| DRS TECHNOLOGIES INC Item 1A Risk Factors The Company’s financial position, results of operations and cash flows are subject to various risks, many of which are not exclusively within the Company’s control that may cause actual performance to differ materially from historical or projected future performance |
| Information in this Form 10-K should be considered carefully by investors in light of the risk factors described below |
| Our revenues depend on our ability to maintain our level of government business |
| The loss of our contracts with domestic and non-US government agencies could adversely affect our revenues |
| We derive the substantial majority of our revenues from contracts or subcontracts with domestic and non-US government agencies |
| A significant reduction in the purchase of our products by these agencies would have a material adverse effect our business |
| For the fiscal years ended March 31, 2006, 2005 and 2004, approximately 87prca, 84prca and 85prca, respectively, of our revenues were derived directly or indirectly from defense-industry contracts with the US government and its agencies |
| In addition, for the fiscal years ended March 31, 2006, 2005 and 2004, approximately 9prca, 12prca and 10prca of our revenues were derived directly or indirectly from sales to foreign governments, respectively |
| Therefore, the development of our business in the future will depend upon the continued willingness of the US government and its prime contractors to commit substantial resources to defense programs and, in particular, upon the continued purchase of our products, and other products which incorporate our products, by the US government |
| In particular, the current funding demands on the US government combined 14 ______________________________________________________________________ with a potential reduction of forces in Iraq, may lead to lower levels of government defense spending |
| The risk that governmental purchases of our products may decline stems from the nature of our business with the US government, in which the US government may: · terminate contracts at its convenience; · terminate, reduce or modify contracts or subcontracts if its requirements or budgetary constraints change; · cancel multi-year contracts and related orders if funds become unavailable; · shift its spending priorities; · adjust contract costs and fees on the basis of audits done by its agencies; and · inquire about and investigate business practices and audit compliance with applicable rules and regulations |
| In addition, as defense businesses, we are subject to the following risks in connection with government contracts: · the frequent need to bid on programs prior to completing the necessary design, which may result in unforeseen technological difficulties and/or cost overruns; · the difficulty in forecasting long-term costs and schedules and the potential obsolescence of products related to long-term fixed-price contracts; · the risk of fluctuations or a decline in government expenditures due to any changes in the DoD budget or appropriation of funds; · when we act as a subcontractor, the failure or inability of the prime contractor to perform its prime contract may result in an inability to obtain payment of fees and contract costs; · restriction or potential prohibition on the export of products based on licensing requirements; and · government contract wins can be contested by other contractors |
| Our revenues will be adversely affected if we fail to receive renewal or follow-on contracts |
| These terms vary from shorter than one year to over five years, particularly for contracts with options |
| The typical term of our contracts with the US government is between one and three years |
| The loss of revenues from our possible failure to obtain renewal or follow-on contracts may be significant because our US government contracts account for a substantial portion of our revenues |
| Our operating results may fluctuate |
| Our results of operations have fluctuated in the past and may continue to fluctuate in the future as a result of a number of factors, many of which are beyond our control |
| These factors include: · the termination of a key government contract; · the size and timing of new contract awards to replace completed or expired contracts; and · changes in DoD policies, budgetary priorities and allocation of funding |
| 15 ______________________________________________________________________ We may not be successful in implementing our growth strategy if we are unable to identify, acquire and finance suitable acquisition targets |
| Finding and consummating acquisitions is an important component of our growth strategy |
| Our continued ability to grow by acquisition is dependent upon the availability of acquisition candidates at reasonable prices and our ability to obtain additional acquisition financing on acceptable terms |
| We experience competition in making acquisitions from larger companies with significantly greater resources |
| We are likely to use significant amounts of cash, issue additional equity securities or incur additional debt in connection with future acquisitions, each of which could have a material adverse effect on our business |
| There can be no assurance that we will be able to procure the necessary funds to effectuate our acquisition strategy on commercially reasonable terms, or at all |
| In addition, as our revenue growth has been historically attributable largely to our successful acquisition strategy, failure to identify, consummate or integrate suitable acquisitions could lead to a reduced rate of revenue growth, operating income and net earnings in the future |
| Integration of the operations of recent acquisitions will be complex, time-consuming and expensive and may adversely affect the results of our operations after the acquisition |
| The anticipated benefits of our acquisitions will depend in part on whether we can integrate our operations in an efficient, timely and effective manner |
| Integrating our acquisitions will be a complex, time-consuming and expensive process |
| Our acquisition of Engineered Support Systems, Inc |
| (ESSI) on January 31, 2006 represents our largest and most significant acquisition to date |
| Successful integration will require, among other things, combining the companies’: · business development efforts; · key personnel; · geographically separate facilities; and · business processes and cultures |
| We may not accomplish this integration successfully and may not realize the benefits contemplated by combining the operations of both companies |
| In the course of our due diligence investigation of ESSI, we determined that ESSI and various of its subsidiaries may not have adequate export authorizations |
| Accordingly, we may be required to make disclosures to governmental agencies and may be subject to fines and penalties as a result of ESSI’s actions or inaction prior to the acquisition |
| We expect to make changes to ESSI’s export compliance program, and we may be required to alter the business practices of ESSI in order to comply with our business practices and standards or applicable federal, state, local and foreign laws |
| Any remedial efforts that we take may require significant management attention and resources and may delay production or require modification to existing products and programs |
| The diversion of our attention to the integration effort and any difficulty encountered in combining operations could cause the interruption of, or a loss of momentum in, the activities of our business |
| 16 ______________________________________________________________________ If we are unable to successfully integrate ESSI and other companies we acquire into our operations on a timely basis, our profitability could be negatively affected |
| We expect that our acquisition of ESSI will result in certain business opportunities and growth prospects |
| We, however, may never realize these expected business opportunities and growth prospects |
| We may experience increased competition that limits our ability to expand our business |
| Our assumptions underlying estimates of expected cost savings may be inaccurate, or general industry and business conditions may deteriorate |
| Acquisitions involve numerous risks, including, but not limited to: · difficulties in assimilating and integrating the operations, technologies and products acquired; · the diversion of our management’s attention from other business concerns; · current operating and financial systems and controls may be inadequate to deal with our growth; · the risk that we will be unable to maintain or renew any of the government contracts of businesses we acquire; · the risks of entering markets in which we have limited or no prior experience; and · the loss of key employees |
| If these factors limit our ability to integrate the operations of our acquisitions, including ESSI, successfully or on a timely basis, our expectations of future results of operations may not be met |
| In addition, our growth and operating strategies for businesses we acquire, including ESSI, may be different from the strategies that such business currently is pursuing |
| If our strategies are not the proper strategies for a company we acquire, it could have a material adverse effect on our business, financial condition and results of operations |
| Further, there can be no assurance that we will be able to maintain or enhance the profitability of any acquired business or consolidate the operations of any acquired business to achieve cost savings |
| In addition, there may be liabilities that we fail or are unable to discover in the course of performing due diligence investigations on each company or business we have already acquired or may acquire in the future |
| Such liabilities could include those arising from employee benefits contribution obligations of a prior owner or non-compliance with or liability pursuant to applicable federal, state or local environmental requirements by prior owners for which we, as a successor owner, may be responsible |
| In addition, there may be additional costs relating to acquisitions, including, but not limited to, possible purchase price adjustments |
| We cannot assure you that rights to indemnification by sellers of assets to us, even if obtained, will be enforceable, collectible or sufficient in amount, scope or duration to fully offset the possible liabilities associated with the business or property acquired |
| Any such liabilities, individually or in the aggregate, could have a material adverse effect on our business |
| Failure to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed-price contract may reduce our profit or cause a loss |
| We provide our services primarily through two types of contracts: fixed-price and cost-type contracts |
| Approximately 83prca, 81prca and 82prca of our total revenues for the fiscal years ended March 31, 2006, 2005 and 2004, respectively, were derived from fixed-price contracts, which require us to perform services under a contract at a stipulated price |
| We derived approximately 17prca, 19prca and 18prca of our revenues for the fiscal years ended March 31, 2006, 2005 and 2004, respectively, from cost-type contracts by which we are reimbursed for incurred costs and receive a 17 ______________________________________________________________________ fee that, depending on the contract, is either dependent on cost savings and/or performance or is a fixed fee which is negotiated but limited by statutes |
| Failure to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed-price contract will reduce our profit or cause a loss |
| In particular, because of their inherent uncertainties and consequent cost overruns, development contracts have historically been less profitable than production contracts |
| Although we believe that adequate provision for our costs of performance is reflected in our consolidated financial statements, we can give no assurance that this provision is adequate or that losses on fixed-price and cost-type contracts will not occur in the future |
| We also cannot assure you that current cost-type contracts will not be changed to fixed-price contracts |
| We may experience production delays if suppliers fail to deliver materials to us |
| Our manufacturing process for certain products consists primarily of the assembly of purchased components and testing of the product at various stages in the assembly process |
| Although we can obtain materials and purchase components for these products from a number of different suppliers, several suppliers are our sole source of certain components |
| If a supplier should cease to deliver such components, we believe that we would probably find other sources; however, this could result in added cost and manufacturing delays |
| We have not experienced significant production delays attributable to supply shortages, but we occasionally experience procurement problems with respect to certain components, such as semiconductors and connectors |
| In addition, with respect to our electro-optical products, certain materials, such as germanium, zinc sulfide and cobalt, may not always be readily available |
| Our backlog is subject to reduction and cancellation, which could negatively impact our revenues and results of operations |
| Backlog represents products or services that our customers have committed by contract to purchase from us |
| Our total funded backlog as of March 31, 2006 was approximately dlra2dtta4 billion |
| Backlog is subject to fluctuations and is not necessarily indicative of future sales |
| Moreover, cancellations of purchase orders or reductions of product quantities in existing contracts could substantially and materially reduce backlog and, consequently, future revenues |
| Our failure to replace canceled or reduced backlog could negatively impact our revenues and results of operations |
| Our international operations expose us to risks of losses |
| Approximately 9prca, 12prca and 10prca of our revenues for the fiscal years ended March 31, 2006, 2005 and 2004, respectively, were derived from sales to foreign governments |
| We are exploring the possibility of expansion into additional international markets, and our acquisition of ESSI may provide entry into additional international markets |
| We cannot assure you that we will maintain significant operations internationally or that any such operations will be successful |
| Any international operations we establish will be subject to risks similar to those affecting our US operations in addition to a number of other risks, including: · political and economic instability in foreign markets; · inconsistent product regulation by foreign agencies or governments; · imposition of product tariffs and burdens; 18 ______________________________________________________________________ · cost of complying with a wide variety of international and US export laws and regulatory requirements, including the Foreign Corrupt Practices Act, the Export Administration Act and the Arms Export Control Act (and the regulations promulgated thereunder); · lack of local business experience; · foreign currency fluctuations; · difficulty in enforcing intellectual property rights; and · language and other cultural barriers |
| We face competition in the military electronics and services industries |
| The military electronics and services industries in which we participate are highly competitive and characterized by rapid technological change |
| Our potential inability to improve existing product lines and develop new products and technologies could have a material adverse effect on our business |
| In addition, our competitors could introduce new products with greater capabilities, which could have a material adverse effect on our business |
| We also compete with these entities with respect to identifying targets and consummating our acquisition strategy |
| There are many competitors in the markets in which we sell our products |
| Many of these competitors are substantially larger than us, devote substantially greater resources to research and development, and generally have greater financial and other resources |
| Consequently, these competitors may be better positioned to take advantage of economies of scale and develop new technologies |
| Some of these competitors are also our suppliers and customers |
| In the military sector, we compete with many large and mid-tier defense contractors on the basis of performance, cost, overall value, delivery and reputation |
| As US defense spending decreased in the early 1990s, the industry experienced substantial consolidation, increasing the market share of certain companies |
| We are dependent in part upon our relationships and alliances with industry participants in order to generate revenue |
| We rely on the strength of our relationships with military industry organizations to form strategic alliances |
| Some of our industry partners assist us in the development of some of our products through teaming arrangements |
| Under these teaming arrangements, our industry partners usually have borne a portion of the expenses associated with our research and development of new and existing products, which are the subject of such agreements |
| We cannot assure you that our industry partners will continue to bear these expenses in the future |
| If any of our existing relationships with our industry partners were impaired or terminated, we could experience significant delays in the development of our new products ourselves, and we would incur additional development costs |
| We would need to fund these costs internally or identify new industry partners |
| Some of our likely industry partners are also potential competitors, which may impair the viability of new strategic relationships |
| While we must compete effectively in the marketplace, our future alliances may depend on our industry partners’ perception of us |
| Our ability to win new and/or follow-on contracts may be dependent upon our relationships within the military industry |
| 19 ______________________________________________________________________ The US government’s right to use technology developed by us limits our intellectual property rights |
| We seek to protect the competitive benefits we derive from our patents, proprietary information and other intellectual property |
| However, we do not have the right to prohibit the US government from using certain technologies developed by us or to prohibit third party companies, including our competitors, from using those technologies in providing products and services to the US government |
| The US government has the right to royalty-free use of technologies that we have developed under US government contracts |
| We are free to commercially exploit those government funded technologies and may assert our intellectual property rights to seek to block other non-government users thereof, but we cannot assure you we could successfully do so |
| We are subject to government regulation, which may require us to obtain additional licenses and could limit our ability to sell our products outside the United States |
| The sale of certain of our products outside the United States is subject to compliance with the United States Export Administration Regulations and the International Traffic in Arms Regulations |
| Our failure to obtain the requisite licenses, meet registration standards or comply with other government export regulations, may affect our ability to export such products or to generate revenues from the sale of our products outside the United States, which could have a material adverse effect on our business, financial condition and results of operations |
| Compliance with government regulations also may subject us to additional fees and costs |
| The absence of comparable restrictions on competitors in other countries may adversely affect our competitive position |
| In order to sell our products in European Union countries, we must satisfy certain registrations and technical requirements |
| If we were unable to comply with those requirements with respect to a significant quantity of our products, our sales in Europe could be restricted, which could have a material adverse effect on our business |
| We are subject to environmental laws and regulations, and our ongoing operations may expose us to environmental liabilities |
| Our operations, like those of other companies engaged in similar businesses, are subject to federal, state, foreign and local environmental and health and safety laws and regulations |
| As a result, we have been involved from time to time in administrative or legal proceedings relating to environmental matters |
| We cannot assure you that the aggregate amount of future clean-up costs and other environmental liabilities will not be material |
| We can be subject to potentially significant fines or penalties, including criminal sanctions, if we fail to comply with these requirements |
| We have made and will continue to make capital and other expenditures in order to comply with these laws and regulations |
| However, the requirements of these laws and regulations are complex, change frequently and could become more stringent in the future |
| We cannot predict what environmental legislation or regulations will be enacted in the future, how existing or future laws or regulations will be administered or interpreted or what environmental conditions may be found to exist |
| Also, in the future, contamination may be found to exist at our current or former facilities or at off-site locations to which we or certain companies that we have acquired may have sent waste, including the Orphan Mine site in the Grand Canyon National Park, Arizona, which is currently subject to a government investigation |
| We could be held liable for such contamination |
| The remediation of such contamination, or the enactment of more stringent laws or regulations or more strict interpretation of existing laws and regulations may require us to make additional expenditures, some of which could be material |
| 20 ______________________________________________________________________ ESSI currently is subject to investigations by the Enforcement Division of the SEC and the Office of the US Attorney for the Eastern District of Missouri, each of which could require significant management attention and legal resources and could have a material adverse effect on the Company |
| In December 2004, ESSI, prior to its acquisition by us, was notified by the Enforcement Division of the SEC of the issuance of a formal order directing a private investigation captioned In the Matter of Engineered Support Systems, Inc, and in September 2005, ESSI received notice that the SEC staff had expanded the scope of its investigation to include ESSI’s disclosure of a November 2004 stop-work order relating to ESSI’s Deployable Power Generation and Distribution Systems program (“DPGDS”) |
| In connection with the investigation, ESSI and certain of its directors and officers have received subpoenas and provided information and testimony to the SEC and one former director, officer and consultant has received a so-called Wells notice |
| ESSI continues to furnish information required by the SEC and otherwise to cooperate in connection with the investigation |
| In January 2006, ESSI was informed that the Office of the US 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 US Attorney’s office advised ESSI that although it considered it to be a subject of its investigation, ESSI was not a target |
| In connection with this investigation, the US Attorney’s office issued ESSI a subpoena requesting specified information, which ESSI continues to furnish |
| In May 2006, we were advised that the Enforcement Division of the SEC and the US Attorney’s office had each expanded its investigation to include possible “backdating” of the timing of option grants at ESSI prior to the time we acquired it |
| Although ESSI continues to be a subject of the US Attorney’s office’s investigation, the US Attorney’s office has advised us that ESSI is not a target |
| Because the events being investigated occurred prior to the time of our acquisition of ESSI, the US Attorney’s office has further advised us that it considers the Company 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 |
| We are unable to determine at this time either the timing of the investigations or the impact, if any, which the investigations could |