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 June 30, 2007

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
incorporation or organization)

 

(IRS Employer
Identification No.)

 

5 Sylvan Way, Parsippany, New Jersey 07054

(Address of principal executive offices)

(973) 898-1500

(Registrant’s telephone number, including area code)

 


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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated filer x

Accelerated Filer o

Non-accelerated filer o

 

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class

 

Outstanding at August 6, 2007

Common Stock—$0.01 par value

 

41,116,298

 

 




DRS TECHNOLOGIES, INC. AND SUBSIDIARIES

Index to Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2007

 

 

 

Page

 

 

PART I—FINANCIAL INFORMATION

 

 

Item 1.

 

Financial Statements (unaudited)

 

 

 

 

 

Consolidated Balance Sheets—June 30, 2007 and March 31, 2007

 

1

 

 

 

Consolidated Statements of Earnings—Three Months Ended June 30, 2007 and
2006

 

2

 

 

 

Consolidated Statements of Cash Flows—Three Months Ended June 30, 2007 and 2006

 

3

 

 

 

Notes to the Consolidated Financial Statements

 

4

 

Item 2.

 

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

 

29

 

Item 3.

 

Quantitative and Qualitative Disclosure about Market Risk

 

40

 

Item 4.

 

Controls and Procedures

 

40

 

 

 

PART II—OTHER INFORMATION

 

 

 

Item 1.

 

Legal Proceedings

 

41

 

Item 1A.

 

Risk Factors

 

43

 

Item 6.

 

Exhibits

 

44

 

Signatures

 

45

 

 




PART I—FINANCIAL INFORMATION

Item 1.                        Financial Statements

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

 

 

June 30,

 

March 31,

 

 

 

2007

 

2007

 

Assets

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

34,113

 

$

95,833

 

Accounts receivable, net of allowance for doubtful accounts of $1,809 and $1,703 as of June 30, 2007 and March 31, 2007, respectively

 

515,782

 

535,242

 

Inventories, net

 

355,737

 

367,612

 

Prepaid expenses, deferred income taxes and other current assets

 

123,767

 

126,975

 

Total current assets

 

1,029,399

 

1,125,662

 

Property, plant and equipment, less accumulated depreciation of $191,000 and $178,241 at June 30, 2007 and March 31, 2007, respectively

 

233,919

 

231,206

 

Acquired intangible assets, net

 

189,709

 

196,984

 

Goodwill

 

2,621,945

 

2,616,642

 

Deferred income taxes and other noncurrent assets

 

44,199

 

44,216

 

Total assets

 

$

4,119,171

 

$

4,214,710

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities

 

 

 

 

 

Current installments of long-term debt

 

$

5,353

 

$

5,161

 

Accounts payable

 

238,029

 

297,427

 

Accrued expenses and other current liabilities

 

468,836

 

467,944

 

Total current liabilities

 

712,218

 

770,532

 

Long-term debt, excluding current installments

 

1,732,102

 

1,783,046

 

Other liabilities

 

161,113

 

158,682

 

Total liabilities

 

2,605,433

 

2,712,260

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Preferred stock, $10 par value per share. Authorized 2,000,000 shares; none issued at June 30, 2007 and March 31, 2007

 

 

 

Common Stock, $.01 par value per share. Authorized 100,000,000 shares; 41,081,214 and 40,673,944 shares issued at June 30, 2007 and March 31, 2007, respectively

 

411

 

407

 

Additional paid-in capital

 

1,107,487

 

1,099,991

 

Retained earnings

 

400,211

 

399,793

 

Accumulated other comprehensive earnings

 

5,629

 

2,259

 

Total stockholders’ equity

 

1,513,738

 

1,502,450

 

Total liabilities and stockholders’ equity

 

$

4,119,171

 

$

4,214,710

 

 

See Accompanying Notes to Consolidated Financial Statements.

1




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

 

 

Three Months Ended
June 30,

 

 

 

2007

 

2006

 

Revenue:

 

 

 

 

 

Products

 

$

532,774

 

$

475,891

 

Services

 

202,856

 

154,374

 

Total revenues

 

735,630

 

630,265

 

Costs and expenses

 

704,296

 

565,280

 

Operating income

 

31,334

 

64,985

 

Interest income

 

559

 

176

 

Interest and related expenses

 

28,710

 

29,902

 

Other expense, net

 

70

 

18

 

Earnings before non-controlling interests and income taxes

 

3,113

 

35,241

 

Non-controlling interests

 

493

 

473

 

Earnings before income taxes

 

2,620

 

34,768

 

Income taxes

 

970

 

13,510

 

Net earnings

 

$

1,650

 

$

21,258

 

Net earnings per share of common stock:

 

 

 

 

 

Basic earnings per share:

 

$

0.04

 

$

0.54

 

Diluted earnings per share:

 

$

0.04

 

$

0.52

 

Dividends per common share

 

$

0.03

 

$

0.03

 

 

See Accompanying Notes to Consolidated Financial Statements.

2




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

 

 

Three Months Ended

 

 

 

June 30,

 

 

 

2007

 

2006

 

Cash Flows from Operating Activities

 

 

 

 

 

Net Earnings

 

$

1,650

 

$

21,258

 

Adjustments to reconcile net earnings to cash flows provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

18,513

 

19,125

 

Share-based compensation

 

2,228

 

2,774

 

Deferred income taxes

 

(926

)

460

 

Inventory write-off

 

36,844

 

 

Inventory reserve and provision for doubtful accounts

 

202

 

1,000

 

Amortization and write-off of deferred financing fees

 

1,623

 

1,473

 

Other, net

 

(85

)

(234

)

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

 

 

 

 

 

Decrease (increase) in accounts receivable

 

20,409

 

(20,861

)

Increase in inventories

 

(23,470

)

(11,275

)

Decrease (increase) in prepaid expenses and other current assets

 

4,151

 

(6,285

)

Decrease in accounts payable

 

(59,246

)

(30,928

)

Decrease in accrued expenses and other current liabilities

 

(14,795

)

(11,579

)

Increase in customer advances

 

14,862

 

9,550

 

(Decrease) increase in pension and postretirement benefit liabilities

 

(1,252

)

53

 

Other, net

 

(181

)

(473

)

Net cash provided by (used in) operating activities

 

527

 

(25,942

)

Cash Flows from Investing Activities

 

 

 

 

 

Capital expenditures

 

(13,893

)

(13,080

)

Payments pursuant to business combinations, net of cash acquired

 

 

(7,688

)

Other, net

 

4

 

84

 

Net cash used in investing activities

 

(13,889

)

(20,684

)

Cash Flows from Financing Activities

 

 

 

 

 

Borrowings on revolving line of credit

 

90,000

 

 

Repayment of revolving line of credit

 

(90,000

)

 

Net borrowings of short-term debt

 

 

918

 

Borrowings of long-term debt

 

 

89,467

 

Repayments of long-term debt

 

(51,317

)

(783

)

Excess tax benefit realized from share-based payment arrangements

 

1,413

 

84

 

Proceeds from stock option exercises

 

2,664

 

873

 

Dividends paid

 

(1,213

)

(1,191

)

Other

 

3

 

 

Net cash (used in) provided by financing activities

 

(48,450

)

89,368

 

Effect of exchange rates on cash and cash equivalents

 

92

 

(253

)

Net (decrease) increase in cash and cash equivalents

 

(61,720

)

42,489

 

Cash and cash equivalents, beginning of period

 

95,833

 

1,293

 

Cash and cash equivalents, end of period

 

$

34,113

 

$

43,782

 

 

See Accompanying Notes to the Consolidated Financial Statements.

3




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

1.                 Description of Business

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

On October 2, 2006, the Company implemented a new organizational operating structure that realigned its operations into four operating segments. The four operating segments are the Command, Control, Communications, Computers and Intelligence (C4I) Segment, the Reconnaissance, Surveillance and Target Acquisition (RSTA) Segment, the Sustainment Systems Segment and the Technical Services Segment. All other operations, primarily the Company’s Corporate Headquarters, are grouped in Other. See Note 12 for a description of each segment. All prior-year amounts presented by segment have been reclassified to reflect the new operating structure.

2.                 Basis of Presentation

The accompanying unaudited consolidated financial statements include all wholly-owned and majority-owned subsidiaries and controlling interests of DRS. The financial statements 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 June 30, 2007 and the results of its operations and cash flows for the three-month periods ended June 30, 2007 and 2006. The results of operations and cash flows for the interim periods ended June 30, 2007 are not necessarily indicative of the results to be expected for the full year. 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, 2007, included in the Company’s filing on Form 10-K for the year ended March 31, 2007.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and costs and expenses during the reporting period. The most significant of these estimates and assumptions relate to contract revenue, costs to complete performance on a contract, profit and loss recognition, fair values of assets acquired and liabilities assumed in business combinations, market values for inventories reported at lower of cost or

4




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

market, pension and postretirement benefit obligations, share-based employee compensation costs, recoverability, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill, income taxes, including the valuation of deferred tax assets, litigation reserves and environmental obligations. Changes in estimates are reflected in the periods during which they become known. Actual amounts will differ from these estimates and could differ materially. For a more complete discussion of these estimates and assumptions, see the Annual Report of DRS Technologies, Inc. on Form 10-K for the fiscal year ended March 31, 2007.

The fiscal year-end consolidated balance sheet data was derived from the Company’s audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. Certain fiscal 2007 amounts have been reclassified to conform to the fiscal 2008 presentation.

3.                 Income Taxes

The provision for income taxes for the three-months ended June 30, 2007, reflected an effective income tax rate of approximately 37%, as compared with 38.9% in the same period last year. The Company’s effective tax rate declined primarily due to the scheduled increase in the Domestic Manufacturing Deduction, reinstatement of the Research & Development Credit and the Company’s April 1, 2007 election to report interest expense associated with the income tax contingencies as interest expense rather than a component of the income tax provision, partially off-set by a reduction in the Extraterritorial Income Exclusion.

In July 2006, the Financial Accounting Standard’s Board (FASB) issued FASB Interpretation No. 48 (FIN 48). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. FIN 48 states that a tax benefit from an uncertain tax position may be recognized only if it is “more likely than not” that the position is sustainable, based on its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with a taxing authority having full knowledge of all relevant information. A tax benefit from an uncertain tax position was previously recognized if it was “probable” of being sustained. Under FIN 48, the liability for unrecognized tax benefits is classified as noncurrent unless the liability is expected to be settled in cash within 12 months of the reporting date. FIN 48 is effective as of the beginning of the first fiscal year beginning after December 15, 2006. The Company adopted the provisions of FIN 48 on April 1, 2007. The impact of adopting FIN 48 on the Company’s consolidated financial statements is summarized below.

 

 

Balance at

 

 

 

Balance at

 

 

 

March 31,

 

FIN 48

 

March 31,

 

 

 

2007

 

Reclassification

 

2007

 

 

 

(in thousands)

 

Accrued interest

 

$

25,608

 

 

$

5,801

 

 

$

31,409

 

Income taxes payable

 

$

51,470

 

 

$

(8,243

)

 

$

43,227

 

Deferred tax assets

 

$

26,451

 

 

$

4,932

 

 

$

31,383

 

Other liabilities

 

$

158,682

 

 

$

7,374

 

 

$

166,056

 

Retained earnings

 

$

399,793

 

 

$

 

 

$

399,793

 

 

The Company operates in multiple taxing jurisdictions, both within the United States and outside of the United States, and faces audits from various tax authorities regarding transfer pricing, equity related

5




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

payroll deductions, the deductibility of certain expenses, intercompany transactions as well as other matters. At April 1, 2007, the total amount of liability for unrecognized tax benefits related to federal, state and foreign taxes was approximately $38.0 million (of which approximately $5.3 million would impact the Company’s effective tax rate if recognized) plus accrued interest of $5.8 million. As of June 30, 2007, the corresponding balance for unrecognized tax benefits is approximately $37.3 million for the items described above plus approximately $6.3 million of accrued interest.

The Company is currently under examination in several tax jurisdictions and remains subject to examination until the statute of limitations expires for the respective tax jurisdiction. Within specific countries, the Company may be subject to audit by various tax authorities, or subsidiaries operating within the country may be subject to different statute of limitations expiration dates. As of April 1, 2007, a summary of the tax years that remain subject to examination in the Company’s major tax jurisdictions are:

United States—Federal

 

March 31, 2002 and forward

United States—States

 

March 31, 2002 and forward

Germany

 

March 31, 2002 and forward

United Kingdom

 

March 31, 2002 and forward

Canada

 

March 31, 2002 and forward

Canada—Provinces

 

March 31, 2002 and forward

 

Based upon the expiration of statutes of limitations and/or the anticipated conclusion of tax examinations in several jurisdictions, the Company believes it reasonably possible that the total amount of previously unrecognized tax benefits for the items discussed above may decrease by up to $22.5 million within 12 months of June 30, 2007.

The Company’s policy is to classify penalties related to unrecognized tax benefits as income tax expense. The Company’s policy is to classify interest related to unrecognized tax benefits as interest expense. In fiscal 2007 and prior, these amounts were classified as income tax expense.

4.                 Share-Based Compensation

In the three months ended June 30, 2007 and 2006, the Company recorded total share-based costs related to stock options and non-vested stock of $2.7 million and $2.6 million, respectively. Such amounts were recognized in the consolidated financial statements as follows:

 

 

Three Months Ended
June 30,

 

 

 

 

   2007   

 

   2006   

 

 

 

 

(in thousands)

 

 

Total cost of share-based payment plans

 

$

2,689

 

 

$

2,644

 

 

Amounts capitalized in inventory

 

(1,374

)

 

(830

)

 

Amounts charged against earnings for amounts previously capitalized in inventory

 

913

 

 

960

 

 

Amounts charged against earnings before income tax benefit

 

2,228

 

 

2,774

 

 

 

6




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

Stock Options   The following table summarizes information regarding the Company’s stock option activity and amounts as of and for the three-months ended June 30, 2007.

 

 

Number of
Options

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Contractual
Term (years)

 

Aggregate
Intrinsic
Value

 

 

 

 

 

 

 

 

 

(in thousands)

 

Outstanding at March 31, 2007

 

2,394,314

 

 

$

32.04

 

 

 

 

 

 

 

 

 

 

Granted

 

224,469

 

 

$

54.30

 

 

 

 

 

 

 

 

 

 

Exercised

 

(148,317

)

 

$

20.53

 

 

 

 

 

 

 

 

 

 

Cancelled/Forfeited

 

(12,897

)

 

$

32.87

 

 

 

 

 

 

 

 

 

 

Outstanding at June 30, 2007

 

2,457,569

 

 

$

34.76

 

 

 

6.39

 

 

 

$

55,314

 

 

Vested and expected to vest at June 30, 2007(1)

 

2,433,990

 

 

$

34.65

 

 

 

6.36

 

 

 

$

55,051

 

 

Exercisable at June 30, 2007

 

1,686,385

 

 

$

30.95

 

 

 

5.51

 

 

 

$

44,397

 

 


(1)          Represents outstanding options reduced by expected forfeitures.

The aggregate intrinsic values, disclosed in the table above, represent the difference between DRS’s closing stock price on the last trading day of the first quarter (June 29, 2007) and the exercise price, multiplied by the number of in-the-money stock options for each category.

The total intrinsic values of stock options exercised, based on the difference between DRS’s stock price at the time of exercise and the related exercise price, during the three months ended June 30, 2007 and 2006, was $4.7 million and $0.6 million, respectively. Total compensation costs related to stock options was $1.3 million and $1.8 million, for the three month periods ended June 30, 2007 and 2006, respectively. At June 30, 2007, unrecognized compensation costs related to stock options was $11.2 million ($7.0 million after income taxes), which is expected to be recognized over a weighted average remaining period of 2.6 years.

The estimated weighted average grant date fair value of each stock option awarded was $21.00 and $21.47 for the three months ended June 30, 2007 and 2006, respectively.

Stock Option Fair Value Estimation Assumptions   For purposes of estimating the fair value provisions of Statement of Financial Accounting Standard (SFAS) 123R, the Company estimates the fair value of its stock options at the date of grant using the Black-Scholes option-pricing valuation model. The Company’s valuation model is impacted by DRS’s stock price as well as weighted average assumptions for a number of subjective variables described below.

·       Expected Holding Period   The expected holding period of stock options granted represents the period of time that stock options granted are expected to be outstanding until they are exercised, cancelled or forfeited. The Company uses historical information to estimate stock option exercise data and employee terminations within the valuation model.

·       Expected Volatility   Expected volatility is based on historical daily volatility of DRS common stock over the expected holding period.

7




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

·       Expected Dividend Yield   Expected dividend yield is based on DRS’s expected dividend payments relative to the current market price of DRS common stock.

·       Risk-Free Interest Rate   The risk-free interest rate for stock options is based on the U.S. Treasury yield curve in effect at the time of grant for maturities similar to the expected holding period of the stock options.

·       Forfeiture Rate   The forfeiture rate is based on the historical forfeiture experience and prospective analysis of different pools of employees. We monitor share option exercise and employee termination patterns of each pool to estimate forfeiture rates within the valuation model.

Changes in assumptions can materially impact the estimated fair value of stock options. The weighted average assumptions used in the Company’s valuation model are presented in the table below.

 

 

Three Months
Ended
June 30,

 

 

 

2007

 

Expected holding period (in years)

 

 

5.4

 

 

Expected volatility

 

 

33.23

%

 

Expected dividend yield

 

 

0.22

%

 

Risk-free interest rate

 

 

4.98

%

 

Weighted-average fair value of options granted

 

 

$

21.00

 

 

 

Non-Vested Stock and Non-Vested Stock Units   Non-vested stock awards are granted to certain employees, as permitted under the 2006 Plan in the name of the employee, who has all the rights of a stockholder, subject to certain restrictions. Non-vested stock units are granted in the name of the employee; however, the participant has no rights as a stockholder. These non-vested stock units are redeemed for DRS common stock once a three year cliff vesting period has been satisfied. The cost of the grants, as determined by the market prices of the common stock at the grant dates, net of expected forfeitures, is recognized over the vesting periods.

Compensation cost for non-vested stock for the three months ended June 30, 2007 and 2006 was $1.4 million and $0.8 million, respectively. As of June 30, 2007, total unrecognized compensation costs related to non-vested stock awards was $25.0 million ($15.7 million after income taxes) and that amount is expected to be recognized over a weighted average remaining period of 2.5 years.

The following table details the activity in non-vested stock awards for the three months ended June 30, 2007.

 

 

Three Months Ended
June 30, 2007

 

 

 

Number of
Shares

 

Weighted
Average Grant
Date Fair Value
per Share

 

Nonvested—Balance at March 31, 2007

 

 

362,396

 

 

 

$

49.86

 

 

Granted

 

 

281,632

 

 

 

$

54.28

 

 

Vested

 

 

(2,000

)

 

 

$

27.79

 

 

Forfeited / cancelled

 

 

(13,023

)

 

 

$

50.16

 

 

Nonvested—Balance at June 30, 2007

 

 

629,005

 

 

 

$

51.91

 

 

 

8




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

5.                 Inventories

Inventories are summarized as follows:

 

 

June 30,

 

March 31,

 

 

 

2007

 

2007

 

 

 

(in thousands)

 

Work-in-process

 

$

466,286

 

$

466,221

 

General and administrative costs

 

69,076

 

64,229

 

Raw material and finished goods

 

51,475

 

53,158

 

 

 

586,837

 

583,608

 

Less: Progress payments and certain customer advances

 

221,830

 

206,746

 

Inventory reserve

 

9,270

 

9,250

 

Total

 

$

355,737

 

$

367,612

 

 

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, not as period expenses, at the majority of the Company’s operating units.

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
June 30,

 

 

 

2007

 

2006

 

 

 

(in thousands)

 

Balance in inventory at beginning of period

 

$

64,229

 

$

63,836

 

Add: Incurred costs

 

79,214

 

68,756

 

Less: Amounts included in costs and expenses

 

(74,367

)

(67,145

)

Balance in inventory at end of period

 

$

69,076

 

$

65,447

 

 

Total expenditures for IRAD amounted to approximately $11.5 million and $11.0 million for the three-month periods ended June 30, 2007 and 2006, respectively.

During the three-month period ended June 30, 2007, the Company recorded a $36.8 million charge to operations for an anticipated loss on the Thermal Weapon Sight II (TWS II) program. The charge reflects the cost of procuring new material following recent design modifications, as well as the write-off of certain obsolete inventory. As a result of the design changes, the Company also transferred $30.0 million of saleable inventory from the TWS II program (transferred inventory) to inventory which is valued at the lower of cost or market as of June 30, 2007. The Company believes that the transferred inventory will be sold primarily through international distribution channels. The sale of certain products outside of the United States is highly regulated and any inability to obtain the requisite licenses, or comply with applicable government export regulations may affect the Company’s ability to export the transferred inventory. If the Company is precluded from selling the transferred inventory to certain international customers and, or is unable to generate sufficient domestic revenues, the value of the transferred inventory may be required to be written down or written off in a future period. Such a write-down or write-off could be material to the results of operations in any one period.

9




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

6.                 Goodwill and Intangible Assets

The table below reconciles the change in the carrying amount of goodwill by operating segment for the period from March 31, 2007 to June 30, 2007.

 

 

C4I

 

RSTA

 

Sustainment
Systems

 

Technical
Services

 

Total

 

 

 

(in thousands)

 

Balance as of March 31, 2007

 

$

654,446

 

$

176,376

 

$

1,040,605

 

$

745,215

 

$

2,616,642

 

Codem acquisition earn-out

 

2,638

 

 

 

 

2,638

 

WalkAbout acquisition earn-out

 

35

 

 

 

 

35

 

Foreign currency translation adjustment

 

2,041

 

 

589

 

 

2,630

 

Balance as of June 30, 2007

 

$

659,160

 

$

176,376

 

$

1,041,194

 

$

745,215

 

$

2,621,945

 

 

The following disclosure presents certain information regarding the Company’s acquired intangible assets as of June 30, 2007 and March 31, 2007. 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 June 30, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Technology-based intangibles

 

 

18 years

 

 

 

$

47,859

 

 

 

$

(17,745

)

 

 

$

30,114

 

 

Customer and program/contract- related intangibles

 

 

11 years

 

 

 

214,506

 

 

 

(54,911

)

 

 

159,595

 

 

Total

 

 

 

 

 

 

$

262,365

 

 

 

$

(72,656

)

 

 

$

189,709

 

 

As of March 31, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Technology-based intangibles

 

 

18 years

 

 

 

$

47,859

 

 

 

$

(17,016

)

 

 

$

30,843

 

 

Customer and program/contract- related intangibles

 

 

11 years

 

 

 

214,439

 

 

 

(48,298

)

 

 

166,141

 

 

Total

 

 

 

 

 

 

$

262,298

 

 

 

$

(65,314

)

 

 

$

196,984

 

 

 

The aggregate acquired intangible asset amortization expense for the three-month periods ended June 30, 2007 and 2006 was $7.3 million and $7.7 million, respectively. The estimated acquired intangible asset annual amortization expense is expected to be approximately $29.2 million for fiscal year 2008, $29.2 million for fiscal year 2009, $28.3 million for fiscal year 2010, $27.5 million for fiscal year 2011 and $14.0 million for fiscal year 2012.

The Company’s goodwill and intangible assets are more fully described in Note 3 to the Company’s consolidated financial statements for the year ended March 31, 2007.

10




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

7.                 Product Warranties

Product warranty costs generally 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 otherwise may be 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 three months ended June 30, 2007 and 2006, which are included in accrued expenses and other current liabilities.

 

 

Three Months Ended
June 30,

 

 

 

2007

 

2006

 

 

 

(in thousands)

 

Balance at beginning of period

 

$

31,180

 

$

29,869

 

Acquisitions during the period

 

 

932

 

Accruals for product warranties issued during the period

 

6,732

 

4,727

 

Settlements made during the period

 

(4,586

)

(3,494

)

Other

 

187

 

121

 

Balance at end of the period

 

$

33,513

 

$

32,155

 

 

8.                 Debt

 

 

June 30, 2007

 

March 31, 2007

 

 

 

(in thousands)

 

Credit Facility:

 

 

 

 

 

 

 

 

 

Revolving line of credit

 

 

$

 

 

 

$

 

 

Term loan

 

 

221,563

 

 

 

272,250

 

 

Canadian Term Loan

 

 

8,652

 

 

 

8,479

 

 

65¤8% Senior Notes due 2016

 

 

350,000

 

 

 

350,000

 

 

75¤8% Senior Subordinated Notes due 2018

 

 

250,000

 

 

 

250,000

 

 

67¤8% Senior Subordinated Notes due 2013

 

 

550,000

 

 

 

550,000

 

 

2% Convertible Senior Notes due 2026

 

 

345,000

 

 

 

345,000

 

 

Unamortized Bond Premium on 67¤8% Senior Subordinated Notes

 

 

7,170

 

 

 

7,453

 

 

Other obligations

 

 

5,070

 

 

 

5,025

 

 

 

 

 

1,737,455

 

 

 

1,788,207

 

 

Less:

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

 

5,353

 

 

 

5,161

 

 

Total long-term debt

 

 

$

1,732,102

 

 

 

$

1,783,046

 

 

 

The weighted average interest rate on the Company’s term loan borrowings under its Credit Facility was 6.9% as of June 30, 2007 (6.9% as of March 31, 2007). At June 30, 2007 and March 31, 2007, there were no outstanding revolving line of credit borrowings against the Credit Facility.

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

11




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

certain contracts to provide products and services and to secure advance payments it has received from its customers. As of June 30, 2007, $49.0 million was contingently payable under letters of credit and bank guarantees. Of this amount, approximately $0.9 million and $0.3 million in letters of credit and bank guarantees, respectively, as of June 30, 2007, were issued under a previous credit agreement and by a bank agreement for the Company’s U.K. subsidiary, respectively, and are not considered when determining the availability under the Company’s revolving line of credit. At June 30, 2007, the Company had $352.2 million of availability under its revolving line of credit.

In April 2007, the Company prepaid, at its discretion, $50.0 million of the outstanding term loan with proceeds from the Company’s revolving line of credit and recognized a $0.1 million charge to interest and related expenses in the first quarter of fiscal 2008.

On March 29, 2006, DRS Technologies Canada Company (DRS Canada) established a five-year senior secured term loan for approximately $9.9 million (C$11.5 million), maturing on April 1, 2011. The weighted average interest rate on the term loan was 6.0% as of June 30, 2007 (6.0% as of March 31, 2007).

Accrued interest expense at June 30, 2007 and March 31, 2007 was $28.3 million and $25.6 million, respectively.

Certain of the Company’s debt arrangements contain customary representations, warranties and default provisions as well as restrictions, that among other things, limit the amount of debt that the Company may have outstanding. As of June 30, 2007, the Company was in compliance with all covenants.

In January 2006, in connection with the offering of the Company’s 2% Convertible Notes due 2026 (Convertible Notes), the Company entered into a registration rights agreement relating to the Company's Common Stock issuable upon conversion of the Convertible Notes.  Pursuant to the registration rights agreement, if the Company does not file a prospectus supplement or shelf registration statement relating to the resale of the Common Stock within certain specified time periods or maintain the effectiveness of a registration statement related to the resale of the Common Stock, subject to certain exceptions, the Company could be subject to additional interest.  The Company believes the likelihood of occurrence of such event is remote and, as such, the Company has not recorded a liability at June 30, 2007.  In the event that it becomes probable that the Company would have to pay additional interest under the registration rights agreement, the Company estimates the maximum potential amount as of June 30, 2007 to be approximately $3.5 million per year.

The Company’s indebtedness is more fully described in Note 8 to the Company’s Consolidated Financial Statements for the year ended March 31, 2007.

9.                 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, convertible debt (if dilutive), non-vested stock and non-vested stock units using the treasury stock method. The following table presents the components of basic and diluted earnings per share:

12




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

 

 

 

Three Months Ended
June 30,

 

 

 

2007

 

2006

 

 

 

(in thousands,
except per-share data)

 

Basic EPS computation

 

 

 

 

 

Net earnings

 

$

1,650

 

$

21,258

 

Weighted average common shares outstanding

 

40,381

 

39,663

 

Basic earnings per share

 

$

0.04

 

$

0.54

 

Diluted EPS computation

 

 

 

 

 

Net earnings

 

$

1,650

 

$

21,258

 

Diluted common shares outstanding

 

 

 

 

 

Weighted average common shares outstanding

 

40,381

 

39,663

 

Stock options and non-vested awards

 

872

 

1,034

 

Diluted common shares outstanding

 

41,253

 

40,697

 

Diluted earnings per share

 

$

0.04

 

$

0.52

 

 

 

At June 30, 2007 and 2006, there were 246,969 and 22,500 options to acquire DRS common stock outstanding, respectively, with weighted average exercise prices of $54.23 and $53.56 per option, respectively, that are excluded from the above calculation because their inclusion would have had an antidilutive effect on EPS in their respective fiscal years.

For the three months ended June 30, 2007 and 2006, DRS’s 2% Convertible Senior Notes due 2026 had no impact on diluted EPS because the average stock price during such periods was below $59.70 per share, and the Convertible Notes, if converted, would require only cash at settlement.

10.          Comprehensive Earnings

The components of comprehensive earnings for the three-month periods ended June 30, 2007 and 2006 consisted of the following:

 

 

Three Months Ended
June 30,

 

 

 

2007

 

2006

 

 

 

(in thousands)

 

Net earnings

 

$

1,650

 

$

21,258

 

Other comprehensive earnings:

 

 

 

 

 

Foreign currency translation adjustments

 

3,535

 

2,442

 

Minimum pension liability, net of income taxes

 

(165

)

(598

)

Comprehensive earnings

 

$

5,020

 

$

23,102

 

 

11.          Pensions and Other Employee Benefits

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plansan amendment of FASB Statements No. 87, 88, 106 and 132(R)” (SFAS 158). The Company adopted the recognition provisions of SFAS 158 in its Consolidated Financial Statements at March 31, 2007. See Note 12 to the Company’s audited Consolidated Financial

13




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

Statements for the year ended March 31, 2007, included in the Company’s Annual Report on Form 10-K for a discussion of the recognition provisions of SFAS 158. In addition, SFAS 158 requires companies to measure pension and postretirement benefit plan assets and benefit obligations as of the date of the employer’s fiscal year end balance sheet. The Company will be required to change the measurement date from December 31 to March 31 for its pension and postretirement plans in the fiscal year beginning April 1, 2008. The Company is currently evaluating the impact of the change in the measurement date on the Company’s results of operations.

On June 29, 2007, the Company approved and adopted an amendment to one of its defined benefit pension plans to cease the accrual of future benefits effective September 30, 2007. All retirement benefits earned by employees enrolled in the plan as of September 30, 2007 will be fully preserved. Such employees’ ongoing service with the Company will continue to be credited for vesting purposes. The amendment of the defined benefit pension plan will be accounted for as a plan curtailment. As a result of this curtailment, the Company expects to record a gain of $11.7 million during the second quarter of fiscal 2008.

The following table summarizes the components of net periodic benefit cost for the Company’s pension and postretirement benefit plans for the three-month periods ended June 30, 2007 and 2006. These plans are more fully described in Note 12 to the Company’s Consolidated Financial Statements for the year ended March 31, 2007.

 

 

 

 

 

 

Unfunded

 

 

 

Funded

 

Postretirement

 

Supplemental

 

 

 

Pension Plans

 

Benefit Plans

 

Retirement Plans

 

 

 

Three Months Ended June 30,

 

 

 

2007

 

2006

 

2007

 

2006

 

2007

 

2006

 

 

 

(in thousands)

 

Service cost

 

$

1,728

 

$

1,834

 

$

120

 

$

146

 

$

146

 

$

143

 

Interest cost

 

3,653

 

3,243

 

332

 

320

 

361

 

318

 

Expected return on plan assets

 

(4,065

)

(3,490

)

(62

)

(56

)

 

 

Amortization of unrecognized loss (gain)

 

102

 

117

 

(35

)

(8

)

41

 

47

 

Amortization of transition obligation

 

 

 

28

 

28

 

 

 

Amortization of unrecognized prior-service cost

 

3

 

39

 

(6

)

(6

)

194

 

194

 

Net periodic benefit cost

 

$

1,421

 

$

1,743

 

$

377

 

$

424

 

$

742

 

$

702

 

 

The Company expects to contribute $15.9 million and $1.6 million to its pension and postretirement plans, respectively, during the fiscal year ended March 31, 2008, of which $3.9 million and $0.4 million, respectively, were contributed during the three-month period ended June 30, 2007.

12.          Operating Segments

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

14




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

The C4I Segment is comprised of the following business areas: Command, Control & Communications, which includes naval display systems, ship communications systems, radar systems, technical support, electronic manufacturing and system integration services, secure voice and data communications, air combat training and electronic warfare and ship network systems; 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, high-speed digital data and imaging systems, unmanned vehicles and mission and flight recorders; and Tactical Systems, which includes battle management tactical computer systems, peripherals, electronic test, diagnostics and vehicle electronics.

The RSTA Segment develops and produces electro-optical sighting, targeting and weapon sensor systems, and image intensification (I2) night vision, combat identification and laser aimers/illuminator products, and provides electronic manufacturing services.

The Sustainment Systems Segment designs, engineers and manufactures integrated military electronics and other military support equipment, primarily for the U.S. Department of Defense (DoD), as well as related heat transfer and air handling equipment, and power generation and distribution equipment for domestic commercial and industrial users. The segment provides these systems for military, humanitarian, disaster recovery and emergency responder applications.

The Technical Services Segment provides engineering services, logistics and training services, advanced technology services, security and asset protection systems and services, telecommunication systems, integration and information technology services, power generation and vehicle armor kits. The segment provides these services for military, intelligence, humanitarian, disaster recovery and emergency responder applications.

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

Transactions between segments generally are negotiated and accounted for under terms and conditions that are similar to other government and commercial contracts; however, these intercompany transactions are eliminated in consolidation. The Company evaluates segment-level performance based on revenues and operating income, as presented in the Consolidated Statements of Earnings. Operating income, as shown, includes amounts allocated from DRS Corporate operations using an allocation methodology prescribed by U.S. government regulations for government contractors.

15




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

 

 

 

C4I

 

RSTA

 

Sustainment
Systems

 

Technical
Services

 

Other

 

Total

 

 

 

(in thousands)

 

Three Months Ended June 30, 2007

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

303,221

 

$

154,791

 

$

115,436

 

$

176,856

 

$

 

$

750,304

 

Intersegment revenues

 

(4,829

)

(1,207

)

(7,458

)

(1,180

)

 

(14,674

)

External revenues

 

$

298,392

 

$

153,584

 

$

107,978

 

$

175,676

 

$

 

$

735,630

 

Operating income (loss)

 

$

31,905

 

$

(21,126

)

$

10,223

 

$

10,492

 

$

(160

)

$

31,334

 

Total assets

 

$

1,237,376

 

$

414,148

 

$

1,304,884

 

$

990,527

 

$

172,236

 

$

4,119,171

 

Depreciation and
amortization

 

$

5,932

 

$

3,368

 

$

4,407

 

$

3,459

 

$

1,347

 

$

18,513

 

Capital expenditures

 

$

7,887

 

$

1,589

 

$

1,371

 

$

696

 

$

2,350

 

$

13,893

 

Three Months Ended June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

271,719

 

$

117,834

 

$

104,233

 

$

157,622

 

$

 

$

651,408

 

Intersegment revenues

 

(1,403

)

(1,200

)

(17,685

)

(855

)

 

(21,143

)

External revenues

 

$

270,316

 

$

116,634

 

$

86,548

 

$

156,767

 

$

 

$

630,265

 

Operating income (loss)

 

$

27,705

 

$

12,981

 

$

11,403

 

$

13,320

 

$

(424

)

$

64,985

 

Total assets

 

$

1,184,475

 

$

429,440

 

$

1,266,100

 

$

975,408

 

$

222,419

 

$

4,077,842

 

Depreciation and
amortization

 

$

6,346

 

$

3,693

 

$

4,156

 

$

3,630

 

$

1,300

 

$

19,125

 

Capital expenditures

 

$

5,938

 

$

2,687

 

$

1,194

 

$

1,152

 

$

2,109

 

$

13,080

 

 

13.   Supplemental Cash Flow Information

 

 

Three Months Ended
June 30,

 

 

 

2007

 

2006

 

 

 

(in thousands)

 

Cash paid for:

 

 

 

 

 

Interest paid

 

$

24,298

 

$

26,373

 

Income taxes paid

 

$

14,432

 

$

3,859

 

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

 

 

 

 

 

Acquisition earn-out—Codem

 

$

2,638

 

$

838

 

Acquisition earn-out—WalkAbout

 

$

35

 

$

 

Acquisition costs for business combinations

 

$

 

$

500

 

Contribution of fixed assets to joint venture

 

$

429

 

$

 

Fixed assets vouchered but not paid

 

$

198

 

$

 

 

14.   Cash Dividends on DRS Common Stock

On May 10, 2007, the Board of Directors declared a $0.03 per common share cash dividend, payable on June 29, 2007 to stockholders of record as of June 15, 2007. Cash dividends paid for the three-month period ended June 30, 2007 were  $1.2 million. On August 9, 2007,  the Board of Directors declared a $0.03 per common share cash dividend, payable on September 28, 2007 to stockholders of record as of September 14, 2007.

16




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

15.   Contingencies

Various legal actions, claims, assessments and other contingencies including certain matters described below, are pending against the Company and certain of the Company’s subsidiaries. These matters are subject to many uncertainties, and it is possible that some of these matters ultimately could be decided, resolved or settled adversely. The Company had recorded accruals totaling $3.0 million at both June 30, 2007 and March 31, 2007 for losses related to those matters that the Company considers to be probable and that can be reasonably estimated (certain legal and environmental matters are discussed in detail below). Based on the Company’s ongoing analysis of various factual, legal and equitable considerations, the Company also has recorded as of June 30, 2007 an accrual of $12.6 million ($11.8 million of which was originally charged against goodwill) to reflect the probable income tax impact of information uncovered in the Company’s ongoing internal investigation of historical ESSI stock option practices. Although, at June 30, 2007, the precise amount of liability 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 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 and/or cash flows from operating activities for a particular reporting period.

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 Integrated Defense Technologies Inc. (IDT), and prior to the Company’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. On February 6, 2005, the NPS sent the Company an Engineering Evaluation/Cost Analysis Work Plan (the NPS EE/CA) under CERCLA (the CERCLA Letter) with regards to Operable Unit 1 of the Orphan Mine site. In the Company’s view, the NPS EE/CA included additional clean up 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 had 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

17




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

technical consultant submitted to the NPS, on behalf of the Company and the other PRP, an alternative Engineering Evaluation/Cost Analysis Work Plan (the alternative EE/CA) with regard to Operable Units 1 and 2 of the Orphan Mine site.

In December 2005 and August 2006, the PRPs and NPS met to discuss the technical merits of the alternative EE/CA and ways to resolve certain differences between the alternative EE/CA and the NPS EE/CA provided with the CERCLA Letter. Since late 2005, the parties also have discussed certain legal issues relating to the process for implementing an alternative EE/CA and entering into a settlement agreement that would memorialize the parties’ intent. The potential liability associated with implementation of an EE/CA can change substantially due to such factors as additional information on the nature or extent of contamination, methods of remediation that might be recommended or required, changes in the apportionment of costs among the responsible parties and other actions by governmental agencies or private parties.

In connection with the Company’s acquisition of ESSI in January 2006, the Company has been made aware of certain legal actions, claims, assessments and other contingencies, including those described below.

In December 2004, ESSI was notified by the Enforcement Division of the SEC of the issuance of a formal order directing a private investigation and was notified that the SEC had issued subpoenas to various individuals associated with ESSI to produce certain documents. The SEC staff also requested that ESSI produce certain documents in connection with the investigation. The subpoenas related to trading in ESSI stock around ESSI’s earnings releases in 2003 and to the adequacy of certain disclosures made by ESSI regarding related-party transactions in 2002 and 2003 involving insurance policies placed by ESSI through an insurance brokerage firm in which an ESSI director was a principal at the time of the transactions. In February 2007, the SEC filed a civil injunctive action in the United States District Court for the Eastern District of Missouri, Eastern Division, against a former director, officer and consultant of ESSI, alleging that he had violated the federal securities laws by “tipping” his financial advisor and close friend by sharing material, nonpublic information regarding ESSI’s financial condition shortly before certain 2003 earnings announcements.

On or about September 23, 2005, the SEC staff advised ESSI’s counsel that it had issued a subpoena directed to ESSI and expanded its investigation to include ESSI’s disclosure of a November 2004 stop work order relating to ESSI’s Deployable Power Generation and Distribution Systems (DPGDS) program for the U.S. Air Force and relating to trading in ESSI stock by certain individuals associated with ESSI. In connection with the foregoing SEC investigation, ESSI and certain of its directors and officers have provided information and/or testimony to the SEC.

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

In May 2006, the Company was advised that the Enforcement Division of the SEC and the U.S. Attorney’s office each had expanded its investigation to include possible “backdating” of the timing of option grants at ESSI prior to the time ESSI was acquired by the Company. As a part of its investigation,

18




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

the SEC issued subpoenas to certain former officers and employees of ESSI to provide testimony and produce certain documents.

In February 2007, the SEC filed civil injunctive actions in the United States District Court for the Eastern District of Missouri, Eastern Division, alleging that ESSI’s former Chief Financial Officer and former controller, in which each was alleged to have participated in a backdating scheme. Also in February 2007, the SEC reported ESSI’s former controller had settled its action against him by consenting to disgorgement, financial penalties, an officer and director bar and a permanent suspension from practicing before the SEC as an accountant. In July 2007, the SEC filed civil injunctive actions in the United States District Court for the Eastern District of Missouri, Eastern Division, alleging that ESSI’s former Chairman of the Board and Chief Executive Officer and his son (who was also a member of ESSI’s Board of Directors and Compensation Committee) each participated in a backdating scheme.

In March 2007, ESSI’s former controller pleaded guilty to a one-count information brought by the office of the United States Attorney for the Eastern District of Missouri, charging him with making false statements to the government. In connection with his plea, this former ESSI executive admitted that a number of documents filed by ESSI with the SEC contained the materially false statement that the option price of shares subject to the ESSI stock option plan was the closing price of the stock on the date the options were awarded.

In March 2007, ESSI’s former Chief Financial Officer was indicted by the grand jury of the United States District Court for the Eastern District of Missouri relating to the backdating of the timing of stock options at ESSI prior to the time ESSI was acquired by DRS.  In July 2007, ESSI’s former Chairman of the Board and Chief Executive Officer and his son (who was also a member of ESSI’s Board of Directors and Compensation Committee) were each indicted on similar charges. The July 2007 superseding indictment charges these former ESSI officers and directors with twelve counts of fraud based on allegations that they backdated stock options on at least eight occasions between 1996 and 2002.

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

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

ESSI’s federal tax returns for the tax periods ended October 31, 2004, October 31, 2005 and January 31, 2006 remain the subject of an Internal Revenue Service audit. In connection with this audit, ESSI expects that it will be required to amend previously filed Federal and state tax returns to reflect the disallowance of certain compensation deductions taken during the periods under review. The Company has recorded an accrual against goodwill to reflect the anticipated disallowance.

On August 7, 2007, a shareholder derivative complaint was filed in the United States District Court for the Eastern District of Missouri against ESSI’s former Chairman of the Board and Chief Executive Officer, his son (who was also a member of ESSI’s Board of Directors and Compensation Committee), ESSI’s former Chief Financial Officer and ESSI’s former Controller relating to the alleged backdating of stock options prior to ESSI’s acquisition by DRS. The complaint also contains claims against each of the current members of DRS’s Board of Directors relating to the alleged backdating of ESSI stock options and

19




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

the ESSI acquisition. The Company believes the claims made against the current DRS directors are without merit.

In July 2006, DRS Technologies, Inc. and one of its subsidiaries, DRS Training & Control Systems, Inc. each were issued a subpoena by the United States District Court for the Northern District of Florida. The subpoenas were issued in connection with an investigation conducted by the Antitrust Division of the U.S. Department of Justice involving allegations of possible anticompetitive activity in certain international markets.  On June 21, 2007, the Company received written notification from the Antitrust Division of the Department of Justice that they had closed this investigation.

16.   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 co-founder and former President and Chief Technical Officer, and the late Leonard Newman, DRS’s co-founder and former Chairman of the Board, Chief Executive Officer and Secretary and the father of Mark S. Newman, DRS’s current Chairman of the Board, President and Chief Executive Officer. 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. The lease agreement, with a monthly rental of $21.2 thousand, expired on April 30, 2007. The new lease commenced May 1, 2007 with the new monthly rental commencing on June 1, 2007 of $21.8 thousand for the first year with annual increases of approximately 3% every June 1. The lease expires August 31, 2010.

Skadden, Arps, Slate, Meagher & Flom LLP, a law firm to which a member of the Company’s Board is of counsel, provided legal services to the Company during the three months ended June 30, 2007 and 2006. Fees paid to Skadden, Arps, Slate, Meagher & Flom LLP for the three months ended June 30, 2007 and 2006 were $0.9 million and $2.4 million, respectively.

In the fourth quarter of 2007, the stepson of Mark S. Newman, the Company’s Chairman of the Board, President and Chief Executive Officer, commenced employment with Nemco Brokerage, Inc., a firm that has a longstanding relationship of providing insurance brokerage services to the Company and which receives commissions from third-party insurers based on policies it places on the Company’s behalf.

17.   Guarantor and Non-Guarantor Financial Statements

As presented in Note 8, “Debt”, the Company has $350.0 million 65¤8% Senior Notes, $550.0 million 67¤8% Senior Subordinated Notes, $250.0 million 75¤8% Senior Subordinated 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 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 in the Condensed Consolidating Balance Sheets as of June 30, 2007 and March 31, 2007, the Condensed Consolidating Statements of Earnings for the three-month periods ended June 30, 2007 and 2006, and the Condensed Consolidating Statements of Cash Flows for the three-month periods ended June 30, 2007 and 2006 presents:

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

b)              the Guarantor Subsidiaries,

20




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

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 information for each of the Guarantor and Non-Guarantor Subsidiaries is not presented because management believes such financial statements would not be meaningful to investors.

21




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

Condensed Consolidating Balance Sheet
As of June 30, 2007
(in thousands)

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

31,996

 

 

$

 

 

 

$

15,117

 

 

 

$

(13,000

)

 

 

$

34,113

 

 

Accounts receivable, net

 

4

 

 

474,319

 

 

 

41,459

 

 

 

 

 

 

515,782

 

 

Inventories, net

 

 

 

316,471

 

 

 

39,272

 

 

 

(6

)

 

 

355,737

 

 

Prepaid expenses, deferred income taxes and other current assets

 

7,530

 

 

295,033

 

 

 

20,230

 

 

 

(199,026

)

 

 

123,767

 

 

Intercompany receivables

 

2,077,221

 

 

 

 

 

 

 

 

(2,077,221

)

 

 

 

 

Total current assets

 

2,116,751

 

 

1,085,823

 

 

 

116,078

 

 

 

(2,289,253

)

 

 

1,029,399

 

 

Property, plant and equipment, net

 

16,883

 

 

206,324

 

 

 

10,712

 

 

 

 

 

 

233,919

 

 

Acquired intangibles, net

 

 

 

188,994

 

 

 

715

 

 

 

 

 

 

189,709

 

 

Goodwill

 

24,115

 

 

2,551,931

 

 

 

45,899

 

 

 

 

 

 

2,621,945

 

 

Deferred income taxes and other noncurrent assets

 

197,153

 

 

2,752

 

 

 

7,113

 

 

 

(162,819

)

 

 

44,199

 

 

Investment in subsidiaries

 

1,143,419

 

 

36,872

 

 

 

34

 

 

 

(1,180,325

)

 

 

 

 

Total assets

 

$

3,498,321

 

 

$

4,072,696

 

 

 

$

180,551

 

 

 

$

(3,632,397

)

 

 

$

4,119,171

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

2,750

 

 

$

193

 

 

 

$

2,410

 

 

 

$

 

 

 

$

5,353

 

 

Accounts payable

 

3,768

 

 

216,436

 

 

 

17,825

 

 

 

 

 

 

238,029

 

 

Accrued expenses and other current liabilities

 

231,257

 

 

395,193

 

 

 

39,437

 

 

 

(197,051

)

 

 

468,836

 

 

Intercompany payables

 

 

 

817,069

 

 

 

3,380

 

 

 

(820,449

)

 

 

 

 

Total current liabilities

 

237,775

 

 

1,428,891

 

 

 

63,052

 

 

 

(1,017,500

)

 

 

712,218

 

 

Long-term debt, excluding current installments

 

1,720,982

 

 

3,187

 

 

 

7,933

 

 

 

 

 

 

1,732,102

 

 

Other liabilities

 

25,826

 

 

279,389

 

 

 

20,708

 

 

 

(164,810

)

 

 

161,113

 

 

Total liabilities

 

1,984,583

 

 

1,711,467

 

 

 

91,693

 

 

 

(1,182,310

)

 

 

2,605,433

 

 

Total stockholders' equity

 

1,513,738

 

 

2,361,229

 

 

 

88,858

 

 

 

(2,450,087

)

 

 

1,513,738

 

 

Total liabilities and stockholders' equity

 

$

3,498,321

 

 

$

4,072,696

 

 

 

$

180,551

 

 

 

$

(3,632,397

)

 

 

$

4,119,171

 

 

 

22




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

Condensed Consolidating Balance Sheet
As of March 31, 2007
(in thousands)

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

92,795

 

$

 

 

$

14,598

 

 

$

(11,560

)

 

$

95,833

 

 

Accounts receivable, net

 

4

 

504,188

 

 

31,050

 

 

 

 

535,242

 

 

Inventories, net

 

 

321,877

 

 

45,735

 

 

 

 

367,612

 

 

Prepaid expenses, deferred income taxes and other current assets

 

8,547

 

298,737

 

 

21,120

 

 

(201,429

)

 

126,975

 

 

Intercompany receivables

 

2,051,028

 

 

 

24,115

 

 

(2,075,143

)

 

 

 

Total current assets

 

2,152,374

 

1,124,802

 

 

136,618

 

 

(2,288,132

)

 

1,125,662

 

 

Property, plant and equipment, net

 

15,389

 

206,332

 

 

9,485

 

 

 

 

231,206

 

 

Acquired intangibles, net

 

 

196,488

 

 

496

 

 

 

 

196,984

 

 

Goodwill

 

24,115

 

2,549,258

 

 

43,269

 

 

 

 

2,616,642

 

 

Deferred income taxes and other noncurrent assets

 

196,737

 

2,292

 

 

7,227

 

 

(162,040

)

 

44,216

 

 

Investment in subsidiaries

 

1,143,419

 

36,905

 

 

 

 

(1,180,324

)

 

 

 

Total assets

 

$3,532,034

 

$

4,116,077

 

 

$

197,095

 

 

$

(3,630,496

)

 

$

4,214,710

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term
debt

 

$

2,750

 

$

188

 

 

$

2,223

 

 

$

 

 

$

5,161

 

 

Accounts payable

 

11,022

 

253,796

 

 

32,609

 

 

 

 

297,427

 

 

Accrued expenses and other current liabilities

 

226,667

 

401,351

 

 

39,370

 

 

(199,444

)

 

467,944

 

 

Intercompany payables

 

 

817,303

 

 

13,347

 

 

(830,650

)

 

 

 

Total current liabilities

 

240,439

 

1,472,638

 

 

87,549

 

 

(1,030,094

)

 

770,532

 

 

Long-term debt, excluding current installments

 

1,771,953

 

3,242

 

 

7,851

 

 

 

 

1,783,046

 

 

Other liabilities

 

17,192

 

285,793

 

 

19,723

 

 

(164,026

)

 

158,682

 

 

Total liabilities

 

2,029,584

 

1,761,673

 

 

115,123

 

 

(1,194,120

)

 

2,712,260

 

 

Total stockholders’ equity

 

1,502,450

 

2,354,404

 

 

81,972

 

 

(2,436,376

)

 

1,502,450

 

 

Total liabilities and stockholders’ equity

 

$

3,532,034

 

$

4,116,077

 

 

$

197,095

 

 

$

(3,630,496

)

 

$

4,214,710

 

 

 

23




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

Condensed Consolidating Statements of Earnings
Three Months Ended June 30, 2007
(in thousands)

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminations

 

Consolidated

 

Revenues

 

 

$

 

 

 

$

674,503

 

 

 

$

64,238

 

 

 

$

(3,111

)

 

 

$

735,630

 

 

Cost and expenses

 

 

142

 

 

 

648,767

 

 

 

58,494

 

 

 

(3,107

)

 

 

704,296

 

 

Operating income

 

 

(142

)

 

 

25,736

 

 

 

5,744

 

 

 

(4

)

 

 

31,334

 

 

Interest income

 

 

501

 

 

 

(8

)

 

 

66

 

 

 

 

 

 

559

 

 

Interest and related expense

 

 

28,483

 

 

 

85

 

 

 

142

 

 

 

 

 

 

28,710

 

 

Other income (expense), net

 

 

577

 

 

 

61

 

 

 

(708

)

 

 

 

 

 

(70

)

 

Management fees

 

 

781

 

 

 

(744

)

 

 

(37

)

 

 

 

 

 

 

 

Royalties

 

 

412

 

 

 

 

 

 

(412

)

 

 

 

 

 

 

 

Intercompany interest

 

 

23,376

 

 

 

(23,363

)

 

 

(13

)

 

 

 

 

 

 

 

Earnings (losses) before non-controlling interest and income taxes

&