Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[x] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 2001.
OR
[_] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Transition Period from _____ to _____ .
Commission File No.1-7348
DYNAMICS RESEARCH CORPORATION
-----------------------------
(Exact name of registrant as specified in its charter)
Massachusetts 04-2211809
------------------------------------------------------
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
60 Frontage Road, Andover, Massachusetts 01810-5498
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (978) 475-9090
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 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
------- -------
The number of shares outstanding of the Registrant's Common stock, par value
$.10 per share, at July 27, 2001 was 7,673,019 shares.
DYNAMICS RESEARCH CORPORATION
INDEX
Page
Part I Financial Information Number
------
Item 1. Financial Statements
Consolidated Balance Sheets -
June 30, 2001 and December 31, 2000 3
Consolidated Statements of Operations -
Three Months Ended June 30, 2001 and
June 30, 2000 4
Consolidated Statements of Operations -
Six Months Ended June 30, 2001 and
June 30, 2000 5
Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2001 and
June 30, 2000 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 17
Signature
2
PART I. FINANCIAL INFORMATION
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars except share and per share data)
(unaudited)
June 30, 2001 December 31, 2000
------------- -----------------
Assets
Current assets
Cash and cash equivalents $ 3,899 $ 527
Receivables, net of allowances of $1,265 in 2001 and $1,096 in 2000 24,342 31,967
Unbilled expenditures and fees on contracts in process 25,175 24,633
Inventories 3,568 3,208
Prepaid expenses and other current assets 1,667 3,926
-------- --------
Total current assets 58,651 64,261
Net property, plant and equipment 14,099 14,441
-------- --------
Total assets $ 72,750 $ 78,702
======== ========
Liabilities and Stockholders' Equity
Current liabilities
Notes payable $ - $ 5,784
Current portion of long-term debt 500 500
Accounts payable 11,887 12,843
Accrued payroll and employee benefits 9,659 9,901
Other accrued expenses 3,112 5,711
Current deferred income taxes 5,427 4,575
-------- --------
Total current liabilities 30,585 39,314
-------- --------
Long-term debt 9,000 9,250
Deferred income taxes 849 849
Commitments and contingencies (Note 6)
Stockholders' Equity
Preferred stock, par value, $.10 per share
5,000,000 shares authorized, none issued - -
Common stock, par value, $.10 per share:
Authorized - 30,000,000 shares
Issued - 9,035,045 shares in 2001 and 8,980,945 in 2000 904 898
Treasury stock - 1,379,426 shares in 2001
and 2000, at par value (138) (138)
Capital in excess of par value 28,739 28,461
Retained earnings 2,811 68
-------- --------
Total stockholders' equity 32,316 29,289
-------- --------
Total liabilities and stockholders' equity $ 72,750 $ 78,702
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
3
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands of dollars except share and per share data)
(unaudited)
Three Three
Months Ended Months Ended
June 30, 2001 June 30, 2000
------------- -------------
Revenue
Contract revenue $ 45,168 $ 47,430
Product sales 5,416 7,010
----------- -----------
Total revenue 50,584 54,440
Costs and expenses
Cost of contract revenue 39,413 42,131
Cost of product sales 4,273 5,094
Selling, engineering and administrative expenses 4,148 4,234
----------- -----------
Total operating costs and expenses 47,834 51,459
----------- -----------
Operating income 2,750 2,981
Other expense 193 -
Interest expense, net 250 547
----------- -----------
Income from continuing operations before provision
for income taxes 2,307 2,434
Provision for income taxes 946 998
----------- -----------
Income from continuing operations 1,361 1,436
Gain from discontinued operations, net of tax 62 35
----------- -----------
Net income $ 1,423 $ 1,471
=========== ===========
Earnings per share
Per common share - basic
Income from continuing operations $ 0.18 $ 0.19
Gain from discontinued operations, net of tax 0.01 -
----------- -----------
Net income $ 0.19 $ 0.19
=========== ===========
Per common share - diluted
Income from continuing operations $ 0.17 $ 0.19
Gain from discontinued operations, net of tax 0.01 -
----------- -----------
Net income $ 0.18 $ 0.19
=========== ===========
Weighted average shares outstanding
Weighted average shares outstanding - basic 7,620,044 7,554,880
Dilutive effect of options 214,088 268,591
----------- -----------
Weighted average shares outstanding - diluted 7,834,132 7,823,471
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
4
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands of dollars except share and per share data)
(unaudited)
Six Six
Months Ended Months Ended
June 30, 2001 June 30, 2000
------------- --------------
Revenue
Contract revenue $ 87,540 $ 88,602
Product sales 11,684 13,628
--------- ---------
Total revenue 99,224 102,230
Costs and expenses
Cost of contract revenue 76,712 79,460
Cost of product sales 8,804 9,999
Selling, engineering and administrative expenses 8,478 8,278
--------- ---------
Total operating costs and expenses 93,994 97,737
--------- ---------
Operating income 5,230 4,493
Other expense 193 -
Interest expense, net 492 1,116
--------- ---------
Income from continuing operations before provision
for income taxes 4,545 3,377
Provision for income taxes 1,864 1,385
--------- ---------
Income from continuing operations 2,681 1,992
Gain from discontinued operations, net of tax 62 206
--------- ---------
Net income $ 2,743 $ 2,198
========= =========
Earnings per share
Per common share - basic
Income from continuing operations $ 0.35 $ 0.26
Gain from discontinued operations, net of tax 0.01 0.03
--------- ---------
Net income $ 0.36 $ 0.29
========= =========
Per common share - diluted
Income from continuing operations $ 0.34 $ 0.26
Gain from discontinued operations, net of tax 0.01 0.02
--------- ---------
Net income $ 0.35 $ 0.28
========= =========
Weighted average shares outstanding
Weighted average shares outstanding - basic 7,612,105 7,497,842
Dilutive effect of options 189,108 263,565
--------- ---------
Weighted average shares outstanding - diluted 7,801,213 7,761,407
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
5
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
(unaudited)
Six Six
Months Ended Months Ended
June 30, 2001 June 30, 2000
------------- -------------
Cash provided by operations
Net income $ 2,743 $ 2,198
Adjustments to reconcile net income to cash
provided by (used for) operating activities:
Loss on disposal of assets 193 -
Gain from discontinued operations (62) (206)
Non-cash stock compensation expense - 114
Depreciation and amortization 1,656 2,132
Deferred income taxes 852 1,644
------- -------
5,382 5,882
------- -------
Cash provided by (used for) working capital
Receivables 7,009 (8,894)
Unbilled expenditures and fees on contracts in process (1,180) (3,746)
Inventories (360) (63)
Prepaid expenses and other current assets 2,259 457
Accounts payable (956) (3,832)
Accrued payroll and employee benefits (242) 2,540
Other accrued expenses (1,499) 117
------- -------
5,031 (13,421)
------- -------
Net cash provided by (used for) continuing operations 10,413 (7,539)
Net cash provided by (used for) discontinued operations 62 (35)
------- -------
Cash provided by (used for) operating activities 10,475 (7,574)
------- -------
Cash provided by (used for) investing activities
Proceeds from sale of assets 100 -
Additions to property, plant and equipment (1,453) (1,108)
------- -------
Net cash used for investing activities (1,353) (1,108)
------- -------
Cash provided by (used for) financing activities
Repayment of working capital agreement - (19,700)
Net borrowings (repayments) under revolving credit agreement (5,784) 15,634
Principal payment under 10-year mortgage (250) 17,500
Repayment of interim mortgage - (7,500)
Proceeds from the exercise of stock options 284 685
------- -------
Net cash provided by (used for) financing activities (5,750) 6,619
------- -------
Net increase (decrease) in cash and cash equivalents 3,372 (2,063)
Cash and cash equivalents at the beginning of the period 527 2,267
------- -------
Cash and cash equivalents at the end of the period $ 3,899 $ 204
======= =======
Supplemental information
Cash paid for interest $ 529 $ 1,245
Cash paid for taxes $ 1,059 $ 94
The accompanying notes are an integral part of these consolidated financial
statements.
6
DYNAMICS RESEARCH CORPORATION
Notes to Consolidated Financial Statements
------------------------------------------
Note 1. Significant Accounting Policies
----------------------------------------
Basis of Presentation
---------------------
The accompanying consolidated financial statements include the accounts of the
company and its wholly owned subsidiaries. All material intercompany
transactions and balances have been eliminated in consolidation. Certain prior
period amounts have been reclassified to conform to current period presentation.
Certain information in footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States has been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission, although the registrant
believes that the disclosures are adequate to make the information presented not
misleading. The accompanying consolidated financial statements have not been
audited by independent accountants, but in the opinion of the management, such
financial statements include all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the results of operations.
The results of the three-month and six-month periods ended June 30, 2001 may not
be indicative of the results for the fiscal year ended December 31, 2001.
Risks, Uncertainties and Use of Estimates
-----------------------------------------
The company is subject to business risks specific to the industries in which it
operates, including, but not limited to, estimates of costs to complete contract
obligations, changes in government policies and procedures, government
contracting issues, changes in demand for inventories, and risks associated with
technological development. The preparation of financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reported period. Actual results
could differ materially from those estimates.
Inventories
-----------
Inventories stated at the lower of cost or market (in thousands of dollars):
-----------------------------------------------------------------------------
June 30, 2001 December 31, 2000
------------- -----------------
Work in process $ 348 $ 726
Raw materials and subassemblies 3,220 2,482
------ ------
Total inventories $3,568 $3,208
====== ======
7
Property, Plant and Equipment
-----------------------------
Property, plant and equipment stated at cost (in thousands of dollars):
------------------------------------------------------------------------------
June 30, 2001 December 31, 2000
-------------- -----------------
Land $ 1,126 $ 1,126
Building 7,774 7,774
Machinery and equipment 46,236 45,133
Leasehold improvements 2,547 2,551
------- -------
Total property, plant and equipment 57,683 56,584
Less accumulated depreciation and
amortization 43,584 42,143
------- -------
Net property, plant and equipment $14,099 $14,441
======= =======
New Accounting Pronouncements
-----------------------------
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. SFAS No. 133 (as amended by SFAS No.
137 and SFAS No. 138) was effective January 1, 2001. The adoption of SFAS No.
133 did not have a material impact on the company's financial position or
results of operations, because it had no derivative instruments or hedging
activities at June 30, 2001.
In June 2001, the FASB issued SFAS No. 141, Business Combinations and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that all
business combinations initiated after June 30, 2001 be accounted for using the
purchase method. SFAS No. 142 requires that acquired intangible assets be
separately recognized if the benefit of the intangible asset is obtained through
a contractual or other legal right, or if it can be sold, transferred,
licensed, rented or exchanged, regardless of the acquirer's intent to do so.
Intangible assets previously categorized as goodwill will be required to be
separated from goodwill and amortized over an appropriate life. The statement
also mandates that goodwill be subject to an annual impairment review by
applying a fair-value-based test and eliminates the previous amortization
requirement. SFAS No. 142 is effective January 1, 2002 and early adoption is not
permitted. The company believes that the adoption of SFAS Nos. 141 and 142 will
not have a material impact on the company's financial position or results of
operations, because it has no recent acquisitions and no goodwill.
Earnings Per Common Share
-------------------------
Basic earnings per share is computed by dividing net income by the weighted
average number of shares of common stock outstanding during the period. Diluted
earnings per share is determined by giving effect to the exercise of stock
options using the treasury stock method. Due to their antidilutive effect,
63,800 and 934,800 options were excluded from the calculation of diluted
earnings per share in the second quarter and first six months of 2001,
respectively. During the second quarter and first six months of 2000, 82,800
options were excluded from the calculation of diluted earnings per share due to
their antidilutive effect.
Note 2. Major Contracts
-----------------------
The company is nearing completion of the Colorado child welfare information
system, which began in 1997 under a fixed price contract with the State's
Department of Human Services. This contract has incurred cost overruns which
were provided for, when estimated, in the company's results of operations.
Entering 2001, the project was scheduled for completion in the first half of the
year, including rollout of the first release of the new child welfare
information and management system, plus three releases of increased
functionality. The first release of the system was successfully deployed in
January 2001, providing 3000 State employees access to a system which allows
them to manage Colorado's child welfare cases. Completion of the additional
releases was extended from June to August of 2001, and as a result, the company
provided for the cost of the schedule extension in the first quarter of 2001.
The first release of increased functionality has been recently deployed. During
the second quarter of 2001, delays were encountered in the completion of the
youth corrections functionality, the final phase of the
8
project. Consequently, at the end of the second quarter of 2001, the company
reassessed its resource levels assigned to the project and final completion
schedule. As a result, the company has reduced project staff levels and,
accordingly, the date for the final release of system functionality has been
revised from the third to the fourth quarter of 2001. The cost impact of these
changes was included in results of operations for the second quarter of 2001.
While the company believes it has reasonably estimated and provided for the
costs to complete the Colorado contract, estimates of project costs will
continue to be updated and changes in estimates provided for, as necessary, in
each reporting period. Accordingly, there can be no assurances that the actual
costs on the project will not differ materially from current estimates.
Note 3. Restructuring
---------------------
In the fourth quarter of 1999, the company adopted a restructuring plan intended
to reduce overhead costs and increase efficiencies. The company recorded a
restructuring charge of $1.2 million. The remaining reserve balance from this
action was $0.2 million at December 31, 2000. During the first three months of
2001, the company expended approximately $0.1 million against the reserve. The
remaining restructuring reserve of $0.1 million at March 31, 2001 was expended
during the second quarter of 2001, primarily on continuation pay for employees
who had left the company prior to December 31, 2000.
During the second quarter of 2001, the company provided $0.2 million for
involuntary severance costs for approximately 30 employees in the Encoder
Division. At June 30, 2001, the remaining balance of this provision was $0.1
million. These costs will be expended in the third quarter of 2001.
Note 4. Discontinued Operations
-------------------------------
In June 1999, the company completed the sale of its previously discontinued
Telecommunications Fraud Control business for $1.7 million plus royalties.
Royalty income of $62,000 and $0.2 million, after taxes, was recognized in the
first six months of 2001 and 2000, respectively. The company may benefit
modestly from future royalty payments through July 31, 2002, up to a cap of $0.9
million, net of taxes. These receipts will be recorded as gain from discontinued
operations, after deducting taxes, when received.
Note 5. Debt
------------
The company's revolving credit agreement (the "Revolver") provides for
borrowings of up to the lesser of $20.0 million or 80% of eligible accounts
receivable, as defined, and expires on February 10, 2003. Interest on the
outstanding balance of the Revolver is payable monthly and prior to February
2001, interest accrued at the prime rate. The agreement included a fee of 0.375%
on the unused portion of the Revolver. Commencing in February 2001, the company
exercised an option to elect, on a fixed 30, 60 or 90-day term, an interest rate
of LIBOR plus 2% or the prime rate, and the fee on the unused Revolver was
reduced to 0.25%.
Effective June 30, 2001, the company and its bank group agreed to amend the
revolving credit agreement (the "Amended Revolver") to release the bank group's
security interests in the company's assets and to continue the Amended Revolver
on an unsecured basis. At June 30, 2001, there was no outstanding balance under
the Amended Revolver, and the company had $20.0 million of unused credit line
available. Available interest rates on the Amended Revolver at June 30, 2001,
were 6.75% under the prime rate option and 5.79% under the 90-day LIBOR rate
option.
The company has a 10-year mortgage loan (the "Mortgage") on the company's real
estate, with $9.5 million outstanding at June 30, 2001. Interest on the Mortgage
accrues at the rate of LIBOR plus 2.5%.
9
The agreement requires quarterly principal payments of $125,000 beginning on
August 1, 2000, with a final payment of $5.0 million in June 2010. The interest
rate on the Mortgage was 7.4% on June 30, 2001.
The Mortgage is secured by the corporate office facility in Andover,
Massachusetts. The Amended Revolver and Mortgage require the company to meet
certain financial covenants including maintaining a minimum tangible net worth,
cash flow and debt coverage ratios, as well as limit the company's ability to
incur additional debt, to pay dividends, to purchase capital assets, to sell or
dispose of assets, to make additional acquisitions or investments, or to enter
into new leases, among other restrictions. The company was in compliance with
all covenants on June 30, 2001.
Note 6. Commitments and Contingencies
--------------------------------------
As a defense contractor, the company is subject to many levels of audit and
review, including the Defense Contract Audit Agency (the "DCAA"), the Inspector
General, the Defense Criminal Investigative Service, the General Accounting
Office, the Department of Justice and Congressional Committees. As a result of
certain DCAA audit findings in January 2000, the United States Government
temporarily deferred a portion of its payments to the company. At December 31,
2000, $1.0 million in payments were deferred, which were remitted in full in the
first half of 2001. The company is, from time to time, involved in audits,
lawsuits, claims, administrative proceedings and investigations in connection
with its defense industry business and other activities, and accrues for
liabilities associated with these activities, if any, for which the company
considers it probable that future expenditures will be made and for which such
expenditures can be reasonably estimated. In management's opinion, the outcome
from such audits and other matters discussed above is not expected to have a
material adverse effect on the company's financial position or results of
operations.
On October 26, 2000, the United States Attorney's Office announced the
indictment of two former company employees for conspiracy to defraud the United
States Air Force. On July 9, 2001, one of the former employees pled guilty to
several of the charges. The government's investigation of the second former
employee is ongoing. The United States Attorney's Office has informed the
company that it is not a target of the investigation. Separately, the United
States Attorney's Office is investigating certain company activity and billing
transactions from prior years. The company does not know, at this time, what
financial effects, if any, may result to the company from these matters.
Note 7. Segment Information
----------------------------
Identifiable assets by business segment include both assets directly identified
with those operations and an allocable share of jointly used assets.
Summarized financial information by business segment for the three months ended
June 30, 2001 and June 30, 2000 are as follows (in thousands of dollars):
-------------------------------------------------------------------------
Identifiable
Systems Continuing
and Metri- Operations
Services Encoder Graphics Corporate Total
---------------------------------------------------------------------------
June 30, 2001
Net sales $45,168 $2,727 $2,689 $ - $50,584
Operating income (loss) 2,490 (550) 810 - 2,750
Identifiable assets at
June 30, 2001 52,194 5,744 3,072 11,740 72,750
June 30, 2000
Net sales $47,430 $4,842 $2,168 $ - $54,440
Operating income 1,953 526 502 - 2,981
Identifiable assets at
June 30, 2000 65,768 6,329 2,691 9,559 84,347
10
Summarized financial information by business segment for the six months ended
June 30, 2001 and June 30, 2000 are as follows (in thousands of dollars):
-------------------------------------------------------------------------
Identifiable
Systems Continuing
and Metri- Operations
Services Encoder Graphics Corporate Total
--------------------------------------------------------------------------
June 30, 2001
Net sales $87,540 $6,217 $5,467 $ - $ 99,224
Operating income (loss) 4,203 (847) 1,874 - 5,230
Identifiable assets at
June 30, 2001 52,194 5,744 3,072 11,740 72,750
June 30, 2000
Net sales $88,602 $9,335 $4,293 $ - $102,230
Operating income 2,615 903 975 - 4,493
Identifiable assets at
June 30, 2000 65,768 6,329 2,691 9,559 84,347
Net sales and operating income (loss) are presented after the elimination of
intersegment transactions, which are not material.
During the second quarter of 2001 and 2000, revenue from Department of Defense
(the "DoD") customers represented approximately 75% and 73% of revenue,
respectively, and 72% of revenue for both the first six months of 2001 and 2000.
Revenue earned from one significant DoD contract represented approximately 21%
and 13% of revenue in the second quarter of 2001 and 2000, respectively, and
approximately 20% and 14% of revenue in the first six months of 2001 and 2000,
respectively.
Note 8. Sale of Tactical Communications Group
---------------------------------------------
On June 1, 2001, the company completed the sale of its Tactical Communications
Group (the "TCG" or the "Group") and the transfer of related employees and
assets. The Group developed and sold communications software for defense
applications. In 2000, TCG recorded revenue of $2.3 million and an after-tax
loss of $0.9 million, including a $0.4 million impairment charge recorded in the
fourth quarter of 2000. For the first six months of 2001, TCG recorded revenue
of approximately $0.8 million and a loss of $0.5 million. The sale resulted in a
net loss of $0.2 million, shown as "Other expense" on the Statements of
Operations. Proceeds from the transactions were $0.1 million in cash and a
$50,000 note receivable due one year from the date of sale.
11
Note 9. Stock Plans
-------------------
On January 30, 2001, the company's shareholders approved the 2000 Employee Stock
Purchase Plan (the "ESPP"). The ESPP is designed to give eligible employees an
opportunity to purchase common stock of the company through accumulated payroll
deductions. The purchase price of the stock is equal to 85% of the fair market
value of a share of common stock on the first day or last day of each three-
month offering period, whichever is lower. All employees of the company or
designated subsidiaries who customarily work at least 20 hours per week and do
not own five percent or more of the company's common stock are eligible to
participate in the purchase plan. A total of 800,000 shares have been reserved
for issuance under the ESPP. The program commenced in May 2001.
During the second quarter of 2001, the Board of Directors approved the Executive
Long Term Incentive Program (the "ELTIP"), implemented under the provisions of
the shareholder approved 2000 Incentive Plan. The ELTIP provides incentives to
program participants through a combination of stock options and restricted stock
grants which vest fully in seven years. The ELTIP allows for accelerated vesting
based on the company's achievement of specified financial performance goals.
During the second quarter of 2001, the company granted under this plan stock
options totaling 750,000 shares of common stock at fair market value and granted
121,000 shares of restricted common stock with approximately $1.1 million of
compensatory value to be amortized over the vesting period of the grant.
Item 2. Management Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Total revenue decreased 7.1% to $50.6 million in the second quarter of 2001
compared with $54.4 million in the second quarter of 2000. For the first six
months of 2001, total revenue decreased slightly to $99.2 million compared with
$102.2 million in the first six months of 2000. The comparison of second quarter
revenue on a year-over-year basis is affected by two non-recurring items. First,
in the second quarter of 2000, the company made a one-time $4.1 million purchase
and resale of equipment to a major customer. Second, the company has changed its
contractual relationship with two major customers. With these changes, slightly
more than $2 million per quarter, or approximately $5 million for the first six
months of 2000, of low margin work performed by subcontractors no longer flows
through the company's operating results as revenue and cost of sales.
Analytically excluding the effect of the non-recurring items, in order to
understand the trend in defense services work, revenue increased 4.6% for the
second quarter of 2001 when compared with the same quarter a year ago, and 6.5%
for the first six months of 2001 compared with the same period last year. These
increases reflect sales growth in government information technology sectors.
Contract revenue for the Systems and Services Segment decreased 4.8% to $45.2
million in the second quarter of 2001 compared with $47.4 million in the same
period last year. For the first six months of 2001 and 2000, contract revenue
was $87.5 million and $88.6 million, respectively. Excluding the non-recurring
items discussed above, Systems and Services revenue increased 9.3% in the second
quarter of 2001 compared with the same quarter a year ago, and 10.1% for the
first six months compared with the same period last year. The increase came from
higher defense sector revenue in acquisition and logistics program support
services and systems engineering services, along with higher revenue from
federal civilian agencies.
Product sales decreased 22.7%, to $5.4 million in the second quarter of 2001
compared with $7.0 million in the same period of 2000. For the first six months
of 2001 and 2000, product revenue was
12
$11.7 million and $13.6 million, respectively. Encoder Division sales decreased
to $2.7 million in the second quarter of 2001 from $4.8 million for the same
period in 2000. For the first six months of 2001 and 2000, Encoder Division
revenue was $6.2 million and $9.3 million, respectively. The Encoder Division
has been significantly affected by the current economic downturn in capital
equipment manufacturing. Order rates for the Encoder Division have fallen
approximately 45% from levels a year ago, stabilizing between $0.8 million and
$0.9 million per month in the second quarter of 2001. Currently, there is no
indication of improvement. The company expects the lower levels of revenue to
continue for the balance of 2001.
Metrigraphics Division sales increased 24.0% to $2.7 million in the second
quarter of 2001 compared with $2.2 million in the second quarter of 2000, and
27.3% to $5.5 million in the first six months of 2001 compared with $4.3 million
in the first six months of 2000. Medical electronics customers contributed to
growth in the first and second quarters of 2001. Inkjet printer cartridge sales
also grew in the first quarter of 2001.
Total gross margin was $6.9 million and $7.2 million in the second quarter of
2001 and 2000, respectively, representing 13.6% and 13.3% of total revenue in
the second quarter of 2001 and 2000, respectively. For the first six months of
2001, total gross margin was $13.7 million, or 13.8% of total revenue, compared
with $12.8 million, or 12.5% of total revenue for the first six months of 2000.
Gross margin on contract revenue was $5.8 million and $5.3 million for the
second quarter of 2001 and 2000, respectively, representing 12.7% and 11.2% of
contract revenue in the second quarter of 2001 and 2000, respectively. For the
first six months of 2001, contract revenue gross margin was $10.8 million, or
12.4% of total contract revenue, compared with $9.1 million, or 10.3% of
contract revenue for the first six months of 2000. In the second quarter and the
first six months of 2001, the increase in gross margin when compared with the
same periods last year, was due to improved contract pricing, a mix shift toward
higher gross margin time and materials work and control of overhead costs.
Second quarter 2001 results included incremental loss provisions of
approximately $1.2 million when compared to the same period a year ago,
primarily related to the Colorado project (see Note 2). These provisions were
fully offset by $1.2 million of contract close out credits in the second quarter
of 2001. While the company believes it has reasonably estimated and provided for
the costs to complete the Colorado contract, estimates of project costs will
continue to be updated and changes in estimates provided for, as necessary, in
each reporting period. Accordingly, there can be no assurances that the actual
costs on the project will not differ materially from current estimates.
In the second quarter of 2001 and 2000, gross margin on product sales was $1.1
million and $1.9 million, respectively, representing 21.1% and 27.3% of product
sales for the second quarter of 2001 and 2000, respectively. Gross margin on
product sales was $2.9 million and $3.6 million for the first six months of 2001
and 2000, respectively, representing 24.7% and 26.6% of product sales for the
first six months of 2001 and 2000, respectively. The decrease in the gross
margin resulted from the decline in Encoder revenue. The Encoder Division gross
margin was at break-even in the second quarter of 2001, down from $1.1 million,
or 22.4%, in the second quarter of 2000. For the first six months of 2001 and
2000, Encoder gross margin was $0.3 million and $2.0 million, respectively,
representing 4.2% and 21.4%, of Encoder revenue for the first six months of 2001
and 2000, respectively. While the company has taken actions to reduce costs,
they have not fully offset the lower revenue. The company continues to evaluate
the need for further action.
13
Gross margin percentage for the Metrigraphics Division was 43.8% for the second
quarter of 2001, up from 38.3% for the same quarter last year. For the first six
months of 2001 and 2000, Metrigraphics gross margin was $2.6 million and $1.7
million, respectively, representing 47.9% and 38.9%, of Metrigraphics revenue
for the first six months of 2001 and 2000, respectively. The increase resulted
entirely from higher revenue, benefiting from leverage on existing fixed
overhead costs.
Operating expenses, which include selling, engineering and administrative costs,
decreased slightly to $4.1 million in the second quarter of 2001 compared with
$4.2 million for the same period in 2000. For the first six months of 2001 and
2000, operating expenses were $8.5 million and $8.3 million, respectively. As
in the first quarter of 2001, the company has continued with a planned increase
in sales and marketing activities and expense. These increases were fully offset
by lower general and administrative expenses.
On June 1, 2001, the company completed the sale of its Tactical Communications
Group (the "TCG" or the "Group") and the transfer of related employees and
assets. The Group developed and sold communications software for defense
applications. In 2000, TCG recorded revenue of $2.3 million and an after tax-
loss of $0.9 million, including a $0.4 million impairment charge recorded in the
fourth quarter of 2000. For the first six months of 2001, TCG recorded revenue
of approximately $0.8 million and a loss of $0.5 million. The sale resulted in a
net loss of $0.2 million, shown as "Other expense" on the Statements of
Operations. Proceeds from the transactions were $0.1 million in cash and a
$50,000 note receivable, due in one year from the date of sale.
Net interest expense was $0.3 million and $0.5 million for the second quarter
of 2001 and 2000, respectively, and $0.5 million and $1.1 million for the first
six months of 2001 and 2000, respectively, reflecting lower average debt levels
and interest rates.
Income tax expense for the second quarter of 2001 and 2000 was $0.9 million and
$1.0 million, respectively, representing 41% of pre-tax income in both quarters.
For the first six months of 2001 and 2000, income tax expense was $1.9 million
and $1.4 million, respectively, also representing 41% of pre-tax income in both
periods.
In June 1999, the company completed the sale of its previously discontinued
Telecommunications Fraud Control business for $1.7 million plus royalties.
Royalty income of $62,000 and $0.2 million, after taxes, was recognized in the
first six months of 2001 and 2000, respectively. The company may benefit
modestly from future royalty payments through July 31, 2002, up to a cap of $0.9
million, net of taxes. These receipts will be recorded as gain from discontinued
operations, after deducting taxes, when received.
The company's total employment at June 30, 2001 was 1,520, up from 1,504 at
December 31, 2000.
The company's funded backlog was $102.4 million at June 30, 2001, up from $89.8
million at December 31, 2000. A portion of the company's backlog is based on
annual purchase contracts. The amount of backlog as of any date can be affected
by the timing of order receipts and associated deliveries.
14
Liquidity and Capital Resources
Cash provided by continuing operations in the first six months of 2001 was $10.4
million primarily resulting from decreased accounts receivable, positive cash
earnings and an income tax refund of $2.2 million partially offset by increased
unbilled expenditures and fees on contracts in process and decreased other
accrued expenses and accounts payable. Cash used for continuing operations in
the first six months of 2000 was $7.5 million resulting from increased
receivables and unbilled expenditures and fees on contracts in process, and
decreased accounts payable, partially offset by positive cash earnings and
increased accrued payroll and employee benefits.
Cash used for investing activities was $1.4 million and $1.1 million in the
first six months of 2001 and 2000, respectively, related to the purchase of
property, plant and equipment.
At June 30, 2001, there was no outstanding balance under the Amended Revolver
and the company had $20.0 million of unused credit line available (see Note 5).
The company has a 10-year mortgage loan (the "Mortgage") on the company's real
estate, with $9.5 million outstanding at June 30, 2001. Interest on the Mortgage
accrues at the rate of LIBOR plus 2.5%. The agreement requires quarterly
principal payments of $125,000 beginning on August 1, 2000, with a final payment
of $5.0 million in June 2010. The interest rate on the Mortgage was 7.4% on June
30, 2001.
The company's prospective cash flows are subject to certain trends, events and
uncertainties, including demands for capital to support growth, economic
conditions, government payment practices and contractual matters. The company's
capital expenditures are expected to be in the range of $5 million in 2001,
primarily for technology advancements, facilities and infrastructure
improvements and capacity expansion in support of growth and operational
performance enhancement.
As a defense contractor, the company is subject to many levels of audit and
review, including the Defense Contract Audit Agency, the Inspector General, the
Defense Criminal Investigative Service, the General Accounting Office, the
Department of Justice and Congressional Committees. Both related to and
unrelated to its defense industry involvement, the company is, from time to
time, involved in audits, lawsuits, claims, administrative proceedings and
investigations, and accrues for liabilities associated with these activities, if
any, for which the company considers it probable that future expenditures will
be made and for which such expenditures can be reasonably estimated. In
management's opinion, the outcome from such audits and other matters discussed
above is not expected to have a material adverse effect on the company's
financial position or results of operations.
On October 26, 2000, the United States Attorney's Office announced the
indictment of two former company employees for conspiracy to defraud the United
States Air Force. On July 9, 2001, one of the former employees pled guilty to
several of the charges. The government's investigation of the second former
employee is ongoing. The United States Attorney's Office has informed the
company that it is not a target of the investigation. Separately, the United
States Attorney's Office is investigating certain company activity and billing
transactions from prior years. The company does not know, at this time, what
financial effects, if any, may result to the company from these matters.
The company's need for, cost of, and access to funds are dependent on future
operating results, as well as conditions external to the company. The company
believes that its current assets, cash flows from operations and available lines
of credit are sufficient to support its normal operations and capital
requirements for the foreseeable future.
15
Forward-Looking Information
Safe harbor statements under the Private Securities Litigation Reform Act of
1995: Some statements contained or implied in this quarterly report which are
not historical fact such as financial forecasts contain forward-looking
information. These statements may be identified by forward-looking words such as
"expect," "look," "believe," "anticipate," "may," "will" and other forward-
looking terminology. Such statements are subject to risks and uncertainties
that could cause actual results to differ materially, including uncertainties
regarding contractual requirements, actions by customers and actual costs to
complete; federal budget matters; government contracting risks, competitive
market conditions; customer requirements, schedules and related funding;
technological change; uncertainty of future financing; overall economic factors;
ability to successfully complete and integrate acquisitions and other matters.
These factors are discussed in more detail in the company's Annual Report on
Form 10-K for the year ended December 31, 2000. The company assumes no
obligation to update any forward-looking information.
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PART II. OTHER INFORMATION
Item 6. (a) Exhibits
10.15 Third Amendment to Loan and Security Agreement dated as of June 30,
2001 by and between Dynamics Research Corporation and Brown Brothers
Harriman & Co. and First Massachusetts Bank, N.A., f/k/a Family Bank,
FSB.
Item 6. (b) Reports on Form 8-K
None
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNAMICS RESEARCH CORPORATION
(Registrant)
Date: August 10, 2001 By: /s/ David Keleher
--------------------
David Keleher
Vice President and Chief Financial Officer
18