ** ** | **Fiscal 2005** | ** ** | **Dividends** | ** ** |
|---------------------------------------------------------------|------------|----------------------|------------|---------------|------------|
| **Fiscal Year Ended March 31, 2005** | ** ** | ** **           | ** ** | **High**      | ** ** | **Low** | ** ** | **Paid** | ** ** |
| First Quarter                                                 |       | $                    | 32.32      |          | $          | 26.26 |   |   | — |   |   |
| Second Quarter                                                |       | $                    | 39.80      |          | $          | 33.84 |   |   | — |   |   |
| Third Quarter                                                 |       | $                    | 45.79      |          | $          | 33.97 |   |   | — |   |   |
| Fourth Quarter                                                |       | $                    | 45.00      |          | $          | 37.31 |   |   | — |   |   |
|                                                               |            |                      |            |               |            |  |  |  |  |  |  |  |  |

 

The closing sale price of our common stock as reportedby the New York Stock Exchange on June 7, 2006 was $50.12 per share. As ofthat date there were approximately 1,462 holders of record of our common stock.

On January 31, 2006, in connection with ouracquisition of Engineered Support Systems, Inc. (ESSI), we sold $300million aggregate principal amount of 2% Senior Convertible Notes (ConvertibleNotes) in a private placement pursuant to Rule 144A under the SecuritiesAct. On February 8, 2006, we sold an additional $45 million in ConvertibleNotes, pursuant to an over-allotment option exercised by the initialpurchasers of the Convertible Notes. The net proceeds of the offering of theConvertible Notes, including the over-allotment option, were $337.2million after deducting $7.8 million in commissions and fees related to theoffering. The Convertible Notes are contingently convertible into shares of DRSCommon Stock at an initial conversion price of $59.70, subject to adjustment incertain circumstances.

We did not repurchase any equitysecurities during the period covered by this report.

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**Equity Compensation PlanInformation**

Thetable below sets forth information about shares of DRS Technologies, Inc.common stock that may be issued under our equity compensation plans as of March 31,2006.

| **Plan Category**                                  | ** ** | ** ** | ** ** | **No. of Securities  to be Issued upon  Exercise of  Outstanding Options** | ** ** | **Weighted Average  Exercise Price of  Outstanding Options** | ** ** | **No. of Securities  Remaining Available  for Future Issuance  Under Equity  Compensation Plans  (Excluding Securities  Reflected in Column(A))** | ** ** |
|---------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                              | ** ** | **(A)**    | ** ** | **(B)**                                                                                                       | ** ** | **(C)**                                                                          | ** ** |
| Equity Compensation Plans  Approved by Stockholders     |       |       | 2,663,358  | (a)                                                                                                           |       |                                                                             | $          | 30.83                                                                                                                                                                                               |       |   |   | 834,417 |   |   |
| Equity Compensation Plans Not  Approved by Stockholders |       |       | 250,000    | (b)                                                                                                           |       |                                                                             | $          | 10.44                                                                                                                                                                                               |       |   |   | — |   |   |

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(a)            Includes50,000 shares of common stock, the issuance and receipt of which weredeferred by Mr. Newman following the exercise of certain options.

(b)           Representsstock options granted to Mr. Newman by the board on October 26, 1998.Such stock options were granted to Mr. Newman by the board in itsdiscretion and not pursuant to any equity compensation plan.

See information with respect to shares of DRS commonstock that may be issued under our equity compensation plan as ofMarch 31, 2006 in our definitive proxy statement, relating to the fiscal2006 annual meeting of stockholders, which definitive proxy statement will befiled with the Securities and Exchange Commission within 120 days afterthe end of the fiscal year to which this report relates.

**Item 6.**                    SelectedFinancial Data

In the following table, we provide you with ourselected historical consolidated financial and operating data as of and for thefiscal years indicated. The selected summary of earnings data, earningsper-share data from continuing operations and certain of the other data for theyears ended March 31, 2006, 2005 and 2004 and the selected balance sheetdata as of March 31, 2006 and 2005 presented below are derived from ouraudited consolidated financial statements included elsewhere in Item 8 ofthis Form 10-K. The selected summary of earnings data, earnings per-sharedata from continuing operations and certain of the other data for the yearsended March 31, 2003 and 2002 and selected balance sheet data as of March 31,2004, 2003 and 2002 presented below are derived from our consolidated financialstatements, which are not included in this Form 10-K.

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When you readthis selected historical financial data, it is important that you also readalong with it our historical consolidated financial statements and relatednotes included in this Form 10-K, as well as “Management’sDiscussion and Analysis of Financial Condition and Results of Operations.”

| ** **                                                                          | ** ** | **Years Ended March 31,(1)**                                        | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2006**                                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                          | ** ** | **(in thousands, except per-share data and ratios)** | ** ** |
| **Summary  of Earnings Data**                                                       | * *   | * *                                                                           | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| Revenues                                                                            |       | $                                                                                  | 1,735,532  |   | $ | 1,308,600 |   | $ | 986,931 |   | $ | 675,762 |   | $ | 517,200 |   |
| Operating income                                                                    |       | $                                                                                  | 192,710    |   | $ | 143,132 |   | $ | 103,332 |   | $ | 67,684 |   | $ | 49,769 |   |
| Earnings from continuing operations before income  taxes                            |       | $                                                                                  | 133,488    |   | $ | 102,968 |   | $ | 77,331 |   | $ | 55,872 |   | $ | 38,361 |   |
| Earnings from continuing operations                                                 |       | $                                                                                  | 81,494     |   | $ | 58,126 |   | $ | 43,542 |   | $ | 30,171 |   | $ | 20,331 |   |
| Net earnings                                                                        |       | $                                                                                  | 81,494     |   | $ | 60,677 |   | $ | 44,720 |   | $ | 30,171 |   | $ | 20,331 |   |
| **Earnings  Per-Share Data from Continuing Operations (2),(3)**                | * *   | * *                                                                           | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| Basic earnings per share                                                            |       | $                                                                                  | 2.75       |   | $ | 2.15 |   | $ | 1.80 |   | $ | 1.64 |   | $ | 1.52 |   |
| Diluted earnings per share                                                          |       | $                                                                                  | 2.67       |   | $ | 2.09 |   | $ | 1.76 |   | $ | 1.58 |   | $ | 1.41 |   |
| **Balance  Sheet Data (at period end)**                                             | * *   | * *                                                                           | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| Working Capital                                                                     |       | $                                                                                  | 200,427    |   | $ | 373,964 |   | $ | 145,315 |   | $ | 107,485 |   | $ | 169,836 |   |
| Net property, plant and equipment                                                   |       | $                                                                                  | 220,506    |   | $ | 143,264 |   | $ | 142,378 |   | $ | 87,610 |   | $ | 50,481 |   |
| Total assets                                                                        |       | $                                                                                  | 4,021,894  |   | $ | 1,891,861 |   | $ | 1,625,390 |   | $ | 993,391 |   | $ | 608,182 |   |
| Long-term debt, excluding current installments                                      |       | $                                                                                  | 1,828,771  |   | $ | 727,611 |   | $ | 565,530 |   | $ | 216,837 |   | $ | 138,060 |   |
| Total stockholders’ equity                                                     |       | $                                                                                  | 1,351,580  |   | $ | 671,428 |   | $ | 595,625 |   | $ | 438,180 |   | $ | 257,235 |   |
| **Financial Ratios and Supplemental Information**                                   | * *   | * *                                                                           | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| Net cash flows provided by operating activities of continuing  operations           |       | $                                                                                  | 157,062    |   | $ | 136,183 |   | $ | 104,717 |   | $ | 52,008 |   | $ | 27,849 |   |
| Net cash flows used in investing activities of continuing  operations               |       | $                                                                                  | (1,467,396 | ) | $ | (53,573 | ) | $ | (273,859 | ) | $ | (278,631 | ) | $ | (84,943 | ) |
| Net cash flows provided by (used in) financing activities  of continuing operations |       | $                                                                                  | 1,004,222  |   | $ | 164,901 |   | $ | 131,613 |   | $ | 204,308 |   | $ | 172,565 |   |
| Capital expenditures                                                                |       | $                                                                                  | 43,194     |   | $ | 34,521 |   | $ | 24,444 |   | $ | 21,526 |   | $ | 13,583 |   |
| Depreciation and amortization                                                       |       | $                                                                                  | 48,985     |   | $ | 40,968 |   | $ | 28,436 |   | $ | 16,614 |   | $ | 13,789 |   |
| Internal research and development                                                   |       | $                                                                                  | 47,600     |   | $ | 38,852 |   | $ | 27,387 |   | $ | 14,355 |   | $ | 9,535 |   |
| Interest and related expenses                                                       |       | $                                                                                  | 64,186     |   | $ | 39,750 |   | $ | 24,259 |   | $ | 10,589 |   | $ | 10,954 |   |
| EBITDA(4)                                                                           |       | $                                                                                  | 239,406    |   | $ | 181,226 |   | $ | 129,272 |   | $ | 81,896 |   | $ | 61,960 |   |
| Free cash flow(5)                                                                   |       | $                                                                                  | 113,868    |   | $ | 101,662 |   | $ | 80,273 |   | $ | 30,482 |   | $ | 14,266 |   |
| Cash dividends declared per common share                                            |       | $                                                                                  | 0.12       |   | — |   | — |   | — |   | — |   |

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(1)            DRS’s selected financial data includes the effect ofthe following purchase business combinations and divestitures from their dateof acquisition or divestiture by fiscal year:

a)               Fiscal Year 2006: Engineered Support Systems, Inc.—AcquiredJanuary 31, 2006, WalkAbout Computer Systems, Inc.—Acquired June 27,2005, Codem Systems, Inc.—Acquired April 15, 2005.

b)               Fiscal Year 2005: Night Vision Equipment Co., Inc.and Affiliate—Acquired December 14, 2004.

c)                 Fiscal Year 2004: Integrated Defense Technologies, Inc.—AcquiredNovember 4, 2003.*

*                   Two operating units acquired in connection with the IDTacquisition were sold in fiscal 2005.

d)               Fiscal Year 2003: The U.S.-based UnmannedAerial Vehicle business of Meggitt Defense Systems—Texas, Inc.—Acquired April 11,2002; The Navy Controls Division of Eaton Corporation—Acquired July 1,2002; DKD, Inc.—Acquired October 15, 2002; Paravant Inc.—AcquiredNovember 27, 2002; the Electromagnetics Development Center of KamanCorporation—Acquired January 15, 2003; and 

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Power Technology Incorporated—AcquiredFebruary 14, 2003; DRS Advanced Programs, Inc.—Sold November 22,2002; DRS Ahead Technology, Inc.—Sold May 27, 2002.

e)               Fiscal Year 2002: The Electro Mechanical Systemsunit of Lockheed Martin Corporation—Acquired August 22, 2001; and theSensors and Electronic Systems business of The Boeing Company—Acquired September 28,2001.

(2)            Per-share data includes the weighted averageimpact of the January 31, 2006 issuance of 11,727,566 shares of commonstock in connection with the ESSI acquisition, the November 4, 2003issuance of 4,323,172 shares of common stock in connection with the IDTacquisition, the December 20, 2002 issuance of 5,462,500 shares of commonstock in a public offering and the December 19, 2001 issuance of 3,755,000of common stock in a public offering.

(3)            DRS declared cash dividends of $0.03 per common shareon June 30, 2005, September 30, 2005, December 30, 2005 and March 30,2006 to stockholders of record on June 15, 2005, September 15, 2005, December 15,2005 and March 15, 2006, respectively. There were no cash dividends paidin fiscal 2005 or prior.

(4)            Earnings from continuing operations beforeextraordinary item, net interest and related expenses (primarily amortizationof debt issuance costs), income taxes and depreciation and amortization(EBITDA). See Management’s Discussion and Analysis of Financial Condition andResults of Operations, Use of Non-GAAP Financial Measures.

(5)            Net cash provided by operating activities of continuingoperations less capital expenditures. See Management’s Discussion and Analysisof Financial Condition and Results of Operations, Use of Non-GAAPFinancial Measures.

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**Item 7.**                    Management’sDiscussion and Analysis of Financial Condition and Results of Operations

We begin the Management’sDiscussion and Analysis of Financial Condition and Results of Operations(MD&A) of DRS Technologies, Inc. and subsidiaries (hereinafter, we,us, our, the Company or DRS) with a company overview, followed by defenseindustry considerations, a summary of our overall business strategy to providecontext for understanding our business and a summary of our acquisitions anddivestitures. This is followed by a discussion of the critical accountingestimates that we believe are important to understanding the assumptions andjudgments incorporated in our reported financial results, which we discussunder “Results of Continuing Operations.” We then provide an analysis of cashflow, and discuss our financial commitments under “Liquidity and FinancialResources” and “Contractual Obligation.”

This MD&A should be read inconjunction with the other sections of this Annual Report on Form 10-K,including our Consolidated Financial Statements.

**Forward-Looking Statements**

The following discussion andanalysis contains forward-looking statements, within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Act of 1934, as amended, that are based on management’s beliefs andassumptions, current expectations, estimates and projections. Such statements,including statements relating to the Company’s expectations for futurefinancial performance, are not considered historical facts and are consideredforward-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 ofour acquisition 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 policy, as they may relate to our products and services, and otherrisks or uncertainties detailed in Item 1A, “Risk Factors” of this AnnualReport. Given these uncertainties, you should not rely on forward-lookingstatements. The Company undertakes no obligations to update any forward-lookingstatements, whether as a result of new information, future events or otherwise.

**Company Overview**

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

During fiscal 2006, we completedthree acquisitions, the largest of which was our January 31, 2006acquisition of Engineered Support Systems, Inc. (ESSI). In the transaction, awholly-owned subsidiary of DRS was merged with and into ESSI, forming DRS’sthird operating segment—the Sustainment Systems & Services Group. See “Acquisitionsand Divestitures” below for further details.

On March 10, 2005, wecompleted the sale of two of our operating units, DRS Weather Systems, Inc.(DRS Weather) and DRS Broadcast Technology, Inc. (DRS Broadcast). The operatingunits were acquired in connection with our fiscal 2004 acquisition ofIntegrated Defense Technologies, Inc. (IDT). The results of operations of DRS Weather and DRS Broadcast for the 

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fiscal year ended March 31, 2005 and for the period from the date ofacquisition through March 31, 2004 are included in the ConsolidatedStatements of Earnings as “Earnings from discontinued operations, net of incometaxes.” The cash flows of the discontinued operations also are presentedseparately in the Consolidated Statement of Cash Flows for the years ended March 31,2005 and 2004. A summary of the operating results of the discontinuedoperations for the years ended March 31, 2005 and 2004 is presented under “Acquisitionsand Divestitures” below.

We operate in three principaloperating segments on the basis of products and services offered. Eachoperating segment is comprised of separate and distinct businesses. Ouroperating segments are: the Command, Control, Communications, Computers andIntelligence (C4I) Group, the Surveillance & Reconnaissance (SR) Group andthe Sustainment Systems & Services (S3) Group. All other operations,primarily our Corporate Headquarters, are grouped in Other.

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

The SR Group is comprised of thefollowing business areas: Reconnaissance, Surveillance & Target Acquisition(RSTA), which develops and produces electro-optical sighting, targetingand weapon sensor systems, high-speed digital data and imaging systems,aircraft weapons alignment systems, mission and flight recorders and imageintensification (I2)night vision, combat identification and laser aimers/illuminator products, andprovides electronic manufacturing services; Training & Control Systems,which develops and produces air combat training, unmanned vehicles, andelectronic warfare and network systems; and Test & Energy Management,which develops and produces electronic test, diagnostics and vehicleelectronics.

The S3 Group is comprised of thefollowing business areas: Sustainment Systems, which designs, engineers andmanufactures integrated military electronics and other military supportequipment, primarily for the United States Department of Defense (DoD) as wellas related heat transfer and air handling equipment and power generation anddistribution equipment for domestic commercial and industrial users; and SupportServices, which provides engineering services, logistics and training services,advanced technology services, asset protection systems and services, telecommunicationsystems integration and information technology services, and vehicle armor kitsfor military, humanitarian, disaster recovery and emergency responderapplications.

The substantial majority of theour revenue is generated pursuant to written contractual arrangements todesign, develop, manufacture and/or modify complex products and to providerelated engineering, technical and other services according to thespecifications of the buyers (customers). Our primary “end-use” customer is theDoD. For the year ended March 31, 2006, sales directly to the DoD andindirect sales to the DoD through its prime contractors and subcontractorsgenerated $1.5 billion, or 87%,of our consolidated revenues. Our other customers include certain U.S.government intelligence agencies, foreign governments, commercial customers andother U.S. federal, state and local government agencies.

**Defense Industry Considerations and Business Strategy**

We believe markets for defense andrelated advanced technology systems for fiscal 2007 and beyond will continue tobe affected by the global war on terrorism, through the continued need 

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for militarymissions and efforts in Iraq and Afghanistan. The war on terrorism has focusedgreater attention on homeland security and better communication and interplay amonglocal, state and federal government agencies and U.S. military services. Webelieve the United States overall defense posture continues to move toward amore joint-capabilities-based structure, which creates the ability for amore flexible response with greater force mobility, stronger spacecapabilities, enhanced missile defense, and improved information systemscapability and security.

The current administration’sdesire to modernize U.S. military forces, coupled with the U.S. military’sengagement in the global war on terrorism, has driven DoD funding increases, comparedwith 2001. For government fiscal year 2006, the Congress appropriated $419.3billion for the DoD, a 41% increase in funding, compared with 2001. This amountincludes $147 billion for procurement and research and development (R&D)activities, an increase of 43% since 2001. Procurement and R&D budgets,also known as investment accounts, provide a significant amount of our revenuesand, over the past several years, these budget accounts have enjoyed sustainedincreases that we believe demonstrate continued administration and Congressionalsupport. For government fiscal year 2007, the President has requested that theCongress appropriate $439 billion for the DoD, a 7% increase over the 2006funding. This includes $157 billion for procurement and R&D, an increase of7% over 2006 investment funds. There are no assurances that these proposedbudget amounts will be approved.

During this wartime era, defensebudgets have evolved to include not only the President’s initial budgetsubmission, but also supplemental funds requested over the course of the fiscalyear. For government fiscal year 2006, the Congress has been asked to provideat least $118 billion in supplemental funding, which, if approved, willbring total defense funding for fiscal year 2006 to over $537 billion, anapproximately 85% increase compared with 2001.

We believe DoD budgets haveexperienced increased focus on command, control, communications, computers,intelligence, surveillance and reconnaissance (C4ISR), precision-guidedweapons, unmanned aerial vehicles (UAVs), network-centric communications,Special Operations Forces (SOF) and missile defense. In addition, we believe theDoD philosophy has focused on a transformation strategy that balancesmodernization and recapitalization (or upgrading existing platforms), whileenhancing readiness and joint operations. As a result, we believe defensebudget program allocations continue to favor advanced information technologiesrelated to command, control, communications, and computers, (C4) andIntelligence, Surveillance and Reconnaissance (ISR). Furthermore, the DoD’semphasis on system interoperability, force multipliers and providingbattlefield commanders with real-time data is increasing the electronic contentof nearly all major military procurement and research programs.

The DoD recently completed the Congressionallymandated 2006 Quadrennial Defense Review (QDR). The QDR continues andaccelerates the DoD’s prior commitment to a transformation of the military tofocus more on the needs of its combatant commanders and to develop portfoliosof joint capabilities, rather than stove-piped programs. This movement towards horizontally-integratedstructures is expected to become an organizing principle for the DoD in makinginvestment decisions for future systems.

Our strategy is designed tocapitalize on the breadth of our technology and extensive expertise in order tomeet the evolving needs of our customers. We intend to expand our share ofexisting programs and participate in new programs by leveraging the strong relationshipsthat we have developed with the DoD, several other U.S. government agencies andall of the major U.S. defense prime contractors. We plan to continue to alignour research and development, manufacturing and new business efforts tocomplement our customers’ requirements and to provide state-of-the-art productsand services. We plan to maintain a diversified and broad business mix withlimited reliance on any single program, a significant follow-on business and anattractive customer profile. We also intend to expand our technical servicesand support offerings 

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to the DoD, thusdiversifying our business beyond the historical investment accounts and intoOperations and Maintenance funded activities.

A significant component of ourstrategy has been to enhance our existing product base through selectiveacquisitions that add new products and technologies in areas that complementour present business base. We intend to continue acquiring select publicly andprivately held companies, as well as defense businesses of larger companiesthat (i) exhibit significant market position(s) in their businessareas, (ii) offer products that complement and/or expand our productofferings and (iii) display growing revenues, and positive operatingincome and cash flow prospects.

**Other Business Considerations**

As a government contractor, we aresubject to U.S. government oversight. The government may ask about andinvestigate our business practices and audit our compliance with applicable rules andregulations. Depending on the results of those audits and investigations, thegovernment could make claims against us. Under government procurementregulations and practices, an indictment of a government contractor couldresult in that contractor being fined and/or suspended from being able to bidon, or be awarded, new government contracts for a period of time. A convictioncould result in debarment for a specific period of time. Similar governmentoversight exists in most other countries where we conduct business.

We are party to various legalactions and claims arising in the ordinary course of our business. We believewe have adequate legal defenses for each of the actions and claims, and webelieve that their ultimate disposition will not have a material adverse effecton our consolidated financial position, results of operations or liquidity. SeeItem 3. Legal Proceedings.

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

Our future operating resultsdepend on our ability to successfully compete in a highly competitive industrythat is characterized by rapid technological change and to find and effectivelyintegrate acquired companies into our existing operations. Continuation of ourrecent revenue growth rate depends primarily on our ability to identify andacquire suitable acquisition targets. We continue to participate successfullyin the defense industry consolidation through strategic business acquisitionsand by streamlining our existing operations; however, we cannot guarantee that wewill have sufficient funds available to us to continue investing in businessacquisitions. See Liquidity and Capital Resources for additional informationregarding certain covenants and restrictions placed on us under our creditfacility.

**Acquisitions and Divestitures**

The following summarizes certainacquisitions and divestitures we completed, which significantly affect thecomparability of the period-to-period results presented in this discussion andanalysis. The acquisitions discussed below have been accounted for using thepurchase method of accounting. Accordingly, the results of operations of theacquired businesses are included in our reported operating results from theirrespective effective dates of acquisition. We selectively target acquisition candidatesthat complement or expand our product lines, services or technicalcapabilities. We continue to seek acquisition opportunities consistent with ouroverall business strategy.

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**Fiscal 2006 Acquisitions—**On January 31, 2006, we completed ouracquisition of Engineered Support Systems, Inc. (ESSI). The purchase price was$43.00 per share of ESSI common stock, which was comprised of $30.10 in cashand a fraction of a share of DRS common stock valued at $12.90. Totalconsideration for the acquisition was $1.93 billion. In addition to thepurchase price, we assumed $78.5 million of ESSI’s debt at closing and recorded$25.5 million of acquisition-related costs, including professional fees. Uponclosing of the acquisition, we repaid ESSI’s credit facility in the amount of$76.3 million. We financed the cash portion of the acquisition by utilizingcash and cash equivalents on hand, revolving credit borrowings, $275.0 millionin term debt and $900 million of new debt securities, including $350 million aggregateprincipal amount of 65¤8% senior notes due 2016, $250 million aggregateprincipal amount of 75¤8% senior subordinated notes due 2018 and $300.0million aggregate principal amount of 2.0% convertible senior notes due 2026.

ESSI, 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 andselected government and intelligence agencies. ESSI also produces specializedequipment and systems for commercial and industrial applications. We believethe addition of ESSI will contribute a significant base of systems, productsand services focused on military force sustainment, technical and logisticssupport, integrated military electronics and field support equipment. Theentities acquired in the ESSI acquisition are being managed as our thirdoperating segment—the S3 Group.

On June 27, 2005, we acquiredWalkAbout Computer Systems, Inc. (WalkAbout) in a stock purchase transactionfor approximately $13.8 million in cash, with additional consideration payableof up to $5.0 million upon achievement of certain revenue targets for a periodof two and a half years. We accrued $0.2million of additional consideration in the fourth quarter of fiscal 2006 as aresult of achieving certain revenue targets. In addition to the purchaseprice, we recorded approximately $0.2million for acquisition-related costs, including professional fees.

WalkAbout, located in West PalmBeach, Florida, is a manufacturer of several lines of rugged, mobile tabletPCs, serving industrial, municipal, military and government markets. We believethat the acquisition of WalkAbout has enhanced our position in the tacticalcomputer systems business by broadening our product offerings. WalkAbout isbeing managed as part of our C4I Group.

On April 15, 2005, weacquired Codem Systems, Inc. (Codem) in a stock purchase transaction forapproximately $31.6 million in cash, with additional consideration payable ofup to $5.0 million upon achievement of certain annual bookings targets fora period of three years. We accrued $0.3million of additional consideration in the fourth quarter of fiscal 2006, as aresult of achieving certain bookings targets. In addition to thepurchase price, we recorded approximately $0.3 million for acquisition-relatedcosts, including professional fees.

Codem, located in Merrimack, NewHampshire, is a provider of signals intelligence (SIGINT) systems, networkinterface modules and high-performance antenna control systems. Managementbelieves that the addition of Codem has enhanced our existing intelligenceproduct base. Codem is being managed as part of our C4I Group.

**Fiscal 2005 Acquisitions**   OnDecember 14, 2004, we acquired certain assets and liabilities of NightVision Equipment Co., Inc. and Excalibur Electro Optics, Inc.(collectively referred to as NVEC and Affiliate hereinafter), a privately heldbusiness headquartered in Allentown, Pennsylvania. The purchase price was$47.2 million in cash, including a $4.7 million working capitaladjustment paid in the fourth quarter of fiscal 2005, with additionalconsideration of up to a maximum of $37.5 million payable upon achievingcertain annual revenue targets for a period of three years. Approximately, $4.6million of additional consideration was paid in the 

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fourth quarter of fiscal2006 as a result of achieving certain revenue targets. In addition to thepurchase price, we recorded approximately $0.1 million for acquisition-related costs.

NVEC is a manufacturer andmarketer of innovative night vision products and combat identification systems.It focuses on the rapid development and delivery of lightweight, affordableimage intensification (I2)night vision, uncooled thermal imaging, reflective combat identification andlaser-based products for U.S. and international militaries and paramilitaryorganizations. NVEC maintains research, development and production facilitiesin Prescott Valley, Arizona, and has production and sales agreements withleading infrared and thermal imaging divisions of several major U.S. primecontractors. The acquisition of NVEC has enhanced DRS’s position in theuncooled infrared sensor and thermal imaging systems market, as well asprovided increased access to and participation in homeland defense efforts atthe federal, state and local levels. NVEC is being managed as part of our SRGroup.

**Fiscal 2005 Divestiture**   OnMarch 10, 2005, we sold our DRS Weather Systems and DRS BroadcastTechnology operating units for $29.0 million, net of transaction costs,and recorded a $0.7 million after-tax gain on the sale. DRS Weatherdesigns, develops and produces meteorological surveillance and analysisproducts, including Doppler weather radar systems, and DRS Broadcast is amanufacturer of radio frequency broadcast transmission equipment. DRS Weatherand DRS Broadcast operated as a part of our C4I Group. A summary of the resultsof discontinued operations for the fiscal years ended March 31, 2005 and2004 follows (the fiscal 2004 amounts include the results of operations of DRSWeather and DRS Broadcast from November 4, 2003, the date they wereacquired by DRS):

| ** **                                                                                              | ** ** | **Year Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                              | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                                                              | ** ** | **(in thousands)**             | ** ** |
| Revenues                                                                                                | ** ** | $                                   | 33,325     |   | $ | 14,319 |   |
| Earnings before taxes                                                                                   | ** ** | $                                   | 3,601      |   | $ | 1,819 |   |
| Income tax expense                                                                                      | ** ** | 1,050                               |       | 641 |   |
| Earnings from discontinued  operations (including after-tax gain on sale of $0.7 million in  2005) | ** ** | $                                   | 2,551      |   | $ | 1,178 |   |

 

**Fiscal 2004 Acquisition**   On November 4, 2003, weacquired all of the outstanding stock of IDT. Headquartered in Huntsville,Alabama, IDT, which consisted of eight operating units, is a designer,developer and provider of advanced electronics and technology products for thedefense and intelligence industries. IDT's systems, subsystems and componentsare sold to all branches of the U.S. armed services, various governmentagencies, major prime defense contractors and international governments. Thetotal merger consideration was $367.4 million, including$261.3 million in cash (excluding cash acquired of $27.5 million) and4.3 million shares of our common stock valued at $24.55 per share, plusour merger-related costs of approximately $12.5 million. Uponclosing of the acquisition, we repaid IDT's term loan in the amount of$200.8 million. The cash consideration for the acquisition and IDT's termloan was financed with borrowings under our amended and restated creditfacility, the issuance of our senior subordinated notes and with existing cashon hand.

We believe IDT's products andtechnologies complement our program and military platform applications and thatIDT is well positioned to leverage the military's near-term force modernizationand emerging transformation initiatives through its complementary programs,depth of engineering talent, commitment to investments in research anddevelopment, and breadth of technology.

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We believe that the acquisition ofIDT provided us with several strategic benefits, including the following:

·  IDT expanded our customer penetration byplacing our products on a new base of U.S. Air Force programs, increasing ourcontent on key Army and Navy weapons programs and significantly expanding ourintelligence business;

·  IDT further diversified and expanded ourprogram portfolio; and

·  IDT provided additional technology andexpertise in power generation. IDT's power generation leadership, including astrong market position on a U.S. Army hybrid electric drive program, and aleading position in power distribution switchgear for the LHD-8 AmphibiousAssault Ship under development at Northrop Grumman Ship Systems, complementsour strong presence in the Naval power systems business.

The acquired IDT operating unitsare being managed as part of our C4I and SR Groups.

**Critical Accounting Policies**

The following is not intended tobe a comprehensive list of all of our accounting policies. Our significantaccounting policies are more fully described in Note 1 to the ConsolidatedFinancial Statements. In many cases, the accounting treatment of a particulartransaction specifically is dictated by accounting principles generally acceptedin the United States of America, with no need for management’s judgment intheir application. Other areas require management’s judgment to make estimatesand assumptions that affect the reported amounts of assets and liabilities andthe reported amounts of revenues and costs and expenses during the reportingperiod. Ultimately, actual amounts may differ from these estimates. We believethat critical accounting estimates have the following attributes: (1) requiremanagement to make assumptions about matters that are uncertain at the time ofthe estimate; and (2) different estimates we reasonably could have used,or changes in the estimates that are reasonably likely to occur, would have amaterial effect on our consolidated financial condition or results ofoperations. We believe the following critical accounting policies contain themore significant judgments and estimates used in the preparation of ourConsolidated Financial Statements.

**Management Estimates**   Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Some of the more significant estimates made bymanagement involve the percentage of completion and total estimated costs atcompletion on long-term contracts, recoverability of goodwill and long-livedand intangible assets, the valuation of deferred tax assets and liabilities,the valuation of assets acquired and liabilities assumed in purchase businesscombinations and the valuation of pensions and other postretirement benefits,as discussed below. We also make estimates regarding the recoverability ofassets, including accounts receivable and inventories, and for litigation andcontingencies. Actual results could differ from these estimates.

**Revenue Recognition on Contractsand Contract Estimates**   The substantial majorityof our revenue is generated pursuant to written contractual arrangements todesign, develop, manufacture and/or modify complex products, and to providerelated engineering, technical and other services according to the specificationsof the buyers (customers). These contracts may be fixed price,cost-reimbursable, or time and material. These contract types are accounted forin accordance with American Institute of Certified Public Accountants Statementof Position 81-1, “Accounting for Performance of Construction-Type andCertain Production-Type Contracts” (SOP 81-1). Cost-reimbursabletype contracts also are specifically covered by Accounting Research 

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Bulletin No. 43,Chapter 11, Section A, “Government Contracts, Cost-Plus-Fixed FeeContracts” (ARB 43), in addition to SOP 81-1.

Revenues and profits on fixed-pricecontracts are recognized using percentage-of-completion methods of accounting.Revenues and profits on fixed-price production contracts, whose units areproduced and delivered in a continuous or sequential process, are recorded asunits are delivered based on their selling prices (the “units-of-deliverymethod’’). In certain limited circumstances, when all applicable revenuerecognition criteria are met, revenue may be recognized prior to shipment tothe customer. Revenues and profits on other fixed-price contracts withsignificant engineering as well as production requirements are recorded basedon the ratio of total actual incurred costs to date to the total estimatedcosts for each contract (“the cost-to-cost method’’). Under thepercentage of completion method of accounting, a single estimated total profitmargin is used to recognize profit for each contract over its entire period ofperformance, which can exceed one year.

Accounting for revenues andprofits on a fixed-price contract requires the preparation of estimates of (1) thetotal contract revenue, (2) the total costs at completion, which is equalto the sum of the actual incurred costs to date on the contract and theestimated costs to complete the contract’s statement of work, and (3) themeasurement of progress towards completion. The estimated profit or loss atcompletion on a contract is equal to the difference between the total estimatedcontract revenue and the total estimated cost at completion. Under theunits-of-delivery method, sales on a fixed-price type contract are recorded asthe units are delivered during the period based on their contractual sellingprices. Under the cost-to-cost method, sales on a fixed-price type contract arerecorded at amounts equal to the ratio of actual cumulative costs incurreddivided by total estimated costs at completion, multiplied by (i) thetotal estimated contract revenue, less (ii) the cumulative salesrecognized in prior periods. The profit recorded on a contract in any periodusing either the units-of-delivery method or cost-to-cost method is equal to (i) thecurrent estimated total profit margin multiplied by the cumulative salesrecognized, less (ii) the amount of cumulative profit previously recordedfor the contract. In the case of a contract for which the total estimated costsexceed the total estimated revenues, a loss arises, and a provision for theentire loss is recorded in the period that it becomes evident. Theunrecoverable costs on a loss contract that are expected to be incurred infuture periods are recorded as a component of other current liabilitiesentitled ‘‘Loss accrual for future costs on uncompleted contracts.’’

Revenue and profits oncost-reimbursable type contracts are recognized as allowable costs are incurredon the contract, at an amount equal to the allowable costs plus the estimatedprofit on those costs. The estimated profit on a cost-reimbursable contract isgenerally fixed or variable based on the contractual fee arrangement. Incentiveand award fees on these contracts are recorded as sales when the conditionsunder which they are earned are reasonably assured of being met and can bereasonably estimated. Sales and profits on time-and-material type contracts arerecognized on the basis of direct labor hours expended multiplied by thecontractual fixed rate per hour, plus the actual costs of material and otherdirect non-labor costs. On a time-and-material type contract the fixed hourlyrates include amounts for the cost of direct labor, indirect contract costs andprofit.

We review cost performance andestimates to complete at least quarterly and in many cases more frequently.Adjustments to original estimates for a contract’s revenue, estimated costs atcompletion and estimated profit or loss are often required as work progressesunder a contract, as experience is gained and as more information is obtained,even though the scope of work required under the contract may not change, or ifcontract modifications occur. The impact of revisions in profit estimates forall types of contracts are recognized on a cumulative catch-up basis in theperiod in which the revisions are made. Amounts representing contract changeorders or claims are included in revenue only when they can be reliablyestimated and their realization 

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is probable, andare determined on a percentage-of-completion basis measured by the cost-to-costmethod. Incentives or penalties and awards applicable to performance oncontracts are considered in estimating revenues and profit rates, and arerecorded when there is sufficient information to assess anticipated contractperformance. Incentive provisions, which increase or decrease earnings basedsolely on a single significant event, are not recognized until the eventoccurs.

We record contract-relatedassets and liabilities acquired in business combinations at their fair value byconsidering the remaining contract amounts to be billed, our estimate tocomplete and a reasonable profit allowance on the remaining contract amount tobe billed commensurate with the profit margin that the we earn on similarcontracts. Revisions to cost estimates subsequent to the date of acquisitionmay be recorded as an adjustment to goodwill or earnings, depending on thenature and timing of the revision.

We often enter into contracts thatprovide for significant engineering as well as the production of finished unitswith the expectation that we will incur substantial up-front costs to engineerthe product to meet customer specifications. These arrangements typicallyprovide us the opportunity to be awarded add-on contracts requiring thedelivery of additional finished units. Our ability to recover up-front costsand earn a reasonable overall profit margin often is contingent on beingawarded multiple contracts. Prior to entering into such arrangements, weestimate the amount of up-front costs to be incurred and evaluate thelikelihood of being awarded the add-on contracts. Inaccurate estimates ofup-front costs, coupled with the failure to obtain, or delays in obtaining,add-on contracts, could have a material effect on the timing of revenue and/orprofit or loss recognition and future cash flows.

Revenues on arrangements that arenot within the scope of SOP 81-1 or ARB 43 are recognized in accordancewith the SEC Staff Accounting Bulletin No. 104, “Revenue Recognition inFinancial Statements.” Revenues are recognized when there is persuasiveevidence of an arrangement, delivery has occurred or services have beenperformed, the selling price to the buyer is fixed or determinable, andcollectibility is reasonably assured.

**Goodwill and Acquired IntangibleAssets**   We allocate the cost of our acquiredbusinesses (commonly referred to as the purchase price allocation) to theassets acquired and liabilities assumed based on their estimated fair values atthe date of acquisition. As part of the purchase price allocations for ouracquired businesses, identifiable intangible assets are recognized as assetsapart from goodwill if they arise from contractual or other legal rights, or ifthey are capable of being separated or divided from the acquired business andsold, transferred, licensed, rented or exchanged, unless the intangible assetis comprised of the assembled workforce of the acquired business.

Generally, the substantialmajority of the intangible assets from the businesses that we acquire arederived from the intellectual capital of the management, administrative,scientific, engineering and technical employees of the acquired businesses. Thesuccess of our businesses is primarily dependent on the management,contracting, engineering and technical skills and knowledge of our employees,rather than productive capital (machinery and equipment). Generally, patents,trademarks and licenses are not material to our acquired businesses. Therefore,the substantial majority of the intangible assets for our acquired businessesis recognized as goodwill.

The values assigned to acquiredidentifiable intangible assets for customer-related and technology-basedidentifiable assets are determined as of the date of acquisition, based onestimates and judgments regarding expectations of the estimated future after-taxcash flows from those assets over their lives, including the probability ofexpected future contract renewals and sales, all of which are discounted topresent value. The value assigned to goodwill equals the 

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amount of thepurchase price of the business acquired in excess of the sum of the amountsassigned to identifiable acquired assets, both tangible and intangible, lessliabilities assumed.

We assess therecoverability of our long-lived assets and acquired identifiable intangibleassets with finite useful lives whenever events or changes in circumstancesindicate that the carrying value of the asset may not be recoverable. Factorswe consider important which could trigger an impairment review include:

·       Significantunder-performance relative to expected historical performance orprojected future operating results;

·       Significantchanges in the manner or use of the assets or the strategy that affects thatasset group;

·       Significantadverse changes in the business climate in which we operate; and

·       Lossof a significant contract or failure to be awarded add-on contracts.

If we identify the existence ofone or more of the above indicators, we would determine if the asset isimpaired by comparing its expected future net undiscounted cash flows with its carryingvalue. If the expected future net undiscounted cash flows are less than thecarrying value of the asset, we would record an impairment loss based on thedifference between the asset’s estimated fair value and its carrying value. Thedetermination of the future net undiscounted cash flows and the fair value ofan asset involves estimates and assumptions regarding future operating results,all of which are impacted by economic conditions related to the industries inwhich those assets operate. Inaccurate estimates could have a material affecton the results of operations, financial position and cash flows. At March 31,2006, we had identifiable acquired intangible assets with finite useful livesof $231.1 million, net ofaccumulated amortization.

Goodwill is tested for impairmentat a level of reporting referred to as a “reporting unit.” We have identified sixreporting units for impairment testing purposes at March 31, 2006.

The annual impairment test isperformed after completion of our annual financial operating plan, which occursin the fourth quarter of our fiscal year. We completed our annual impairmenttests with no adjustment to the carrying value of our goodwill, as of March 31,2006 and 2005. The annual goodwill impairment assessment involves estimatingthe fair values of our reporting units and comparing such fair values with thereporting unit’s respective carrying value. If the carrying value of thereporting unit exceeds its fair value, additional steps are followed torecognize a potential goodwill impairment loss. Beginning in fiscal 2006, weestimate the fair value of our reporting units with the assistance of athird-party appraiser. Fair value is estimated based upon two methodologies: amarket approach and an income approach. The market approach includes applyingvaluation multiples to each reporting unit’s projected revenues, earningsbefore net interest and taxes (EBIT), and earnings before net interest, taxes,depreciation and amortization (EBITDA). The income approach discounts futurenet cash flows to their present value at a rate that reflects both the currentreturn requirements of the market and the risks inherent in the reporting unit.The results of the two approaches are averaged together and compared with thecarrying value of the reporting units. Estimating the fair value of thereporting units requires significant estimates and assumptions by management,as the calculation is dependent on estimates for future revenues, EBIT, EBITDAand cash flows, all of which are impacted by economic conditions related to theindustries in which we operate, as well as conditions in the U.S. capitalmarkets. A decline in the estimated fair value of a reporting unit could resultin an impairment charge to goodwill, which could have a material adverse effecton our business, financial condition and results of operations. At March 31,2006, we had goodwill of $2.6 billion.

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**Pension Plan and PostretirementBenefit Plan Obligations**   The obligations for ourpension plans and postretirement benefit plans and the related annual costs ofemployee benefits are calculated based on several long-term assumptions,including discount rates for employee benefit liabilities, rates of return on planassets, expected annual rates for salary increases for employee participants inthe case of pension plans, and expected annual increases in the costs ofmedical and other healthcare benefits in the case of postretirement benefitobligations. These long-term assumptions are subject to revision based onchanges in interest rates, financial market conditions, expected versus actualreturns on plan assets, participant mortality rates and other actuarialassumptions, including future rates of salary increases, benefit formulas andlevels, and rates of increase in the costs of benefits. Changes in theassumptions, if significant, can materially affect the amount of annual netperiodic benefit costs recognized in our results of operations from one year tothe next, the liabilities for the pension plans and postretirement benefitplans, and our annual cash requirements to fund these plans.

The fiscal 2006 discount rateassumptions used to determine the pension and postretirement benefitobligations were based on a hypothetical double A yield curve represented by aseries of annualized individual discount rates. The current year’s discountrates were selected using a method that matches projected payouts from theplans with a zero-coupon double A bond yield curve. This yield curve wasconstructed from the underlying bond price and yield data collected as of theplan's measurement date and is represented by a series of annualized,individual discount rates with durations ranging from six months to thirtyyears. These individual discount rates are then converted into a singleequivalent discount rate. Prior years’ discount rate assumptions were set basedon investment yields available on double A long-term corporate bonds.

Our benefit obligation and annualnet periodic expense are significantly affected by the discount rate assumptionwe use. For example, including ESSI, an additional reduction to the discountrate of 25 basis points would have increased our benefit obligation atMarch 31, 2006 by approximately $9.4 million, and our estimatedannual net periodic expense for fiscal 2007 by approximately $0.3 million.Conversely, an increase to the discount rate of 25 basis points would havedecreased our benefit obligation at March 31, 2006 by approximately $9.1 million,and our estimated annual net periodic expense for fiscal 2007 by approximately$0.2 million.

**Income Taxes**   AtMarch 31, 2006, we had net deferred tax assets of $26.3 million, including$27.9 million of loss and tax credit carryforwards, which are subject tovarious limitations and will expire if unused within their respectivecarryforward periods. As of March 31, 2006, we provided $17.5 millionvaluation allowance associated with the loss carryforwards and certain othertemporary differences that are included in our net deferred tax assets.Deferred taxes are determined separately for each of our tax paying entities ineach tax jurisdiction. Future realization of deferred tax assets ultimatelydepends on the existence of sufficient taxable income of the appropriatecharacter (for example, ordinary income or capital gain) within the carrybackand carryforward periods available under the tax law. Based on our estimates ofthe amounts and timing of future taxable income, At March 31, 2006 webelieve we will realize our recorded net deferred tax assets. A change in theability of our operations to continue to generate future taxable income couldaffect our ability to realize the future tax deductions underlying our netdeferred tax assets and require us to increase our valuation allowance againstour deferred tax assets. Such changes, if significant, could have a materialimpact on our effective tax rate, results of operations and financial positionin any given period.

Our annual effective tax rate isbased on expected pre-tax earnings, statutory tax rates and tax planningopportunities available in various jurisdictions in which we operate.Significant judgment is required in determining our annual effective tax rateand in evaluating our tax positions.

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We establish accruals for tax contingencies when,notwithstanding the reasonable belief that our tax return positions are fullysupported, we believe that certain filing positions are likely to be challengedand moreover, that such filing positions may not be fully sustained. Wecontinually evaluate our tax contingency accruals and will adjust such amountsin light of changing facts and circumstances, including but not limited toemerging case law, tax legislation, rulings by relevant tax authorities and theprogress of ongoing tax audits. Settlement of a given tax contingency couldimpact the income tax provision in the year of resolution. Our tax contingencyaccruals are presented in the consolidated balance sheet within income taxespayable.

**Other ManagementEstimates**   A substantial majority of our revenuesand, consequently, our outstanding accounts receivables are directly orindirectly with the U.S. government. Therefore, our risk of not collectingamounts due us under such arrangements is minimal. We generally require lettersof credit or deposit payments prior to the commencement of work or obtainprogress payments upon the achievement of certain milestones from ourcommercial customers. In addition, our revenues are supported by contractualarrangements specifying the timing and amounts of payments. Consequently, wehistorically have experienced and expect to continue to experience a minimalamount of uncollectible accounts receivable. Changes in the underlyingfinancial condition of our customers or changes in the industry in which weoperate necessitating revisions to our standard contractual terms andconditions could have an impact on our results of operations and cash flows inthe future.

Our inventory consists of work-in-process, general andadministrative costs, raw materials and finished goods, including subassembliesprincipally for use in our products. We continually evaluate the adequacy ofour reserves on our raw materials and finished goods inventory by reviewinghistorical rates of scrap, on-hand quantities as compared with historical andprojected usage levels, and other anticipated contractual requirements.

We record a liability pertainingto pending litigation or contingencies based on our best estimate of potentialloss, if any, or at the minimum end of the range of loss in circumstances wherea range of loss reasonably can be estimated. Because of uncertaintiessurrounding the nature of litigation and the cost to us, if any, we continuallyrevise our estimated losses as additional facts become known.

**Results of ContinuingOperations**

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

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Members of oursenior management team regularly review key performance metrics and the statusof operating initiatives within our business. These key performance indicatorsare primarily revenues, operating income and bookings. We review thisinformation on a monthly basis through operating segment reviews which include,among other operating issues, discussions related to significant programs,proposed investments in new business opportunities or property, plant andequipment, and integration and cost reduction efforts. The following tablepresents a summary comparison of the key performance metrics, other significantfinancial metrics and significant liquidity metrics monitored by our seniormanagement.

| ** **                               | ** ** | ** **                                          | ** ** | **Percent Changes** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------|------------|
| ** **                               | ** ** | **Fiscal Year Ended March 31,** | ** ** | **2006 vs.**        | ** ** | **2005 vs.** | ** ** |
| ** **                               | ** ** | **2006**                                            | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **(in thousands)**                             | ** ** | ** **               | ** ** | ** ** | ** ** |
| **Key  performance metrics**             |       |                                                |       |                     |       |   |   |   |   |   |   |   |   |   |   |
| Revenues                                 |       | $                                                   | 1,735,532  |                     | $          | 1,308,600 |   | $ | 986,931 |   |   | 32.6 | % |   |   | 32.6 | % |   |
| Operating income                         |       | $                                                   | 192,710    |                     | $          | 143,132 |   | $ | 103,332 |   |   | 34.6 | % |   |   | 38.5 | % |   |
| Bookings                                 |       | $                                                   | 2,172,905  |                     | $          | 1,433,030 |   | $ | 1,052,630 |   |   | 51.6 | % |   |   | 36.1 | % |   |
| **Other significant financial  metrics** |       |                                                |       |                     |       |   |   |   |   |   |   |   |   |   |   |
| Interest and related  expenses           |       | $                                                   | 64,186     |                     | $          | 39,750 |   | $ | 24,259 |   |   | 61.5 | % |   |   | 63.9 | % |   |
| Income taxes                             |       | $                                                   | 51,994     |                     | $          | 44,842 |   | $ | 33,789 |   |   | 15.9 | % |   |   | 32.7 | % |   |
| **Significant liquidity metrics(A)**     |       |                                                |       |                     |       |   |   |   |   |   |   |   |   |   |   |
| Free Cash Flow                           |       | $                                                   | 113,868    |                     | $          | 101,662 |   | $ | 80,273 |   |   | 12.0 | % |   |   | 26.6 | % |   |
| EBITDA                                   |       | $                                                   | 239,406    |                     | $          | 181,226 |   | $ | 129,272 |   |   | 32.1 | % |   |   | 40.2 | % |   |

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

**Fiscal Year Ended March 31,2006, Compared with Fiscal Year Ended March 31, 2005**

**Revenues andOperating Income****  **Consolidatedrevenues and operating income for the year ended March 31, 2006 increased$426.9 million and $49.6 million, respectively, to $1.7 billion and $192.7million, respectively, as compared with the prior fiscal year. The increase inrevenues was largely driven by our fiscal 2006 acquisitions of ESSI, Codemand WalkAbout and fiscal 2005 acquisition of NVEC, which combined contributedincremental (current fiscal year over prior fiscal year) revenues of $256.8million. Also contributing to the overall increase in revenues were increasedshipments of certain rugged computer systems, airborne training pods, targetacquisition and missile control subsystems, and vision enhancement equipmentfor ground-based vehicles. Partially offsetting the overall increase inrevenues were decreased DD(X)-related ship propulsion engineering services, lower shipments of certain turbinegenerator sets****and lowervolume from a light armored vehicle service life extension program, which wassubstantially completed in fiscal 2005.

The growth in operating income for the year ended March 31,2006, as compared with the corresponding prior fiscal year, was due primarilyto the overall increase in revenues and favorable margins on certain control cabinets for nuclearfacilities, vision enhancement equipment for ground-basedvehicles, and flight control computer contract manufacturing. Ouracquisitions of****ESSI, NVEC, Codem and WalkAboutcontributed $30.2 million of incremental operating income for the year ended March 31,2006. Partially offsetting the overall increase in operating income were lossesfrom DD(X)-relatedship propulsion engineering. See Operating Segments discussion below foradditional information.

**Bookings****  **We define bookings as the value of contract awardsreceived from the U.S. government for which the U.S. government hasappropriated funds, plus the value of 

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contract awards and orders received from customersother than the U.S. government. Bookings for the year ended March 31, 2006increased $739.9 million, versus the same period in the prior year, to $2.2billion. The primary drivers of the increase were significant bookings fortarget acquisition and missile control subsystems, long-range infrared searchand tracking systems and rugged computers. Our ESSI, NVEC, Codem, and WalkAboutacquisitions contributed combined incremental bookings of $275.5 million.

**Interest and RelatedExpenses**   Interest and related expenses increased$24.4 million for the year ended March 31, 2006, as compared with the sameperiod in the prior year, to $64.2 million. The increase in interest andrelated expenses was primarily the result of an increase in our averageborrowings outstanding for the year ended March 31, 2006, as compared withthe previous fiscal year. The increase in average borrowings was due to our December 23,2004, issuance of $200 million of 67¤8%senior subordinated notes, incremental borrowings under our amended andrestated credit agreement, $900 million of new debt securities issued on January 31,2006 relating to our acquisition of ESSI and the exercise of a $45 millionover-allotment option on our convertible debt (see Liquidity and CapitalResources below).

**Income Taxes**   Theprovision for income taxes for fiscal year ended March 31, 2006 reflectsan annual effective income tax rate of approximately 39.0%, as compared with43.5% in the prior year. Factors contributing to the decrease in our effectivetax rate included a favorable resolution of an IRS examination, an increase inbenefit from the research and development credit, a benefit from the domesticmanufacturing deduction and a reduction in the state tax rate, offset, in part,by an increase in valuation allowances.

**Fiscal Year Ended March 31,2005, Compared with Fiscal Year Ended March 31, 2004**

**Revenues andOperating Income**   Revenues and operating incomefor the fiscal year ended March 31, 2005 were $1.3 billion and$143.1 million, respectively, increasing approximately $321.7 millionand $39.8 million, respectively, as compared with the prior fiscal year.The increase in revenues was primarily driven by our November 4, 2003acquisition of IDT and our December 14, 2004 acquisition of NVEC, whichcontributed incremental (current fiscal year over corresponding prior fiscalyear) revenues of $211.8 million and $18.4 million, respectively.Also contributing to the overall increase in revenues were higher shippropulsion-related volume, increased shipments of certain combat displayworkstations, rugged computers, airborne-based electro-opticalsighting systems and certain airborne-based infrared countermeasuresubassemblies. Partially offsetting the overall increase in revenues weredecreased shipments of certain ground-based infrared sighting andtargeting systems. The growth in operating income for the fiscal year ended March 31,2005, as compared with the corresponding prior fiscal year, was due primarilyto the overall increase in revenues and strong margins from certain ground-basedinfrared sighting and targeting systems and a certain carrier landing system.The acquired IDT and NVEC operating units contributed incremental operatingincome of $27.1 million and $4.5 million, respectively, for thefiscal year ended March 31, 2005. Partially offsetting the overallincrease in operating income were certain legal and severance-relatedcharges. See Operating Segments discussion below for additional information.

**Bookings**   Bookingsfor the fiscal year ended March 31, 2005 increased $380.4 million,versus the prior fiscal year, to $1.4 billion. The primary driver of theoverall increase was the acquisition of IDT and NVEC, which contributedincremental bookings of $241.1 million and $21.5 million,respectively.

**Interest and RelatedExpenses**   Interest and related expenses increased$15.5 million for the fiscal year ended March 31, 2005, as comparedwith the prior fiscal year, to $39.8 million. The increase in interest andrelated expenses was primarily the result of an increase in our averageborrowings outstanding for the year ended March 31, 2005, as compared withthe prior fiscal year. The increase in the average borrowings outstanding wasdriven by the financing of our 

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November 4, 2003 acquisition of IDT, as well asour December 23, 2004 issuance of an additional $200 million of our 67¤8%senior subordinated notes. The notes were priced at 105% of the principalamount, reflecting an effective interest rate of approximately 6.13% (seeLiquidity and Capital Resources below).

**Income Taxes**   Theprovision for income taxes for the fiscal year ended March 31, 2005reflects an annual effective income tax rate of approximately 43.5%, ascompared with 43.7% in the prior year. Factors contributing to the decrease inour effective tax rate include a reduction in the valuation allowance for statenet operating losses and a reduction of certain non-deductible expenses,offset, in part, by higher net foreign and state tax rates.

***Operating Segments***

The followingtables set forth, by operating segment, revenues, operating income and operatingmargin and the percentage increase or decrease of those items, as compared withthe prior fiscal year:

| ** **              | ** ** | ** **                              | ** ** | **Percent Changes** | ** ** |
|-------------------------|------------|-----------------------------------------|------------|--------------------------|------------|
| ** **              | ** ** | **Year Ended March 31,** | ** ** | **2006 vs.**        | ** ** | **2005 vs.** | ** ** |
| ** **              | ** ** | **2006**                                | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **              | ** ** | **(dollars in thousands)**    | ** ** | ** **               | ** ** | ** ** | ** ** |
| **C4I  Group**          | ** ** | ** **                              | ** ** | ** **               | ** ** | ** ** | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Revenues*               |       | $                                       | 820,431    |                     | $          | 700,432 |   | $ | 552,274 |   |   | 17.1 | % |   |   | 26.8 | % |   |
| Operating income        |       | $                                       | 92,504     |                     | $          | 73,566 |   | $ | 58,652 |   |   | 25.7 | % |   |   | 25.4 | % |   |
| Operating margin        |       | 11.3                                    | %          | 10.5                     | %          | 10.6 | % |   | 7.4 | % |   |   | (1.1 | )% |   |
| **SR Group**            |       |                                    |       |                     |       |   |   |   |   |   |   |   |   |   |   |
| Revenues*               |       | $                                       | 747,075    |                     | $          | 608,168 |   | $ | 434,657 |   |   | 22.8 | % |   |   | 39.9 | % |   |
| Operating income        |       | $                                       | 87,942     |                     | $          | 69,893 |   | $ | 44,597 |   |   | 25.8 | % |   |   | 56.7 | % |   |
| Operating margin        |       | 11.8                                    | %          | 11.5                     | %          | 10.3 | % |   | 2.4 | % |   |   | 12.0 | % |   |
| **S3 Group**            |       |                                    |       |                     |       |   |   |   |   |   |   |   |   |   |   |
| Revenues*               |       | $                                       | 168,026    |                     | $          | — |   | $ | — |   |   | n/a |   |   |   | n/a |   |   |
| Operating income        |       | $                                       | 15,058     |                     | $          | — |   | $ | — |   |   | n/a |   |   |   | n/a |   |   |
| Operating margin        |       | 9.0                                     | %          | n/a                      |       | n/a |   |   | n/a |   |   |   | n/a |   |   |
| **Other**               |       |                                    |       |                     |       |   |   |   |   |   |   |   |   |   |   |
| Revenues*               |       | $                                       | —     |                     | $          | — |   | $ | — |   |   | n/a |   |   |   | n/a |   |   |
| Operating (loss) income |       | $                                       | (2,794     | )                        | $          | (327 | ) | $ | 83 |   |   | (754.4 | )% |   |   | (494.0 | )% |   |
| Operating margin        |       | n/a                                     |       | n/a                      |       | n/a |   |   | n/a |   |   |   | n/a |   |   |

----

*                    Revenuesare net of intersegment eliminations.

**Fiscal Year Ended March 31,2006, Compared with Fiscal Year Ended March 31, 2005**

**C4I Group**   Revenuesincreased $120.0 million, or 17.1%, to $820.4 million for the year ended March 31,2006, as compared with the prior fiscal year. Operating income increased $18.9 million,or 25.7%, to $92.5 million. The increase in revenue was largely attributable tocertain rugged computer systems, advanced propulsion steam turbines, combatdisplay workstations, power conversion/distribution and control systems, andcommunications intelligence and signals intelligence programs. Our acquisitionsof Codem and WalkAbout contributed incremental (current fiscal year over priorfiscal year) revenues of $41.3 million to the year ended March 31, 2006.Partially offsetting the overall increase in revenues were decreased DD(X)-relatedship propulsion engineering services and decreased shipments of certain turbinegenerator sets and satellite communication equipment.

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The increase in operating income for the year ended March 31,2006, as compared with the prior fiscal year, was primarily driven by theoverall increase in revenues, as well as $7.5 million of incremental operatingincome contribution from our acquisitions of Codem and WalkAbout. Partiallyoffsetting the overall increase in operating income were losses from DD(X)-related ship propulsionengineering, cost growth on an advanced propulsion steam turbine program and apower conversion/distribution and control program. Operating income for fiscal2005 was unfavorably impacted by a $6.5 million charge to increasethe accrual for the settlement of litigation with Miltope Corporation andIV Phoenix Group, Inc., pursuant to which the Company agreed to pay$7.5 million to resolve all outstanding claims. Also impacting fiscal 2005was $1.2 million in severance-related charges.

**SR Group**   Revenuesincreased $138.9 million, or 22.8%, to $747.1 million for the year ended March 31,2006, as compared with the prior fiscal year. Operating income increased $18.0 million,or 25.8%, to $87.9 million. The increase in revenues was primarily attributableto our fiscal 2005 acquisition of NVEC, which contributed incrementalrevenues of $47.5 million. Revenues also were favorably impacted by increasesfrom airborne training pods, target acquisition and missile control subsystems,vision enhancement equipment for ground-based vehicles, electro-opticalsensors and space electronics, and flight range test and evaluation equipment. Partiallyoffsetting the overall increase in revenues were lower volume from a lightarmored vehicle service life extension program, which was substantiallycompleted in fiscal 2005, and decreased shipments of certain motor controlsubassemblies and certain forward-looking infrared sighting systems.

The increase in operating income for the year ended March 31,2006, as compared with the prior fiscal year, was driven by overall higher revenues,our fiscal 2005 acquisition of NVEC, which contributed $7.6 million tooperating income, and favorable margins on driver vision enhancement equipmentand certain launch control electronics.

**S3 Group**   Sincetheir acquisition on January 31, 2006, and through March 31, 2006,the operating units acquired in connection with ESSI, now operating as the S3Group, recorded revenues and operating income of $168.0 million and $15.1million, respectively. The primary revenue and operating income drivers in thegroup were the Rapid Response (R2) program, mobile power generation anddistribution for the U.S. Air Force and a heavy equipment transportrefurbishment program for the U.S. Army.

**Other**   The$2.8 million operating loss in Other in the year ended March 31, 2006 wasdriven primarily by a $2.0 million charge recorded in the second quarter offiscal 2006, in connection with a contingent liability. See Item 3. LegalProceedings.

**Fiscal Year Ended March 31,2005, Compared with Fiscal Year Ended March 31, 2004**

**C4I Group**   Revenuesincreased $148.2 million, or 26.8%, to $700.4 million for the fiscalyear ended March 31, 2005, as compared with the corresponding prior fiscalyear. Operating income increased $14.9 million, or 25.4%, to$73.6 million. The increase in revenue was attributable to the legacy IDToperating units, which contributed incremental revenues of $57.8 million,as well as the overall increase in revenues from higher ship propulsionengineering volume, increased shipments of combat display workstations, securetelephone and communications equipment, certain turbine generators and aninternational long-range infrared surveillance and observation system.Partially offsetting the overall increase in revenues was decreased volume fora certain mobile ground-based radar system, nuclear instrumentation andcontrol systems and naval power control systems.

The increase in operating income for the fiscal yearended March 31, 2005, as compared with the corresponding prior fiscalyear, was primarily driven by the overall increase in revenues. The IDToperating units contributed $10.7 million of operating income to thefiscal year ended March 31, 2005. Operating income for fiscal 2005 wasunfavorably impacted by a $6.5 million 

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charge to increase the accrual forthe settlement of the Miltope litigation and $1.2 million in severance-relatedcharges. For the fiscal year ended March 31, 2004, operating income wasunfavorably impacted by certain program charges totaling $9.6 million. Thecharges were recorded for program cost growth of $6.2 million on certainradar programs and $3.4 million for various other programs and inventory-relateditems.

**SR Group**   Revenuesincreased $173.5 million, or 39.9%, to $608.2 million for the fiscalyear ended March 31, 2005, as compared with the corresponding prior fiscalyear. Operating income increased $25.3 million, or 56.7%, to$69.9 million. The increase in revenues was primarily attributable to theIDT operating units and the fiscal 2005 acquisition of NVEC. The IDT operatingunits and NVEC contributed incremental revenues of $154.0 million and$18.4 million, respectively. Revenues also were favorably impacted byincreased shipments of certain airborne-based electro-opticalsighting and targeting systems, airborne-based infrared countermeasuresubassemblies and certain infrared focal plane arrays. Partially offsetting theoverall increase in revenues were lower shipments of certain ground-basedelectro-optical infrared sighting and targeting systems.

The increase in operating incomefor fiscal year ended March 31, 2005, as compared with the correspondingprior fiscal year, was primarily driven by the overall increase in revenues, aswell as strong margins on a certain ground-based electro-opticalreconnaissance, surveillance and targeting system platform. The IDT operatingunits and NVEC contributed $16.3 million and $4.5 million,respectively, in incremental operating income. Partially offsetting the overallincrease in operating income was the impact of a $1.0 million inventorywrite-down on certain uncooled infrared programs recorded in the first quarterof fiscal 2005. For the fiscal year ended March 31, 2004, operating incomewas unfavorably impacted by cost overruns of $3.0 million for a thermaltarget and acquisition system program, partially offset by a $1.6 millionfavorable program adjustment, due to changes in estimates to complete.

**Results of DiscontinuedOperations**

A consolidatedsummary of the operating results of the discontinued operations for the yearsended March 31, 2005 and 2004 is as follows:

| ** **                                                                                              | ** ** | **Year Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                              | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                                                              | ** ** | **(in thousands)**             | ** ** |
| Revenues                                                                                                | ** ** | $                                   | 33,325     |   | $ | 14,319 |   |
| Earnings before taxes                                                                                   | ** ** | $                                   | 3,601      |   | $ | 1,819 |   |
| Income tax expense                                                                                      | ** ** | 1,050                               |       | 641 |   |
| Earnings from discontinued  operations (including after-tax gain on sale of $0.7 million in  2005) | ** ** | $                                   | 2,551      |   | $ | 1,178 |   |

 

**Liquidity and CapitalResources**

Cash and cash equivalents, internally generated cashflow from operations and other available financing resources are expected to besufficient to meet anticipated operating, capital expenditure and debt servicerequirements, and expected dividend payments during the next 12 months.There can be no assurance, however, that our business will continue to generatecash flow at current levels, or that anticipated operational improvements willbe achieved. If we are unable to generate sufficient cash flow from operationsto service our debt, we may be required to sell assets, reduce capitalexpenditures, refinance all or a portion of our existing debt or obtainadditional financing. Our ability to make scheduled principal payments or payinterest on or refinance our indebtedness depends on our future performance andfinancial results, which, to a certain extent, are subject to generalconditions in or affecting the defense industry and are 

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subject to general economic,political, financial, competitive, legislative and regulatory factors that are beyondour control.

**Cash Flows**   Thefollowing table provides our cash flow data for the fiscal years ended March 31,2006, 2005 and 2004:

| ** **                                                          | ** ** | **Year Ended March 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                          | ** ** | **(in thousands)**                 | ** ** |
| Net cash provided by  operating activities of continuing operations |       | $                                       | 157,062    |   | $ | 136,183 |   | $ | 104,717 |   |
| Net cash provided by  operating activities                          |       | $                                       | 157,062    |   | $ | 138,410 |   | $ | 102,633 |   |
| Net cash used in  investing activities of continuing operations     |       | $                                       | (1,467,396 | ) | $ | (53,573 | ) | $ | (273,859 | ) |
| Net cash used in  investing activities                              |       | $                                       | (1,467,396 | ) | $ | (54,398 | ) | $ | (274,460 | ) |
| Net cash provided by  financing activities of continuing operations |       | $                                       | 1,004,222  |   | $ | 164,901 |   | $ | 131,613 |   |
| Net cash provided by financing activities                           |       | $                                       | 1,004,222  |   | $ | 164,871 |   | $ | 131,767 |   |

 

**Operatingactivities of Continuing Operations**   Duringfiscal 2006, we generated $157.1 million of operating cash flow,$20.9 million more than the $136.2 million reported in the priorfiscal year. Earnings from continuing operations increased $23.4 millionto $81.5 million. Non-cash adjustments to reconcile net earnings to cashflows from operating activities increased $1.0 million over thecorresponding prior fiscal period. These non-cash adjustments primarily consistof depreciation and amortization of fixed assets and acquired intangibleassets, stock-based compensation, changes in deferred income taxes,non-cash adjustments to inventory reserves and provisions for doubtfulaccounts, amortization and write-offs of deferred financing fees andamortization of bond premium, which are recognized as a component of interestand related expenses, and changes in non-controlling interest. The primarydrivers of the increase in these non-cash adjustments were amortization ofidentified acquired intangible assets and deferred financing fees, related tothe financing of the ESSI acquisition, offset by an increase in net deferredtax liabilities, resulting primarily from the utilization of certain netoperating losses and tax credit carry forwards, and increase in the valuationallowance, and the realization and adjustment of certain deferred tax assets.

Changes in assets and liabilities, net of effects frombusiness combinations, provided $1.2 million for the fiscal year ended March 31,2006. Accounts receivable increased $28.6 million mainly due to better salesvolume and increased activity related to the ESSI acquisition in the fourthquarter of fiscal 2006, as compared with the prior year. Inventory used $36.7 millionof cash due to the increase in certain of our electro-optical sighting,targeting surveillance and acquisition inventories. Accounts payable increased$51.0 million, as purchases required to build inventories and acquirecapital assets exceeded related payments. Accrued expenses and other currentliabilities provided $10.5 million of cash during the year. The cash generatedby these accounts primarily resulted from an increase in income taxes payable,as income tax expense exceeded related payments. Net customer advances provided$2.1 million in cash and are directly related to the inventory increases. Othercurrent assets provided $2.8 million, as we received payment of ESSI optionsexercised prior to the acquisition, offset by expenditures for prepaid jobcosts.

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**Investing activities**   Thefollowing table summarizes the cash flow impact of our business combinationsfor the fiscal years ended March 31, 2006, 2005 and 2004:

| ** **                                                             | ** ** | **Date of  Original  Transaction** | ** ** | **Paid to  Sellers, Net  of Cash  Acquired** | ** ** | **Earn-Out  Payments** | ** ** | **Working  Capital  Adjustments** | ** ** | **Acquisition-  Related  Payments** | ** ** | **Other** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------|------------|-------------------------------------------------------------|------------|------------------------|------------|-----------------------------------|------------|-------------------------------------|------------|-----------|------------|-----------|------------|
| ** **                                                             | ** ** | **(in thousands)**                 | ** ** |
| **Fiscal 2006**                                                        |       |                                    |       |                                                        |       |                   |       |                              |       |                                |       |      |       |      |       |   |   |   |   |   |   |   |   |   |   |
| ESSI                                                                   |       |                                    | 1/31/06    |                                                        |       |                   | $          | 1,343,338                         |       |                                |       | $         | —     |      |       |   | $ | — |   |   |   | $ | 25,223 |   |   | $ | — |   | $ | 1,368,561 |   |
| Codem                                                                  |       |                                    | 4/15/05    |                                                        |       |                   | 29,200     |                              |       |                                | —     |      |       |      | 2,363      |   |   |   | 374 |   |   | — |   | 31,937 |   |
| WalkAbout                                                              |       |                                    | 6/27/05    |                                                        |       |                   | 10,663     |                              |       |                                | —     |      |       |      | 3,065      |   |   |   | 164 |   |   | — |   | 13,892 |   |
| DKD, Inc (Nytech)                                                      |       |                                    | 10/15/02   |                                                        |       |                   | —     |                              |       |                                | 6,742      |      |       |      | —     |   |   |   | — |   |   | — |   | 6,742 |   |
| Night Vision Equipment Co. (NVEC)                                      |       |                                    | 12/14/04   |                                                        |       |                   | —     |                              |       |                                | 4,564      |      |       |      | —     |   |   |   | — |   |   | — |   | 4,564 |   |
| Total payments pursuant to  business combinations                 |       |                                    |       |                                                        |       |                   | $          | 1,383,201                         |       |                                |       | $         | 11,306     |      |       |   | $ | 5,428 |   |   |   | $ | 25,761 |   |   | $ | — |   | $ | 1,425,696 |   |
| **Fiscal 2005**                                                        | ** ** |                                    |       |                                                        | ** ** |                   |       |                              |       |                                |       |      |       |      |       |   |   |   |   |   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Electro Mechanical Systems  unit of Lockheed Martin Co. (DRS SSS) |       |                                    | 9/28/01    |                                                        |       |                   | $          | —                            |       |                                |       | $         | —     |      |       |   | $ | — |   |   |   | $ | — |   |   | $ | (500 | ) | $ | (500 | ) |
| DKD, Inc (Nytech)                                                      |       |                                    | 10/15/02   |                                                        |       |                   | —     |                              |       |                                | 3,118      |      |       |      | —     |   |   |   | — |   |   | — |   | 3,118 |   |
| Night Vision Equipment Co. (NVEC)                                      |       |                                    | 12/14/04   |                                                        |       |                   | 42,500     |                              |       |                                | —     |      |       |      | 4,655      |   |   |   | 66 |   |   | — |   | 47,221 |   |
| Total payments pursuant to  business combinations                 |       |                                    |       |                                                        |       |                   | $          | 42,500                            |       |                                |       | $         | 3,118      |      |       |   | $ | 4,655 |   |   |   | $ | 66 |   |   | $ | (500 | ) | $ | 49,839 |   |
| **Fiscal 2004**                                                        | ** ** |                                    |       |                                                        | ** ** |                   |       |                              |       |                                |       |      |       |      |       |   |   |   |   |   | ** ** | ** ** | ** ** | ** ** | ** ** |
| SES Business of the Boeing  Company                                    |       |                                    | 9/28/01    |                                                        |       |                   | $          | —                            |       |                                |       | $         | —     |      |       |   | $ | — |   |   |   | $ | 75 |   |   | $ | — |   | $ | 75 |   |
| Navy Controls Division of  Eaton Corporation                           |       |                                    | 7/1/02     |                                                        |       |                   | —     |                              |       |                                | —     |      |       |      | —     |   |   |   | 292 |   |   | — |   | 292 |   |
| DKD, Inc (Nytech)                                                      |       |                                    | 10/15/02   |                                                        |       |                   | —     |                              |       |                                | —     |      |       |      | —     |   |   |   | 6 |   |   | — |   | 6 |   |
| Paravant Inc.                                                          |       |                                    | 11/27/02   |                                                        |       |                   | —     |                              |       |                                | —     |      |       |      | —     |   |   |   | 1,559 |   |   | (2,501 | ) | (942 | ) |
| Kaman Electromagnetics Development Center                         |       |                                    | 12/27/02   |                                                        |       |                   | —     |                              |       |                                | —     |      |       |      | —     |   |   |   | 73 |   |   | — |   | 73 |   |
| Power Technology Inc.                                                  |       |                                    | 2/14/03    |                                                        |       |                   | —     |                              |       |                                | 4,000      |      |       |      | 547        |   |   |   | 72 |   |   | — |   | 4,619 |   |
| Integrated Defense  Technologies, Inc.                                 |       |                                    | 11/04/03   |                                                        |       |                   | 233,810    |                              |       |                                | —     |      |       |      | —     |   |   |   | 5,226 |   |   | 7,170 |   | 246,206 |   |
| Total  payments pursuant to business combinations                 |       |                                    |       |                                                        |       |                   | $          | 233,810                           |       |                                |       | $         | 4,000      |      |       |   | $ | 547 |   |   |   | $ | 7,303 |   |   | $ | 4,669 |   | $ | 250,329 |   |

 

The followingtable summarizes the net cash received from the sale of certain businesses forthe year ended March 31, 2005:

| **Fiscal 2005 Divestiture**             | ** ** | ** ** | ** ** | **Date of  Transaction** | ** ** | **Amount** | ** ** |
|---------------------------------------------------|------------|------------|------------|-------------------------------|------------|------------|------------|
| ** **                                        | ** ** | ** ** | ** ** | **(in thousands)**       | ** ** |
| DRS Weather Systems and  DRS Broadcast Technology |       |       | 3/10/05    |                          |       |       | $          | 29,096 |   |   |
|                                                   |            |            |            |                               |            |            |            |  |  |  |  |  |

 

Our long-term growth strategy includes a disciplinedprogram of acquiring companies that are both strategic to our business andexpected to be accretive to our earnings. Continuation of our acquisitionprogram will depend, in part, on the availability of financial resources at acost of capital that is acceptable to us. We would expect to utilize cashgenerated by operations, as well as cash available under our credit facility,which also may include the renegotiation of our credit limit to finance suchacquisitions. Other sources of capital could include the issuance of our commonstock and the placement of debt. We continually evaluate the capital marketsclimate and may access such markets when the circumstances appear favorable tous. We believe that sufficient capital resources will be available to us fromone or several of these sources to finance future acquisitions that wedetermine to be strategic and accretive to our net earnings. However, noassurances can be made that such financing will be available and at a cost thatis acceptable to us, that we will identify acceptable acquisition candidates,or that such acquisitions will be accretive to earnings.

We paid $43.2 million for capital improvementsmade primarily to our manufacturing facilities and equipment during fiscal2006, as compared with $34.5 million and $24.4 million for the fiscalyears ended 2005 and 2004, respectively. We expect capital expenditures of 

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approximately $50 million to$60 million in fiscal 2007, as we continue to upgrade our facilities, aswell as manufacturing and engineering capabilities.

**Financing Activities**   Forthe fiscal years ended March 31, 2006, 2005 and 2004, net cash provided byfinancing activities of continuing operations provided $1,004.2 million,$164.9 million and $131.6 million, respectively, as detailed below:

| ** **                                                          | ** ** | **Year Ended March 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                          | ** ** | **(in thousands)**                 | ** ** |
| Sources of Cash                                                     |       |                                    |       |   |   |   |   |
| Proceeds  from senior subordinated notes                            |       | $                                       | 945,000    |   | $ | 210,000 |   | $ | 350,000 |   |
| Receipt  of advance interest on senior subordinated notes           |       | —                                  |       | 1,986 |   | — |   |
| Term  loans                                                         |       | 275,000                                 |       | — |   | 236,000 |   |
| Borrowings  from revolving line of credit                           |       | 40,000                                  |       | — |   | — |   |
| Stock  option exercises                                             |       | 12,540                                  |       | 8,097 |   | 1,970 |   |
| Borrowings  of other debt                                           |       | 9,853                                   |       | — |   | — |   |
| Total                                                               |       | 1,282,393                               |       | 220,083 |   | 587,970 |   |
| Uses of Cash                                                        |       |                                    |       |   |   |   |   |
| Discretionary  payments of DRS term loans                           |       | (165,690                                | )          | (45,000 | ) | (231,451 | ) |
| Scheduled  payments of DRS term loan                                |       | (1,770                                  | )          | (2,360 | ) | (2,254 | ) |
| Repayment  of IDT term loan                                         |       | —                                  |       | — |   | (200,776 | ) |
| Scheduled  payment on Nytech Note                                   |       | —                                  |       | (3,000 | ) | (5,000 | ) |
| Payments  on ESSI short-term debt                                   |       | (76,300                                 | )          | (82 | ) | (521 | ) |
| Payments  on other debt                                             |       | (348                                    | )          | (547 | ) | (611 | ) |
| Dividends                                                           |       | (3,705                                  | )          | — |   | — |   |
| Return  of advanced interest on senior subordinated notes           |       | (1,986                                  | )          | — |   | — |   |
| Debt  and bond issuance costs                                       |       | (28,372                                 | )          | (4,193 | ) | (15,744 | ) |
| Total                                                               |       | (278,171                                | )          | (55,182 | ) | (456,357 | ) |
| Net Cash Provided by  Financing Activities of Continuing Operations |       | $                                       | 1,004,222  |   | $ | 164,901 |   | $ | 131,613 |   |

 

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 syndicateof lenders (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. Weare permitted, on no more than two occasions, to increase the aggregate amountof the Credit Facility by up to $250.0 million, subject to certainrestrictions. Any increase in the aggregate amount of the Credit Facility maybe borrowed in the form of either additional term loans or available amountsunder the revolving line of credit. The Credit Facility is guaranteed bysubstantially all of our domestic subsidiaries. In addition, it iscollateralized by liens on substantially all of the assets of our subsidiaryguarantors’ and certain of our other subsidiaries’ assets and by a pledge of aportion of certain of our non-guarantor subsidiaries’ capital stock. The termloan and the revolving credit facility mature on January 31, 2013 and2012, respectively. 

We previously had a credit facility for up to anaggregate amount of $411.0 million. The credit facility consisted of a$175.0 million senior secured revolving line of credit and a$236.0 million senior secured term loan. During the week of January 9,2006, we prepaid the remaining $135.7 million balance of our term loans at ourdiscretion and recognized a $1.1 million charge to interest and relatedexpenses in the fourth quarter of fiscal 2006 for the write-off of the balanceof the term loan debt issuance costs, net of the recognition of a previouslydeferred gain for the termination of related interest rate swap agreements. Therewere no 

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outstanding borrowings under the previousrevolving credit facility at the time that we entered into the new CreditFacility.

Borrowings under the new Credit Facility generallybear interest at our option at either: 1) “base rate,” which is defined as thehigher of (a) the prime rate or (b) the federal funds rate plus 0.50%,plus the applicable margin; or 2) the LIBOR rate, plus the applicable margin.Revolving credit loans that are base rate loans bear interest at the base rateplus a margin ranging from 0.00% to 0.50% per annum, depending on our totalleverage ratio (TLR), as the term is defined in the credit agreement, at thetime of determination. Revolving credit loans that are LIBOR rate loans bearinterest at LIBOR plus a margin ranging from 1.00% to 1.75% per annum,depending on our TLR. Term loans that are base rate loans bear interest at thebase rate plus 0.25%, and term loans that are LIBOR rate loans bear interest atLIBOR plus 1.50%. 

We pay commitment fees calculated on the average dailyunused portion of our revolving line of credit at a rate ranging from 0.375%and 0.50% per annum, depending on our TLR. We pay commissions and issuance feeson our outstanding letters of credit and are obligated to pay or reimburse theissuing lender for such normal and customary costs and expenses incurred orcharged by the issuing lender in issuing, effecting payment under, amending orotherwise administering any letter of credit. Letter-of-credit commissions arecalculated at a rate ranging from 1.00% to 1.75% per annum, depending on ourTLR ratio at the time of issuance, multiplied by the face amount of such letterof credit. Letter-of-credit issuance fees are charged at 0.125% per annum,multiplied by the face amount of such letter of credit. Both letter-of-creditcommissions and issuance fees are paid quarterly. 

There are certain covenants and restrictions placed onDRS under the Credit Facility, including, but not limited to, quarterlyfinancial covenants specifying maximum total leverage ratio, maximum seniorleverage ratio, and minimum fixed charge coverage ratio beginning with thequarter ending June 30, 2006, and restrictions  or limitations on acquisitions andinvestments, equity issuances, sales of assets, dividends that the Company maybe declare and pay on its common stock, issuance of additional debt ormodifications of existing debt, incurrence of liens and capital expenditures.

The principal amount of any outstanding revolvingcredit loans is due and payable in full on January 31, 2012, the sixthanniversary of the closing date of the Credit Facility. We are required torepay the aggregate outstanding principal amount of the initial term loanborrowings ($275.0 million) in consecutive quarterly installments on the lastbusiness day of each of December, March, June and September, commencingJune 30, 2006. From June 30, 2006 through March 31, 2012, eachsuch principal payment is $0.7 million. Each principal payment from June 30,2012 through January 31, 2013 is $64.6 million.

As of March 31, 2006, $275.0 million of termloans and $40.0 million of the revolving line of credit borrowings wereoutstanding against the Credit Facility. The weighted average interest rate onour term loan borrowings was 6.3%, as of March 31, 2006 (4.4% on previousterm loans as of March 31, 2005). The weighted average interest rate underthe revolving line of credit borrowings was 6.2%. There were no borrowingsunder the revolving line of credit at March 31, 2005.

From time to time, we enter into standbyletters-of-credit and bank guarantee agreements with financial institutions andcustomers, primarily relating to the guarantee of our future performance oncertain contracts to provide products and services and to secure advancepayments we have received from our customers. As of March 31, 2006,$38.8 million was contingently payable under letters of credit and bankguarantees. Of this amount approximately $0.9 million and$0.5 million in letters of credit and bank guarantees, respectively, as ofMarch 31, 2006 were issued under IDT’s previous credit agreement and by abank agreement for 

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our U.K. subsidiary, respectively,and are not considered when determining the availability under our revolvingline of credit.

On March 29, 2006, DRS Technologies CanadaCompany (DRS Canada) established a five-year senior secured term loan forapproximately $9.9 million (C$11.5 million) maturing on April 1, 2011. Theproceeds of the loan were utilized in order to permit repatriation of certainamounts from Canada to the U.S., which were subject to more favorable tax treatmentunder the American Jobs Creation Act (for further information see Notes 1.R and10.) The term loan bears interest at our option at either: (i) prime rateor (ii) LIBOR rate plus 1.75%. We are required to repay aggregateoutstanding principal of approximately C$575.0 thousand on the first businessday of every January, April, July and October commencing July 1,2006. The term debt under the agreement ranks senior in priority of payment toall subordinated debt of DRS. The debt is collateralized by the assets of DRS Canadaand guaranteed by DRS Technologies, Inc.

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 notesdue 2016, $250.0 million aggregate principal amount of 75¤8% seniorsubordinated notes due 2018 (collectively the January 2006 Notes) and $300.0million aggregate principal amount of 2.0% convertible senior notes due 2026(Convertible Notes). On February 8, 2006, we sold an additional $45.0million of Convertible Notes, pursuant to an over-allotment option exercised bythe initial purchasers of the Convertible Notes. The net proceeds of the January 2006Notes and the Convertible Notes, together with a portion of our available cashand initial borrowings under the Credit Facility, were used to fund the ESSIacquisition, repay certain of ESSI’s outstanding indebtedness, and pay relatedfees and expenses.

The January 2006 Notes are unsecured. The 75¤8%senior subordinated notes rank behind the Credit Facility, the 65¤8% senior notesand the Convertible Notes, other than trade payables and is pari passu with the67¤8%senior subordinated notes.

The January 2006 Notes pay interest semi-annuallyin arrears on February 1 and August 1, commencing August 1, 2006.The net proceeds of the offering of the January 2006 Notes were $588.0million, after deducting $12.0 million in commissions and fees related to theofferings. The January 2006 Notes were issued under indentures with TheBank of New York. Subject to a number of exceptions, the indentures restrictour ability and the ability of our subsidiaries to incur more debt, paydividends and make distributions, make certain investments, repurchase stock,create liens, enter into transactions with affiliates, enter into salelease-back transactions, merge or consolidate, and transfer or sell assets. TheJanuary 2006 Notes are unconditionally guaranteed, jointly and severally,by certain of our existing and future domestic subsidiaries. See Note 15, “Guarantorand Non-guarantor Financial Statements,” for additional disclosures.

At any time prior to February 1, 2009, we may onany one or more occasions redeem up to 35% of the aggregate principal amount ofthe 65¤8%senior notes and 75¤8%senior subordinated notes with the net cash proceeds of one or more equityofferings at a redemption price of 106.625% and 107.625%, respectively, of theprincipal amount, plus accrued and unpaid interest, if any, subject to certainrestrictions.

At any time prior to February 1, 2011, we mayredeem the 65¤8%senior notes and 75¤8%senior subordinated notes for cash at our option, in whole or in part, at anytime or from time to time at a redemption price equal to the greater of (1) 100%of the principal amount of the January 2006 Notes being redeemed and (2) thesum of (a) the present values of 103.313% of the principal amount of the 65¤8%senior notes and 103.813% of the principal amount of the 75¤8% seniorsubordinated notes being redeemed and (b) the scheduled payments ofinterest on the respective January 2006 Notes discounted to the date ofredemption, together with accrued and unpaid interest, if any.

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On or after February 1,2011, we may redeem, at our option, all or a part of the January 2006 Notesat the redemption prices (expressed as percentages of principal amount) setforth below plus accrued and unpaid interest, if any:

| **Year**            | ** ** | ** ** | ** ** | **6**5¤8% Senior  Notes: | ** ** | **7**5¤8% Senior  Subordinated  Notes: | ** ** |
|---------------------|------------|------------|------------|------------------------------------|------------|--------------------------------------------------|------------|
| 2011                |       |       | 103.313    | %                                  |       |                                             | 103.813    | % |   |
| 2012                |       |       | 102.209    | %                                  |       |                                             | 102.542    | % |   |
| 2013                |       |       | 101.105    | %                                  |       |                                             | 101.271    | % |   |
| 2014 and thereafter |       |       | 100.000    | %                                  |       |                                             | 100.000    | % |   |

 

In certain instances of a changein control, the Company must offer to repurchase all or part of the January 2006Notes at a redemption price equal to 101% of the principal amount.

The net proceeds of the offeringof the Convertible Notes, including the over-allotment, were $337.2 millionafter deducting $7.8 million in commissions and fees related to the offering. Certainof our existing and future domestic subsidiaries unconditionally guarantee ourpayment obligations under the Convertible Notes, jointly and severally, on asenior unsecured basis. See Note 15, “Guarantor and Non-guarantorFinancial Statements,” for additional disclosures. The Convertible Notes willmature on February 1, 2026, unless earlier converted, redeemed orrepurchased. The Convertible Notes pay interest semi-annually in arrears onFebruary 1 and August 1, commencing August 1, 2006.

Commencing with the six-monthperiod beginning on February 1, 2011, we will pay contingent interest tothe holders of the Convertible Notes during any six-month period from February 1to July 31, and from August 1 to January 31, if the market priceof a Convertible Note, for each of the five trading-day period ending on thethird trading day immediately preceding an interest payment date equals 120% ormore of the principal amount of the Convertible Note. The amount of anycontingent interest payable will equal 0.50% per annum of the average marketprice of a convertible note for the five trading-day period. The contingentinterest feature of the Convertible Notes represents an embedded derivativeinstrument, as it is based on the market price of a convertible note. The valueof the contingent interest feature is zero at the date of the issuance of theConvertible Notes and March 31, 2006. The amount recorded for the embeddedderivative will be adjusted periodically through interest expense for materialchanges in its fair value.

The shares of DRS common stockthat may be issued, if any, upon conversion of the Convertible Notes may beregistered or unregistered shares. At the date of issuance, the underlyingshares of DRS common stock have been registered through an automaticallyeffective registration statement filed with the Securities and ExchangeCommission. We are obligated to use our reasonable best efforts to maintainsuch registration for two years or pay “additional interest” ranging from 0.25%to 1.00% per annum on the principal of the Convertible Notes.

Upon conversion of a ConvertibleNote, we will deliver cash in an amount equal to the lesser of (a) theprincipal amount of the notes surrendered for conversion and (b) theconversion value (the applicable conversion rate multiplied by the average ofthe closing prices of DRS common stock for a defined 20-day period), and if theconversion value is greater than the principal amount, an amount of DRS commonstock equal to such excess. The initial conversion value is based on aconversion rate of 16.7504 shares per $1,000 principal amount of ConvertibleNotes (representing a conversion price of approximately $59.70 per share of DRScommon stock), subject to adjustment under certain circumstances.

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On or prior toFebruary 1, 2010, the Convertible Notes may be converted by the holderonly under the following circumstances:

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

·       Duringprescribed periods, upon the occurrence of specified corporate transactions orfundamental changes, as the term is described in the Convertible Noteagreement; or

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

After February 1,2010, the Convertible Notes may be converted by the holder into cash andshares, if any, of our common stock, only under the following circumstances:

·       Duringany calendar quarter (and only during such calendar quarter) commencing after December 31,2009, if the closing sale price of our common stock for at least 20 tradingdays in the period of 30 consecutive trading days ending on the last tradingday of the preceding calendar quarter is greater than or equal to 110% of theapplicable conversion price;

·       Onor after February 1, 2025;

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

·       Duringprescribed periods, upon the occurrence of specified corporate transactions or “fundamentalchanges,” as the term is defined in the Convertible Note agreement; or

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

We may redeem the ConvertibleNotes in whole or in part for cash with proper notice at any time on or after February 1,2009 and prior to February 4, 2011, if the sale price of our common stockhas exceeded 130% of the conversion price for at least 20 trading days in anyconsecutive 30-day trading period ending on the trading day prior to providingnotice of redemption, at a redemption price equal to 100% of the principalamount of the Convertible Notes to be redeemed plus any accrued and unpaidinterest (including contingent interest and additional interest, if any) up tobut not including the redemption date and a ‘‘make-whole’’ premium. Themake-whole premium is payable only in cash equal to the present value of allremaining scheduled payments of interest on the Convertible Notes to beredeemed through February 2011.

We may, at any time after February 4,2011, redeem the Convertible Notes in whole or in part for cash at a redemptionprice equal to 100% of the principal amount of the Convertible Notes to beredeemed plus any accrued and unpaid interest (including contingent interestand additional interest, if any).

Holders have the right to requireus to purchase all or a portion of their Convertible Notes for cash on February 1,2011, February 1, 2016 and February 1, 2021, at a purchase priceequal to 

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100% of theprincipal amount of the Convertible Notes plus accrued and unpaid interest(including additional interest, if any).

On October 30, 2003, weissued $350.0 million aggregate principal amount of 67¤8%senior subordinated notes, due November 1, 2013 (the October 2003Notes). Interest is payable every six months on May 1 and November 1,which commenced on May 1, 2004. The net proceeds from the offering of the October 2003Notes were $341.2 million, after deducting $8.8 million incommissions and fees related to the offering. 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 IDT acquisition,repay certain of our and IDT’s outstanding indebtedness, and pay related feesand expenses. The October 2003 Notes were issued under an indenture withThe Bank of New York. Subject to a number of exceptions, the indenture restrictsour ability and the ability of our subsidiaries to incur more debt, paydividends and make distributions, make certain investments, repurchase stock,create liens, enter into transactions with affiliates, enter into salelease-back transactions, merge or consolidate, and transfer or sell assets. TheOctober 2003 Notes are unconditionally guaranteed, jointly and severally,by certain of our current and future wholly-owned domestic subsidiaries.The foreign subsidiaries and certain domestic subsidiaries of DRS do notguarantee October 2003 Notes. See Note 15, “Guarantor andNon-guarantor Financial Statements,” for additional disclosures.

On December 23, 2004, weissued an additional $200.0 million aggregate principal amount of 67¤8%Senior Subordinated Notes due November 2013 (December 2004 Notes).The December 2004 Notes were offered as additional debt securities underour indenture with the Bank of New York with identical terms and the sameguarantors as the October 2003 Notes. The December 2004 Notes werepriced at 105% of the principal amount, reflecting an effective interest rateof approximately 6.13%. The net proceeds of the offering were approximately$208.3 million (including $2.0 million of advanced interest on thenew notes that had accrued from November 1, 2004 to December 23,2004), after deducting $3.7 million in commissions and other costs relatedto the debt issuance.

At any timeprior to November 1, 2006, we may on any one or more occasions redeem upto 35% of the aggregate principal amount of the 67¤8% seniorsubordinated notes issued with the net cash proceeds of one or more equityofferings at a redemption price of 106.875% of the principal amount, plusaccrued and unpaid interest, if any, subject to certain restrictions. On orafter November 1, 2008, we may redeem, at our option, all or a part of the67¤8%senior subordinated notes at the redemption prices (expressed as percentages ofprincipal amount) set forth below, plus accrued and unpaid interest andliquidating damages, if any:

| **Year**            | ** ** | ** ** | ** ** | **Percentage** | ** ** |
|---------------------|------------|------------|------------|----------------|------------|
| 2008                |       |       | 103.438    | %              |       |
| 2009                |       |       | 102.292    | %              |       |
| 2010                |       |       | 101.146    | %              |       |
| 2011 and thereafter |       |       | 100.000    | %              |       |

 

At March 31, 2006 other debt consists of amortgage on our Palm Bay, Florida facility of $2.8 million, $0.8 millionfor certain notes payable to the former owners of DRS MobilizedSystems, Inc. and $1.3 million of debt at our DRS Pivotal Power businessunit. At March 31, 2005 other debt consists of a mortgage on our Palm Bay,Florida facility of $3.0 million and $0.1 million of capital leases.

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The aggregate maturities oflong-term debt for fiscal 2007, 2008, 2009, 2010 and 2011 are $4.6 million,$5.1 million, $5.5 million, $5.3 million and $5.0 millionper year, respectively, and $1.8 billion thereafter.

**Free cashflow**   Free cash flow represents net cash providedby operating activities of continuing operations less capital expenditures. Freecash flow for the fiscal year ended March 31, 2006 was$113.9 million, or $12.2 million greater than free cash flow of$101.7 million for fiscal 2005. Free cash flow for the fiscal year ended March 31,2005 was $101.7 million, or $21.4 million greater than free cash flow of$80.3 million for fiscal 2004. See Use of Non-GAAP Financial Measuresbelow for additional discussion and information.

**EBITDA**   Earningsfrom continuing operations before net interest and related expenses (primarilythe amortization and write-off of debt premium and issuance costs), incometaxes, depreciation and amortization (EBITDA) for the year ended March 31,2006 was $239.4 million, or $58.2 million greater than $181.2 millionfor fiscal 2005. EBITDA for the year ended March 31, 2005 was$181.2 million, or $51.9 million greater than $129.3 million fromfiscal 2004. See use of Non-GAAP Financial Measures below for additionaldiscussion and information.

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

**Contractual Obligations**   Ourcontractual obligations and commitments principally include obligationsassociated with our outstanding indebtedness and future minimum operating leaseobligations, as set forth in the table below:

| ** **                    | ** ** | ** **              | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------|------------|-------------------------|------------|-------------------------------------------|------------|
| ** **                    | ** ** | **Total**               | ** ** | **Less than  year**                  | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                    | ** ** | **(in thousands)** | ** ** |
| Long-term debt                |       | $                       | 1,824,808  |                                      |       | $ | 4,622 |   |   | $ | 10,606 |   | $ | 10,341 |   | $ | 1,799,239 |   |
| Operating lease commitments   |       | 108,830                 |       |                                      | 29,942     |   |   | 37,255 |   | 19,995 |   | 21,638 |   |
| Acquisition earn-outs(A)      |       | 36,525                  |       |                                      | 14,789     |   |   | 21,736 |   | — |   | — |   |
| Purchase obligations(B)       |       | 44,270                  |       |                                      | 37,137     |   |   | 7,117 |   | 16 |   | — |   |
| Total contractual obligations |       | $                       | 2,014,433  |                                      |       | $ | 86,490 |   |   | $ | 76,714 |   | $ | 30,352 |   | $ | 1,820,877 |   |

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

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

We enter into standbyletter-of-credit agreements and bank guarantee agreements with financialinstitutions and customers primarily relating to the guarantee of our futureperformance on certain contracts to provide products and services and to secureadvance payments we have received from certain international customers. At March 31,2006, we had contingent liabilities on outstanding letters of credit as follows:

| ** **                | ** ** | **Contingent Payments Due by Period** | ** ** |
|---------------------------|------------|-----------------------------------------------------------|------------|
| ** **                | ** ** | **Total**                                                 | ** ** | **Within  1 Year** | ** ** | **1-3 Years** | ** ** | **After  3 Years** | ** ** |
| ** **                | ** ** | **(in thousands)**                                   | ** ** |
| Standby letters of credit |       | $                                                         | 38,293     |   | $ | 35,065 |   |   | $ | 3,228 |   |   |   | $ | — |   |   |
| Bank guarantees           |       | $                                                         | 526        |   | $ | 526 |   |   | $ | — |   |   |   | $ | — |   |   |

** **

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**Backlog**   Fundedbacklog represents products or services that our customers have committed bycontract to purchase from us. Due to the general nature of defense procurementand contracting, the operating cycle for our military business typically hasbeen long term. Military backlog currently consists of various production andengineering development contracts with varying delivery schedules and projecttimetables. Our backlog also includes a significant amount of commercialoff-the-shelf (COTS)-based systems for the military, which have shorterdelivery times. Accordingly, revenues for a particular year, or year-to-yearcomparisons of reported revenues and related backlog positions, may not beindicative of future results.

Backlog at March 31, 2006 was $2.4 billion, ascompared with $1.3 billion at March 31, 2005. We booked$2.2 billion in new orders in fiscal 2006. The increase in backlog was dueto the net effect of bookings and $695.4 million of acquired backlogobtained through our fiscal 2006 acquisitions of Walkabout, Codem and ESSI.Approximately 74% of backlog, as of March 31, 2006, is expected to resultin revenues during fiscal 2007.

**InternalResearch and Development**   In addition to customer-sponsoredresearch and development, we also engage in internal research and development.These expenditures reflect our continued investment in new technology anddiversification of our products. Expenditures for internal research anddevelopment in fiscal 2006, 2005 and 2004 were $47.6 million,$38.9 million and $27.4 million, respectively.

**Use of Non-GAAP Financial Measures****  **Certain disclosures in this documentinclude “non-GAAP (Generally Accepted Accounting Principles) financialmeasures.” A non-GAAP financial measure is defined as a numerical measure of theCompany’s financial performance that excludes or includes amounts so as to bedifferent than the most directly comparable measure calculated and presented inaccordance with GAAP in our Consolidated Balance Sheets, Statements of Earningsor Statements of Cash Flows. The components of EBITDA and a reconciliation ofEBITDA and “free cash flow” with the most directly comparable GAAP measurefollows:

| ** **                                                                                          | ** ** | **Year Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                          | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                          | ** ** | **(in thousands)**                 | ** ** |
| Earnings from continuing  operations                                                                |       | $                                       | 81,494     |   | $ | 58,126 |   | $ | 43,542 |   | $ | 30,171 |   | $ | 20,331 |   |
| Income taxes                                                                                        |       | 51,994                                  |       | 44,842 |   | 33,789 |   | 25,701 |   | 18,030 |   |
| Interest income                                                                                     |       | (7,253                                  | )          | (2,460 | ) | (754 | ) | (1,179 | ) | (1,144 | ) |
| Interest and related  expenses                                                                      |       | 64,186                                  |       | 39,750 |   | 24,259 |   | 10,589 |   | 10,954 |   |
| Depreciation and  amortization                                                                      |       | 48,985                                  |       | 40,968 |   | 28,436 |   | 16,614 |   | 13,789 |   |
| EBITDA(A)                                                                                           |       | 239,406                                 |       | 181,226 |   | 129,272 |   | 81,896 |   | 61,960 |   |
| Income taxes                                                                                        |       | (51,994                                 | )          | (44,842 | ) | (33,789 | ) | (25,701 | ) | (18,030 | ) |
| Interest income                                                                                     |       | 7,253                                   |       | 2,460 |   | 754 |   | 1,179 |   | 1,144 |   |
| Interest and related  expenses                                                                      |       | (64,186                                 | )          | (39,750 | ) | (24,259 | ) | (10,589 | ) | (10,954 | ) |
| Deferred income taxes                                                                               |       | 15,454                                  |       | 24,660 |   | (5,558 | ) | 203 |   | (4,195 | ) |
| Changes in assets and  liabilities, net of effects from business combinations and divestitures |       | 1,219                                   |       | 4,708 |   | 32,743 |   | 585 |   | (2,723 | ) |
| Other, net                                                                                          |       | 9,910                                   |       | 7,721 |   | 5,554 |   | 4,435 |   | 647 |   |
| Net cash provided by operating activities of continuing operations                                  |       | 157,062                                 |       | 136,183 |   | 104,717 |   | 52,008 |   | 27,849 |   |
| Capital expenditures                                                                                |       | (43,194                                 | )          | (34,521 | ) | (24,444 | ) | (21,526 | ) | (13,583 | ) |
| Free cash flow(B)                                                                                   |       | $                                       | 113,868    |   | $ | 101,662 |   | $ | 80,273 |   | $ | 30,482 |   | $ | 14,266 |   |

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(A)          We define EBITDA as netearnings from continuing operations before net interest and related expenses(principally amortization and write-off of debt premium and issuance costs),income taxes, depreciation and amortization. The table above presents thecomponents of 

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EBITDA and a reconciliation of EBITDA to net cashprovided by operating activities of continuing operations. EBITDA is presentedas additional information because we believe it to be a useful indicator of ourdebt capacity and our ability to service our debt. EBITDA is not a substitutefor operating income, net earnings or cash flows from operating activities ofcontinuing operations, as determined in accordance with GAAP. EBITDA is not acomplete net cash flow measure because EBITDA is a measure of liquidity thatdoes not reflect cash flows from discontinued operations, and does not includereductions for cash payments for an entity’s obligation to service its debt,fund its working capital, business acquisitions and capital expenditures, andpay its income taxes. Rather, EBITDA is one potential indicator of an entity’sability to fund these cash requirements. EBITDA also is not a complete measureof an entity’s profitability because it does not include costs and expenses fordepreciation and amortization, interest and related expenses and income taxes,and it also does not include the results of operations of discontinuedoperations. EBITDA, as we defined it, may differ from similarly named measuresused by other entities and, consequently, could be misleading unless allentities calculate and define EBITDA in the same manner.

(B)           Freecash flow is defined as net cash provided by operating activities of continuingoperations less capital expenditures. We disclose free cash flow because webelieve that it is useful in evaluating our financial performance and measuringcash flows generated that are available for investing and financing activities.We believe that the most directly comparable GAAP financial measure to freecash flow is net cash provided by operating activities of continuing operations.Free cash flow represents cash generated after paying for interest onborrowings, income taxes, capital expenditures and changes in working capital,but before repaying outstanding debt, investing cash to acquire businesses andmaking other strategic investments, and it does not reflect cash flows ofdiscontinued operations. Thus, key assumptions underlying free cash flow are thatwe will be able to refinance our existing debt when it matures with new debtand that we will be able to finance any new acquisitions we make by raising newdebt or equity capital. We also use free cash flow as a performance measure anda component of our management incentive compensation program. Free cash flow,as we define it, may differ from similarly named measures used by otherentities and, consequently, could be misleading unless all entities calculateand define free cash flow in the same manner.

**Item 7A.**           Quantitativeand Qualitative Disclosures About Market Risk

**Market Risk**   Inthe normal course of business, we are exposed to market risks relating tofluctuations in interest rates and foreign currency exchange risk.

**Interest RateRisk**   Simultaneously with the closing of ouracquisition of ESSI on January 31, 2006, the Company entered into anamended and restated senior secured credit facility for up to an aggregateamount of $675.0 million, replacing the Company’s then existing creditfacility. The amended and restated senior secured credit facility consists of (i) aseven-year term loan facility in an aggregate principal amount equal to $275.0million, with principal repayable in quarterly installments for the first fiveyears at a rate of 1.00% per year and the balance to be repaid in equalquarterly installments beginning six years following the completion of theacquisition, and (ii) a six-year revolving credit facility in an aggregateprincipal amount of $400.0 million, to be repaid in full on the sixthanniversary of the closing date of the facility. Borrowings under the CreditFacility generally bear interest as either: 1) “base rate” loans, which aredefined as the higher of (a) the prime rate or (b) the federal fundsRate plus 0.50%, plus the applicable margin; or 2) LIBOR rate loans plus theapplicable margin. Revolving credit loans that are base rate loans bearinterest at the base rate plus a margin ranging from 0.00% to 0.50% per annum,depending on the Company’s total leverage ratio (TLR), as the term is definedin the credit agreement, at the time of determination. Revolving credit loansthat are LIBOR rate loans bear interest at LIBOR plus a margin ranging from 1.00%to 1.75% per annum, depending on the Company’s TLR. Term 

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loans that are base rate loans bear interest at thebase rate plus 0.25%, and term loans that are LIBOR rate loans bear interest atLIBOR plus 1.50%. 

On March 29, 2006, DRS Technologies Canada Company(DRS Canada) entered into a five-year senior secured term loan forapproximately $9.9 million (C$11.5 million) maturing on April 1, 2011.  The term loan bears interest at our option ateither: 1) prime rate or (ii) LIBOR rate plus 1.75%. We are required to repayaggregate outstanding principal of approximately C$575.0 thousand on the firstbusiness day of every January, April, July and October commencing July 1, 2006.

A 1% increase/decrease in the weighted averageinterest rate on our variable rate debt outstanding at March 31, 2006would result in an increase/decrease in annual interest expense ofapproximately $3.2 million. The carrying values of the Company’s borrowingsunder the amended and restated credit facility and Canadian term loan approximatetheir fair values at March 31, 2006.

Simultaneously with the closing of our acquisition ofESSI, we also entered into $900 million of new debt securities, including $350million aggregate principal amount of 65¤8% senior notes due 2016, $250million aggregate principal amount of 75¤8% senior subordinated notesdue 2018 and $300 million aggregate principal amount of 2.0% senior convertiblenotes due 2026. On February 8, 2006, we sold an additional$45.0 million of convertible senior notes pursuant to an over-allotmentoption exercised by the initial purchasers of the convertible senior notes. Theinterest rates on our senior notes, convertible notes and seniorsubordinated notes are fixed.

The convertible notes contain a contingent interestfeature which represents an embedded derivative instrument, as it is based onDRS’s stock price. The value of the contingent interest was zero at the date ofthe issuance of the Convertible Notes. The amount recorded for the embeddedderivative will be adjusted periodically through interest expense for materialchanges in its fair value.

In connection with our IDT acquisition, on October 30,2003 we issued $350.0 million of 67¤8% SeniorSubordinated Notes, due 2013. On December 23, 2004, we issued anadditional $200.0 million aggregate principal amount of 67¤8% SeniorSubordinated Notes due 2013. The additional notes were offered as additionaldebt securities under the indenture with identical terms as the existing notes.The interest rate on these notes is fixed.

The market-basedfair value of our notes are as follows:

| ** **                | ** ** | **March 31,**      | ** ** |
|---------------------------|------------|-------------------------|------------|
| ** **                | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                | ** ** | **Carrying Value** | ** ** | **Fair Value** | ** ** | **Carrying Value** | ** ** | **Fair Value** | ** ** |
| ** **                | ** ** | **(in thousands)** | ** ** |
| Senior Notes              |       |                    | $          | 350,000 |   |   | $ | 348,250 |   |   | $ | — |   |   | $ | — |   |
| Senior Subordinated Notes |       |                    | $          | 808,585 |   |   | $ | 808,438 |   |   | $ | 559,716 |   |   | $ | 550,000 |   |
| Senior Convertible Notes  |       |                    | $          | 345,000 |   |   | $ | 365,269 |   |   | $ | — |   |   | $ | — |   |

 

**ForeignCurrency Exchange Risk**   We operate and conduct business in foreign countries and,as a result, are exposed to movements in foreign currency exchange rates. Morespecifically, our stockholders’ equity is impacted by the conversion of the netassets of foreign subsidiaries for which the functional currency is not theU.S. dollar for U.S. reporting purposes. Our exposure to foreign currencyexchange risk related to our foreign operations is not material to our resultsof operations, cash flows or financial position. Beginning in January 2006,in order to mitigate the risk associated with certain of these contractsdenominated in foreign currency, we have entered into foreign currency forwardcontracts. We account for these contracts as cash flow hedges. At March 31,2006, the foreign currency forward contracts were immaterial to us.

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**Item 8.**   FinancialStatements and Supplementary Data

**INDEX TOCONSOLIDATED FINANCIAL STATEMENTSAND FINANCIAL STATEMENT SCHEDULE**
|                                                                                                                                              | ** ** | Page |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------|
| Report of Independent  Registered Public Accounting Firm                                                                                     |       | 64   |   |
| Consolidated Balance Sheets as of  March 31, 2006 and 2005                                                                              |       | 65   |   |
| Consolidated Statements of  Earnings for the years ended March 31, 2006, 2005 and 2004                                                  |       | 66   |   |
| Consolidated Statements of  Stockholders’ Equity and Comprehensive Earnings for the years ended  March 31, 2006, 2005 and 2004     |       | 67   |   |
| Consolidated Statements of  Cash Flows for the years ended March 31, 2006, 2005 and 2004                                           |       | 68   |   |
| Notes to Consolidated Financial Statements                                                                                                   |       | 69   |   |
| Financial Statement Schedule—Schedule II—Valuation and  Qualifying Accounts for the years ended March 31, 2006, 2005 and 2004 |       | 127  |   |

 

63

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**Report of IndependentRegistered Public Accounting Firm**

The Board ofDirectors and Stockholders

DRS Technologies, Inc.:

We have audited the accompanying consolidated balancesheets of DRS Technologies, Inc. and subsidiaries as of March 31, 2006 and2005, and the related consolidated statements of earnings, stockholders’ equityand comprehensive earnings, and cash flows for each of the years in thethree-year period ended March 31, 2006. In connection with our audits ofthe consolidated financial statements, we also have audited financial statementschedule II. These consolidated financial statements and the financialstatement schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements and financial statement schedule based on audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financial positionof DRS Technologies, Inc. and subsidiaries as of March 31, 2006 and 2005,and the results of their operations and their cash flows for each of the yearsin the three-year period ended March 31, 2006, in conformity with U.S.generally accepted accounting principles. Also, in our opinion, the relatedfinancial statement schedule, when considered in relation to the basicconsolidated financial statements taken as a whole, presents fairly, in allmaterial respects, the information set forth therein.

We also haveaudited, in accordance with standards of the Public Company AccountingOversight Board (United States), the effectiveness of DRS Technologies, Inc.and subsidiaries’ internal control over financial reporting as ofMarch 31, 2006, based on criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO), and our report dated June 9, 2006 expressed anunqualified opinion on management’s assessment of, and the effective operationof, internal control over financial reporting. This report includes anexplanatory paragraph stating that management excluded from its assessment ofthe effectiveness of DRS Technologies, Inc. and subsidiaries’ internal controlover financial reporting as of March 31, 2006, Engineered Support Systems,Inc.’s and Codem Systems, Inc.’s internal control over financial reportingassociated with total assets of $392.6 million as of March 31, 2006and total revenues of $194.1 million for the year ended March 31, 2006.
| /s/ KPMG LLP            |   |
|-------------------------|--------|
| Short Hills, New Jersey |
| June 9, 2006       |

 

64

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

| ** **                                                                                                                                                                                                                  | ** ** | **March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                                                                                                                                                                                  | ** ** | **2006**           | ** ** | **2005** | ** ** |
| **Assets**                                                                                                                                                                                                                  |       |               |       |   |   |
| Current assets                                                                                                                                                                                                              |       |               |       |   |   |
| Cash and cash equivalents                                                                                                                                                                                                   |       | $                  | 1,293      |   | $ | 306,852 |   |
| Accounts receivable, net                                                                                                                                                                                                    |       | 435,035            |       | 237,912 |   |
| Inventories, net                                                                                                                                                                                                            |       | 331,624            |       | 213,361 |   |
| Prepaid expenses, deferred income taxes and other current assets                                                                                                                                                            |       | 135,613            |       | 42,134 |   |
| Total current assets                                                                                                                                                                                                        |       | 903,565            |       | 800,259 |   |
| Property, plant and equipment, net                                                                                                                                                                                          |       | 220,506            |       | 143,264 |   |
| Acquired intangible  assets, net                                                                                                                                                                                            |       | 231,139            |       | 100,030 |   |
| Goodwill                                                                                                                                                                                                                    |       | 2,608,068          |       | 815,407 |   |
| Deferred income taxes and  other noncurrent assets                                                                                                                                                                          |       | 58,616             |       | 32,901 |   |
| **Total assets**                                                                                                                                                                                                            |       | $                  | 4,021,894  |   | $ | 1,891,861 |   |
| **Liabilities and Stockholders’ Equity**                                                                                                                                                                               |       |               |       |   |   |
| Current liabilities                                                                                                                                                                                                         |       |               |       |   |   |
| Current installments of long-term debt                                                                                                                                                                                      |       | $                  | 4,622      |   | $ | 2,652 |   |
| Accounts payable                                                                                                                                                                                                            |       | 224,673            |       | 111,222 |   |
| Accrued expenses and other current liabilities                                                                                                                                                                              |       | 473,843            |       | 312,421 |   |
| Total current liabilities                                                                                                                                                                                                   |       | 703,138            |       | 426,295 |   |
| Long-term debt, excluding current installments                                                                                                                                                                              |       | 1,828,771          |       | 727,611 |   |
| Other liabilities                                                                                                                                                                                                           |       | 138,405            |       | 66,527 |   |
| **Total liabilities**                                                                                                                                                                                                       |       | 2,670,314          |       | 1,220,433 |   |
| Commitments and  contingencies (Notes 2, 8 and 13)                                                                                                                                                                          |       |               |       |   |   |
| Stockholders’ equity                                                                                                                                                                                                   |       |               |       |   |   |
| Preferred stock, $10 par value. Authorized 2,000,000 shares; none  issued at March 31, 2006 and 2005                                                                                                                   |       | —             |       | — |   |
| Common stock, $.01 par value per share. Authorized 100,000,000 and  50,000,000 shares at March 31, 2006 and 2005, respectively; 39,912,541  and 27,472,495 shares issued at March 31, 2006 and 2005, respectively |       | 399                |       | 275 |   |
| Additional paid-in capital                                                                                                                                                                                                  |       | 1,076,786          |       | 467,027 |   |
| Retained earnings                                                                                                                                                                                                           |       | 277,706            |       | 199,924 |   |
| Accumulated other comprehensive earnings                                                                                                                                                                                    |       | 3,885              |       | 6,198 |   |
| Unamortized stock compensation                                                                                                                                                                                              |       | (7,196             | )          | (1,996 | ) |
| **Total stockholders’ equity**                                                                                                                                                                                         |       | 1,351,580          |       | 671,428 |   |
| **Total  liabilities and stockholders’ equity**                                                                                                                                                                        |       | $                  | 4,021,894  |   | $ | 1,891,861 |   |

 

See accompanying Notes to Consolidated Financial Statements.

65

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

| ** **                                                                                                            | ** ** | **Year ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                            | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenues                                                                                                              |       | $                                       | 1,735,532  |   | $ | 1,308,600 |   | $ | 986,931 |   |
| Costs and expenses                                                                                                    |       | 1,542,822                               |       | 1,165,468 |   | 883,599 |   |
| **Operating income**                                                                                                  |       | 192,710                                 |       | 143,132 |   | 103,332 |   |
| Interest income                                                                                                       |       | 7,253                                   |       | 2,460 |   | 754 |   |
| Interest and related  expenses                                                                                        |       | 64,186                                  |       | 39,750 |   | 24,259 |   |
| Other expense, net                                                                                                    |       | 727                                     |       | 719 |   | 545 |   |
| Earnings from continuing operations before minority interests and  income taxes                                       |       | 135,050                                 |       | 105,123 |   | 79,282 |   |
| Non-controlling interest                                                                                              |       | 1,562                                   |       | 2,155 |   | 1,951 |   |
| Earnings from continuing operations before income taxes                                                               |       | 133,488                                 |       | 102,968 |   | 77,331 |   |
| Income taxes                                                                                                          |       | 51,994                                  |       | 44,842 |   | 33,789 |   |
| Earnings from continuing operations                                                                                   |       | 81,494                                  |       | 58,126 |   | 43,542 |   |
| Earnings from  discontinued operations (including gain   on disposal of $700 in 2005), net of income taxes            |       | —                                  |       | 2,551 |   | 1,178 |   |
| **Net earnings**                                                                                                      |       | $                                       | 81,494     |   | $ | 60,677 |   | $ | 44,720 |   |
| **Net  earnings per share of common stock:**                                                                          |       |                                    |       |   |   |   |   |
| Basic earnings per share                                                                                              |       |                                    |       |   |   |   |   |
| Earnings from continuing operations                                                                                   |       | $                                       | 2.75       |   | $ | 2.15 |   | $ | 1.80 |   |
| Earnings from  discontinued operations (including gain on disposal of $0.03 per share in  2005), net  of income taxes |       | $                                       | —     |   | $ | 0.09 |   | $ | 0.05 |   |
| Net earnings                                                                                                          |       | $                                       | 2.75       |   | $ | 2.24 |   | $ | 1.84 |   |
| Diluted earnings per  share                                                                                           |       |                                    |       |   |   |   |   |
| Earnings from continuing  operations                                                                                  |       | $                                       | 2.67       |   | $ | 2.09 |   | $ | 1.76 |   |
| Earnings from  discontinued operations (including gain on disposal of $0.02 per share in  2005), net  of income taxes |       | $                                       | —     |   | $ | 0.09 |   | $ | 0.05 |   |
| Net earnings                                                                                                          |       | $                                       | 2.67       |   | $ | 2.18 |   | $ | 1.80 |   |
| **Dividends  per common share**                                                                                       |       | $                                       | 0.12       |   | $ | — |   | $ | — |   |

 

See accompanying Notes to Consolidated Financial Statements.

66

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**DRSTECHNOLOGIES, INC. AND SUBSIDIARIESConsolidated Statements of Stockholders’ Equity and Comprehensive Earnings(in thousands, except share data)**

| ** **                                                                                       | ** ** | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **        | ** ** | **Accumulated**            | ** ** | ** **             | ** **  | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|-------------------|------------|----------------------------|------------|------------------------|-------------|------------|------------|
| ** **                                                                                       | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **        | ** ** | **Other**                  | ** ** | **Unamortized**        | ** **  | **Total**  | ** ** |
| ** **                                                                                       | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Retained**   | ** ** | **Comprehensive** | ** ** | **Stock**                  | ** ** | **Stockholders’** | ** **  |
| ** **                                                                                       | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Earnings**      | ** ** | **(Losses) Earnings** | ** ** | **Compensation**       | ** **  | **Equity** | ** ** |
| **Balances  at March 31, 2003**                                                             |       | 22,421,986            |       |        | $          | 224            |       |              | $          | 343,605                    |       | $                      | 94,527      |       |       | $ | (176 | ) |   |   | $ | — |   |   |   | $ | 438,180 |   |   |
| Comprehensive earnings:                                                                          |       |                  |       |        |       |           |       |              |       |                       |       |                   |        |       |       |   |   |   |   |   |   |   |   |
| Net earnings                                                                                     |       | —                |       |        | —     |           |       | —            |       | 44,720                     |       |                   | —      |       |       |   | — |   |   |   | 44,720 |   |   |
| Unrealized gains on  hedging instruments, net of $236 of income taxes                       |       | —                |       |        | —     |           |       | —            |       | —                     |       |                   | 335         |       |       |   | — |   |   |   | 335 |   |   |
| Minimum pension liability,  net of $1,632 income tax benefit                                     |       | —                |       |        | —     |           |       | —            |       | —                     |       |                   | (3,662      | )          |       |   | — |   |   |   | (3,662 | ) |   |
| Foreign currency  translation adjustments                                                        |       | —                |       |        | —     |           |       | —            |       | —                     |       |                   | 6,538       |       |       |   | — |   |   |   | 6,538 |   |   |
| Total comprehensive  earnings                                                                    |       |                  |       |        |       |           |       |              |       |                       |       |                   |        |       |       |   |   |   |   |   | 47,931 |   |   |
| Issuance of shares to  purchase Integrated Defense Technologies, Inc.                            |       | 4,323,172             |       |        | 43         |           |       | 106,090           |       | —                     |       |                   | —      |       |       |   | — |   |   |   | 106,133 |   |   |
| Stock options exercised                                                                          |       | 185,115               |       |        | 2          |           |       | 1,968             |       | —                     |       |                   | —      |       |       |   | — |   |   |   | 1,970 |   |   |
| Income tax benefit from  stock options exercised                                                 |       | —                |       |        | —     |           |       | 1,055             |       | —                     |       |                   | —      |       |       |   | — |   |   |   | 1,055 |   |   |
| Restricted stock grants                                                                          |       | 135,250               |       |        | 2          |           |       | 4,008             |       | —                     |       |                   | —      |       |       |   | (4,010 | ) |   |   | — |   |   |
| Restricted stock  cancellations                                                                  |       | (2,430                | )          |        |       |           |       | (62               | )          |                       |       |                   |        |       |       |   | 62 |   |   |   | — |   |   |
| Compensation relating to  restricted stock                                                       |       | —                |       |        | —     |           |       | —            |       | —                     |       |                   | —      |       |       |   | 356 |   |   |   | 356 |   |   |
| **Balances  at March 31, 2004**                                                             |       | 27,063,093            |       |        | 271        |           |       | 456,664           |       | 139,247                    |       |                   | 3,035       |       |       |   | (3,592 | ) |   |   | 595,625 |   |   |
| Comprehensive earnings:                                                                          |       |                  |       |        |       |           |       |              |       |                       |       |                   |        |       |       |   |   |   |   |   |   |   |   |
| Net earnings                                                                                     |       | —                |       |        | —     |           |       | —            |       | 60,677                     |       |                   | —      |       |       |   | — |   |   |   | 60,677 |   |   |
| Unrealized gains on  hedging instruments, net of $515 of income taxes                       |       | —                |       |        | —     |           |       | —            |       | —                     |       |                   | 754         |       |       |   | — |   |   |   | 754 |   |   |
| Minimum pension liability,  net of $525 income tax benefit                                       |       | —                |       |        | —     |           |       | —            |       | —                     |       |                   | (956        | )          |       |   | — |   |   |   | (956 | ) |   |
| Foreign currency  translation adjustments                                                        |       | —                |       |        | —     |           |       | —            |       | —                     |       |                   | 3,365       |       |       |   | — |   |   |   | 3,365 |   |   |
| Total comprehensive  earnings                                                                    |       |                  |       |        |       |           |       |              |       |                       |       |                   |        |       |       |   |   |   |   |   | 63,840 |   |   |
| Stock options exercised                                                                          |       | 426,742               |       |        | 4          |           |       | 8,093             |       | —                     |       |                   | —      |       |       |   | — |   |   |   | 8,097 |   |   |
| Income tax benefit from  stock options exercised                                                 |       | —                |       |        | —     |           |       | 2,778             |       | —                     |       |                   | —      |       |       |   | — |   |   |   | 2,778 |   |   |
| Restricted stock grants                                                                          |       | 2,400                 |       |        |       |           |       | 69                |       | —                     |       |                   |        |       |       |   | (69 | ) |   |   | — |   |   |
| Restricted stock  cancellations                                                                  |       | (19,740               | )          |        | —     |           |       | (577              | )          | —                     |       |                   | —      |       |       |   | 577 |   |   |   | — |   |   |
| Compensation relating to  restricted stock                                                       |       | —                |       |        | —     |           |       | —            |       | —                     |       |                   | —      |       |       |   | 1,088 |   |   |   | 1,088 |   |   |
| **Balances  at March 31, 2005**                                                             |       | 27,472,495            |       |        | 275        |           |       | 467,027           |       | 199,924                    |       |                   | 6,198       |       |       |   | (1,996 | ) |   |   | 671,428 |   |   |
| Comprehensive earnings:                                                                          |       |                  |       |        |       |           |       |              |       |                       |       |                   |        |       |       |   |   |   |   |   |   |   |   |
| Net earnings                                                                                     |       | **—**            | ** ** | ** **  | **—** | ** **     | ** ** | **—**        |       | **81,494**                 |       | ** **             | **—**  | ** ** | ** ** | ** ** | **—** | ** ** | ** ** | ** ** | **81,494** | ** ** |   |
| Reclassification adjustment  for gain on hedgings instruments, net of $751 of income tax benefit |       | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **        |       | ** **                 |       | ** **             | **(1,052**  | **)**      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **(1,052** | **)** |   |
| Unrealized losses on  hedging instruments, net of $10 of income tax benefit                 |       | **—**            | ** ** | ** **  | **—** | ** **     | ** ** | **—**        |       | **—**                 |       | ** **             | **20**      | ** ** | ** ** | ** ** | **—** | ** ** | ** ** | ** ** | **20** | ** ** |   |
| Minimum pension liability,  net of $1,142 income tax benefit                                     |       | **—**            | ** ** | ** **  | **—** | ** **     | ** ** | **—**        |       | **—**                 |       | ** **             | **(2,646**  | **)**      | ** ** | ** ** | **—** | ** ** | ** ** | ** ** | **(2,646** | **)** |   |
| Foreign currency  translation adjustments                                                        |       | **—**            | ** ** | ** **  | **—** | ** **     | ** ** | **—**        |       | **—**                 |       | ** **             | **1,365**   | ** ** | ** ** | ** ** | **—** | ** ** | ** ** | ** ** | **1,365** | ** ** |   |
| Total comprehensive  earnings                                                                    |       | ** **            | ** ** | ** **  | ** ** | ** **     | ** ** | ** **        |       | ** **                 |       | ** **             | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **79,181** | ** ** |   |
| Dividends declared                                                                               |       | **—**            | ** ** | ** **  | **—** | ** **     | ** ** | **—**        |       | **(3,712**                 | )          | ** **             | **—**  | ** ** | ** ** | ** ** | **—** | ** ** | ** ** | ** ** | **(3,712** | **)** |   |
| Issuance of shares to  purchase Engineered Support Systems, Inc.                            |       | **11,727,566**        | ** ** | ** **  | **117**    | ** **     | ** ** | **587,143**       |       | **—**                 |       | ** **             | **—**  | ** ** | ** ** | ** ** | **—** | ** ** | ** ** | ** ** | **587,260** | ** ** |   |
| Stock options exercised                                                                          |       | **563,620**           | ** ** | ** **  | **5**      | ** **     | ** ** | **12,535**        |       | **—**                 |       | ** **             | **—**  | ** ** | ** ** | ** ** | **—** | ** ** | ** ** | ** ** | **12,540** | ** ** |   |
| Income tax benefit from  stock options exercised                                                 |       | **—**            | ** ** | ** **  | **—** | ** **     | ** ** | **5,540**         |       | **—**                 |       | ** **             | **—**  | ** ** | ** ** | ** ** | **—** | ** ** | ** ** | ** ** | **5,540** | ** ** |   |
| Restricted stock grants                                                                          |       | **166,880**           | ** ** | ** **  | **2**      | ** **     | ** ** | **8,694**         |       | **—**                 |       | ** **             | **—**  | ** ** | ** ** | ** ** | **(8,696** | **)** | ** ** | ** ** | **—** | ** ** |   |
| Restricted stock  cancellations                                                                  |       | **(18,020**           | **)**      | ** **  | **—** | ** **     | ** ** | **(640**          | )          | **—**                 |       | ** **             | **—**  | ** ** | ** ** | ** ** | **640** | ** ** | ** ** | ** ** | **—** | ** ** |   |
| Compensation relating to  restricted stock                                                       |       | **—**            | ** ** | ** **  | **—** | ** **     | ** ** | **—**        |       | **—**                 |       | ** **             | **—**  | ** ** | ** ** | ** ** | **2,856** | ** ** | ** ** | ** ** | **2,856** | ** ** |   |
| Other                                                                                            |       | **—**            | ** ** | ** **  | **—** | ** **     | ** ** | **(3,513**        | )          | **—**                 |       | ** **             | **—**  | ** ** | ** ** | ** ** | **—** | ** ** | ** ** | ** ** | **(3,513** | **)** |   |
| **Balances  at March 31, 2006**                                                             |       | **39,912,541**        | ** ** | ** **  | **$**      | **399**        | ** ** | ** **        | **$**      | **1,076,786**              |       | **$**                  | **277,706** |       | ** ** | **$** | **3,885** | ** ** | ** ** | ** ** | **$** | **(7,196** | **)** | ** ** | ** ** | **$** | **1,351,580** | ** ** |   |

 

See accompanying Notes toConsolidated Financial Statements.

67

 

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

| ** **                                                                                                                             | ** ** | **Year Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                                             | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                             | ** ** | ** **                              | ** ** | **(Revised—see Note 1.D.)** | ** ** |
| **Cash Flows from Operating Activities**                                                                                               |       |                                    |       |   |   |   |   |
| Net earnings                                                                                                                           |       | $                                       | 81,494     |   | $ | 60,677 |   | $ | 44,720 |   |
| Earnings from discontinued  operations                                                                                                 |       | —                                  |       | (2,551 | ) | (1,178 | ) |
| Earnings from continuing  operations                                                                                                   |       | 81,494                                  |       | 58,126 |   | 43,542 |   |
| Adjustments to reconcile net earnings of continuing  operations to cash flows from operating activities of continuing operations: |       |                                    |       |   |   |   |   |
| Depreciation and  amortization                                                                                                         |       | 48,985                                  |       | 40,968 |   | 28,436 |   |
| Restricted stock  amortization                                                                                                         |       | 2,856                                   |       | 1,088 |   | 343 |   |
| Deferred income taxes                                                                                                                  |       | 15,454                                  |       | 24,660 |   | (5,558 | ) |
| Inventory reserves and  provision for doubtful accounts                                                                                |       | 3,147                                   |       | 1,519 |   | 2,159 |   |
| Amortization and write-off  of deferred financing fees                                                                                 |       | 6,632                                   |       | 3,765 |   | 1,645 |   |
| Other, net                                                                                                                             |       | (2,725                                  | )          | 1,349 |   | 1,407 |   |
| Changes in assets and liabilities, net of effects  from business combinations and divestitures:                                        |       |                                    |       |   |   |   |   |
| (Increase) decrease in  accounts receivable                                                                                            |       | (28,554                                 | )          | 155 |   | (322 | ) |
| Increase in inventories                                                                                                                |       | (36,658                                 | )          | (29,819 | ) | (11,476 | ) |
| Decrease (increase) in  prepaid expenses and other current assets                                                                      |       | 2,783                                   |       | 1,073 |   | (2,552 | ) |
| Increase in accounts  payable                                                                                                          |       | 51,008                                  |       | 27,109 |   | 3,124 |   |
| Increase (decrease) in  accrued expenses and other current liabilities                                                                 |       | 10,518                                  |       | (6,725 | ) | 29,082 |   |
| Increase in customer  advances                                                                                                         |       | 2,110                                   |       | 7,200 |   | 21,582 |   |
| Increase (decrease) in  pension and postretirement liability                                                                           |       | 1,338                                   |       | (2,372 | ) | 3,900 |   |
| Other, net                                                                                                                             |       | (1,326                                  | )          | 8,087 |   | (10,595 | ) |
| **Net cash  provided by operating activities of continuing operations**                                                                |       | 157,062                                 |       | 136,183 |   | 104,717 |   |
| **Net cash  provided by (used in) operating activities of discontinued  operations**                                                   |       | —                                  |       | 2,227 |   | (2,084 | ) |
| **Net cash  provided by operating activities**                                                                                         |       | 157,062                                 |       | 138,410 |   | 102,633 |   |
| **Cash Flows from Investing Activities**                                                                                               |       |                                    |       |   |   |   |   |
| Capital expenditures                                                                                                                   |       | (43,194                                 | )          | (34,521 | ) | (24,444 | ) |
| Payments pursuant to  business combinations, net of cash acquired                                                                      |       | (1,425,696                              | )          | (49,839 | ) | (250,329 | ) |
| Proceeds from sales of  businesses                                                                                                     |       | —                                  |       | 29,096 |   | — |   |
| Investment in short-term  notes                                                                                                        |       | —                                  |       | (10,000 | ) | — |   |
| Proceeds from sale of  short-term notes                                                                                                |       | —                                  |       | 10,000 |   | — |   |
| Dispositions of property,  plant and equipment                                                                                         |       | 1,432                                   |       | 825 |   | — |   |
| Other, net                                                                                                                             |       | 62                                      |       | 866 |   | 914 |   |
| **Net cash  used in investing activities of continuing operations**                                                                    |       | (1,467,396                              | )          | (53,573 | ) | (273,859 | ) |
| **Net cash  used in investing activities of discontinued operations**                                                                  |       | —                                  |       | (825 | ) | (601 | ) |
| **Net cash  used in investing activities**                                                                                             |       | (1,467,396                              | )          | (54,398 | ) | (274,460 | ) |
| **Cash Flows from Financing Activities**                                                                                               |       |                                    |       |   |   |   |   |
| Net proceeds from acquisition-related debt                                                                                             |       |                                    |       |   |   |   |   |
| Net repayments of  short-term debt                                                                                                     |       | (36,300                                 | )          | (82 | ) | (521 | ) |
| Borrowings of long-term  debt                                                                                                          |       | 1,229,853                               |       | 210,000 |   | 586,000 |   |
| (Return of) receipt of  advanced interest on senior subordinated notes                                                                 |       | (1,986                                  | )          | 1,986 |   | — |   |
| Debt issuance costs                                                                                                                    |       | (28,372                                 | )          | (4,193 | ) | (15,744 | ) |
| Repayments of long-term  debt                                                                                                          |       | (167,808                                | )          | (50,907 | ) | (440,092 | ) |
| Dividends paid                                                                                                                         |       | (3,705                                  | )          | — |   | — |   |
| Proceeds from exercise of  stock options                                                                                               |       | 12,540                                  |       | 8,097 |   | 1,970 |   |
| **Net cash  provided by financing activities of continuing operations**                                                                |       | 1,004,222                               |       | 164,901 |   | 131,613 |   |
| **Net cash  (used in) provided by financing activities of discontinued  operations**                                                   |       | —                                  |       | (30 | ) | 154 |   |
| **Net cash  provided by financing activities**                                                                                         |       | 1,004,222                               |       | 164,871 |   | 131,767 |   |
| **Effect  of exchange rates on cash and cash equivalents**                                                                             |       | 553                                     |       | 1,179 |   | 912 |   |
| **Net  (decrease) increase in cash and cash equivalents**                                                                              |       | (305,559                                | )          | 250,062 |   | (39,148 | ) |
| **Cash and  cash equivalents, beginning of year**                                                                                      |       | 306,852                                 |       | 56,790 |   | 95,938 |   |
| **Cash and  cash equivalents, end of year**                                                                                            |       | $                                       | 1,293      |   | $ | 306,852 |   | $ | 56,790 |   |

 

See accompanying Notes to Consolidated Financial Statements.

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

**1.   Summary of Significant Accounting Policies**

**A.   Organization**   DRSTechnologies, Inc. and subsidiaries (hereinafter, DRS or the Company) is asupplier of defense electronic products, systems and military support services.The Company provides high-technology products and services to all branches ofthe U.S. military, major aerospace and defense prime contractors, governmentintelligence agencies, international military forces and industrial markets. TheCompany focuses on several key areas of importance for the U.S. Department ofDefense (DoD), such as intelligence, surveillance, reconnaissance, powermanagement, advanced communications and network systems. Incorporated in 1968,DRS has served the defense industry for over 37 years. DRS is a providerof thermal 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 andshelters, and integrated logistics support services. The Company’s products aredeployed on a wide range of high-profilemilitary platforms, such as DDG-51Aegis destroyers, M1A2 Abrams Main Battle Tanks, M2A3 Bradley FightingVehicles, OH-58DKiowa Warrior helicopters, AH-64Apache helicopters, F/A-18E/FSuper Hornet, F-16Fighting Falcon jet fighters and F-15 Eagle tactical fighters, C-17 Globemaster II and C-130 Hercules cargo aircraft, Ohio,Los Angeles and Virginia class submarines, and on several other platforms formilitary and non-militaryapplications. The Company also has contracts that support future militaryplatforms, such as the CVN-78 next generation aircraft carrier, LittoralCombat Ship and Future Combat Systems. In addition, DRS provides sustainmentproducts that support military forces, such as environmental control systems,power generators, water and fuel distribution systems, chemical/biologicaldecontamination shelters and heavy equipment transport systems. The Companyalso provides support services to the military, including security and assetprotection system services, telecommunication and information technologyservices, training and logistics support services for all branches of the U.S.armed forces, and certain foreign militaries, homeland security forces andselected government and intelligence agencies.

As more fully described in Note 2, “Acquisitions andDivestitures,” on January 31, 2006 the Company acquired all of theoutstanding stock of Engineered Support Systems, Inc. (ESSI). The entitiesacquired from ESSI are managed as the Company’s third operating segment calledthe Sustainment Systems & Services (S3) Group. The total transactionvalue, excluding acquisition-related costs of $25.5 million, was approximately$1.93 billion.

On March 10, 2005, the Company completed the saleof two of its operating units—DRS Weather Systems, Inc. (DRS Weather) andDRS Broadcast Technology (DRS Broadcast) and recorded an after-tax gain of$0.7 million in the fourth quarter of fiscal 2005. Both operating unitsoperated as a part of the Company’s Command, Control, Communications, Computersand Intelligence (C4I) Group. The operating units were acquired inconnection with the Company’s fiscal 2004 acquisition of Integrated DefenseTechnologies, Inc. (IDT). The results of operations of DRS Weather and DRSBroadcast for the fiscal year ended March 31, 2005 and for the period fromthe date of acquisition through March 31, 2004 are included in theConsolidated Statements of Earnings as “Earnings from discontinued operations.”The cash flows of the discontinued operations also are presented separately inthe Consolidated Statements of Cash Flows for the years ended March 31,2005 and 2004. All corresponding footnotes reflect the discontinued operationspresentation.

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

A summary of the results ofdiscontinued operations for the year ended March 31, 2005 and for theperiod from November 4, 2003 through March 31, 2004 (the period forwhich DRS Weather and DRS Broadcast were owned by DRS) follows:

| ** **                                                                                              | ** ** | **Year Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                              | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                                                              | ** ** | **(in thousands)**             | ** ** |
| Revenues                                                                                                | ** ** | **$**                               | **33,325** |   | $ | 14,319 |   |
| Earnings before taxes                                                                                   | ** ** | **$**                               | **3,601**  |   | $ | 1,819 |   |
| Income tax expense                                                                                      | ** ** | **1,050**                           |       | 641 |   |
| Earnings from discontinued  operations (including after-tax gain on sale of $0.7 million in  2005) | ** ** | **$**                               | **2,551**  |   | $ | 1,178 |   |

 

The Company’s three operatingsegments are the C4I Group, the Surveillance & Reconnaissance (SR)Group and the S3 Group. See Note 14 for a description of the operations ofthe three operating segments.

**B.   Variable InterestEntities**   In January 2004, the FinancialAccounting Standards Board (FASB) issued revised FASB Interpretation No. 46,“Consolidation of Variable Interest Entities” (FIN 46), which addresseshow a business enterprise should evaluate whether it has a controllingfinancial interest in an entity through means other than voting rights, and,accordingly, whether it should consolidate the entity as the primarybeneficiary of the assets, liabilities and results of operations.

During fiscal 2005, the Companyentered into a joint venture agreement with a third party to manufacture andmarket high-performance, lightweight motors, generators and drive electronicsto the industrial market. The joint venture is still in its early stages ofdevelopment and did not have significant activities in fiscal 2005 or fiscal2006. The joint venture is considered a variable interest entity because it isa development stage enterprise, and its equity is not sufficient to finance itsactivities without additional subordinated financial support. Based upon areview of the provisions of FIN 46, the structure of the agreement andactivities of the entity, the Company determined that it is not the primarybeneficiary of the joint venture at March 31, 2006 and 2005. If the factsand circumstances change in the future, the Company could determine that it hasbecome the primary beneficiary, which would require DRS to consolidate the fairvalue of the assets, liabilities and noncontrolling interest of the jointventure. The Company currently accounts for its 50% ownership interest in thejoint venture under the equity method of accounting. The Company’s investmentin the joint venture was immaterial as of March 31, 2006 and 2005.

**C.   Basisof Presentation and Use of Estimates**   Theconsolidated financial statements include the accounts of DRS Technologies, Inc.,its wholly-owned subsidiaries and a partnership of which DRS owns an 80%controlling interest. All intercompany transactions and balances have beeneliminated in consolidation.

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosures of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. The most significant ofthese estimates and assumptions relate to the recognition of contract revenuesand estimated costs to complete contracts in process, valuation of inventoriesreported at lower of cost or market, recoverability 

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

of reported amounts of fixedassets, goodwill and intangible assets, valuation of pensions and otherpostretirement benefits, the valuation of assets acquired and liabilitiesassumed in purchase business combinations, and the valuation of deferred taxassets and liabilities. Actual results could differ from these estimates.

**D.   Classifications**   Unbilledreceivables, inventories, accrual for future costs on uncompleted contracts andaccrual for future costs related to acquired contracts are primarilyattributable to long-term contracts or programs in progress for which the relatedoperating cycles may be longer than one year. In accordance with industrypractice, these items are included in current assets and liabilities.

Certain amounts for prior years have been reclassifiedto conform with the fiscal 2006 presentation. In fiscal 2006, the Companyrevised its Consolidated Statements of Cash Flows to provide a reconciliationof net earnings to earnings from continuing operations for each year presented.

**E.   Translationof Foreign Currency Financial Statements and Foreign Currency Transactions**   Significanttransactions in foreign currencies are translated into U.S. dollars at theapproximate prevailing rate at the time of the transaction. Foreign exchangetransaction gains and losses in fiscal 2006, 2005 and 2004 are immaterial tothe Company’s results of operations. The operations of the Company’s foreignsubsidiaries are translated from the local (functional) currencies into U.S.dollars using weighted average rates of exchange during each monthly period.The rates of exchange at each balance sheet date are used for translatingcertain balance sheet accounts, and gains or losses resulting from thesetranslation adjustments are included in the accompanying Consolidated BalanceSheets as a component of accumulated other comprehensive earnings. The Companyhas accumulated exchange gains resulting from the translation of foreignsubsidiaries financial statements of $11.1 million and $9.8 millionas of March 31, 2006 and 2005, respectively. Beginning in January 2006,in order to mitigate the risk associated with certain contracts denominated inforeign currency, the Company entered into foreign currency forward contracts. SeeNote 1.M. for further detail.

**F.   Cashand Cash Equivalents**   The Company considers allhighly liquid investments purchased with a maturity of three months or less atthe date of purchase to be cash equivalents.

**G.   Receivables**   Receivablesconsist of amounts billed and currently due from customers, and unbilled costsand accrued profits primarily related to revenues on long-term contracts thathave been recognized for accounting purposes, but not yet billed to customers,net of allowance for uncollectible accounts.

**H.   Inventories**   Inventoriedcontract costs represent incurred costs on contracts in process that have notyet been recognized as costs and expenses because the related sales, which areprimarily recorded using the units-of-delivery percentage-of-completion method,have not been recognized. As discussed below in Note 5, the Company’sinventoried contract costs for certain government contracts, and contracts withprime contractors or subcontractors of the government, include direct andindirect costs and allocated general and administrative costs, independentresearch and development costs, and bid and proposal costs. Total expendituresfor internal research and development amounted to approximately$47.6 million, $38.9 million and $27.4 million for fiscal 2006,2005 and 2004, respectively. General and administrative expenses related tocommercial-type products and services provided under commercial terms andconditions are expensed as incurred and are included in costs and expenses inthe Consolidated Statements of Earnings.

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

Pursuant to contract provisions, agencies of the U.S.government and certain other customers have title to, or a security interestin, inventories related to certain contracts as a result of progress paymentsand advances. Accordingly, such progress payments and certain advances arereflected as an offset, first against the related unbilled receivables, thenagainst the related inventory balances. To the extent that customer advancesexceed related unbilled receivables and inventory levels, such excess advancesare classified as current liabilities.

Inventories other than inventoried contract costs arestated at the lower of cost, primarily using the average cost method, ormarket.

TheCompany records contract-related assets and liabilities acquired in businesscombinations at their fair value by considering the remaining contract amountsto be billed, DRS’s estimate to complete and a reasonable profit allowance onthe remaining contract amount to be billed commensurate with the profit marginthat the Company earns on similar contracts. Revisions to cost estimatessubsequent to the date of acquisition may be recorded as an adjustment togoodwill or earnings, depending on the nature and timing of the revision.

**I.   Property,Plant and Equipment**   Property, plant andequipment are stated at cost less accumulated depreciation. Depreciation iscalculated on the straight-line method. The ranges of estimated useful livesare: office furnishings, laboratory, production, computer and other equipment, 3-10 years;building and building improvements, 15-40 years; and leaseholdimprovements, over the shorter of the estimated useful lives of theimprovements or the life of the lease. When property, plant and equipment areretired or otherwise disposed of, the net book value of the asset is removedfrom the Consolidated Balance Sheet and the net gain or loss is included in thedetermination of net earnings. Maintenance and repairs are charged tooperations as incurred; renewals and betterments are capitalized.

**J.   SoftwareCapitalization**   Internally used software, whetherpurchased or developed, is capitalized and amortized using the straight-linemethod over an estimated useful life of three to eight years. Capitalizedsoftware costs are included in machinery and equipment. In accordance with AmericanInstitute of Certified Public Accountants (AICPA) Statement of Position 98-1, “Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use,” theCompany capitalizes certain costs associated with internal-use software, suchas the payroll costs of employees devoting time to the projects and externaldirect costs for materials and services. Costs associated with internal-usesoftware are expensed during the design phase until the point at which theproject has reached the development stage. Subsequent additions, modificationsor upgrades to internal-use software are capitalized only to the extent thatthey allow the software to perform a task it previously did not perform. Softwaremaintenance and training costs are expensed in the period in which they areincurred. The capitalization of software requires judgment in determining when a project has reached the developmentstage and the period over which the Company expects to benefit from the use ofthat software. The Company capitalized $3.8 million, $4.0 million and $4.4million of internal-use software for the years ended March 31, 2006, 2005and 2004, respectively. Depreciation expense for capitalized software wasapproximately $3.4 million, $2.9 million and $1.7 million in fiscal 2006, 2005and 2004, respectively.

**K.   BondPremium and Debt Issuance Costs**   Bond premium anddebt issuance costs are amortized as a component of interest expense over theterm of the related debt using a method that approximates the effectiveinterest method. The nature and extent of subsequent modifications to theCompany’s term loans and lines of credit affect whether debt issuance costs 

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

are expensed or capitalized. If the Company prepaysits term loans or portions thereof, the debt issuance costs associated withsuch term loans are written-off in proportion to the decrease in term loanborrowings, as compared with the total borrowings outstanding prior to theprepayment.

**L.   Goodwill**   TheCompany annually reviews goodwill for impairment by “reporting unit” orwhenever events or changes in circumstances indicate that the carrying amountof these assets may not be recoverable. A reporting unit is an operatingsegment or a component of an operating segment. A component of an operatingsegment is a reporting unit if the component constitutes a business for whichdiscrete financial information is available and is reviewed. Two or morecomponents of an operating segment may be aggregated and deemed a singlereporting unit if the components have similar economic characteristics. Basedupon the aggregation criteria, the Company concluded that it had six reportingunits for purposes of goodwill impairment testing at March 31, 2006.

Theannual impairment test is performed after completion of the Company’s annualfinancial operating plan, which occurs in the fourth quarter of its fiscalyear. The annual goodwill impairment assessment involves estimating the fairvalues of the Company’s reporting units and comparing such fair values with thereporting unit’s respective carrying value. If the carrying value of thereporting unit exceeds its fair value, additional steps are followed torecognize a potential goodwill impairment loss. Calculating the fair value of areporting unit requires significant estimates and assumptions by management*.*Beginning in fiscal 2006, the Companyestimates the fair value of its reporting units with the assistance of athird-party appraiser. Fiscal 2006 fair values are estimated based upon the twomethodologies, a market approach and an income approach. The market approachincludes applying valuation multiples to each reporting unit’s projectedrevenues, earnings before net interest and taxes (EBIT), and earnings beforenet interest, taxes, depreciation and amortization (EBITDA). The incomeapproach discounts future net cash flows to their present value at a rate thatreflects both the current return requirements of the market and the risksinherent in the reporting unit. The results of the two approaches are averagedtogether and compared with the carrying value of the reporting units. In fiscal2005 and prior, the Company estimated fair values of its reporting units byapplying third-party market value indicators to each reporting unit’s projectedrevenues, EBIT and EBITDA, and calculating a weighted average of the threeextended values. The Company completed its annual impairment tests with noadjustment to the carrying value of its goodwill as of March 31, 2006,2005 and 2004.

**M.   Long-LivedAssets and Acquired Identifiable Intangible Assets**   Identifiableintangible assets represent assets acquired as part of the Company’s businessacquisitions and include customer-related and technology-basedintangibles. The values assigned to acquired identifiable intangible assets aredetermined, as of the date of acquisition, based on estimates and judgmentsregarding expectations for the estimated future after-tax cash flows from thoseassets over their lives, including the probability of expected future contractrenewals and revenues, all of which are discounted to present value.

The Company assesses the recoverability of thecarrying value of its long-lived assets and acquired intangible assets withfinite useful lives whenever events or changes in circumstances indicate thatthe carrying amount of the assets may not be recoverable. If there are anyindicators of impairment present, the Company would then evaluate therecoverability of the potentially impaired long-lived assets and acquired identifiableintangible assets based upon the expectations of undiscounted cash flows fromsuch assets. If the sum of the expected future 

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

undiscounted net cash flows isless than the carrying amount of the asset, a loss would be recognized for thedifference between the fair value and the carrying amount of the asset. Assetsto be disposed of, including those of discontinued operations, are reported atthe lower of the carrying amount or fair value, less the costs to sell.

**N.   DerivativeFinancial Instruments**   The Company does not usederivative financial instruments for trading purposes. The Company utilizesvariable rate debt to fund its operations and sustain its growth. Such variablerate borrowings expose the Company to interest rate risk and the related impactthat changes in interest rates can have on the Company’s earnings and on itscash flows. We also operate and conduct business in foreign countries and, as aresult, are exposed to movements in foreign currency exchange rates. Morespecifically, our net equity is impacted by the conversion of the net assets offoreign subsidiaries for which the functional currency is not the U.S. dollarfor U.S. reporting purposes. In an effort to limit interest expense, cash flow exposureand foreign currency exposure, the Company has and may in the future enter intovarious derivative instruments that meet the criteria to be accounted for ascash flow hedges. The Company does not enter into derivatives designated asfair value hedges.

All derivative instruments are carried on theConsolidated Balance Sheets as either assets or liabilities at fair value. Theclassification of gains and losses resulting from changes in the fair values ofderivatives is dependent on the intended use of the derivative and its resultantdesignation.

On the date a derivative contract is entered into, theCompany designates the hedging relationship. The Company formally documents allrelationships between hedging instruments and hedged items, as well as its riskmanagement objective and strategy. This process includes linking allderivatives that are designated as hedges to specific assets or liabilities onthe balance sheet or to forecasted transactions. The Company also formallyassesses, both at the hedge’s inception and on an ongoing basis, whether thederivatives that are used in hedging transactions are highly effective inoffsetting changes in cash flows of the hedged items. Changes in the fair valueof a derivative that is highly effective and that is designated and qualifies asa cash flow hedge are recorded in accumulated other comprehensive earnings(losses) until operations are affected by the variability in cash flows of thedesignated item. When it is determined that a derivative is not highlyeffective as a hedge or that it has ceased to be a highly effective hedge, theCompany discontinues hedge accounting prospectively, as discussed below.

The Company discontinues hedge accountingprospectively when: (1) it is determined that a derivative is no longereffective in offsetting changes in the cash flows of a hedged item; (2) thederivative expires or is sold, terminated or exercised; or (3) thederivative is discontinued as a hedging instrument, because it is unlikely thata forecasted transaction will occur. When hedge accounting is discontinuedbecause it is determined that the derivative no longer qualifies as aneffective hedge of cash flows, the derivative will continue to be carried atfair value in the Consolidated Balance Sheets, and gains and losses that weredeferred in accumulated other comprehensive earnings (losses) are recognized asthe forecasted transaction occurs or at such time that the transaction is nolonger probable to occur.

Beginning in January 2006, in order to mitigatethe risk associated with certain of the Company’s contracts denominated inforeign currency the Company entered into foreign currency forward contracts.DRS accounts for these contracts as cash flow hedges. The effect of the cashflow hedges is considered immaterial to the Consolidated Balance Sheet andConsolidated Statement of Earnings.

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

The Company has a mortgage note payable that issecured by a lien on its facility located in Palm Bay, Florida, and bearsinterest at a rate equal to the one-month LIBOR plus 1.65%. The Company had aninterest rate swap relating to the mortgage that qualified for hedgeaccounting. Pursuant to the swap, the Company received interest at a variablerate equal to the one-month LIBOR plus 1.65% and paid interest at a fixed rateof 7.85%. During the third quarter of fiscal 2005, the Company terminated theswap and paid $0.4 million, an amount that approximated the fair value ofthe swap at termination.

During fiscal 2005, the Company had two interest rateswap agreements, each in the amount of $25.0 million, with Wachovia Bank,N.A. and Bank of America Corporation (the Banks) both of which had expirationdates of September 30, 2008. The swap agreements effectively converted thevariable interest rate on a total of $50.0 million of the Company’s termloan to a fixed interest rate. Under the terms of these swap agreements, theCompany paid or received the difference between the variable interest ratepayable by the Banks and the fixed 2.59% interest rate payable by the Company.These swap agreements were accounted for as cash flow hedges, and as such,changes in the fair values of the swap agreements were recorded as adjustmentsto accumulated other comprehensive earnings. On January 18, 2005, theCompany terminated the two swap agreements. As a result of the termination, theCompany received $1.8 million in cash and recorded an unrealized gain inother comprehensive income, net of taxes, which was to be credited to interestexpense over the remaining life of the Company’s term loan. During the week of January 9,2006, the Company prepaid the remaining $135.7 million balance of its termloan, at its discretion, and recognized a $1.1 million charge to interest andrelated expenses in the fourth quarter of fiscal 2006 for the write off of thebalance of the term loan debt issuance costs, net of the recognition of thepreviously deferred gain for the termination of the related interest rate swapagreements.

As of March 31, 2006 and 2005, the balance of theunrealized gain**on hedginginstruments, included in accumulated other comprehensive earnings was $20thousand, net of income taxes, and $1.1 million, net of income taxes,respectively.

**O.   RevenueRecognition**   The substantial majority of theCompany’s direct and indirect sales to the U.S. government and certain of theCompany’s sales to foreign governments and commercial customers are madepursuant to written contractual arrangements to design, develop, manufactureand/or modify complex products and to provide related engineering and technicalor other services according to the specifications of the buyers (customers).These contracts are generally fixed price, cost-reimbursable, or time andmaterial. These contract types are accounted for in accordance with AICPAStatement of Position 81-1, “Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts” (SOP 81-1). Cost-reimbursabletype contracts also are specifically covered by Accounting Research Bulletin No. 43,Chapter 11, Section A, Government Contracts, Cost-Plus Fixed-Fee Contracts(ARB 43), in addition to SOP 81-1.

Revenues and profits on fixed price contracts arerecognized using percentage-of-completion methods of accounting. Revenues andprofits on fixed-price production contracts, whose units are produced anddelivered in a continuous or sequential process, are recorded as units aredelivered based on their selling prices (the units-of-delivery method). Incertain limited circumstances, when all applicable revenue recognition criteriaare met, revenue may be recognized prior to shipment to the customer. Revenuesand profits on other fixed-price contracts with significant engineeringas well as production requirements are recorded based on the ratio of totalactual incurred costs to date to the total estimated costs for each contract 

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

(cost-to-cost method). Underthe percentage-of-completion method of accounting, a single estimatedtotal profit margin is used to recognize profit for each contract over itsentire period of performance, which can exceed one year.

Accounting for the revenues and profits on afixed-price contract, requires the preparation of estimates of (1) thetotal contract revenue, (2) the total costs at completion, which is equalto the sum of the actual incurred costs to date on the contract and theestimated costs to complete the contract’s statement of work, and (3) themeasurement of progress towards completion. The estimated profit or loss atcompletion on a contract is equal to the difference between the total estimatedcontract revenue and the total estimated cost at completion. Under theunits-of-delivery method, sales on a fixed-price type contract are recorded asthe units are delivered during the period based on their contractual sellingprices. Under the cost-to-cost method, sales on a fixed-price type contract arerecorded at amounts equal to the ratio of actual cumulative costs incurreddivided by total estimated costs at completion, multiplied by (i) thetotal estimated contract revenue, less (ii) the cumulative salesrecognized in prior periods. The profit recorded on a contract in any periodusing either the units-of-delivery method or cost-to-cost method is equal to (i) thecurrent estimated total profit margin multiplied by the cumulative salesrecognized, less (ii) the amount of cumulative profit previously recordedfor the contract. In the case of a contract for which the total estimated costsexceed the total estimated revenues, a loss arises, and a provision for theentire loss is recorded in the period that it becomes evident. Theunrecoverable costs on a loss contract that are expected to be incurred infuture periods are recorded as a component of other current liabilitiesentitled ‘‘Loss accrual for future costs on uncompleted contracts.’’

Revenue and profits on cost-reimbursable typecontracts are recognized as allowable costs are incurred on the contract, at anamount equal to the allowable costs plus the estimated profit on those costs.The estimated profit on a cost-reimbursable contract may be fixed or variablebased on the contractual fee arrangement. Incentive and award fees on thesecontracts are recorded as revenue when the conditions under which they areearned are reasonably assured of being met and can be reasonably estimated.Revenue and profits on time-and-material type contracts are recognized on thebasis of direct labor hours expended multiplied by the contractual fixed rateper hour, plus the actual costs of material and other direct non-labor costs.On a time-and-material type contract, the fixed hourly rates include amountsfor the cost of direct labor, indirect contract costs and profit.

The Company reviews cost performance and estimates tocomplete on its contracts at least quarterly and in many cases more frequently.Adjustments to original estimates for a contract’s revenue, estimated costs atcompletion and estimated profit or loss are often required as work progressesunder a contract, as experience is gained and as more information is obtained,even though the scope of work required under the contract may not change, or ifcontract modifications occur. The impact of revisions in profit estimates forall types of contracts is recognized on a cumulative catch-up basis in theperiod in which the revisions are made. Amounts representing contract changeorders or claims are included in revenue only when they can be reliablyestimated and their realization is probable, and are determined on apercentage-of-completion basis measured by the cost-to-cost method. Incentivesor penalties and awards applicable to performance on contracts are consideredin estimating revenues and profit rates, and are recorded when there issufficient information to assess anticipated contract performance. Incentiveprovisions, which increase or decrease earnings based solely on a singlesignificant event, are not recognized until the event occurs.

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

Revenues on arrangements that are not within the scopeof SOP 81-1 or ARB 43 are recognized in accordance with the Securitiesand Exchange Commission Staff Accounting Bulletin No. 104, “RevenueRecognition in Financial Statements.” Revenues are recognized when there ispersuasive evidence of an arrangement, delivery has occurred or services havebeen performed, the selling price to the buyer is fixed or determinable, andcollectibility is reasonably assured.

Included in revenues for fiscal 2006, 2005 and 2004were $106.1 million, $93.1 million and $74.4 million,respectively, of customer-sponsored research and development, whichprincipally are accounted for under the cost-reimbursement method.

Approximately 87%, 84% and 85% of the revenues infiscal 2006, 2005 and 2004, respectively, were derived directly or indirectlyfrom defense-related contracts with the United States government. Inaddition, approximately 9%, 12% and 10% of the Company’s revenues were deriveddirectly or indirectly from sales to international governments in fiscal 2006,2005 and 2004, respectively.

**P.   Pension and OtherPostretirement Benefits**   The obligations for theCompany’s pension plans and postretirement benefit plans and the related annualcosts of employee benefits are calculated based on several long-termassumptions, including discount rates for employee benefit liabilities, ratesof return on plan assets, expected annual rates for salary increases foremployee participants in the case of pension plans, and expected annualincreases in the costs of medical and other health care benefits in the case ofpostretirement benefit obligations. These long-term assumptions are subject torevision based on changes in interest rates, financial market conditions,expected versus actual returns on plan assets, participant mortality rates andother actuarial assumptions, including future rates of salary increases,benefit formulas and levels, and rates of increase in the costs of benefits. Changesin the assumptions, if significant, can materially affect the amount of annualnet periodic benefit costs recognized in the Company’s results of operationsfrom one year to the next, the liabilities for the pension plans andpostretirement benefit plans, and the Company’s annual cash requirements tofund these plans. See Note 12 for further information on the Company’spension and postretirement plans.

**Q.   Stock-BasedCompensation**   The Company accounts for stockoptions granted to employees and directors under the recognition andmeasurement principles of APB Opinion No. 25, “Accounting for StockIssued to Employees” and related interpretations (APB Opinion No. 25).Compensation expense for stock options granted to an employee or director isrecognized in earnings based on the excess, if any, of the quoted market priceof DRS common stock at the date of grant, or other measurement date, over theamount an employee or director must pay to acquire the common stock. When theexercise price of the option granted to an employee or director equals orexceeds the quoted market price of DRS common stock at the date of grant, theCompany does not recognize compensation expense. Compensation cost forrestricted stock is recorded based on the market value of DRS common stock onthe date of grant.

The Company elected not to adopt the fair-value-basedmethod of accounting for stock-based employee compensation, as permittedby Statement of Financial Accounting Standards (SFAS) No. 123, “Accountingfor Stock-Based Compensation,” as amended by SFAS No. 148,“Accounting for Stock-Based Compensation—Transition and Disclosure—anamendment of SFAS No. 123” (collectively, SFAS No. 123). Had theCompany adopted the fair-value-based method provisions of SFASNo. 123, it would have recorded a non-cash expense for the estimated fairvalue of the stock options that the Company has granted to its employees anddirectors.

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

The tablebelow compares the “as reported” net earnings and earnings per share to the“pro forma” net earnings and earnings per share that the Company wouldhave reported if it had elected to recognize compensation expense in accordancewith the fair value-based method of accounting of SFAS No. 123. Optionforfeitures are accounted for as they occurred, and no amounts of compensationexpense have been capitalized into inventory or other assets, but instead areconsidered period expenses in the pro forma amounts.

| ** **                                                                                                           | ** ** | **Year Ended March, 31**                   | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2006**                                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                           | ** ** | **(in thousands, except  per-share data)** | ** ** |
| Net earnings, as reported                                                                                            |       | $                                                         | 81,494     |   | $ | 60,677 |   | $ | 44,720 |   |
| Add: Stock-based  compensation expense included in reported net earnings, net of taxes                               |       | 1,744                                                     |       | 657 |   | 211 |   |
| Less: Total stock-based  compensation expense determined under fair-value-based method for all awards,  net of taxes |       | (9,466                                                    | )          | (5,180 | ) | (3,542 | ) |
| Pro forma net earnings                                                                                               |       | $                                                         | 73,772     |   | $ | 56,154 |   | $ | 41,389 |   |
| Earnings per share:                                                                                                  |       |                                                      |       |   |   |   |   |
| Basic—as  reported                                                                                              |       | $                                                         | 2.75       |   | $ | 2.24 |   | $ | 1.84 |   |
| Basic—pro  forma                                                                                                |       | $                                                         | 2.49       |   | $ | 2.07 |   | $ | 1.71 |   |
| Diluted—as  reported                                                                                            |       | $                                                         | 2.67       |   | $ | 2.18 |   | $ | 1.80 |   |
| Diluted—pro forma                                                                                               |       | $                                                         | 2.36       |   | $ | 2.03 |   | $ | 1.70 |   |

 

For purposes of determining thepro forma effects of SFAS No.123, the estimated fair value of options grantedwas calculated using the Black-Scholes option pricing valuation model.The weighted-average assumptions used in the valuation model and theweighted-average fair value of options granted are presented in the tablebelow:

| ** **                                      | ** ** | **Year Ended March 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected holding period  (in years)             |       | 6.25                                    |       | 5.0 |   | 5.0 |   |
| Expected volatility                             |       | 42.16                                   | %          | 44.19 | % | 45.2 | % |
| Expected dividend yield                         |       | 0.2                                     | %          | — |   | — |   |
| Risk-free interest  rate                        |       | 4.0                                     | %          | 3.5 | % | 3.0 | % |
| Weighted-average fair  value of options granted |       | $                                       | 23.51      |   | $ | 16.07 |   | $ | 11.97 |   |
|                                                 |            |                                         |            |  |  |  |  |  |  |  |

 

In December 2004, the FASBissued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFASNo. 123(R)), which replaces SFAS No. 123 and supercedesAPB Opinion No. 25. SFAS No. 123(R) requires all share-basedpayments to employees, including grants of employee stock options and nonvested(restricted) stock grants and units, to be recognized as a compensation costbased on their fair values. On April 15, 2005, the SEC issued ReleaseNo. 33-8568, Amendment to Rule 4-01a ofRegulation S-X, which amended the compliance date for SFASNo. 123(R) to the beginning of the first fiscal year followingJune 15, 2005, which is the fiscal year beginning on April 1, 2006for DRS. On March 29, 2005, the SEC issued Staff Accounting Bulletin (SAB)No. 107, “Share-Based Payment” (SAB 107). SAB 107 provides guidanceto assist registrants in the initial implementation of SFAS No. 123(R).

 

78

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

The Company will adopt SFAS No. 123(R) effectiveApril 1, 2006, using the modified prospective method. Under the modifiedprospective method, compensation cost is recognized beginning with theeffective date (a) based on the requirements of SFAS No. 123(R) forall share-based payments granted after the effective date and (b) based onthe requirements of SFAS No. 123 for all awards granted to employees priorto the effective date of SFAS No. 123(R) that remain unvested on theeffective date. The Company has estimated that the fiscal 2007 share-basedcosts related to the adoption of SFAS No. 123(R) will beapproximately $4.6 million, net of tax (unaudited).

On November 10, 2005, theFASB issued FASB Staff Position (FSP) 123(R)-3 (“FSP123R-3”), “TransitionElection Related to Accounting for the Tax Effects of Share-based PaymentAwards,” that provides an elective alternative transition method of calculatingthe pool of excess tax benefits available to absorb tax deficiencies recognizedsubsequent to the adoption of SFAS No. 123(R) (the “APIC Pool”) to the methodotherwise required by paragraph 81 of SFAS No. 123(R). The Company may take upto one year from the adoption date to evaluate its available alternatives andmake its one-time election. The Company currently is evaluating the alternativemethods in connection with the adoption of SFAS No. 123(R). Until and unlessthe Company elects the transition method described in this FSP, the Companywill follow the transition method described in paragraph 81 of SFAS No. 123(R).

On February 3, 2006, the FASBissued FSP 123(R)-4, “Classification of Options and Similar Instrumentsas Employee Compensation That Allow for Cash Settlement upon the Occurrence ofa Contingent Event.” This amends paragraphs 32 and A229 of SFAS No. 123(R),which required that share options with contingent cash settlement features beclassified as liabilities regardless of the event’s likelihood of occurrence.FSP 123(R)-4 requires companies with cash-settleable provisions in theiremployee share-option awards to assess the probability of the contingent event’soccurrence when determining the classification of the awards as liability orequity. If the event’s likelihood of occurrence is less than probable and theaward would otherwise be classified as equity, under FSP 123(R)-4 itwould be equity classified. The Company would be required to make an ongoingassessment of the probability of the contingent event occurring and reclassifythe award as a liability should the event become probable. The Company isrequired to adopt the provisions of this FSP as of the date of adoption of SFASNo. 123(R). The adoption of FSP 123(R)-4 will have no impact on theCompany’s results of operations or financial condition, as it has not issuedany share options with contingent cash settlement features.

**R.   Income Taxes**   TheCompany accounts for income taxes in accordance with the asset-and-liabilitymethod. The Company recognizes deferred tax assets and liabilities for thefuture tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax basis. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin earnings in the period that includes the enactment date. A valuationallowance is provided when it is more likely than not that some portion or allof a deferred tax asset will not be realized. The ultimate realization ofdeferred tax assets is dependent upon the generation of future taxable incomeand the reversal of deferred tax liabilities during the period in which relatedtemporary differences become deductible. Management considers the scheduledreversal of deferred tax liabilities, projected future taxable income and taxplanning strategies in making this assessment.

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

The U.S. enacted the American JobsCreation Act of 2004 (the Jobs Act) in October 2004 which contains manyprovisions affecting corporate taxation. TheJobs Act phases out the extraterritorial income exclusion benefit for exportsales and phases in a new tax deduction for income from qualified domesticproduction activities over a transition period that began in 2005. In responseto the Jobs Act, the FASB issued FASB Staff Position 109-1 , "Application of FASB Statement No. 109, *Accounting for Income Taxes*, to the TaxDeduction on Qualified Production Activities Provided by the American JobsCreation Act of 2004" (FSP 109-1). FSP No. 109-1 clarifies how to applySFAS No. 109 to the new law's tax deduction for income attributable to"domestic production activities." The fully phased-in tax deductionis up to 9% of the lesser of taxable income or "qualified productionactivities income," as defined by the Jobs Act. The FSP requires that thededuction be accounted for as a special deduction in the period earned, not asa tax-rate reduction. As a result, the Company recognized a reduction in itsfiscal 2006 provision for income taxes for the domestic production activitiesin the quarterly periods in which the Company was eligible for the deduction.

The Jobs Actalso included a provision that encourages companies to reinvest foreignearnings in the U.S. by temporarily making certain dividends received by a U.S.corporation from controlled foreign corporations eligible for an 85%dividends-received deduction. In accordance with the Jobs Act, the Companyelected to take the special one-time 85% deduction for dividends received andaccordingly repatriated$14.0 million in dividends during the fourth quarter of fiscal 2006 (see Note 10).As a result of the repatriation, the Company recorded total taxes of $1.4million, consisting of taxes on income of $0.7 million and foreign withholdingtaxes of $0.7 million in 2006. The Company has not changed its intentionto indefinitely reinvest other accumulated earnings of its foreign subsidiaries.Accordingly, no provision will be made for income taxes that would be payableupon distribution of such earnings, and it is not practicable to determine therelated unrecognized deferred income tax liability.

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

**S.   Earnings per Share**   Basicearnings per share (EPS) is computed by dividing net earnings by the weightedaverage number of shares of common stock outstanding during each period. Thecomputation of diluted earnings per share includes the effect of shares fromthe assumed exercise of dilutive stock options, convertible debt (if dilutive),restricted stock and restricted stock units using the treasury stock method.The following table presents the components of basic and diluted earnings pershare:

| ** **                                                                                                           | ** ** | **Year Ended March 31,**                  | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                           | ** ** | **(in thousands, except per-share data)** | ** ** |
| **Basic EPS  Computation**                                                                                           |       |                                                     |       |   |   |   |   |
| Earnings  from continuing operations                                                                                 |       | $ 81,494                                            |       | $ 58,126 |   | $ 43,542 |   |
| Earnings  from discontinued operations (including gain on disposal of $0.7 million in  2005), net of income taxes    |       | —                                                   |       | 2,551 |   | 1,178 |   |
| Net  earnings                                                                                                        |       | $ 81,494                                            |       | $ 60,677 |   | $ 44,720 |   |
| Weighted  average common shares outstanding                                                                          |       | 29,623                                                   |       | 27,096 |   | 24,251 |   |
| Basic  earnings per share                                                                                            |       |                                                     |       |   |   |   |   |
| Earnings  from continuing operations                                                                                 |       | $   2.75                                  |       | $   2.15 |   | $   1.80 |   |
| Earnings  from discontinued operations (including gain on disposal of $0.03 per share  in 2005), net of income taxes |       | $      —              |       | $   0.09 |   | $   0.05 |   |
| Net  earnings                                                                                                        |       | $   2.75                                  |       | $   2.24 |   | $   1.84 |   |
| **Diluted EPS Computation**                                                                                          |       |                                                     |       |   |   |   |   |
| Earnings  from continuing operations                                                                                 |       | $ 81,494                                            |       | $ 58,126 |   | $ 43,542 |   |
| Earnings  from discontinued operations (including gain on disposal of $0.7 million in  2005), net of income taxes    |       | —                                                   |       | 2,551 |   | 1,178 |   |
| Net  earnings                                                                                                        |       | $ 81,494                                            |       | $ 60,677 |   | $ 44,720 |   |
| Diluted  common shares outstanding Weighted average common shares outstanding                                   |       | 29,623                                                   |       | 27,096 |   | 24,251 |   |
| Stock  options and restricted stock                                                                                  |       | 953                                                      |       | 737 |   | 526 |   |
| Diluted  common shares outstanding                                                                                   |       | 30,576                                                   |       | 27,833 |   | 24,777 |   |
| Diluted  earnings per share Earnings from continuing operations                                       |       | $   2.67                                  |       | $   2.09 |   | $   1.76 |   |
| Earnings  from discontinued operations (including gain on disposal of $0.02 per share  in 2005), net of income taxes |       | $      —              |       | $   0.09 |   | $   0.05 |   |
| Net earnings                                                                                                         |       | $   2.67                                  |       | $   2.18 |   | $   1.80 |   |

 

At March 31, 2006, 2005 and 2004, there were22,500, 2,500 and 1,185,708 options to acquire DRS common stock outstanding,respectively, with weighted average exercise prices of $53.56, $41.89 and$33.19 per option, respectively, that are excluded from the above calculationsbecause their inclusion would have had an antidilutive effect on EPS in theirrespective fiscal years.

For the year ended March 31, 2006, DRS’s 2%Convertible Senior Notes due 2026 had no impact on diluted EPS because theaverage stock price during the period was below $59.70 per 

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

share, and the Convertible Notes,if converted, would require only cash at settlement. See Note 8, Debt, forfurther information on the Convertible Notes.

**T.   Fair Value of FinancialInstruments**   Cash and cash equivalents, accountsreceivable, accounts payable, accrued expenses and other current liabilities,and derivative instruments reported in the Consolidated Balance Sheets equal orapproximate their fair values. The fair value of the Company’s revolving creditfacility and term loans approximate their recorded value, based on the variableinterest rates of the facility and currently available terms and conditions forsimilar debt at March 31, 2006 and 2005. Fair values are determinedthrough information obtained from third parties using the latest availablemarket data. Long-term debt is reflected on the Consolidated Balance Sheets atamortized cost. Below is a summary of carrying value and fair value of theCompany’s notes.

| ** **                | ** ** | **March 31,**      | ** **     |
|---------------------------|------------|-------------------------|----------------|
| ** **                | ** ** | **2006**                | ** **     | **2005** | ** ** |
| ** **                | ** ** | **Carrying Value** | ** **     | **Fair Value** | ** ** | **Carrying Value** | ** ** | **Fair Value** | ** ** |
| ** **                | ** ** | **(in thousands)** | ** **     |
| Senior Notes              |       |                    | $ 350,000 |   |   | $ 348,250 |   |   | $        — |   |   | $        — |   |
| Senior Subordinated Notes |       |                    | $ 808,585 |   |   | $ 808,438 |   |   | $ 559,716 |   |   | $ 550,000 |   |
| Senior Convertible Notes  |       |                    | $ 345,000 |   |   | $ 365,269 |   |   | $        — |   |   | $        — |   |

 

**U.   Product Warranties**   Productwarranty costs are accrued when the covered products are delivered to thecustomer. Product warranty expense is recognized based on the terms of theproduct warranty and the related estimated costs, considering historical claimsexpense. Accrued warranty costs are reduced as these costs are incurred and asthe warranty period expires and may be otherwise modified as specific productperformance issues are identified and resolved. The table below presents thechanges in the Company’s accrual for product warranties as of March 31,2006, 2005 and 2004, which is included in accrued expenses and other currentliabilities:

| ** **                                                     | ** ** | **March 31,**      | ** ** |
|----------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                     | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                     | ** ** | **(in thousands)** | ** ** |
| Balance at beginning of  year                                  |       | $ 21,839           |       | $ 23,279 |   | $ 19,365 |   |
| Acquisitions during the  period                                |       | 4,497                   |       | 25 |   | 6,000 |   |
| Accruals for product  warranties issued during the period |       | 9,235                   |       | 8,687 |   | 9,250 |   |
| Settlements made during  the period                            |       | (12,011                 | )          | (10,296 | ) | (11,589 | ) |
| Other                                                          |       | 36                      |       | 144 |   | 253 |   |
| Balance at the end of year                                     |       | $ 23,596           |       | $ 21,839 |   | $ 23,279 |   |

 

**V.   NewAccounting Pronouncements****  **In November 2004, the FASB issued SFAS No. 151,“Inventory Costs—An Amendment of ARB No. 43, Chapter 4.” SFAS No. 151clarifies that abnormal inventory costs, such as costs of idle facilities,excess freight and handling costs, and wasted materials (spoilage), arerequired to be recognized as current period charges. Additionally, SFAS No. 151requires that the allocation of fixed production overheads to the costs ofconversion be based on the normal capacity of the production facility. Theprovisions of SFAS No. 151 are effective for the Company’s fiscal yearbeginning April 1, 2006. The Company does not expect the adoption of SFAS No. 151to have any impact on the Company’s consolidated financial position or resultsof operations.

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

In December 2004, the FASB issued SFAS No. 153,“Exchanges of Nonmonetary Assets—An Amendment of APB Opinion No. 29,Accounting for Nonmonetary Transactions.” SFAS No. 153 eliminates theexception from fair value measurement for nonmonetary exchanges of similarproductive assets in paragraph 21(b) of APB Opinion No. 29,“Accounting for Nonmonetary Transactions,” and replaces it with an exceptionfor exchanges that do not have commercial substance. SFAS No. 153specifies that a nonmonetary exchange has commercial substance if the futurecash flows of the entity are expected to change significantly as a result ofthe exchange. The Company adopted SFAS No. 153 beginning on July 1,2005, and its adoption had no impact on its consolidated results of operationsand financial condition.

In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Corrections—a replacement of APB Opinion No. 20 and FASBStatement No. 3.” This Statement replaces APB Opinion No. 20, “AccountingChanges,” and FASB Statement No. 3, “Reporting Accounting Changes inInterim Financial Statements.” SFAS No. 154 changes the requirements forthe accounting for and reporting of a change in accounting principle.Previously, most voluntary changes in accounting principles requiredrecognition through a cumulative adjustment within net earnings in the periodof the change. SFAS No. 154 requires retrospective application to priorperiods’ financial statements, unless it is impracticable to determine eitherthe period-specific effects or the cumulative effect of the change. SFAS No. 154is effective for accounting changes that may be made by DRS beginning in fiscal2007; however, the Statement does not change the specific transition provisionsof any existing or future accounting pronouncements. The adoption of SFAS No. 154will have no immediate effect on the Company’s consolidated financial positionand results of operations.

In February 2006, the FASB issued SFAS No. 155,“Accounting for Certain Hybrid Financial Instruments—an amendment of FASBStatements No. 133 and 140” (SFAS No. 155). SFAS No. 155permits a fair value remeasurement for any hybrid financial instrument thatcontains an embedded derivative that would otherwise require bifurcation. Thisaccounting standard will be effective for the 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 March 2005, the FASBissued Interpretation No. 47, “Accounting for Conditional Asset RetirementObligations,”**( FIN 47), whichclarifies that the term “conditional asset retirement obligation,” as used inSFAS No. 143, “Accounting for Asset Retirement Obligations,” refers to alegal obligation to perform an asset retirement activity in which the timingand/or method of settlement are conditional on a future event that may or maynot be within the control of the entity. However, the obligation to perform theasset retirement activity is unconditional even though uncertainty exists aboutthe timing and/or method of settlement. FIN 47 requires that the uncertaintyabout the timing and/or method of settlement of a conditional asset retirementobligation be factored into the measurement of the liability when sufficientinformation exists. FIN 47 also clarifies when an entity would have sufficientinformation to reasonably estimate the fair value of an asset retirementobligation. FIN 47 was adopted by the Company beginning April 1, 2005 and hadno effect on the Company’s consolidated financial statements.

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

**2.    Acquisitions**

Allof the Company’s acquisitions have been accounted for as purchase businesscombinations and are included in the Company’s results of operations from theirrespective acquisition dates. Any additional payments of contingentconsideration (e.g., earn-outs) are payable in cash and will be recorded asadditional goodwill when the contingencies for such payments have been met (alsosee Note 13).

***ESSI:*****  **

On January 31, 2006, the Company completed itsacquisition of all of the outstanding common stock and options to acquire thecommon stock of Engineered Support Systems, Inc. In the transaction, awholly-owned subsidiary of DRS was mergedwith and into ESSI (the Acquisition), forming DRS’s third operating segment—theS3 Group. The purchase price was $43.00 per share of ESSI common stock, whichwas comprised of $30.10 in cash and a fraction of a share of DRS common stockvalued at $12.90. Total consideration for the Acquisition consisted of $1.34billion in cash and 11.7 million shares of DRS common stock, or an aggregatevalue of $1.93 billion. In addition to the purchase price, the Company assumed$78.5 million in debt and recorded $25.5 million of acquisition-relatedcosts, including professional fees. Thestock component of the consideration was valued at $50.08 per share, using theaverage price of DRS common stock on the measurement date (January 27, 2006,the date the number of shares was known) and a few days before and after themeasurement date. Upon closing of the Acquisition, the Company repaid ESSI’scredit facility in the amount of $76.3 million. The Companyfinanced the cash portion of the Acquisition by utilizing cash and cashequivalents on hand, revolving credit borrowings, $275.0 million in term debtand $900 million of new debt securities, including $350 million aggregateprincipal amount of 65/8% senior notes due 2016, $250million aggregate principal amount of 75/8%senior subordinated notes due 2018 and $300.0 million aggregate principalamount of 2.0% convertible senior notes due 2026. See Note 8, Debt, for a description of the new amended and restatedcredit facility and the new debt securities.

ESSI, 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 andselected government and intelligence agencies. ESSI also produces specializedequipment and systems for commercial and industrial applications. The additionof ESSI has provided for a larger, more competitive and more diversifiedcompany through the contribution of a significant base of systems, products andservices focused on military force sustainment, technical and logisticssupport, integrated military electronics and field support equipment.

The Company is in the process ofobtaining a third-party valuation of certain assets and liabilities,including acquired intangible assets and finalizing its own internal assessmentof the purchase price allocation; thus, the preliminary allocation of purchaseprice will change, and such change could be material. Goodwill of $1.8 billionhas been allocated to the S3 Group, $283.4 million of which is expected tobe deductible for tax purposes. The assets acquired also reflect a preliminaryestimate of $136.1 million in customer-related intangibles with weightedaverage useful lives of 7.1 years. The following table summarizes the estimatedfair value of the assets acquired and liabilities assumed in the Acquisition. TheCompany anticipates completing the purchase price allocation in the thirdquarter of fiscal 2007.

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

 

| ** **                                      | ** ** | **January 31,  2006** | ** **                 |
|-------------------------------------------------|------------|----------------------------|----------------------------|
| ** **                                      | ** ** | **(in thousands)**    | ** **                 |
| Accounts receivable                             |       |                       | $   164,425 |   |   |
| Inventory                                       |       |                       | 77,573                     |   |   |
| Other current assets                            |       |                       | 64,704                     |   |   |
| Current deferred tax  asset                     |       |                       | 39,320                     |   |   |
| Property, plant and  equipment                  |       |                       | 69,632                     |   |   |
| Other assets                                    |       |                       | 3,022                      |   |   |
| Long-term deferred tax  asset                   |       |                       | 6,122                      |   |   |
| Acquired intangible  assets                     |       |                       | 136,130                    |   |   |
| Goodwill                                        |       |                       | 1,781,062                  |   |   |
| Total assets acquired                           |       |                       | 2,341,990                  |   |   |
| Short-term debt                                 |       |                       | 76,300                     |   |   |
| Accrual for future costs  on acquired contracts |       |                       | 82,848                     |   |   |
| Other current liabilities                       |       |                       | 128,027                    |   |   |
| Long-term debt                                  |       |                       | 2,229                      |   |   |
| Benefit plan obligations                        |       |                       | 54,083                     |   |   |
| Long-term deferred tax  liability               |       |                       | 38,489                     |   |   |
| Other liabilities                               |       |                       | 3,859                      |   |   |
| Total liabilities assumed                       |       |                       | 385,835                    |   |   |
| Net assets acquired                             |       |                       | $ 1,956,155           |   |   |

 

In accordance with EITF 95-3 "Recognition ofLiabilities in Connection with a Purchase Business Combination", theCompany recorded a $5.1 million liability in the preliminary purchaseprice allocation in connection with a plan to involuntarily terminate certainemployees of ESSI. The Company is currently in the process of evaluatingadditional restructuring actions. Management anticipates finalizing its plansin the second quarter of fiscal 2007. There were no payments against the$5.1 million accrual as of March 31, 2006.

***WalkAbout:***

On June 27, 2005, we acquired WalkAbout ComputerSystems, Inc. (WalkAbout) in a stock purchase transaction for $13.8 million incash, with additional consideration payable of up to $5.0 million uponachievement of certain revenue targets for a period of two and a half years(i.e., earn-out). In addition to the purchase price, the Company paid $0.2million for acquisition-related costs, including professional fees.

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

The Company obtained a third-partyvaluation of certain assets and liabilities, including acquired intangibleassets and finalized its own internal assessment of the purchase priceallocation during the fourth quarter of fiscal 2006. As a result, the Companyrecorded a total of $8.8 million of goodwill (including a $0.2 million earn-outadjustment recorded in the fourth quarter of fiscal 2006), all of which hasbeen allocated to the C4I Group. Of the total goodwill recorded, $2.3 millionis expected to be deductible for tax purposes. The Company recorded $1.3 millionof customer-related intangibles that have weighted-average useful lives of 5years.

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

***Codem:***

On April 15, 2005, we acquired Codem Systems, Inc.(Codem) in a stock purchase transaction for $31.6 million in cash, withadditional consideration payable of up to $5.0 million upon achievement ofcertain annual bookings targets for a period of three years. In addition to thepurchase price, the Company paid $0.3 million for acquisition-related costs,including professional fees.

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 the Company’s existing intelligence productbase. Codem is being managed as a part of the Company’s C4I Group.

The Company obtained a third-partyvaluation of certain assets and liabilities, including acquired intangibleassets and finalized its own internal assessment of the purchase priceallocation during the fourth quarter of fiscal 2006. As a result, the Companyrecorded a total of $25.7 million of goodwill (including a $0.3 millionearn-out adjustment recorded in the fourth quarter of fiscal 2006), all ofwhich has been allocated to the C4I Group. None of Codem’s goodwill is expectedto be deductible for tax purposes. The Company recorded $1.9 million and $4.2million of technology-based and customer-related intangibles, respectively,both of which have weighted average useful lives of 9 years.

***NVEC:***

On December 14, 2004, the Company acquiredcertain assets and liabilities of Night Vision Equipment Co., Inc. andExcalibur Electro Optics, Inc. (collectively referred to as NVEChereafter), a privately-held business headquartered in Allentown, Pennsylvania.The purchase price was $47.2 million in cash, including a$4.7 million working capital adjustment paid in the fourth quarter offiscal 2005, with additional consideration of up to a maximum of$37.5 million payable upon achieving certain annual revenue targets for aperiod of three years. In addition to the purchase price, the Company paid$0.1 million for acquisition-related costs, including professionalfees. The Company paid an additional $4.6 million associated with achievingcertain earn-out targets achieved in fiscal 2006.

NVEC is a manufacturer and marketer of innovativenight vision products and combat identification systems. It focuses on therapid development and delivery of lightweight, affordable image intensification(I2)night vision, uncooled thermal imaging, reflective combat identification andlaser-based products for U.S. and international militaries andparamilitary organizations. NVEC maintains research, development and productionfacilities in Prescott Valley, Arizona. The acquisition of NVEC has enhancedDRS’s position in the uncooled infrared sensor and thermal imaging systemsmarket, as well as provided increased access to and participation in homelanddefense efforts at the federal, state and local levels. NVEC is being managedas part of the Company’s SR Group.

The Company obtained a third-partyvaluation of certain assets, including acquired intangible assets, andfinalized its own internal assessment of certain other assets and liabilitiesduring fiscal 2006. The Company recorded total goodwill at March 31, 2006 inconnection with the acquisition of NVEC of $27.7 million. Goodwill has beenallocated to the SR Group, and $27.7 million is expected to be deductiblefor tax purposes. The purchase price also reflects $8.9 million and$0.2 million of customer-related and technology-based acquiredintangible assets, respectively, which are being amortized over 8 and12 years, respectively.

86

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

***IDT:***

On November 4, 2003, a wholly-ownedsubsidiary of the Company merged with and into Integrated Defense Technologies, Inc.(IDT) in a purchase business combination with IDT being the survivingcorporation and continuing as a wholly-owned subsidiary of DRS (theMerger). The total consideration for the Merger consisted of$261.3 million in cash (excluding cash acquired of $27.5 million) and4.3 million shares of DRS common stock, or an aggregate value of$367.4 million, and the assumption of $201.0 million in debt,including $0.2 million of IDT’s capital leases. In addition to thepurchase price, the Company paid $12.5 million in acquisition-related costs,including professional fees. The stock component of the consideration wasvalued at $24.55 per share using the average price of DRS common stock onthe measurement date of the Merger (October 31, 2003) and a few daysbefore and after the measurement date. Upon closing of the Merger, the Companyrepaid IDT’s term loan in the amount of $200.8 million. The Companyfinanced the Merger with borrowings under its amended and restated creditfacility, the issuance of $350.0 million of senior subordinated notes (seeNote 8, Debt, for a description of the amended and restated creditfacility and the senior subordinated notes) and with existing cash on hand.

Headquartered in Huntsville,Alabama, IDT is a designer and developer of advanced electronics and technologyproducts for the defense and intelligence industries. The Merger enhanced DRS’scontent on key U.S. Army and Navy weapons programs, contributed asignificant new base of U.S. Air Force programs and greatly expanded DRS’sintelligence agency business. Operating units acquired in the Merger nowoperate in both the C4I Group and the SR Group. At March 31,2006, goodwill of $144.9 million and $217.6 million was allocated tothe Company’s C4I Group and SR Group, respectively, of which$143.5 million is expected to be deductible for tax purposes.

On March 10, 2005, theCompany completed the sale of DRS Weather and DRS Broadcast, two ofthe operating units acquired in the Merger. The Company allocated$8.5 million of goodwill to the net assets sold in the divestiture ofDRS Weather and DRS Broadcast. The IDT purchase price allocation,including the value assigned to DRS Weather and DRS Broadcast, identified$37.4 million and $25.3 million of customer-related andtechnology-based acquired intangible assets, respectively. The net assetsof DRS Weather and DRS Broadcast included $0.1 million and$7.4 million of customer-related and technology-related intangibleassets, respectively. The remaining acquired IDT intangible assets are beingamortized over their weighted average useful lives of 19 years forcustomer-related intangibles and 18 years for technology-relatedintangibles.

***Other:***

During fiscal 2006, the Companypaid $6.7 million in consideration to satisfy an earn-out obligation on its2002 acquisition of DKD, Inc. (now operating as a component of DRSInfrared Technologies L.P.). The earn-out was recorded as an increase togoodwill during the fourth quarter of fiscal 2005, when it was probable apayment was required. The Company also recorded an additional $7.1 millionincrease to goodwill in fiscal 2006 in final satisfaction of its earn-outobligations, which was paid in the first quarter of fiscal 2007.

87

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

***Pro FormaResults***

The following pro forma financial information showsthe results of continuing operations for the years ended March 31, 2006and 2005, as though the acquisition of ESSI had occurred at the beginning ofeach respective fiscal year as though the acquisition of NVEC and Affiliate hadoccurred at the beginning of fiscal 2005 and ESSI’s acquisition of SpacelinkInternational, LLC (a significant purchase business combination by ESSI intheir most recent fiscal year) occurred at the beginning of fiscal 2005. Thepro forma financial information does not reflect the WalkAbout and Codemacquisitions as the effect of these acquisitions were not significant on anindividual or aggregate basis. The pro forma financial information includes, whereapplicable, adjustments for: (i) the capitalization of general andadministrative costs to be consistent with DRS’s accounting practice,(ii) the amortization of acquired intangible assets, (iii) additionalnet interest expense on acquisition-related borrowings, (iv) theamendment and restatement of certain credit facilities in fiscal 2006,(v) the pay-down of acquired companies’ debt, (vi) the issuance of11.7 million shares of DRS common stock in fiscal 2006 (vii) theelimination of certain of ESSI’s nonrecurring Acquisition-related costs recognizedin its historical financial statements and (viii) the income tax effect onthe pro forma adjustments, using a statutory tax rate of 40%. The pro formaadjustments related to the acquisition of ESSI are based on a preliminarypurchase price allocation. Differences between the preliminary and finalpurchase price allocations could have an impact on the pro forma financialinformation presented and such impact could be material. The pro forma financialinformation below is presented for illustrative purposes only and is notnecessarily indicative of the operating results that would have been achievedhad the acquisitions been completed as of the dates indicated above or theresults that may be obtained in the future.

| ** **                                                      | ** ** | **Year Ended March 31,**                        | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2006**                                                       | ** ** | **2005** | ** ** |
| ** **                                                      | ** ** | **(in thousands, except per  share data)** | ** ** |
| ** **                                                      | ** ** | **(unaudited)**                                                | ** ** |
| Revenues                                                        |       | $                                                              | 2,559,500  |   | $ | 2,417,663 |   |
| Earnings from continuing  operations                            |       | $                                                              | 88,005     |   | $ | 95,814 |   |
| Earnings from continuing  operations per share of common stock: |       |                                                           |       |   |   |
| Basic earnings per share                                        |       | $                                                              | 2.23       |   | $ | 2.47 |   |
| Diluted earnings per share                                      |       | $                                                              | 2.18       |   | $ | 2.42 |   |

 

**3.   Goodwill and Related Intangible Assets**

The following disclosure presents certain informationregarding the Company’s acquired intangible assets as of March 31, 2006 and2005. 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  March 31, 2006**           | ** ** |                    | ** ** | ** **                                  |       | ** **                  | ** ** |                          | ** ** | ** **       |       |   | ** ** | ** ** |   |
| Technology-based intangibles             |       |                    | 18 years   | ** **                                  |       | $                           | 47,861     |                          |       | $                | (14,100    | ) |   |   | $ | 33,761 | ** ** |   |
| Customer-related intangibles             |       |                    | 11 years   | ** **                                  |       | 217,190                     |       |                          | (19,812    | )                |       |   | 197,378 | ** ** |   |
| Total                                    |       |                    |       | ** **                                  |       | $                           | 265,051    |                          |       | $                | (33,912    | ) |   |   | $ | 231,139 | ** ** |   |
| **As of  March 31, 2005**           | ** ** |                    | ** ** | ** **                                  |       | ** **                  | ** ** |                          | ** ** | ** **       |       |   | ** ** | ** ** |   |
| Technology-based intangibles             |       |                    | 19 years   | ** **                                  |       | $                           | 45,961     |                          |       | $                | (11,172    | ) |   |   | $ | 34,789 | ** ** |   |
| Customer-related intangibles             |       |                    | 17 years   | ** **                                  |       | 75,590                      |       |                          | (10,349    | )                |       |   | 65,241 | ** ** |   |
| Total                                    |       |                    |       | ** **                                  |       | $                           | 121,551    |                          |       | $                | (21,521    | ) |   |   | $ | 100,030 | ** ** |   |

 

88

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

The aggregate acquired intangibleasset amortization expense for the fiscal years ended March 31, 2006, 2005and 2004 was $12.4 million, $7.0 million and $5.0 million,respectively. The estimated acquired intangible asset annual amortizationexpense is approximately $27.9 million for each of the subsequent three fiscalyears ending March 31, 2009, $27.8 million for the fiscal year March 31,2010 and $26.9 million for the fiscal year ended March 31, 2011. Asdiscussed in further detail in Note 2, the Company is in the process ofreviewing a third-party valuation of the acquired intangible assets in the ESSIacquisition.

The tablebelow reconciles the change in the carrying amount of goodwill by operatingsegment for the period from March 31, 2004 to March 31, 2006:

| ** **                                                                         | ** ** | **C4I Group**      | ** **  | **SR Group** | ** ** | **S3 Group** | ** ** | **Total**   | ** **    |
|------------------------------------------------------------------------------------|------------|-------------------------|-------------|-------------------|------------|-------------------|------------|-------------|---------------|
| ** **                                                                         | ** ** | **(in thousands)** | ** **  |
| **Balance as of March 31, 2004**                                              | ** ** | **$**                   | **442,607** | ** **        | **$**      | **357,524**       | ** ** | **$**       | —        | ** ** | **$** | **800,131** | ** ** |
| NVEC acquisition                                                                   | ** ** | —                  |        | 23,337            | ** ** | —            |       | 23,337      |          |
| Purchase price allocation  adjustments on acquisitions completed in prior years(A) |       | 3,758                   |        | (19,945           | )          | —            |       | (16,187     | )             |
| Acquisition earn-out, Nytech                                                       | ** ** | —                  |        | 6,860             | ** ** | —            |       | 6,860       |          |
| Foreign currency translation  adjustment                                           |       | 1,266                   | ** **  | **—**        | ** ** | —            |       | 1,266       |          |
| **Balance as of March 31, 2005**                                              | ** ** | **447,631**             | ** **  | **367,776**       | ** ** | —            | ** ** | **815,407** | ** **    |
| ESSI acquisition                                                                   | ** ** | —                  | ** **  | —            |       | 1,781,062         |       | 1,781,062   |          |
| Codem acquisition                                                                  |       | 25,421                  | ** **  | —            | ** ** | —            |       | 25,421      |          |
| WalkAbout acquisition                                                              |       | 8,642                   | ** **  | —            | ** ** | —            |       | 8,642       |          |
| Deferred tax adjustments related  to prior acquisitions(B)                         |       | (9,460                  | )           | (23,777           | )          | —            |       | (33,237     | )             |
| Acquisition earn-out, NVEC                                                         | ** ** | —                  |        | 4,564             | ** ** | —            |       | 4,564       |          |
| Accrued acquisition earn-out,  Nytech                                              |       | —                  |        | 7,140             | ** ** | —            |       | 7,140       |          |
| Accrued acquisition earn-out,  Codem                                               |       | 316                     | ** **  | —            | ** ** | —            |       | 316         |          |
| Accrued acquisition earn-out,  WalkAbout                                           |       | 162                     | ** **  | —            | ** ** | —            |       | 162         |          |
| Expiration of unexercised  contract options relating to the IDT acquisition        | ** ** | (1,179                  | )           | (566              | )          | —            |       | (1,745      | )             |
| Other adjustments                                                                  |       | 94                      |        | (328              | )          | —            |       | (234        | )             |
| Foreign currency translation  adjustment                                           |       | 603                     |        | —            |       | (33               | )          | 570         |          |
| **Balance as of March 31, 2006**                                              | ** ** | **$**                   | **472,230** |              | **$**      | **354,809**       | ** ** | **$**       | **1,781,029** | ** ** | **$** | **2,608,068** | ** ** |

----

(A)          Thefiscal 2005 purchase price allocation adjustments in the table above reflectthe following:

| ** **                                      | ** ** | **Purchase Price   Allocation** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                      | ** ** | **Adjustments**                      | ** ** |
| ** **                                      | ** ** | **Fiscal 2005**                 | ** ** |
| ** **                                      | ** ** | **(in thousands)**              | ** ** |
| **C4I Group:**                                  | ** ** |                                 | ** ** | ** ** |   |
| IDT                                             |       |                                 | $          | 3,753 |  (a) |   |
| Kaman Electromagnetics Development Center (EPT) |       |                                 | (62        | )(b) |   |
| Power Technology Incorporated (PTI)             |       |                                 | (8         | )(b) |   |
| Paravant, Inc.                             |       |                                 | 515        |  (b) |   |
| Navy Controls Division of Eaton Corp. (PCT)     |       |                                 | (133       | )(b) |   |
| Other adjustments                               |       |                                 | (307       | ) |   |
| ** **                                      | ** ** |                                 | **$**      | **3,758** | ** ** |   |

 

89

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

 

| ** **                        | ** ** | **Purchase Price   Allocation** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|
| ** **                        | ** ** | **Adjustments**                      | ** ** |
| ** **                        | ** ** | **Fiscal 2005**                 | ** ** |
| ** **                        | ** ** | **(in thousands)**              | ** ** |
| **SR Group:**                     | ** ** |                                 | ** ** | ** ** |   |
| IDT                               |       |                                 | $          | (18,870 | )(c) |   |
| Boeing  Company (SES business)    |       |                                 | (6         | )(b) |   |
| EOS  Business of Raytheon Company |       |                                 | (1,198     | )(d) |   |
| DKD, Inc.  (Nytech)          |       |                                 | 41         |  (b) |   |
| Other  adjustments                |       |                                 | 88         |   |   |
| ** **                        | ** ** |                                 | **$**      | **(19,945** | **)** |   |

 

(a)           Reflects a purchaseprice allocation adjustment of $2.8 million (increase to goodwill)associated with an IDT merger-related facility consolidation. The Companyterminated 60 individuals and exited a leased facility, with the severancepayments being completed in the first quarter of fiscal 2006 and the leasepayments being completed by the first quarter of fiscal 2007. At March 31,2006, 0.5 million of the facility consolidation accrual remained.  The amount also reflects adjustments foracquired deferred taxes of $1.1 million, net, (net increase to goodwill)and a net decrease to goodwill of $0.2 million for changes in estimates,primarily for certain acquired contracts, acquisition-related costs andcertain accrued expenses.

(b)          Reflects adjustments toacquired deferred taxes.

(c)            Reflects purchaseprice allocation adjustments (decreases to goodwill) of $10.0 million fornet deferred tax assets, $8.4 million for changes in estimates on certainacquired contracts and acquisition-related costs and $0.5 million toreflect the disposition of certain assets held for sale by the acquired companyat acquisition.

(d)          Reflects adjustments of$0.9 million for contract options that expired unexercised during fiscal2005 and $0.3 million to adjust certain acquired deferred tax amounts.

(B)           The Company operates inmultiple taxing jurisdictions, both within the United States and outside theUnited States, and faces audits from these various tax authorities regardingthe amount of taxes due. Such audits can involve complex issues and may requirean extended period of time to resolve. In the second quarter of fiscal 2006,the Company’s income tax provision was reduced by $3.0 million predominantly dueto the resolution of the IRS’s examination of the fiscal 1999-2001 tax years.Also in connection with the resolution of the fiscal 1999-2001 tax audits, theCompany adjusted certain acquired deferred tax assets and liabilities andcertain other pre-acquisition related tax amounts, totaling $33.2 million, witha corresponding net decrease to goodwill.

90

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

**4.   AccountsReceivable**

Unbilledreceivables represent sales for which billings have not been presented tocustomers as of the end of the fiscal year, including retentions arising fromcontractual provisions. At March 31, 2006 and 2005, retentions amounted to$12.4 million and $7.1 million, respectively. Approximately$3.7 million of March 31, 2006 retentions are anticipated to becollected beyond one year. The component elements of accounts receivable, netof allowances for doubtful accounts of $1.7 million and $2.7 millionat March 31, 2006 and 2005, respectively, are as follows:

| ** **                        | ** ** | **March 31,**      | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(in thousands)** | ** ** |
| U.S. government  contracts:       |       |                    |       |   |   |
| Billed receivables                |       | $                       | 130,242    |   | $ | 62,261 |   |
| Unbilled receivables              |       | 92,071                  |       | 40,263 |   |
|                              |       | 222,313                 |       | 102,524 |   |
| Other defense-related  contracts: |       |                    |       |   |   |
| Billed receivables                |       | 119,724                 |       | 79,994 |   |
| Unbilled receivables              |       | 56,425                  |       | 33,476 |   |
|                              |       | 176,149                 |       | 113,470 |   |
| Other trade receivables           |       | 36,573                  |       | 21,918 |   |
| Total                             |       | $                       | 435,035    |   | $ | 237,912 |   |

 

**5.   Inventories**

Inventoriesare summarized as follows:

| ** **                                             | ** ** | **March 31,**      | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(in thousands)** | ** ** |
| Work-in-process                                        |       | $                       | 371,343    |   | $ | 217,134 |   |
| General and  administrative costs                      |       | 63,850                  |       | 47,365 |   |
| Raw material and finished  goods                       |       | 66,705                  |       | 33,127 |   |
|                                                   |       | 501,898                 |       | 297,626 |   |
| Less: Progress payments  and certain customer advances |       | 160,914                 |       | 75,541 |   |
|  Inventory  reserve                               |       | 9,360                   |       | 8,724 |   |
| Total                                                  |       | $                       | 331,624    |   | $ | 213,361 |   |

 

Inventoried contract costs for the Company’sbusinesses that are primarily government contractors may include certaingeneral and administrative (G&A) costs, including internal research anddevelopment costs (IRAD) and bid and proposal costs (B&P). G&A, IRADand B&P are allowable, indirect contract costs under U.S. governmentregulations. The Company allocates these costs to government contracts andaccounts for them as product costs at the majority of the Company’s operatingunits, not as period expenses.

91

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

The table below presents a summary of G&A, IRADand B&P costs included in inventoried contract costs and changes to them,including amounts used in the determination of costs and expenses.

The cost data in the tables below do not include theG&A, IRAD and B&P costs for the Company’s lines of businesses that arenot primarily contracted with the U.S. government, which are expensed asincurred:

| ** **                                    | ** ** | **Year Ended March 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                    | ** ** | **(in thousands)**                 | ** ** |
| Balance in inventory at  beginning of year    |       | $                                       | 47,365     |   | $ | 37,854 |   | $ | 25,489 |   |
| Add: Acquired costs                           |       | 9,943                                   |       | — |   | 7,353 |   |
| Incurred costs                                |       | 239,831                                 |       | 212,167 |   | 161,007 |   |
| Less: Amounts included in costs  and expenses |       | 233,289                                 |       | 202,656 |   | 155,995 |   |
| Balance in inventory at end of year           |       | $                                       | 63,850     |   | $ | 47,365 |   | $ | 37,854 |   |

 

**6.   Property, Plant and Equipment**

Property,plant and equipment are summarized as follows:

| ** **                                      | ** ** | **March 31,**      | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | **(in thousands)** | ** ** |
| Land                                            |       | $                       | 20,242     |   | $ | 15,560 |   |
| Machinery and equipment                         |       | 144,966                 |       | 115,368 |   |
| Computer equipment and software                 |       | 69,328                  |       | 44,353 |   |
| Buildings and improvements                      |       | 75,580                  |       | 30,030 |   |
| Leasehold improvements                          |       | 25,672                  |       | 20,364 |   |
| Office furnishings, equipment  and other        |       | 23,042                  |       | 18,924 |   |
|                                            |       | 358,830                 |       | 244,599 |   |
| Less accumulated depreciation  and amortization |       | 138,324                 |       | 101,335 |   |
| Total                                           |       | $                       | 220,506    |   | $ | 143,264 |   |

 

Annual depreciation of property,plant and equipment amounted to $36.6 million, $33.8 million and$23.2 million in fiscal 2006, 2005 and 2004, respectively.

**7.   Accrued Expenses and Other CurrentLiabilities**

The componentelements of accrued expenses and other current liabilities are as follows:

| ** **                                               | ** ** | **March 31,**      | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|
| ** **                                               | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                               | ** ** | **(in thousands)** | ** ** |
| Accruals for future costs  related to acquired contracts |       | $109,223                |       | $ | 28,137 |   |
| Customer advances                                        |       | 90,993                  |       | 79,680 |   |
| Payroll, other compensation and  related expenses        |       | 92,872                  |       | 60,976 |   |
| Accrued interest                                         |       | 27,270                  |       | 16,513 |   |
| Accrued product warranty (Note 1.U.)                     |       | 23,596                  |       | 21,839 |   |
| Income taxes payable                                     |       | 34,560                  |       | 39,286 |   |
| Loss accrual for future costs on  uncompleted contracts  |       | 20,947                  |       | 19,766 |   |
| Other                                                    |       | 74,382                  |       | 46,224 |   |
| Total                                                    |       | $                       | 473,843    |   | $ | 312,421 |   |
|                                                          |            |                         |            |  |  |  |  |

 

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

Components in “Other” at March 31,2006 and 2005 include litigation and contingency related-accruals, shortterm pension liabilities, and accrued acquisition earn-outs (see Note 3).

**8.   Debt**

A summary ofdebt is as follows:

| ** **                                     | ** ** | **March 31,**      | ** ** |
|------------------------------------------------|------------|-------------------------|------------|
| ** **                                     | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(in thousands)** | ** ** |
| Credit Facility:                               |       |                    |       |   |   |
| Revolving  line of credit                      |       | $                       | 40,000     |   | $ | — |   |
| Term  loans                                    |       | 275,000                 |       | 167,460 |   |
| Canadian Term Loan                             |       | 9,853                   |       | — |   |
| 65¤8%  Senior Notes due 2016              |       | 350,000                 |       | — |   |
| 75¤8%  Senior Subordinated Notes due 2018 |       | 250,000                 |       | — |   |
| 67¤8%  Senior Subordinated Notes due 2013 |       | 550,000                 |       | 550,000 |   |
| 2.0% Convertible Senior  Notes due 2026        |       | 345,000                 |       | — |   |
| Unamortized Bond Premium on 67¤8%         |       |                    |       |   |   |
| Senior  Subordinated Notes                     |       | 8,585                   |       | 9,716 |   |
| Other obligations                              |       | 4,955                   |       | 3,087 |   |
|                                           |       | 1,833,393               |       | 730,263 |   |
| Less:                                          |       |                    |       |   |   |
| Current installments of  long-term debt        |       | 4,622                   |       | 2,652 |   |
| Total long-term debt                           |       | $                       | 1,828,771  |   | $ | 727,611 |   |

 

Simultaneously with the closing of the Company’sacquisition of ESSI, on January 31, 2006 the Company entered into anamended and restated credit facility for up to an aggregate amount of$675.0 million with a syndicate of lenders (the Credit Facility),replacing DRS’s previously existing credit facility. The Credit Facilityconsists of a $400.0 million senior secured revolving line of credit and a$275.0 million senior secured term loan. The Company is permitted, on nomore than two occasions, to increase the aggregate  amount of the Credit Facility by up to $250.0million, subject to certain restrictions. Any increase in the aggregate amountof the Credit Facility may be borrowed in the form of either additional termloans or available amounts under the revolving line of credit. The CreditFacility is guaranteed by substantially all of DRS’s domestic subsidiaries. Inaddition, it is collateralized by liens on substantially all of the assets ofthe Company’s subsidiary guarantors’ and certain of DRS’s other subsidiaries’assets and by a pledge of a portion of certain of the Company’s non-guarantorsubsidiaries’ capital stock. The term loan and the revolving credit facilitymature on January 31, 2013 and 2012, respectively. 

The Company previously had a credit facility for up toan aggregate amount of $411.0 million. The credit facility consisted of a$175.0 million senior secured revolving line of credit and a$236.0 million senior secured term loan. During the week of January 9,2006, the Company prepaid the remaining $135.7 million balance of its termloans at its discretion and recognized a $1.1 million charge to interest andrelated expenses in the fourth quarter of fiscal 2006 for the write-off of thebalance of the term loan debt issuance costs, net of the recognition of apreviously deferred gain for the termination of related interest rate swapagreements. There were no outstanding borrowings under the previous revolvingcredit facility at the time that the Company entered into the new CreditFacility.

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

Revolving line of credit and term loan borrowingsunder the Credit Facility generally bear interest at the Company’s option at either:1) a “base rate,” which is defined as the higher of (a) the prime rate or (b) thefederal funds rate plus 0.50%, plus the applicable margin; or 2) the LIBOR rateplus the applicable margin. Revolving credit loans that are base rate loansbear interest at the base rate plus a margin ranging from 0.00% to 0.50% perannum, depending on the Company’s total leverage ratio (TLR), as the term isdefined in the credit agreement, at the time of determination. Revolving creditloans that are LIBOR rate loans bear interest at LIBOR plus a margin rangingfrom 1.00% to 1.75% per annum, depending on the Company’s TLR. Term loans thatare base rate loans bear interest at the base rate plus 0.25%, and term loansthat are LIBOR rate loans bear interest at LIBOR plus 1.50%. Borrowings underthe previous credit facility bore interest in a similar manner with generallyhigher margins on each type of available loan.

The Company pays commitment fees calculated on theaverage daily unused portion of its revolving line of credit at a rate rangingfrom 0.375% and 0.50% per annum, depending on the Company’s TLR. The Companypays commissions and issuance fees on its outstanding letters of credit and isobligated to pay or reimburse the issuing lender for such normal and customarycosts and expenses incurred or charged by the issuing lender in issuing, effectingpayment under, amending or otherwise administering any letter of credit.****Letter-of-credit commissions arecalculated at a rate ranging from 1.00% to 1.75% per annum, depending on theCompany’s TLR ratio at the time of issuance, multiplied by the face amount ofsuch letter of credit. Letter-of-credit issuance fees are charged at 0.125% perannum, multiplied by the face amount of such letter of credit. Bothletter-of-credit commissions and issuance fees are paid quarterly.****The Company was subject to similarletter-of-credit commissions and issuance fees on its previous credit facility.

There are certain covenants and restrictions placed onDRS under the Credit Facility, including, but not limited to, quarterlyfinancial covenants specifying maximum total leverage ratio, maximum seniorleverage ratio, and minimum fixed charge coverage ratio beginning with thequarter ending June 30, 2006, and restrictions or limitations on acquisitionsand investments, equity issuances, sales of assets, dividends that the Companymay declare and pay on its common stock, issuance of additional debt ormodifications of existing debt, incurrence of liens and capital expenditures.

The principal amount of any outstanding revolvingcredit loans are due and payable in full on January 31, 2012, the sixthanniversary of the closing date of the Credit Facility. The Company is required to repay the aggregate outstanding principalamount of the initial term loan borrowings ($275.0 million) in consecutivequarterly installments on the last business day of each of December, March, June andSeptember commencing June 30, 2006.****From June 30, 2006 through March 31, 2012, eachsuch principal payment is $0.7 million. Each principal payment from June 30,2012 through January 31, 2013 is $64.6 million.

As of March 31, 2006, $275.0 million of termloans and $40.0 million of revolving line of credit borrowings were outstandingagainst the Credit Facility. The weighted average interest rate on the Company’sterm loan borrowings was 6.3%, as of March 31, 2006 (4.4% on previous termloans, as of March 31, 2005). The weighted average interest rate under therevolving line of credit borrowings was 6.2%. There were no borrowings underthe revolving line of credit at March 31, 2005.

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 advance 

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

payments it has received from itscustomers. As of March 31, 2006, $38.8 million was contingentlypayable under letters of credit and bank guarantees. Of this amount, approximately$0.9 million and $0.5 million in letters of credit and bankguarantees, respectively, as of March 31, 2006, were issued under IDT’sprevious credit agreement and by a bank agreement for the Company’s U.K.subsidiary, respectively, and are not considered when determining theavailability under the Company’s revolving line of credit.

On March 29, 2006, DRS Technologies CanadaCompany (DRS Canada) established a five-year senior secured term loan forapproximately $9.9 million (C$11.5 million), maturing on April 1, 2011. Theproceeds of the loan were utilized to permit repatriation of certain amounts fromCanada to the U.S. which were subject to more favorable tax treatment under theJobs Act (for further information see Notes 1.R and 10.) The term loan bears interestat the Company’s option at either: (i) prime rate or (ii) LIBOR rate plus1.75%. The weighted average interest rate on the term loan was 5.5% as ofMarch 31, 2006. DRS Canada is required to repay aggregate outstandingprincipal of approximately C$575.0 thousand on the first business day of everyJanuary, April, July and October, commencing July 1, 2006. Theterm debt under the agreement ranks senior in priority of payment to allsubordinated debt of DRS Canada and the Company. The debt is collateralized bythe assets of DRS Canada and guaranteed by DRS Technologies, Inc. TheCompany is subject to the same financial covenants beginning with the quarterending June 30, 2006 under the DRS Canada loan, as it is under the Credit Facilitydescribed above, and DRS Canada is subject to other non-financial covenantsthat are similar to those described for the Credit Facility.

On January 31, 2006, in connection with theacquisition of ESSI, the Company 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% convertible seniornotes due 2026 (Convertible Notes). On February 8, 2006, the Company soldan additional $45.0 million of Convertible Notes pursuant to an over-allotmentoption 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 senior notesand the Convertible Notes, other than trade payables and is pari passu with the67¤8%senior subordinated notes.

The January 2006 Notes pay interest semi-annuallyin arrears on February 1 and August 1, commencing August 1, 2006.The net proceeds of the offering of the January 2006 Notes were $588.0million after deducting $12.0 million in commissions and fees related to theofferings. The January 2006 Notes were issued under indentures with TheBank of New York. Subject to a number of exceptions, the indentures restrictsthe Company’s ability and the ability of its subsidiaries to incur more debt,pay dividends and make distributions, make certain investments, repurchasestock, create liens, enter into transactions with affiliates, enter into salelease-back transactions, merge or consolidate, and transfer or sell assets. TheJanuary 2006 Notes are unconditionally guaranteed, jointly and severally,by certain of DRS’s existing and future domestic subsidiaries. See Note 15,“Guarantor and Non-guarantor Financial Statements,” for additional disclosures.

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

At any time prior to February 1, 2009, theCompany may on any one or more occasions redeem up to 35% of the aggregateprincipal amount of the 65¤8% senior notesand 75¤8%senior subordinated notes with the net cash proceeds of one or more equityofferings at a redemption price of 106.625% and 107.625%, respectively, of theprincipal amount, plus accrued and unpaid interest, if any, subject to certainrestrictions.

At any time prior to February 1, 2011, theCompany may redeem the 65¤8%senior notes and 75¤8%senior subordinated notes for cash at the Company’s option, in whole or inpart, at any time or from time to time at a redemption price equal to thegreater of (1) 100% of the principal amount of the January 2006 Notesbeing redeemed and (2) the sum of (a) the present values of 103.313%of the principal amount of the 65¤8%senior notes and 103.813% of the principal amount of the 75¤8% seniorsubordinated notes being redeemed and (b) the scheduled payments ofinterest on the respective January 2006 Notes, discounted to the date ofredemption, together with accrued and unpaid interest, if any.

On or after February 1,2011, DRS may redeem, at its option, all or a part of the January 2006Notes at the redemption prices (expressed as percentages of principal amount)set forth below plus accrued and unpaid interest, if any:

| Year                | ** ** | ** ** | ** ** | **6**5¤8% Senior  Notes | ** ** | **7**5¤8% Senior  Subordinated  Notes | ** ** |
|---------------------|------------|------------|------------|-----------------------------------|------------|-------------------------------------------------|------------|
| 2011                |       |       | 103.313    | %                                 |       |                                            | 103.813    | % |   |
| 2012                |       |       | 102.209    | %                                 |       |                                            | 102.542    | % |   |
| 2013                |       |       | 101.105    | %                                 |       |                                            | 101.271    | % |   |
| 2014 and thereafter |       |       | 100.000    | %                                 |       |                                            | 100.000    | % |   |

 

In certain instances of a change in control, theCompany must offer to repurchase all or part of the January 2006 Notes ata redemption price equal to 101% of the principal amount.

The net proceeds of the offering of the ConvertibleNotes, including the over-allotment, were $337.2 million after deducting $7.8million in commissions and fees related to the offering. Certain of the Company’sexisting and future wholly-owned domestic subsidiaries will fully andunconditionally guarantee the Company’s payment obligations under theConvertible Notes, jointly and severally, on a senior unsecured basis. TheConvertible Notes will mature on February 1, 2026, unless earlierconverted, redeemed or repurchased. The Convertible Notes pay interestsemi-annually in arrears on February 1 and August 1, commencingAugust 1, 2006.

Commencing with the six-month period beginning onFebruary 1, 2011, the Company will pay contingent interest to the holdersof the Convertible Notes during any six-month period from February 1 to July 31,and from August 1 to January 31, if the market price of a ConvertibleNote for each of the days in the five trading-day period ending on the thirdtrading day immediately preceding an interest payment date equals 120% or moreof the principal amount of the Convertible Note. The amount of any contingentinterest payable will equal 0.50% per annum of the average market price of aconvertible note for the five trading-day period. The contingent interestfeature of the Convertible Notes represents an embedded derivative instrument.The value of the contingent interest feature is zero at the date of theissuance of the Convertible Notes. The amount recorded for the embeddedderivative will be adjusted periodically through interest expense for materialchanges in its fair value. 

Upon conversion of a Convertible Note, the Companywill deliver cash in an amount equal to the lesser of (a) the principalamount of the notes surrendered for conversion and (b) the 

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

conversion value (the applicableconversion rate multiplied by the average of the closing prices of DRS commonstock for a defined 20-day period), and if the conversion value is greater thanthe principal amount, an amount of DRS common stock equal to such excess. Theinitial conversion value is based on a conversion rate of 16.7504 shares per$1,000 principal amount of Convertible Notes (representing a conversion priceof approximately $59.70 per share of DRS common stock), subject to adjustment undercertain circumstances.

The Company evaluated the accounting for theconversion feature in accordance with EITF Issue No. 00-19,“Accounting for Derivative Financial Instruments Indexed to and PotentiallySettled in, a Company’s Own Stock,” and related issues, at the date of issuanceof the Convertible Notes and determined that the conversion feature should beclassified as equity, and therefore it does not need to be accounted forseparately from the Convertible Notes. The Company will update its analysis of theaccounting for the conversion feature as circumstances warrant. If theconversion feature is required to be bifurcated in the future, changes in thefair value of the conversion feature would be charged or credited to interestexpense in each period. 

The shares of DRS commonstock that may be issued, if any, upon conversion of the Convertible Notes maybe registered or unregistered shares. At the date of issuance, the underlyingshares of DRS common stock have been registered through an automaticallyeffective registration statement filed with the Securities and ExchangeCommission. The Company is obligated to use its reasonable best efforts tomaintain such registration for two years or pay “additional interest” rangingfrom 0.25% to 1.00% per annum on the principal of the Convertible Notes.

On or prior to February 1,2010, the Convertible Notes may be converted by the holder only under thefollowing circumstances: 

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

·       Duringprescribed periods, the term is, upon the occurrence of specified corporatetransactions or fundamental changes, as described in the Convertible Noteagreement; or

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

After February 1,2010, the Convertible Notes may be converted by the holder into cash andshares, if any, of DRS’s common stock, only under the following circumstances:

·       Duringany calendar quarter (and only during such calendar quarter) commencing after December 31,2009, if the closing sale price of DRS’s common stock for at least 20 tradingdays in the period of 30 consecutive trading days ending on the last tradingday of the preceding calendar quarter is greater than or equal to 110% of theapplicable conversion price;

·       Onor after February 1, 2025;

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

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

·       Duringprescribed periods, upon the occurrence of specified corporate transactions or “fundamentalchanges,” as the term is defined in the Convertible Note agreement; or

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

The Company may redeem the Convertible Notes in wholeor in part for cash, with proper notice, at any time on or after February 1,2009 and prior to February 4, 2011, if the sale price of DRS’s commonstock has exceeded 130% of the conversion price for at least 20 trading days inany consecutive 30-day trading period ending on the trading day prior toproviding notice of redemption, at a redemption price equal to 100% of theprincipal amount of the Convertible Notes to be redeemed plus any accrued andunpaid interest (including contingent interest and additional interest, if any)up to but not including the redemption date and a ‘‘make-whole’’ premium. Themake-whole premium is payable only in cash equal to the present value of allremaining scheduled payments of interest on the Convertible Notes to beredeemed through February 2011.

The Company may, at any time after February 4,2011, redeem the Convertible Notes in whole or in part for cash at a redemptionprice equal to 100% of the principal amount of the Convertible Notes to beredeemed plus any accrued and unpaid interest (including contingent interestand additional interest, if any) up to but not including the redemption date.

Holders have the right to require the Company topurchase all or a portion of their Convertible Notes for cash on February 1,2011, February 1, 2016 and February 1, 2021 at a purchase price equalto 100% of the principal amount of the Convertible Notes plus accrued andunpaid interest (including additional interest, if any) to but not includingthe purchase date. 

On October 30, 2003, the Company issued$350.0 million aggregate principal amount of 67¤8% seniorsubordinated notes, due November 1, 2013 (the October 2003 Notes).Interest is payable every six months on May 1 and November 1, whichcommenced on May 1, 2004. The net proceeds from the offering of the October 2003Notes were $341.2 million, after deducting $8.8 million in commissionsand fees related to the offering. The net proceeds of the October 2003Notes, together with a portion of the Company’s available cash and initialborrowings under the then existing credit facility, were used to fund the IDTacquisition, repay certain of DRS’s and IDT’s outstanding indebtedness, and payrelated fees and expenses. The October 2003 Notes were issued under anindenture with The Bank of New York. Subject to a number of exceptions, theindenture restricts the Company’s ability and the ability of its subsidiariesto incur more debt, pay dividends and make distributions, make certaininvestments, repurchase stock, create liens, enter into transactions withaffiliates, enter into sale lease-back transactions, merge or consolidate, andtransfer 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. See Note 15,“Guarantor and Non-guarantor Financial Statements,” for additional disclosures.

On December 23, 2004, the Company issued anadditional $200.0 million aggregate principal amount of 6 7¤8% Senior Subordinated Notes,due November 2013 (December 2004 Notes). The December 2004 Noteswere offered as additional debt securities under the Company’s indenture withthe Bank of New York with identical terms and the same guarantors as the October 2003Notes. The December 2004 Notes were priced at 105% of the principalamount, reflecting an effective interest rate of approximately 6.13%. The netproceeds of the offering were approximately $208.3 million (including$2.0 million of advanced interest on the new notes that 

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

had accrued from November 1,2004 to December 23, 2004), after deducting $3.7 million incommissions and other costs related to the debt issuance.

At any time prior to November 1,2006, the Company may on any one or more occasions redeem up to 35% of theaggregate principal amount of the 6 7¤8% senior subordinated notes issued withthe net cash proceeds of one or more equity offerings at a redemption price of106.875% of the principal amount, plus accrued and unpaid interest, if any,subject to certain restrictions. On or after November 1, 2008, DRS mayredeem, at its option, all or part of the 67¤8% senior subordinated notes at theredemption prices (expressed as percentages of principal amount) set forthbelow, plus accrued and unpaid interest and liquidating damages, if any:

| **Year**            | ** ** | ** ** | ** ** | **Percentage** | ** ** |
|---------------------|------------|------------|------------|----------------|------------|
| 2008                |       |       | 103.438    | %              |       |
| 2009                |       |       | 102.292    | %              |       |
| 2010                |       |       | 101.146    | %              |       |
| 2011 and thereafter |       |       | 100.000    | %              |       |

 

At March 31, 2006 other debt consisted of amortgage on our Palm Bay, Florida facility of $2.8 million, and $0.8 millionfor certain notes payable to the former owners of DRS Mobilized Systems, Inc.,and $1.3 million of debt at our DRS Pivotal Power business unit. AtMarch 31, 2005 other debt consists of a mortgage on our Palm Bay, Floridafacility of $3.0 million and $0.1 million of capital leases.

The aggregate maturities of long-term debt for fiscal2007, 2008, 2009, 2010 and 2011 are $4.6 million, $5.1 million, $5.5 million,$5.3 million and $5.0 million per year, respectively, and $1.8 billionthereafter.

**9.   Supplemental CashFlow Information**

| ** **                                                                           | ** ** | **Year Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                           | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                           | ** ** | **(in thousands)**                 | ** ** |
| Supplemental disclosure of cash flow information:                                    |       |                                    |       |   |   |   |   |
| Cash paid for:                                                                       |       | ** **                              |       |   |   |   |   |
| Interest                                                                             |       | $                                       | 47,385     | * | $ | 32,603 |   | $ | 11,878 |   |
| Income taxes                                                                         |       | $                                       | 44,891     |   | $ | 8,588 |   | $ | 7,574 |   |
| Supplemental disclosure of significant non-cash  investing and financing activities: |       |                                    |       |   |   |   |   |
| Acquisition earn-out—Nytech                                                     |       | $                                       | 7,140      |   | $ | 6,742 |   | $ | 3,000 |   |
| Acquisition earn-out—Codem                                                      |       | $                                       | 316        |   | $ | — |   | $ | — |   |
| Acquisition earn-out—Walkabout                                                  |       | $                                       | 162        |   | $ | — |   | $ | — |   |
| Acquisition costs for business  combinations                                         |       | $                                       | 334        |   | $ | 613 |   | $ | 2,945 |   |
| Common stock issued in ESSI  acquisition                                             |       | $                                       | 587,260    |   | $ | — |   | $ | — |   |
| Common stock issued in IDT acquisition                                               |       | $                                       | —     |   | $ | — |   | $ | 106,133 |   |

----

*                    Excludes theadvance interest of $2.0 million that was repaid on May 1, 2005 inconjunction with the semi-annual interest payments on the senior subordinatednotes (see Note 8, Debt).

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

**10.   Income Taxes**

Earnings from continuingoperations before income taxes consist of the following:

| ** **                                               | ** ** | **Year Ended March 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                               | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                               | ** ** | **(in thousands)**                 | ** ** |
| Earnings from continuing operations before income taxes: |       |                                    |       |   |   |   |   |
| Domestic earnings                                        | ** ** | $                                       | 124,837    |   | $ | 102,318 |   | $ | 71,203 |   |
| Foreign earnings                                         | ** ** | 8,651                                   |       | 650 |   | 6,128 |   |
| Total                                                    | ** ** | $                                       | 133,488    |   | $ | 102,968 |   | $ | 77,331 |   |

 

Income tax expense from continuingoperations consists of the following:

| ** **                                                            | ** ** | **Year Ended March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                            | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                            | ** ** | **(in thousands)**                 | ** ** |
| Income tax expense (benefit) on earnings from continuing  operations: |       |                                    |       |   |   |   |   |
| Current:                                                              |       |                                    |       |   |   |   |   |
| Federal                                                               | ** ** | $                                       | 24,897     |   | $ | 17,539 |   | $ | 2,920 |   |
| State                                                                 | ** ** | 8,963                                   |       | 5,140 |   | 542 |   |
| Foreign                                                               | ** ** | 2,680                                   |       | (383 | ) | 1,577 |   |
|                                                                  | ** ** | 36,540                                  |       | 22,296 |   | 5,039 |   |
| Deferred:                                                             | ** ** |                                    |       |   |   |   |   |
| Federal                                                               | ** ** | 13,067                                  |       | 17,934 |   | 22,580 |   |
| State                                                                 | ** ** | 2,790                                   |       | 3,597 |   | 5,833 |   |
| Foreign                                                               | ** ** | (403                                    | )          | 1,015 |   | 337 |   |
|                                                                  | ** ** | 15,454                                  |       | 22,546 |   | 28,750 |   |
| Total                                                                 | ** ** | $                                       | 51,994     |   | $ | 44,842 |   | $ | 33,789 |   |

 

Income tax expense on earningsfrom discontinued operations was $1.1 million and $0.6 million forthe fiscal years ended March 31, 2005 and 2004, respectively.

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

Deferredincome taxes reflect the impact of temporary differences between amounts ofassets and liabilities for financial reporting purposes and such amounts asmeasured by tax laws. The tax effects of temporary differences that give riseto significant portions of the deferred tax assets and deferred tax liabilitiesat March 31, 2006 and 2005 are as follows:

| ** **                                         | ** ** | **March 31,**      | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|
| ** **                                         | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                         | ** ** | **(in thousands)** | ** ** |
| Deferred tax assets:                               |       |                    |       |   |   |
| Acquired federal net operating loss  carryforwards |       | $                       | 7,360      |   | $ | 5,057 |   |
| State net operating loss  carryforwards            |       | 9,271                   |       | 5,300 |   |
| Foreign net operating loss  carryforwards          |       | 5,136                   |       | 3,956 |   |
| Capital loss carryforwards                         |       | 3,994                   |       | — |   |
| Tax credit carryforwards                           |       | 2,093                   |       | 216 |   |
| Costs accrued on uncompleted  contracts            |       | 39,982                  |       | 14,652 |   |
| Inventory capitalization                           |       | 9,890                   |       | 6,449 |   |
| Allowance for doubtful accounts                    |       | 563                     |       | 737 |   |
| Deferred compensation                              |       | 32,693                  |       | 9,321 |   |
| Accrued liabilities                                |       | 37,543                  |       | 24,369 |   |
| Other                                              |       | 9,556                   |       | 4,130 |   |
| Total gross deferred tax assets                    |       | 158,081                 |       | 74,187 |   |
| Less valuation allowance                           |       | (17,491                 | )          | (6,515 | ) |
| Deferred tax assets                                |       | 140,590                 |       | 67,672 |   |
| Deferred tax liabilities:                          |       |                    |       |   |   |
| Depreciation and amortization                      |       | 11,027                  |       | 12,201 |   |
| Long-term contract costs                           |       | 23,598                  |       | 18,111 |   |
| Goodwill                                           |       | 39,316                  |       | 26,693 |   |
| Intangibles                                        |       | 37,288                  |       | 2,615 |   |
| Federal impact of state benefits                   |       | 1,943                   |       | 1,855 |   |
| Work in progress inventory                         |       | 258                     |       | 345 |   |
| Other                                              |       | 862                     |       | 649 |   |
| Deferred tax liabilities                           |       | 114,292                 |       | 62,469 |   |
| Net deferred tax assets                            |       | $                       | 26,298     |   | $ | 5,203 |   |

 

A valuation allowance is providedwhen it is more likely than not that some portion or all of a deferred taxasset will not be realized. The Company has established a valuation allowancefor a portion of the state and foreign deferred tax assets at March 31,2006 and 2005, due to the uncertainty of future earnings of certainsubsidiaries of the Company and the status of applicable statutory regulationsthat could limit or preclude utilization of these benefits in future periods.During the fiscal year ended March 31, 2006, the valuation allowance increasedby $11.0 million as follows: a $1.4 million net increase in the valuationallowance associated with certain temporary differences and various state netoperating losses due to current year activity and assessment of futureutilization, a $10.2 million increase associated with capital losscarryforwards, state and foreign net operating losses and temporary differencesas a result of the acquisition of ESSI, offset in part by a $0.6 million netdecrease in the valuation allowance due to the utilization of U.K. netoperating losses. During the fiscal year ended March 31, 2005, the valuationallowance decreased by $2.7 million as follows: a $0.6 million net decrease in the valuation allowance due to theutilization of U.K. net operating losses and temporary differences againstprior year taxable income, offset in part by a valuation allowance on currentlosses net of group relief provisions in the U.K. tax law, and a $2.1 milliondecrease in the valuation allowance associated with various state net operatinglosses due to their current year utilization, expiration or elimination, and reassessmentof future years’ utilization. Based upon the level of historical taxable incomeand projections for future taxable income over the periods in which the Company’sdeferred tax assets are deductible, management believes it is more likely thannot the Company will realize the benefits of these deductible differences, netof the existing valuation allowances, at March 31, 2006 and 2005.

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

As of March 31, 2006, theConsolidated Balance Sheets include net current deferred tax assets and (liabilities)of $59.6 million and $(0.1) million, respectively and net non-current deferredtax assets and (liabilities) of $2.4 million and $(35.6) million, respectively.As of March 31, 2005, the Consolidated Balance Sheets includes net currentdeferred tax assets of $25.1 million and net non-current deferred taxassets and (liabilities) of $2.1 million and $(22.0) million,respectively.

The loss carryforwards availableat March 31, 2006 include $20.9 million of U.S. federal and $112.0 millionof state net operating loss carryforwards, which expire between fiscal years2007 and 2026, and $ 15.9 million of foreign losses, of which the majority willcarryforward indefinitely. All of the Company’s remaining U.S. federal net operatingloss carryforwards as of March 31, 2006 were acquired in connection withthe NAI and Walkabout acquisitions, and approximately $6.9 million, $0.7million, $7.0 million and $29.8 million of its remaining state netoperating loss carryforwards were acquired in connection with the NAI, IDT,Walkabout and ESSI acquisitions, respectively. Future utilization of these netoperating loss carryforwards may result in an adjustment to goodwill to theextent it reduces any related valuation allowance. The annual utilization ofthe NAI and Walkabout federal net operating loss carryforwards is subject tolimitation under Section 382 of the Internal Revenue Code. 

During the second quarter of 2006,the Internal Revenue Service concluded its examination of the tax returns forthe years ended March 31, 1999 through March 31, 2001. As a result ofthe outcome of the audit, the Company recorded a tax benefit of approximately$3.0 million. 

The Company is currently underexamination by the Internal Revenue Service for the years ended March 31,2002 through March 31, 2004 and by various state jurisdictions for variousfiscal years, which could result in challenges to tax positions taken and,accordingly, the Company may record adjustments to provisions based on theoutcomes of such matters. However, at March 31, 2006 the Company believesthat the resolution of these matters, after considering amounts accrued, willnot have a material adverse effect on its consolidated financial statements.

       As previously disclosed, in October 2004 the Jobs Actwas signed into law. The Jobs Act created a temporary incentive for U.S.multinational corporations to repatriate accumulated income earned outside ofthe United States, as of December 31, 2002. In accordance with the JobsAct, the Company repatriated $14.0 million during the fourth quarter of fiscal2006. The Company recorded an income tax charge of $1.4 million, net of the 85%dividends-received deduction, in fiscal 2006 related to the repatriation,approximately $0.7 million of which was paid in fiscal 2006 through withholdingof tax and $0.7 million will be paid during the first quarter of fiscal 2007.

A reconciliation of theexpected U.S. federal income tax rate to the actual (effective) income tax rateis as follows:

| ** **                                                | ** ** | **Year Ended March 31,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected U.S. federal income tax  expense                 |       |                                    | 35.0       | % |   |   | 35.0 | % |   |   | 35.0 | % |   |
| Difference between U.S. and foreign  tax rates            |       |                                    | —     |   |   |   | 0.1 | % |   |   | (0.1 | )% |   |
| State income tax rate, net of  federal income tax benefit |       |                                    | 4.8        | % |   |   | 7.6 | % |   |   | 5.3 | % |   |
| Nondeductible expenses                                    |       |                                    | 1.4        | % |   |   | 1.2 | % |   |   | 3.2 | % |   |
| Change in valuation allowance                             |       |                                    | 0.9        | % |   |   | (0.3 | )% |   |   | 1.5 | % |   |
| Foreign investment tax credits                            |       |                                    | (0.6       | )% |   |   | (0.5 | )% |   |   | (0.7 | )% |   |
| Settlement of IRS audit                                   |       |                                    | (2.2       | )% |   |   | — |   |   |   | — |   |   |
| Other                                                     |       |                                    | (0.3       | )% |   |   | 0.4 | % |   |   | (0.5 | )% |   |
| Total                                                     |       |                                    | 39.0       | % |   |   | 43.5 | % |   |   | 43.7 | % |   |

 

102

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

**11.   Common Stock and Stock Compensation Plans**

**Common Stock**   OnMay 12, 2006, the Company announced that its Board of Directors declared aquarterly cash dividend of $0.03 per share on the Company’s common stock. Thedividend is payable on June 30, 2006 to stockholders of record as of theclose of business on June 15, 2006. During fiscal 2006, the Board ofDirectors declared cash dividends of $0.03 per share on the Company’s commonstock on June 30, 2005, September 30, 2005, December 30, 2005and March 30, 2006 to stockholders of record as of June 15, 2005, September 15,2005, December 15, 2005 and March 15, 2006, respectively. There wereno dividends paid prior to fiscal 2006.

On January 30, 2006, a special meeting of theCompany’s stockholders was held at which the Company’s stockholders approved anamendment to its certificate of incorporation to increase the Company’sauthorized common stock from 50,000,000 shares to 100,000,000 shares.

On January 31, 2006, the Company issued11,727,566 shares of DRS common stock in connection with the Company’sacquisition of ESSI (see Note 2). On November 4,2003, the Company issued 4,323,172 shares of DRS common stock in connectionwith the Company’s acquisition of IDT (see Note 2).

On January 22, 2004, a special meeting of theCompany’s stockholders was held at which the Company’s stockholders approved anamendment and restatement of the Company’s 1996 Omnibus Plan to increase themaximum number of shares available for award from 3,875,000 to 5,875,000.

As of March 31, 2006 and 2005, the authorizedcapital of the Company also included 2.0 million shares of preferred stock(no shares issued).

**Stock Compensation Plans**   OnAugust 7, 1996, the stockholders approved the 1996 Omnibus Plan(Omnibus Plan). Under the terms of the Omnibus Plan, options may be granted tokey employees, directors and consultants of the Company. The Omnibus Planinitially was limited to 500,000 shares of DRS common stock and has since beenincreased, with stockholder approval, to 5,875,000 at March 31, 2006.Awards under the Omnibus Plan are at the discretion of the ExecutiveCompensation Committee and may be made in the form of: incentive stock options, non-qualifiedstock options, stock appreciation rights, restricted stock andrestricted stock units, phantom stock, stock bonuses and otherawards. Unless the Executive Compensation Committee expressly providesotherwise, options granted under the Omnibus Plan have a 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, recipients are required to hold any shares acquiredupon exercise of the options until the earlier of one year from the date ofexercise or March 31, 2008. The Company’s decision to modify itstraditional vesting terms for the July 6, 2005 stock option grant was madepursuant to management’s ongoing evaluation of the Company’s overall incentivecompensation strategy, including the types of future stock-based compensationawards. As part of its evaluation, management considered the amount of compensationexpense that would otherwise have been recognized in the Company’s results ofoperations in future periods upon DRS’s April 1, 2006 adoption of SFASNo. 123(R). The July 6, 2005 stock option grant had a$4.8 million impact on the Company’s pro forma pre-tax compensationexpense for fiscal 2006 (see Note 1. Q.). As of March 31, 2006, 3,497,775shares remain available for future grants under the Omnibus Plan.

103

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

During fiscal 1999, the Board of Directors issuedoptions to purchase 250,000 shares of DRS commonstock with vesting terms similar to awards issued under the Omnibus Plan atexercise prices in excess of the market price on the date of grant. The optionsexpire in 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 fiscal 2006, 2005 and2004.

A summary ofstock option activity is as follows:

| ** **                          | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|-------------------------------------|------------|-----------------------------|------------|----------------------------------------|------------|
| Outstanding at  March 31, 2003 |       | 2,701,049                   |       |                                   | $          | 21.87 |   |   |
| Granted                             |       | 904,340                     |       |                                   | $          | 26.89 |   |   |
| Exercised                           |       | (185,115                    | )          |                                   | $          | 10.64 |   |   |
| Expired or cancelled                |       | (179,049                    | )          |                                   | $          | 29.08 |   |   |
| Outstanding at  March 31, 2004 |       | 3,241,225                   |       |                                   | $          | 23.53 |   |   |
| Granted                             |       | 751,750                     |       |                                   | $          | 36.30 |   |   |
| Exercised                           |       | (426,742                    | )          |                                   | $          | 18.98 |   |   |
| Expired or cancelled                |       | (217,872                    | )          |                                   | $          | 30.41 |   |   |
| Outstanding at  March 31, 2005 |       | 3,348,361                   |       |                                   | $          | 26.52 |   |   |
| Granted                             |       | 237,000                     |       |                                   | $          | 50.53 |   |   |
| Exercised                           |       | (563,620                    | )          |                                   | $          | 22.29 |   |   |
| Expired or cancelled                |       | (108,383                    | )          |                                   | $          | 32.29 |   |   |
| Outstanding at March 31,  2006 |       | 2,913,358                   |       |                                   | $          | 29.08 |   |   |

 

As of March 31, 2006, 2005 and 2004, 1,945,915,1,692,158 and 1,486,197 options were exercisable, respectively, at weightedaverage exercise prices of $26.99, $20.64 and $17.54 per option, respectively.

Informationregarding all options outstanding at March 31, 2006 follows:

| ** **                               | ** ** | **Options  Outstanding** | ** ** | **Options**                 | ** ** |
|------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                               | ** ** | ** **               | ** ** | ** **                  | ** ** | **Weighted** | ** ** | **Exercisable** | ** ** |
| **Range of Exercise  Prices:** | ** ** | ** **               | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Average  Remaining  Contractual  Life** | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $7.00 - $11.00                           |       | 413,525                  |       |                        | $          | 9.87 |   |   | 2.57 years |   | 413,525 |   |   | $ | 9.87 |   |   |
| $11.01 - $25.50                          |       | 496,338                  |       |                        | $          | 19.60 |   |   | 6.10 years |   | 349,226 |   |   | $ | 17.13 |   |   |
| $25.51 - $31.00                          |       | 405,780                  |       |                        | $          | 28.13 |   |   | 7.71 years |   | 197,590 |   |   | $ | 28.08 |   |   |
| $31.01 - $33.00                          |       | 404,800                  |       |                        | $          | 32.08 |   |   | 6.61 years |   | 280,549 |   |   | $ | 32.08 |   |   |
| $33.01 - $37.00                          |       | 340,839                  |       |                        | $          | 34.11 |   |   | 5.82 years |   | 337,839 |   |   | $ | 34.11 |   |   |
| $37.01 - $38.00                          |       | 598,326                  |       |                        | $          | 37.31 |   |   | 8.55 years |   | 142,436 |   |   | $ | 37.33 |   |   |
| $38.01 and over                          |       | 253,750                  |       |                        | $          | 49.54 |   |   | 9.05 years |   | 224,750 |   |   | $ | 49.19 |   |   |
| Total                                    |       | 2,913,358                |       |                        |       |   |   | 7.22 years |   | 1,945,915 |   |   |   |   |   |
|                                          |            |                          |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

104

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

During fiscal 2006, 2005 and 2004, the Company awarded166,880, 2,400 and 135,250 shares, respectively, of restricted stock to certainemployees, as permitted under the Omnibus Plan, 40,190 of which have been forfeitedthrough March 31, 2006. Restricted stock is granted in the name of theemployee, who has all the rights of a stockholder, subject to certainrestrictions. The restricted stock cliff vests three years from the date ofgrant. Upon issuance of the restricted stock during fiscal 2006, 2005 and 2004,unearned compensation of $8.4 million, $69 thousand and $3.7 million,respectively, was charged to stockholders’ equity for the fair value of therestricted stock. Compensation expense, net of the value of forfeited shares,is recognized over a three-year period from the date of grant. Compensationexpense for the years ended March 31, 2006, 2005 and 2004 was$2.7 million, $985 thousand and $321 thousand, respectively.

In fiscal 2006 and 2004, theCompany issued 6,430 and 12,350 restricted stock units, respectively, tocertain employees, 1,530 of which have been forfeited through March 31,2006. Upon issuance of the restricted stock units during fiscal 2006 and 2004,unearned compensation of $0.3 million was charged in each of the years to additionalpaid-in capital for the fair value of the restricted stock units. Restrictedstock units are granted in the name of the employee; however, the participanthas no rights as a stockholder. These restricted stock units are redeemed forDRS common stock once a three-year cliff vesting period has been satisfied. Thecost of the grants, as determined by the market prices of the common stock atthe grant dates, is being recognized over the vesting period, and is includedin stock-based compensation expense on the Consolidated Statements of Earnings.Compensation expense related to restricted stock units was $173 thousand,$103 thousand and $35 thousand in fiscal 2006, 2005 and 2004,respectively.

**12.   Pensions andOther Employee Benefits**

The Company maintains multiple pension plans, bothcontributory and non-contributory, covering employees at certain locations.Eligibility for participation in the plans vary, and benefits generally arebased on the participant’s compensation and years of service, as defined. TheCompany’s funding policy is generally to contribute in accordance with costaccounting standards that affect government contractors, subject to theInternal Revenue Code and regulations therein. Plan assets are investedprimarily in U.S. government and U.S. government agency instruments, stocks andbonds.

The Company also provides postretirement medicalbenefits for certain retired employees and dependents at certain locations.Participants are eligible for these benefits when they retire from activeservice and meet the eligibility requirements for the Company’s pension plans.The Company’s contractual arrangements with the U.S. government provide for therecovery of contributions to a Voluntary Employees’ Beneficiary Association(VEBA) trust and, for non-funded plans, recovery of claims on a pay-as-you-gobasis, subject to the Internal Revenue Code and regulations therein, with theretiree generally paying a portion of the costs through contributions, deductiblesand coinsurance provisions.

The Company also maintains certain non-contributoryand unfunded supplemental retirement plans. Eligibility for participation inthe supplemental retirement plans is limited and benefits are generally basedon the participant’s compensation and/or years of service.

105

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

The following tables provide certain informationregarding the Company’s pension, postretirement and supplemental retirementplans. Such information excludes the plans that were acquired in the January 31,2006 acquisition of ESSI, as DRS utilizes a December 31 measurement dateto calculate its end of year (March 31) benefit obligations, fair value ofplan assets and annual net periodic benefit cost. The pension, postretirementand supplemental retirement plans acquired in the ESSI acquisition aresummarized below under the heading “ESSI Plans.”

| ** **                                              | ** ** | **Funded**               | ** ** | ** **             | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|--------------------------|------------|------------------------|------------|---------------------------|------------|------------|------------|------------|------------|
| ** **                                              | ** ** | **Defined Benefit** | ** ** | **Postretirement**     | ** ** | **Supplemental**          | ** ** |
| ** **                                              | ** ** | **Pension Plans**   | ** ** | **Benefit Plans** | ** ** | **Retirement Plans** | ** ** |
| ** **                                              | ** ** | **2006**                 | ** ** | **2005**               | ** ** | **2006**                  | ** ** | **2005**   | ** ** | **2006**   | ** ** | **2005** | ** ** |
| ** **                                              | ** ** | **(in thousands)**  | ** ** |
| **Change  in benefit obligation:**                      | ** ** | ** **               | ** ** | ** **             | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Benefit obligation at beginning  of year                |       | $                        | 110,246    |                   | $          | 94,737                    |       | $          | 17,905     |       | $          | 14,776 |   | $ | 19,317 |   | $ | 11,680 |   |
| Addition of a plan                                      |       | —                   |       | —                 |       | —                    |       | 171        |       | —     |       | — |   |
| Service cost                                            |       | 3,958                    |       | 3,858                  |       | 598                       |       | 535        |       | 544        |       | 416 |   |
| Interest cost                                           |       | 6,007                    |       | 5,833                  |       | 965                       |       | 959        |       | 1,116      |       | 962 |   |
| Plan participants’ contributions                   |       | 111                      |       | 101                    |       | —                    |       | —     |       | —     |       | — |   |
| Actuarial loss (gain)                                   |       | 4,052                    |       | 9,710                  |       | (1,532                    | )          | 1,942      |       | 878        |       | 1,440 |   |
| Benefits paid                                           |       | (4,343                   | )          | (4,784                 | )          | (592                      | )          | (535       | )          | (219       | )          | (78 | ) |
| Change in plan provisions                               |       | —                   |       | 83                     |       | —                    |       | —     |       | —     |       | 4,897 |   |
| Exchange rate differences and  other                    |       | (908                     | )          | 708                    |       | 1,429                     |       | 57         |       | —     |       | — |   |
| Benefit obligation at end of  year                      |       | 119,123                  |       | 110,246                |       | 18,773                    |       | 17,905     |       | 21,636     |       | 19,317 |   |
| **Change  in plan assets:**                             | ** ** | ** **               | ** ** | ** **             | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of plan assets at  beginning of year         |       | 88,394                   |       | 78,918                 |       | 2,839                     |       | 695        |       | —     |       | — |   |
| Actual return on plan assets                            |       | 4,003                    |       | 6,995                  |       | 88                        |       | 18         |       | —     |       | — |   |
| Plan participants’ contributions                   |       | 111                      |       | 101                    |       | —                    |       | —     |       | —     |       | — |   |
| Employer contributions                                  |       | 3,915                    |       | 6,702                  |       | 1,706                     |       | 2,661      |       | 219        |       | 78 |   |
| Benefits paid                                           |       | (4,343                   | )          | (4,784                 | )          | (592                      | )          | (535       | )          | (219       | )          | (78 | ) |
| Exchange rate differences                               |       | (422                     | )          | 462                    |       | —                    |       | —     |       | —     |       | — |   |
| Fair value of plan assets at end of  year          |       | 91,658                   |       | 88,394                 |       | 4,041                     |       | 2,839      |       | —     |       | — |   |
| **Net  amount recognized:**                             | ** ** | ** **               | ** ** | ** **             | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Funded status of the plans                              |       | (27,465                  | )          | (21,852                | )          | (14,732                   | )          | (15,066    | )          | (21,636    | )          | (19,317 | ) |
| Contributions from measurement  date to fiscal year end |       | 428                      |       | 257                    |       | 85                        |       | —     |       | 81         |       | 4 |   |
| Unrecognized transition  obligation                     |       | —                   |       | —                 |       | 1,453                     |       | 542        |       | —     |       | — |   |
| Unrecognized loss                                       |       | 21,263                   |       | 14,773                 |       | 1,728                     |       | 2,984      |       | 4,717      |       | 4,006 |   |
| Unrecognized prior service cost                         |       | 72                       |       | 77                     |       | —                    |       | —     |       | 7,107      |       | 7,884 |   |
| Net amount recognized                                   |       | $                        | (5,702     | )                      | $          | (6,745                    | )          | $          | (11,466    | )          | $          | (11,540 | ) | $ | (9,731 | ) | $ | (7,423 | ) |

 

106

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

The amountsrecognized in the Consolidated Balance Sheets, as of March 31, consist of:

| ** **                             | ** ** | **Funded**               | ** ** | ** **             | ** ** | ** **                | ** ** | **Unfunded** | ** ** |
|----------------------------------------|------------|--------------------------|------------|------------------------|------------|---------------------------|------------|--------------|------------|
| ** **                             | ** ** | **Defined Benefit** | ** ** | **Postretirement**     | ** ** | **Supplemental**          | ** ** |
| ** **                             | ** ** | **Pension Plans**   | ** ** | **Benefit Plans** | ** ** | **Retirement Plans** | ** ** |
| ** **                             | ** ** | **2006**                 | ** ** | **2005**               | ** ** | **2006**                  | ** ** | **2005**     | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **(in thousands)**  | ** ** |
| Intangible asset                       |       | $                        | 72         |                   | $          | 77                        |       | $            | —     |   | $ | — |   | $ | 5,084 |   | $ | 4,296 |   |
| Accumulated other  comprehensive  loss |       | 10,563                   |       | 6,775                  |       | —                    |       | —       |       | — |   | — |   |
| Prepaid benefit cost                   |       | —                   |       | 7                      |       | —                    |       | —       |       | — |   | — |   |
| Accrued benefit liability              |       | (16,337                  | )          | (13,604                | )          | (11,466                   | )          | (11,540      | )          | (14,815 | ) | (11,719 | ) |
| Net amounts recognized                 |       | $                        | (5,702     | )                      | $          | (6,745                    | )          | $            | (11,466    | ) | $ | (11,540 | ) | $ | (9,731 | ) | $ | (7,423 | ) |

 

The aggregateaccumulated benefit obligation (ABO) for the Company’s pension/retirement planscombined was $120.5 million and $108.0 million at March 31, 2006 and2005, respectively. The table below represents the aggregate ABO and fair valueof plan assets for those pension plans with an ABO in excess of the fair valueof plan assets at March 31, 2006 and 2005.

| ** **                      | ** ** | **2006**                | ** ** | **2005** | ** ** |
|---------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                      | ** ** | **(in thousands)** | ** ** |
| Accumulated benefit  obligation |       | $                       | 87,340     |     | $          | 57,239 |   |
| Fair value of plan assets       |       | $                       | 55,960     |     | $          | 32,409 |   |

 

The tablebelow represents the aggregate benefit obligation and fair value of plan assetsfor those plans with benefit obligations in excess of the fair value of planassets at March 31, 2006 and 2005.

| ** **                | ** ** | **2006**                | ** ** | **2005** | ** ** |
|---------------------------|------------|-------------------------|------------|----------|------------|
| ** **                | ** ** | **(in thousands)** | ** ** |
| Benefit obligation        |       | $                       | 159,532    |     | $          | 147,468 |   |
| Fair value of plan assets |       | $                       | 95,700     |     | $          | 91,233 |   |

 

Because theABO exceeds the fair value of plan assets, the Company has recognized in theConsolidated Balance Sheets at March 31, 2006 and 2005 the additionalminimum liability of the unfunded accumulated benefit obligation. The increasein minimum liability included in other comprehensive income is as follows:

| ** **                         | ** ** | **Funded Defined  Benefit Plans** | ** ** | **Unfunded  Supplemental  Retirement Plans** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                    | ** ** | **2005**                                          | ** ** | **  2006  ** | ** ** | **  2005  ** | ** ** |
| ** **                         | ** ** | **(in thousands)**                     | ** ** |
| Other comprehensive  (loss) income |       | $                                           | (3,788     | )                                                 | $          | (1,913 | ) |   | $ | — |   |   |   | $ | 432 |   |   |
|                                    |            |                                             |            |                                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

107

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

The followingweighted average actuarial assumptions were used to determine the benefitobligation and funded status of the plans:

| ** **                              | ** ** | **Funded**                       | ** ** | **Postretirement**               | ** ** | **Unfunded  Supplemental**       | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **Pension Plans**           | ** ** | **Benefit Plans**           | ** ** | **Retirement Plans**        | ** ** |
| ** **                              | ** ** | **  2006  ** | ** ** | **  2005  ** | ** ** | **  2006  ** | ** ** | **  2005  ** | ** ** | **  2006  ** | ** ** | **  2005  ** | ** ** |
| **Rate assumptions**                    | ** ** |                             | ** ** | ** **                       |       |                             | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Discount rate                           |       |                             | 5.40       | %                                |       |                             | 5.65       | % |   |   | 5.50 | % |   |   | 5.65 | % |   |   | 5.55 | % |   |   | 5.80 | % |   |
| Increase in future  compensation levels |       |                             | 3.90       | %                                |       |                             | 3.85       | % |   |   | 4.00 | % |   |   | 4.00 | % |   |   | 4.05 | % |   |   | 4.10 | % |   |

 

The followingtable summarizes the components of net periodic benefit cost for the Company’spension, postretirement and supplemental retirement plans.

| ** **                                          | ** ** | ** **              | ** ** | ** **             | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Unfunded** | ** ** |
|-----------------------------------------------------|------------|-------------------------|------------|------------------------|------------|---------------------------|------------|------------|------------|------------|------------|------------|------------|--------------|------------|
| ** **                                          | ** ** | **Funded**              | ** ** | **Postretirement**     | ** ** | **Supplemental**          | ** ** |
| ** **                                          | ** ** | **Pension Plans**  | ** ** | **Benefit Plans** | ** ** | **Retirement Plans** | ** ** |
| ** **                                          | ** ** | **2006**                | ** ** | **2005**               | ** ** | **2004**                  | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2006**     | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                          | ** ** | **(in thousands)** | ** ** |
| **Components of net periodic benefit cost:**        | ** ** | ** **              | ** ** | ** **             | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                        |       | $                       | 3,958      |                   | $          | 3,858                     |       | $          | 2,890      |       | $          | 598        |       | $            | 535        |   | $ | 505 |   | $ | 544 |   | $ | 416 |   | $ | 441 |   |
| Interest cost                                       |       | 6,007                   |       | 5,833                  |       | 4,560                     |       | 965        |       | 959        |       | 691        |       | 1,116        |       | 962 |   | 655 |   |
| Expected return on plan  assets                     |       | (7,056                  | )          | (6,410                 | )          | (4,444                    | )          | (167       | )          | (92        | )          | (33        | )          | —       |       | — |   | — |   |
| Amortization of  unrecognized actuarial loss (gain) |       | 165                     |       | 130                    |       | 541                       |       | (11        | )          | 54         |       | (2         | )          | 167          |       | 5 |   | 125 |   |
| Transition obligation                               |       | —                  |       | —                 |       | —                    |       | 110        |       | 37         |       | 34         |       | —       |       | — |   | — |   |
| Amortization of  unrecognized prior-service cost    |       | 5                       |       | 5                      |       | —                    |       | —     |       | —     |       | —     |       | 777          |       | 777 |   | 298 |   |
| Net periodic expense                                |       | $                       | 3,079      |                   | $          | 3,416                     |       | $          | 3,547      |       | $          | 1,495      |       | $            | 1,493      |   | $ | 1,195 |   | $ | 2,604 |   | $ | 2,160 |   | $ | 1,519 |   |

 

The following weighted average actuarial assumptionswere used to determine the net periodic cost of the plans:

| ** **                                     | ** ** | **Funded**             | ** ** | **Postretirement**     | ** ** | **Unfunded Supplemental** | ** ** |
|------------------------------------------------|------------|------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                                     | ** ** | **Pension Plans** | ** ** | **Benefit Plans** | ** ** | **Retirement Plans**      | ** ** |
| ** **                                     | ** ** | **2006**               | ** ** | **2005**               | ** ** | **2004**                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Rate assumptions**                           | ** ** |                   | ** ** | ** **             |       |                           | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Discount rate                                  |       |                   | 5.65       | %                      |       |                           | 6.15       | % |   |   | 6.35 | % |   |   | 5.65 | % |   |   | 6.25 | % |   |   | 6.50 | % |   |   | 5.80 | % |   |   | 6.25 | % |   |   | 6.75 | % |   |
| Expected long-term return on plan  assets |       |                   | 8.05       | %                      |       |                           | 8.00       | % |   |   | 8.10 | % |   |   | 7.25 | % |   |   | 7.25 | % |   |   | 7.25 | % |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Increase in future compensation  levels        |       |                   | 3.85       | %                      |       |                           | 3.95       | % |   |   | 3.90 | % |   |   | 4.00 | % |   |   | 4.00 | % |   |   | 4.00 | % |   |   | 4.05 | % |   |   | 4.10 | % |   |   | 3.90 | % |   |

 

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

The expected long-term return on plan assetsassumption represents the average rate that the Company expects to earn overthe long term on the assets of the Company’s benefit plans, including thosefrom dividends, interest income and capital appreciation. The assumption has beendetermined based on expectations regarding future rates of return for the plans’investment portfolio, with consideration given to the allocation of investmentsby asset class and historical rates of return for each individual asset class.

The annual increase in cost of benefits (health carecost trend rate) is assumed to be an average of 11.1% in fiscal 2007 and isassumed to gradually decrease to a rate of 4.5% in fiscal 2011 andthereafter. Assumed healthcare cost trend rates have an effect on amountsreported for postretirement medical benefit plans. A one percentage pointdecrease in the assumed healthcare cost trend rates would have the effect ofdecreasing the annual aggregate service and interest cost by $12 thousandand the postretirement medical obligations by $158 thousand. A onepercentage point increase in the assumed healthcare cost trend rate would havethe effect of increasing the annual aggregate service and interest cost by$14 thousand and the postretirement medical obligations by $187 thousand.

**ESSI Plans**   Inconnection with the acquisition of ESSI on January 31, 2006, the Companyassumed certain defined benefit pension, postretirement and supplementalretirement plan liabilities for present and former employees of ESSI.

The followingtable provides a summary of the funded status of the ESSI plans at January 31, 2006.

| ** **                   | ** ** | **January 31, 2006** | ** ** |
|------------------------------|------------|--------------------------------|------------|
| ** **                   | ** ** | **Funded**                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **Defined Benefit**       | ** ** | **Postretirement** | ** ** | **Supplemental** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | **Pension Plans**         | ** ** | **Benefit Plans** | ** ** | **Retirement Plans** | ** ** | **Total** | ** ** |
| ** **                   | ** ** | **(in thousands)**        | ** ** |
| Projected benefit obligation |       |                           | $          | 131,810 |   |   |   | $ | 7,900 |   |   |   | $ | 3,498 |   |   | $ | 143,208 |   |
| Fair value of plan assets    |       |                           | 89,125     |   |   |   | — |   |   |   | — |   |   | 89,125 |   |
| Accrued benefit liability    |       |                           | $          | 42,685 |   |   |   | $ | 7,900 |   |   |   | $ | 3,498 |   |   | $ | 54,083 |   |

 

The followingweighted average actuarial assumptions were used to determine the January 31,2006 benefit obligation and funded status of the ESSI plans.

| ** **                                | ** ** | **January 31, 2006** | ** ** |
|-------------------------------------------|------------|--------------------------------|------------|
| ** **                                | ** ** | **Funded Pension  Plans** | ** ** | **Postretirement  Benefit Plans** | ** ** | **Unfunded  Supplemental  Retirement Plans** | ** ** |
| **Rate  Assumptions**                     | ** ** |                           | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Discount  rate                            |       |                           | 5.60       | % |   |   | 5.40 | % |   |   | 5.60 | % |   |
| Increase  in future compensation  levels  |       |                           | 3.75       | % |   |   | — |   |   |   | 3.75 | % |   |
| Expected long-term return  on plan assets |       |                           | 8.25       | % |   |   | — |   |   |   | — |   |   |

 

The annual increase in cost of benefits (health carecost care trend rate) for the ESSI plans is assumed to be an average of 9.1% infiscal 2007 and is assumed to gradually decrease to a rate of 5.4% in fiscal2011 and thereafter. 

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

The Company has the responsibility to formulate theinvestment policies and strategies for each plan’s assets. The overall domesticplans’ policies and strategies, which differ from plan to plan, include:maintaining the highest possible return commensurate with the level of assumedrisk, preserving the benefit security for the plan’s participants andmaintaining the fund at an appropriately funded status (inclusive of fees).

The Companydoes not involve itself with the day-to-day operations and selection process ofindividual securities and investments, and, accordingly, has retained theprofessional services of investment management organizations to fulfill thosetasks. The investment management organizations have investment discretion overthe assets placed under their management. The Company provides each investmentmanager with specific investment guidelines relevant to its asset class. Thetable below represents the Company’s domestic and foreign pension plans andpostretirement benefit plans, including ESSI plans, weighted-averageasset allocation at March 31, 2006 and 2005 by asset category:

| ** **                                  | ** ** | **Asset Allocation** | ** ** |
|---------------------------------------------|------------|---------------------------|------------|
| **Asset Category**                     | ** ** | ** **                | ** ** | **2006** | ** ** | **2005** | ** ** |
| Equity securities                           |       |                      | 63         | % |   |   | 64 | % |   |
| Debt securities                             |       |                      | 29         | % |   |   | 28 | % |   |
| Other, primarily cash and cash  equivalents |       |                      | 8          | % |   |   | 8 | % |   |
| Total                                       |       |                      | 100        | % |   |   | 100 | % |   |
|                                             |            |                           |            |  |  |  |  |  |  |  |  |

 

The tablebelow presents the target allocation ranges for each major asset category forthe Company’s benefit plans, including the ESSI plans, for fiscal 2007.

| ** **                                 | ** ** | **Target Asset** | ** **                    |
|--------------------------------------------|------------|-----------------------|-------------------------------|
| **Asset Category**                    | ** ** | ** **            | ** **                    | **Allocation Range** | ** ** |
| Equity securities                          |       |                  | 30% - 85%           |   |   |
| Debt securities                            |       |                  | 10% - 60%           |   |   |
| Real Estate                                |       |                  | 0% - 7%   |   |   |
| Other, primarily cash and cash equivalents |       |                  | 0% - 25%            |   |   |
|                                            |            |                       |                               |  |  |  |  |

 

For fiscal 2007, the Companyexpects to contribute $7.9 million and $2.3 million to its pensionplans and postretirement plans, respectively, which includes contributions forthe acquired plans of ESSI.

The followingtable presents expected pension and post-retirement benefit payments, includingthe ESSI plans:

| ** **      | ** ** | ** **              | ** ** | ** **         | ** ** | **Supplemental** | ** ** |
|-----------------|------------|-------------------------|------------|--------------------|------------|------------------|------------|
| ** **      | ** ** | ** **              | ** ** | ** **         | ** ** | **Retirement**   | ** ** |
| ** **      | ** ** | **Pension**             | ** ** | **Postretirement** | ** ** | **Plan**         | ** ** |
| ** **      | ** ** | **Benefits**            | ** ** | **Payments**       | ** ** | **Payments**     | ** ** |
| ** **      | ** ** | **(in thousands)** | ** ** |
| 2007            |       | $                       | 10,337     |               |       | $                | 1,450      |   |   |   | $ | 611 |   |   |
| 2008            |       | $                       | 10,816     |               |       | $                | 1,554      |   |   |   | $ | 648 |   |   |
| 2009            |       | $                       | 11,400     |               |       | $                | 1,605      |   |   |   | $ | 824 |   |   |
| 2010            |       | $                       | 12,066     |               |       | $                | 1,711      |   |   |   | $ | 870 |   |   |
| 2011            |       | $                       | 12,633     |               |       | $                | 1,786      |   |   |   | $ | 878 |   |   |
| Years 2012-2015 |       | $                       | 73,610     |               |       | $                | 10,145     |   |   |   | $ | 7,748 |   |   |

 

The Company maintains definedcontribution plans covering substantially all domestic full-time eligibleemployees. The Company’s contributions to these plans for fiscal 2006, 2005 and2004 amounted to $16.8 million, $13.8 million and $9.4 million,respectively.

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

**13. Commitments,Contingencies and Related Party Transactions**

**Commitments and Contingencies**   AtMarch 31, 2006, the Company was party to various noncancellable operatingleases that expire at various dates through 2021 (principally foradministration, engineering and production facilities) with minimum rentalpayments as follows:

| ** ** | ** ** | **(in thousands)** | ** ** |
|------------|------------|-------------------------|------------|
| 2007       |       |                    | $          | 29,942 |   |   |
| 2008       |       |                    | 20,686     |   |   |
| 2009       |       |                    | 16,569     |   |   |
| 2010       |       |                    | 13,262     |   |   |
| 2011       |       |                    | 6,733      |   |   |
| Thereafter |       |                    | 21,638     |   |   |
| Total      |       |                    | $          | 108,830 |   |   |

 

It is not certain as to whetherthe Company will negotiate new leases as existing leases expire. Determinationsto that effect will be made as existing leases approach expiration and will bebased on an assessment of the Company’s capacity requirements at that time.

Rent expense was$25.9 million, $26.3 million and $22.2 million in fiscal 2006,2005 and 2004, respectively.

As of March 31, 2006,$38.8 million was contingently payable under letters of credit and bankguarantees (see Note 8).

In connection with variouspurchase business combinations, the Company may pay up to an aggregate of $14.8million in contingent purchase price earn-outs in fiscal 2007 and $21.7 millionwithin the following two fiscal years. Earn-outs are recorded as additional goodwillwhen the contingencies for such payments have been met.

The Company is subject to purchaseobligations for goods and services. The purchase obligations include amountsunder legally enforceable agreements for goods and services with defined termsas to quantity, price and timing of delivery and excludes purchase orders forproducts and services under firm government contracts for which the Company hasfull recourse under normal contract termination clauses. As of March 31, 2006,the Company had purchase obligations of $44.2 million and expects to satisfy$37.1 million within the next year and $7.1 million within the next one to twoyears.

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

Various legal actions, claims,assessments and other contingencies arising in the normal course of theCompany’s business, including certain matters described below, are pendingagainst the Company and certain of its subsidiaries. These matters are subjectto many uncertainties, and it is possible that some of these matters could beultimately decided, resolved or settled adversely. The Company has recordedaccruals totaling $4.5 million and $10.3 million at March  31, 2006 andMarch 31, 2005, respectively, for losses related to those matters that itconsiders to be probable and that can be reasonably estimated (certain legaland environmental matters are discussed in detail below). Although the ultimateamount of liability at March 31, 2006 that may result from those mattersfor which the Company has recorded accruals is not ascertainable, the Companybelieves that any amounts exceeding the Company’s recorded accruals should not 

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

materiallyaffect the Company’s financial condition or liquidity. It is possible, however,that the ultimate resolution of those matters could result in a materialadverse effect on the Company’s results of operations for a particularreporting period.

Some environmental laws, such asthe Comprehensive Environmental Response, Compensation and Liability Act of1980 (also known as CERCLA or the Superfund law) and similar state statutes,can impose liability for the entire cost of the clean up of contaminated sitesupon any of the current or former site owners or operators (or upon parties whosend waste to these sites), regardless of the lawfulness of the originalactivities that led to the contamination. In July 2000, prior to itsacquisition by IDT, and prior to DRS’s acquisition of IDT, Tech-Sym Corporationreceived a Section 104(e) Request for Information from the NationalPark Service (NPS), pursuant to CERCLA, regarding a site known as the OrphanMine site in the Grand Canyon National Park, Arizona, which is the subject ofan NPS investigation regarding the presence of residual radioactive materialsand contamination. A corporation of which Tech-Sym is an alleged successoroperated this uranium mine from 1956 to 1967. In 1962, the land was sold to theU.S. government and the alleged predecessor of Tech-Sym was given a 25-yearmining lease. In 1967, the mining rights were transferred to a third party by atrustee in bankruptcy, and the Company believes that the mine was operated bysuch third party until approximately 1969. The Company understands 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 sentthe Company an Engineering Evaluation/Cost Analysis Work Plan (the “NPS EE/CA”)under CERCLA (the ‘‘CERCLA Letter’’) with regards to Operable Unit 1 of theOrphan Mine site. In the Company’s view, the NPS EE/CA included additionalclean up not covered by CERCLA. The CERCLA Letter also requested(a) payment of $0.5 million for costs incurred by the NPS related to theOrphan Mine, and (b) a ‘‘good faith offer’’ to conduct the responseactivity outlined by the NPS and to reimburse the NPS for future costs. The NPSadvised that a similar letter has been sent to another PRP. The Companyinitiated discussions with the other PRP and with NPS, and engaged a technicalconsultant to evaluate the existing documentation and the site in depth. As aresult, on September 29, 2005, the technical consultant submitted to theNPS, on behalf of the Company and the other PRP, an alternative EngineeringEvaluation/Cost Analysis Work Plan (the “alternative EE/CA”) with regards toOperating Units 1 and 2 of the Orphan Mine Site.

On December 6, 2005, the PRPsand NPS met to discuss the alternative EE/CA. The meeting focused on thetechnical merits of the alternative EE/CA and certain differences between thealternative EE/CA and the NPS EE/CA provided with the CERCLA Letter. Thedifferences included an alternative sampling technique and the inclusion ofOperable Unit 2 (the lower mine area) in the alternative EE/CA. Since thatmeeting in late 2005, the parties have also discussed certain legal issuesrelating to the process for implementing an alternative EE/CA and entering intoa Settlement Agreement that would memorialize the parties’ intent. Thepotential liability associated with implementation of the EE/CA can changesubstantially due to such factors as additional information on the nature orextent of contamination, methods of remediation that might be recommended orrequired, changes in the apportionment of costs among the responsible partiesand other actions by governmental agencies or private parties.

112

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

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

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

On or about September 23, 2005, the SEC staff advisedESSI’s counsel that it had issued a subpoena directed to ESSI and expanded itsinvestigation to include ESSI’s disclosure of a November 2004 stop work order relatingto ESSI’s Deployable Power Generation and Distribution Systems (“DPGDS”)program for the U.S. Air Force, and relating to trading in ESSI stock bycertain 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 that one of ESSI’s former directors and officers, andsubsequently a consultant to ESSI, had been issued a so-called Wells noticeinforming him that the staff of the SEC was considering recommending that theSEC bring a civil injunctive action against him in connection with the SEC’sinvestigation into trading in ESSI common stock in 2003. A Wells noticeprovides prospective defendants with an opportunity to respond to the SEC staffmembers before the staff makes a formal recommendation on whether the SECshould pursue disciplinary action against them. ESSI, itself, has not receiveda Wells notice and continues to cooperate with the investigation.

In January 2006, ESSI was informed that the Office ofthe U.S. Attorney for the Eastern District of Missouri was initiating aninvestigation into ESSI’s disclosure of the DPGDS stop-work order and into tradingin ESSI stock by ESSI insiders which preceded such disclosure. The U.S.Attorney’s office advised ESSI that although it considered it to be a subjectof its investigation, ESSI was not a target. In connection with this investigation, the U.S. Attorney’s office issuedESSI a subpoena requesting specified information, which ESSI continues tofurnish. 

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.  Although ESSI continues to be a subject ofthe U.S. Attorney’s office’s investigation, the U.S. Attorney’s office hasadvised the Company that ESSI is not a target. Because the events being investigated occurred prior to the time of theCompany’s acquisition of ESSI, the U.S. Attorney’s office has further advised theCompany that it considers DRS to be a witness, not a subject or target of itsinvestigation.  

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

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

**Related Party Transactions**   TheCompany currently leases a building in Oakland, New Jersey owned by LDR RealtyCo., a partnership that was wholly owned, in equal amounts, by David E. Gross,DRS’s co-founder and the former President and Chief Technical Officer, and thelate Leonard Newman, DRS’s co-founder and the former Chairman of the Board,Chief Executive Officer and Secretary and the father of Mark S. Newman, DRS’scurrent Chairman of the Board, President and Chief Executive Officer. The leaseagreement with a monthly rental of $21.2 thousand expires on April 30,2007. Following Leonard Newman’s death in November 1998, Mrs. RuthNewman, the wife of Leonard Newman and the mother of Mark S. Newman, succeededto Leonard Newman’s interest in LDR Realty Co.

Skadden, Arps, Slate, Meagher &Flom LLP, a law firm to which a member of the Company’s Board is of counsel,provides legal services to DRS. The Company paid $2.3 million,$1.4 million and $2.9 million in fees to the firm during fiscal 2006,2005 and 2004, respectively.

Kronish Lieb Weiner &Hellman LLP, a law firm of which Alison Newman, the sister of Mark S. Newman,is a partner, provides legal services to DRS. The Company paid $0.2 million infees to the firm during fiscal 2006. The amounts paid to the firm during fiscal2005 and 2004 were immaterial.

**14. Operating Segments**

The C4I Group is comprised of thefollowing business areas: Command, Control and Communications (C3), whichincludes naval display systems, ship communications systems, radar systems,technical support, electronic manufacturing and system integration services,and secure voice and data communications; Power Systems, which includes navaland industrial power generation, conversion, propulsion, distribution andcontrol systems; Intelligence Technologies, which includes signalsintelligence, communications intelligence, data collection, processing anddissemination equipment; and Tactical Systems, which includes battle managementtactical computer systems and peripherals.

The SR Group is comprised of thefollowing business areas: Reconnaissance, Surveillance & Target Acquisition(RSTA), which develops and produces electro-optical sighting, targetingand weapon sensor systems, high-speed digital data and imaging systems,aircraft weapons alignment systems, mission and flight recorders and imageintensification (I2)night vision, combat identification and laser aimers/illuminator products, andprovides electronic manufacturing services; Training & Control Systems,which develops and produces air combat training, electronic warfare and networksystems, and unmanned vehicles; and Test & Energy Management, whichdevelops and produces electronic test, diagnostics and vehicle electronics.

The S3 Group is comprised of thefollowing business areas:  SustainmentSystems, which designs, engineers and manufactures integrated militaryelectronics and other military support equipment, primarily for the U.S.Department of Defense, as well as related heat transfer and air handlingequipment and power generation and distribution equipment for domesticcommercial and industrial users; and Support Services, which providesengineering services, logistics and training services, advanced technologyservices, asset protection systems and services, telecommunication systemsintegration and information technology services, and vehicle armor kits formilitary, humanitarian, disaster recovery and emergency responder applications.

Other includes the activities ofDRS Corporate Headquarters and certain non-operating subsidiaries of theCompany.

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

Transactionsbetween segments generally are negotiated and accounted for under terms andconditions that are similar to other government and commercial contracts;however, these intercompany transactions are eliminated in consolidation. Otheraccounting policies of the segments are consistent with those described in thesummary of significant accounting policies (see Note 1). The Companyevaluates segment-level performance based on revenues and operatingincome, as presented in the Consolidated Statements of Earnings. Operatingincome, as shown, includes amounts allocated from DRS Corporate operationsusing an allocation methodology prescribed by U.S. government regulations forgovernment contractors. The segment financial data excludes the assets andresults of discontinued operations. Information about the Company’s operatingsegments follows:

| ** **                       | ** ** | **C4I**                 | ** ** | **SR** | ** ** | **S3**  | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------|------------|-------------------------|------------|--------|------------|---------|------------|-----------|------------|-----------|------------|
| ** **                       | ** ** | **(in thousands)** | ** ** |
| Fiscal 2006:                     |       |                    |       |   |       |    |       |      |       |      |       |
| Total revenues                   |       | $                       | 823,672    |   | $          | 751,110 |       | $         | 168,035    |      | $          | — |   | $ | 1,742,817 |   |
| Intersegment revenues            |       | (3,241                  | )          | (4,035 | )          | (9      | )          | —    |       | (7,285    | )          |
| External revenues                |       | $                       | 820,431    |   | $          | 747,075 |       | $         | 168,026    |      | $          | — |   | $ | 1,735,532 |   |
| Operating income (loss)          |       | $                       | 92,504     |   | $          | 87,942  |       | $         | 15,058     |      | $          | (2,794 | ) | $ | 192,710 |   |
| Total assets                     |       | $                       | 842,388    |   | $          | 763,949 |       | $         | 2,296,953  |      | $          | 118,604 |   | $ | 4,021,894 |   |
| Depreciation and  amortization   |       | $                       | 15,377     |   | $          | 24,260  |       | $         | 5,257      |      | $          | 4,091 |   | $ | 48,985 |   |
| Capital expenditures             |       | $                       | 13,609     |   | $          | 20,861  |       | $         | 2,772      |      | $          | 5,952 |   | $ | 43,194 |   |
| Fiscal 2005:                     |       |                    |       |   |       |    |       |      |       |      |       |
| Total revenues                   |       | $                       | 702,404    |   | $          | 616,743 |       | $         | —     |      | $          | — |   | $ | 1,319,147 |   |
| Intersegment revenues            |       | (1,972                  | )          | (8,575 | )          | —  |       | —    |       | (10,547   | )          |
| External revenues                |       | $                       | 700,432    |   | $          | 608,168 |       | $         | —     |      | $          | — |   | $ | 1,308,600 |   |
| Operating income (loss)          |       | $                       | 73,566     |   | $          | 69,893  |       | $         | —     |      | $          | (327 | ) | $ | 143,132 |   |
| Total assets                     |       | $                       | 790,371    |   | $          | 740,392 |       | $         | —     |      | $          | 361,098 |   | $ | 1,891,861 |   |
| Depreciation and  amortization   |       | $                       | 12,923     |   | $          | 24,940  |       | $         | —     |      | $          | 3,105 |   | $ | 40,968 |   |
| Capital expenditures             |       | $                       | 12,242     |   | $          | 16,923  |       | $         | —     |      | $          | 5,356 |   | $ | 34,521 |   |
| Fiscal 2004:                     |       |                    |       |   |       |    |       |      |       |      |       |
| Total revenues                   |       | $                       | 554,394    |   | $          | 438,094 |       | $         | —     |      | $          | — |   | $ | 992,488 |   |
| Intersegment revenues            |       | (2,120                  | )          | (3,437 | )          | —  |       | —    |       | (5,557    | )          |
| External revenues                |       | $                       | 552,274    |   | $          | 434,657 |       | $         | —     |      | $          | — |   | $ | 986,931 |   |
| Operating income                 |       | $                       | 58,652     |   | $          | 44,597  |       | $         | —     |      | $          | 83 |   | $ | 103,332 |   |
| Assets of continuing  operations |       | $                       | 753,273    |   | $          | 714,014 |       | $         | —     |      | $          | 117,808 |   | $ | 1,585,095 |   |
| Depreciation and  amortization   |       | $                       | 9,163      |   | $          | 17,005  |       | $         | —     |      | $          | 2,268 |   | $ | 28,436 |   |
| Capital expenditures             |       | $                       | 7,607      |   | $          | 12,920  |       | $         | —     |      | $          | 3,917 |   | $ | 24,444 |   |

 

115

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

Revenues bymajor product category is as follows:

| ** **                                                  | ** ** | **Years Ended March 31,** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                  | ** ** | **2006**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                  | ** ** | **(in thousands)**                  | ** ** |
| Command, Control and   Communications                       |       | $                                        | 276,838    |   | $ | 245,668 |   | $ | 214,365 |   |
| Power Systems                                               |       | 175,743                                  |       | 190,091 |   | 151,929 |   |
| Intelligence Technologies                                   |       | 174,193                                  |       | 138,340 |   | 81,162 |   |
| Tactical Systems                                            |       | 193,656                                  |       | 126,334 |   | 104,818 |   |
| Reconnaissance,  Surveillance & Target Acquisition |       | 472,467                                  |       | 358,583 |   | 340,906 |   |
| Training & Control  Systems                             |       | 187,135                                  |       | 179,192 |   | 63,859 |   |
| Test & Energy  Management                          |       | 87,473                                   |       | 70,392 |   | 29,892 |   |
| Sustainment Systems                                         |       | 69,404                                   |       | — |   | — |   |
| Support Services                                            |       | 98,623                                   |       | — |   | — |   |
| Total revenues                                              |       | $                                        | 1,735,532  |   | $ | 1,308,600 |   | $ | 986,931 |   |

 

Revenues,total assets and long-lived assets by geographic location are presented in thetable below. Revenues are attributed to countries based on the physicallocation of the operating unit generating the revenues. Information about theCompany’s operations in these geographic locations for each of the three yearsended March 31, 2006 is as follows:

| ** **                       | ** ** | **United States** | ** ** | **Canada** | ** ** | **United Kingdom** | ** ** | **Total** | ** ** |
|----------------------------------|------------|------------------------|------------|------------|------------|-------------------------|------------|-----------|------------|
| Fiscal 2006:                     |       |                   |       |       |       |                    |       |      |       |   |   |   |   |
| Revenues                         |       |                   | $          | 1,676,555  |       |                    | $          | 43,238    |       |   | $ | 15,739 |   |   | $ | 1,735,532 |   |
| Total  assets                    |       |                   | $          | 3,931,356  |       |                    | $          | 60,229    |       |   | $ | 30,309 |   |   | $ | 4,021,894 |   |
| Long-lived  assets               |       |                   | $          | 3,019,804  |       |                    | $          | 22,741    |       |   | $ | 17,168 |   |   | $ | 3,059,713 |   |
| Fiscal  2005:                    |       |                   |       |       |       |                    |       |      |       |   |   |   |   |
| Revenues                         |       |                   | $          | 1,247,179  |       |                    | $          | 41,370    |       |   | $ | 20,051 |   |   | $ | 1,308,600 |   |
| Total  assets                    |       |                   | $          | 1,813,849  |       |                    | $          | 49,577    |       |   | $ | 28,435 |   |   | $ | 1,891,861 |   |
| Long-lived  assets               |       |                   | $          | 1,033,436  |       |                    | $          | 14,509    |       |   | $ | 10,757 |   |   | $ | 1,058,702 |   |
| Fiscal  2004:                    |       |                   |       |       |       |                    |       |      |       |   |   |   |   |
| Revenues                         |       |                   | $          | 928,924    |       |                    | $          | 33,788    |       |   | $ | 24,219 |   |   | $ | 986,931 |   |
| Assets  of continuing operations |       |                   | $          | 1,499,294  |       |                    | $          | 50,059    |       |   | $ | 35,742 |   |   | $ | 1,585,095 |   |
| Long-lived assets                |       |                   | $          | 1,003,895  |       |                    | $          | 17,998    |       |   | $ | 18,538 |   |   | $ | 1,040,431 |   |

 

Export sales accounted for approximately 10%, 14% and12% of total revenues in the fiscal years ended March 31, 2006, 2005 and2004, respectively.

116

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

The followingtable provides a reconciliation of total consolidated assets to assets ofcontinuing operations presented above:

| ** **                         | ** ** | **March 31,**      | ** ** |
|------------------------------------|------------|-------------------------|------------|
| ** **                         | ** ** | **2004**                | ** ** |
| ** **                         | ** ** | **(in thousands)** | ** ** |
| Assets of continuing  operations   |       |                    | $          | 1,585,095 |   |   |
| Assets of discontinued  operations |       |                    | 40,295     |   |   |
| Total assets                       |       |                    | $          | 1,625,390 |   |   |

 

**15. Guarantor andNon-Guarantor Financial Statements**

As further discussed in Note 8, Debt, the Companyhas an aggregate of $350.0 million 65¤8% SeniorNotes, $550.0 million 67¤8%Senior Subordinated Notes, $250.0 million 75¤8% SeniorSubordinated Notes and $345.0 million 2% Convertible Senior Notes outstanding(collectively, the Notes). The Notes are fully and unconditionally guaranteed,jointly and severally, by the Company’s wholly-owned domesticsubsidiaries (the Guarantor Subsidiaries). The foreign subsidiaries and certaindomestic subsidiaries of DRS (the Non-Guarantor Subsidiaries) do not guaranteethe Notes.

The following condensedconsolidating financial information presents the Condensed ConsolidatingBalance Sheets as of March 31, 2006 and 2005, the related CondensedConsolidating Statements of Earnings and Condensed Consolidating Statements ofCash Flows for the years ended March 31, 2006, 2005 and 2004 for:

a)    DRSTechnologies, Inc. (the Parent),

b)    theGuarantor Subsidiaries,

c)    theNon-guarantor Subsidiaries, and

d)    DRSTechnologies, Inc. on a consolidated basis

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

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

117

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

**Condensed ConsolidatingBalance SheetsAs 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                   |       |                        | 404,156    |                              |       |             | 30,874     | ** **       |       |   | — |   |   |   | 435,035 | ** ** |   |
| Inventories, net                                                        |       | —              |       |                        | 280,729    |                              |       |             | 50,907     | ** **       |       |   | (12 | ) |   |   | 331,624 | ** ** |   |
| Prepaid expenses, deferred  income taxes 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           |       |                        | 789,049    |                              |       |             | 120,766    | ** **       |       |   | (2,009,494 | ) |   |   | 903,565 | ** ** |   |
| 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  |                        |       | $                                 | 3,820,358  |             |       |             | $          | 175,616 | ** ** |   |   | $ | (3,209,676 | ) |   |   | $ | 4,021,894 | ** ** |   |
| **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              |       |                        | 404,898    |                              |       |             | 24,108     | ** **       |       |   | (8,564 | ) |   |   | 473,843 | ** ** |   |
| Intercompany payables                                                   |       | —              |       |                        | 1,670,055  |                              |       |             | 22,098     | ** **       |       |   | (1,692,153 | ) |   |   | — | ** ** |   |
| Total current liabilities                                               |       | 65,852              |       |                        | 2,261,677  |                              |       |             | 76,326     | ** **       |       |   | (1,700,717 | ) |   |   | 703,138 | ** ** |   |
| 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           |       |                        | 2,392,135  |                              |       |             | 108,362    | ** **       |       |   | (1,714,199 | ) |   |   | 2,670,314 | ** ** |   |
| **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  |                        |       | $                                 | 3,820,358  |             |       |             | $          | 175,616 | ** ** |   |   | $ | (3,209,676 | ) |   |   | $ | 4,021,894 | ** ** |   |

 

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

**Condensed ConsolidatingBalance SheetsAs of March 31, 2005(in thousands)**

| ** **                                                        | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                        | ** ** | ** **          | ** ** |                        | ** ** | ** **                        |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **Current assets**                                                | ** ** | ** **          | ** ** |                        | ** ** | ** **                        |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Cash and cash equivalents                                         |       | $                   | 300,788    |                        |       | $                                 | (8,272     | )                |       |             | $          | 14,336 | ** ** |   |   | $ | — |   |   |   | $ | 306,852 | ** ** |   |
| Accounts receivable, net                                          |       | 5                   |       |                        | 202,516    |                              |       |             | 35,391     | ** **       |       |   | — |   |   |   | 237,912 | ** ** |   |
| Inventories, net                                                  |       | —              |       |                        | 170,256    |                              |       |             | 43,105     | ** **       |       |   | — |   |   |   | 213,361 | ** ** |   |
| Prepaid expenses, deferred  income taxes and other current assets |       | 4,645               |       |                        | 35,180     |                              |       |             | 2,309      | ** **       |       |   | — |   |   |   | 42,134 | ** ** |   |
| Intercompany receivables                                          |       | 667,987             |       |                        | 23,270     |                              |       |             | 49,876     | ** **       |       |   | (741,133 | ) |   |   | — | ** ** |   |
| **Total current assets**                                          |       | 973,425             |       |                        | 422,950    |                              |       |             | 145,017    | ** **       |       |   | (741,133 | ) |   |   | 800,259 | ** ** |   |
| Property, plant and  equipment, net                               |       | 12,073              |       |                        | 125,422    |                              |       |             | 5,769      | ** **       |       |   | — |   |   |   | 143,264 | ** ** |   |
| Acquired intangibles, net                                         |       | —              |       |                        | 100,030    |                              |       |             | —     | ** **       |       |   | — |   |   |   | 100,030 | ** ** |   |
| Goodwill                                                          |       | 24,093              |       |                        | 768,303    |                              |       |             | 23,011     | ** **       |       |   | — |   |   |   | 815,407 | ** ** |   |
| Deferred income taxes and  other noncurrent assets      |       | 30,068              |       |                        | 3,803      |                              |       |             | 1,679      | ** **       |       |   | (2,649 | ) |   |   | 32,901 | ** ** |   |
| Investment in subsidiaries                                        |       | 397,168             |       |                        | 49,635     |                              |       |             | —     | ** **       |       |   | (446,803 | ) |   |   | — | ** ** |   |
| **Total assets**                                                  |       | $                   | 1,436,827  |                        |       | $                                 | 1,470,143  |             |       |             | $          | 175,476 | ** ** |   |   | $ | (1,190,585 | ) |   |   | $ | 1,891,861 | ** ** |   |
| **Liabilities and Stockholders’ Equity**                     | ** ** | ** **          | ** ** |                        | ** ** | ** **                        |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **Current liabilities**                                           | ** ** | ** **          | ** ** |                        | ** ** | ** **                        |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Current installments of  long-term debt                           |       | $                   | 2,360      |                        |       | $                                 | 292        |             |       |             | $          | — | ** ** |   |   | $ | — |   |   |   | $ | 2,652 | ** ** |   |
| Accounts payable                                                  |       | 3,146               |       |                        | 85,922     |                              |       |             | 22,154     | ** **       |       |   | — |   |   |   | 111,222 | ** ** |   |
| Accrued expenses and other current  liabilities              |       | 26,109              |       |                        | 262,249    |                              |       |             | 18,193     | ** **       |       |   | 5,870 |   |   |   | 312,421 | ** ** |   |
| Intercompany payables                                             |       | —              |       |                        | 465,948    |                              |       |             | 46,772     | ** **       |       |   | (512,720 | ) |   |   | — | ** ** |   |
| Total current liabilities                                         |       | 31,615              |       |                        | 814,411    |                              |       |             | 87,119     | ** **       |       |   | (506,850 | ) |   |   | 426,295 | ** ** |   |
| Long-term debt, excluding  current installments                   |       | 724,817             |       |                        | 2,794      |                              |       |             | —     | ** **       |       |   | — |   |   |   | 727,611 | ** ** |   |
| Other liabilities                                                 |       | 8,967               |       |                        | 51,916     |                              |       |             | 14,131     | ** **       |       |   | (8,487 | ) |   |   | 66,527 | ** ** |   |
| **Total liabilities**                                             |       | 765,399             |       |                        | 869,121    |                              |       |             | 101,250    | ** **       |       |   | (515,337 | ) |   |   | 1,220,433 | ** ** |   |
| **Total stockholders’ equity**                               |       | 671,428             |       |                        | 601,022    |                              |       |             | 74,226     | ** **       |       |   | (675,248 | ) |   |   | 671,428 | ** ** |   |
| **Total liabilities and stockholders’  equity**              |       | $                   | 1,436,827  |                        |       | $                                 | 1,470,143  |             |       |             | $          | 175,476 | ** ** |   |   | $ | (1,190,585 | ) |   |   | $ | 1,891,861 | ** ** |   |

 

119

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

**Condensed Consolidating Statements of EarningsFiscal Year Ended March 31, 2006 (in thousands)**

| ** **                                                   | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                                 |       | $                   | —     |                        | $          | 1,528,458                         |       |             | $          | 230,826          |       |   |   | $ | (23,752 | ) |   |   | $ | 1,735,532 |   |   |
| Cost and expenses                                            |       | 2,794               |       | 1,347,349                   |       |                              | 216,418    |             |       |             | (23,739    | ) |   |   | 1,542,822 |   |   |
| Operating income                                             |       | (2,794              | )          | 181,109                     |       |                              | 14,408     |             |       |             | (13        | ) |   |   | 192,710 |   |   |
| Interest income                                              |       | 6,801               |       | 80                          |       |                              | 372        |             |       |             | —     |   |   |   | 7,253 |   |   |
| Interest and related  expense                                |       | 63,996              |       | 184                         |       |                              | 6          |             |       |             | —     |   |   |   | 64,186 |   |   |
| Other income (expense),  net                                 |       | 128                 |       | (782                        | )          |                              | (77        | )                |       |             | 4          |   |   |   | (727 | ) |   |
| Management fees                                              |       | 2,261               |       | (2,083                      | )          |                              | (178       | )                |       |             | —     |   |   |   | — |   |   |
| Royalties                                                    |       | 2,096               |       | (113                        | )          |                              | (1,983     | )                |       |             | —     |   |   |   | — |   |   |
| Intercompany interest                                        |       | 37,604              |       | (37,707                     | )          |                              | 99         |             |       |             | 4          |   |   |   | — |   |   |
| Earnings before minority interest and income taxes |       | (17,900             | )          | 140,320                     |       |                              | 12,635     |             |       |             | (5         | ) |   |   | 135,050 |   |   |
| Non-controlling interest                                     |       | —              |       | —                      |       |                              | 1,562      |             |       |             | —     |   |   |   | 1,562 |   |   |
| Earnings before income taxes                                 |       | (17,900             | )          | 140,320                     |       |                              | 11,073     |             |       |             | (5         | ) |   |   | 133,488 |   |   |
| Income taxes                                                 |       | (6,969              | )          | 54,654                      |       |                              | 4,314      |             |       |             | (5         | ) |   |   | 51,994 |   |   |
| Earnings (losses) from  subsidiary entities                  |       | 92,425              |       | —                      |       |                              | —     |             |       |             | (92,425    | ) |   |   | — |   |   |
| **Net  earnings**                                            |       | $                   | 81,494     |                        | $          | 85,666                            |       |             | $          | 6,759            |       |   |   | $ | (92,425 | ) |   |   | $ | 81,494 |   |   |

 

120

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

**Condensed Consolidating Statements of EarningsFiscal Year Ended March 31, 2005(in thousands)**

| ** **                                                                               | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                                                             |       |                | $          | —                      |       |                              | $          | 1,116,949        |       |             | $          | 211,184 |   |   |   | $ | (19,533 | ) |   |   | $ | 1,308,600 |   |   |
| Cost and expenses                                                                        |       |                | 326        |                        |       | 983,589                           |       |             | 201,172    |             |       |   | (19,619 | ) |   |   | 1,165,468 |   |   |
| Operating income                                                                         |       |                | (326       | )                           |       | 133,360                           |       |             | 10,012     |             |       |   | 86 |   |   |   | 143,132 |   |   |
| Interest income                                                                          |       |                | 2,246      |                        |       | 97                                |       |             | 117        |             |       |   | — |   |   |   | 2,460 |   |   |
| Interest and related   expense                                                           |       |                | 39,462     |                        |       | 162                               |       |             | 126        |             |       |   | — |   |   |   | 39,750 |   |   |
| Other income (expense),   net                                                            |       |                | 130        |                        |       | (161                              | )          |             | (641       | )                |       |   | (47 | ) |   |   | (719 | ) |   |
| Management fees                                                                          |       |                | 1,925      |                        |       | (1,764                            | )          |             | (161       | )                |       |   | — |   |   |   | — |   |   |
| Royalties                                                                                |       |                | 1,890      |                        |       | (185                              | )          |             | (1,705     | )                |       |   | — |   |   |   | — |   |   |
| Intercompany interest                                                                    |       |                | 26,951     |                        |       | (26,687                           | )          |             | (264       | )                |       |   | — |   |   |   | — |   |   |
| Earnings from continuing operations before minority interest and income  taxes |       |                | (6,646     | )                           |       | 104,498                           |       |             | 7,232      |             |       |   | 39 |   |   |   | 105,123 |   |   |
| Non-controlling interest                                                                 |       |                | —     |                        |       | —                            |       |             | 2,155      |             |       |   | — |   |   |   | 2,155 |   |   |
| Earnings from continuing operations before income taxes                             |       |                | (6,646     | )                           |       | 104,498                           |       |             | 5,077      |             |       |   | 39 |   |   |   | 102,968 |   |   |
| Income taxes                                                                             |       |                | (2,917     | )                           |       | 45,508                            |       |             | 2,212      |             |       |   | 39 |   |   |   | 44,842 |   |   |
| Earnings (losses) from  subsidiary entities                                              |       |                | 63,713     |                        |       | —                            |       |             | —     |             |       |   | (63,713 | ) |   |   | — |   |   |
| Earnings (losses) from  continuing operations                                            |       |                | 59,984     |                        |       | 58,990                            |       |             | 2,865      |             |       |   | (63,713 | ) |   |   | 58,126 |   |   |
| Earnings from  discontinued operations, net of tax                                  |       |                | 693        |                        |       | 1,858                             |       |             | —     |             |       |   | — |   |   |   | 2,551 |   |   |
| **Net  earnings**                                                                        |       |                | $          | 60,677                      |       |                              | $          | 60,848           |       |             | $          | 2,865 |   |   |   | $ | (63,713 | ) |   |   | $ | 60,677 |   |   |

 

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

**Condensed ConsolidatingStatements of EarningsFiscal Year Ended March 31, 2004(in thousands)**

| ** **                                                                     | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Revenues**                                                                   |       |                | $          | —                      |       |                              |       | $                | 818,755    |             |       |   | $ | 182,507 |   |   |   | $ | (14,331 | ) |   |   | $ | 986,931 |   |   |
| Cost and expenses                                                              |       |                | (83        | )                           |       |                              | 731,194    |             |       |             | 166,779    |   |   |   | (14,291 | ) |   |   | 883,599 |   |   |
| Operating  income                                                              |       |                | 83         |                        |       |                              | 87,561     |             |       |             | 15,728     |   |   |   | (40 | ) |   |   | 103,332 |   |   |
| Interest income                                                                |       |                | 601        |                        |       |                              | —     |             |       |             | 153        |   |   |   | — |   |   |   | 754 |   |   |
| Interest and related  expense                                                  |       |                | 23,721     |                        |       |                              | 249        |             |       |             | 289        |   |   |   | — |   |   |   | 24,259 |   |   |
| Other income (expense),  net                                                   |       |                | 137        |                        |       |                              | 210        |             |       |             | (915       | ) |   |   | 23 |   |   |   | (545 | ) |   |
| Management fees                                                                |       |                | 1,309      |                        |       |                              | (1,198     | )                |       |             | (111       | ) |   |   | — |   |   |   | — |   |   |
| Royalties                                                                      |       |                | 1,650      |                        |       |                              | (715       | )                |       |             | (935       | ) |   |   | — |   |   |   | — |   |   |
| Intercompany interest                                                          |       |                | 13,106     |                        |       |                              | (11,840    | )                |       |             | (1,266     | ) |   |   | — |   |   |   | — |   |   |
| Earnings  from continuing operations before minority interest and income taxes |       |                | (6,835     | )                           |       |                              | 73,769     |             |       |             | 12,365     |   |   |   | (17 | ) |   |   | 79,282 |   |   |
| Non-controlling interest                                                       |       |                | —     |                        |       |                              | —     |             |       |             | 1,951      |   |   |   | — |   |   |   | 1,951 |   |   |
| Earnings  from continuing operations before income taxes                       |       |                | (6,835     | )                           |       |                              | 73,769     |             |       |             | 10,414     |   |   |   | (17 | ) |   |   | 77,331 |   |   |
| Income taxes                                                                   |       |                | (2,976     | )                           |       |                              | 32,227     |             |       |             | 4,555      |   |   |   | (17 | ) |   |   | 33,789 |   |   |
| Earnings (losses) from  subsidiary entities                                    |       |                | 48,579     |                        |       |                              | —     |             |       |             | —     |   |   |   | (48,579 | ) |   |   | — |   |   |
| Earnings (losses) from  continuing operations                                  |       |                | 44,720     |                        |       |                              | 41,542     |             |       |             | 5,859      |   |   |   | (48,579 | ) |   |   | 43,542 |   |   |
| Earnings from  discontinued operations, net of tax                             |       |                | —     |                        |       |                              | 1,178      |             |       |             | —     |   |   |   | — |   |   |   | 1,178 |   |   |
| **Net  earnings**                                                              |       |                | $          | 44,720                      |       |                              |       | $                | 42,720     |             |       |   | $ | 5,859 |   |   |   | $ | (48,579 | ) |   |   | $ | 44,720 |   |   |

 

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

**Condensed ConsolidatingStatements of Cash FlowsFiscal Year Ended March 31, 2006 (in thousands)**

| ** **                                                        | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Net cash provided by operating activities**                     |       | $                   | 44,828     |                        |       | $                                 | 106,167    |             |       |             | $          | 6,067 |   |   |   | $ | — |   |   |   | $ | 157,062 |   |   |
| **Cash Flows from Investing Activities**                          |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Capital expenditures                                              |       | (5,953              | )          |                        | (34,142    | )                                 |       |             | (3,099     | )                |       |   | — |   |   |   | (43,194 | ) |   |
| Payments pursuant to  business combinations, net of cash acquired |       | (1,425,696          | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (1,425,696 | ) |   |
| Dispositions of property,  plant and equipment                    |       | —              |       |                        | 523        |                              |       |             | 909        |             |       |   | — |   |   |   | 1,432 |   |   |
| Other, net                                                        |       | 62                  |       |                        | (207       | )                                 |       |             | 207        |             |       |   | — |   |   |   | 62 |   |   |
| **Net cash  used in investing activities**                        |       | (1,431,587          | )          |                        | (33,826    | )                                 |       |             | (1,983     | )                |       |   | — |   |   |   | (1,467,396 | ) |   |
| **Cash Flows from Financing Activities**                          |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Net repayments of  short-term  debt                               |       | (36,300             | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (36,300 | ) |   |
| Borrowings of long-term  debt                                     |       | 1,220,000           |       |                        | —     |                              |       |             | 9,853      |             |       |   | — |   |   |   | 1,229,853 |   |   |
| Debt issuance costs                                               |       | (28,372             | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (28,372 | ) |   |
| Repayments of long-term  debt                                     |       | (167,461            | )          |                        | (324       | )                                 |       |             | (23        | )                |       |   | — |   |   |   | (167,808 | ) |   |
| Proceeds from exercise of  stock options                          |       | 12,540              |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 12,540 |   |   |
| Return of advanced  interest on senior subordinated notes    |       | (1,986              | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (1,986 | ) |   |
| Dividends paid                                                    |       | (3,705              | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (3,705 | ) |   |
| Net borrowings from  (repayments to) Parent company               |       | 107,160             |       |                        | (83,265    | )                                 |       |             | (23,895    | )                |       |   | — |   |   |   | — |   |   |
| **Net cash  provided by (used in) financing activities**          |       | 1,101,876           |       |                        | (83,589    | )                                 |       |             | (14,065    | )                |       |   | — |   |   |   | 1,004,222 |   |   |
| **Effects  of exchange rates on cash and cash equivalents**       |       | —              |       |                        | —     |                              |       |             | 553        |             |       |   | — |   |   |   | 553 |   |   |
| **Net decrease  in cash and cash equivalents**                    |       | (284,883            | )          |                        | (11,248    | )                                 |       |             | (9,428     | )                |       |   | — |   |   |   | (305,559 | ) |   |
| **Cash and  cash equivalents, beginning of period**               |       | 300,788             |       |                        | (8,272     | )                                 |       |             | 14,336     |             |       |   | — |   |   |   | 306,852 |   |   |
| **Cash and  cash equivalents, end of period**                     |       | $                   | 15,905     |                        |       | $                                 | (19,520    | )                |       |             | $          | 4,908 |   |   |   | $ | — |   |   |   | $ | 1,293 |   |   |
|                                                                   |            |                     |            |                             |            |                                   |            |                  |            |                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

**CondensedConsolidating Statements of Cash FlowsFiscal Year Ended March 31, 2005(in thousands)**

| ** **                                                                             | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Net cash provided by operating activities of continuing operations**            |       |                | $          | 32,032                      |       |                              |       | $                | 89,936     |             |       |   | $ | 14,215 |   |   |   | $ | — |   |   |   | $ | 136,183 |   |   |
| **Net cash provided by operating activities of discontinued  operations**         |       |                | —     |                        |       |                              | 2,227      |             |       |             | —     |   |   |   | — |   |   |   | 2,227 |   |   |
| **Net cash provided by operating  activities**                                         |       |                | 32,032     |                        |       |                              | 92,163     |             |       |             | 14,215     |   |   |   | — |   |   |   | 138,410 |   |   |
| **Cash Flows from Investing  Activities**                                              | ** ** |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Capital  expenditures                                                                  |       |                | (5,355     | )                           |       |                              | (27,412    | )                |       |             | (1,754     | ) |   |   | — |   |   |   | (34,521 | ) |   |
| Payments  pursuant to business combinations, net of cash acquired                      |       |                | —     |                        |       |                              | (49,839    | )                |       |             | —     |   |   |   | — |   |   |   | (49,839 | ) |   |
| Proceeds  from sales of businesses                                                     |       |                | 29,096     |                        |       |                              | —     |             |       |             | —     |   |   |   | — |   |   |   | 29,096 |   |   |
| Investments  in short-term notes                                                       |       |                | (10,000    | )                           |       |                              | —     |             |       |             | —     |   |   |   | — |   |   |   | (10,000 | ) |   |
| Proceeds  from short-term notes                                                        |       |                | 10,000     |                        |       |                              | —     |             |       |             | —     |   |   |   | — |   |   |   | 10,000 |   |   |
| Dispositions  of property, plant and equipment                                    |       |                | —     |                        |       |                              | 825        |             |       |             | —     |   |   |   | — |   |   |   | 825 |   |   |
| Other,  net                                                                            |       |                | 744        |                        |       |                              | (691       | )                |       |             | 813        |   |   |   | — |   |   |   | 866 |   |   |
| **Net cash provided by (used in) investing activities of  continuing operations** | ** ** |                | 24,485     |                        |       |                              | (77,117    | )                |       |             | (941       | ) |   |   | — |   |   |   | (53,573 | ) |   |
| **Net cash used in investing activities of discontinued operations**                   | ** ** |                | —     |                        |       |                              | (825       | )                |       |             | —     |   |   |   | — |   |   |   | (825 | ) |   |
| **Net cash provided by (used in) investing activities**                           |       |                | 24,485     |                        |       |                              | (77,942    | )                |       |             | (941       | ) |   |   | — |   |   |   | (54,398 | ) |   |
| **Cash Flows from Financing  Activities**                                              | ** ** |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Net  payments of short-term debt                                                       |       |                | —     |                        |       |                              | —     |             |       |             | (82        | ) |   |   | — |   |   |   | (82 | ) |   |
| Repayments  of long-term debt                                                          |       |                | (50,360    | )                           |       |                              | (547       | )                |       |             | —     |   |   |   | — |   |   |   | (50,907 | ) |   |
| Proceeds  from senior subordinated  notes                                              |       |                | 210,000    |                        |       |                              | —     |             |       |             | —     |   |   |   | — |   |   |   | 210,000 |   |   |
| Receipt of advanced Interest  on Senior Subordinated Notes                             |       |                | 1,986      |                        |       |                              | —     |             |       |             | —     |   |   |   | — |   |   |   | 1,986 |   |   |
| Debt  issuance costs                                                                   |       |                | (4,193     | )                           |       |                              | —     |             |       |             | —     |   |   |   | — |   |   |   | (4,193 | ) |   |
| Net  borrowings from (repayments to) Parent Company                                    |       |                | 23,399     |                        |       |                              | (16,286    | )                |       |             | (7,113     | ) |   |   | — |   |   |   | — |   |   |
| Proceeds  from exercise of stock  options                                              |       |                | 8,097      |                        |       |                              | —     |             |       |             | —     |   |   |   | — |   |   |   | 8,097 |   |   |
| Other,  net                                                                            |       |                | —     |                        |       |                              | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |
| **Net cash provided by (used in) financing activities of continuing  operations**      | ** ** |                | 188,929    |                        |       |                              | (16,833    | )                |       |             | (7,195     | ) |   |   | — |   |   |   | 164,901 |   |   |
| **Net cash used in financing activities of discontinued operations**              | ** ** |                | —     |                        |       |                              | (30        | )                |       |             | —     |   |   |   | — |   |   |   | (30 | ) |   |
| **Net cash provided by (used in) financing activities**                                | ** ** |                | 188,929    |                        |       |                              | (16,863    | )                |       |             | (7,195     | ) |   |   | — |   |   |   | 164,871 |   |   |
| **Effects of exchange rates on cash and cash equivalents**                             | ** ** |                | —     |                        |       |                              | —     |             |       |             | 1,179      |   |   |   | — |   |   |   | 1,179 |   |   |
| **Net increase (decrease) in cash and cash equivalents**                          | ** ** |                | 245,446    |                        |       |                              | (2,642     | )                |       |             | 7,258      |   |   |   | — |   |   |   | 250,062 |   |   |
| **Cash and cash equivalents, beginning of period**                                |       |                | 55,342     |                        |       |                              | (5,630     | )                |       |             | 7,078      |   |   |   | — |   |   |   | 56,790 |   |   |
| **Cash and cash equivalents, end of  period**                                          |       |                | $          | 300,788                     |       |                              |       | $                | (8,272     | )                |       |   | $ | 14,336 |   |   |   | $ | — |   |   |   | $ | 306,852 |   |   |

 

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

**Condensed ConsolidatingStatements of Cash FlowsFiscal Year Ended March 31, 2004(in thousands)**

| ** **                                                                        | ** ** | **Parent  Company** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Net cash provided by operating activities of continuing  operations**      |       | $                   | 8,758      |                        |       | $                                 | 82,211     |             |       |             | $          | 13,748 |   |   |   | $ | — |   |   |   | $ | 104,717 |   |   |
| **Net cash used in operating activities of discontinued  operations**        |       | —              |       |                        | (2,084     | )                                 |       |             | —     |             |       |   | — |   |   |   | (2,084 | ) |   |
| **Net cash provided by operating  activities**                                    |       | 8,758               |       |                        | 80,127     |                              |       |             | 13,748     |             |       |   | — |   |   |   | 102,633 |   |   |
| **Cash  Flows from Investing Activities**                                         |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Capital  expenditures                                                             |       | (3,917              | )          |                        | (19,234    | )                                 |       |             | (1,293     | )                |       |   | — |   |   |   | (24,444 | ) |   |
| Payments  pursuant to business combinations, net of cash acquired                 |       | (250,329            | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (250,329 | ) |   |
| Other,  net                                                                       |       | 520                 |       |                        | 396        |                              |       |             | (2         | )                |       |   | — |   |   |   | 914 |   |   |
| **Net cash used in investing activities of continuing  operations**          |       | (253,726            | )          |                        | (18,838    | )                                 |       |             | (1,295     | )                |       |   | — |   |   |   | (273,859 | ) |   |
| **Net cash used in investing activities of discontinued  operations**        |       | —              |       |                        | (601       | )                                 |       |             | —     |             |       |   | — |   |   |   | (601 | ) |   |
| **Net cash used in investing activities**                                         |       | (253,726            | )          |                        | (19,439    | )                                 |       |             | (1,295     | )                |       |   | — |   |   |   | (274,460 | ) |   |
| **Cash  Flows from Financing Activities**                                         |       |                |       |                        |       |                              |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Net  payments of short-term debt                                                  |       | —              |       |                        | —     |                              |       |             | (521       | )                |       |   | — |   |   |   | (521 | ) |   |
| Borrowings  of long-term debt                                                     |       | 586,000             |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 586,000 |   |   |
| Repayments  of long-term debt                                                     |       | (439,481            | )          |                        | (611       | )                                 |       |             | —     |             |       |   | — |   |   |   | (440,092 | ) |   |
| Debt  issuance costs                                                              |       | (15,744             | )          |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | (15,744 | ) |   |
| Net  borrowings from (repayments to) Parent Company                               |       | 79,451              |       |                        | (69,112    | )                                 |       |             | (10,339    | )                |       |   | — |   |   |   | — |   |   |
| Proceeds  from exercise of stock options                                          |       | 1,970               |       |                        | —     |                              |       |             | —     |             |       |   | — |   |   |   | 1,970 |   |   |
| Other,  net                                                                       |       |                |       |                        |       |                              |       |             |       |             |       |   | — |   |   |   | — |   |   |
| **Net cash provided by (used in) financing activities of continuing  operations** |       | 212,196             |       |                        | (69,723    | )                                 |       |             | (10,860    | )                |       |   | — |   |   |   | 131,613 |   |   |
| **Net cash used in financing activities of discontinued operations**              |       | —              |       |                        | 154        |                              |       |             | —     |             |       |   | — |   |   |   | 154 |   |   |
| **Net cash provided by (used in) financing activities**                           |       | 212,196             |       |                        | (69,569    | )                                 |       |             | (10,860    | )                |       |   | — |   |   |   | 131,767 |   |   |
| **Effects of exchange rates on cash and cash equivalents**                   |       | —              |       |                        | —     |                              |       |             | 912        |             |       |   | — |   |   |   | 912 |   |   |
| **Net (decrease) increase in cash and cash  equivalents**                         |       | (32,772             | )          |                        | (8,881     | )                                 |       |             | 2,505      |             |       |   | — |   |   |   | (39,148 | ) |   |
| **Cash and cash equivalents, beginning of period**                                |       | 88,114              |       |                        | 3,251      |                              |       |             | 4,573      |             |       |   | — |   |   |   | 95,938 |   |   |
| **Cash and  cash equivalents, end of period**                                     |       | $                   | 55,342     |                        |       | $                                 | (5,630     | )                |       |             | $          | 7,078 |   |   |   | $ | — |   |   |   | $ | 56,790 |   |   |

 

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

**16.   Unaudited Quarterly Financial Information**

The followingtable sets forth unaudited quarterly financial information for fiscal 2006 and 2005:

| ** **                                                       | ** ** | **First**                                                     | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **                                                       | ** ** | **Quarter**                                                   | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| ** **                                                       | ** ** | **(in thousands, except per-share data)** | ** ** |
| **Fiscal year ended March 31, 2006**                        | ** ** | ** **                                                    | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** |
| Revenues                                                         |       | $                                                             | 338,459    |        | $          | 361,930     |       | $           | 389,490    |   | $ | 645,653 |   |
| Operating income                                                 |       | $                                                             | 35,058     |        | $          | 38,577      |       | $           | 44,827     |   | $ | 74,248 |   |
| Net earnings                                                     |       | $                                                             | 14,018     |        | $          | 18,954      |       | $           | 19,744     |   | $ | 28,778 |   |
| Basic earnings per share:                                        |       |                                                          |       |        |       |        |       |        |       |
| Net earnings                                                     |       | $                                                             | 0.51       |        | $          | 0.68        |       | $           | 0.71       |   | $ | 0.81 |   |
| Diluted earnings per share:                                      |       |                                                          |       |        |       |        |       |        |       |
| Net earnings                                                     |       | $                                                             | 0.49       |        | $          | 0.66        |       | $           | 0.69       |   | $ | 0.79 |   |
| **Fiscal  year ended March 31, 2005**                       | ** ** | ** **                                                    | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** |
| Revenues                                                         |       | $                                                             | 291,151    |        | $          | 318,053     |       | $           | 338,232    |   | $ | 361,164 |   |
| Operating income                                                 |       | $                                                             | 28,500     |        | $          | 33,806      |       | $           | 39,249     |   | $ | 41,577 |   |
| Earnings from continuing  operations                             |       | $                                                             | 10,971     |        | $          | 14,003      |       | $           | 16,837     |   | $ | 16,315 |   |
| Earnings from  discontinued operations, net of income taxes      |       | $                                                             | 800        |        | $          | 398         |       | $           | 624        |   | $ | 729 |   |
| Net earnings                                                     |       | $                                                             | 11,771     |        | $          | 14,401      |       | $           | 17,461     |   | $ | 17,044 |   |
| Basic earnings per share:                                        |       |                                                          |       |        |       |        |       |        |       |
| Earnings from continuing  operations                             |       | $                                                             | 0.41       |        | $          | 0.52        |       | $           | 0.62       |   | $ | 0.60 |   |
| Earnings from  discontinued operations, net of income taxes |       | $                                                             | 0.03       |        | $          | 0.01        |       | $           | 0.02       |   | $ | 0.03 |   |
| Net earnings                                                     |       | $                                                             | 0.44       |        | $          | 0.53        |       | $           | 0.64       |   | $ | 0.63 |   |
| Diluted earnings per share:                                      |       |                                                          |       |        |       |        |       |        |       |
| Earnings from continuing  operations                             |       | $                                                             | 0.40       |        | $          | 0.50        |       | $           | 0.60       |   | $ | 0.58 |   |
| Earnings from  discontinued operations, net of income taxes |       | $                                                             | 0.03       |        | $          | 0.01        |       | $           | 0.02       |   | $ | 0.03 |   |
| Net earnings                                                     |       | $                                                             | 0.43       |        | $          | 0.52        | *          | $           | 0.62       |   | $ | 0.61 |   |

----

*                    Column doesnot foot due to rounding

126

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**DRS TECHNOLOGIES, INC. AND SUBSIDIARIESSchedule II. Valuation and Qualifying AccountsYears Ended March 31, 2006, 2005 and 2004**

| **Col. A**                                        | ** ** | **Col. B**         | ** ** | **Col. C  Additions(a)**                  | ** ** | **Col. D  Deductions(b)**                | ** ** | **Col. E**                                      | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                             | ** ** | ** **              | ** ** | **(1)**                                        | ** ** | **(2)**                                       | ** ** | **(1)**                                              | ** ** | **(2)** | ** ** | ** ** | ** ** |
| **Description**                                        | ** ** | ** **              | ** ** | **Balance at  Beginning of  Period** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Charged to  Other  Accounts—  Describe** | ** ** | **Credited to  Costs and  Expenses** | ** ** | **Credited to  Other  Accounts—  Describe** | ** ** | **Balance at  End of  Period** | ** ** |
| ** **                                             | ** ** | **(in thousands)** | ** ** |
| **Inventory reserve**                                  |       |                    |       |                                           |       |                                          |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Year ended March 31,  2006                        |       |                    | $          | 8,724                                          |       |                                          |       | $                                                    | 3,437      |   |   |   | $ | 1,197 | (c) |   |   | $ | 787 |   |   |   | $ | 3,211 | (d) |   |   | $ | 9,360 |   |   |
| Year ended March 31,  2005                        |       |                    | $          | 7,060                                          |       |                                          |       | $                                                    | 3,873      |   |   |   | $ | 30 | (c) |   |   | $ | 1,098 |   |   |   | $ | 1,141 | (d) |   |   | $ | 8,724 |   |   |
| Year ended March 31,  2004                        |       |                    | $          | 5,000                                          |       |                                          |       | $                                                    | 3,236      |   |   |   | $ | 1,912 | (c) |   |   | $ | 282 |   |   |   | $ | 2,806 | (d) |   |   | $ | 7,060 |   |   |
| **Allowance  for doubtful accounts**                   |       |                    |       |                                           |       |                                          |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Year ended March 31,  2006                        |       |                    | $          | 2,659                                          |       |                                          |       | $                                                    | 964        |   |   |   | $ | — |   |   |   | $ | 467 |   |   |   | $ | 1,488 | (d) |   |   | $ | 1,668 |   |   |
| Year ended March 31,  2005                        |       |                    | $          | 3,890                                          |       |                                          |       | $                                                    | 732        |   |   |   | $ | 142 |   |   |   | $ | 1,314 |   |   |   | $ | 791 |   |   |   | $ | 2,659 |   |   |
| Year ended March 31,  2004                        |       |                    | $          | 2,901                                          |       |                                          |       | $                                                    | 921        |   |   |   | $ | 270 | (c) |   |   | $ | 129 |   |   |   | $ | 73 | (d) |   |   | $ | 3,890 |   |   |
| **Other  current assets—note receivable reserve** |       |                    |       |                                           |       |                                          |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Year ended March 31,  2006                        |       |                    | $          | 1,116                                          |       |                                          |       | $                                                    | 750        |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 416 | (e) |   |   | $ | 1,450 |   |   |
| Year ended March 31,  2005                        |       |                    | $          | 816                                            |       |                                          |       | $                                                    | 700        |   |   |   | $ | — |   |   |   | $ | 400 |   |   |   | $ | — |   |   |   | $ | 1,116 |   |   |
| Year ended March 31, 2004                         |       |                    | $          | 1,375                                          |       |                                          |       | $                                                    | —     |   |   |   | $ | — |   |   |   | $ | 300 |   |   |   | $ | 259 | (e) |   |   | $ | 816 |   |   |
|                                                        |            |                         |            |                                                |            |                                               |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(a)    Represents,on a full-year basis, net credits to reserve accounts.

(b)    Represents,on a full-year basis, net charges to reserve accounts.

(c)     Representsamounts reclassified from related reserve accounts.

(d)    Representsamounts utilized and credited to related asset accounts.

(e)    Representsan uncollectible amount written off.

127

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**Item 9.**                    Changesin and Disagreements with Accountants on Accounting and Financial Disclosure

Not Applicable.

**Item 9A.   Controls and Procedures**

(a)           Disclosure Controls andProcedures. The Company’s management, with the participation of the Company’sChief Executive Officer and Chief Financial Officer, has evaluated theeffectiveness of the Company’s disclosure controls and procedures (as such termis defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as ofthe end of the period covered by this report. Based on such evaluation, theCompany’s Chief Executive Officer and Chief Financial Officer have concludedthat, as of the end of such period, the Company’s disclosure controls andprocedures are effective in recording, processing, summarizing and reporting,on a timely basis, information required to be disclosed by the Company in thereports that it files or submits under the Exchange Act.

(b)          Internal Control OverFinancial Reporting. The addition of the business units added through theacquisition of ESSI on January 31, 2006 resulted in a material change ininternal control over financial reporting. The acquired ESSI business units utilizeseparate information and accounting systems and processes. With the exceptionof the change in internal control over financial reporting from the acquiredESSI business units, there have not been any changes in the Company’s internalcontrol over financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during the fourth quarter of thefiscal year ended March 31, 2006 that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

(c)            Section 404 ofthe Sarbanes-Oxley Act of 2002 requires that management document and testthe Company’s internal control over financial reporting and include in thisAnnual Report on Form 10-K a report on management’s assessment ofthe effectiveness of the Company’s internal control over financial reporting.See “Management’s Report on Internal Control over Financial Reporting,” below. Theattestation report of our independent registered public accounting firm, KPMGLLP, on our management’s assessment of our internal control over financialreporting also is included below.

***Management’s Report onInternal Control over Financial Reporting.******  ***Our managementis responsible for establishing and maintaining adequate internal control overfinancial reporting, as such term is defined in Rule 13a-15(f) ofthe Exchange Act. Under the supervision and with the participation of ourmanagement, including our Chief Executive Officer and Chief Financial Officer,we conducted an evaluation of the effectiveness of our internal control overfinancial reporting based upon the framework in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO). Based on that evaluation, our management concluded that ourinternal control over financial reporting is effective, as of March 31, 2006.

We acquired Engineered Support Systems, Inc. and CodemSystems, Inc. (the acquired businesses) during fiscal 2006, and managementexcluded from its assessment of the effectiveness of our internal control overfinancial reporting as of March 31, 2006, the acquired businesses’internal control over financial reporting associated with total assets of $392.6 millionand total revenues of $194.1 million included in our consolidatedfinancial statements as of and for the year ended March 31, 2006.

128

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KPMGLLP, independent registered public accounting firm, has audited theconsolidated financial statements included in this Annual Report on Form 10-Kand, as part of their audit, has issued their report, included herein, on (1) ourmanagement’s assessment of the effectiveness of our internal control overfinancial reporting and (2) the effectiveness of our internal control overfinancial reporting as of March 31, 2006.

**Report of IndependentRegistered Public Accounting Firm**

The Board of Directors andStockholdersDRS Technologies, Inc.:

We have audited management's assessment, included inthe accompanying Management's Report on Internal Control Over FinancialReporting, that DRS Technologies, Inc. and subsidiaries maintained effectiveinternal control over financial reporting as of March 31, 2006, based oncriteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO). DRSTechnologies, Inc.'s management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management's assessment and an opinion on theeffectiveness of the Company's internal control over financial reporting basedon our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement's assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company's internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Acompany's internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (2) provide reasonable assurance that transactions arerecorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company's assets that could have amaterial effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

In our opinion, management's assessment that DRSTechnologies, Inc. and subsidiaries maintained effective internal control overfinancial reporting as of March 31, 2006, is fairly stated, in all materialrespects, based on criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO). Also, in our opinion, DRS Technologies, Inc. andsubsidiaries maintained, in all material respects, effective internal controlover financial reporting as of March 31, 2006, based on the criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (COSO).

129

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DRS Technologies, Inc. acquired Engineered SupportServices, Inc. and Codem Systems, Inc. during the year ended March 31, 2006 andmanagement excluded from its assessment of the effectiveness of DRSTechnologies, Inc. and subsidiaries' internal control over financial reportingas of March 31, 2006, Engineered Support Services, Inc.’s and Codem Systems,Inc.’s internal control over financial reporting associated with total assetsof $392.6 million and total revenues of $194.1 million included in theconsolidated financial statements of DRS Technologies, Inc. and subsidiaries asof and for the year ended March 31, 2006. Our audit of internal control overfinancial reporting of DRS Technologies, Inc. and subsidiaries also excluded anevaluation of the internal control over financial reporting of EngineeredSupport Systems, Inc. and Codem Systems, Inc.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of DRS Technologies, Inc. andsubsidiaries as of March 31, 2006 and 2005, and the related consolidatedstatements of earnings, stockholders' equity and comprehensive earnings, andcash flows for each of the years in the three-year period ended March 31, 2006,and our report dated June 9, 2006, expressed an unqualified opinion on thoseconsolidated financial statements.
| /s/ KPMG LLP            |   |
|-------------------------|--------|
| Short Hills, New Jersey |
| June 9, 2006       |

 

**Item 9B.   Other Information**

**Employment Rider**

**On June 8, 2006, DRS and Richard A. Schneider (the“Executive”), Executive Vice President and Chief Financial Officer of DRS,entered into Amendment No. 2 (the “Second Amendment”) to the EmploymentAgreement dated February 19, 1999 between the Executive and DRS (as amended,the “Employment Agreement” and, as amended by the Second Amendment, the“Amended Employment Agreement”).  TheSecond Amendment provides that the Employment Agreement shall remain in effectfor at least two years immediately following a Change in Control (as defined inthe Amended Employment Agreement).**

**A copyof the Second Amendment is attached to this report as Exhibit 10.14 and isincorporated herein by reference.  A copyof the Employment Agreement is included as Exhibit 10.49 to the Company’sAnnual Report on Form 10-K (Commission File No. 001-08533), for the fiscal yearended March 31, 1999, filed with the Securities and Exchange Commission on June29, 1999 and a copy of Amendment No. 1 to the Employment Agreement dated August18, 2004 is included as Exhibit 10.5 to the Company’s Quarterly Report on Form10-Q, for the quarter ended September 30, 2004, filed with the Securities andExchange Commission on November 9, 2004. The description of the Second Amendment is qualified in its entirety byreference to the Second Amendment.**

**PART III**

Theinformation required by Items 10, 11, 12, 13 and 14 of Part III of thisReport, to the extent not set forth herein, is incorporated herein by referencefrom the registrant’s definitive proxy statement relating to the annual meetingof stockholders to be held in 2006, which definitive proxy statement shall befiled with the Securities and Exchange Commission within 120 days afterthe end of the fiscal year to which this report relates. Reference also is madeto the information under Executive Officers of the registrant in Part I ofthis report.

130

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**PART IV**

**Item 15.   Exhibits and Financial Statement Schedules**
| (a)    | The following are documents filed as part of this report:    |                                                                                                                                                                                                             |
|--------|--------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 1.                                                           | Financial Statements                                                                                                                                                                                             |   |
|   |                                                         | See Item 8. Financial  Statements and Supplementary Data                                                                                                                                                         | 63 |
|   | 2.                                                           | Financial Statement Schedules                                                                                                                                                                                    |   |
|   |                                                         | Schedule II—Valuation  and Qualifying Accounts                                                                                                                                                         | 127 |
|   |                                                         | All other financial statement schedules have been omitted because  they are either not required, not applicable or the required information is  shown in the Consolidated Financial Statements or Notes thereto. |   |
| (b)    | Exhibits                                                     |                                                                                                                                                                                                             |
|   | See Exhibits Index following the signature  page hereto | 133                                                                                                                                                                                                              |

 

131

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**SIGNATURES**

Pursuant tothe requirements of Section 13 or 15(d) of the Securities Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.
|                           | **DRS TECHNOLOGIES, INC.**          |
|---------------------------|------------------------------------------|
| Dated: June 12, 2006 |                                     |
|                      | /s/ MARK S. NEWMAN                       |
|                      | Mark S. Newman, *Chairman of the Board,* |
|                      | *President  and Chief Executive Officer* |

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated.

|                          | **Signature** | ** **                           | ** ** | ** **         | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|--------------------------|---------------|--------------------------------------|------------|--------------------|-----------|------------|------------|------------|----------|------------|
| /s/ MARK S. NEWMAN       |          | Chairman of the Board,  President,   |       | June 12, 2006 |
| Mark S. Newman           |          | Chief Executive Officer and Director |       |               |
| /s/ RICHARD A. SCHNEIDER |          | Executive Vice President,            |       | June 12, 2006 |
| Richard A. Schneider     |          | Chief Financial Officer              |       |               |
| /s/ IRA ALBOM            |          | Director                             |       | June 12, 2006 |
| Ira Albom                |          |                                 |       |               |
| /s/ DONALD C. FRASER     |          | Director                             |       | June 12, 2006 |
| Donald C. Fraser         |          |                                 |       |               |
| /s/ WILLIAM F. HEITMANN  |          | Director                             |       | June 12, 2006 |
| William F. Heitmann      |          |                                 |       |               |
| /s/ STEVEN S. HONIGMAN   |          | Director                             |       | June 12, 2006 |
| Steven S. Honigman       |          |                                 |       |               |
| /s/ C. SHELTON JAMES     |          | Director                             |       | June 12, 2006 |
| C. Shelton James         |          |                                 |       |               |
| /s/ MARK N. KAPLAN       |          | Director                             |       | June 12, 2006 |
| Mark N. Kaplan           |          |                                 |       |               |
| /s/ STUART F. PLATT      |          | Director                             |       | June 12, 2006 |
| Stuart F. Platt          |          |                                 |       |               |
| /s/ DENNIS J. REIMER     |          | Director                             |       | June 12, 2006 |
| Dennis J. Reimer         |          |                                 |       |               |
| /s/ ERIC J. ROSEN        |          | Director                             |       | June 12, 2006 |
| Eric  J. Rosen           |          |                                 |       |               |

 

132

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**EXHIBIT INDEX**

Certain of thefollowing exhibits, designated with an asterisk (*) are filed herewith. Theexhibits not so designated have been previously filed by the Company with the Securitiesand Exchange Commission and are incorporated herein by reference to thedocuments indicated in brackets, following the descriptions of such exhibits.
| Exhibit No. | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                       | ** ** | **Description** |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 3.1              |       | Amended and Restated Certificate of Incorporation of  DRS Technologies, Inc. [Registration Statement on Form S-1,  File No. 33-64641, Post-Effective Amendment No. 1 filed  on May 10, 1996, Exhibit 3.4]                                                                                                                                                                                     |
| 3.2              |       | Certificate of Amendment of the  Amended and Restated Certificate of Incorporation of  DRS Technologies, Inc. [Form 8-K filed on  August 14, 1997, Exhibit 3.9]                                                                                                                                                                                                                                         |
| 3.3              |       | Certificate of Amendment to the  Amended and Restated Certificate of Incorporation of  DRS Technologies, Inc. [Form 10-Q filed on  August 14, 2001, Exhibit 3.9]                                                                                                                                                                                                                                        |
| 3.4              |       | Certificate of Amendment to the  Amended and Restated Certificate of Incorporation of  DRS Technologies, Inc. [Registration Statement on Form S-4,  File No. 333-112423 filed on February 2, 2004,  Exhibit 3.4]                                                                                                                                                                                   |
| 3.5              |       | Amended and Restated By-Laws  of the Company [Form 10-K filed on June 14, 2004, Exhibit 3.5]                                                                                                                                                                                                                                                                                                                      |
| *3.6             |       | Certificate of Amendment to the  Amended and Restated Certificate of Incorporation of DRS Technologies, Inc.                                                                                                                                                                                                                                                                                                                     |
| 4.1              |       | Registration Rights Agreement,  dated as of September 22, 1995, between the Company and Forum Capital  Markets L.P., as initial purchaser [Registration Statement on Form S-2,  File No. 33-64641, filed on November 30, 1995,  Exhibit 4.3]                                                                                                                                                            |
| 4.2              |       | Registration Rights Agreement  dated as of October 30, 2003, by and among the Company, each of the  Guarantors (as defined therein), and Bear, Stearns & Co., Wachovia  Capital Markets, LLC and Fleet Securities, Inc., as initial  purchasers, relating to the Company’s 67¤8%  Senior Subordinated Notes due 2013 [Form 10-Q filed on  November 14, 2003, Exhibit 10.2]           |
| 4.3              |       | Registration Rights Agreement,  dated as of December 23, 2004, by and among the Company, each of the Guarantors  (as defined therein), and Bear, Stearns & Co. Inc., Wachovia  Capital Markets, LLC and Banc of America Securities LLC, as initial  purchasers, relating to the Company’s 67¤8  Senior Subordinated Notes due 2013. [Form 10-K filed on June 14,  2005, Exhibit 4.2] |
| 4.4              |       | Indenture, dated as of  October 30, 2003, among the Company, the Guarantors (as defined therein)  and The Bank of New York, as trustee, relating to the Company’s 67¤8%  Senior Subordinated Notes due 2013 [Form 10-Q filed on  November 14, 2003, Exhibit 4.1]                                                                                                                                   |
| 4.5              |       | Form of Indenture, between DRS Technologies, Inc.  and The Bank of New York, as trustee, relating to Senior Debt Securities [Registration  Statement on Form S-3 ASR, File No. 333-130926, filed on  January 9, 2006, Exhibit 4.1]                                                                                                                                                                           |

133

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| 4.6  |   | First  Supplemental Indenture, dated as of January 31, 2006, among DRS  Technologies, Inc., the Guarantors (as defined therein) and The Bank of  New York, as trustee, relating to $350,000,000 aggregate principal amount of  65¤8%  Senior Notes due 2016. [Form 8-K filed on February 6, 2006,  Exhibit 4.1]          |
|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.7  |   | Form of Indenture between DRS Technologies, Inc. and The Bank of New  York, as trustee, relating to Subordinated Debt Securities [Registration  Statement on Form S-3 ASR, File No. 333-130926, filed on  January 9, 2006, Exhibit 4.2]                                                                                            |
| 4.8  |   | First Supplemental Indenture,  dated as of January 31, 2006, among DRS Technologies, Inc., the  Guarantors (as defined therein) and The Bank of New York, as trustee,  relating to $250,000,000 aggregate principal amount of 75¤8%  Senior Subordinated Notes due 2018. [Form 8-K filed  February 6, 2006, Exhibit 4.2] |
| 4.9  |   | Indenture, dated as of January 31,  2006, among DRS Technologies, Inc., the Guarantors (as defined therein)  and The Bank of New York, as trustee, relating to $300,000,000 aggregate  principal amount of 2.00% Convertible Senior Notes due 2026. [Form 8-K  filed February 6, 2006, Exhibit 4.3]                           |
| 4.10 |   | Registration Rights Agreement,  dated as of January 31, 2006, by and among DRS Technologies, Inc.  and the Initial Purchasers (as defined therein), relating to the $345,000,000  aggregate principal amount of 2.00% Convertible Senior Notes due 2026. [Form 8-K  filed February 6, 2006, Exhibit 4.4]                      |
| 10.1 |   | Amended and Restated 1996  Omnibus Plan [Registration Statement on Form S-4, File No. 333-112423,  filed on February 2, 2004, Exhibit 10.3]                                                                                                                                                                                        |
| 10.2 |   | Joint Venture Agreement, dated  as of November 3, 1993, by and between DRS Systems Management  Corporation and Laurel Technologies, Inc. [Form 10-Q, filed  on February 16, 1993, Exhibit 6(a)(3)]                                                                                                                       |
| 10.3 |   | Partnership Agreement dated  December 13, 1993, by and between DRS Systems Management  Corporation and Laurel Technologies, Inc. [Form 10-Q, filed  on February 16, 1993, Exhibit 6(a)(5)]                                                                                                                               |
| 10.4 |   | Waiver Letter dated as of  December 13, 1993, by and between DRS Systems Management  Corporation and Laurel Technologies, Inc. [Form 10-Q, filed  on February 16, 1993, Exhibit 6(a)(4)]                                                                                                                                 |
| 10.5 |   | Amendment to Partnership  Agreement of Laurel Technologies Partnership by and among Laurel  Technologies, Inc., now known as Sunburst Management Inc., and  DRS Systems Management Corporation, effective August 3, 1999. [Form 10-K,  filed on June 14, 2005, Exhibit 10.4]                                             |
| 10.6 |   | Employment, Non-Competition  and Termination Agreement, dated July 20, 1994, between  Diagnostic/Retrieval Systems, Inc. and David E. Gross [Form 10-Q,  filed on August 15, 1994, Exhibit 1]                                                                                                                            |
| 10.7 |   | Employment Agreement, dated as  of November 20, 1996, by and between the Company and Mark S. Newman  [Form 10-K filed on June 29, 1999, Exhibit 10.47]                                                                                                                                                                        |
| 10.8 |   | Amendment 1 to the Employment Agreement between DRS  Technologies, Inc. and Mark S. Newman, dated August 18, 2004.  [Form 10-Q filed on November 11, 2004, Exhibit 10.1]                                                                                                                                                 |

134

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| 10.9   |   | Amended and Restated Employment Agreement between  DRS Technologies Inc. and Mark S. Newman, executed June 10, 2005. [Form 10-K  filed on June 14, 2005, Exhibit 10.13]                                                                                                                                                                                                                                            |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.10  |   | Employment Agreement, dated as  of April 30, 1997, by and between the Company and Nina Laserson Dunn  [Form 10-K filed on June 29, 1999, Exhibit 10.48]                                                                                                                                                                                                                                                            |
| 10.11  |   | Amendment No. 1 to the  Employment Agreement between DRS Technologies, Inc. and Nina Laserson  Dunn, dated August 18, 2004. [Form 10-Q filed on  November 9, 2004, Exhibit 10.3]                                                                                                                                                                                                                         |
| 10.12  |   | Employment Agreement, dated as  of February 19, 1999, by and between the Company and Richard A.  Schneider [Form 10-K filed on June 29, 1999,  Exhibit 10.49]                                                                                                                                                                                                                                                      |
| 10.13  |   | Amendment No. 1 to the  Employment Agreement between DRS Technologies, Inc. and Richard A.  Schneider, dated August 18, 2004. [Form 10-Q filed on  November 9, 2004, Exhibit 10.5]                                                                                                                                                                                                                       |
| *10.14 |   | Amendment No. 2 to the  Employment Agreement between DRS Technologies, Inc. and Richard A.  Schneider, dated June 8, 2006.                                                                                                                                                                                                                                                                                              |
| 10.15  |   | Employment Agreement, dated as  of June 26, 2002, by and between the Company and Robert F. Mehmel  [Form 10-K filed on June 28, 2002, Exhibit 10.36]                                                                                                                                                                                                                                                          |
| 10.16  |   | Amendment No. 1 to the  Employment Agreement between DRS Technologies, Inc. and Robert F.  Mehmel, dated August 18, 2004. [Form 10-Q filed on  November 9, 2004, Exhibit 10.4]                                                                                                                                                                                                                      |
| 10.17  |   | Agreement and Plan of Merger,  among DRS Technologies, Inc., Maxco, Inc. and Engineered Support Systems, Inc.,  dated September 21, 2005 [Form 8-K filed on September 23, 2005,  Exhibit 2.1]                                                                                                                                                                                                       |
| 10.18  |   | Third Amended and Restated  Credit Agreement, dated as of January 31, 2006, by and among DRS  Technologies, Inc., the lenders party to the agreement and the lenders  who may become party to the agreement, Wachovia Bank, National Association,  Bear Stearns Corporate Lending Inc., and Bank of America, N.A., BNP Paribas  and Calyon, New York Branch. [Form 8-K filed February 6, 2006,  Exhibit 10.1] |
| *10.19 |   | Modification Number 1 to Amendment to Partnership  Agreement of Laurel Technologies Partnership, dated as of December 30,  2005, by and between Laurel Technologies, Inc., now known as Sunburst  Management, Inc., and DRS Systems Management Corporation                                                                                                                                                              |

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| *10.20 |   | Amendment No. 2 to the DRS  Technologies, Inc. Amended and Restated 1996 Omnibus Plan Effective  July 6, 2005.                                                              |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.21  |   | Amendment to  DRS Technologies, Inc. Amended and Restated 1996 Omnibus Incentive Plan  [Form 10-K filed on June 14, 2004, Exhibit 10.18]                               |
| 10.22  |   | Amended and Restated DRS Technologies, Inc.  Supplemental Executive Retirement Plan, Effective March 31, 2005.  [Form 10-K filed on June 15, 2005, Exhibit 10.27] |
| *21    |   | List of subsidiaries of the  Company, as of March 31, 2006                                                                                                                            |
| *23.1  |   | Consent of KPMG LLP                                                                                                                                                                        |
| *31.1  |   | Certification of Chief Executive  Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of  the Securities Exchange Act, as amended                                    |
| *31.2  |   | Certification of Chief Financial  Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of  the Securities Exchange Act, as amended                                    |
| *32.1  |   | Certification of CEO Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                             |
| *32.2  |   | Certification of CFO Pursuant to 18 U.S.C.  Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002                                             |

 

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