Diagnostic/Retrieval Systems (DRS) Technologies (NYSE:DRS) sells thermal imaging devices, electronic sensor systems, and rugged computers to the U.S. military and government intelligence agencies. DRS is in the midst of a merger with Finmeccanica, S.p.A. (Milan: FNC), who will acquire 100% of DRS’ stock for US$81 per share in cash.
93% of the company's sales are to the U.S. government. Military spending, such as on the Iraq War, increases DRS’ revenue and earnings. Democratic Presidential Candidate Barack Obama has promised to end the Iraq War, which would greatly reduce defense spending, while Republican Candidate John McCain has vowed to continue in Iraq. As a result, DRS stands to gain or lose from the outcome of the 2008 elections.
DRS operates in four segments: Command, Control, Communications, Computers & Intelligence (C4I) Segment (40% fiscal 2008), Reconnaissance, Surveillance & Target Acquisition (RSTA) Segment (24%), Sustainment Systems Segment (15%), and Technical Services Segment (21%). Net earnings for fiscal 2008 was $165.8M, 60% higher than $103.6M last fiscal year, 2007. Revenue increased 17% from $2.82B in fiscal 2007 to $3.3B in 2008. The increase was attributable entirely to strong growth in each of the company's four operating segments. Total assets were $4.2B and total liabilities were $2.7B with a current ratio of 1.46, a 99.6% debt-to-equity ratio, and a 4.5 percent net profit margin.
|Foreign governments||$208,807||$ 213,397||$240,976||$171,880|
Backlog increased by 18.7% in 2008. Fixed price contracts made 76% of the contracts and the remaining 24% were cost-type/time and materials contracts. Fixed price contracts enables DRS to benefit from any disparity between cost price and the contract price. However, any overrun costs that exceed the fixed contract price, DRS bears all the cost. For cost-type contracts DRS is reimbursed for any extra costs and is also paid an extra fee.
|Business Segment||2008||2007||% change|
The C4I Segment is comprised of the following business areas: Command, Control & Communications (C3), 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, and diagnostics and vehicle electronics.
Revenues increased $195.7M, or 17.2%, to $1.3B for the year ended March 31, 2008, as compared with the fiscal 2007. Operating income increased $21.1M, or 16.2%, to $151.1M. The key drivers were: increased shipments related to driver vision enhancement systems for groung-based vehicles, rugged computer systems, and replacement video display modules. Partially offsetting overall higher revenues were decreased shipments of rugged computer systems sold in the international market.
The RSTA Segment develops and produces electro-optical sighting, targeting and weapon sensor systems, and image intensification night vision, combat identification and laser aimer/illuminator products, and provides electronic manufacturing services. 
Revenues increased $182.1M, or 30.4%, to $781.7M for the fiscal 2008 compared with the 2007 fiscal year. Operating income increased $53.5M, or 168.2%, to $85.4M. The increase in revenues was primarily attributable to increased shipments of driver vision enhancement equipment for ground-based vehicles, thermal imaging systems and subsystems for a long-range surveillance system, and ground-based target acquisiotion and missile control subsytems. Partially offsetting the overall increase in revenues were lower volume from rapidly deployable thermal imaging systems.
The Sustainment Systems Segment designs, engineers and manufactures integrated military electronics and other military support equipment, primarily for the 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 primarily for military, humanitarian, disaster recovery and emergency responder applications.
For fiscal 2008, revenues increased $94.5M, or 23.6%, to $495.3M. Its operating income also increase $12.6M, or 21.3%, to $72M. The primary revenue drivers were: increased shipments of tactical quiet generator sets, higher demand for replacement environmental control systems for missile launch and alert facilities, and heavy mobile ammunition trailers for the U.S. Army; however, there were lower shipments of a precision targeting system, partially offsetting overall revenue
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.
In fiscal 2008, it saw a $2.1M increase, or 0.3%, to $683.4M. Its operatin income also increased $3.5M, or 7.1%, to $52.6M. The primary revenue drivers were significant increases on the Rapid Response program and a satellite-based communication network program; however, decreases in various government installations, commercial vehicle armor kits and mobile power generation and distribution equipment programs largely offsetted revenue increases.
A substantial amount of DRS Technologies’ revenue depends on U.S. Government and other foreign governments sales. For the fiscal years 2008, 2007 and 2006, approximately93%, 90%, and 87%, respectively, of DRS’s revenues came from defense industry contracts with the U.S. government and its agencies. In addition, for the fiscal years 2008, 2007 and 2006, approximately 5%, 7%, and 9% of DRS’s revenues came from sales to foreign governments, respectively. Renewal and follow-on contracts are important because contracts are for fixed terms, varying between a couple of months to over five years. Failure to obtain renewal or follow-on contracts with the U.S. can result in an adverse loss of revenue since U.S. government contracts account for a substantial portion of their revenues.
The federal budget for the Departmen of Defense (DoD) has been in a sustained upswing since 9/11, and this strong environment has benefited the vast majority of defense contractors, DRS being no exception. The 2007 federal budget had a 7 percent increase in DoD spending, from 410.8 B to 439.3B. According to the federal budget for 2008, spending for DoD is projected to increase to 479.5B in 2008 and 515.4B in 2009. Decisions made by the U.S. Congress on spending directly affects DRS. Both presidential and congressional decision can have adverse affects on future sales for DRS. Democrats are more likely to support social programs such as national healthcare and also more willing to end wars, therefore fixing the U.S. federal budget to promote social programs and reduce national defense spending.
Most of DRS' contracts are fixed-price contracts, 76% in 2008, in which a price is agreed upon for their products or services. DRS benefits from cutting costs and widening the gap between cost of production and the fixed-price contract, increasing their earning. However, if DRS fails to perform under such contracts, it will have the burden of righting the contracts. Any cost overruns on fixed-price contracts reduce its profitability because DRS must take in the extra costs.
|Type of Contract||2008||2007||2006||2005|
|Cost-type/time and materials||24%||24%||17%||19%|
DRS’ growth strategy has depended on acquiring businesses. Through many acquisitions DRS has also acquired a 118.7% debt-to-equity ratio with a long term debt of $1,783M in 2007. DRS paid off more than $150M of it’s long term debt in 2008; it has reduced its debt-to-equity ratio to 96.6% by reducing its long term debt to $1,627M in fiscal 2008. Competitors also compete in acquiring businesses, and DRS will have to incur additional debt by issuing additional securities for future acquisitions. Even though DRS has a total of $1,627M of long term debt, it is able to create a substantial amount of cash from operating activities, $211.5M in 2008, enabling it to pay its debts. Paying off its debts allows the company to take into consideration additional debt in order to procure the necessary funds to continue their acquisition strategy. Since past revenue growth has been largely attributed to their successful acquisition strategy, failure to continue acquiring and integrating businesses will have reduce revenue growth. Failure to integrate acquired companies into their operations will have additional negative effects.
Finmeccanica, S.p.A. (Milan: FNC), a supplier of electronics equipment and defense and security systems and services, will acquire 100% of DRS stock for US$81 per share in cash, valued at approximately US$5.2 billion (euro 3.4 billion). The transaction lets Finmeccanica consolidate its international role as a key supplier of integrated systems for defense and security, but it will have to comply with all national security requirements in order to enter the U.S. market as a key player. This however, will further let DRS to seek new business opportunities in the U.S. and abroad.
|Date||Business Acquired||Stock Purchase Transaction|
|Jan-06||Engineered Support Systems, Inc. (ESSI)||$1,930.00|
|Jun-05||Walk About Computer Systems, Inc. (WalkAbout)||$13.80|
|Apr-05||Codem Systems, Inc. (Codem)||$31.60|
|Dec-04||Night Vision Equipment Co., Inc. and Excalibur Electro Optics, Inc. (NVEC)||$47.20|
DRS' largest competitors are BAE Systems PLC, Raytheon Company (RTN), and L-3 Communications Holdings, Inc., among others. DRS is the best cost value producer. Some competitors are also their customers and suppliers. DRS received a $23M order from Northrop Grumman to provide replacement environment control systems for electronic equipment and personnel. It won three contracts for a total $55M from the U.S. Army’s Communications Electronic Command to manufacture tactical quiet generators.
|Quarterly Revenue Growth (yoy)||23.00%||NA||6.30%||11.40%||13.20%|