UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2005

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to             

 

Commission file number 1-8533


GRAPHIC

DRS Technologies, Inc.

(Exact name of registrant as specified in its charter)

Delaware

 

13-2632319

(State or other jurisdiction of

 

(IRS Employer Identification No.)

incorporation or organization)

 

 

 

5 Sylvan Way, Parsippany, New Jersey 07054

(Address of principal executive offices)

(973) 898-1500

(Registrant’s telephone number, including area code)


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

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

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

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

 




DRS TECHNOLOGIES, INC. AND SUBSIDIARIES
Index to Quarterly Report on Form 10-Q
For the Quarter Ended December 31, 2005

 

 

 

Page

 

 

PART I—FINANCIAL INFORMATION

 

 

Item 1.

 

Financial Statements (unaudited)

 

 

 

 

Consolidated Balance Sheets—December 31, 2005 and March 31, 2005

 

1

 

 

Consolidated Statements of Earnings—Three and Nine Months Ended December 31, 2005 and 2004

 

2

 

 

Consolidated Statements of Cash Flows—Nine Months Ended December 31, 2005 and 2004

 

3

 

 

Notes to the Consolidated Financial Statements

 

4

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations 

 

34

Item 3.

 

Quantitative and Qualitative Disclosure about Market Risk

 

50

Item 4.

 

Controls and Procedures

 

51

 

 

PART II—OTHER INFORMATION

 

 

Item 1.

 

Legal Proceedings

 

52

Item 6.

 

Exhibits

 

54

Signatures

 

55

 




PART I—FINANCIAL INFORMATION

Item 1.   Financial Statements

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

 

 

December 31,

 

March 31,

 

 

 

2005

 

2005

 

Assets

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

259,666

 

 

$

306,852

 

Accounts receivable, net of allowance for doubtful accounts of $1,964 and $2,659 as of December 31, 2005 and March 31, 2005, respectively

 

 

219,250

 

 

237,912

 

Inventories, net

 

 

251,343

 

 

208,141

 

Prepaid expenses, deferred income taxes and other current assets

 

 

53,061

 

 

42,134

 

Total current assets

 

 

783,320

 

 

795,039

 

Property, plant and equipment, less accumulated depreciation of $127,819 and $102,644 at December 31, 2005 and March 31, 2005, respectively

 

 

145,242

 

 

143,264

 

Acquired intangible assets, net

 

 

99,789

 

 

100,030

 

Goodwill

 

 

824,108

 

 

815,407

 

Other noncurrent assets

 

 

39,414

 

 

32,901

 

Total assets

 

 

$

1,891,873

 

 

$

1,886,641

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

Current installments of long-term debt (Note 7)

 

 

$

135,891

 

 

$

2,652

 

Accounts payable

 

 

140,641

 

 

111,222

 

Accrued expenses and other current liabilities

 

 

251,649

 

 

301,361

 

Total current liabilities

 

 

528,181

 

 

415,235

 

Long-term debt, excluding current installments (Note 7)

 

 

561,520

 

 

727,611

 

Other liabilities

 

 

64,157

 

 

72,367

 

Total liabilities

 

 

1,153,858

 

 

1,215,213

 

Commitments and contingencies (Notes 2, 7, 14 and 17)

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

Preferred stock, $10 par value per share. Authorized 2,000,000 shares; none issued at December 31, 2005 and March 31, 2005

 

 

 

 

 

Common Stock, $.01 par value per share. Authorized 50,000,000 shares; issued 28,080,523 and 27,472,495 shares at December 31, 2005 and March 31, 2005, respectively (Note 17)

 

 

281

 

 

275

 

Additional paid-in capital

 

 

489,210

 

 

467,027

 

Retained earnings

 

 

250,124

 

 

199,924

 

Accumulated other comprehensive earnings

 

 

6,340

 

 

6,198

 

Unamortized stock compensation

 

 

(7,940

)

 

(1,996

)

Total stockholders’ equity

 

 

738,015

 

 

671,428

 

Total liabilities and stockholders’ equity

 

 

$

1,891,873

 

 

$

1,886,641

 

 

See accompanying Notes to the Consolidated Financial Statements.

1




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

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

December 31,

 

December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

Revenues

 

$

389,490

 

$

338,232

 

$

1,089,879

 

$

947,436

 

Costs and expenses

 

344,663

 

298,983

 

971,417

 

845,881

 

Operating income

 

44,827

 

39,249

 

118,462

 

101,555

 

Interest income

 

2,283

 

389

 

6,228

 

687

 

Interest and related expenses

 

12,458

 

9,447

 

36,959

 

27,447

 

Other expense, net

 

134

 

303

 

446

 

455

 

Earnings from continuing operations before minority interest and income taxes

 

34,518

 

29,888

 

87,285

 

74,340

 

Minority interest

 

477

 

551

 

1,559

 

1,476

 

Earnings from continuing operations before income taxes

 

34,041

 

29,337

 

85,726

 

72,864

 

Income taxes

 

14,297

 

12,500

 

33,010

 

31,053

 

Earnings from continuing operations

 

19,744

 

16,837

 

52,716

 

41,811

 

Earnings from discontinued operations, net of income taxes

 

 

624

 

 

1,822

 

Net earnings

 

$

19,744

 

$

17,461

 

$

52,716

 

$

43,633

 

Net earnings per share of common stock:

 

 

 

 

 

 

 

 

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

0.71

 

$

0.62

 

$

1.91

 

$

1.55

 

Earnings from discontinued operations, net of income taxes

 

$

 

$

0.02

 

$

 

$

0.07

 

Net earnings

 

$

0.71

 

$

0.64

 

$

1.91

 

$

1.61

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

0.69

 

$

0.60

 

$

1.84

 

$

1.51

 

Earnings from discontinued operations, net of income taxes

 

$

 

$

0.02

 

$

 

$

0.07

 

Net earnings

 

$

0.69

 

$

0.62

 

$

1.84

 

$

1.57

 

Dividends per common share

 

$

0.03

 

$

 

$

0.09

 

$

 

 

See accompanying Notes to the Consolidated Financial Statements.

2




DRS TECHNOLOGIES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)

 

 

Nine Months Ended

 

 

 

December 31,

 

 

 

2005

 

2004

 

Cash Flows from Operating Activities

 

 

 

 

 

Earnings from continuing operations

 

$

52,716

 

$

41,811

 

Adjustments to reconcile earnings from continuing operations to cash flows from operating activities of continuing operations:

 

 

 

 

 

Depreciation and amortization

 

31,719

 

30,348

 

Stock-based compensation

 

1,895

 

923

 

Deferred income taxes

 

(500

)

(378

)

Inventory reserve and provision for doubtful accounts

 

766

 

2,925

 

Amortization and write-off of deferred financing fees

 

2,846

 

2,576

 

Other, net

 

(439

)

1,163

 

Changes in assets and liabilities, net of effects from business combinations:

 

 

 

 

 

Decrease (increase) in accounts receivable

 

22,844

 

(3,262

)

Increase in inventories

 

(37,053

)

(6,378

)

(Increase) decrease in prepaid expenses and other current assets

 

(3,453

)

1,422

 

Increase in accounts payable

 

27,365

 

16,318

 

(Decrease) increase in accrued expenses and other current liabilities

 

(30,876

)

832

 

Decrease in customer advances

 

(7,981

)

(4,520

)

Decrease (increase) in pension and postretirement benefit liabilities

 

347

 

(1,325

)

Other, net

 

(742

)

(1,107

)

Net cash provided by operating activities of continuing operations

 

59,454

 

81,348

 

Net cash provided by operating activities of discontinued operations

 

 

2,697

 

Net cash provided by operating activities

 

59,454

 

84,045

 

Cash Flows from Investing Activities

 

 

 

 

 

Capital expenditures

 

(26,311

)

(20,742

)

Payments pursuant to business combinations, net of cash acquired

 

(54,489

)

(45,141

)

Disposition of property, plant and equipment

 

946

 

825

 

Other, net

 

22

 

468

 

Net cash used in investing activities of continuing operations

 

(79,832

)

(64,590

)

Net cash used in investing activities of discontinued operations

 

 

(596

)

Net cash used in investing activities

 

(79,832

)

(65,186

)

Cash Flows from Financing Activities

 

 

 

 

 

Net borrowings of short-term debt

 

 

(82

)

Proceeds from senior subordinated notes, including advanced interest

 

 

211,986

 

Return of advanced interest on senior subordinated notes

 

(1,986

)

 

Debt issuance costs

 

(681

)

(3,745

)

Repayment of long-term debt

 

(32,037

)

(30,218

)

Proceeds from stock option exercises

 

9,750

 

3,316

 

Dividends paid

 

(2,508

)

 

Net cash (used in) provided by financing activities of continuing operations

 

(27,462

)

181,257

 

Net cash used in financing activities of discontinued operations

 

 

(23

)

Net cash (used in) provided by financing activities

 

(27,462

)

181,234

 

Effect of exchange rates on cash and cash equivalents

 

654

 

1,286

 

Net (decrease) increase in cash and cash equivalents

 

(47,186

)

201,379

 

Cash and cash equivalents, beginning of period

 

306,852

 

56,790

 

Cash and cash equivalents, end of period

 

$

259,666

 

$

258,169

 

 

See accompanying Notes to the Consolidated Financial Statements.

3




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

1.   Basis of Presentation

The accompanying unaudited Consolidated Financial Statements of DRS Technologies, Inc., its wholly-owned subsidiaries and a partnership of which DRS owns an 80% controlling interest (hereinafter, DRS or the Company) have been prepared in accordance with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of the Company, the interim consolidated financial information provided herein reflects all adjustments (consisting of normal and recurring adjustments) necessary for a fair presentation of the Company’s consolidated financial position as of December 31, 2005, the results of its operations for the three- and nine-month periods ended December 31, 2005 and 2004, and its cash flows for the nine-month periods ended December 31, 2005 and 2004. The results of operations for the three- and nine-month periods ended December 31, 2005 are not necessarily indicative of the results to be expected for the full year. Certain fiscal 2005 amounts have been reclassified to conform to the fiscal 2006 presentation. These interim Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements of the Company for the fiscal year ended March 31, 2005, included in the Company’s filing on Form 10-K for the year ended March 31, 2005.

ESSI Acquisition

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

Discontinued Operations

On March 10, 2005, the Company completed the sale of two of its operating units—DRS Weather Systems, Inc. (DRS Weather) and DRS Broadcast Technology (DRS Broadcast). The operating units were acquired in connection with the Company’s fiscal 2004 acquisition of Integrated Defense Technologies, Inc. (IDT). As a result of the divestiture, DRS Weather’s and DRS Broadcast’s results of operations for the three- and nine-month periods ended December 31, 2004 are included in the Consolidated Statement of Earnings as “Earnings from discontinued operations.” The cash flows of the discontinued operations also are presented separately in the Consolidated Statements of Cash Flows for the nine months ended December 31, 2004. All corresponding notes reflect the discontinued operations presentation.

A summary of the results of discontinued operations for the three- and nine-month periods ended December 31, 2004 follows:

 

 

Three Months Ended
December 31, 2004

 

Nine Months Ended
December 31, 2004

 

 

 

(in thousands)

 

Revenues

 

 

$

8,212

 

 

 

$

27,759

 

 

Earnings before taxes

 

 

$

1,030

 

 

 

$

3,020

 

 

Income tax expense

 

 

406

 

 

 

1,198

 

 

Earnings from discontinued operations

 

 

$

624

 

 

 

$

1,822

 

 

 

4




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

2.   Acquisitions

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

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

The Company is in the process of finalizing its assessment of certain acquired assets and liabilities; thus, the preliminary allocation of the purchase price may change. The Company recorded goodwill of $26.5 million, which has been allocated to the C4I Group. The Company recorded $1.9 million and $4.2 million of technology-based and customer-related intangibles, respectively, both of which have weighted average useful lives of 9 years. The Company will complete its purchase price allocation in the fourth quarter of fiscal 2006.

On June 27, 2005, DRS acquired WalkAbout Computer Systems Inc. (WalkAbout) in a stock purchase transaction for approximately $13.8 million in cash, with additional consideration payable of up to $5.0 million upon achievement of certain revenue targets for a period of two and a half years. In addition to the purchase price, the Company recorded $0.3 million for acquisition-related costs. The results of WalkAbout have been included in the Company’s financial statements since the date of acquisition.

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

The Company is in the process of reviewing a third-party valuation of certain WalkAbout acquired assets (including acquired intangible assets), as well as performing its own internal assessment of certain other acquired assets and liabilities; thus, the preliminary allocation of the purchase price will change. Based on preliminary purchase price allocations, the Company has estimated goodwill to be $12.5 million and has allocated the goodwill to the C4I Group. No amounts have been allocated to acquired intangible assets pending finalization of the third-party valuation, however such amounts are not expected to be significant. The Company will complete its purchase price allocation in the fourth quarter of fiscal 2006.

Unaudited pro forma financial information for the Codem and WalkAbout transactions discussed above is not presented because the effects of these acquisitions were not material on either an individual or aggregate basis.

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

5




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

component of DRS Infrared Technologies L.P.). The earn-out was recorded as an increase to goodwill during the fourth quarter of fiscal 2005, when it was assumed a payment was required. During the three months ended December 31, 2005, the Company recorded an earn-out of $4.6 million for its acquisition of Night Vision Equipment Co. Inc. and Excalibur Electro Optics, Inc. (collectively NVEC and Affiliate). The earn-out, which was recorded as an increase to goodwill, is expected to be paid in the fourth quarter of fiscal 2006.

3.   Stock-Based Compensation

The Company has one stock-based compensation plan, the 1996 Omnibus Plan (Omnibus Plan). Under the terms of the Omnibus Plan, stock options and restricted stock may be granted to key employees, directors and consultants of the Company. The Company accounts for stock options granted to employees and directors under the recognition and measurement principles of Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees” and related interpretations. Compensation expense for stock options granted to an employee or director is recognized in earnings based on the excess, if any, of the quoted market price of DRS common stock at the date of the grant, or other measurement date, over the amount an employee or director must pay to acquire the common stock. When the exercise price of the option granted to an employee or director equals or exceeds the quoted market price of DRS common stock at the date of grant, the Company does not recognize compensation expense. Compensation cost for restricted stock is recorded based on the quoted market price of DRS common stock on the date of grant.

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

6




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

The table below compares the “as reported” net earnings and earnings per share to the “pro forma” net earnings and earnings per share that the Company would have reported if it had elected to recognize compensation expense in accordance with the fair value-based method of accounting of SFAS No. 123. For purposes of determining the pro forma effects of SFAS No. 123, the estimated fair value of options granted was calculated using the Black-Scholes option pricing valuation model. Option forfeitures are accounted for as they occurred and no amounts of compensation expense have been capitalized into inventory or other assets, but instead are considered period expenses.

 

 

Three Months Ended
December 31,

 

Nine Months Ended
December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

(in thousands, except per-share data)

 

Net earnings, as reported

 

$

19,744

 

$

17,461

 

$

52,716

 

$

43,633

 

Add: Stock-based compensation expense included in reported net earnings, net of taxes

 

478

 

173

 

1,145

 

549

 

Less: Total stock-based compensation expense determined under fair-value-based method for all awards, net of taxes

 

(2,601

)

(1,426

)

(6,860

)

(3,897

)

Pro forma net earnings

 

$

17,621

 

$

16,208

 

$

47,001

 

$

40,285

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic—as reported

 

$

0.71

 

$

0.64

 

$

1.91

 

$

1.61

 

Basic—pro forma

 

$

0.63

 

$

0.60

 

$

1.70

 

$

1.49

 

Diluted—as reported

 

$

0.69

 

$

0.62

 

$

1.84

 

$

1.57

 

Diluted—pro forma

 

$

0.61

 

$

0.59

 

$

1.65

 

$

1.47

 

 

In December 2004, the Financial Accounting Standards Board  (FASB) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R), which replaces SFAS No. 123 and supercedes APB Opinion No. 25. SFAS No. 123R addresses the accounting for transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options and restricted stock grants and units, to be recognized as a compensation cost based on their fair values. The pro forma disclosures previously permitted under SFAS No. 123 no longer will be an alternative to financial statement recognition. Under SFAS No. 123R, the Company must determine the appropriate fair-value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include prospective and retroactive adoption options. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption of SFAS No. 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the first period restated. The Company is evaluating the requirements of SFAS No. 123R and expects that the adoption of SFAS No. 123R will have a material impact on the Company’s consolidated results of operations and earnings per share. The Company has not yet determined the method of adoption or the

7




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

effect of adopting SFAS No. 123R, and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS No. 123 included above.

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

In November 2005, the FASB issued FSP FAS123(R)-3, “Transition Election to Accounting for the Tax Effects of Share Based Payment Awards.” This FSP requires an entity to follow either the transition guidance for the additional paid-in capital pool as prescribed in SFAS No. 123R, or the alternative transition method as described in the FSP. An entity that adopts SFAS No. 123R using the modified prospective application may make a one-time election to adopt the transition method described in this FSP. An entity may take up to one year from the later of its initial adoption of SFAS No. 123R or the effective date of this FSP to evaluate its available transition alternatives and make its one-time election. This FSP became effective in November 2005. The Company is evaluating the impact of the adoption of this FSP in connection with its adoption of SFAS No. 123R.

4.   Inventories

Inventories are summarized as follows:

 

 

December 31,

 

March 31,

 

 

 

2005

 

2005

 

 

 

(in thousands)

 

Work-in-process

 

 

$

293,042

 

 

$

211,914

 

General and administrative costs

 

 

50,274

 

 

47,365

 

Raw material and finished goods

 

 

50,658

 

 

33,127

 

 

 

 

393,974

 

 

292,406

 

Less: Progress payments and certain customer advances

 

 

136,165

 

 

75,541

 

Inventory reserve

 

 

6,466

 

 

8,724

 

Total

 

 

$

251,343

 

 

$

208,141

 

 

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

8




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

The table below presents a summary of G&A, IRAD and 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 table below does not include the G&A, IRAD and B&P costs for the Company’s lines of businesses that are not primarily contracted with the U.S. government, which are expensed as incurred.

 

 

Three Months Ended
December 31,

 

Nine Months Ended
December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

(in thousands)

 

Balance beginning of period

 

$

50,813

 

$

43,307

 

$

47,365

 

$

37,854

 

Add: Incurred costs

 

57,697

 

50,729

 

162,970

 

150,068

 

Less: Amounts included in costs and expenses

 

(58,236

)

(50,856

)

(160,061

)

(144,742

)

Balance in inventory at December 31,

 

$

50,274

 

$

43,180

 

$

50,274

 

$

43,180

 

 

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

5.   Goodwill and Intangible Assets

The following disclosure presents certain information regarding the Company’s acquired intangible assets as of December 31, 2005 and March 31, 2005. All acquired intangible assets are being amortized over their estimated useful lives, as indicated below, with no estimated residual values.

Acquired Intangible Assets

 

 

 

Weighted
Average
Amortization
Period

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net Balance

 

 

 

(in thousands)

 

As of December 31, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Technology-based intangibles

 

 

18 years

 

 

$

47,861

 

 

$

(13,360

)

 

 

$

34,501

 

 

Customer-related intangibles

 

 

17 years

 

 

79,790

 

 

(14,502

)

 

 

65,288

 

 

Total

 

 

 

 

 

$

127,651

 

 

$

(27,862

)

 

 

$

99,789

 

 

As of March 31, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Technology-based intangibles

 

 

19 years

 

 

$

45,961

 

 

$

(11,172

)

 

 

$

34,789

 

 

Customer-related intangibles

 

 

17 years

 

 

75,590

 

 

(10,349

)

 

 

65,241

 

 

Total

 

 

 

 

 

$

121,551

 

 

$

(21,521

)

 

 

$

100,030

 

 

 

The aggregate acquired intangible asset amortization expense for the three-month periods ended December 31, 2005 and 2004 was $2.2 million and $1.7 million, respectively, and for the nine-month periods ended December 31, 2005 and 2004 was $6.3 million and $5.0 million, respectively. The estimated acquired intangible amortization expense, based on gross carrying amounts at December 31, 2005, is estimated to be $2.2 million for the remainder of fiscal 2006, $8.5 million per year for fiscal 2007 through fiscal 2009, $8.3 million for fiscal 2010 and $7.7 million for fiscal 2011.

9




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

The table below reconciles the change in the carrying amount of goodwill by operating segment for the period from March 31, 2005 to December 31, 2005.

 

 

C4I
Group

 

SR
Group

 

Total

 

 

 

(in thousands)

 

Balance as of March 31, 2005

 

$

447,631

 

$

367,776

 

$

815,407

 

Codem acquisition

 

26,481

 

 

26,481

 

WalkAbout acquisition

 

12,507

 

 

12,507

 

Deferred tax adjustments related to prior acquisitions(A)

 

(9,460

)

(24,219

)

(33,679

)

Accrued acquisition earn-out, Night Vision Equipment Company

 

 

4,564

 

4,564

 

Expiration of unexercised contract options relating to the IDT acquisition

 

 

(566

)

(566

)

Other Adjustments

 

94

 

(328

)

(234

)

Foreign currency translation adjustment

 

(372

)

 

(372

)

Balance as of December 31, 2005

 

$

476,881

 

$

347,227

 

$

824,108

 


(A)       The Company operates in multiple taxing jurisdictions, both within the United States and outside the United States, and faces audits from these various tax authorities regarding the amount of taxes due. Such audits can involve complex issues and may require an 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 predominately due to the resolution of the IRS’s examination of the 1999-2001 tax years. Also in connection with the resolution of the 1999-2001 tax audits, the Company adjusted certain acquired deferred tax assets and liabilities and certain other pre-acquisition related tax amounts, totaling $33.7 million, with a corresponding net decrease to goodwill.

6.   Product Warranties

Product warranty costs are accrued when the covered products are delivered to the customer. Product warranty expense is recognized based on the terms of the product warranty and the related estimated costs, considering historical claims expense. Accrued warranty costs are reduced as these costs are incurred and as the warranty period expires, and may be otherwise modified as specific product performance issues are identified and resolved. The table below presents the changes in the Company’s accrual for product warranties for the nine months ended December 31, 2005 and 2004, which are included in accrued expenses and other current liabilities.

 

 

Nine Months Ended
December 31,

 

 

 

2005

 

2004

 

 

 

(in thousands)

 

Balance at March 31,

 

$

21,839

 

$

23,279

 

Acquisitions during the period

 

360

 

25

 

Accruals for product warranties issued during the period

 

6,853

 

5,695

 

Settlements made during the period

 

(9,388

)

(5,657

)

Other

 

31

 

179

 

Balance at December 31,

 

$

19,695

 

$

23,521

 

 

10




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

7.   Debt

 

 

December 31,
2005

 

March 31,
2005

 

 

 

(in thousands)

 

Senior subordinated notes, including bond premium of $8,868 and $9,716 at December 31, 2005 and March 31, 2005, respectively

 

 

$

558,868

 

 

$

559,716

 

Term loan

 

 

135,690

 

 

167,460

 

Other obligations

 

 

2,853

 

 

3,087

 

 

 

 

697,411

 

 

730,263

 

Less:

 

 

 

 

 

 

 

Current installments of long-term debt

 

 

135,891

 

 

2,652

 

Total long-term debt

 

 

$

561,520

 

 

$

727,611

 

 

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

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

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

At December 31, 2005, the Company had a $411.0 million credit facility (the Credit Facility), consisting of a $175.0 million senior secured revolving line of credit and a $236.0 million senior secured term loan. As of December 31, 2005 and March 31, 2005, the Company had $135.7 million and $167.5 million, respectively, of term loans outstanding against the Credit Facility. The Credit Facility was guaranteed by substantially all of DRS’s domestic subsidiaries. In addition, it is collateralized by liens on substantially all of the assets of the Company’s subsidiary guarantors and certain of DRS’s other subsidiaries’ assets and by a pledge of certain of the Company’s non-guarantor subsidiaries’ capital stock. The term loan and the revolving credit facility would have matured on November 2010 and November 2008, respectively. The weighted average interest rate on the Company’s term loans was 5.9% as

11




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

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

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

From time to time, the Company enters into standby letters-of-credit and bank guarantee agreements with financial institutions and customers, primarily relating to the guarantee of its future performance on certain contracts to provide products and services and to secure advance payments it has received from its customers. As of December 31, 2005, an aggregate of $36.8 million was contingently payable under letters of credit and bank guarantees. Approximately $0.9 million and $0.4 million in letters of credit and bank guarantees, respectively, as of December 31, 2005 were issued outside of the Credit Facility and by a bank agreement for the Company’s U.K. subsidiary, respectively, that are not considered when determining the availability under the Company’s revolving line of credit.

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

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

12




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

8.   Earnings per Share

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

 

 

Three Months Ended
December 31,

 

Nine Months Ended
December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

(in thousands, except per-share data)

 

Basic EPS computation

 

 

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

19,744

 

$

16,837

 

$

52,716

 

$

41,811

 

Earnings from discontinued operations, net of income taxes

 

 

624

 

 

1,822

 

Net earnings

 

$

19,744

 

$

17,461

 

$

52,716

 

$

43,633

 

Weighted average common shares outstanding

 

27,778

 

27,116

 

27,645

 

27,042

 

Basic earnings per share

 

 

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

0.71

 

$

0.62

 

$

1.91

 

$

1.55

 

Earnings from discontinued operations, net of income taxes 

 

$

 

$

0.02

 

$

 

$

0.07

 

Net earnings

 

$

0.71

 

$

0.64

 

$

1.91

 

$

1.61

 

Diluted EPS computation

 

 

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

19,744

 

$

16,837

 

$

52,716

 

$

41,811

 

Earnings from discontinued operations, net of income taxes

 

 

624

 

 

1,822

 

Net earnings

 

$

19,744

 

$

17,461

 

$

52,716

 

$

43,633

 

Diluted common shares outstanding

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

27,778

 

27,116

 

27,645

 

27,042

 

Stock options and restricted stock

 

942

 

846

 

951

 

688

 

Diluted common shares outstanding

 

28,720

 

27,962

 

28,596

 

27,730

 

Diluted earnings per share

 

 

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

0.69

 

$

0.60

 

$

1.84

 

$

1.51

 

Earnings from discontinued operations, net of income taxes

 

$

 

$

0.02

 

$

 

$

0.07

 

Net earnings

 

$

0.69

 

$

0.62

 

$

1.84

 

$

1.57

 

 

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

13




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

9.   Comprehensive earnings

The components of comprehensive earnings for the three- and nine-month periods ended December 31, 2005 and 2004 consisted of the following:

 

 

Three Months Ended
December 31,

 

Nine Months Ended
December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

(in thousands)

 

Net earnings

 

$

19,744

 

$

17,461

 

$

52,716

 

$

43,633

 

Other comprehensive earnings:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(562

)

2,969

 

283

 

3,831

 

Unrealized net gains on hedging instruments arising during the period, net of income tax

 

 

187

 

 

789

 

Amortization of unrealized gain on terminated instruments, net of income taxes

 

(49

)

 

(141

)

 

Comprehensive earnings

 

$

19,133

 

$

20,617

 

$

52,858

 

$

48,253

 

 

10.   Pensions and Other Employee Benefits

The following table summarizes the components of net periodic benefit cost for the Company’s pension and postretirement benefit plans for the three- and nine-month periods ended December 31, 2005 and 2004. These plans are more fully described in Note 12 to the Company’s Consolidated Financial Statements for the year ended March 31, 2005.

 

 

 

 

 

 

Unfunded

 

 

 

Funded

 

Postretirement

 

Supplemental

 

 

 

Pension Plans

 

Benefit Plans

 

Retirement Plans

 

 

 

Three Months Ended December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

2005

 

2004

 

 

 

(in thousands)

 

Service cost

 

$

988

 

$

961

 

$

150

 

$

134

 

136

 

$

104

 

Interest cost

 

1,511

 

1,455

 

  241

 

238

 

279

 

241

 

Expected return on plan assets

 

(1,769

)

(1,600

)

   (42

)

(23

)

 

 

Amortization of unrecognized loss (gain)

 

43

 

32

 

(2

)

23

 

42

 

1

 

Amortization of transition obligation

 

 

 

27

 

9

 

 

 

Amortization of unrecognized prior-service cost

 

1

 

1

 

 

 

194

 

194

 

Net periodic benefit cost

 

$

774

 

$

849

 

$

374

 

$

381

 

$

651

 

$

540

 

 

 

14




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

 

 

 

 

 

 

 

Unfunded

 

 

 

Funded

 

Postretirement

 

Supplemental

 

 

 

Pension Plans

 

Benefit Plans

 

Retirement Plans

 

 

 

Nine Months Ended December 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

2005

 

2004

 

 

 

(in thousands)

 

Service cost

 

$

2,964

 

$

2,883

 

$

450

 

$

402

 

$

408

 

$

312

 

Interest cost

 

4,533

 

4,365

 

723

 

714

 

837

 

723

 

Expected return on plan assets

 

(5,307

)

(4,800

)

(126

)

(69

)

 

 

Amortization of unrecognized loss (gain)

 

129

 

96

 

(6

)

69

 

126

 

3

 

Amortization of transition obligation

 

 

 

81

 

27

 

 

 

Amortization of unrecognized prior-service cost

 

3

 

3

 

 

 

582

 

582

 

Net periodic benefit cost

 

$

2,322

 

$

2,547

 

$

1,122

 

$

1,143

 

$

1,953

 

$

1,620

 

 

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

11.   Operating Segments

At December 31, 2005, the Company had two principal operating segments, on the basis of products and services offered: the Command, Control, Communications, Computers and Intelligence (C4I) Group and the Surveillance and Reconnaissance (SR) Group. All other operations are grouped in Other.

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

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

15




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

Other includes the activities of DRS Corporate Headquarters and certain non-operating subsidiaries of the Company. Information about the Company’s operating segments for the three- and nine-month periods ended December 31, 2005 and 2004 is as follows:

 

 

C4I Group

 

SR Group

 

Other

 

Total

 

 

 

(in thousands)

 

Three Months Ended December 31, 2005

 

 

 

 

 

 

 

 

 

Total revenues

 

$

203,977

 

$

187,218

 

$

 

$

391,195

 

Intersegment revenues

 

(1,062

)

(643

)

 

(1,705

)

External revenues

 

$

202,915

 

$

186,575

 

$

 

$

389,490

 

Operating income (loss)

 

$

23,866

 

$

20,979

 

$

(18

)

$

44,827

 

Total assets

 

$

844,775

 

$

730,323

 

$

316,775

 

$

1,891,873

 

Depreciation and amortization

 

$

3,725

 

$

5,981

 

$

1,072

 

$

10,778

 

Capital expenditures

 

$

2,186

 

$

6,020

 

$

1,851

 

$

10,057

 

Three Months Ended December 31, 2004

 

 

 

 

 

 

 

 

 

Total revenues

 

$

189,589

 

$

151,745

 

$

 

$

341,334

 

Intersegment revenues

 

(556

)

(2,546

)

 

(3,102

)

External revenues

 

$

189,033

 

$

149,199

 

$

 

$

338,232

 

Operating income (loss)

 

$

23,095

 

$

16,173

 

$

(19

)

$

39,249

 

Assets of continuing operations

 

$

778,182

 

$

748,782

 

$

276,619

 

$

1,803,583

 

Depreciation and amortization

 

$

3,145

 

$

5,831

 

$

725

 

$

9,701

 

Capital expenditures

 

$

3,033

 

$

3,431

 

$

698

 

$

7,162

 

Nine Months Ended December 31, 2005

 

 

 

 

 

 

 

 

 

Total revenues

 

$

589,855

 

$

503,499

 

$

 

$

1,093,354

 

Intersegment revenues

 

(2,030

)

(1,445

)

 

(3,475

)

External revenues

 

$

587,825

 

$

502,054

 

$

 

$

1,089,879

 

Operating income (loss)

 

$

63,072

 

$

57,844

 

$

(2,454

)

$

118,462

 

Total assets

 

$

844,775

 

$

730,323

 

$

316,775

 

$

1,891,873

 

Depreciation and amortization

 

$

10,817

 

$

17,971

 

$

2,931

 

$

31,719

 

Capital expenditures

 

$

8,059

 

$

14,130

 

$

4,122

 

$

26,311

 

Nine Months Ended December 31, 2004

 

 

 

 

 

 

 

 

 

Total revenues

 

$

517,207

 

$

438,631

 

$

 

$

955,838

 

Intersegment revenues

 

(1,466

)

(6,936

)

 

(8,402

)

External revenues

 

$

515,741

 

$

431,695

 

$

 

$

947,436

 

Operating income (loss)

 

$

55,772

 

$

45,888

 

$

(105

)

$

101,555

 

Assets of continuing operations

 

$

778,182

 

$

748,782

 

$

276,619

 

$

1,803,583

 

Depreciation and amortization

 

$

9,591

 

$

18,721

 

$

2,036

 

$

30,348

 

Capital expenditures

 

$

6,993

 

$

11,799

 

$

1,950

 

$

20,742

 

 

16




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

The table below provides a reconciliation of total consolidated assets to total assets of continuing operations presented above:

 

 

December 31,

 

 

 

2004

 

 

 

(in thousands)

 

Assets of continuing operations

 

 

$

1,803,583

 

 

Assets of discontinued operations

 

 

38,864

 

 

Total assets

 

 

$

1,842,447

 

 

 

12.   Supplemental Cash Flow Information

 

 

Nine Months Ended
December 31,

 

 

 

2005

 

2004

 

 

 

(in thousands)

 

Cash paid for:

 

 

 

 

 

Income taxes

 

$

35,624

 

$

7,271

 

Interest

 

$

43,038

*

$

30,523

 

Supplemental disclosure of significant non-cash investing and financing activities:

 

 

 

 

 

Acquisition costs for business combinations, net

 

$

11,848

 

$

4,946

 


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

13.   Cash Dividends on DRS Common Stock

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

14.   Contingencies and Related Party Transactions

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

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

17




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

accruals should not materially affect the Company’s financial condition or liquidity. It is possible, however, that the ultimate resolution of those matters could result in a material adverse effect on the Company’s results of operations for a particular reporting period.

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

Some environmental laws, such as the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (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 sites upon any of the current or former site owners or operators (or upon parties who send waste to these sites), regardless of the lawfulness of the original activities that led to the contamination. In July 2000, prior to its acquisition by IDT, and prior to DRS’s acquisition of IDT, Tech-Sym Corporation received a Section 104(e) Request for Information from the National Park Service (NPS), pursuant to CERCLA, regarding a site known as the Orphan Mine site in the Grand Canyon National Park, Arizona, which is the subject of an NPS investigation regarding the presence of residual radioactive materials and contamination. A corporation of which Tech-Sym is an alleged successor operated this uranium mine from 1956 to 1967. In 1962, the land was sold to the U.S. government and the alleged predecessor of Tech-Sym was given a 25-year mining lease.  In 1967, the mining rights were transferred to a third party by a trustee in bankruptcy, and the Company believes that the mine was operated by such third party until approximately 1969. The Company understands that there are other companies in the chain of title to the mining rights subsequent to Tech-Sym’s alleged predecessor, and, accordingly, that there are other potentially responsible parties (PRPs) for the environmental conditions at the site, including the U.S. government as owner, operator and arranger at the site. During its period of ownership, IDT retained a technical consultant in connection with this matter, who conducted a limited, preliminary review of site conditions and communicated with the NPS regarding actions that may be required at the site by all of the PRPs. The initial remediation estimate for the CERCLA related cleanup of the Operable Unit 1 (the upper mine area) site was $0.8 million and a second, independent evaluation estimated remediation costs at $1.0 million. On February 6, 2005, the NPS sent the Company an Engineering Evaluation/Cost Analysis Work Plan under CERCLA (the ‘‘CERCLA Letter’’) with regards to Operable Unit 1 of the Orphan Mine site. In the Company’s view, this Work Plan included additional cleanup not covered by CERCLA. The CERCLA Letter also requested (a) payment of $0.5 million for costs incurred by the NPS related to the Orphan Mine, and (b) a ‘‘good faith offer’’ to conduct the response activity outlined by the NPS and to reimburse the NPS for future costs. The NPS advised that a similar letter has been sent to another PRP. The Company initiated discussions with the other PRP and with NPS, and engaged a technical consultant to evaluate the existing documentation and the site in depth.   As a result, on September 29, 2005, the technical consultant submitted to the NPS, on behalf of the

18




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

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

On December 6, 2005 the PRPs and NPS met to discuss the alternative EE/CA. The meeting focused on the technical merits of the alternative EE/CA and certain differences between the alternative EE/CA and the NPS EE/CA provided with the CERCLA Letter. The differences included an alternative sampling technique and the inclusion of Operable Unit 2 (the lower mine area) in the EE/CA. In addition, certain legal issues relating to the process for implementing an agreed upon EE/CA were discussed. It is anticipated that further meetings will be held between the PRPs and NPS early in 2006. The potential liability can change substantially due to such factors as additional information on the nature or extent of contamination, methods of remediation required, changes in the apportionment of costs among the responsible parties and other actions by governmental agencies or private parties.

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

Related Party Transactions   The Company currently leases a building in Oakland, New Jersey, owned by LDR Realty Co., a partnership that was wholly owned in equal amounts by David E. Gross, DRS’s cofounder and the former President and Chief Technical Officer, and the late Leonard Newman, DRS’s cofounder, the former Chairman of the Board, Chief Executive Officer, and Secretary and the father of Mark S. Newman, the Company’s current Chairman of the Board, President and Chief Executive Officer. The lease agreement with a monthly rental of $21.2 thousand expires on April 30, 2007. Following Leonard Newman’s death in November 1998, Mrs. Ruth Newman, the wife of Leonard Newman and the mother of Mark S. Newman, succeeded to Leonard Newman’s interest in LDR Realty Co.

Skadden, Arps, Slate, Meagher & Flom LLP, a law firm to which a member of our Board is of counsel, provided legal services to DRS during the nine months ended December 31, 2005 and 2004. Fees paid to Skadden, Arps, Slate, Meagher & Flom LLP for the nine months ended December 31, 2005 and 2004 were $2.2 million and $0.7 million, respectively.

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

15.   Guarantor and Non-Guarantor Financial Statements

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

19




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

and severally, by the Company’s wholly-owned domestic subsidiaries (the Guarantor Subsidiaries). The foreign subsidiaries and certain domestic subsidiaries of DRS (the Non-Guarantor Subsidiaries) do not guarantee the Notes. The following condensed consolidating financial information presents the Condensed Consolidating Balance Sheets, as of December 31, 2005 and March 31, 2005, the Condensed Consolidating Statements of Earnings for the three- and nine-month periods ended December 31, 2005 and 2004, and the Condensed Consolidating Statements of Cash Flows for the nine months ended December 31, 2005 and 2004 for:

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

b)              the Guarantor Subsidiaries,

c)               the Non-guarantor Subsidiaries, and

d)              DRS Technologies, Inc. on a consolidated basis

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

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

20




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

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

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

241,077

 

$

(398

)

 

$

18,987

 

 

$

 

 

$

259,666

 

 

Accounts receivable, net

 

4

 

195,633

 

 

23,613

 

 

 

 

219,250

 

 

Inventories, net

 

 

208,485

 

 

42,885

 

 

(27

)

 

251,343

 

 

Prepaid expenses and other current assets

 

5,221

 

48,302

 

 

1,768

 

 

(2,230

)

 

53,061

 

 

Intercompany receivables

 

753,266

 

 

 

23,926

 

 

(777,192

)

 

 

 

Total current assets

 

999,568

 

452,022

 

 

111,179

 

 

(779,449

)

 

783,320

 

 

Property, plant and equipment, net

 

13,266

 

126,245

 

 

5,731

 

 

 

 

145,242

 

 

Acquired intangibles, net

 

 

99,789

 

 

 

 

 

 

99,789

 

 

Goodwill

 

23,926

 

777,190

 

 

22,992

 

 

 

 

824,108

 

 

Deferred income taxes and other noncurrent assets

 

36,906

 

4,541

 

 

2,382

 

 

(4,415

)

 

39,414

 

 

Investment in subsidiaries

 

403,911

 

49,635

 

 

 

 

(453,546

)

 

 

 

Total assets

 

$

1,477,577

 

$

1,509,422

 

 

$

142,284

 

 

$

(1,237,410

)

 

$

1,891,873

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt 

 

$

135,690

 

$

201

 

 

$

 

 

$

 

 

$

135,891

 

 

Accounts payable

 

5,896

 

115,932

 

 

18,813

 

 

 

 

140,641

 

 

Accrued expenses and other current liabilities

 

28,456

 

205,163

 

 

20,269

 

 

(2,239

)

 

251,649

 

 

Intercompany payables

 

 

476,744

 

 

12,627

 

 

(489,371

)

 

 

 

Total current liabilities

 

170,042

 

798,040

 

 

51,709

 

 

(491,610

)

 

528,181

 

 

Long-term debt, excluding current installments

 

558,868

 

2,652

 

 

 

 

 

 

561,520

 

 

Other liabilities

 

10,652

 

45,282

 

 

12,638

 

 

(4,415

)

 

64,157

 

 

Total liabilities

 

739,562

 

845,974

 

 

64,347

 

 

(496,025

)

 

1,153,858

 

 

Total stockholders’ equity

 

738,015

 

663,448

 

 

77,937

 

 

(741,385

)

 

738,015

 

 

Total liabilities and stockholders’ equity

 

$

1,477,577

 

$

1,509,422

 

 

$

142,284

 

 

$

(1,237,410

)

 

$

1,891,873

 

 

 

21




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

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

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

300,788

 

$

(8,272

)

 

$

14,336

 

 

$

 

 

$

306,852

 

 

Accounts receivable, net

 

5

 

202,516

 

 

35,391

 

 

 

 

237,912

 

 

Inventories, net

 

 

165,036

 

 

43,105

 

 

 

 

208,141

 

 

Prepaid expenses and other current assets

 

4,645

 

35,180

 

 

2,309

 

 

 

 

42,134

 

 

Intercompany receivables

 

667,987

 

23,269

 

 

49,876

 

 

(741,132

)

 

 

 

Total current assets

 

973,425

 

417,729

 

 

145,017

 

 

(741,132

)

 

795,039

 

 

Property, plant and equipment, net

 

12,073

 

125,422

 

 

5,769

 

 

 

 

143,264

 

 

Acquired intangibles, net

 

 

100,030

 

 

 

 

 

 

100,030

 

 

Goodwill

 

24,093

 

768,303

 

 

23,011

 

 

 

 

815,407

 

 

Deferred income taxes and other noncurrent assets

 

30,068

 

3,803

 

 

1,679

 

 

(2,649

)

 

32,901

 

 

Investment in subsidiaries

 

397,168

 

49,635

 

 

 

 

(446,803

)

 

 

 

Total assets

 

$

1,436,827

 

$

1,464,922

 

 

$

175,476

 

 

$

(1,190,584

)

 

$

1,886,641

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt 

 

$

2,360

 

$

292

 

 

$

 

 

$

 

 

$

2,652

 

 

Accounts payable

 

3,146

 

85,922

 

 

22,154

 

 

 

 

111,222

 

 

Accrued expenses and other current liabilities

 

26,109

 

257,028

 

 

18,193

 

 

31

 

 

301,361

 

 

Intercompany payables

 

 

465,948

 

 

46,772

 

 

(512,720

)

 

 

 

Total current liabilities

 

31,615

 

809,190

 

 

87,119

 

 

(512,689

)

 

415,235

 

 

Long-term debt, excluding current installments

 

724,817

 

2,794

 

 

 

 

 

 

727,611

 

 

Other liabilities

 

8,967

 

51,916

 

 

14,131

 

 

(2,647

)

 

72,367

 

 

Total liabilities

 

765,399

 

863,900

 

 

101,250

 

 

(515,336

)

 

1,215,213

 

 

Total stockholders’ equity

 

671,428

 

601,022

 

 

74,226

 

 

(675,248

)

 

671,428

 

 

Total liabilities and stockholders’ equity

 

$

1,436,827

 

$

1,464,922

 

 

$

175,476

 

 

$

(1,190,584

)

 

$

1,886,641

 

 

 

22




DRS TECHNOLOGIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial