Fitch Affs United Defense at 'BB'; Revises Outlk to Positive.

Business Editors

NEW YORK--(BUSINESS WIRE)--July 16, 2003

Fitch Ratings has affirmed its 'BB' rating on United Defense Industries' (UDI) senior secured credit facilities, and has revised the Rating Outlook to Positive from Stable.

The affirmation takes into consideration the company's continued solid financial performance, cash flow generation and liquidity, UDI's appointment to the design team for Future Combat Systems (FCS) ground combat vehicles and the company's position in the currently favorable defense spending environment.

Fitch remains concerned with UDI's acquisition strategy. Partially mitigating this concern is the potential use of cash or secondary equity offerings to offset acquisition-related debt. Additional concerns focus on reduced spending on the Bradley program, timing of near term Bradley deliveries and a revenue shift to lower margin developmental work.

In May 2002, Fitch changed UDI's Outlook from Positive to Stable mainly due to the impact of $300 million of additional debt from the United States Marine Repair (USMR) acquisition and the uncertainty surrounding the fate of the Crusader program, which represented approximately 20% of UDI's revenues. Since then, USMR has performed well and UDI has continued to build upon its solid track record of accelerated debt reduction. Additionally, Fitch's previous concerns regarding Crusader uncertainty and UDI's role in the U.S. Army's transformation have been lessened as a result of UDI's appointment to develop the Crusader's replacement program, the Non-Line-of-Sight Cannon (NLOS-C), and the appointment to the design team for the development of FCS armored vehicles. Going forward, Fitch expects UDI to continue to exhibit solid financial performance and cash flow generation that will allow the company to pay down debt and exhibit improved credit protection measures.

Fitch's revision of the Outlook to Positive from Stable assumes future acquisitions will be modest relative to UDI's existing business. The revision also assumes that UDI will continue to reduce debt in the near term. Future acquisitions could negatively affect credit quality and require Fitch to review its rating and outlook for UDI. The company's ability to use cash or equity to finance all or a portion of future acquisitions could mitigate Fitch's concerns relating to acquisition-related debt.

UDI generated particularly strong free cash flow of $157 million in 2002 benefiting from a reversal of a $50 million deferred tax valuation allowance and improvements to working capital. This trend continued into the first quarter of 2003 with UDI generating $47 million of free cash flow. This strong cash flow generation has allowed UDI to continue to accelerate debt reduction. Since the July 2002 acquisition of USMR, UDI has paid down $133 million of bank debt while still increasing cash on the balance sheet. However, Fitch notes that in the first quarter of 2003, UDI accumulated cash as opposed to reducing debt. Despite the run off of net operating loss carry forwards which have historically offset cash tax payments for UDI, Fitch expects UDI to continue to generate solid free cash flow going forward.

The proposed DoD budget for 2004 included significant reductions for the Bradley Fighting Vehicle (BFV) program with spending authority budgeted at $113 million in 2004, down from $437 million in 2003. This production program represented approximately 19% of UDI's revenues and generates some of UDI's top margins. Subsequent to the submission of the 2004 Budget, the House Appropriations Committee and the Senate Appropriations Committee have proposed additional funding, $259 million and $62 million, respectively, for Bradley upgrades. Despite this proposed additional funding, Fitch remains concerned that potential future funding for the Bradley program may be shifted to newer, transformational platforms like the Interim Armored Vehicle (IAV). Current multi-year contracts carry the Bradley program through 2005. Due to the current deployment of troops in Iraq, the timing of Bradley deliveries and revenue recognition may be delayed in the near term. UDI is currently in discussions with the Army regarding modifications to the existing contract to allow UDI to recognize deliveries as scheduled. Fitch remains concerned that the combination of potential reduced spending and delivery delays could negatively affect UDI's results in the intermediate term.

UDI has made good progress in solidifying its position on transformational military platforms. UDI's selection to the team that will design the FCS ground vehicles partially mitigates the effect of BFV funding cuts. However, this appointment does not necessarily guarantee UDI's level of participation on the production portion of the program. Since this program is only in the design phase, Fitch does not expect that revenues and margins from this program will be sufficient to make up for lower BFV revenues. The FCS vehicles are not expected to be fielded until 2008.

As part of its role in FCS, UDI also has entered into an agreement for the design and production of the NLOS-C. Funding for the NLOS-C is expected to be approximately $353 million in 2004. Fitch remains concerned that this program may compete for funding with other programs that are intended to provide artillery like capabilities such as NetFires.

Some of UDI's other developmental programs include the engineering development models for the Advance Gun System and Advance Vertical Launch System for the U.S. Navy's new DD(X) destroyer. Since DD(X) is the first in the family of a new class of ships, UDI may benefit from the application of these systems to related new ships such as CG(X). While UDI's participation on the aforementioned transformational platforms is a positive credit factor in the long term, Fitch recognizes that in the intermediate term, UDI's revenues and margins may be pressured by a gap between its current production and developmental programs.

As of March 31, 2003, UDI maintained $156 million of cash, approximately $45 million of availability under its revolving credit facility and $26 million of current maturities, netting to a liquidity position of $175 million. Since the USMR acquisition, UDI has repaid $133 million of debt, resulting in solid credit protection measures for the rating category, with leverage, as defined by debt-to-EBITDAP, of 2.2 times (x) and adjusted leverage, including rent and operating lease expenses, of 2.6x for the 12-month period ending March 31, 2003. UDI also maintained good interest coverage, as defined by EBITDAP-to-interest, and adjusted interest coverage, as defined by EBITDAPR-to-(interest plus rent), of 7.9x and 5.5x, respectively, for the same period. Since approximately two-thirds of UDI's debt carries a floating rate, net of interest rate swaps, UDI's interest coverage has benefited from a historically low interest rate environment.