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 September 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
--------------------------------------------------------------
(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 November 5, 2001 was 7,907,783 shares.
DYNAMICS RESEARCH CORPORATION
INDEX
Page
Part I Financial Information Number
------
Item 1.Financial Statements
Consolidated Balance Sheets -
September 30, 2001 and December 31, 2000 3
Consolidated Statements of Operations -
Three Months Ended September 30, 2001 and
September 30, 2000 4
Consolidated Statements of Operations -
Nine Months Ended September 30, 2001 and
September 30, 2000 5
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2001 and
September 30, 2000 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13
Part II. Other Information
Item 6.Exhibits and Reports on Form 8-K 17
Signature 18
2
PART I. FINANCIAL INFORMATION
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars except share and per share data)
(unaudited)
Assets September 30, 2001 December 31, 2000
------ ------------------ -----------------
Current assets
Cash and cash equivalents $ 9,317 $ 527
Receivables, net of allowances of $1,413 in 2001 and $1,096 in 2000 25,111 31,967
Unbilled expenditures and fees on contracts in process 24,605 24,633
Inventories 3,420 3,208
Prepaid expenses and other current assets 1,166 3,926
------------------- ------------------
Total current assets 63,619 64,261
Net property, plant and equipment 14,521 14,441
------------------- ------------------
Total assets $ 78,140 $ 78,702
=================== ==================
Liabilities and Stockholders' Equity
------------------------------------
Current liabilities
Notes payable $ - $ 5,784
Current portion of long-term debt 500 500
Accounts payable 12,039 12,843
Accrued payroll and employee benefits 10,565 9,901
Other accrued expenses 4,032 5,711
Current deferred income taxes 6,492 4,575
------------------- ------------------
Total current liabilities 33,628 39,314
------------------- ------------------
Long-term debt 8,875 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 - 9,216,727 shares in 2001 and 8,980,945 in 2000 922 898
Treasury stock - 1,379,426 shares in 2001
and 2000, at par value (138) (138)
Capital in excess of par value 30,252 28,461
Unearned compensation (1,037) -
Retained earnings 4,789 68
------------------- ------------------
Total stockholders' equity 34,788 29,289
------------------- ------------------
Total liabilities and stockholders' equity $ 78,140 $ 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 data)
(unaudited)
Three Three
Months Ended Months Ended
September 30, 2001 September 30, 2000
------------------ ------------------
Revenue
Contract revenue $ 45,091 $ 41,643
Product sales 5,154 6,733
------------------ ------------------
Total revenue 50,245 48,376
Costs and expenses
Cost of contract revenue 38,655 37,429
Cost of product sales 3,906 4,690
Selling, engineering and administrative expenses 4,188 3,556
------------------ ------------------
Total operating costs and expenses 46,749 45,675
Operating income 3,496 2,701
Interest expense, net 144 417
------------------ ------------------
Income before provision for income taxes 3,352 2,284
Provision for income taxes 1,374 934
------------------ ------------------
Net income $ 1,978 $ 1,350
================== ==================
Earnings per share
------------------
Net income per common share - basic $ 0.26 $ 0.18
Net income per common share - diluted $ 0.24 $ 0.17
Weighted average shares outstanding
-----------------------------------
Weighted average shares outstanding - basic 7,693,060 7,578,859
Dilutive effect of options 499,300 270,900
------------------ ------------------
Weighted average shares outstanding - diluted 8,192,360 7,849,759
================== ==================
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 data)
(unaudited)
Nine Nine
Months Ended Months Ended
September 30, 2001 September 30, 2000
------------------ ------------------
Revenue
Contract revenue $ 132,631 $ 130,245
Product sales 16,837 20,361
------------------ ------------------
Total revenue 149,468 150,606
Costs and expenses
Cost of contract revenue 115,367 116,889
Cost of product sales 12,710 14,689
Selling, engineering and administrative expenses 12,665 11,834
------------------ ------------------
Total operating costs and expenses 140,742 143,412
Operating income 8,726 7,194
Other expense 193 -
Interest expense, net 636 1,533
------------------ ------------------
Income from continuing operations before provision
for income taxes 7,897 5,661
Provision for income taxes 3,238 2,319
------------------ ------------------
Income from continuing operations 4,659 3,342
Gain from discontinued operations, net of tax 62 206
------------------ ------------------
Net income $ 4,721 $ 3,548
================== ==================
Earnings per share
------------------
Per common share - basic $ 0.61 $ 0.44
Income from continuing operations 0.01 0.03
Gain from discontinued operations, net of tax ------------------ ------------------
$ 0.62 $ 0.47
Net income ================== ==================
Per common share - diluted
Income from continuing operations $ 0.59 $ 0.43
Gain from discontinued operations, net of tax 0.01 0.03
------------------ ------------------
Net income $ 0.60 $ 0.46
================== ==================
Weighted average shares outstanding
-----------------------------------
Weighted average shares outstanding - basic 7,640,135 7,523,033
Dilutive effect of options 257,949 268,030
------------------ ------------------
Weighted average shares outstanding - diluted 7,898,084 7,791,063
================== ==================
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)
Nine Nine
Months Ended Months Ended
September 30, 2001 September 30, 2000
------------------ ------------------
Cash provided by operations
Net income $ 4,721 $ 3,548
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 45 114
Depreciation and amortization 2,497 2,921
Deferred income taxes 1,917 2,413
--------------- --------------
9,311 8,790
--------------- --------------
Cash provided by (used for) working capital
Receivables 6,240 (2,926)
Unbilled expenditures and fees on contracts in process (610) 1,459
Inventories (212) (311)
Prepaid expenses and other current assets 2,760 37
Accounts payable (804) (2,761)
Accrued payroll and employee benefits 664 1,477
Other accrued expenses (579) (1,483)
--------------- --------------
7,459 (4,508)
--------------- --------------
Net cash provided by continuing operations 16,770 4,282
Net cash provided by (used for) discontinued operations 62 (35)
--------------- --------------
Cash provided by operating activities 16,832 4,247
--------------- --------------
Cash provided by (used for) investing activities
Proceeds from sale of assets 100 -
Additions to property, plant and equipment (2,716) (1,599)
--------------- --------------
Net cash used for investing activities (2,616) (1,599)
--------------- --------------
Cash provided by (used for) financing activities
Net borrowings (repayments) under revolving credit agreement (5,784) 4,696
Repayment of working capital agreement - (19,700)
Proceeds from mortgage agreements - 17,500
Repayment of interim mortgage - (7,500)
Principal payment under 10-year mortgage (375) (125)
Proceeds from stock plans 733 742
--------------- --------------
Net cash used for financing activities (5,426) (4,387)
--------------- --------------
Net increase (decrease) in cash and cash equivalents 8,790 (1,739)
Cash and cash equivalents at the beginning of the period 527 2,267
--------------- --------------
Cash and cash equivalents at the end of the period $ 9,317 $ 528
=============== ==============
Supplemental information
Cash paid for interest $ 707 $ 1,785
Cash paid for taxes $ 1,065 $ 253
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 nine-month periods ended September 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):
----------------------------------------------------------------------------
September 30, 2001 December 31, 2000
------------------ -----------------
Work in process $ 342 $ 726
Raw materials and subassemblies 3,078 2,482
------------------ -----------------
Total inventories $ 3,420 $ 3,208
================== =================
7
Property, Plant and Equipment
-----------------------------
Property, plant and equipment stated at cost (in thousands of dollars):
------------------------------------------------------------------------------
September 30, 2001 December 31, 2000
------------------ -----------------
Land $ 1,126 $ 1,126
Building 8,435 7,774
Machinery and equipment 46,662 45,133
Leasehold improvements 2,723 2,551
------------------ -----------------
Total property, plant and equipment 58,946 56,584
Less accumulated depreciation and
Amortization 44,425 42,143
------------------ -----------------
Net property, plant and equipment $ 14,521 $ 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 has no derivative instruments or hedging
activities.
In June 2001, the FASB issued SFAS No. 141, Business Combinations and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method. It also specifies the types of acquired intangible assets
required to be recognized and reported separately from goodwill. SFAS No. 142
will require that goodwill and certain intangibles no longer be amortized, but
instead be tested for impairment at least annually. SFAS No. 142 is required to
be applied starting with fiscal years beginning after December 15, 2001. 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 currently has no goodwill or other intangible assets recorded.
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,
41,800 options were excluded from the calculation of diluted earnings per share
in the first nine months of 2001. During the third quarter and first nine months
of 2000, 62,800 and 82,800 options, respectively, 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
8
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 that
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 was deployed in the second
quarter of 2001. During the second quarter of 2001, delays were encountered in
the completion of the youth corrections functionality, the final phase of the
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 until completion. 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 six months of
2001, the company expended the remaining restructuring reserve, primarily for
continuation pay for employees who had left the company prior to December 31,
2000.
During the second and third quarters of 2001, the company provided $0.3 million
for involuntary severance costs for approximately 45 employees in the Encoder
Division. At September 30, 2001, the remaining balance of this provision was
$0.2 million. These costs will be expended in the fourth quarter of 2001,
primarily for continuation pay.
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 nine 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%.
9
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 September 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 September
30, 2001, were 6.0% under the prime rate option and 4.59% under the 90-day LIBOR
rate option.
The company has a 10-year mortgage loan (the "Mortgage") on the company's real
estate, with $9.4 million outstanding at September 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,
under the 90-day LIBOR option elected at July 16, 2001, was 6.3% on September
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 September 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. Both former employees have pleaded guilty to several of the
charges and are scheduled to be sentenced in February 2002. 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.
10
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
September 30, 2001 and September 30, 2000 are as follows (in thousands of
dollars):
-------------------------------------------------------------------------------
Identifiable
Systems Continuing
and Metri- Operations
Services Encoder Graphics Corporate Total
-----------------------------------------------------------------------------
September 30, 2001
Net sales $ 45,091 $ 2,242 $ 2,912 $ - $ 50,245
Operating income (loss) 3,039 (645) 1,102 - 3,496
Identifiable assets at
September 30, 2001 52,953 5,292 3,568 16,327 78,140
September 30, 2000
Net sales $ 41,643 $ 4,074 $ 2,659 $ - $ 48,376
Operating income 1,515 203 983 - 2,701
Identifiable assets at
September 30, 2000 55,307 5,925 3,257 9,379 73,868
Summarized financial information by business segment for the nine months ended
September 30, 2001 and September 30, 2000 are as follows (in thousands of
dollars):
------------------------------------------------------------------------------
Identifiable
Systems Continuing
and Metri- Operations
Services Encoder Graphics Corporate Total
---------------------------------------------------------------------------
September 30, 2001
Net sales $132,631 $ 8,459 $ 8,378 $ - $ 149,468
Operating income (loss) 7,242 (1,492) 2,976 - 8,726
Identifiable assets at
September 30, 2001 52,953 5,292 3,568 16,327 78,140
September 30, 2000
Net sales $130,245 $13,409 $ 6,952 $ - $ 150,606
Operating income 4,130 1,106 1,958 - 7,194
Identifiable assets at
September 30, 2000 55,307 5,925 3,257 9,379 73,868
Net sales and operating income (loss) are presented after the elimination of
intersegment transactions, which are not material.
During the third quarter of 2001 and 2000, revenue from Department of Defense
(the "DoD") customers represented approximately 73% and 74% of revenue,
respectively, and approximately 72% and 73% of revenue for the first nine months
of 2001 and 2000, respectively. Revenue earned from one significant
11
DoD contract represented approximately 20% and 18% of revenue in the third
quarter of 2001 and 2000, respectively, and approximately 20% and 15% of
revenue in the first nine 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.
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 and as of
September 30, 2001, 30,282 shares have been issued through the plan.
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. In the
third quarter of 2001, the company recognized approximately $45,000 of
compensation expense under this plan.
Note 10. Supplemental Information
---------------------------------
Direct margin as a percentage of revenue (in thousands of dollars):
-------------------------------------------------------------------
Quarter ended Nine months ended
September 30, September 30,
2001 2000 2001 2000
---------- ------------ ------------- -----------
Systems and services direct margin $19,081 $ 16,723 $ 54,553 $ 50,431
As a percentage of contract revenue 42.3% 40.2% 41.1% 38.7%
Total company direct margin $22,682 $ 21,586 $ 66,473 $ 64,644
As a percentage of total revenue 45.1% 44.6% 44.5% 42.9%
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Total revenue increased 3.9% to $50.2 million in the third quarter of 2001
compared with $48.4 million in the third quarter of 2000. For the first nine
months of 2001, total revenue decreased slightly to $149.5 million compared with
$150.6 million in the first nine months of 2000. During 2001, the company
changed its contractual relationship with two major customers, moving from a
prime contractor position to one as a subcontractor. Further, work that was
previously subcontracted through the company is now directed to other companies
which were awarded the prime contracts. As a result of these changes, $2.7
million in the third quarter, and approximately $7.5 million in the first nine
months of 2000, of low margin work performed by subcontractors to the company no
longer flows through the company's operating results as revenue and cost of
sales in 2001. The comparison of the nine-month period revenue on a year-over-
year basis is also affected by a one-time $4.1 million purchase and resale of
equipment to a major customer in the second quarter of 2000. Analytically
excluding the effect of the non-recurring items, in order to understand the
trend in defense services work, revenue increased 10.0% and 7.5% in the third
quarter and the first nine months of 2001, respectively, compared with the same
periods last year. These increases reflect sales growth in government
information technology sectors.
Contract revenue for the Systems and Services Segment increased 8.3% to $45.1
million in the third quarter of 2001 compared with $41.6 million in the same
period last year. For the first nine months of 2001 and 2000, contract revenue
was $132.6 million and $130.2 million, respectively. Excluding the non-
recurring items discussed above, Systems and Services revenue increased 15.8%
and 11.8% for the third quarter and the first nine months of 2001, respectively,
compared with the same period last year.
The terrorist attacks of September 11, 2001 have greatly impacted the company's
defense department customers, which represent approximately 72% of the company's
business. The company believes that significant workload impacts of the
increased operational activity have yet to be felt by the company and, for the
most part, the company's offices are operating at near normal workload levels at
the present time. The closure of several bases during the week of September 11,
2001 resulted in the loss of approximately $0.3 million in revenues during the
third quarter of 2001.
Product sales for the Precision Manufacturing Group, which consists of the
Encoder and Metrigraphics Divisions, decreased $1.6 million to $5.2 million in
the third quarter of 2001 compared with the same period of 2000. For the first
nine months of 2001 and 2000, product revenue was $16.8 million and $20.4
million, respectively. Encoder Division sales decreased to $2.2 million in the
third quarter of 2001 from $4.1 million for the same period in 2000. For the
first nine months of 2001 and 2000, Encoder Division revenue was $8.5 million
and $13.4 million, respectively. The Encoder Division has been significantly
affected by the current economic downturn in capital equipment manufacturing.
Currently, there is no indication of improvement, and the company expects the
lower levels of revenue to continue at least into the first quarter of 2002.
Metrigraphics Division sales increased 9.5% to $2.9 million in the third quarter
of 2001 compared with $2.7 million in the third quarter of 2000, and 20.5% to
$8.4 million in the first nine months of 2001 compared with $7.0 million in the
first nine months of 2000. Medical electronics customers contributed to growth
in the third quarter and first nine months of 2001. The company remains cautious
about the potential for further economic weakness negatively impacting the
Encoder and Metrigraphics Divisions.
13
Total gross margin was $7.7 million and $6.3 million in the third quarter of
2001 and 2000, respectively, representing 15.3% and 12.9% of total revenue in
the third quarter of 2001 and 2000, respectively. For the first nine months of
2001, total gross margin was $21.4 million, or 14.3% of total revenue, compared
with $19.0 million, or 12.6% of total revenue for the first nine months of 2000.
Gross margin on contract revenue was $6.4 million and $4.2 million for the third
quarter of 2001 and 2000, respectively, representing 14.3% and 10.1% of contract
revenue in the third quarter of 2001 and 2000, respectively. For the first nine
months of 2001, contract revenue gross margin was $17.3 million, or 13.0% of
total contract revenue, compared with $13.4 million, or 10.3% of contract
revenue for the first nine months of 2000. In the third quarter and the first
nine 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. Time
and materials contracts represent more than 50% of total systems and services
revenue. The results for the first nine months of 2001 included incremental loss
provisions of approximately $0.6 million when compared to the same period a year
ago, primarily related to the Colorado project (see Note 2). These provisions
were more than 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 until completion. Accordingly, there can
be no assurances that the actual costs on the project will not differ materially
from current estimates.
In the third quarter of 2001 and 2000, gross margin on Precision Manufacturing
Group sales was $1.2 million and $2.0 million, respectively, representing 24.2%
and 30.3% of product sales for the third quarter of 2001 and 2000, respectively.
Gross margin on product sales was $4.1 million and $5.7 million for the first
nine months of 2001 and 2000, respectively, representing 24.5% and 27.9% of
product sales for the first nine months of 2001 and 2000, respectively. The
decrease in gross margin resulted from the decline in Encoder revenue.
Operating expenses, which include selling, engineering and administrative costs,
increased to $4.2 million in the third quarter of 2001 compared with $3.6
million for the same period in 2000. For the first nine months of 2001 and 2000,
operating expenses were $12.7 million and $11.8 million, respectively. In the
third quarter of 2001, the company has continued with a planned increase in
sales and marketing activities and expense. The company's planned investment in
marketing and sales activities is expected to add $0.3 million to total
operating expenses in the fourth quarter of 2001.
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 $0.1 million and $0.4 million for the third quarter of
2001 and 2000, respectively, and $0.6 million and $1.5 million for the first
nine months of 2001 and 2000, respectively, reflecting lower average debt levels
and interest rates, and the net benefit of interest income on cash balances.
14
Income tax expense for the third quarter of 2001 and 2000 was $1.4 million and
$0.9 million, respectively. For the first nine months of 2001 and 2000, income
tax expense was $3.2 million and $2.3 million, respectively. Income taxes were
provided for at a rate of 41% for all periods presented.
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 nine 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.
Recent increases in the company's stock price have resulted in an increase in
the number of employee stock options counted as outstanding common equivalent
shares and included in the dilutive effect of options for the purpose of
computing diluted earnings per share. Outstanding common equivalent shares
increased from 7.8 million in the third quarter of 2000 to 8.2 million in the
third quarter of 2001. Outstanding common equivalent shares were 7.9 million and
7.8 million for the first nine months of 2001 and 2000, respectively.
The company's total employment at September 30, 2001 was 1,508, up from 1,504 at
December 31, 2000.
The company's funded backlog was $94.6 million at September 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.
Liquidity and Capital Resources
Cash provided by continuing operations in the first nine months of 2001 was
$16.8 million primarily resulting from decreased accounts receivable, positive
cash earnings, an income tax refund of $2.2 million and increased deferred
income taxes, partially offset by decreased accounts payable and other accrued
expenses, and increased unbilled expenditures and fees on contracts in process.
Cash provided by continuing operations in the first nine months of 2000 was $4.3
million resulting from positive cash earnings, decreased unbilled expenditures
and fees on contracts in process, and increased deferred income taxes and
accrued payroll and employee benefits, partially offset by decreased accounts
payable and increased accounts receivable.
Cash used for investing activities was $2.6 million and $1.6 million in the
first nine months of 2001 and 2000, respectively, related to the purchase of
property, plant and equipment.
At September 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 $9.4 million outstanding at September 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,
15
with a final payment of $5.0 million in June 2010. The interest rate on the
Mortgage, under the 90-day LIBOR option elected at July 16, 2001, was 6.3% on
September 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 $4 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. Both former employees have pleaded guilty to several of the
charges and are scheduled to be sentenced in February 2002. 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. Based on its
present operating plans and budgets for existing operations, 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.
Forward-Looking Information
Safe harbor statements under the Private Securities Litigation Reform Act of
1995: Some statements contained or implied in this quarterly report that 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 and actual
results could differ materially from such statements. These risks and
uncertainties are related to 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. In addition, material
risks and uncertainties have resulted from the terrorist attacks of September
11, 2001 and the commencement of hostile activities resulting therefrom.
The company assumes no obligation to update any forward-looking information.
16
PART II. OTHER INFORMATION
Item 6. (a) Exhibits
None
(b) Reports on Form 8-K
None
17
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: November 13, 2001 By: /s/ David Keleher
--------------------
David Keleher
Vice President and Chief Financial Officer
18