Dynamics Research Corporation Form 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended December 31, 2004 |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period
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Commission file number 000-02479
Dynamics Research Corporation
(Exact Name of Registrant as Specified in Its Charter)
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Massachusetts
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04-2211809 |
(State or other jurisdiction of
incorporation or organization) |
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(I.R.S. Employer
Identification No.) |
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60 Frontage Road
Andover, Massachusetts
(Address of Principal Executive Offices) |
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01810-5498
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Registrant’s telephone number, including area code
(978) 475-9090
Securities registered pursuant to Section 12(b) of the
Act:
None
Securities registered pursuant to Section 12(g) of the
Act:
Common Stock, $0.10 par value
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 þ No o
Indicate
by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrant’s
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or
any amendment to this
Form 10-K. o
Indicate
by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange
Act). Yes þ No o.
The
aggregate market value of the registrant’s common stock,
$0.10 par value, held by nonaffiliates of the registrant as
of June 30, 2004, was $99,420,589.80 based on the reported
last sale price per share of $17.98 on that date on the Nasdaq
Stock Market. As of February 28, 2005,
8,831,922 shares of the registrant’s common stock,
$0.10 par value, were outstanding.
This Annual Report on Form 10-K for the year ended
December 31, 2004 does not include the audit report or
consent of Grant Thornton LLP, our current auditors, or KPMG
LLP, our previous auditors, and portions of Item 9A of
Part II for the reasons outlined in our filing on
Form 12b-25 made with the Securities and Exchange
Commission on March 16, 2004, and therefore, this Annual
Report on Form 10-K is incomplete until the time as such
audit reports and consents of Grant Thornton LLP and of KPMG LLP
and Item 9A of Part II are included in an amendment to
this Annual Report filed on Form 10-K/A.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the
registrant’s Proxy Statement involving the election of
directors, which is expected to be filed within 120 days
after the end of the registrant’s fiscal year, are
incorporated by reference in Part III of this Report.
DYNAMICS RESEARCH CORPORATION
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 2004
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PART I
OVERVIEW
Dynamics Research Corporation (“DRC” or the
“company”) provides information technology,
engineering, logistics and other consulting services to federal
defense, civil and state agency customers. Founded in 1955 and
headquartered in Andover, Massachusetts, DRC has approximately
1,960 employees, located throughout the United States. The
company operated through the parent corporation and its wholly
owned subsidiaries, HJ Ford Associates, Inc. (“HJ
Ford”), Andrulis Corporation (“ANDRULIS”) and
Impact Innovations Group LLC (“Impact Innovations”)
through December 31, 2004, at which time ANDRULIS and
Impact Innovations merged with and into the company. Effective
January 1, 2005, the company operates through the parent
corporation and its wholly owned subsidiary, HJ Ford.
DRC’s core capabilities are focused on information
technology, engineering and technical subject matter expertise
that pertain to the knowledge domains relevant to the
company’s core customers. More specifically, these
solutions, which are offered by the company’s Systems and
Services business segment, include design, development,
operation and maintenance of business intelligence systems,
business transformation services, defense program acquisition
management services, training and performance support systems
and services, automated case management systems and information
technology (“IT”) infrastructure services.
DRC strives to apply these processes and technologies to enhance
the performance and cost effectiveness of a variety of
mission-critical customer systems. DRC believes that one of its
distinguishing competitive features is its ability to provide
subject matter experts who work closely with specialists in
disciplines such as logistics, engineering, IT, modeling,
simulation and training systems to develop innovative solutions
to customer challenges.
The company’s business growth strategy is focused on three
national priority markets: national defense, public safety and
legislated citizen services. Within these markets there are six
strategic business areas on which the company focuses its
efforts: C4ISR (Command, control, communications, computing,
intelligence, surveillance and reconnaissance),
logistics, readiness, military space, public security and
citizen services. Because these markets address the mission
critical functions of government, we expect that they will be
funded regardless of economic cycle. The strategy leverages six
solution sets where DRC has strong competencies and a record of
meeting its customers’ most difficult challenges. These
repeatable, proven, cost effective solutions are acquisition
management services, training and performance support, business
transformation, business intelligence, IT infrastructure
services and automated case management.
DRC has an organic and acquisition growth strategy,
supplementing organic growth with the acquisition of businesses
with additional or complementary capabilities, providing access
to new customers. Consistent with this strategy, the company has
completed three business acquisitions since 2002.
The company’s other business segment, the Metrigraphics
Division, develops and produces components for original
equipment manufacturers in the computer peripheral device,
medical electronics, telecommunications and other industries.
Manufacturing core capabilities are focused on the custom design
and manufacture of miniature electronics parts that are designed
to meet ultra-high precision requirements through the use of
electroforming, thin film deposition and photolithography
technologies.
Financial data and other information about the company’s
operating segments can be found in Management’s Discussion
and Analysis of Financial Condition and Results of Operations in
Part I, Item 7 of this Annual Report on
Form 10-K, and in Note 9, “Business Segment,
Geographic, Major Customer and Related Party Information”,
of the company’s Notes to Consolidated Financial Statements
in Part II, Item 8 of this Annual Report on
Form 10-K.
Unless otherwise indicated, all financial information contained
in this Annual Report on Form 10-K refers to continuing
operations.
DRC maintains an Internet website at http://www.drc.com.
The company’s Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q and Current Reports on Form 8-K
and all amendments to these reports are available free of charge
through the company’s website by clicking on the
“Investor Relations” page and selecting “SEC
Filings”. These filings are also accessible on the
Securities and Exchange Commission’s website at
http://www.sec.gov. The company does not intend
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that the information contained on the company’s website be
deemed a part of this report or to be deemed filed with the
Securities and Exchange Commission.
MARKETS
DRC’s systems and services business, which accounted for
97.4% of revenue in 2004, is focused on providing technical and
information technology services to government customers. The
government market is composed of three sectors: defense, federal
civilian agencies, and state and local governments.
According to a report published in 2003 by Input, Inc.
(“Input”), a leading research firm specializing in the
market for government contractors, the federal market demand for
vendor-furnished information systems and services will increase
from $58.6 billion in fiscal 2004 to $80.7 billion in
fiscal 2009, a compound annual growth rate of 6.6%. The Fiscal
Year 2005 Mid-Session Review of the Federal Budget, submitted to
Congress by the U.S. Office of Management and Budget, shows
increases in the fiscal 2005 discretionary budgets for national
defense and citizen security of 7.1% and 9.7%, respectively.
The company believes that several factors are driving growth in
the defense sector of this market. First, the continued focus on
the war in Iraq is beginning to shift from short-term fixes for
physical security to programs with sustaining focus that will
rely on the application of information technology for the
improvement of processes and training. Second, the company
believes that increased reliance on contracts to supply
mission-critical services is increasing due to government
workforce ceilings and the administration’s emphasis on
outsourcing activities that are not unique to government.
The company believes the factors driving growth in the federal
civilian agency sector include homeland security needs, an
ongoing need for systems modernization, and, as in the defense
sector, government workforce ceilings. These factors have
caused, and are expected to continue to cause, federal civilian
agencies to turn to contractors on an increasing basis to fill
their needs for information technology services. The recent
elections in Iraq could also mark a shift of resources away from
military operations and renew the emphasis on Department of
Defense (“DoD”) transformation, new systems
development and systems modernization, areas where DRC is
focused.
In the state and local government sector, state and local
jurisdictions are expected to spend $44.7 billion on
information technology products and services in 2005, according
to the market research firm Gartner, Inc. Additionally, Input
projects growth rates in state and local outsourcing to reach
56% over the next five years, with an aging workforce and
outdated equipment as the primary drivers for this growth. There
is also a need for states to continue to modernize child welfare
systems and Medicare management systems, areas where DRC’s
Automated Case Management solution fits well. DRC has
considerable experience in providing information technology
expertise in the health and human services areas. The company
believes the primary driving factors driving growth in this
sector are infrastructure modernization and expansion, the
migration of information and training to web-based applications
and cost-sharing incentives to facilitate data exchange with
federal agencies, which generally have large and burdensome
caseloads. These agencies must maintain extensive records,
report program data, eliminate errors and work toward a more
responsive management. Yet the information systems of many of
these agencies are antiquated; in some cases more than twenty
years old, and have limited data interfacing and reporting
capabilities.
DRC’s Metrigraphics Division represented 2.6% of the
company’s revenue in 2004. The Division serves the
commercial original equipment manufacturers (“OEM”)
market. This market includes manufacturers of computer
peripheral devices, telecommunications and medical technology
equipment. The Division sells principally to commercial
customers.
MAJOR CUSTOMERS
The company’s 2004 contract revenue, which accounted for
97.4% of revenues, delineated by market sector, was derived
80.2% from the defense sector, 11.6% from federal civilian
agencies, 7.6% from state and local governments, and 0.6% from
other commercial customers.
Defense Sector
United States Air Force customers constituted the largest
component of DRC’s defense revenue in 2004, representing
49.0% of total revenue, while U.S. Navy revenue represented
15.9%, U.S. Army revenue represented 7.8% and revenue from
other agencies represented 5.4% of total revenue. Key
capabilities that DRC offers defense customers include business
intelligence systems, business transformation services,
acquisition management services, training and performance support
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systems and services, and IT infrastructure services. In
addition, DRC’s test equipment business develops, maintains
and validates hardware and software for complex weapons systems.
The work DRC performs for its major customers in this sector is
described below.
Aeronautical Systems Center, Air Force Materiel
Command
The Aeronautical Systems Center, headquartered at
Wright-Patterson Air Force Base in Dayton, Ohio, is responsible
for research, development, testing, evaluation and initial
acquisition of aeronautical systems and related equipment for
the Air Force. Major active programs supported include: B-2 and
B-1B bombers; C-17 airlifter; Joint Unmanned Combat Air systems
(“J-UCAS”), Reconnaissance, Special Operations
Forces, F/A-22 Raptor fighter-attack aircraft;
F-117A stealth fighter, F-15 Eagle air-to-ground
fighter aircraft; and F-16 Fighting Falcon fighter
aircraft. Through prime contracts held by the company’s HJ
Ford subsidiary, DRC provides technical and subject matter
expertise supporting a number of the offices responsible for
these programs in carrying out their mission-essential
acquisition management tasks and objectives such as product
support, information service, supply management, depot
maintenance, science and technology, test and evaluation,
information management, installations and support, and combat
support.
The services provided under this contract are subject to
re-competition in 2005. It is anticipated that the competition
will limit prime contract awards to small businesses. The
company expects to participate in the competition through its
wholly owned subsidiary, HJ Ford, as a sub-contractor to a small
business, which has qualified for this competition under the
Small Business Administration mentor-protégé joint
venture program.
Air Force Electronic Systems Center
The mission of the Air Force Electronic Systems Center
(“ESC”), headquartered at Hanscom Air Force Base,
Bedford, Massachusetts, is to serve as the Center of Excellence
for command and control and information systems to support the
Air Force war fighter in war and peace. ESC provides full
spectrum architectures, weapon systems management and technical
cognizance throughout the life cycle of communications,
intelligence, surveillance, reconnaissance and information
systems.
DRC evaluates system requirements, provides software development
and test services, integrates products into airborne and ground
weapons systems, and provides management services supporting ESC
systems program offices, including the Combat Air Forces Command
and Control, Military Satellite Communications, Joint
Surveillance Target Attack Radar, Global Command and Control,
Airborne Warning and Control Systems and Defense Information
Infrastructure offices.
DRC is the prime support contractor to the Joint Surveillance
Target Attack Radar System (“Joint STARS”) Program
Office, which has played a key role in warfare and peacekeeping
operations. The surveillance system is designed to detect,
classify and track ground targets in all weather conditions on
land or at sea within a 155-mile range. DRC supports Joint STARS
by providing advisory, engineering, logistics and program
management services. Under this program, DRC also supports the
Multi-Sensor Command and Control Aircraft System
(“MC2A”), a next-generation airborne integrated ground
surveillance system that is intended to eventually supercede
Joint STARS.
The services provided under this contract are subject to
re-competition in 2005. It is currently anticipated that the
competition will limit prime contract awards to small
businesses. DRC expects to participate in the competition as a
sub-contractor to a qualified small business.
Air National Guard
Through its work on the Guard Information Analysis Network
(“GUARDIAN”), DRC is playing a key role in the
transformation of the Air National Guard and its preparedness
for homeland defense. Initially created by DRC as a web-enabled
database, GUARDIAN is intended to fulfill a critical need for
real-time information on aircraft readiness and performance
information. In October 2004, DRC’s work on GUARDIAN was
increased by more than $5 million a year in this third year
of the company’s five-year, $36.6 million effort to
support Air National Guard activities throughout the United
States. DRC is now working to expand GUARDIAN’s
functionality so it can be used to determine and forecast
manpower resources and munitions readiness. The system is also
being converted so it is compatible with the Global Combat
Support System architecture for eventual migration to the Air
Force Portal, which is intended to integrate more than
28,000 information systems into one point of easy access.
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Office of the Undersecretary of Defense for Public
Affairs
DRC is subcontractor under a $37 million, five year
contract, of which DRC’s contract value is equal to 93% of
the total contract value. DRC provides systems engineering and
IT support services to the Office of the Undersecretary of
Defense for Public Affairs (“OASD(PA)”) Headquarters
and its field activities, including the Defense Information
School, the American Forces Information Service and the Defense
Media Center. As part of this effort, DRC maintains the
DefendAmerica web site, providing the public with timely,
reliable news about the war on terrorism and daily updates on
activities in Iraq.
Navy Trident Missile Program
For more than forty years, the company has provided services to
the United States Navy’s Strategic Systems Programs. DRC
builds specialized equipment that tests and validates the
accuracy and operability of gyroscopes and other guidance
equipment for Trident II submarine-launched ballistics
missiles. DRC develops and maintains performance, reliability
and logistics databases and management systems for the inertial
guidance instruments housed in the missile guidance systems. The
company also provides independent analysis and
reliability/availability monitoring of submarine-based inertial
navigation instruments and systems, tactical software and
electronic modules.
Air Force Depot Operations
DRC performs logistics analyses and operations for the United
States Air Force’s three domestic Air Logistics Centers at
Tinker, Robins and Hill Air Force Bases in Midwest City,
Oklahoma, Warner Robins, Georgia and Ogden, Utah, respectively.
The company provides logistics support, information technology
management and analysis, system engineering and technical
services on programs such as the B-1B, the B-2, the B-52, the
KC-135 and the E-3A aircraft repair, maintenance and upgrade
programs. DRC has installed, integrated and is providing
operational support for a customized suite of commercial
software products to improve productivity at the United States
Air Force’s landing gear maintenance, repair and overhaul
operations at Hill Air Force Base. The company also provides
support to Air Force reengineering and business process
improvement initiatives at these Air Logistics Centers.
Army Aviation/ Missile Command
DRC provides programmatic consulting, engineering and logistics
management to the Army Materiel Command and Army program
executive officers for acquisition of major weapon systems. DRC
engineers analyze and review airframe, avionics, aeromechanics
and propulsion issues for Army project managers, provide
logistics and fielding support, and prepare electronic technical
manuals for rotary and fixed-wing aircraft systems. DRC supports
other United States Army activities with acquisition logistics,
systems engineering and other related program management
services for the United States Army Aviation Center,
Tank-Automotive and Armaments Command and
Communications-Electronics Command.
Army Training
In 2003, DRC was selected, as part of the Boeing-SAIC Lead
System Integrator (“LSI”) team, under a new seven-year
blanket purchase order, to provide training software and
documentation to support the U.S. Army’s Future Combat
Systems (“FCS”) program. DRC is developing training
support packages for this vital transformation program. Services
to be provided include analysis of training requirements and
design, media selection and production of training support
products. The work is performed in Orlando, Florida,
Leavenworth, Kansas and Andover, Massachusetts. The company
believes that the award of this contract reflects recognition of
DRC’s proven instructional system development and track
record of developing training support packages.
Air Force Air Mobility Command
The Air Mobility Command, headquartered at Scott Air Force Base
in Belleville, Illinois, has as its primary mission rapid,
global mobility and sustainment for America’s armed forces.
The Command also plays an important role in providing
humanitarian support in the United States and around the world.
DRC provides technical and subject matter expertise in support
of this mission, providing program planning, decision support,
logistics analysis and financial analysis services.
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Office of Naval Research
DRC provides engineering and information technology services to
the Office of Naval Research’s Navy Manufacturing
Technology Program, known as MANTECH. This is a contract to
continue supporting MANTECH, as well as a related program known
as Lean Pathways and the Office of the Secretary of
Defense’s own MANTECH initiative. MANTECH’s mission is
to drive down costs for Navy weapons systems through the
development of and transition to advanced manufacturing
technology. DRC provides support in the annual strategic
planning process, as well as project tracking and benefits
analysis. For Lean Pathways, DRC provides a transformation
process to eliminate waste and drive enterprise-wide
improvements at small- and medium-sized suppliers. It supports
programs designed to improve value chain performance and weapon
systems affordability.
Missile Defense Agency
The Missile Defense Agency is chartered with developing the
future space-based missile defense capabilities. DRC currently
provides research on manufacturability and research services to
this client, under multi-year contracts. In December 2004, DRC
was awarded a cost plus fixed fee contract to engage a diverse
set of Ballistic Missile Defense Systems (“BMDS”)
customers to develop and utilize a unique transformation process
to eliminate waste and facilitate enterprise-wide performance
across the entities that make up the BMDS supply chain. The
42-month contract has a total ceiling amount of $25 million
and is expected to be completed in January 2008.
Navy Central HIV Program
DRC provides network and database administration, system
security and other information technology services to support
and maintain the Navy’s HIV Management System
(“HMS”) under a $4.8 million contract. The HMS
supports clinical and patient management at field, hospital and
branch clinical locations worldwide and processes approximately
10,000 records each day.
Air Force Materiel Support Group
The Weapon Systems Management Information System, a key
decision-support tool for assessing the impacts of maintenance,
parts and repair status on weapons systems availability, is the
responsibility of the Materiel Support Group (“MSG”).
DRC provides operations, maintenance and development support
services to MSG for this system.
Naval Air Systems Command
In 2000, DRC was awarded a five-year subcontract to provide
engineering and information services to the United States Naval
Air Systems Command, or NAVAIR. DRC is a primary subcontractor
to Lockheed Martin Systems Integration-Owego in assisting NAVAIR
in the modernization of naval aviation logistics information
management systems.
In 2003, DRC was one of three companies selected as a prime
contractor to support NAVAIR located at Patuxent River,
Maryland, on a new joint U.S. Navy-Air Force information
technology program. This contract supports the NAVAIR Industrial
Operations Competency, all Naval Aviation Depots, the Air Force
Materiel Command Air Logistics Centers and the Joint DoD
Manufacturing Resource Planning (“MRPII”) Program
Office. DRC’s role includes the delivery of acquisition
management, contract planning, program management, systems
engineering and risk management services as well as the
performance of advanced concepts and optimization studies. The
company believes this opportunity positions DRC to significantly
expand its business with the Naval Aviation Depots and Air
Force’s Air Logistics Centers by providing a wide range of
enterprise and business structure expertise critical to the
implementation of Maintenance, Overhaul and Repair
(“MRO”) solutions tailored to each of the
service’s MRPII programs.
Other Business Intelligence Programs
DRC applies its capabilities in the area of modeling and
simulation on many engagements, including projects for the
United States Joint Forces Command, the Defense Modeling and
Simulation Office, the Naval Aviation Warfare Center and the
Chief of Naval Education and Training.
The United States Joint Forces Command Joint Warfighting Center
orchestrates military training exercises in various world
theaters. These war games entail major geographic and functional
commands, and thousands of troops, as well as the
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supplies, vehicles and equipment to support them. Such exercises
require top-level coordination to maximize effectiveness and
avoid schedule and resource conflicts. DRC developed and is now
enhancing the Joint Training Information Management System
(“JTIMS”), a web-based application that lets
authorized personnel collaboratively plan and execute war games.
The system is designed to enable combatant commands, joint
organizations and defense agencies to align training with
assigned missions, and helps ensure missions are consistent with
organizational priorities. In 2004, DRC was asked by the
Department of Defense to continue to support JTIMS by providing
joint training information across the entire DoD under contracts
valued at $8.2 million in the aggregate.
DRC also has developed an analytical tool for the Chief of Naval
Education and Training designed to simulate the training
pipeline and help the Navy predict demand for various training
programs. The system has been designed to help the Navy
ascertain the costs and risks of potential changes to training
programs before they are made.
The United States Naval Aviation Warfare Center’s Training
Systems Division develops instructional programs for Navy pilots
and maintenance personnel. After identifying aviation readiness
as an area of concern, the Navy established a program to improve
aviator training. DRC has completed the first phase of this
program, by analyzing course content and recommending which
material is best taught in the classroom, through self-study
programs, at simulators or in flight for an initial set of
aircraft. The next phase of this program will involve extending
the analysis to additional aircraft. DRC engineers and training
specialists are also working to deconstruct and categorize
flight mission tasks. This information will be used to design
flight simulators intended to provide relevant, cost-effective
training and accurate performance measures.
Federal Civilian Agency Sector
The company believes that the United States Government federal
civilian agencies present an important growth market for DRC.
Growth in spending in this sector is being driven by the threat
of domestic terrorism, as well as a high need for modernization.
Civilian agencies must also prepare for potential changes in
their workforces. According to industry analysts, approximately
half of all federal employees engaged in program management are
estimated to be eligible for retirement over the next four
years. With its core capabilities in the design, development,
acquisition, deployment and support of high technology systems,
DRC believes it is well positioned to attract new customers in
this sector. The company’s major customer engagements in
this sector are described below.
Internal Revenue Service
The Internal Revenue Service (“IRS”) is DRC’s
largest customer in the federal civilian agency sector. In July
2000, DRC signed a five-year contract with the IRS to provide
technical and management services in four task areas:
telecommunications, information services, organizational
management and operational support. Currently, DRC’s
efforts focus on two major projects: the Compliance Research
Information System (“CRIS”), a tool that helps IRS
statisticians detect deviations that indicate potential tax
fraud; and the Integrated Collection System (“ICS”), a
tool for more timely, accurate and productive tax collection.
DRC is helping convert CRIS to a web-based platform, giving
hundreds of IRS statisticians access to the latest version
regardless of location or computer configuration. DRC is also
assisting with data warehousing, data mining and expanding the
system for more users. On the ICS project, DRC is helping the
IRS migrate from a legacy system to a Windows NT
environment, which will allow agents responsible for
apprehending tax evaders to access ICS, Microsoft Office and
e-mail from laptops while they are out in the field. The
services provided under this contract are subject to
re-competition in 2005.
Federal Deposit Insurance Corporation
DRC currently serves the Federal Deposit Insurance Corporation
(“FDIC”) through three contracts; two as prime and one
as a subcontractor. Under the Configuration and Quality
Management Staff contract DRC delivers independent software
testing, quality assurance analysis and configuration management
expertise for comprehensive, complex systems in development,
implementation, maintenance and platform migration. The
contract, awarded in 2004, includes two base years with an
additional three-year option worth up to $16.6 million.
Under the Release Management contract, awarded in 2003, DRC
supports the FDIC’s Release Management Team for all phases
of software quality assurance and independent application
compatibility testing before software is released into the
FDIC’s production computing environment. This
$8.3 million effort includes two base years and three
one-year options. Under the FDIC Internet/ Intranet Support
contract, DRC provides
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maintenance support of the FDIC Internet (www.fdic.gov),
FDIC Intranet (FDICnet) and FDICconnect (formerly FDIC BankNet)
sites with the company’s prime-teaming partner. On a weekly
basis, the team handles over 50 routine site content update and
move requests.
United States Customs Service Air and Marine Interdiction
Division
The United States Customs Service National Aviation Center in
Oklahoma City, Oklahoma trains pilots and other flight personnel
for aerial border surveillance. DRC has assisted agency flight
experts to plan standardized training systems and develop
courseware. Manuals and other paper curriculum materials were
converted to a computer-based system and integrated into an
overall instructional framework. DRC now creates electronic
training materials for use in classrooms, on stand-alone
computers, over the agency’s local area network, and via a
secure web site for distance learning.
State and Local Government Sector
DRC designs, develops, implements, maintains and supports
automated case management systems, networks and systems for
state health and human services agencies and local users of
these statewide systems. As states began to experience economic
improvement in 2004, DRC saw increased bidding opportunities
related to its case management solutions as applied to child
welfare services. Primarily as a result of a new contract with
the State of Ohio, DRC’s revenue in this sector increased
approximately $9 million in 2004 from the 2003 level. The
company believes that additional opportunities related to
DRC’s solutions in this area will bring growth to its
business in this sector in 2005. A description of DRC’s
major customer engagements in this sector follows.
State of Ohio
In May 2004, DRC was awarded a $30 million contract by the
State of Ohio to develop and implement a web-based
statewide-automated child welfare information system. The
contract has a three-and-a-half-year base period, plus a
one-year option. The new statewide system will provide a
centralized database for use by the state and county officials
to track children in their care. With real time access to
critical information, county children’s service agencies
can make informed decisions that will help protect children and
provide needed services to their families.
The Ohio system will utilize a three-tier, web-based,
model-driven architecture that uses the Java 2 Enterprise Editor
architectural specification. This represents the
state-of-the-art in case management solutions and can be easily
extended to support a state’s juvenile justice system.
DRC, with Compuware Corporation (“Compuware”) as a
major subcontractor, will provide a wide array of services,
including analysis, design, development and implementation
support. Compuware will fulfill the software development and
data conversion aspects of the program.
State of Colorado
DRC has worked with and for the State of Colorado since 1997.
DRC’s original Colorado effort was to develop an integrated
statewide child welfare and youth corrections system, known as
the Colorado Trails application. DRC continues to support this
application with database and host server maintenance and
support.
DRC provides network management and support for the Colorado
Department of Human Services network, which covers
6,300 state and county workers using various state
applications and services. In 2003, DRC converted this network
to a web portal design, now providing users with secure and
customizable intranet and Internet browser-based access to state
legacy, client server and web-based applications and services.
DRC also is performing as a key subcontracting team member to
Electronic Data Systems Corporation for the State of Colorado on
the Colorado Benefits Management System project to deploy an
integrated, statewide eligibility system that replaces six
existing legacy systems.
9
DRC’s SOLUTIONS
Systems and Services
DRC’s systems and services business provides solutions to
its customers that include the design, development, operation
and maintenance of business intelligence systems, business
transformation services, defense program acquisition management
services, training and performance support systems and services,
automated case management systems and IT infrastructure services.
Business Intelligence
DRC provides business intelligence systems and solutions that
help end users make sense of the intelligence buried in their
data systems, giving them the actionable information needed to
make critical decisions and continuously improve organizational
performance. The company’s Capability Maturity Model
(“CMM”) Level 3 and Capability Maturity Model
Integration (“CMMI”) Level 2 ratings reflect our
dedication to continuous improvement. Developed by the Software
Engineering Institute, CMM and CMMI are internationally
recognized measures to determine the level of maturity of
software development processes in an organization.
Business Transformation
DRC provides its customers with a comprehensive set of services
and tools to support rapidly transforming organizations and to
significantly improve their organizational performance.
Acquisition Management
DRC offers a complete set of business, financial, engineering
and logistic services to support the acquisition and management
of complex systems throughout their life cycle.
Training and Performance Support
DRC works with its customers to develop flexible, interactive
training and support products to enhance performance on
mission-essential operations.
Automated Case Management
DRC’s automated case management solutions combine
technology, training and performance support and business
transformation tools to increase organizational efficiency and
provide better services to our customers and their clients.
IT Infrastructure Services
DRC provides a full range of services to support the design,
development, installation, operation and management of large
complex networks and other critical IT infrastructures.
Precision Manufacturing
DRC’s Metrigraphics Division’s expertise centers on
photolithography, thin film deposition of metals and
dielectrics, and electroforming. The company believes that
Metrigraphics’ superior ability to design and manufacture
components and maintain critical tolerances is an important
driver for a wide range of high-technology applications. The
company currently applies these technologies in four distinct
applications: (1) inkjet printer cartridge nozzle plates
and hard drive test devices; (2) medical applications for
micro-flex circuits used in angioplasty and for blood testing;
(3) electrical test device for application in flexible
interposers and 3-D microstructures; and (4) devices used
in the manufacture of fiber optic system components requiring
precision alignment and 3-D microstructures.
BUSINESS DEVELOPMENT
The company believes it has a well-established record of winning
contract renewals and re-competitions based on the
company’s line management knowledge of customer needs and
DRC’s incumbent expertise.
10
The company’s business development group is charged with
identifying and winning significant new business opportunities
and supporting major competitions related to existing customers
and business. The group is centrally managed, with resources
aligned to strategic business areas and opportunities. The group
also maintains a proposal development and publication
capability. The group operates with formal processes that
monitor the pipeline of opportunities, align resources to
significant opportunities and engage line and executive
management.
GOVERNMENT CONTRACTS
The federal procurement process has changed significantly in
recent years. The traditional method of federal government
procurement had been to conduct a lengthy competitive bidding
process for each award. Today, base purchase agreements,
indefinite delivery, indefinite quantity contracts, the General
Services Administration contract and other government-wide
acquisition contract vehicles, referred to as GWACS, are the
predominant forms of contracting for information technology and
technical services. These vehicles have enabled contracting
officers to accelerate the pace of awards.
The company’s government contracts fall into one of three
categories: (1) fixed-price, including service-type
contracts, (2) time and materials, and (3) cost
reimbursable. Under a fixed-price contract, the government pays
an agreed upon price for the company’s services or
products, and the company bears the risk that increased or
unexpected costs may reduce its profits or cause it to incur a
loss. Conversely, to the extent the company incurs actual costs
below anticipated costs on these contracts, the company could
realize greater profits. Under a time and materials contract,
the government pays the company a fixed hourly rate intended to
cover salary costs and related indirect expenses plus a profit
margin. Under a cost reimbursable contract, the government
reimburses the company for its allowable direct expenses and
allowable and allocable indirect costs and pays a negotiated fee.
The company’s state contracts are generally either
fixed-price, including service-type contracts, or time and
materials. In certain instances, funding for these contracts is
subject to annual state legislative approval and to termination
provisions.
DRC’s contracts with the United States government and state
customers generally are subject to termination at the
convenience of the United States Government or the state.
However, in the event that a United States Government or state
contract is terminated by the respective government, the company
would be reimbursed for its allowable costs up to the time of
termination and would be paid a proportionate amount of the
stipulated profit attributable to the work actually performed.
Although United States Government or state contracts may extend
for several years, they are generally funded on an annual basis
and are subject to reduction or cancellation in the event of
changes in United States government or state requirements, lack
of appropriations or budgetary concerns. In addition, if the
United States Government or state curtails expenditures for
research, development and consulting activities, such
curtailment could have a material adverse impact on the
company’s revenue and earnings.
BACKLOG
The company’s funded backlog was $165.0 million at
December 31, 2004, $123.9 million at December 31,
2003 and $111.1 million at December 31, 2002. The
company expects that substantially all of its backlog at
December 31, 2004 will generate revenue during the year
ending December 31, 2005. The funded backlog generally is
subject to possible termination at the convenience of the
contracting party. The company has a number of multi-year
contracts with agencies of the United States and state
governments for which actual funding generally occurs on an
annual basis. A portion of its funded backlog is based on annual
purchase contracts and subject to annual governmental approval
or appropriations legislation, and the amount of funded backlog
as of any date can be affected by the timing of order receipts
and deliveries.
COMPETITION
The company’s systems and services business competes with a
large number of public and privately-held firms, which
specialize in providing government information technology
services.
The company also competes with the government services divisions
of large commercial information technology service firms and
with government information technology service divisions of
large defense weapons systems producers. The competition varies
depending on the customer, geographic market and required
capabilities. The United States Government’s in-house
capabilities are also, in effect, competitors, because various
agencies are able to perform services, which might
11
otherwise be performed by the company. The principal competitive
factors affecting the systems and services business are past
performance, technical competence and price.
In the precision manufacturing business, the company competes
with other manufacturers of electroform vendors and suppliers of
precision management discs, scales and reticles. The principal
competitive factors affecting the precision manufacturing
business are price, product quality and custom engineering to
meet customers’ system requirements.
RAW MATERIALS
Raw materials and components are purchased from a large number
of independent sources and are generally available in sufficient
quantities to meet current requirements.
GOVERNMENT REGULATION
Compliance with federal, state and local provisions relating to
the protection of the environment has not had and is not
expected to have a material effect upon the capital
expenditures, earnings or competitive position of the company.
As a defense contractor, the company is subject to many levels
of audit and review, including by the Defense Contract Audit
Agency, the various inspectors general, the Defense Criminal
Investigative Service, the General Accounting Office, the
Department of Justice and Congressional committees. These audits
and reviews could result in the termination of contracts, the
imposition of fines or penalties, the withholding of payments
due to us or the prohibition from participating in certain
United States government contracts for a specified period of
time. Any such action could have a material adverse effect on
our business, financial condition, results of operations and
cash flows.
Governmental awards of contracts are subject to regulations and
procedures that permit formal bidding procedures and protests by
losing bidders. Such protests may result in significant delays
in the commencement of expected contracts, the reversal of a
previous award or the reopening of the competitive bidding
process, which could have a material adverse effect upon the
company’s business, financial condition, results of
operations and cash flows.
The United States Government has the right to terminate
contracts for convenience. If the government terminated
contracts, the company would generally recover costs incurred up
to termination, costs required to be incurred in connection with
the termination and a portion of the fee earned commensurate
with the work performed to termination. However, significant
adverse effects on the company’s indirect cost pools may
not be recoverable in connection with a termination for
convenience. Contracts with state and other governmental
entities are subject to the same or similar risks.
EMPLOYEES
At December 31, 2004, the company had 1,960 employees. The
company considers its relationship with its employees to be
satisfactory.
PROPRIETARY INFORMATION
Patents, trademarks and copyrights are not materially important
to the company’s business. The United States Government has
certain proprietary rights in processes and data developed by
the company in its performance of government contracts.
The company leases approximately 293,000 square feet of
office and manufacturing space. This space is used for its
federal and state government services and manufacturing
operations as well as its marketing and engineering offices. The
company has approximately 113,000 square feet of
manufacturing and office space in three Wilmington,
Massachusetts facilities. The company’s Metrigraphics
segment utilizes a portion of this space for its activities. The
Wilmington leases expire in 2005, with options to renew the
leases to the year 2010. The remaining leased facilities consist
of offices in 24 locations across the United States. The company
owns a 135,000 square foot facility in Andover,
Massachusetts, which serves as its corporate headquarters. The
company has a mortgage, collateralized by this facility, with an
outstanding balance of $7.8 million at December 31,
2004. The remaining facilities, as well as a portion of the
corporate headquarters building, are used by the company’s
Systems and Services segment. With the exception of
approximately 50,000 square feet of
12
leased manufacturing space previously occupied by the divested
Encoder Division, the company’s leased space is fully
utilized in all material respects. The company believes that its
owned and leased properties are adequate for its present needs.
|
|
| Item 3. |
LEGAL PROCEEDINGS |
As a defense contractor, the company is subject to many levels
of audit and review from various government agencies, including
the Defense Contract Audit Agency, various inspectors general,
the Defense Criminal Investigation Service, the General
Accounting Office, the Department of Justice and other
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. The company accrues for liabilities
associated with these activities when it becomes probable that
future expenditures will be made and such expenditures can be
reasonably estimated. The company’s evaluation of the
likelihood of expenditures related to these matters is subject
to change in future periods, depending on then current events
and circumstances, which could have material adverse effects on
the company’s business, financial position, results of
operations and cash flows.
On October 9, 2003, the United States Attorney filed a
civil complaint against the company in the United States
District Court for the District of Massachusetts based in
substantial part upon the actions and omissions of two former
employees which gave rise to criminal cases against them. The
United States Attorney seeks to recover up to three times its
actual damages and penalties under the False Claims Act and
double damages and penalties under the Anti-Kickback Act and to
recover costs and interest. The company disputes the claims,
believes it has substantive defenses, and intends to vigorously
defend itself. However, the outcome of such litigation, if
unfavorable, could have a material adverse effect on the
company’s business, financial position, results of
operations and cash flows. The company and the United States
Attorney have agreed to non-binding mediation of this matter.
In 2002, a dispute arose between Genesis Tactical Group LLC
(“Genesis”), Lockheed Martin Corporation
(“Lockheed”) and DRC related to a contract for
services to Lockheed which DRC sold to Genesis in 2001. In the
first quarter of 2005, Genesis, Lockheed and the company settled
the outstanding issues related to this dispute. The settlement
did not have a material effect on the company’s business,
financial position, results of operations or cash flows.
The company has provided documents in response to a previously
disclosed grand jury subpoena issued on October 15, 2002 by
the United States District Court for the District of
Massachusetts, directing the company to produce specified
documents dating back to 1996. The subpoena relates to an
investigation, currently focused on the period from 1996 to
1999, by the Antitrust Division of the Department of Justice
into bidding and procurement activities involving the company
and several other defense contractors who have received similar
subpoenas and may also be subjects of the investigation.
Although the company is cooperating in the investigation, it
does not have a sufficient basis to predict the outcome of the
investigation. Should the company be found to have violated the
antitrust laws, the matter could have a material adverse effect
on the company’s business, financial position, results of
operations and cash flows.
|
|
| Item 4. |
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
During the quarter ended December 31, 2004, no matters were
submitted to a vote of security holders through the solicitation
of proxies or otherwise.
Executive Officers of the Registrant
The following is a list of the names and ages of the executive
officers of the company, all positions and offices held by each
person and each person’s principal occupations or
employment during the past five years. The officers were elected
by the Board of Directors and will hold office until the next
annual election of officers and their successors are elected and
13
qualified, or until their earlier resignation or removal by the
Board of Directors. There are no family relationships between
any executive officers and directors.
| |
|
|
|
|
|
| Name and Position |
|
Age | |
| |
|
| |
|
James P. Regan
|
|
|
64 |
|
| |
Chairman and Chief Executive Officer
|
|
|
|
|
|
William C. Hoover
|
|
|
55 |
|
| |
President and Chief Operating Officer
|
|
|
|
|
|
Richard A. Covel
|
|
|
58 |
|
| |
Vice President, General Counsel and Secretary
|
|
|
|
|
|
David Keleher
|
|
|
55 |
|
| |
Senior Vice President and Chief Financial Officer
|
|
|
|
|
|
Steven P. Wentzell
|
|
|
58 |
|
| |
Senior Vice President and General Manager,
Human Resources |
|
|
|
|
Mr. Regan joined the company in 1999 as President, Chief
Executive Officer and Director. He was elected Chairman in April
2001. Prior to that, he was President and Chief Executive
Officer of CVSI, Inc. from 1997 to October 1999 and served as
Senior Vice President of Litton PRC from 1992 to 1996.
Mr. Hoover joined the company in April 2003 as President
and Chief Operating Officer. Prior to joining DRC,
Mr. Hoover was President and Chief Executive Officer of
Aquiline Partners, Inc. from October 2001 to April 2003. Prior
to that, he served as President of FutureNext, Senior Vice
President at Oracle Services Industries, President of WCH
Enterprises, Executive Vice President at BDM International and
President and Chief Operating Officer of PRC, Inc.
Mr. Covel joined the company as Vice President and General
Counsel in December 2000. Prior to that, he was General Counsel,
Patent Counsel and Clerk at Foster-Miller, Inc. from 1985 to
2000.
Mr. Keleher joined the company as Vice President and Chief
Financial Officer in January 2000. Prior to that, he was
employed by Raytheon Company as Group Controller for the
Commercial Electronics Division in 1999 and Assistant Corporate
Controller in 1998. Prior to that, he served in several senior
management positions in corporate finance and operations at
Digital Equipment Corporation from 1981 to 1997.
Mr. Wentzell joined the company as Senior Vice President
and General Manager, Human Resources, in October 2004. Prior to
joining DRC, Mr. Wentzell was Senior Vice President of
Human Resources for Brooks Automation, Inc., from 2002 to 2004,
following its acquisition of PRI Automation, Inc., where
Mr. Wentzell served as Corporate Vice President for Human
Resources from 1997 through the acquisition. Prior to that,
Mr. Wentzell served as the Corporate Vice President of
Human Resources for Dialogic Corporation from 1993 through 1997.
14
PART II
|
|
| Item 5. |
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
The company’s common stock is traded on the Nasdaq National
Market under the symbol “DRCO”. The following table
sets forth, for the periods indicated, the high and low sale
prices per share of the company’s common stock, as reported
by the Nasdaq National Market. These market quotations reflect
inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions.
| |
|
|
|
|
|
|
|
|
|
| |
|
High | |
|
Low | |
| |
|
| |
|
| |
|
Fiscal year ended December 31, 2004
|
|
|
|
|
|
|
|
|
| |
First quarter
|
|
$ |
18.44 |
|
|
$ |
14.69 |
|
| |
Second quarter
|
|
$ |
18.90 |
|
|
$ |
15.06 |
|
| |
Third quarter
|
|
$ |
17.97 |
|
|
$ |
14.91 |
|
| |
Fourth quarter
|
|
$ |
18.00 |
|
|
$ |
15.22 |
|
| |
|
Fiscal year ended December 31, 2003
|
|
|
|
|
|
|
|
|
| |
First quarter
|
|
$ |
14.90 |
|
|
$ |
9.70 |
|
| |
Second quarter
|
|
$ |
16.16 |
|
|
$ |
9.33 |
|
| |
Third quarter
|
|
$ |
19.21 |
|
|
$ |
15.20 |
|
| |
Fourth quarter
|
|
$ |
19.50 |
|
|
$ |
15.22 |
|
Number of Holders
As of January 7, 2005, there were 635 holders of record of
the company’s common stock.
Dividend Policy
In September 1984, the company’s Board of Directors voted
not to declare cash dividends to preserve cash for the future
growth and development of the company. The company did not
declare any cash dividends between 1984 and 2004 and does not
intend to in the near future. In addition, the company’s
financing arrangements restrict the company’s ability to
pay dividends, as described in Liquidity and Capital Resources
in Part II, Item 7 of this Annual Report on
Form 10-K and in Note 11, “Financing
Arrangements”, of the company’s Notes to Consolidated
Financial Statements in Part II, Item 8 of this Annual
Report on Form 10-K.
|
|
| Item 6. |
SELECTED FINANCIAL DATA |
The selected condensed consolidated financial data set forth
below should be read in conjunction with “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations” included as Part II, Item 7 of this
Annual Report
15
on Form 10-K, and the consolidated financial statements and
notes thereto of the company included in Part II
Item 8 of this Annual Report on Form 10-K. The
historical results provided below are not necessarily indicative
of future results.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, | |
| |
|
| |
| |
|
2004(1) | |
|
2003 | |
|
2002(2)(3) | |
|
2001(3) | |
|
2000(3) | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| (in thousands, except share and per share data) |
|
(unaudited) | |
|
|
|
|
|
|
|
|
|
Revenue
|
|
$ |
275,706 |
|
|
$ |
244,808 |
|
|
$ |
192,610 |
|
|
$ |
190,264 |
|
|
$ |
182,527 |
|
|
Operating income (loss)
|
|
$ |
17,507 |
|
|
$ |
15,389 |
|
|
$ |
12,647 |
|
|
$ |
13,010 |
|
|
$ |
6,584 |
|
|
Income from continuing operations
|
|
$ |
9,373 |
|
|
$ |
8,655 |
|
|
$ |
7,357 |
|
|
$ |
7,102 |
|
|
$ |
2,808 |
|
|
Income (loss) from discontinued operations
|
|
|
— |
|
|
|
(1,635 |
) |
|
|
(1,124 |
) |
|
|
(619 |
) |
|
|
1,545 |
|
|
Gain (loss) on disposal of discontinued operations
|
|
|
— |
|
|
|
(348 |
) |
|
|
— |
|
|
|
62 |
|
|
|
206 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Net income
|
|
$ |
9,373 |
|
|
$ |
6,672 |
|
|
$ |
6,233 |
|
|
$ |
6,545 |
|
|
$ |
4,559 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per share — basic
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income from continuing operations
|
|
$ |
1.10 |
|
|
$ |
1.05 |
|
|
$ |
0.92 |
|
|
$ |
0.92 |
|
|
$ |
0.37 |
|
| |
Income (loss) from discontinued operations
|
|
|
— |
|
|
|
(0.20 |
) |
|
|
(0.14 |
) |
|
|
(0.08 |
) |
|
|
0.20 |
|
| |
Gain (loss) on disposal of discontinued operations
|
|
|
— |
|
|
|
(0.04 |
) |
|
|
— |
|
|
|
0.01 |
|
|
|
0.03 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Net earnings per share — basic
|
|
$ |
1.10 |
|
|
$ |
0.81 |
|
|
$ |
0.78 |
|
|
$ |
0.85 |
|
|
$ |
0.60 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per share — diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Income from continuing operations
|
|
$ |
1.03 |
|
|
$ |
0.98 |
|
|
$ |
0.83 |
|
|
$ |
0.88 |
|
|
$ |
0.36 |
|
| |
Income (loss) from discontinued operations
|
|
|
— |
|
|
|
(0.18 |
) |
|
|
(0.13 |
) |
|
|
(0.08 |
) |
|
|
0.20 |
|
| |
Gain (loss) on disposal of discontinued operations
|
|
|
— |
|
|
|
(0.04 |
) |
|
|
— |
|
|
|
0.01 |
|
|
|
0.03 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Net earnings per share — diluted
|
|
$ |
1.03 |
|
|
$ |
0.76 |
|
|
$ |
0.70 |
|
|
$ |
0.81 |
|
|
$ |
0.59 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities — continuing
operations
|
|
$ |
3,997 |
|
|
$ |
13,186 |
|
|
$ |
9,915 |
|
|
$ |
23,554 |
|
|
$ |
3,765 |
|
|
Research and development expense
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
175 |
|
|
$ |
367 |
|
|
$ |
— |
|
|
Capital expenditures
|
|
$ |
4,544 |
|
|
$ |
8,163 |
|
|
$ |
3,347 |
|
|
$ |
3,595 |
|
|
$ |
2,917 |
|
|
Depreciation
|
|
$ |
3,624 |
|
|
$ |
3,007 |
|
|
$ |
3,192 |
|
|
$ |
2,989 |
|
|
$ |
3,155 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
As of December 31, | |
| |
|
| |
| |
|
2004(1) | |
|
2003 | |
|
2002(2)(3) | |
|
2001(3) | |
|
2000(3) | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
|
|
(unaudited) | |
|
Total assets
|
|
$ |
205,134 |
|
|
$ |
121,070 |
|
|
$ |
111,676 |
|
|
$ |
80,821 |
|
|
$ |
78,175 |
|
|
Current portion of long-term debt, notes payable and revolving
credit facilities
|
|
$ |
18,357 |
|
|
$ |
9,000 |
|
|
$ |
15,144 |
|
|
$ |
500 |
|
|
$ |
6,284 |
|
|
Long-term debt (less current portion)
|
|
$ |
51,485 |
|
|
$ |
7,750 |
|
|
$ |
8,250 |
|
|
$ |
8,750 |
|
|
$ |
9,250 |
|
|
Stockholders’ equity
|
|
$ |
61,318 |
|
|
$ |
48,651 |
|
|
$ |
39,809 |
|
|
$ |
37,138 |
|
|
$ |
29,289 |
|
|
Return on invested capital
|
|
|
10.7 |
% |
|
|
14.0 |
% |
|
|
14.4 |
% |
|
|
17.7 |
% |
|
|
8.6 |
% |
|
Stockholders’ equity per share
|
|
$ |
7.02 |
|
|
$ |
5.76 |
|
|
$ |
4.88 |
|
|
$ |
4.68 |
|
|
$ |
3.85 |
|
|
Return on stockholders’ equity
|
|
|
17.0 |
% |
|
|
20.3 |
% |
|
|
18.6 |
% |
|
|
23.5 |
% |
|
|
14.7 |
% |
|
Backlog (unaudited)
|
|
$ |
165,017 |
|
|
$ |
123,895 |
|
|
$ |
111,070 |
|
|
$ |
90,382 |
|
|
$ |
88,000 |
|
|
Number of shares outstanding
|
|
|
8,737,562 |
|
|
|
8,443,082 |
|
|
|
8,164,180 |
|
|
|
7,940,610 |
|
|
|
7,601,519 |
|
|
|
| (1) |
Amounts include results of operations of Impact Innovations
Group LLC (acquired September 1, 2004) for the period
subsequent to its acquisition. |
| |
| (2) |
Amounts include results of operations of Andrulis Corporation
(acquired December 20, 2002) and HJ Ford Associates, Inc.
(acquired May 31, 2002) for the periods subsequent to their
respective acquisitions. |
| |
| (3) |
Amounts were restated to report the results of the
company’s Encoder Division as discontinued operations as a
result of the decision to exit the business in 2002. |
16
|
|
| Item 7. |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS |
FORWARD-LOOKING STATEMENTS
Certain statements in this Annual Report on Form 10-K
constitute “forward-looking statements” which involve
known risks, uncertainties and other factors which may cause the
actual results, performance or achievements of Dynamics Research
Corporation (“DRC” or the “company”) to be
materially different from any future results, performance or
achievements expressed or implied by such forward-looking
statements. Such factors include the “Factors That May
Affect Future Results” set forth in this Management’s
Discussion and Analysis of Financial Condition and Results of
Operations. Precautionary statements made herein should be read
as being applicable to all related forward-looking statements
whenever they appear in this report.
OVERVIEW
DRC, founded in 1955 and headquartered in Andover,
Massachusetts, provides information technology (“IT”),
engineering and other services focused on defense, public safety
and citizen services for federal, state and local governments.
The company’s core capabilities are focused on information
technology, engineering and technical subject matter expertise
that pertain to the knowledge domains of the company’s core
customers.
The company’s strategy is comprised of four key objectives:
(a) to increase shareholder value; (b) to grow
revenues in selected markets; (c) to achieve operational
excellence; and (d) to be an employer of choice. Operating
margin and cash generation improvement initiatives support the
company’s shareholder value objective. DRC has a balanced
growth strategy aimed at organic growth in its existing markets
and penetrating new market segments through acquisition. The
company has made three business acquisitions since 2002. The
company’s initiatives related to its employer of choice
objective include professional development programs,
performance-based compensation programs and competitive benefit
programs.
The company has two reportable business segments: Systems and
Services, and Metrigraphics. The Systems and Services segment
provides technical and information technology solutions to
government customers. These solutions include design,
development, operation and maintenance of business intelligence
systems, business transformation services, defense program
acquisition management services, training and performance
support systems and services, automated case management systems
and IT infrastructure services. Revenues for this segment are
reported in the caption “Contract revenue” in the
company’s Consolidated Statements of Operations. The
Metrigraphics segment develops and builds components for
original equipment manufacturers (“OEM”) in the
computer peripheral device, medical electronics,
telecommunications and other industries, with the focus on the
custom design and manufacture of miniature electronic parts that
meet high precision requirements through the use of
electroforming, thin film deposition and photolithography
technologies. Revenues for this segment are reported in the
caption “Product sales” in the company’s
Consolidated Statements of Operations.
The company’s business growth strategy is focused on three
national priority markets: national defense, public safety and
legislated citizen services. Within these markets there are six
strategic business areas on which the company focuses its
efforts: C4ISR (Command, control, communications, computing,
intelligence, surveillance and reconnaissance), logistics,
readiness, military space, public security and citizen services.
Because these markets address the mission critical functions of
government, the company expects that they will be funded
regardless of economic cycle. The strategy leverages six
solution sets where DRC has strong competencies and a record of
meeting its customers’ most difficult challenges. These
repeatable, proven, cost-effective solutions are acquisition
management services, training and performance support, business
transformation, business intelligence, IT infrastructure
services and automated case management.
On July 1, 2004, the company announced that it had
sharpened its government focus by consolidating and realigning
its operations to better facilitate the execution of its
recently developed business growth strategy, better address the
needs of its customers and further strengthen the delivery of
its solutions-based services. Accordingly, effective
July 1, 2004, the company consolidated its five Systems and
Services segment operating groups into two organizations. The
two new organizations encompass all of the capabilities of the
five former groups. This realignment did not impact the
company’s business segments, as the new groups both provide
solutions-based services and are subject to similar regulations.
ACQUISITIONS
The company has completed three business acquisitions since
2002: Impact Innovations LLC (“Impact Innovations”) on
September 1, 2004, Andrulis Corporation
(“ANDRULIS”) on December 20, 2002, and HJ Ford
Associates, Inc. (“HJ
17
Ford”) on May 31, 2002. The results of these acquired
entities are included in the company’s Consolidated
Statements of Operations, Consolidated Statements of Changes in
Stockholders Equity and Comprehensive Income (Loss) and
Consolidated Statements of Cash Flows for the periods subsequent
to their respective acquisitions.
DISCONTINUED OPERATIONS
On October 18, 2002, the company announced that it was
actively pursuing the divestiture of the Encoder Division, a
manufactured products business previously reported as a business
segment. Effective in the fourth quarter of 2002, the
company’s consolidated financial statements and notes
thereto were restated to reflect the discontinuation of the
Encoder Division for all periods presented. On May 2, 2003,
the company completed the sale of its Encoder Division assets to
GSI Lumonics Inc. (“GSI”) in Billerica, Massachusetts.
CRITICAL ACCOUNTING POLICIES
There are business risks specific to the industries in which the
company operates. These risks include, but are not limited to:
estimates of costs to complete contract obligations, changes in
government policies and procedures, government contracting
issues 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 and disclosure of contingent assets and
liabilities at the date of the financial statements. Estimates
and assumptions also affect the amount of revenue and expenses
during the reported period. Actual results could differ from
those estimates.
The company believes the following critical accounting policies
affect the more significant judgments made and estimates used in
the preparation of its consolidated financial statements.
Revenue Recognition
The company’s systems and services business provides its
services under time and materials, cost reimbursable and
fixed-price contracts, including service-type contracts.
For time and materials contracts, revenue reflects the number of
direct labor hours expended in the performance of a contract
multiplied by the contract billing rate, as well as
reimbursement of other billable direct costs. The risk inherent
in time and materials contracts is that actual costs may differ
materially from negotiated billing rates in the contract, which
directly affects operating income.
For cost reimbursable contracts, revenue is recognized as costs
are incurred and include a proportionate amount of the fee
earned. Cost reimbursable contracts specify the contract fee in
dollars or as a percentage of estimated costs. The primary risk
on a cost reimbursable contract is that a government audit of
direct and indirect costs could result in the disallowance of
certain costs, which would directly impact revenue and margin on
the contract. Historically, such audits have had no material
impact on the company’s revenue and operating income.
Under fixed-price contracts, other than service-type contracts,
revenue is recognized primarily under the percentage of
completion method or, for certain short-term contracts, by the
completed contract method, in accordance with American Institute
of Certified Public Accountants Statement of Position 81-1,
Accounting for Performance of Construction-Type and Certain
Production-Type Contracts (“SOP 81-1”).
Revenue from service-type fixed-price contracts is recognized
ratably over the contract period or by other appropriate output
methods to measure service provided, and contract costs are
expensed as incurred. The risk to the company related to a fixed
price contract is that if estimates to complete the contract
change from one period to the next, profit levels will vary from
period to period.
For all types of contracts, the company recognizes anticipated
contract losses as soon as they become known and estimable.
Out-of-pocket expenses that are reimbursable by the customer are
included in contract revenue and cost of contract revenue.
Unbilled expenditures and fees on contracts in process are the
amounts of recoverable contract revenue that have not been
billed at the balance sheet date. Generally, the company’s
unbilled expenditures and fees relate to revenue that is billed
in the month after services are performed. In certain instances,
billing is deferred in compliance with contract terms, such as
milestone billing arrangements and withholdings, or delayed for
other reasons. Costs related to United States Government
contracts, including applicable indirect costs, are subject to
audit by the government. Revenue from such contracts has been
18
recorded at amounts the company expects to realize upon final
settlement. Unbilled expenditures and fees also include
subcontractor costs for which invoices have not been received
and for which revenues have not been recognized.
Valuation Allowances
The company provides for potential losses against accounts
receivable and unbilled expenditures and fees on contracts in
process based on the company’s expectation of a
customer’s ability to pay. These reserves are based
primarily upon specific identification of potential
uncollectible accounts. In addition, payments to the company for
performance on United States Government contracts are subject to
audit by the Defense Contract Audit Agency. If necessary, the
company provides an estimated reserve for adjustments resulting
from rate negotiations and audit findings. The company routinely
provides for these items when they are identified and can be
reasonably estimated.
Intangible and Other Long-lived Assets
The company uses assumptions in establishing the carrying value,
fair value and estimated lives of intangible and other
long-lived assets. Long-lived assets are reviewed for impairment
whenever events or changes in circumstances indicate that the
asset carrying value may not be recoverable. Recoverability is
measured by a comparison of the asset’s continuing ability
to generate positive income from operations and positive cash
flow in future periods compared to the carrying value of the
asset. If assets are considered to be impaired, the impairment
is recognized in the period of identification and is measured as
the amount by which the carrying value of the asset exceeds the
fair value of the asset.
The useful lives and related amortization of intangible assets
are based on their estimated residual value in proportion to the
economic benefit consumed. The useful lives and related
depreciation of other long-lived assets are based on the
company’s estimate of the period over which the asset will
generate revenue or otherwise be used by the company.
Goodwill
The company assesses goodwill for impairment at the segment
level at least once each year by applying a fair value test.
Goodwill could be impaired due to market declines, reduced
expected future cash flows, or other factors or events. Should
the fair value of goodwill, as determined by the company at any
measurement date, fall below its carrying value, a charge for
impairment of goodwill would occur in that period.
Business Combinations
Since 2002, the company has completed three business
acquisitions. The company determines and records the fair values
of assets acquired and liabilities assumed as of the dates of
acquisition. The company utilizes an independent valuation
specialist to determine the fair values of identifiable
intangible assets acquired in order to allocate a portion of the
purchase price to these assets.
Deferred Taxes
The company records a valuation allowance to reduce its deferred
tax assets to the amount that is more likely than not to be
realized. The company has considered future taxable income and
ongoing prudent and feasible tax planning strategies in
assessing the need for the valuation allowance. In the event it
is determined that the company would be able to realize its
deferred tax assets in excess of their net recorded amount, an
adjustment to the deferred tax asset would increase income in
the period such determination was made. Likewise, should the
company determine it would not be able to realize all or part of
its net deferred tax asset in the future, an adjustment to the
deferred tax asset would be charged to income in the period such
determination was made.
Pensions
Accounting and reporting for the company’s pension plan
requires the use of assumptions, including but not limited to,
discount rate, rate of compensation increases and expected
return on assets. If these assumptions differ materially from
actual results, the company’s obligations under the pension
plan could also differ materially, potentially requiring the
company to record an additional pension liability. An actuarial
valuation is performed each year. The results of this actuarial
valuation are reflected in the accounting for the pension plan
upon determination.
19
RESULTS OF OPERATIONS
Operating results expressed as a percentage of total revenues
for the years ended December 31, 2004, 2003 and 2002 are as
follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Contract revenue
|
|
|
97.4 |
% |
|
|
97.2 |
% |
|
|
96.0 |
% |
|
Product sales
|
|
|
2.6 |
% |
|
|
2.8 |
% |
|
|
4.0 |
% |
| |
|
|
|
|
|
|
|
|
|
| |
Total revenue
|
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
| |
|
Gross margin on contract revenue(1)
|
|
|
15.3 |
% |
|
|
16.1 |
% |
|
|
15.4 |
% |
|
Gross margin on product sales(1)
|
|
|
26.3 |
% |
|
|
26.4 |
% |
|
|
31.2 |
% |
| |
Total gross margin(1)
|
|
|
15.6 |
% |
|
|
16.4 |
% |
|
|
16.1 |
% |
| |
|
Selling, general and administrative expenses
|
|
|
8.4 |
% |
|
|
9.4 |
% |
|
|
9.3 |
% |
|
Amortization of intangible assets
|
|
|
0.8 |
% |
|
|
0.7 |
% |
|
|
0.2 |
% |
| |
|
Operating income
|
|
|
6.4 |
% |
|
|
6.3 |
% |
|
|
6.6 |
% |
|
Interest expense, net
|
|
|
(0.8 |
)% |
|
|
(0.3 |
)% |
|
|
(0.2 |
)% |
|
Other income (expense), net
|
|
|
0.1 |
% |
|
|
0.1 |
% |
|
|
— |
|
| |
|
Income from continuing operations before provision for income
taxes
|
|
|
5.7 |
% |
|
|
6.1 |
% |
|
|
6.4 |
% |
|
|
| (1) |
These amounts represent a percentage of contract revenues,
product sales and total revenues, respectively. |
Revenue
The company reported revenues of $275.7 million,
$244.8 million and $192.6 million in 2004, 2003 and
2002, respectively. These revenues represent an increase from
the respective prior year of 12.6% in 2004 and 27.1% in 2003.
Contract revenues
Contract revenues in the company’s Systems and Services
segment were $268.6 million in 2004, $237.9 million in
2003 and $185.0 million in 2002. The increase in the
current year was attributable to organic growth of 6.2% and
$16.1 million of revenues added through acquisition. In
2004, organic growth was reduced by the completion in 2003 of
the company’s quality assurance work at the Homeland
Security Bureau of Citizenship and Immigration Services, which
had contributed $8.1 million to revenues during 2003. The
increase in revenues in 2003 compared to 2002 was primarily
attributable to the addition of approximately $54 million
in revenues through acquisitions. In 2003, revenues grew on an
organic basis by approximately 2.1%. Reductions in subcontractor
pass-through revenue with the Air Force Electronic Systems
Center and in Navy Strategic Systems guidance work reduced 2003
revenues in the aggregate by an estimated $9 million, or
3.8%.
Revenues from defense and intelligence agencies in 2004, 2003
and 2002 were $215.4 million, $191.7 million and
$154.2 million, respectively. The increase in 2004 from
2003 was primarily attributable to internally generated growth,
primarily in the C4ISR (Command, control, communications,
computing, intelligence, surveillance and reconnaissance),
readiness and logistics markets. The increase in 2003 from 2002
was primarily attributable to the company’s acquisitions,
coupled with organic growth of the company’s core business.
The 2003 increase was net of the $9 million reduction in
subcontractor pass-through revenues and Navy Strategic Systems
guidance work discussed above.
Revenues from federal civilian agencies were $31.3 million,
$35.2 million and $17.8 million in 2004, 2003 and
2002, respectively. The decrease in 2004 compared to 2003 was
primarily due to the completion late in 2003 of the
company’s quality assurance work at the Homeland Security
Bureau of Citizenship and Immigration Services, which accounted
for $8.1 million of revenue in 2003, partially offset by
$16.1 million of revenues added through acquisition.
Revenues for this sector virtually doubled in 2003, compared to
the prior year, primarily as a result of the acquisitions
discussed above.
20
Revenues from state and local government agencies were
$20.3 million in 2004, $11.0 million in 2003 and
$12.9 million in 2002. In May 2004, the company announced
that it had signed a fixed price contract with the state of Ohio
for $30 million to design, develop and install an automated
child welfare case management system. Revenues for 2004 under
this three and one-half year contract were approximately
$8 million. This new contract, coupled with higher revenues
in 2004 from training and network management services with
health and human services customers, accounted for the increase
in state and local government revenues in 2004. The reduction in
state and local revenues in 2003 from the prior year was
primarily the result of significant state spending cutbacks in
response to state budget deficits during 2003.
Revenues by contract type as a percentage of Systems and
Services segment revenues, were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
|
Time and materials
|
|
|
59 |
% |
|
|
64 |
% |
|
|
58 |
% |
|
Cost reimbursable
|
|
|
21 |
% |
|
|
23 |
% |
|
|
31 |
% |
|
Fixed price, including service-type contracts
|
|
|
20 |
% |
|
|
13 |
% |
|
|
11 |
% |
| |
|
|
|
|
|
|
|
|
|
| |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
| |
|
|
|
|
|
|
|
|
|
|
Prime contract
|
|
|
74 |
% |
|
|
69 |
% |
|
|
66 |
% |
|
Sub-contract
|
|
|
26 |
% |
|
|
31 |
% |
|
|
34 |
% |
| |
|
|
|
|
|
|
|
|
|
| |
|
|
100 |
% |
|
|
100 |
% |
|
|
100 |
% |
| |
|
|
|
|
|
|
|
|
|
The company’s contracts with the Internal Revenue Service,
the Air Force Electronic Systems Center and the Aeronautical
Systems Center, which provided approximately $12 million,
$31 million and $47 million, respectively, of revenues
in 2004, are subject to re-competition in 2005. The company has
submitted a proposal for a prime contract with the Internal
Revenue Service. It is currently anticipated that the 2005
competitions with the Air Force Electronic Systems Center and
the Aeronautical Systems Center will restrict prime contract
awards to small businesses. DRC expects to participate in the
competitions as a sub-contractor to qualified small businesses.
Product sales
Product sales for the Metrigraphics segment were
$7.1 million, $6.9 million and $7.6 million the
years ended December 31, 2004, 2003 and 2002, respectively.
The slight increase in 2004 from 2003, compared to the decrease
in 2003 from 2002, is due in part to an overall improvement in
order levels and a strengthening in the segment’s market in
the recent periods.
Funded backlog
The company’s funded backlog was $165.0 million at
December 31, 2004, $123.9 million at December 31,
2003 and $111.1 million at December 31, 2002. Included
in the company’s funded backlog at December 31, 2004,
was $30.9 million of funded backlog attributable to Impact
Innovations. The company expects that substantially all of its
backlog at December 31, 2004, will generate revenue during
the year ended December 31, 2005. In 2003, ANDRULIS and HJ
Ford contributed significantly to the increase in backlog,
coupled with organic growth of the company’s core business.
The funded backlog generally is subject to possible termination
at the convenience of the contracting counter party. A portion
of the company’s backlog is based on annual purchase
contracts and subject to annual governmental approvals or
appropriations legislation. The amount of backlog as of any date
may be affected by the timing of order receipts and associated
deliveries.
Gross profit and margin
Total gross margin was 15.6%, 16.4% and 16.1% for 2004, 2003 and
2002, respectively. Gross margin on contract revenues was 15.3%,
16.1% and 15.4% for 2003, 2003 and 2002, respectively. In 2004,
the portion of the company’s revenues derived from prime
contracts increased by five percentage points. Related to this
shift, the portion of revenues generated through sub-contractors
and other direct costs, which contribute lower margins than
DRC’s labor-generated revenues, increased by two percentage
points. Amortization and maintenance expense related to the
implementation of the company’s new PeopleSoft-based
enterprise business system, which was placed into service on
January 1, 2004, was also a factor in this segment’s
lower gross margin in 2004. These factors were partially offset
by efficiencies realized from the
21
integration of the company’s earlier acquisitions into the
company’s operations, primarily through facility
consolidation and lower overhead as a percentage of revenues.
The improved performance in 2003 was attributable to
efficiencies realized from the integration of the recent
acquisitions into the company’s operations, contract mix
and lower overhead costs as a percentage of revenues.
The company’s product sales gross margin was virtually flat
in 2004 compared to 2003, and is indicative of the improvement
in the sector in which the company’s Metrigraphics segment
operates, as also evidenced in the slight increase in product
sales in 2004, discussed above and compared to 2003 decline from
2002. This decline was attributable to decreased product sales
in 2003 compared to the prior year, a result of continued weak
economic conditions and customer product life cycle shifts,
partially offset by cost reductions.
Selling, general and administrative expenses
Selling, general and administrative expenses were
$23.2 million in 2004, $22.9 million in 2003 and
$17.9 million in 2002. The increase in 2004 compared to
2003 was primarily attributable to higher personnel costs
related to increased staffing levels. The overall increase in
2003 was in part attributable to the absorption of general and
administrative expenses of the company’s acquisitions.
Higher employee benefit costs also contributed to the increase
in selling, general and administrative costs in 2003. Legal
expenses related to the U.S. Attorney’s civil
complaint and antitrust investigation totaled $0.8 million
in 2004 and $0.7 million in both 2003 and 2002.
In response to lower than expected demand in certain sectors of
the company’s business, as well as the need to maintain a
competitive cost structure, the company incurred involuntary
separation costs for 85 employees, excluding discontinued
operations, in 2002. All operating groups and functions of the
company were affected. Costs associated with these terminations
totaled $0.8 million and are included in reported operating
results for 2002, with $0.6 million charged to cost of
contract revenue and $0.2 million charged to selling,
engineering and administrative expenses. The remaining accrual
of $0.2 million at December 31, 2002 was paid in the
first half of 2003.
Amortization of intangible assets
Amortization expense of $2.3 million, $1.7 million and
$0.4 million in 2004, 2003 and 2002, respectively, reflects
the amortization of identifiable intangible assets associated
with the company’s business acquisitions. As a result of
the acquisition of Impact Innovations on September 1, 2004,
the company anticipates amortization expense for intangible
assets will approximate $3 million in 2005.
Operating income
Operating income for the Systems and Services segment was
$17.4 million in 2004, compared to $14.8 million in
2003, and $11.5 million in 2002. Operating income for the
Metrigraphics segment was $0.1 million in 2004, compared to
$0.6 million in 2003, and $1.1 million in 2002.
Segment operating income for each segment includes amortization
of intangible assets and selling, engineering and administrative
expenses directly attributable to the segment. All corporate
operating expenses are allocated between the segments based on
segment revenues, including depreciation.
The company’s operating income was $17.5 million,
$15.4 million, and $12.6 million in 2004, 2003 and
2002, respectively. The increase in operating margin in the
current year, compared to 2003, is primarily attributable to
higher gross profit resulting from the company’s higher
revenue in 2004. These amounts were partially offset by
increased amortization of the company’s acquired intangible
assets. The decrease in operating margin in 2003, compared to
2002, is primarily attributable to higher selling, general and
administrative expenses, coupled with amortization expense for
the company’s acquired intangible assets.
Interest income and expense
The company incurred interest expense totaling $2.3 million
in 2004, $0.9 million in 2003 and $0.6 million in
2002. The increase in interest expense in 2004 is primarily
attributable to the acquisition loan used to fund the
September 1, 2004 acquisition of Impact Innovations,
coupled with interest on the outstanding balance of the
company’s revolving credit facility and mortgage on its
Andover, Massachusetts corporate headquarters facility. Interest
expense in 2003 and 2002 relates primarily to the outstanding
balances on the company’s revolving credit facility and the
mortgage on the corporate headquarters facility. The company
recorded $60,000, $27,000 and $0.2 million of interest
income in 2004, 2003 and 2002, respectively. The interest rates
on the company’s current financing vehicles are variable.
These vehicles are described
22
in detail in the “Liquidity and Capital Resources”
section below. The weighted average interest rates on the
company’s outstanding borrowings were 5.36%, 3.16% and
3.96% at December 2004, 2003 and 2002, respectively. An increase
of one percentage point in the company’s rates would result
in approximately $0.7 million of additional interest
expense on an annual basis.
Other income and expense
The company reported $0.4 million and $0.5 million of
net other income in 2004 and 2003, respectively, including
$0.1 million and $0.2 million which is attributable to
gains on the company’s deferred compensation plan
investments. The company reported other income of
$0.1 million in 2002.
Income taxes
Income tax expense was recorded at rates of 40.1% in 2004, 42.3%
in 2003, and 40.2% in 2002. The increase in 2003 was due to
amortization of acquired intangible assets that is not
deductible for income tax purposes. These rates reflect the
statutory federal rate of 34%, combined with an average state
income tax rate, net of federal income tax benefit.
Discontinued operations
On May 2, 2003, the company completed the sale of its
Encoder Division assets and certain liabilities to GSI for
$3.3 million in cash, subject to post-closing adjustments
related to a valuation of the net assets of the Encoder Division
and assumption by GSI of certain of DRC’s liabilities with
respect to the assets acquired.
The company recognized a loss of $0.6 million before taxes,
or a loss of $0.3 million, net of $0.3 million of
income tax benefit, on the disposal of discontinued operations
in 2003. This loss is attributable to a $1.3 million
pre-tax loss related to the sale of the Encoder division, net of
$0.7 million received as the final royalty payment
associated with the 1999 sale of its discontinued
Telecommunications Fraud Control business (the “Fraud
Control business”). The company recognizes this royalty
income on a cash basis. In connection with the sale of the
Encoder Division, the company recorded charges of
$0.2 million and $1.1 million before taxes as a loss
on the disposal of discontinued operations in the fourth and
first quarters of 2003, respectively. The fourth quarter charges
represent additional facility costs related to the sale. The
components of the first quarter charges were $0.3 million
of professional fees and $0.8 million of exit costs,
comprised of $0.5 million for severance costs for
approximately 45 Encoder Division employees and
$0.3 million for future lease costs, net of contractual
sublease income from GSI for the Encoder facility.
The company’s loss from discontinued operations, net of
taxes, was $1.6 million, or $0.18 per diluted share,
in 2003. This amount includes four months of operating loss from
the Encoder division, as well as costs incurred subsequent to
the transaction related to certain liabilities that GSI did not
assume, including $1.5 million of accrued lease costs, net
of estimated sublease income for the Encoder facility.
Due to the company’s decision on October 18, 2002, to
divest the Encoder Division, it became necessary to restate the
company’s results in order to reflect the Encoder Division
as a discontinued operation. Because Arthur Andersen LLP was no
longer able to provide current assurance as to the validity of
its previously issued opinions on the company’s financial
statements for the fiscal years prior to 2002, it became
necessary to engage KPMG LLP, who served as the company’s
independent auditors through November 2003, to re-audit results
for the years ended December 31, 2001 and 2000 in order to
obtain a current independent auditor opinion for those years.
The 2002 loss from discontinued operations includes
$0.4 million in fees to re-audit the 2001 and 2000 results.
Shares used in computing earnings (loss) per share
Weighted average common shares outstanding and common equivalent
shares totaled 9.1 million, 8.8 million and
8.9 million at December 31, 2004, 2003 and 2002,
respectively. The increase in 2004 from 2003 is primarily
attributable to 0.3 million additional shares issued and
outstanding in 2004. The slight decrease in 2003 from 2002 is
primarily attributable to a reduction 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.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2004 and 2003, the company had cash and
cash equivalents aggregating $0.9 million and
$2.7 million, respectively. The decrease in cash and cash
equivalents is primarily the result of $60.7 million of
cash used in
23
investing activities, including $54.0 million related to
the acquisition of Impact Innovations. This amount was partially
offset by $55.7 million of cash provided by financing
activities, including $55.0 million of cash proceeds from
borrowings used to fund the aforementioned acquisition of Impact
Innovations, and $3.2 million of cash provided by operating
activities, including $0.8 million used in discontinued
operations.
Operating Activities
Cash provided by operating activities was $3.2 million, and
is primarily attributable to $9.4 million of income from
continuing operations, depreciation and amortization expenses
aggregating $5.9 million, and increases in accounts payable
and deferred income taxes of $8.5 million and
$7.7 million, respectively. These amounts were partially
offset by increases of $7.6 million in accounts receivable,
$17.1 million in unbilled expenditures and fees on
contracts in process, and $3.3 million in prepaid expenses
and other current assets. The company used $0.8 million of
cash for discontinued operations, primarily for lease
liabilities related to the divestiture of the Encoder business.
Stock compensation expense increased to $0.5 million for
2004, from $0.2 million in 2003 and $0.1 million in
2002. The company has realigned its approach to equity
compensation by increasing its use of restricted stock awards
and reducing its use of stock option awards. As a result, higher
non-cash expense was recorded in 2004 and will continue to be
recorded in subsequent periods.
Non-cash amortization expense of the company’s acquired
intangible assets was $2.3 million in 2004,
$1.7 million in 2003 and $0.4 million in 2002. As a
result of the company’s recent business acquisition, the
company anticipates non-cash expense for the amortization of
intangible assets to increase to approximately $3 million
in 2005.
Increases in deferred income taxes were $7.7 million in
2004, $2.7 million in 2003 and $0.3 million in 2002.
These increases relate primarily to higher unbilled receivables
and the deferral of income taxes thereon. At the end of 2004,
deferred taxes on unbilled receivables totaled
$17.4 million. Concurrent with an ongoing audit of the
company’s 2003 and 2002 federal income tax returns, the
Internal Revenue Service (“IRS”) has challenged the
deferral of income for tax purposes related to the
company’s unbilled accounts receivable (which is reported
under the caption “Unbilled expenditures and fees on
contracts in process” in the company’s Consolidated
Balance Sheets), including the applicability of a Letter Ruling
issued by the IRS to the company in January 1976, which granted
the company deferred tax treatment of its unbilled receivables.
While the outcome of the audit is not known, it is possible that
the company’s deferred tax liabilities would be reduced and
income tax payments would be increased substantially in 2005 and
beyond. The company anticipates that 2005 payments will be
offset by $3.8 million of refundable income taxes which are
included in Prepaid expenses and other current assets at
December 31, 2004, and are the primary source of cash from
prepaid expenses in 2004.
Total accounts receivable, billed and unbilled, were
$96.3 million and $62.5 million at December 31,
2004 and 2003, respectively. Receivables days sales outstanding,
or DSO, was 111 at December 31, 2004, compared to 89 at
December 31, 2003. These amounts include amounts reported
under the captions “Accounts receivable, net of
allowances” and “Unbilled expenditures and fees on
contracts in process.”
In the fourth quarter of 2004, the company encountered
collection delays with U.S. Defense Finance and Accounting
Services and the General Services Administration totaling
approximately $7 million, or 8 days sales outstanding.
The company previously submitted invoices to these agencies, but
due to technical problems at the agencies, the agencies
requested that the company resubmit the invoices. A portion of
these outstanding amounts has been collected, and the company is
diligently supporting the customers’ requirements to ensure
payment on the balances. Upon collection of the remainder of
these amounts, the company expects that its days sales
outstanding on its billed accounts receivable will decrease to
the company’s historical range of 40 to 45 days. The
company has no indication of concerns of collectibility of these
or any of its other outstanding invoices.
The December 31, 2004 unbilled receivables balance includes
$8.2 million related to the company’s contract with
the State of Ohio. Under the current terms of the contract,
invoicing does not begin until 2005 in accordance with
anticipated completion of contract milestones. This amount
represents approximately 10 days sales outstanding of the
company’s 111 days at December 31, 2004.
Accounts payable increased by $8.5 million in 2004.
Approximately $4 million of this increase relates to
subcontractor costs for the Ohio contract which will be paid
when the company receives payment from the State of Ohio.
24
Investing Activities
The company used $60.7 million of cash in investing
activities, principally comprised of $54.0 million related
to the acquisition of Impact Innovations and $4.5 million
for capital expenditures. The company used the proceeds from its
acquisition loan, described below, to pay the consideration for
Impact Innovations. The company believes that selective
acquisitions are an important component of its growth strategy.
The company may acquire, from time to time, firms or properties
that are aligned with the company’s core capabilities and
which complement the company’s customer base. The company
will continue to consider acquisition opportunities that align
with its strategic objectives, along with the possibility of
utilizing the credit facility as a source of financing.
The company’s capital expenditures in 2004 were primarily
comprised of $1.7 million related to the implementation of
the company’s new PeopleSoft-based enterprise business
system and $1.4 million for facility renovation costs for
its corporate headquarters in Andover, Massachusetts. The
company’s capital expenditures, excluding business
acquisitions, are expected to approximate $5 to $6 million
in 2005, primarily for facilities infrastructure consolidation
and improvements.
Financing Activities
Cash provided by financing activities was comprised of
$55.0 million from the company’s new acquisition term
loan, described below, $1.5 million of net borrowings under
the company’s revolver and $2.6 million of cash
proceeds from the exercise of stock options and issuance of
shares under the employee stock purchase plan. As discussed
above, the company entered into a new financing arrangement, of
which $55.0 million was related to the acquisition of
Impact Innovations. The company repaid $1.6 million of the
principal borrowed immediately after the initial consideration
paid for Impact Innovations was reduced to $53.4 million.
The company’s proceeds from financing activities were
partially offset by $2.9 million of acquisition term loan
principal payments, including the $1.6 million of principal
repaid immediately as discussed above and $0.5 million of
principal payments under the company’s term loan.
On September 1, 2004, the company entered into a new
secured financing agreement (the “facility”) with a
bank group to restructure and increase the company’s credit
facilities to $100.0 million, including the current
mortgage financing on the company’s Andover, Massachusetts
corporate headquarters, which had a balance of $7.9 million
at closing (the “term loan”). The facility provides
for a $55.0 million, five-year term loan (the
“acquisition term loan”) with a seven-year
amortization schedule for the acquisition of Impact Innovations
and a $37.0 million, five-year revolving credit agreement
for working capital (the “revolver”). The bank group,
led by Brown Brothers Harriman & Co. as a lender and as
administrative agent (when acting such capacity, the
“Administrative Agent”), also includes KeyBank
National Association, Banknorth, NA and Fleet National Bank, a
Bank of America company. The facility replaces the
company’s previous $50.0 million revolving credit
agreement, which was entered into on June 28, 2002.
The company used $53.4 million of the $55.0 million of
proceeds from the acquisition term loan to complete the
acquisition of Impact Innovations. The company repaid
$1.6 million of the $55.0 million financed on
September 1, 2004. The facility requires quarterly
principal payments of approximately $2 million on the
acquisition term loan, with a final payment of approximately
$16 million on September 1, 2009. At December 31,
2004, the outstanding principal balance on the acquisition term
loan was $52.1 million.
The company has a ten-year term loan as amended and restated on
September 1, 2004, with an outstanding balance of
$7.8 million, which is secured by a mortgage on the
company’s headquarters in Andover, Massachusetts. The
agreement requires quarterly principal payments of $125,000,
with a final payment of $5.0 million due on May 1,
2010.
The revolver has a five-year term and is available to the
company for general corporate purposes, including strategic
acquisitions. The fee on the unused portion of the revolver
ranges from 0.25% to 0.50%, depending on the company’s
leverage ratio, and is payable quarterly in arrears.
All of the obligations of the company and its subsidiaries under
the new facility are secured by a security interest in
substantially all of the assets of the company and its
subsidiaries granted to the Administrative Agent. The agreement
requires financial covenant tests to be performed against the
company’s annual results beginning with the results for the
year ended December 31, 2005, that, if met, would result in
the release of all collateral securing the facility except for
the mortgage that secures the term loan. If the company’s
results do not meet specific financial ratio requirements, the
company and its subsidiaries will be required to perfect the
security interest granted to the Administrative Agent in all of
the government contracts of the company and its subsidiaries.
25
On an ongoing basis, the facility requires the company to meet
certain financial covenants, including maintaining a minimum net
worth and certain cash flow and debt coverage ratios. The
covenants also limit the company’s ability to incur
additional debt, pay dividends, purchase capital assets, sell or
dispose of assets, make additional acquisitions or investments,
or enter into new leases, among other restrictions. In addition,
the facility provides that the bank group may accelerate payment
of all unpaid principal and all accrued and unpaid interest
under the facility, upon the occurrence and continuance of
certain events of default, including, among others, the
following:
|
|
|
| |
• |
Any failure by the company and its subsidiaries to make any
payment of principal, interest and other sums due under the
facility within three calendar days of the date when such
payment is due; |
| |
| |
• |
Any breach by the company or any of its subsidiaries of certain
covenants, representations and warranties; |
| |
| |
• |
Any default and acceleration of any indebtedness owed by the
company or any of its subsidiaries to any person (other than the
bank group) which is in excess of $1,000,000; |
| |
| |
• |
Any final judgment against the company or any of its
subsidiaries in excess of $1,000,000 which has not been insured
to the reasonable satisfaction of the Administrative Agent; |
| |
| |
• |
Any bankruptcy (voluntary or involuntary) of the company or any
of its subsidiaries; and |
| |
| |
• |
Any material adverse change in the business or financial
condition of the company and its subsidiaries; or |
| |
| |
• |
Any change in control of the company. |
In addition to the principal payments required on the
acquisition term loan and the term loan, the company will also
make annual payments by February 15 of each year, commending in
2006. The payment amount will be equal to 50.0% of the
company’s excess cash flow, defined as EBITDA (earnings
before interest, taxes, depreciation and amortization) plus net
decreases in working capital or less net increases in working
capital, minus interest expense and principal payments on the
acquisition term loan and term loan, capital expenditures, and
all cash taxes and cash dividends paid for the most recently
completed fiscal year, commencing with the year ended
December 31, 2005. Each payment will be applied: first, to
the outstanding balance of the revolver, provided the
outstanding balance on the last day of the fiscal year compared
with the outstanding balance of the revolver on the last day of
the previous fiscal year does not already reflect such a
reduction; second, to the outstanding principal balance of the
acquisition term loan; and lastly, to the outstanding principal
balance of the term loan.
The company’s results of operations, cash flows and
financial condition 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 need for, cost of and
access to funds are dependent on future operating results, the
company’s growth and acquisition activity, and conditions
external to the company.
Based upon its present business plan and operating performance,
the company believes that cash provided by operating activities,
combined with amounts available for borrowing under the
revolver, will be adequate to fund the capital requirements of
its existing operations during 2005 and for the foreseeable
future. In the event that the company’s current capital
resources are not sufficient to fund requirements, the company
believes its access to additional capital resources would be
sufficient to meet its needs. However, the development of
adverse economic or business conditions could significantly
affect the need for and availability of capital resources.
Commitments
The company’s contractual obligations as of
December 31, 2004 consist of the following (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Payments due by period | |
| |
|
| |
| |
|
|
|
Less than | |
|
Two to | |
|
Four to | |
|
|
| |
|
Total | |
|
one year | |
|
three years | |
|
five years | |
|
Thereafter | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Revolver
|
|
$ |
10,000 |
|
|
$ |
10,000 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
Long-term debt
|
|
|
59,842 |
|
|
|
8,357 |
|
|
|
16,714 |
|
|
|
29,521 |
|
|
|
5,250 |
|
|
Operating leases
|
|
|
14,515 |
|
|
|
4,370 |
|
|
|
5,223 |
|
|
|
3,021 |
|
|
|
1,901 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total contractual obligations
|
|
$ |
84,357 |
|
|
$ |
22,727 |
|
|
$ |
21,937 |
|
|
$ |
32,542 |
|
|
$ |
7,151 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
26
The amounts above related to the revolver and long-term debt do
not include interest payments on any outstanding principal
balance, because the interest rates on the company’s
financing arrangements are not fixed. Additionally, the amounts
above exclude the effect on the schedule of payments of the
application of any annual February 15 payments, as described
above, to the outstanding principal balances of either the
acquisition term loan or the term loan (reported under the
caption “Long-term debt” in the table above), as these
amounts are not fixed.
The amounts above related to operating leases include payments
on facilities that the company either no longer occupies or is
in the process of abandoning, for which the company is
contractually obligated.
The company currently expects to contribute $4.4 million in
2005 to fund its pension plan. This amount is not included in
the table above.
Contingencies
The company has change of control agreements with certain of its
employees that provide them with benefits should their
employment with the company be terminated other than for cause
or their disability or death, or if they resign for good reason,
as defined in these agreements, within a certain period of time
from the date of any change of control of the company.
As a defense contractor, the company is subject to many levels
of audit and review from various government agencies, including
the Defense Contract Audit Agency, various inspectors general,
the Defense Criminal Investigation Service, the General
Accounting Office, the Department of Justice and other
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. The company accrues for liabilities
associated with these activities when it becomes probable that
future expenditures will be made and such expenditures can be
reasonably estimated. The company’s evaluation of the
likelihood of expenditures related to these matters is subject
to change in future periods, depending on then current events
and circumstances, which could have material adverse effects on
the company’s business, financial position, results of
operations and cash flows.
On October 9, 2003, the United States Attorney filed a
civil complaint against the company in the United States
District Court for the District of Massachusetts based in
substantial part upon the actions and omissions of two former
employees which gave rise to criminal cases against them. The
United States Attorney seeks to recover up to three times its
actual damages and penalties under the False Claims Act and
double damages and penalties under the Anti-Kickback Act and to
recover costs and interest. The company disputes the claims,
believes it has substantive defenses, and intends to vigorously
defend itself. However, the outcome of such litigation, if
unfavorable, could have a material adverse effect on the
company’s business, financial position, results of
operations and cash flows. The company and the United States
Attorney have agreed to non-binding mediation of this matter.
In 2002, a dispute arose between Genesis Tactical Group LLC
(“Genesis”), Lockheed Martin Corporation
(“Lockheed”) and DRC related to a contract for
services to Lockheed which DRC sold to Genesis in 2001. In the
first quarter of 2005, Genesis, Lockheed and the company settled
the outstanding issues related to this dispute. The settlement
did not have a material effect on the company’s business,
financial position, results of operations or cash flows.
The company has provided documents in response to a previously
disclosed grand jury subpoena issued on October 15, 2002 by
the United States District Court for the District of
Massachusetts, directing the company to produce specified
documents dating back to 1996. The subpoena relates to an
investigation, currently focused on the period from 1996 to
1999, by the Antitrust Division of the Department of Justice
into the bidding and procurement activities involving the
company and several other defense contractors who have received
similar subpoenas and may also be subjects of the investigation.
Although the company is cooperating in the investigation, it
does not have a sufficient basis to predict the outcome of the
investigation. Should the company be found to have violated the
antitrust laws, the matter could have a material adverse effect
on the company’s business, financial position, results of
operations and cash flows.
27
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123(R),
Share-Based Payments (“SFAS 123R”).
SFAS 123R replaces SFAS No. 123, Accounting
for Stock-Based Compensation (“SFAS 123”),
and supersedes Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees
(“APB 25”). Under SFAS 123R, companies will
be required to recognize compensation costs related to
share-based payment transactions to employees in their financial
statements. The amount of compensation cost will be measured
using the grant-date fair value of the equity or liability
instruments issued. Additionally, liability awards will be
re-measured each reporting period. Compensation cost will be
recognized over the period that an employee provides service in
exchange for the award. The company is required to adopt the new
standard in its third quarter of 2005. The company historically
has disclosed the pro forma effect of expensing its stock
options as prescribed by SFAS 123. The company is
evaluating the different alternatives available for applying the
provisions of SFAS 123R and is currently assessing their
effects on its financial position and results of operations.
In December 2004, the FASB issued FASB Staff Position
(“FSP”) SFAS No. 109-1, Application of
FASB Statement No. 109, Accounting for Income Taxes, to the
Tax Deduction on Qualified Production Activities Provided by the
American Jobs Creation Act of 2004 (“FSP
SFAS 109-1”). FAS SFAS 109-1 provides guidance on
the application of SFAS No. 109, Accounting for
Income Taxes (“SFAS 109”), to the provision
within the American Jobs Creation Act of 2004 (the
“Act”) that provides tax relief to U.S. domestic
manufacturers. FSP SFAS 109-1 states that the
manufacturer’s deduction provided for under the Act should
be accounted for as a special deduction in accordance with
SFAS 109 and not as a tax rate reduction. A special
deduction is accounted for by recording the benefit of the
deduction in the year in which it can be taken in the
company’s tax return, and by not adjusting deferred tax
assets and liabilities in the period of the Act’s
enactment. FSP SFAS 109-1 was effective upon issuance. The
adoption of FSP SFAS 109-1 did not have a material effect
on the company’s financial position and results of
operations. Further, the company does not believe the adoption
of FSP SFAS 109-1 will have a material effect on its
federal income tax returns.
In November 2004, the FASB issued SFAS No. 151,
Inventory Costs, an amendment of ARB No. 43,
Chapter 4 (“SFAS 151”). SFAS 151
clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted material by
requiring that these items be recognized as current period
charges regardless of whether they meet the “so
abnormal” criterion outlined in ARB 43. The company is
required to adopt the new standard in its third quarter of 2005.
The company is currently assessing the impact of this new
standard on its financial position and results of operations;
however, the company does not believe the adoption of
SFAS 151 will have a material effect on its financial
position, results of operations or cash flows.
IMPACT OF INFLATION AND CHANGING PRICES
Overall, inflation has not had a material impact on the
company’s operations. Additionally, the terms of Department
of Defense contracts, which accounted for approximately 78% of
revenue in 2004, are generally one year contracts and include
salary increase factors for future years, thus reducing the
potential impact of inflation on the company.
FACTORS THAT MAY AFFECT FUTURE RESULTS
You should carefully consider the risks described below before
deciding to invest in shares of our common stock. These are
risks and uncertainties we believe are most important for you to
consider. Additional risks and uncertainties not presently known
to us, or which we currently deem immaterial, or which are
similar to those faced by other companies in our industry or
business in general, may also impair our business operations. If
any of the following risks or uncertainties actually occurs, our
business, financial condition, results of operations or cash
flows would likely suffer. In that event, the market price of
our common stock could decline.
Our Revenue is Highly Concentrated on the Department of
Defense and Other Federal Agencies, and A Significant Portion of
Our Revenue is Derived From a Few Customers. Decreases in Their
Budgets, Changes in Program Priorities or Military Base Closures
Could Affect Our Results.
In the years ended December 31, 2004 and 2003,
approximately 89% and 93% of our revenue, respectively, was
derived from United States government agencies. Within the
Department of Defense, certain programs account for a
significant portion of our United States Government business.
Our revenue from contracts with the Department of Defense,
either as a prime contractor or subcontractor, accounted for
approximately 78% of our total revenue in both 2004 and 2003. We
cannot provide any assurance that any of these programs will
continue as such or will continue at current levels. Our revenue
could be adversely affected by significant changes in defense
spending during periods of declining United States
28
defense budgets. Among the effects of this general decline has
been increased competition within a consolidating defense
industry.
Under procedures established by the Base Reduction and Closure
Act, the Department of Defense has announced its intention to
select in 2005 certain military bases for closure. In 2003, the
Department of Defense published an initial list of bases from
which it is expected the final selections will be made. Hanscom
Air Force Base and other installations at which the company does
business were included on the initial list for consideration.
Should a base be selected for closure at which the company has
significant business, the company’s business, financial
condition, results of operations and cash flows could be
adversely affected.
It is not possible for us to predict whether defense budgets
will increase or decline in the future. Further, changing
missions and priorities in the defense budget may have adverse
effects on our business. Funding limitations could result in a
reduction, delay or cancellation of existing or emerging
programs. We anticipate there will continue to be significant
competition when our defense contracts are re-bid, as well as
significant competitive pressure to lower prices, which may
reduce profitability in this area of our business, which would
adversely affect our business, financial condition, results of
operations and cash flows.
We Must Bear the Risk of Various Pricing Structures
Associated With Government Contracts.
We historically have derived a substantial portion of our
revenue from contracts and subcontracts with the United States
Government. A significant portion of our federal and state
government contracts are undertaken on a time and materials
nature, with fixed hourly rates that are intended to cover
salaries, benefits, other indirect costs of operating the
business and profit. The pricing of such contracts is based upon
estimates of future costs and assumptions as to the aggregate
volume of business that we will perform in a given business
division or other relevant unit.
Alternatively, we undertake various government projects on a
fixed-price basis, as distinguished from billing on a time and
materials basis. Under a fixed-price contract, the government
pays an agreed upon price for our services or products, and we
bear the risk that increased or unexpected costs may reduce our
profits or cause us to incur a loss. Significant cost overruns
can occur if we fail to:
|
|
|
| |
• |
adequately estimate the resources required to complete a project; |
| |
| |
• |
properly determine the scope of an engagement; or |
| |
| |
• |
complete our contractual obligation in a manner consistent with
the project plan. |
For fixed price contracts, we must estimate the costs necessary
to complete the defined statement of work and recognize revenue
or losses in accordance with such estimates. Actual costs may
vary materially from the estimates made from time to time,
necessitating adjustments to reported revenue and net income.
Underestimates of the costs associated with a project could
adversely affect our overall profitability and could have a
material adverse effect on our business, financial condition,
results of operations and cash flows. While we endeavor to
maintain and improve contract profitability, we cannot be
certain that any of our existing or future time and materials or
fixed-price projects will be profitable.
A substantial portion of our United States Government business
is as a subcontractor. In such circumstances, we generally bear
the risk that the prime contractor will meet its performance
obligations to the United States Government under the prime
contract and that the prime contractor will have the financial
capability to pay us amounts due under the subcontract. The
inability of a prime contractor to perform or make required
payments to us could have a material adverse effect on the
company’s business, financial condition, results of
operations and cash flows.
Our Contracts and Subcontracts with Government Agencies
are Subject to a Competitive Bidding Process and to Termination
Without Cause by the Government.
A significant portion of our federal and state government
contracts are renewable on an annual basis, or are subject to
the exercise of contractual options. Multi-year contracts often
require funding actions by the United States Government, state
legislature or others on an annual or more frequent basis. As a
result, our business could experience material adverse
consequences should such funding actions or other approvals not
be taken.
Recent federal regulations and renewed congressional interest in
small business set aside contracts is likely to influence
decisions pertaining to contracting methods for many of the
company’s customers. These regulations require more
frequent review and certification of small business contractor
status, so as the ensure that companies competing for contracts
29
intended for small business are qualified as such at the time of
the competition. In the years ended December 31, 2004 and
2003, the company derived $43.6 million and
$42.4 million, respectively, of revenue from a small
business set aside contract held by its HJ Ford subsidiary and
due for re-competition in 2005. The customer has currently
indicated that the re-competition will continue to be set aside,
or reserved, to include only prime contractors that qualify as
small businesses under regulations established by the Small
Business Administration. The company will strive to retain its
current work by moving work to other contract vehicles to the
extent possible and by partnering with firms that will qualify
as small businesses. To the extent these efforts are not
successful, the company’s business, financial condition,
results of operations and cash flows could be adversely affected.
The company’s contracts with the Internal Revenue Service,
Air Force Electronic Systems Center and Aeronautical Systems
Center are subject to re-competition in 2005.
Governmental awards of contracts are subject to regulations and
procedures that permit formal bidding procedures and protests by
losing bidders. Such protests may result in significant delays
in the commencement of expected contracts, the reversal of a
previous award decision or the reopening of the competitive
bidding process, which could have a material adverse effect on
our business, financial condition, results of operations and
cash flows.
Because of the complexity and scheduling of contracting with
government agencies, from time to time we may incur costs before
receiving contractual funding by the United States Government.
In some circumstances, we may not be able to recover such costs
in whole or in part under subsequent contractual actions.
Failure to collect such amounts may have material adverse
consequences on our business, financial condition, results of
operations and cash flows.
In addition, the United States Government has the right to
terminate contracts for convenience. If the government
terminated contracts with us, we would generally recover costs
incurred up to termination, costs required to be incurred in
connection with the termination and a portion of the fee earned
commensurate with the work we have performed to termination.
However, significant adverse effects on our indirect cost pools
may not be recoverable in connection with a termination for
convenience. Contracts with state and other governmental
entities are subject to the same or similar risks.
We Are Subject to a High Level of Government Regulations
and Audits Under Our Government Contracts and
Subcontracts.
As a defense contractor, we are subject to many levels of audit
and review, including by the Defense Contract Audit Agency,
various inspectors general, the Defense Criminal Investigative
Service, the General Accounting Office, the Department of
Justice and congressional committees. These audits, reviews and
the pending grand jury investigation and civil suit in the
United States District Court for the District of Massachusetts
could result in the termination of contracts, the imposition of
fines or penalties, the withholding of payments due to us or the
prohibition from participating in certain United States
government contracts for a specified period of time. Any such
action could have a material adverse effect on our business,
financial condition, results of operations and cash flows.
Loss of Key Personnel Could Limit Our Growth.
We are dependent on our ability to attract and retain highly
skilled technical personnel. Many of our technical personnel may
have specific knowledge and experience related to various
government customer operations and these individuals would be
difficult to replace in a timely fashion. In addition, qualified
technical personnel are in high demand worldwide and are likely
to remain a limited resource. The loss of services of key
personnel could impair our ability to perform required services
under some of our contracts, to retain such business after the
expiration of the existing contract, or to win new business in
the event that we lost the services of individuals who have been
identified in a given proposal as key personnel in the proposal.
Any of these situations could have a material adverse effect on
our business, financial condition, results of operations and
cash flows.
Our Failure to Obtain and Maintain Necessary Security
Clearances May Limit Our Ability to Perform Classified Work for
Government Clients, Which Could Harm Our Business.
Some government contracts require us to maintain facility
security clearances, and require some of our employees to
maintain individual security clearances. If our employees lose
or are unable to obtain security clearances on a timely basis,
or we lose a facility clearance, the government client can
terminate the contract or decide not to renew the contract upon
its expiration. As a result, to the extent that we cannot obtain
the required security clearances for our employees working on a
30
particular contract, or we fail to obtain them on a timely
basis, we may not derive the revenue anticipated from the
contract, which could have a material adverse effect on our
business, financial condition, results of operations and cash
flows.
Security Breaches in Sensitive Government Systems Could
Harm Our Business.
Many of the systems we develop, install and maintain involve
managing and protecting information involved in intelligence,
national security, and other sensitive or classified government
functions. A security breach in one of these systems could cause
serious harm to our business, damage our reputation, and prevent
us from being eligible for further work on sensitive or
classified systems for federal government clients. We could
incur losses from such a security breach that could exceed the
policy limits under our errors and omissions and product
liability insurance. Damage to our reputation or limitations on
our eligibility for additional work resulting from a security
breach in one of our systems could have a material adverse
effect on our business, financial condition, results of
operations and cash flows.
Our Employees May Engage in Misconduct or Other Improper
Activities, Which Could Harm Our Business.
We are exposed to the risk that employee fraud or other
misconduct could occur. Misconduct by employees could include
intentional failures to comply with federal government
procurement regulations, engaging in unauthorized activities, or
falsifying time records. Employee misconduct could also involve
the improper use of our clients’ sensitive or classified
information, which could result in regulatory sanctions against
us and serious harm to our reputation. It is not always possible
to deter employee misconduct, and the precautions we take to
prevent and detect this activity may not be effective in
controlling unknown or unmanaged risks or losses, which could
have a material adverse effect on our business, financial
condition, results of operations and cash flows.
We Are Involved in Various Litigation Matters Which, If
Not Resolved in Our Favor, Could Harm Our Business.
On October 26, 2000, two former company employees were
indicted and charged with conspiracy to defraud the United
States, and wire fraud, among other charges, arising out of a
scheme to defraud the United States out of approximately
$10 million. Both men subsequently pled guilty to the
principal charges against them. On October 9, 2003, the
United States Attorney’s office filed a civil complaint in
the District Court of Massachusetts against the company based in
substantial part upon the actions and omissions of the former
executives that gave rise to the criminal cases against them. In
the civil action, the United States is asserting claims against
the company based on the False Claims Act and the Anti-Kickback
Act, in addition to certain common law and equitable claims. The
United States seeks to recover up to three times its actual
damages and penalties under the False Claims Act, and double
damages and penalties under the Anti-Kickback Act. The United
States also seeks to recover its costs and interest in this
action. The company believes it has substantive defenses to
these claims and intends to vigorously defend itself. However,
the outcome of this litigation and other proceedings to which
the company is a part, if unfavorable, could have a material
adverse effect on the company’s business, financial
position, results of operations and cash flows.
Additionally, the Antitrust Division of the Department of
Justice is engaged in an investigation, currently focused on the
period from 1996 to 1999, into bidding and procurement
activities involving the company and several other defense
contractors who may also be subjects of the investigation.
Although the company is cooperating in the investigation, it
does not have a sufficient basis to predict the outcome of the
investigation. Should the company be found to have violated
antitrust laws, the matter could have a material adverse effect
on the company’s business, financial position, results of
operations and cash flows.
If We Are Unable to Effectively and Efficiently Eliminate
the Significant Deficiencies That Have Been Identified in Our
Internal Controls and Procedures, There Could Be a Material
Adverse Effect On Our Operations or Financial Results.
In March 2004, our management and Audit Committee were notified
by our independent accountants, Grant Thornton LLP, of two
significant deficiencies in our internal controls and procedures
regarding, first, the accrual of subcontractor work performed
and, second, our manually intensive financial reporting process.
In 2003, our management and Audit Committee were notified by our
then engaged independent accountants, KPMG LLP, of three
significant deficiencies relating to contract initiation and
set-up for certain fixed price contracts, inefficiencies in our
quarterly and year-end closing procedures and consolidation and
the level of SEC and generally accepted accounting principles,
or GAAP, experience of our personnel responsible for accounting
and financial reporting. Although we are committed to addressing
these deficiencies, we cannot assure you that we will be able to
successfully implement the revised controls and procedures or
that our revised controls
31
and procedures will be effective in remedying all of the
identified significant deficiencies. Our inability to
successfully eliminate these significant deficiencies could have
a material adverse effect on our business, financial condition,
results of operations and cash flows. Our auditors are
completing their work relating to the preparation and delivery
of their attestation report on our management’s assessment
of our internal control over financial reporting. The outcome of
that work could impact the matters reported in this
Form 10-K and require amendment of this Form 10-K.
Moreover, this Form 10-K is incomplete until the time the
auditor reports and consents discussed on the cover page to this
Form 10-K and amendments to Item 9A of Part II of
this Form 10-K are included in an amendment filed on
Form 10-K/ A. If this Annual Report on Form 10-K is
not so amended or completed by March 31, 2005, we will not
be current in our SEC filings.
We Operate in Highly Competitive Markets and May Have
Difficulties Entering New Markets.
The markets for our services are highly competitive. The
government contracting business is subject to intense
competition from numerous companies, many of which have
significantly greater financial, technical and marketing
resources than we do. The principal competitive factors are
prior performance, previous experience, technical competence and
price.
Competition in the market for our commercial products is also
intense. There is a significant lead-time for developing such
business, and it involves substantial capital investment
including development of prototypes and investment in
manufacturing equipment. Principal competitive factors are
product quality, the ability to specialize our engineering in
order to meet our customers’ specific system requirements
and price. Our precision products business has a number of
competitors, many of which have significantly greater financial,
technical and marketing resources than we do. Competitive
pressures in our government and commercial businesses could have
a material adverse effect on our business, financial condition,
results of operations and cash flows.
In our efforts to enter new markets, including commercial
markets and United States Government agencies other than the
Department of Defense, we generally face significant competition
from other companies that have prior experience with such
potential customers, as well as significantly greater financial,
technical and marketing resources than we have. As a result, we
may not achieve the level of success that we expect in our
efforts to enter such new markets.
We May Be Subject to Product Liability Claims.
Our precision manufactured products are generally designed to
operate as important components of complex systems or products.
Defects in our products could cause our customer’s product
or systems to fail or perform below expectations. Although we
attempt to contractually limit our liability for such defects or
failures, we cannot assure you that our attempts to limit our
liability will be successful. Like other manufacturing
companies, we may be subject to claims for alleged performance
issues related to our products. Such claims, if made, could
damage our reputation and could have a material adverse effect
on our business, financial condition, results of operations and
cash flows.
Economic Events May Affect Our Business Segments.
Many of our precision products are components of commercial
products. Factors that affect the production and demand for such
products, including economic events both domestically and in
other regions of the world, competition, technological change
and production disruption, could adversely affect demand for our
products. Many of our products are incorporated into capital
equipment, such as machine tools and other automated production
equipment, used in the manufacture of other products. As a
result, this portion of our business may be subject to
fluctuations in the manufacturing sector of the overall economy.
An economic recession, either in the United States or elsewhere
in the world, could have a material adverse effect on the rate
of orders received by the commercial division. Significantly
lower production volumes resulting in under-utilization of our
manufacturing facilities would adversely affect our business,
financial condition, results of operations and cash flows.
Our Products and Services Could Become Obsolete Due to
Rapid Technological Changes in the Industry.
We offer sophisticated products and services in areas in which
there have been and are expected to continue to be significant
technological changes. Many of our products are incorporated
into sophisticated machinery, equipment or electronic systems.
Technological changes may be incorporated into competitors’
products that may adversely affect the market for our products.
If our competitors introduce superior technologies or products,
we cannot assure you that we will be able to respond quickly
enough to such changes or to offer services that satisfy our
customers’ requirements at a competitive price. Further, we
cannot provide any assurance that our research and product
development efforts will be successful or result in new or
improved products that may be required to sustain our market
position.
32
Our Financing Requirements May Increase and We Could Have
Limited Access to Capital Markets.
While we believe that our current resources and access to
capital markets are adequate to support operations over the near
term and foreseeable future, we cannot assure you that these
circumstances will remain unchanged. Our need for capital is
dependent on operating results and may be greater than expected.
Our ability to maintain our current sources of debt financing
depends on our ability to remain in compliance with certain
covenants contained in our financing agreements, including,
among other requirements, maintaining a minimum total net worth
and minimum cash flow and debt coverage ratios. If changes in
capital markets restrict the availability of funds or increase
the cost of funds, we may be required to modify, delay or
abandon some of our planned expenditures, which could have a
material adverse effect on our business, financial condition,
results of operations and cash flows.
Accounting System Upgrades and Conversions May Delay
Billing and Collections of our Accounts Receivable.
In 2004, we installed a new enterprise business system, and from
time to time, we may be required to make changes to that system
as we integrate businesses or upgrade to new technologies.
Future accounting system conversions and upgrades could cause
delays in billing and collection of accounts receivable under
our contracts, which could adversely affect our business,
financial condition, results of operations and cash flows.
Our Quarterly Operating Results May Vary Significantly
From Quarter to Quarter.
Our revenue and earnings may fluctuate from quarter to quarter
depending on a number of factors, including:
|
|
|
| |
• |
the number, size and timing of client projects commenced and
completed during a quarter; |
| |
| |
• |
bid and proposal efforts undertaken; |
| |
| |
• |
progress on fixed-price projects during a given quarter; |
| |
| |
• |
employee productivity and hiring, attrition and utilization
rates; |
| |
| |
• |
accuracy of estimates of resources required to complete ongoing
projects; and |
| |
| |
• |
general economic conditions. |
Demand for our products and services in each of the markets we
serve can vary significantly from quarter to quarter due to
revisions in customer budgets or schedules and other factors
beyond our control. In addition, because a high percentage of
our expenses is fixed and does vary relative to revenue, a
decrease in revenue may cause a significant variation in our
operating results.
We May Not Make or Complete Future Mergers, Acquisitions
or Strategic Alliances or Investments.
In 2004, we acquired Impact Innovations Group LLC, and in 2002,
we acquired HJ Ford Associates, Inc. and Andrulis Corporation.
We may seek to continue to expand our operations through
mergers, acquisitions or strategic alliances with businesses
that will complement our existing business. However, we may not
be able to find attractive candidates, or enter into
acquisitions on terms that are favorable to us, or successfully
integrate the operations of companies that we acquire. In
addition, we may compete with other companies for these
acquisition candidates, which could make an acquisition more
expensive for us. If we are able to successfully identify and
complete an acquisition or similar transaction, it could involve
a number of risks, including, among others:
|
|
|
| |
• |
the difficulty of assimilating the acquired operations and
personnel; |
| |
| |
• |
the potential disruption of our ongoing business and diversion
of resources and management time; |
| |
| |
• |
the potential failure to retain key personnel of the acquired
business; |
| |
| |
• |
the difficulty of integrating systems, operations and
cultures; and |
| |
| |
• |
the potential impairment of relationships with customers as a
result of changes in management or otherwise arising out of such
transactions. |
We cannot assure you that any acquisition will be made, that we
will be able to obtain financing needed to fund such
acquisitions and, if any acquisitions are so made, that the
acquired business will be successfully integrated into our
operations or that the acquired business will perform as
expected. In addition, if we were to proceed with one or more
33
significant strategic alliances, acquisitions or investments in
which the consideration consists of cash, a substantial portion
of our available cash could be used to consummate the strategic
alliances, acquisitions or investments. The financial impact of
acquisitions, investments and strategic alliances could have a
material adverse effect on our business, financial condition,
results of operations and cash flows and could cause substantial
fluctuations in our quarterly and annual operating results.
The Market Price of Our Common Stock May Be
Volatile.
The market price of securities of technology companies
historically has faced significant volatility. The stock market
in recent years has also experienced significant price and
volume fluctuations that often have been unrelated or
disproportionate to the operating performance of particular
companies. Many factors that have influenced trading prices will
vary from period to period, including:
|
|
|
| |
• |
decreases in our earnings and revenue or quarterly operating
results; |
| |
| |
• |
changes in estimates by analysts; |
| |
| |
• |
market conditions in the industry; |
| |
| |
• |
announcements and new developments by competitors; and |
| |
| |
• |
regulatory reviews. |
Any of these events could have a material adverse effect on the
market price of our common stock.
|
|
| Item 7A. |
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The company is subject to interest rate risk associated with our
acquisition term loan, term loan and revolver, where interest
payments are tied to either the LIBOR or prime rate. The
interest rate on the acquisition term loan was 5.41% at
December 31, 2004, under the 90 day LIBOR Rate option
elected on November 1, 2004. The interest rate on the term
loan was 5.16% at December 31, 2004, under the 90 day
LIBOR Rate option elected on November 1, 2004. The interest
rate on the revolver was 5.28% at December 31, 2004, under
the 30 day LIBOR Rate option elected on December 1,
2004. At any time, a sharp rise in interest rates could have an
adverse effect on net interest expense as reported in the
company’s Consolidated Statements of Operations. An
increase of one full percentage point in the interest rate on
the company’s acquisition term loan, term loan and revolver
would result in increases in annual interest expense aggregating
$0.7 million.
The company presently has no investments, and, accordingly, no
exposure to market interest rates on investments.
The company has no significant exposure to foreign currency
fluctuations. Foreign sales, which are nominal, are primarily
denominated in United States dollars.
34
PART II
|
|
| Item 8. |
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
35
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
| |
|
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
ASSETS |
|
Current assets
|
|
|
|
|
|
|
|
|
| |
Cash and cash equivalents
|
|
$ |
925 |
|
|
$ |
2,724 |
|
| |
Accounts receivable, net of allowances of $396 and $321 at
December 31, 2004 and 2003, respectively
|
|
|
45,978 |
|
|
|
28,251 |
|
| |
Unbilled expenditures and fees on contracts in process
|
|
|
50,322 |
|
|
|
34,257 |
|
| |
Prepaid expenses and other current assets
|
|
|
5,668 |
|
|
|
2,145 |
|
| |
|
|
|
|
|
|
| |
|
|
Total current assets
|
|
|
102,893 |
|
|
|
67,377 |
|
| |
|
|
|
|
|
|
|
Noncurrent assets
|
|
|
|
|
|
|
|
|
| |
Property, plant and equipment, net
|
|
|
22,139 |
|
|
|
20,672 |
|
| |
Deferred income taxes
|
|
|
— |
|
|
|
2,337 |
|
| |
Goodwill
|
|
|
63,055 |
|
|
|
26,711 |
|
| |
Intangible assets, net
|
|
|
11,519 |
|
|
|
2,343 |
|
| |
Other noncurrent assets
|
|
|
5,528 |
|
|
|
1,630 |
|
| |
|
|
|
|
|
|
| |
|
|
Total noncurrent assets
|
|
|
102,241 |
|
|
|
53,693 |
|
| |
|
|
|
|
|
|
| |
|
|
Total assets
|
|
$ |
205,134 |
|
|
$ |
121,070 |
|
| |
|
|
|
|
|
|
| |
|
LIABILITIES AND STOCKHOLDERS’ EQUITY |
| |
|
Current liabilities
|
|
|
|
|
|
|
|
|
| |
Current portion of long-term debt
|
|
$ |
8,357 |
|
|
$ |
500 |
|
| |
Notes payable and revolver
|
|
|
10,000 |
|
|
|
8,500 |
|
| |
Accounts payable
|
|
|
21,778 |
|
|
|
13,351 |
|
| |
Accrued payroll and employee benefits
|
|
|
17,914 |
|
|
|
15,657 |
|
| |
Deferred income taxes
|
|
|
15,418 |
|
|
|
9,698 |
|
| |
Other accrued expenses
|
|
|
4,447 |
|
|
|
2,371 |
|
| |
Discontinued operations
|
|
|
422 |
|
|
|
778 |
|
| |
|
|
|
|
|
|
| |
|
|
Total current liabilities
|
|
|
78,336 |
|
|
|
50,855 |
|
| |
|
|
|
|
|
|
|
Long-term liabilities
|
|
|
|
|
|
|
|
|
| |
Long-term debt, less current portion
|
|
|
51,485 |
|
|
|
7,750 |
|
| |
Deferred income taxes
|
|
|
591 |
|
|
|
— |
|
| |
Accrued pension liability
|
|
|
11,336 |
|
|
|
12,030 |
|
| |
Other long-term liabilities
|
|
|
2,068 |
|
|
|
1,386 |
|
| |
Discontinued operations
|
|
|
— |
|
|
|
398 |
|
| |
|
|
|
|
|
|
| |
|
|
Total long-term liabilities
|
|
|
65,480 |
|
|
|
21,564 |
|
| |
|
|
|
|
|
|
| |
|
|
Total liabilities
|
|
|
143,816 |
|
|
|
72,419 |
|
| |
|
|
|
|
|
|
|
Commitments and contingencies
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity
|
|
|
|
|
|
|
|
|
| |
Preferred stock, $0.10 par value, 5,000,000 shares
authorized, no shares issued
|
|
|
— |
|
|
|
— |
|
| |
Common stock, $0.10 par value, 30,000,000 shares
authorized:
|
|
|
|
|
|
|
|
|
| |
|
Issued — 8,737,562 and 9,822,508 shares at
December 31, 2004 and 2003, respectively
|
|
|
874 |
|
|
|
982 |
|
| |
|
Treasury stock — 1,379,426 shares at
December 31, 2003
|
|
|
— |
|
|
|
(138 |
) |
| |
Capital in excess of par value
|
|
|
40,849 |
|
|
|
36,642 |
|
| |
Unearned compensation
|
|
|
(1,572 |
) |
|
|
(797 |
) |
| |
Accumulated other comprehensive loss
|
|
|
(7,724 |
) |
|
|
(7,556 |
) |
| |
Retained earnings
|
|
|
28,891 |
|
|
|
19,518 |
|
| |
|
|
|
|
|
|
| |
|
|
Total stockholders’ equity
|
|
|
61,318 |
|
|
|
48,651 |
|
| |
|
|
|
|
|
|
| |
|
|
Total liabilities and stockholders’ equity
|
|
$ |
205,134 |
|
|
$ |
121,070 |
|
| |
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
36
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
Contract revenue
|
|
$ |
268,634 |
|
|
$ |
237,876 |
|
|
$ |
184,994 |
|
|
Product sales
|
|
|
7,072 |
|
|
|
6,932 |
|
|
|
7,616 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
Total revenue
|
|
|
275,706 |
|
|
|
244,808 |
|
|
|
192,610 |
|
| |
|
|
|
|
|
|
|
|
|
|
Cost of contract revenue
|
|
|
227,509 |
|
|
|
199,647 |
|
|
|
156,441 |
|
|
Cost of product sales
|
|
|
5,214 |
|
|
|
5,100 |
|
|
|
5,238 |
|
|
Selling, general and administrative expenses
|
|
|
23,152 |
|
|
|
22,948 |
|
|
|
17,910 |
|
|
Amortization of intangible assets
|
|
|
2,324 |
|
|
|
1,724 |
|
|
|
374 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
Total operating costs and expenses
|
|
|
258,199 |
|
|
|
229,419 |
|
|
|
179,963 |
|
| |
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
17,507 |
|
|
|
15,389 |
|
|
|
12,647 |
|
|
Interest expense, net
|
|
|
(2,225 |
) |
|
|
(854 |
) |
|
|
(421 |
) |
|
Other income, net
|
|
|
360 |
|
|
|
454 |
|
|
|
67 |
|
| |
|
|
|
|
|
|
|
|
|
|
Income from continuing operations before provision for income
taxes
|
|
|
15,642 |
|
|
|
14,989 |
|
|
|
12,293 |
|
|
Provision for income taxes
|
|
|
6,269 |
|
|
|
6,334 |
|
|
|
4,936 |
|
| |
|
|
|
|
|
|
|
|
|
|
Income from continuing operations
|
|
|
9,373 |
|
|
|
8,655 |
|
|
|
7,357 |
|
|
Loss from discontinued operations, net of tax benefit of $1,058
and $741 in the years ended December 31, 2003 and 2002,
respectively
|
|
|
— |
|
|
|
(1,635 |
) |
|
|
(1,124 |
) |
|
Loss on disposal of discontinued operations, net of tax benefit
of $226 in the year ended December 31, 2003
|
|
|
— |
|
|
|
(348 |
) |
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
9,373 |
|
|
$ |
6,672 |
|
|
$ |
6,233 |
|
| |
|
|
|
|
|
|
|
|
|
|
Earnings (loss) per common share
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Basic
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Income from continuing operations
|
|
$ |
1.10 |
|
|
$ |
1.05 |
|
|
$ |
0.92 |
|
| |
|
Loss from discontinued operations
|
|
|
— |
|
|
|
(0.20 |
) |
|
|
(0.14 |
) |
| |
|
Loss on disposal of discontinued operations
|
|
|
— |
|
|
|
(0.04 |
) |
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
Net earnings per common share
|
|
$ |
1.10 |
|
|
$ |
0.81 |
|
|
$ |
0.78 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Income from continuing operations
|
|
$ |
1.03 |
|
|
$ |
0.98 |
|
|
$ |
0.83 |
|
| |
|
Loss from discontinued operations
|
|
|
— |
|
|
|
(0.18 |
) |
|
|
(0.13 |
) |
| |
|
Loss on disposal of discontinued operations
|
|
|
— |
|
|
|
(0.04 |
) |
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
Net earnings per common share
|
|
$ |
1.03 |
|
|
$ |
0.76 |
|
|
$ |
0.70 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Weighted average shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Weighted average shares outstanding — basic
|
|
|
8,499,013 |
|
|
|
8,226,225 |
|
|
|
7,989,793 |
|
| |
|
Dilutive effect of options
|
|
|
574,035 |
|
|
|
615,818 |
|
|
|
887,376 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Weighted average shares outstanding — diluted
|
|
|
9,073,048 |
|
|
|
8,842,043 |
|
|
|
8,877,169 |
|
| |
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
37
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’
EQUITY AND COMPREHENSIVE INCOME (LOSS)
(in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Common Stock | |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
Capital | |
|
|
|
Accumulated | |
|
|
|
|
| |
|
Preferred Stock |
|
Issued | |
|
Treasury Stock | |
|
in Excess | |
|
|
|
Other | |
|
|
|
|
| |
|
|
|
| |
|
| |
|
of Par | |
|
Unearned | |
|
Comprehensive | |
|
Retained | |
|
|
| |
|
Shares | |
|
Par value |
|
Shares | |
|
Par value | |
|
Shares | |
|
Par value | |
|
Value | |
|
Compensation | |
|
Loss | |
|
Earnings | |
|
Total | |
| |
|
| |
|
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Balance at December 31, 2001
|
|
|
— |
|
|
$ |
— |
|
|
|
9,320 |
|
|
$ |
932 |
|
|
|
(1,379 |
) |
|
$ |
(138 |
) |
|
$ |
31,331 |
|
|
$ |
(992 |
) |
|
$ |
(608 |
) |
|
$ |
6,613 |
|
|
$ |
37,138 |
|
|
Issuance of common stock
|
|
|
— |
|
|
|
— |
|
|
|
227 |
|
|
|
22 |
|
|
|
— |
|
|
|
— |
|
|
|
2,346 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2,368 |
|
|
Forfeiture of restricted stock
|
|
|
— |
|
|
|
— |
|
|
|
(3 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(27 |
) |
|
|
27 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Amortization of unearned compensation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
149 |
|
|
|
— |
|
|
|
— |
|
|
|
149 |
|
|
Accumulated other comprehensive loss(1)
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(6,273 |
) |
|
|
— |
|
|
|
(6,273 |
) |
|
Tax benefit from stock options exercised
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
194 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
194 |
|
|
Net income
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
6,233 |
|
|
|
6,233 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2002
|
|
|
— |
|
|
|
— |
|
|
|
9,544 |
|
|
|
954 |
|
|
|
(1,379 |
) |
|
|
(138 |
) |
|
|
33,844 |
|
|
|
(816 |
) |
|
|
(6,881 |
) |
|
|
12,846 |
|
|
|
39,809 |
|
|
Issuance of common stock
|
|
|
— |
|
|
|
— |
|
|
|
255 |
|
|
|
26 |
|
|
|
— |
|
|
|
— |
|
|
|
2,373 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2,399 |
|
|
Forfeiture of restricted stock
|
|
|
— |
|
|
|
— |
|
|
|
23 |
|
|
|
2 |
|
|
|
— |
|
|
|
— |
|
|
|
228 |
|
|
|
(230 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Amortization of unearned compensation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
249 |
|
|
|
— |
|
|
|
— |
|
|
|
249 |
|
|
Accumulated other comprehensive loss(1)
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(675 |
) |
|
|
— |
|
|
|
(675 |
) |
|
Tax benefit from stock options exercised
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
197 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
197 |
|
|
Net income
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
6,672 |
|
|
|
6,672 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2003
|
|
|
— |
|
|
|
— |
|
|
|
9,822 |
|
|
|
982 |
|
|
|
(1,379 |
) |
|
|
(138 |
) |
|
|
36,642 |
|
|
|
(797 |
) |
|
|
(7,556 |
) |
|
|
19,518 |
|
|
|
48,651 |
|
|
Unaudited:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Issuance of common stock
|
|
|
— |
|
|
|
— |
|
|
|
235 |
|
|
|
23 |
|
|
|
— |
|
|
|
— |
|
|
|
2,584 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2,607 |
|
| |
Issuance of restricted stock
|
|
|
— |
|
|
|
— |
|
|
|
94 |
|
|
|
10 |
|
|
|
— |
|
|
|
— |
|
|
|
1,680 |
|
|
|
(1,690 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Forfeiture of restricted stock
|
|
|
— |
|
|
|
— |
|
|
|
(32 |
) |
|
|
(3 |
) |
|
|
— |
|
|
|
— |
|
|
|
(374 |
) |
|
|
377 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Repurchase and retirement of restricted stock
|
|
|
— |
|
|
|
— |
|
|
|
(3 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(36 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(36 |
) |
| |
Amortization of unearned compensation
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
538 |
|
|
|
— |
|
|
|
— |
|
|
|
538 |
|
| |
Accumulated other comprehensive loss(1)
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(168 |
) |
|
|
— |
|
|
|
(168 |
) |
| |
Tax benefit from stock options exercised and employee stock
purchase plan
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
353 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
353 |
|
| |
Redesignation of treasury stock to common stock in accordance
with Massachusetts Business Corporation Act, Chapter 156D
|
|
|
— |
|
|
|
— |
|
|
|
(1,379 |
) |
|
|
(138 |
) |
|
|
1,379 |
|
|
|
138 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
| |
Net income
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
9,373 |
|
|
|
9,373 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004 (unaudited)
|
|
|
— |
|
|
$ |
— |
|
|
|
8,737 |
|
|
$ |
874 |
|
|
|
— |
|
|
$ |
— |
|
|
$ |
40,849 |
|
|
$ |
(1,572 |
) |
|
$ |
(7,724 |
) |
|
$ |
28,891 |
|
|
$ |
61,318 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
Comprehensive income (loss) is calculated as follows: |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
Net income
|
|
$ |
9,373 |
|
|
$ |
6,672 |
|
|
$ |
6,233 |
|
|
Adjustments to accumulated comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Minimum pension liability adjustment, net of tax effect and
adjustments aggregating $193 in the year ended December 31,
2004, and net tax benefits of $1,732 and $4,059 in the years
ended December 31, 2003 and 2002, respectively
|
|
|
(1,703 |
) |
|
|
(675 |
) |
|
|
(6,273 |
) |
| |
Unrealized gain on investment in Lucent Technologies, net of tax
effect of $993 in 2004
|
|
|
1,535 |
|
|
|
— |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss)
|
|
$ |
9,205 |
|
|
$ |
5,997 |
|
|
$ |
(40 |
) |
| |
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
38
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
Operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net income
|
|
$ |
9,373 |
|
|
$ |
6,672 |
|
|
$ |
6,233 |
|
| |
Loss from discontinued operations
|
|
|
— |
|
|
|
(1,635 |
) |
|
|
(1,124 |
) |
| |
Loss on disposal of discontinued operations
|
|
|
— |
|
|
|
(348 |
) |
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
Income from continuing operations
|
|
|
9,373 |
|
|
|
8,655 |
|
|
|
7,357 |
|
| |
Adjustments to reconcile net cash provided by operating
activities
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Depreciation
|
|
|
3,624 |
|
|
|
3,007 |
|
|
|
3,192 |
|
| |
|
(Gain) loss on disposal of assets
|
|
|
(2 |
) |
|
|
2 |
|
|
|
— |
|
| |
|
Non-cash interest expense
|
|
|
154 |
|
|
|
137 |
|
|
|
92 |
|
| |
|
Investment income from equity interest
|
|
|
(249 |
) |
|
|
(198 |
) |
|
|
(46 |
) |
| |
|
Stock compensation expense
|
|
|
538 |
|
|
|
249 |
|
|
|
149 |
|
| |
|
Tax benefit from stock options exercised
|
|
|
353 |
|
|
|
197 |
|
|
|
194 |
|
| |
|
Amortization of intangible assets
|
|
|
2,324 |
|
|
|
1,724 |
|
|
|
374 |
|
| |
|
Deferred income taxes provision
|
|
|
7,697 |
|
|
|
2,733 |
|
|
|
343 |
|
| |
Change in operating assets and liabilities, net of effect of
acquisitions
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Accounts receivable, net
|
|
|
(7,612 |
) |
|
|
1,568 |
|
|
|
3,422 |
|
| |
|
Unbilled expenditures and fees on contracts in process
|
|
|
(17,078 |
) |
|
|
(7,643 |
) |
|
|
3,961 |
|
| |
|
Prepaid expenses and other current assets
|
|
|
(3,336 |
) |
|
|
(729 |
) |
|
|
(205 |
) |
| |
|
Accounts payable
|
|
|
8,486 |
|
|
|
1,017 |
|
|
|
(8,734 |
) |
| |
|
Accrued payroll and employee benefits
|
|
|
850 |
|
|
|
3,759 |
|
|
|
(1,695 |
) |
| |
|
Other accrued expenses
|
|
|
(1,125 |
) |
|
|
(1,292 |
) |
|
|
1,511 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
Net cash provided by continuing operations
|
|
|
3,997 |
|
|
|
13,186 |
|
|
|
9,915 |
|
| |
|
|
Net cash provided by (used in) discontinued operations
|
|
|
(754 |
) |
|
|
(1,425 |
) |
|
|
379 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
|
Net cash provided by operating activities
|
|
|
3,243 |
|
|
|
11,761 |
|
|
|
10,294 |
|
| |
|
|
|
|
|
|
|
|
|
|
Investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Purchase of property, plant and equipment
|
|
|
(4,544 |
) |
|
|
(8,163 |
) |
|
|
(3,347 |
) |
| |
Proceeds from the sale of assets
|
|
|
17 |
|
|
|
— |
|
|
|
— |
|
| |
Purchase of businesses, net of cash acquired
|
|
|
(53,967 |
) |
|
|
(376 |
) |
|
|
(24,321 |
) |
| |
Dividends from equity investment
|
|
|
60 |
|
|
|
— |
|
|
|
— |
|
| |
Increase in other assets
|
|
|
(2,271 |
) |
|
|
(279 |
) |
|
|
(434 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
|
Net cash used in continuing operations
|
|
|
(60,705 |
) |
|
|
(8,818 |
) |
|
|
(28,102 |
) |
| |
|
|
Net cash provided by (used in) discontinued operations
|
|
|
— |
|
|
|
2,950 |
|
|
|
(177 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
|
|
Net cash used in investing activities
|
|
|
(60,705 |
) |
|
|
(5,868 |
) |
|
|
(28,279 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net borrowings (repayments) under revolving credit
agreement and notes payable
|
|
|
1,500 |
|
|
|
(6,144 |
) |
|
|
2,240 |
|
| |
Issuance of long-term debt
|
|
|
55,000 |
|
|
|
— |
|
|
|
— |
|
| |
Repayments under loan agreement
|
|
|
(2,908 |
) |
|
|
— |
|
|
|
(700 |
) |
| |
Principal payments under mortgage agreement
|
|
|
(500 |
) |
|
|
(500 |
) |
|
|
(500 |
) |
| |
Proceeds from the issuance of common stock
|
|
|
2,571 |
|
|
|
2,399 |
|
|
|
2,368 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
|
Net cash provided by (used in) financing activities
|
|
|
55,663 |
|
|
|
(4,245 |
) |
|
|
3,408 |
|
| |
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
(1,799 |
) |
|
|
1,648 |
|
|
|
(14,577 |
) |
|
Cash and cash equivalents, beginning of period
|
|
|
2,724 |
|
|
|
1,076 |
|
|
|
15,653 |
|
| |
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period
|
|
$ |
925 |
|
|
$ |
2,724 |
|
|
$ |
1,076 |
|
| |
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Cash paid during the year for interest
|
|
$ |
1,488 |
|
|
$ |
711 |
|
|
$ |
440 |
|
| |
Cash paid during the year for income taxes, net of refunds
|
|
$ |
124 |
|
|
$ |
2,403 |
|
|
$ |
4,001 |
|
|
Supplemental disclosure of noncash financing and investing
activities
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Restricted stock issued
|
|
$ |
1,680 |
|
|
$ |
230 |
|
|
$ |
— |
|
|
Supplemental disclosure — acquisitions
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Assets acquired
|
|
$ |
59,267 |
|
|
$ |
— |
|
|
$ |
21,498 |
|
| |
Cash payments, net of cash acquired
|
|
|
(53,967 |
) |
|
|
(376 |
) |
|
|
(24,321 |
) |
| |
Issuance of notes payable to sellers
|
|
|
— |
|
|
|
— |
|
|
|
(12,404 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
Liabilities assumed
|
|
$ |
5,300 |
|
|
$ |
(376 |
) |
|
$ |
(15,227 |
) |
| |
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
39
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
|
|
| NOTE 1. |
NATURE OF THE BUSINESS |
Dynamics Research Corporation (“DRC” or the
“company”), headquartered in Andover, Massachusetts,
provides information technology, engineering, logistics and
other consulting services to federal defense, civil and state
agency customers. Founded in 1955 and headquartered in Andover,
Massachusetts, DRC has approximately 1,960 employees located
throughout the United States. The company operated through the
parent corporation and its wholly owned subsidiaries, HJ Ford
Associates, Inc. (“HJ Ford”), Andrulis Corporation
(“ANDRULIS”) and Impact Innovations Group LLC
(“Impact Innovations”) through December 31, 2004,
at which time ANDRULIS and Impact Innovations merged with and
into the company. Effective January 1, 2005, the company
operates through the parent corporation and its wholly owned
subsidiary, HJ Ford.
DRC’s core capabilities are focused on information
technology, engineering and technical subject matter expertise
that pertain to the knowledge domains relevant to the
company’s core customers. These capabilities include
design, development, operation and maintenance of information
technology systems, engineering services, complex logistics
planning systems and services, defense program administrative
support services, simulation, modeling, training systems and
services, and custom built electronic test equipment and
services.
|
|
| NOTE 2. |
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of
the company and all wholly owned subsidiaries. All significant
intercompany accounts and transactions are eliminated.
On September 1, 2004, the company completed the acquisition
of Impact Innovations from J3 Technology Services Corp.
(“J3 Technology”), a Georgia corporation. Impact
Innovations, based in the Washington, D.C. area, offers
solutions in business intelligence, enterprise software,
application development, information technology service
management and other related areas. This transaction was
recorded using the purchase method of accounting in accordance
with Financial Accounting Standards Board (“FASB”)
Statement of Financial Accounting Standards (“SFAS”)
No. 141, Business Combinations
(“SFAS 141”). Accordingly, the results of this
acquired entity are included in the company’s Consolidated
Statements of Operations and of Cash Flows for the period
subsequent to its acquisition.
On December 20, 2002, the company completed the acquisition
of all of the outstanding shares of capital stock of ANDRULIS,
and on May 31, 2002, the company completed the acquisition
of all of the outstanding voting common stock of HJ Ford. These
transactions were recorded in accordance with SFAS 141.
Accordingly, the results of these acquired entities are included
in the company’s Consolidated Statements of Operations and
of Cash Flows for the periods subsequent to their respective
acquisitions.
As part of the HJ Ford purchase, the company acquired a 40%
ownership interest in HMR Tech, a small disadvantaged business,
as defined by the United States Government. This business is
accounted for using the equity method. This ownership interest
is reported as a component of “Other noncurrent
assets” in the company’s Consolidated Balance Sheets.
On October 18, 2002, the company announced that it was
actively pursuing the divestiture of the Encoder Division, a
manufactured products business previously reported as a business
segment, due to continued weakness in the manufacturing sector.
In accordance with FASB SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets
(“SFAS 144”), effective in the fourth quarter
of fiscal 2002, the company’s consolidated financial
statements and notes thereto were restated to reflect the
discontinuation of the Encoder Division for all periods
presented. On May 2, 2003, the company completed the sale
of its Encoder Division assets and certain liabilities to GSI
Lumonics Inc. (“GSI”) in Billerica, Massachusetts.
Unless otherwise indicated, all financial information presented
herein refers to continuing operations.
40
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
Risks, Uncertainties and Use of Estimates
There are business risks specific to the industries in which the
company operates. These risks include, but are not limited to,
estimates of costs to complete contract obligations, changes in
government policies and procedures, government contracting
issues 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 and disclosure of contingent assets and
liabilities at the date of the financial statements. Estimates
and assumptions also affect the amount of revenue and expenses
during the reported period. Management believes the most
sensitive estimates include the allowance for uncollectible
accounts receivable, recoverability of unbilled expenditures and
fees on contracts in process, valuation allowance of deferred
tax assets, assumptions made in business combinations and in the
impairment analysis of goodwill and intangible assets,
assumptions to estimate pension obligations and cost, estimates
to complete on percentage-of-completion revenue recognition,
costs billed to the government subject to audit and adjustments,
provision for contract losses, and amounts and disclosures of
contingent liabilities. Actual results could differ from those
estimates.
Revenue Recognition
The company’s systems and services business segment
provides its services under time and materials, cost
reimbursable and fixed-price contracts including service-type
contracts.
For time and materials contracts, revenue reflects the number of
direct labor hours expended in the performance of a contract
multiplied by the contract billing rate, as well as
reimbursement of other billable direct costs. The risk inherent
in time and materials contracts is that if actual costs differ
materially from negotiated billing rates in the contract,
operating income is negatively impacted.
For cost reimbursable contracts, revenue is recognized as costs
are incurred and include a proportionate amount of the fee
earned. Cost reimbursable contracts specify the contract fee in
dollars or as a percentage of estimated costs. The primary risk
on a cost reimbursable contract is that a government audit of
direct and indirect costs could result in the disallowance of
certain costs, which would directly impact revenue and margin on
the contract. Historically, such audits have had no material
impact on the company’s revenue and operating income.
Under fixed-price contracts, other than service-type contracts,
revenue is recognized under the percentage of completion method,
on the basis of costs incurred in relation to estimated total
costs to complete the contract. Under service-type contracts,
costs incurred are not indicative of progression toward
completion of the contract. Revenue from service-type fixed
price contracts is recognized ratably over the contract period
or by other appropriate output methods to measure service
provided, and contract costs are expensed as incurred. The risk
to the company on a fixed-price contract is that if actual costs
exceed the estimated costs to complete the contract, operating
income is negatively impacted.
The company does not recognize revenue associated with amounts
claimed under a contract that are not agreed to by the customer.
For all types of contracts, the company recognizes anticipated
contract losses as soon as they become known and estimable.
Out-of-pocket expenses that are reimbursable by the customer are
included in contract revenue and cost of contract revenue.
The company’s Metrigraphics business segment generally
recognizes revenue from product sales, less estimated returns,
upon transfer of title and risk of loss to the customer,
generally the time of shipment, provided there is evidence of an
arrangement, fees are fixed or determinable, no significant
obligations remain, collection of the related receivable is
reasonably assured and customer acceptance criteria have been
successfully demonstrated.
Income Taxes
The company accounts for income taxes using the asset and
liability method in accordance with SFAS No. 109,
Accounting for Income Taxes (“SFAS 109”),
pursuant to which deferred income taxes are recognized based on
temporary differences between the financial statement and tax
basis of assets and liabilities using enacted tax rates in
effect for the
41
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
current year. Valuation allowances are provided if, based upon
the weight of available evidence, it is more likely than not
that some or all of the deferred tax assets will not be realized.
Cash and Cash Equivalents
All cash investments, which consist primarily of money market
accounts, have original maturities of three months or less and
are classified as cash equivalents.
Unbilled Expenditures and Fees on Contracts in Process
Unbilled expenditures and fees on contracts in process include
work in process which will be billed in accordance with contract
terms and delivery schedules, as well as amounts billable upon
final execution of contracts, contract completion, milestones or
completion of rate negotiations. Generally, unbilled
expenditures and fees on contracts in process are expected to be
collected within one year. At December 31, 2004, the
company was carrying approximately $4 million of working
capital related to its child welfare systems contract with the
State of Ohio. Under the current contract, approximately
$1 million of the working capital would not be realized in
2005. The State of Ohio and the company have agreed to
renegotiate to accelerate the payment terms of the contract. As
a result, the company anticipates it will receive these amounts
in 2005. Payments to the company for performance on certain
United States Government contracts are subject to audit by the
Defense Contract Audit Agency. Revenue has been recorded at
amounts the company expects to realize upon final settlement.
Concentration of Risk
A majority of the company’s revenue is derived from United
States Government agencies, primarily the Department of Defense.
Any cancellations or modifications of the company’s
significant contracts or subcontracts, or failure by the
government to exercise option periods relating to those
contracts or subcontracts, could adversely affect the
company’s business, financial condition, results of
operations and cash flows. It is not possible to predict whether
defense budgets will increase or decline, but any significant
decline in defense spending could negatively affect our
business, financial condition, results of operations and cash
flows. A significant portion of the company’s federal
government contracts are renewable on an annual basis, or are
subject to the exercise of contractual options. The government
has the right to terminate contracts for convenience. Multi-year
contracts often require funding actions by the government on an
annual or more frequent basis. The company could experience
material adverse consequences should such funding actions or
other approvals not be taken. In addition to contract
cancellations and declines in government budgets, the
company’s business, financial condition, results of
operations and cash flows may be adversely affected by
competition within a consolidating defense industry, increased
government regulation and general economic conditions.
Inventories
Inventories are stated at the lower of cost (first-in,
first-out) or market, and consist of materials, labor and
overhead. There are no amounts in inventories relating to
contracts having production cycles longer than one year.
Work-in-process, raw materials and subassemblies aggregated
approximately $64,000 and $40,000 at December 31, 2004 and
2003, respectively.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Plant and
equipment are depreciated principally on the straight-line basis
over their estimated useful lives. Useful lives for equipment
range from three to ten years. The corporate office building has
a useful life of 31 years. Leasehold improvements are
amortized over the shorter of the remaining term of the lease or
42
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
the life of the related asset. The components of Property, plant
and equipment, net, in the Consolidated Balance Sheets are as
follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
Land
|
|
$ |
1,126 |
|
|
$ |
1,126 |
|
|
Building
|
|
|
11,525 |
|
|
|
10,535 |
|
|
Machinery and equipment
|
|
|
42,985 |
|
|
|
39,182 |
|
|
Leasehold improvements
|
|
|
2,520 |
|
|
|
2,363 |
|
| |
|
|
|
|
|
|
|
Total property, plant and equipment, at cost
|
|
|
58,156 |
|
|
|
53,206 |
|
|
Less accumulated depreciation and amortization
|
|
|
36,017 |
|
|
|
32,534 |
|
| |
|
|
|
|
|
|
| |
Net property, plant and equipment
|
|
$ |
22,139 |
|
|
$ |
20,672 |
|
| |
|
|
|
|
|
|
At December 31 2003, the company had construction in
progress (“CIP”) of $6.7 million, which has been
reclassified to the applicable property, plant and equipment
captions for presentation purposes. This amount included
$6.1 million reported under the caption “Machinery and
equipment”, which represents capitalized costs related to
the company’s new PeopleSoft-based enterprise business
system, which was placed into service effective January 1,
2004. During 2004, the company incurred approximately
$1.7 million related to additional enhancements of its new
PeopleSoft-based enterprise business system. The remainder of
the December 31, 2003 CIP balance was principally comprised
of costs related to renovations to the company’s corporate
headquarters facility in Andover, Massachusetts. The company
does not depreciate CIP until it is placed into service.
During 2004 and 2003, the company recorded disposals of
$0.1 million and $0.5 million, respectively, of fully
depreciated machinery, equipment and leasehold improvements.
Goodwill and Intangible Assets
Goodwill is recorded when the consideration paid for
acquisitions exceeds the fair value of net tangible and
identifiable intangible assets acquired. In June 2001, the FASB
issued SFAS 141 and SFAS No. 142, Goodwill and
Other Intangible Assets (“SFAS 142”).
SFAS 141 requires that the purchase method of accounting be
used for all business combinations completed after June 30,
2001. SFAS 142 requires that goodwill and other intangible
assets with indefinite useful lives no longer be amortized, but
rather, be tested annually for impairment. In accordance with
SFAS 141, goodwill recorded in conjunction with the
company’s acquisitions of Impact Innovations, HJ Ford and
ANDRULIS was not amortized.
Impairment of Goodwill and Long-Lived Assets
Goodwill and intangible assets with indefinite lives are tested
annually for impairment in accordance with the goodwill
provisions of SFAS 142. The company’s impairment
review is based on a fair value test. The company uses its
judgment in assessing whether assets may have become impaired
between annual impairment tests. Indicators such as unexpected
adverse business conditions, economic factors, unanticipated
technological change or competitive activities, loss of key
personnel and acts by governments and courts may signal that an
asset has been impaired. Should the fair value of goodwill, as
determined by the company at any measurement date, fall below
its carrying value, a charge for impairment of goodwill will be
recorded in the period.
Intangible assets with estimated lives and other long-lived
assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset or
asset group may not be recoverable in accordance with
SFAS 144. Recoverability of intangible assets with
estimated lives and other long-lived assets is measured by a
comparison of the carrying amount of an asset or asset group to
future net undiscounted pretax cash flows expected to be
43
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
generated by the asset or asset group. If these comparisons
indicate that an asset is not recoverable, the company will
recognize an impairment loss in the amount by which the carrying
value of the asset or asset group exceeds the related estimated
fair value. Estimated fair value is based on either discounted
future pretax operating cash flows or appraised values,
depending on the nature of the asset. The company determines the
discount rate for this analysis based on the expected internal
rate of return of the related business and does not allocate
interest charges to the asset or asset group being measured.
Considerable judgment is required to estimate discounted future
operating cash flows.
Business Combinations
Since 2002, the company has completed three business
acquisitions. The company determines and records the fair values
of assets acquired and liabilities assumed as of the dates of
acquisition. The company utilizes an independent valuation
specialist to determine the fair values of identifiable
intangible assets acquired in order to determine the portion of
the purchase price allocable to these assets.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, accounts
receivable, unbilled expenditures and fees on contracts in
process, and accounts payable approximate fair value because of
the short-term nature of these instruments. The fair value of
each of the debt instruments approximates carrying value because
these agreements bear interest at variable market rates.
Stockholders’ Equity
Effective July 1, 2004, companies incorporated in
Massachusetts became subject to the Massachusetts Business
Corporation Act, Chapter 156D. Chapter 156D eliminates
the concept of “treasury shares” and provides that
shares reacquired by a company become “authorized but
unissued” shares. As a result of this change, the company
has redesignated its existing treasury shares, with a par value
of approximately $138,000, to common stock.
Stock-Based Compensation
The company accounts for stock option plans under Accounting
Principles Board (“APB”) Opinion No. 25,
Accounting for Stock Issued to Employees
(“APB 25”), and related Interpretations. The
following table illustrates the effect of net earnings per
common share as if the company had applied the fair value based
method of SFAS No. 123, Accounting for Stock-Based
Compensation (“SFAS 123”), to all outstanding
and unvested awards in each period for the purpose of recording
expense for stock option compensation (in thousands of dollars,
except per share data).
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
Net income as reported
|
|
$ |
9,373 |
|
|
$ |
6,672 |
|
|
$ |
6,233 |
|
|
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net of
related tax effects
|
|
|
(654 |
) |
|
|
(2,092 |
) |
|
|
(3,895 |
) |
| |
|
|
|
|
|
|
|
|
|
|
Pro forma net income
|
|
$ |
8,719 |
|
|
$ |
4,580 |
|
|
$ |
2,338 |
|
| |
|
|
|
|
|
|
|
|
|
|
Net earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Basic, as reported
|
|
$ |
1.10 |
|
|
$ |
0.81 |
|
|
$ |
0.78 |
|
| |
Basic, pro forma
|
|
$ |
1.03 |
|
|
$ |
0.56 |
|
|
$ |
0.29 |
|
| |
Diluted, as reported
|
|
$ |
1.03 |
|
|
$ |
0.76 |
|
|
$ |
0.70 |
|
| |
Diluted, pro forma
|
|
$ |
0.96 |
|
|
$ |
0.52 |
|
|
$ |
0.28 |
|
44
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
The weighted average fair values of options granted were $10.62
in 2004, $8.49 in 2003 and $13.69 in 2002. The fair value of
each option for the company’s plans is estimated on the
date of the grant using the Black-Scholes option pricing model,
with the following weighted average assumptions:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
Expected volatility
|
|
|
66.88 |
% |
|
|
64.43 |
% |
|
|
63.68 |
% |
|
Dividend yield
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Risk-free interest rate
|
|
|
3.81 |
% |
|
|
3.9 |
% |
|
|
5.0 |
% |
|
Expected life in years
|
|
|
7.0 |
|
|
|
8.0 |
|
|
|
8.3 |
|
Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing net
income (loss) by the weighted average number of shares of common
stock outstanding during the period. For periods in which there
is net income, diluted earnings per share is determined by using
the weighted average number of common and dilutive common
equivalent shares outstanding during the period unless the
effect is antidilutive.
Due to their antidilutive effect, approximately 64,900, 72,100
and 75,600 options to purchase common stock were excluded from
the calculation of diluted earnings per share for the years
ended December 31, 2004, 2003 and 2002, respectively.
However, these options could become dilutive in future periods.
Investment Held for Sale
In 1998, the company obtained an ownership interest in Telica, a
privately-held start-up company, in exchange for technology
developed by DRC. On September 20, 2004, as a result of the
acquisition of Telica by Lucent Technologies
(“Lucent”), the company received 672,518 shares
of common stock in Lucent (the “Lucent shares”) in
exchange for the 1,627,941 shares of Telica common stock
(the “Telica shares”) it owned. The company has
classified the Lucent shares as available-for-sale securities,
and is accounting for them in accordance with the provisions of
SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securities (“SFAS 115”).
Prior to the acquisition of Telica by Lucent, the company
carried the Telica shares at $0, as there was no readily
determinable market value for Telica, which reflected the
company’s cost basis in the Telica shares. The company has
recorded the Lucent shares at a fair value of $2.5 million
at December 31, 2004. This amount is reported in Other
assets in the company’s Consolidated Balance Sheet at
December 31, 2004. The unrealized gain of
$2.5 million, net of $1.0 million of tax effect, is
reported as a component of Accumulated other comprehensive loss
in the company’s Consolidated Balance Sheet at
December 31, 2004. An additional 74,274 Lucent shares are
currently held in escrow for indemnification related to
Lucent’s acquisition of Telica. The company will record the
fair value of the shares held in escrow at the time that these
shares, or any portion thereof, are issued.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R),
Share-Based Payments (“SFAS 123R”).
SFAS 123R replaces SFAS No. 123, Accounting
for Stock-Based Compensation (“SFAS 123”),
and supersedes Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees
(“APB 25”). Under SFAS 123R, companies will
be required to recognize compensation costs related to
share-based payment transactions to employees in their financial
statements. The amount of compensation cost will be measured
using the grant-date fair value of the equity or liability
instruments issued. Additionally, liability awards will be
re-measured each reporting period. Compensation cost will be
recognized over the period that an employee provides service in
exchange for the award. The company is required to adopt the new
standard in its third quarter of 2005. The company historically
has disclosed the pro forma effect of expensing its
45
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
stock options as prescribed by SFAS 123. The company is
evaluating the different alternatives available for applying the
provisions of SFAS 123R and is currently assessing their effects
on its financial position and results of operations.
In December 2004, the FASB issued FASB Staff Position
(“FSP”) SFAS No. 109-1, Application of
FASB Statement No. 109, Accounting for Income Taxes, to the
Tax Deduction on Qualified Production Activities Provided by the
American Jobs Creation Act of 2004 (“FSP
SFAS 109-1”). FAS SFAS 109-1 provides guidance on
the application of SFAS No. 109, Accounting for
Income Taxes (“SFAS 109”), to the provision
within the American Jobs Creation Act of 2004 (the
“Act”) that provides tax relief to U.S. domestic
manufacturers. FSP SFAS 109-1 states that the
manufacturer’s deduction provided for under the Act should
be accounted for as a special deduction in accordance with
SFAS 109 and not as a tax rate reduction. A special
deduction is accounted for by recording the benefit of the
deduction in the year in which it can be taken in the
company’s tax return, and by not adjusting deferred tax
assets and liabilities in the period of the Act’s
enactment. FSP SFAS 109-1 was effective upon issuance. The
adoption of FSP SFAS 109-1 did not have a material effect
on the company’s financial position and results of
operations. Further, the company does not believe the adoption
of FSP SFAS 109-1 will have a material effect on its
federal income tax returns.
In November 2004, the FASB issued SFAS No. 151,
Inventory Costs, an amendment of ARB No. 43,
Chapter 4 (“SFAS 151”). SFAS 151
clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted material by
requiring that these items be recognized as current period
charges regardless of whether they meet the “so
abnormal” criterion outlined in ARB 43. The company is
required to adopt the new standard in its third quarter of 2005.
The company is currently assessing the impact of this new
standard on its financial position and results of operations;
however, the company does not believe the adoption of
SFAS 151 will have a material effect on its financial
position, results of operations or cash flows.
|
|
| NOTE 3. |
BUSINESS ACQUISITIONS |
Impact Innovations Group LLC
On September 1, 2004, the company completed the acquisition
of Impact Innovations from J3 Technology, a Georgia corporation,
for $53.4 million in cash, subject to adjustment based upon
the value of tangible net assets acquired in accordance with the
provisions of the Equity Purchase Agreement among the company,
Impact Innovations and J3 Technology. The company used the
proceeds from the acquisition term loan portion of its new
financing facility, entered into on September 1, 2004, to
finance the transaction. The company acquired all of the
outstanding membership interests of Impact Innovations, which
constituted the government contracts business of J3 Technology.
Impact Innovations, based in the Washington, D.C. area,
offered solutions in business intelligence, enterprise software,
application development, information technology service
management and other related areas. Its customers include United
States government intelligence agencies and various Department
of Defense agencies, as well as federal civilian agencies. The
company believes that the acquisition of Impact Innovations
enhances its Capability Maturity Model (“CMM”) Level 3
rating for software engineering core competency and enriches
DRC’s business intelligence, business transformation and
network engineering and operations solution sets, while adding a
number of key government defense and civilian customers to the
company’s portfolio, including a new customer base in the
intelligence community. As part of this transaction, the company
has paid $0.6 million and accrued an additional
$0.1 million for legal, audit and other transaction costs
related to the acquisition. The company also accrued
$0.5 million for exit costs, primarily related to the
consolidation of one of the Impact Innovations facilities into a
DRC facility, including lease costs for the abandoned acquired
facility. As of December 31, 2004, $0.1 million of
expenditures had been charged against this accrual.
The purchase price was determined through negotiations with J3
Technology based upon the company’s access to new
customers, customer relationships and cash flows. A portion of
the excess of purchase price over fair value of net assets
acquired was allocated on a preliminary basis to customer
relationships, which the company estimates to have a useful life
of five years, based upon a preliminary independent appraisal.
Accordingly, the company is amortizing this intangible asset
over five years, based upon the estimated future cash flows of
the individual contracts related to this asset. The balance of
the excess purchase price was recorded as goodwill. Finalization
of the allocation of excess of purchase price over the fair
46
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
value of net assets acquired to identifiable intangible assets
and goodwill will be made after completion of the analysis of
their fair values, which the company expects to occur in the
first half of 2005. The company believes it has sufficient
information to finalize the purchase price allocation but
requires additional time to complete the analysis. The company
has accrued $0.5 million for additional cash consideration to
the seller based upon the value of tangible net assets acquired
that were recorded at December 31, 2004. A change of
$1.0 million in the allocation between the acquired
identifiable intangible assets and would result in a change in
annual amortization expense of approximately $0.2 million.
An increase in the useful life of the acquired identifiable
intangible asset from five years to six years would result in a
decrease in annual amortization expense of approximately
$0.4 million. A decrease in the useful life of the
identifiable intangible asset from five years to four years
would result in an increase in annual amortization expense of
approximately $0.6 million. This sensitivity analysis
assumes that any change would be allocated equally to each
financial reporting period. Any actual change to the value or
useful life of the customer relationships intangible asset would
require analysis to calculate the new estimated future cash
flows of the individual contracts related to this asset in order
to determine the period amortization expense to be recorded. A
summary of the transaction is as follows (in thousands)
(unaudited):
| |
|
|
|
|
|
|
|
|
Consideration:
|
|
|
|
|
| |
Cash
|
|
$ |
53,399 |
|
| |
Accrued estimated additional cash consideration
|
|
|
473 |
|
| |
Transaction costs
|
|
|
726 |
|
| |
Exit costs
|
|
|
469 |
|
| |
|
|
|
| |
|
|
Total consideration
|
|
|
55,067 |
|
| |
|
|
|
|
Preliminary allocation of consideration to assets
acquired/(liabilities assumed):
|
|
|
|
|
| |
|
|
Working capital
|
|
|
6,768 |
|
| |
|
|
Property and equipment
|
|
|
562 |
|
| |
|
|
Other noncurrent assets
|
|
|
57 |
|
| |
|
|
Long-term liabilities
|
|
|
(164 |
) |
| |
|
|
|
| |
|
Preliminary total fair value of net tangible assets acquired
|
|
|
7,223 |
|
| |
|
|
|
|
Preliminary excess of consideration over fair value of net
tangible assets acquired
|
|
|
47,844 |
|
| |
|
|
|
|
Preliminary allocation of excess consideration to identifiable
intangible assets:
|
|
|
|
|
| |
|
|
Customer relationships
|
|
|
11,500 |
|
| |
|
|
|
|
Preliminary allocation of excess consideration to goodwill
|
|
$ |
36,344 |
|
| |
|
|
|
The following pro forma results of operations for the years
ended December 31, 2004 and 2003 have been prepared as
though the acquisition of Impact Innovations had occurred on
January 1, 2003. These pro forma results include
adjustments for interest expense and amortization of deferred
financing costs on the acquisition term loan used to finance the
transaction, amortization expense for the identifiable
intangible asset recorded and the effect of income taxes.
Additionally, these pro forma results include nonrecurring
events recorded by Impact Innovations in the third quarter of
2004 prior to their acquisition by the company, including
approximately $150,000 of revenues with no associated costs
related to award fees and excess performance on service level
agreements, and approximately $500,000 of reductions to selling,
general and administrative expenses; primarily employee-related
costs. This pro forma information does not purport to be
47
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
indicative of the results of operations that would have been
attained had the acquisition been made as of
January 1, 2003, or of results of operations that may
occur in the future (in thousands, except per share data)
(unaudited):
| |
|
|
|
|
|
|
|
|
|
| |
|
Year ended | |
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
|
Revenue
|
|
$ |
309,222 |
|
|
$ |
286,810 |
|
|
Income from continuing operations
|
|
$ |
9,692 |
|
|
$ |
7,942 |
|
|
Earnings per share from continuing operations:
|
|
|
|
|
|
|
|
|
| |
Basic
|
|
$ |
1.14 |
|
|
$ |
0.97 |
|
| |
Diluted
|
|
$ |
1.07 |
|
|
$ |
0.90 |
|
Andrulis Corporation
On December 20, 2002, the company completed the acquisition
of all of the outstanding shares of capital stock of ANDRULIS, a
provider of information technology and engineering solutions to
federal government customers in the defense and federal civilian
sectors. In consideration, the company paid the selling
stockholders $12.2 million of net cash and issued three
separate promissory notes payable aggregating
$12.4 million, due January 2, 2003, at an interest
rate of 4.0%. In addition, the company incurred
$1.1 million of transaction costs and $0.7 million of
exit costs. The notes were settled in January 2003. The company
used cash on hand and its $50.0 million revolving credit
facility to fund the cash payments to the selling stockholders.
The purchase price was finalized upon the completion of
independent appraisals and determination of the fair values of
the assets acquired and liabilities assumed, in accordance with
the purchase agreement, during the third quarter of 2003. As a
result of this process, the company made an additional payment
of $0.3 million to the selling stockholders for the amount
that the acquired net assets exceeded the target asset value as
stipulated in the purchase agreement.
A portion of the excess of purchase price over the fair value of
net tangible assets acquired has been allocated to identifiable
intangible assets with estimated useful lives ranging between
two and five years, based upon an independent appraisal. These
assets are being amortized based upon an analysis of expected
cash flows. The balance of the excess purchase price was
recorded as goodwill.
48
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
A summary of the transaction and the allocation of the purchase
price is as follows (in thousands):
| |
|
|
|
|
|
|
|
Consideration:
|
|
|
|
|
| |
Cash, net of cash acquired of $1,709
|
|
$ |
12,172 |
|
| |
Notes payable issued to selling stockholders
|
|
|
12,400 |
|
| |
Transaction costs
|
|
|
1,116 |
|
| |
Exit costs
|
|
|
705 |
|
| |
|
|
|
| |
|
Total consideration
|
|
|
26,393 |
|
| |
|
|
|
|
Allocation of consideration to assets acquired/(liabilities
assumed):
|
|
|
|
|
| |
Working capital, excluding cash acquired of $1,709
|
|
|
4,459 |
|
| |
Property and equipment
|
|
|
649 |
|
| |
Other noncurrent assets
|
|
|
30 |
|
| |
Other liabilities
|
|
|
(1,934 |
) |
| |
|
|
|
| |
|
Total fair value of net tangible assets acquired
|
|
|
3,204 |
|
| |
|
|
|
|
Excess of consideration over fair value of net tangible assets
acquired
|
|
|
23,189 |
|
| |
|
|
|
|
Allocation of excess consideration to identifiable intangible
assets:
|
|
|
|
|
| |
Customer relationships
|
|
|
1,300 |
|
| |
Non-competition agreements
|
|
|
1,340 |
|
| |
|
|
|
| |
|
|
2,640 |
|
| |
|
|
|
|
Allocation of excess consideration to goodwill
|
|
$ |
20,549 |
|
| |
|
|
|
HJ Ford Associates, Inc.
On May 31, 2002, the company completed the acquisition of
all of the outstanding voting common stock of HJ Ford. HJ Ford
helps its clients manage operational process and acquisition
programs through systems and information engineering,
information technology, enterprise engineering and acquisition
program support. In consideration, the company paid the HJ Ford
stockholders $10.2 million of net cash and incurred
$0.4 million and $0.1 million of transaction costs and
exit costs, respectively, for a total purchase price of
$10.7 million. The net cash payment to the selling
stockholders includes $1.3 million for the sellers’
consent to treat the transaction as an asset purchase for tax
purposes, under Section 338(h)(10) of the Internal Revenue
Code. This tax treatment enables the company to take future tax
deductions for the amortization of goodwill for tax purposes
related to the transaction.
The purchase agreement also requires the company to pay the
sellers an additional $1.0 million in 2005, contingent upon
the occurrence of certain events related to contract renewals.
The contingent consideration will be recorded as an addition to
the purchase price at the time it becomes probable that a
payment will be required.
As part of this purchase, the company acquired a 40% ownership
interest in a small disadvantaged business. This business is
accounted for using the equity method. The company has
continuing business relationships with this business and had
provided a guarantee of the business’s line of credit,
under which its maximum exposure was $0.2 million. On
April 1, 2004, the company was released as guarantor for
this line of credit.
A portion of the excess of purchase price over the fair value of
net tangible assets acquired has been allocated to identifiable
intangible assets with estimated useful lives ranging between
two and four years, based upon an independent appraisal. These
assets are being amortized based upon analysis of expected cash
flows. The balance of the excess purchase price was recorded as
goodwill.
49
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
A summary of the transaction and the allocation of the purchase
price is as follows (in thousands):
| |
|
|
|
|
|
|
|
Consideration:
|
|
|
|
|
| |
Cash, net of cash acquired of $554
|
|
$ |
10,251 |
|
| |
Transaction costs
|
|
|
342 |
|
| |
Exit costs
|
|
|
140 |
|
| |
|
|
|
| |
|
Total consideration
|
|
|
10,733 |
|
| |
|
|
|
|
Allocation of consideration to assets acquired/(liabilities
assumed):
|
|
|
|
|
| |
Working capital, excluding cash acquired of $554
|
|
|
3,054 |
|
| |
Property and equipment
|
|
|
195 |
|
| |
Other noncurrent assets
|
|
|
222 |
|
| |
Long-term debt
|
|
|
(700 |
) |
| |
|
|
|
| |
|
Total fair value of net tangible assets acquired
|
|
|
2,771 |
|
| |
|
|
|
|
Excess of consideration over fair value of net tangible assets
acquired
|
|
|
7,962 |
|
| |
|
|
|
|
Allocation of excess consideration to identifiable intangible
assets:
|
|
|
|
|
| |
Customer relationships
|
|
|
1,400 |
|
| |
Non-competition agreements
|
|
|
400 |
|
| |
|
|
|
| |
|
|
1,800 |
|
| |
|
|
|
|
Allocation of excess consideration to goodwill
|
|
$ |
6,162 |
|
| |
|
|
|
The company repaid the long-term debt of $0.7 million in
the second quarter of 2002 and canceled the related loan
agreement.
|
|
| NOTE 4. |
DISCONTINUED OPERATIONS |
On October 18, 2002, the company announced that it was
actively pursuing the divestiture of the Encoder Division.
Effective in the fourth quarter of 2002, and in accordance with
SFAS 144, the company’s consolidated financial
statements and notes thereto were restated to reflect the
discontinuation of the Encoder Division. Accordingly, the
revenue, costs, expenses, assets, liabilities and cash flows of
the Encoder Division are reported separately in the Consolidated
Statements of Operations, Consolidated Balance Sheets and
Consolidated Statements of Cash Flows for all periods presented.
The results of discontinued operations do not reflect any
interest expense or any allocation of corporate general and
administrative expense.
On May 2, 2003, the company completed the sale of the
Encoder Division assets and certain liabilities to GSI for
$3.3 million in cash, subject to post-closing adjustments
related to a valuation of the net assets of the Encoder Division
and the assumption by GSI of certain of DRC’s liabilities
with respect to the assets acquired.
In connection with this transaction, the company recorded
$1.3 million of pre-tax charges for the disposal of
discontinued operations in 2003. Of this amount,
$0.2 million was charged in the fourth quarter and
represents additional facility costs related to the sale. The
company recorded charges aggregating $1.1 million before
taxes in the first quarter, comprised of $0.3 million of
professional fees and $0.8 million of exit costs. The exit
costs are comprised of $0.5 million for severance costs for
approximately 45 Encoder Division employees and
$0.3 million for future lease costs, net of contractual
sublease income, from GSI for the Encoder facility.
During the first quarter of 2003, the company recognized, on a
cash basis, $0.7 million received as the final royalty
payment associated with the 1999 sale of its discontinued
Telecommunications Fraud Control business, which was recorded
against the loss on the disposal of discontinued operations.
This income, net of the $1.3 million of charges described
above,
50
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
resulted in a loss on the disposal of discontinued operations of
$0.6 million before taxes, or a loss of $0.3 million,
net of $0.3 million of income tax benefit.
The company’s loss from discontinued operations in 2003 of
$1.6 million, or $0.18 per diluted share, reflects
four months of operating loss from the Encoder Division, as well
as costs incurred subsequent to the transaction related to
certain liabilities that GSI did not assume, primarily,
$1.5 million of accrued lease costs, net of estimated
sublease income, for the Encoder facility. The company reported
a loss from discontinued operations of $1.1 million, or
$0.13 per diluted share, in 2002. Due to the company’s
decision to divest the Encoder Division, it became necessary to
restate the company’s results in order to reflect the
Encoder Division as a discontinued operation. Because Arthur
Andersen LLP was no longer able to provide current assurance as
to the validity of its previously issued opinions on the
company’s financial statements for the fiscal years prior
to 2002, it became necessary to engage KPMG LLP, who served as
the company’s independent auditors through November 2003,
to re-audit results for the years ended December 31, 2001
and 2000 in order to obtain a current independent auditor
opinion for those years. The 2002 loss from discontinued
operations includes $0.4 million in fees to re-audit the
2001 and 2000 results.
The activity for the years ended December 31, 2004 and
2003, related to the company’s exit cost accrual for
discontinued operations is as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Activity — Year Ended December 31, 2004 (unaudited) | |
| |
|
| |
| |
|
Balance | |
|
|
|
Adjustments |
|
Expenditures | |
|
Balance | |
| |
|
December 31, | |
|
|
|
for changes |
|
charged against | |
|
December 31, | |
| |
|
2003 | |
|
Provision |
|
in estimate |
|
accrual | |
|
2004 | |
| |
|
| |
|
|
|
|
|
| |
|
| |
|
Severance
|
|
$ |
74 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
(74 |
) |
|
$ |
— |
|
|
Lease
|
|
|
932 |
|
|
|
— |
|
|
|
— |
|
|
|
(510 |
) |
|
|
422 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
1,006 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
(584 |
) |
|
$ |
422 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Activity — Year Ended December 31, 2003 | |
| |
|
| |
| |
|
Balance |
|
|
|
Adjustments | |
|
Expenditures | |
|
Balance | |
| |
|
December 31, |
|
|
|
for changes | |
|
charged against | |
|
December 31, | |
| |
|
2002 |
|
Provision | |
|
in estimate | |
|
accrual | |
|
2003 | |
| |
|
|
|
| |
|
| |
|
| |
|
| |
|
Severance
|
|
$ |
— |
|
|
$ |
544 |
|
|
$ |
— |
|
|
$ |
(470 |
) |
|
$ |
74 |
|
|
Lease
|
|
|
— |
|
|
|
1,325 |
|
|
|
420 |
|
|
|
(813 |
) |
|
|
932 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
— |
|
|
$ |
1,869 |
|
|
$ |
420 |
|
|
$ |
(1,283 |
) |
|
$ |
1,006 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The balance sheet captions for discontinued operations include
the following (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
Current liabilities
|
|
|
|
|
|
|
|
|
| |
Accrued payroll and employee benefits
|
|
$ |
— |
|
|
$ |
74 |
|
| |
Other accrued expenses
|
|
|
422 |
|
|
|
704 |
|
| |
|
|
|
|
|
|
| |
|
Total current liabilities
|
|
$ |
422 |
|
|
$ |
778 |
|
| |
|
|
|
|
|
|
|
Long-term liabilities
|
|
|
|
|
|
|
|
|
| |
Other long-term liabilities
|
|
$ |
— |
|
|
$ |
398 |
|
| |
|
|
|
|
|
|
51
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
The lease on the Encoder facility will expire in August 2005;
accordingly, lease payments and payments for other associated
costs will be made and charged to the accrual through that date.
The difference between the fair value of the total lease costs
and the total cash payments will be charged to discontinued
operations as expense through the expiration of the lease term,
including sublease income initially estimated at the time the
accrual was recorded, but not subsequently realized.
In accordance with SFAS 144, the company had reviewed the
possible impairment of assets associated with the Encoder
Division as of December 31, 2002, and determined that an
impairment charge was not required.
|
|
| NOTE 5. |
GOODWILL AND INTANGIBLE ASSETS |
Components of the company’s identifiable intangible assets
are as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, 2004 | |
|
December 31, 2003 | |
| |
|
| |
|
| |
| |
|
|
|
Accumulated | |
|
|
|
Accumulated | |
| |
|
Cost | |
|
amortization | |
|
Cost | |
|
amortization | |
| |
|
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
Customer relationships
|
|
$ |
14,200 |
|
|
$ |
2,681 |
|
|
$ |
2,700 |
|
|
$ |
1,187 |
|
|
Non-competition agreements
|
|
|
1,740 |
|
|
|
1,740 |
|
|
|
1,740 |
|
|
|
910 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
$ |
15,940 |
|
|
$ |
4,421 |
|
|
$ |
4,440 |
|
|
$ |
2,097 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
The company recorded amortization expense for its identifiable
intangible assets of $2.3 million, $1.7 million and
$0.4 million in the years ended December 31, 2004,
2003 and 2002, respectively. Estimated future amortization
expense for the identifiable intangible assets recorded by the
company as of December 31, 2004 is as follows (in
thousands) (unaudited):
| |
|
|
|
|
|
2005
|
|
$ |
3,108 |
|
|
2006
|
|
$ |
2,787 |
|
|
2007
|
|
$ |
2,581 |
|
|
2008
|
|
$ |
2,021 |
|
|
2009
|
|
$ |
1,022 |
|
The changes in the carrying amount of goodwill for the year
ended December 31, 2004 are as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Systems and | |
|
|
|
|
| |
|
Services | |
|
Metrigraphics |
|
Total | |
| |
|
| |
|
|
|
| |
|
Balance at December 31, 2003
|
|
$ |
26,711 |
|
|
$ |
— |
|
|
$ |
26,711 |
|
|
Business acquisition (unaudited)
|
|
|
36,344 |
|
|
|
— |
|
|
|
36,344 |
|
| |
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004 (unaudited)
|
|
$ |
63,055 |
|
|
$ |
— |
|
|
$ |
63,055 |
|
| |
|
|
|
|
|
|
|
|
|
The company is required to perform an annual impairment test of
its goodwill under the provisions of SFAS 142. Impairment
exists when the carrying value of goodwill is not recoverable
and its carrying amount exceeds its fair value. SFAS 142
requires a two-step impairment testing approach. Companies must
first determine whether goodwill is impaired and if so, they
must value that impairment based on the amount by which the book
value exceeds the estimated fair value. As a result of the
annual impairment test performed as of December 31, 2004,
the company determined that the carrying amount of goodwill did
not exceed its fair value and, accordingly, did not record a
charge for impairment. However, there can be no assurance that
goodwill will not be impaired in subsequent periods.
52
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
Total income tax expense (benefit) was allocated as follows (in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
Income from continuing operations
|
|
$ |
6,269 |
|
|
$ |
6,334 |
|
|
$ |
4,936 |
|
|
Discontinued operations
|
|
|
— |
|
|
|
(1,284 |
) |
|
|
(741 |
) |
|
Stockholders’ equity for compensation expense for tax
purposes in excess of amounts recognized for financial reporting
purposes
|
|
|
(353 |
) |
|
|
(197 |
) |
|
|
(194 |
) |
|
Other comprehensive income
|
|
|
1,187 |
|
|
|
(1,732 |
) |
|
|
(4,059 |
) |
| |
|
|
|
|
|
|
|
|
|
| |
|
$ |
7,103 |
|
|
$ |
3,121 |
|
|
$ |
(58 |
) |
| |
|
|
|
|
|
|
|
|
|
The components of the provision for federal and state income
taxes from continuing operations are as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
Currently payable
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Federal
|
|
$ |
(1,326 |
) |
|
$ |
3,054 |
|
|
$ |
3,862 |
|
| |
State
|
|
|
(101 |
) |
|
|
547 |
|
|
|
731 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
(1,427 |
) |
|
|
3,601 |
|
|
|
4,593 |
|
| |
|
|
|
|
|
|
|
|
|
|
Deferred
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Federal
|
|
|
6,144 |
|
|
|
2,138 |
|
|
|
208 |
|
| |
State
|
|
|
1,552 |
|
|
|
595 |
|
|
|
135 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
|
7,696 |
|
|
|
2,733 |
|
|
|
343 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
$ |
6,269 |
|
|
$ |
6,334 |
|
|
$ |
4,936 |
|
| |
|
|
|
|
|
|
|
|
|
The major items contributing to the difference between the
statutory United States federal income tax rate of 34% and the
company’s effective tax rate on income from continuing
operations are as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
Provision at statutory rate
|
|
$ |
5,318 |
|
|
$ |
5,096 |
|
|
$ |
4,179 |
|
|
State income taxes, net of federal tax benefit
|
|
|
1,091 |
|
|
|
740 |
|
|
|
569 |
|
|
Decrease in valuation allowance
|
|
|
(442 |
) |
|
|
— |
|
|
|
(7 |
) |
|
Amortization of acquired intangible assets
|
|
|
— |
|
|
|
320 |
|
|
|
— |
|
|
Other, net
|
|
|
302 |
|
|
|
178 |
|
|
|
195 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Provision for income taxes
|
|
$ |
6,269 |
|
|
$ |
6,334 |
|
|
$ |
4,936 |
|
| |
|
|
|
|
|
|
|
|
|
In 2003, the company carried back $1.1 million of federal
net operating losses, resulting in an income tax refund of
$0.4 million.
53
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
The company utilized federal and state net operating loss
carryforwards of $0.5 million and $0.9 million to
reduce taxable income in the years ended December 31, 2003
and 2002, respectively.
In 2004, the company realized a tax benefit on its 2003 income
tax return of $0.4 million from the use of a capital loss
carryforward that arose in 1999 and was due to expire in 2004.
The valuation allowance related to this capital loss
carryforward decreased in 2004 due to the use of the capital
loss carryforward and the expiration in 2004.
The company also utilized $1.0 million of capital loss
carryforwards to fully reduce capital gains from the sale of the
Encoder Division, resulting a in a reduction of taxable income
in the year ended December 31, 2003.
The tax effects of significant temporary differences that
comprise deferred tax assets and liabilities are as follows (in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
Pension liability
|
|
$ |
5,995 |
|
|
$ |
6,189 |
|
|
Accrued expenses
|
|
|
2,271 |
|
|
|
2,653 |
|
|
Inventory reserves
|
|
|
— |
|
|
|
3 |
|
|
Capital loss carryforward
|
|
|
— |
|
|
|
442 |
|
|
Receivables reserves
|
|
|
189 |
|
|
|
182 |
|
| |
|
|
|
|
|
|
| |
|
|
8,455 |
|
|
|
9,469 |
|
| |
Valuation allowance
|
|
|
— |
|
|
|
(442 |
) |
| |
|
|
|
|
|
|
| |
Deferred tax assets, net
|
|
|
8,455 |
|
|
|
9,027 |
|
| |
|
|
|
|
|
|
|
Unbilled expenditures and fees on contracts in process
|
|
|
(17,368 |
) |
|
|
(12,222 |
) |
|
Fixed assets and intangibles
|
|
|
(3,807 |
) |
|
|
(1,766 |
) |
|
Unrealized gain on securities available for sale
|
|
|
(993 |
) |
|
|
— |
|
|
Domestic International Sales Corporation
|
|
|
(1,798 |
) |
|
|
(1,722 |
) |
|
Other
|
|
|
(498 |
) |
|
|
(678 |
) |
| |
|
|
|
|
|
|
| |
Deferred tax liability
|
|
|
(24,464 |
) |
|
|
(16,388 |
) |
| |
|
|
|
|
|
|
| |
|
Deferred tax liability, net
|
|
$ |
(16,009 |
) |
|
$ |
(7,361 |
) |
| |
|
|
|
|
|
|
Management believes that it is more likely than not that these
deferred tax assets will be realized. The company recognizes the
tax liability related to the amounts recorded to unbilled
expenditures and fees on contracts in process when the related
invoices are issued to customers, and the invoiced amounts are
reclassified to accounts receivable. Accordingly, the deferred
taxes initially recorded for these unbilled amounts will become
payable in future periods. Concurrent with an ongoing audit of
the company’s 2003 and 2002 federal income tax returns, the
Internal Revenue Service (“IRS”) has challenged the
deferral of income for tax purposes related to the
company’s unbilled accounts receivable (which is reported
under the caption “Unbilled expenditures and fees on
contracts in process” in the company’s Consolidated
Balance Sheets) including the applicability of a Letter Ruling
issued by the IRS to the company in January 1976, which granted
the company deferred tax treatment of its unbilled receivables.
While the outcome of the audit is not known, it is possible that
the company’s deferred tax liabilities would be reduced and
income tax payments would be increased substantially in 2005 and
beyond.
54
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
|
|
| NOTE 7. |
EMPLOYEE BENEFIT PROGRAMS |
In December 2001, the Board of Directors approved actions to
proceed with amendments limiting future increases in benefits
under the company’s Defined Benefit Pension Plan (the
“Plan”), freezing membership in the Plan, and
providing for improvements to the company’s deferred
savings plan (the “401(k) Plan”).
In February 2002, the Board of Directors approved the specific
retirement program changes that limited future increases in
benefits under the company’s Plan, froze membership in the
Plan, and provided for improvements to the company’s 401(k)
Plan. Actual changes to the company’s Plan and 401(k) Plan
were effective July 1, 2002.
The company’s Plan is non-contributory, covering
substantially all employees of the company who had completed a
year of service prior to July 1, 2002. This benefit,
available to participants, will increase by 3% each year while
an employee is working at the company. Employees must be
actively employed on the last day of the year to realize this
increase in benefits. This increase in benefits is included as a
factor in estimating the company’s periodic pension cost
and projected benefit obligation.
In selecting the expected long-term rate of return on assets,
the company considered its investment return goals stated in the
Plan’s investment policy. The company, with input from the
Plan’s professional investment managers, also considered
the average rate of earnings expected on the funds invested or
to be invested to provide Plan benefits. This process included
determining expected returns for the various asset classes that
comprise the Plan’s target asset allocation. Based on this
analysis, the company’s overall expected long-term rate of
return on assets is over 9.0%; however, the company determined
that the selection of a 9.0% long-term asset return assumption
is appropriate and prudent. This basis for selecting the
expected long-term asset return assumption is consistent with
the prior year.
The company’s funding policy is to contribute at least the
minimum amount required by the Employee Retirement Income
Security Act of 1974. Additional amounts are contributed to
assure that plan assets will be adequate to provide retirement
benefits. Contributions are intended to provide for benefits
earned through the Plan curtailment, as well as the 3% annual
increases thereafter. The company expects to contribute
$4.4 million to the Plan in 2005.
In 2003, the company changed its Plan measurement date to
November 30, 2003 to facilitate its fiscal year-end
accounting for and disclosure of its Plan assets, liabilities,
income and expense. However, the income and expense in 2004 and
2003 has been estimated for the entire year.
Periodic Pension Cost (in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
|
Service cost — benefits earned during the period
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
1,168 |
|
|
Interest cost on projected benefit obligation
|
|
|
3,940 |
|
|
|
3,808 |
|
|
|
3,487 |
|
|
Expected return on plan assets
|
|
|
(3,847 |
) |
|
|
(3,310 |
) |
|
|
(3,785 |
) |
|
Recognized actuarial loss
|
|
|
1,282 |
|
|
|
1,198 |
|
|
|
102 |
|
| |
|
|
|
|
|
|
|
|
|
| |
Net periodic pension cost
|
|
$ |
1,375 |
|
|
$ |
1,696 |
|
|
$ |
972 |
|
| |
|
|
|
|
|
|
|
|
|
55
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
Changes in Benefit Obligations (in thousands)
| |
|
|
|
|
|
|
|
|
| |
|
November 30, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
Projected benefit obligation at beginning of year
|
|
$ |
63,417 |
|
|
$ |
55,564 |
|
|
Interest cost on projected benefit obligation
|
|
|
3,940 |
|
|
|
3,808 |
|
|
Benefits paid
|
|
|
(2,059 |
) |
|
|
(1,778 |
) |
|
Actuarial loss
|
|
|
3,060 |
|
|
|
5,823 |
|
| |
|
|
|
|
|
|
|
Projected benefit obligation at end of year
|
|
$ |
68,358 |
|
|
$ |
63,417 |
|
| |
|
|
|
|
|
|
Change in Plan Assets (in thousands)
| |
|
|
|
|
|
|
|
|
| |
|
November 30, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
Fair value of plan assets at beginning of year
|
|
$ |
42,557 |
|
|
$ |
36,940 |
|
|
Actual return on plan assets
|
|
|
3,912 |
|
|
|
5,819 |
|
|
Employer contributions
|
|
|
2,927 |
|
|
|
1,576 |
|
|
Benefits and expenses paid
|
|
|
(2,059 |
) |
|
|
(1,778 |
) |
| |
|
|
|
|
|
|
|
Fair value of plan assets at end of year
|
|
$ |
47,337 |
|
|
$ |
42,557 |
|
| |
|
|
|
|
|
|
Funded Status (in thousands)
| |
|
|
|
|
|
|
|
|
| |
|
November 30, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
Plan assets less than projected benefit obligation
|
|
$ |
(21,022 |
) |
|
$ |
(20,860 |
) |
|
Unrecognized net actuarial loss
|
|
|
20,572 |
|
|
|
18,858 |
|
| |
|
|
|
|
|
|
|
Accrued pension liability
|
|
$ |
(450 |
) |
|
$ |
(2,002 |
) |
| |
|
|
|
|
|
|
Weighted Average Assumptions Used to Determine Benefit
Obligations at Measurement Date
| |
|
|
|
|
|
|
|
|
| |
|
November 30, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
Discount rate
|
|
|
6.00 |
% |
|
|
6.25 |
% |
|
Rate of compensation increase
|
|
|
N/A |
|
|
|
N/A |
|
56
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
Weighted Average Assumptions Used to Determine Net Periodic
Benefit Cost
| |
|
|
|
|
|
|
|
|
| |
|
Year Ended | |
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
Discount rate
|
|
|
6.25 |
% |
|
|
6.75 |
% |
|
Expected rate of return on assets
|
|
|
9.00 |
% |
|
|
9.00 |
% |
|
Rate of compensation increase
|
|
|
N/A |
|
|
|
N/A |
|
The company’s investment policy includes a periodic review
of the Plan’s investment in the various asset classes. The
current asset allocation target is 65% equities, 33% fixed
income and 2% cash. The company’s asset allocations as of
November 30, 2004 and 2003 are as follows:
| |
|
|
|
|
|
|
|
|
| |
|
November 30, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
Equity securities
|
|
|
63 |
% |
|
|
67 |
% |
|
Debt securities
|
|
|
21 |
% |
|
|
28 |
% |
|
Other
|
|
|
16 |
% |
|
|
5 |
% |
| |
|
|
|
|
|
|
| |
|
|
100 |
% |
|
|
100 |
% |
| |
|
|
|
|
|
|
At both November 30, 2004 and 2003, the Plan was
under-funded relative to its accumulated benefit obligations. As
a result, the company recorded an additional liability of
$1.5 million to reflect the required minimum pension
liability of $15.3 million at November 30, 2004. In
2003, the company recorded an additional liability of
$2.4 million to reflect the required minimum pension
liability of $13.7 million. In 2002, the company recorded
an additional liability of $10.3 million to reflect the
required minimum pension liability of $11.3 million. These
amounts are reflected, net of related tax effects, in the
caption “Accumulated other comprehensive loss” in the
company’s Consolidated Balance Sheets.
Additional Liability (in thousands)
| |
|
|
|
|
|
|
|
|
| |
|
November 30, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
Accumulated benefit obligation at end of year
|
|
$ |
63,049 |
|
|
$ |
58,312 |
|
| |
|
|
|
|
|
|
|
Unfunded accumulated benefit obligation
|
|
$ |
15,712 |
|
|
$ |
15,755 |
|
|
Accrued pension liability
|
|
|
(450 |
) |
|
|
(2,002 |
) |
| |
|
|
|
|
|
|
|
Additional minimum liability
|
|
$ |
15,262 |
|
|
$ |
13,753 |
|
| |
|
|
|
|
|
|
57
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
Five Year Benefit Payment Projections (in thousands)
(unaudited)
| |
|
|
|
|
|
Year ending December 31, 2005
|
|
$ |
2,349 |
|
|
Year ending December 31, 2006
|
|
$ |
2,605 |
|
|
Year ending December 31, 2007
|
|
$ |
2,751 |
|
|
Year ending December 31, 2008
|
|
$ |
3,098 |
|
|
Year ending December 31, 2009
|
|
$ |
3,246 |
|
|
Five subsequent fiscal years ending December 31, 2014
|
|
$ |
20,055 |
|
The company also maintains a cash or deferred savings plan, the
401(k) Plan. All employees are eligible to elect to defer a
portion of their salary and contribute the deferred portion to
the 401(k) Plan. Since July 1, 2002, the 401(k) Plan has
been structured with three components: (a) a company
matching contribution to 50% of the first 6% of the employee
contribution; (b) a core contribution for all employees, in
which the company contributes 1.5% of the employee’s
eligible wages each pay period; and (c) a discretionary
profit sharing component to the 401(k) Plan by the company, even
if the employee does not contribute to the 401(k) Plan. Prior to
July 1, 2002, the company contributed an amount equal to
25% of the first 6% of an employee’s contribution to the
401(k) Plan. The company’s contributions charged to expense
aggregated $4.1 million, $4.6 million and
$2.5 million in 2004, 2003 and 2002, respectively. Employee
contributions and the company’s matching and core
contributions are invested in one or more collective investment
funds at the participant’s direction. The company’s
matching and core contributions are subject to forfeitures of
any non-vested portion if termination occurs within the first
five years of employment.
The company has a Supplemental Executive Retirement Plan, or
SERP, for certain former key employees providing for annual
benefits commencing on the sixth anniversary of the
executive’s retirement. The cost of these benefits is being
charged to expense and accrued using a projected unit credit
method. Expense related to this plan was approximately $23,900
in 2004, $23,800 in 2003, and $22,300 in 2002. The liability
related to the SERP, which is unfunded, was $0.4 million at
both December 31, 2004 and 2003. These amounts represent
the amounts the company believed to be the present value of the
obligation at each respective date.
On October 31, 2000, the Board of Directors approved a
deferred compensation plan. The plan provides certain employees
of the company the ability to annually elect to defer up to 100%
of any cash incentive payments from the company and any salary
in excess of the FICA earnings ceiling. Employee contributions
are invested in selected mutual funds held within a Rabbi Trust.
These investments, which the company has classified as trading
securities in accordance with SFAS 115, are recorded at
fair value and reported as a component of Other noncurrent
assets in the company’s Consolidated Balance Sheets.
Amounts recorded as deferred compensation liabilities are
adjusted to reflect the fair value of investments held by the
Rabbi Trust. Changes in obligations to participants as a result
of gains or losses on the fair value of the investments are
reflected as a component of compensation expense. At
December 31, 2004 and 2003, $1.2 million and
$0.9 million, respectively, had been deferred under the
plan.
The company also has a deferred compensation plan under which
non-employee directors may elect to defer their directors’
fees. Amounts deferred for each participant are credited to a
separate account, and interest at the lowest rate at which the
company borrowed money during each quarter or, if there was no
such borrowing, at the prime rate, is credited to each account
quarterly. The balance in a participant’s account is
payable in a lump sum or in installments when the participant
ceases to be a director.
The company has equity incentive plans, which are administered
by the Compensation Committee of the Board of Directors (the
“Committee”). The Committee determines which employees
receive grants, the number of shares or options granted and the
exercise prices of the shares covered by each grant.
58
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
The 1993 Equity Incentive Plan (the “1993 Plan”)
permits the company to grant incentive stock options,
nonqualified stock options, stock appreciation rights, awards of
nontransferable shares of restricted common stock and deferred
grants of common stock. The option price of incentive stock
options will not be less than the fair market value at the time
the option is granted. The option period will not be greater
than 10 years from the date the option is granted. Normally
the stock options have been exercisable in three equal
installments beginning one year from the date of the grant.
Through shareholder approval, 580,800 shares were reserved
for the 1993 Plan. The 1993 Plan expired on April 27,
2003. At that time, there were 12,808 shares available for
future grants under the 1993 Plan.
The company’s 1995 Stock Option Plan for Non-employee
Directors provides for each outside director to receive options
to purchase 5,000 shares of common stock at the first
annual meeting at which the director is elected. As long as he
or she remains an eligible director, the director receives
options to purchase 1,000 shares of common stock at
each annual meeting. Eligible directors cannot be an employee of
the company or one of its subsidiaries or a holder of five
percent or more of the company’s common stock. The exercise
price of these options is the fair market value of the common
stock on the date of grant. Each option is not transferable
except upon death and expires 10 years after the date of
grant. The options become exercisable in three equal
installments on the first, second and third anniversaries of the
date of grant. A total of 132,000 shares were reserved for
issuance. At December 31, 2004, 71,374 shares remained
available for future grants. In 2002, the non-employee directors
entitled to grants under this plan consented to forgo their
rights to such grants and, accordingly, no shares were granted
under this plan in 2002.
On January 18, 2000, the company’s shareholders
approved the adoption of the 2000 Incentive Plan (the “2000
Plan”). The 2000 Plan allows the company to grant incentive
stock options, nonqualified stock options, stock appreciation
rights, awards of nontransferable shares of restricted common
stock and deferred grants of common stock up to a total of
1.5 million shares. In the case of incentive stock options,
the option price will not be less than the fair market value of
the stock at the date of grant. The option period will not
exceed 10 years from the date of grant. The terms of the
2000 Plan are substantially similar to those of the 1993 Plan. A
total of 1.5 million shares were reserved for issuance, of
which 135,148 shares remained available at
December 31, 2004. During 2004, a total of 95,433 shares of
restricted stock wee issued under the 2000 plan.
During 2001, the Board of Directors approved the Executive Long
Term Incentive Program (the “ELTIP”), implemented
under the provisions of the shareholder-approved 2000 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. Additionally, in
2003, the company granted 23,100 shares of restricted stock
under an Executive Incentive Plan (“EIP”) under the
provisions of the 2000 Plan.
In 2004, 2003 and 2002, the company recognized approximately
$538,000, $249,000 and $149,000, respectively, of compensation
expense related to shares of restricted common stock issued
under the 2000 Plan.
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 ESPP. A total of 800,000 shares have been reserved for
issuance under the ESPP, which commenced in May 2001. In 2004,
2003 and 2002, 129,121, 171,228 and 126,962 shares were
issued, respectively, under the ESPP.
In 2003, the company’s shareholders approved the 2003
Incentive Plan (the “2003 Plan”). The 2003 Plan allows
the company to grant incentive stock options, non-qualified
stock options, stock appreciation rights, awards of
nontransferable
59
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
shares of restricted common stock and deferred grants of common
stock up to a total of 400,000 shares to directors or key
employees of the company. In the case of incentive stock
options, the option price may not be less than the fair market
value of the stock at the date of grant. The option period may
not exceed ten years from the date of grant. There were no
options granted during either 2004 or 2003 under the 2003 Plan.
Stock option activity for 2004, 2003 and 2002 is summarized as
follows:
| |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Weighted | |
| |
|
Number of | |
|
average | |
| |
|
shares | |
|
price | |
| |
|
| |
|
| |
|
Outstanding at December 31, 2001
|
|
|
1,751,153 |
|
|
$ |
7.76 |
|
| |
Granted
|
|
|
98,050 |
|
|
$ |
16.50 |
|
| |
Exercised
|
|
|
(99,607 |
) |
|
$ |
6.84 |
|
| |
Canceled
|
|
|
(35,090 |
) |
|
$ |
9.38 |
|
| |
|
|
|
|
|
|
|
Outstanding at December 31, 2002
|
|
|
1,714,506 |
|
|
$ |
9.56 |
|
| |
Granted
|
|
|
113,500 |
|
|
$ |
12.32 |
|
| |
Exercised
|
|
|
(84,734 |
) |
|
$ |
7.76 |
|
| |
Canceled
|
|
|
(38,386 |
) |
|
$ |
11.58 |
|
| |
|
|
|
|
|
|
|
Outstanding at December 31, 2003
|
|
|
1,704,886 |
|
|
$ |
7.47 |
|
| |
Unaudited:
|
|
|
|
|
|
|
|
|
| |
|
Granted
|
|
|
35,500 |
|
|
$ |
15.81 |
|
| |
|
Exercised
|
|
|
(106,132 |
) |
|
$ |
7.36 |
|
| |
|
Canceled
|
|
|
(135,149 |
) |
|
$ |
9.43 |
|
| |
|
|
|
|
|
|
|
Outstanding at December 31, 2004 (unaudited)
|
|
|
1,499,105 |
|
|
$ |
8.75 |
|
| |
|
|
|
|
|
|
The following tables summarize information about stock options
outstanding and exercisable at December 31, 2004:
Options Outstanding (unaudited)
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Weighted | |
|
|
| |
|
|
|
average | |
|
Weighted | |
| |
|
|
|
remaining | |
|
average | |
| |
|
|
|
contractual | |
|
exercise | |
| Range of exercise prices |
|
Shares | |
|
life (years) | |
|
price | |
| |
|
| |
|
| |
|
| |
|
$ 3.13 – $ 7.50
|
|
|
421,318 |
|
|
|
4.12 |
|
|
$ |
5.19 |
|
|
$ 7.51 – $13.68
|
|
|
973,142 |
|
|
|
6.32 |
|
|
$ |
9.27 |
|
|
$13.69 – $18.60
|
|
|
81,046 |
|
|
|
8.20 |
|
|
$ |
17.11 |
|
|
$18.61 – $24.50
|
|
|
23,599 |
|
|
|
7.03 |
|
|
$ |
22.04 |
|
| |
|
|
|
|
|
|
|
|
|
|
$ 3.13 – $24.50
|
|
|
1,499,105 |
|
|
|
5.82 |
|
|
$ |
8.75 |
|
| |
|
|
|
|
|
|
|
|
|
60
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
Options Exercisable (unaudited)
| |
|
|
|
|
|
|
|
|
| |
|
|
|
Weighted | |
| |
|
|
|
average | |
| |
|
|
|
exercise | |
| Range of exercise prices |
|
Shares | |
|
price | |
| |
|
| |
|
| |
|
$ 3.13 – $ 7.50
|
|
|
419,651 |
|
|
$ |
5.18 |
|
|
$ 7.51 – $13.68
|
|
|
288,303 |
|
|
$ |
9.22 |
|
|
$13.69 – $18.60
|
|
|
28,979 |
|
|
$ |
18.31 |
|
|
$18.61 – $24.50
|
|
|
16,075 |
|
|
$ |
22.09 |
|
| |
|
|
|
|
|
|
|
$ 3.13 – $24.50
|
|
|
753,008 |
|
|
$ |
7.59 |
|
| |
|
|
|
|
|
|
There were 783,672 and 646,691 stock options exercisable at
December 31, 2003 and 2002, respectively.
|
|
| NOTE 9. |
BUSINESS SEGMENT, GEOGRAPHIC, MAJOR CUSTOMER AND RELATED
PARTY INFORMATION |
The company has two reportable business segments: Systems and
Services, and Metrigraphics.
The Systems and Services segment provides technical and
information technology services to government customers. The
segment was comprised of five operating groups that provided
similar services and solutions and were subject to similar
regulations. These services and solutions include design,
development, operation and maintenance of business intelligence
systems, business transformation services, defense program
acquisition management services, training and performance
support systems and services, automated case management systems
and IT infrastructure services. On July 1, 2004, the
company announced that it had sharpened its government customer
focus by consolidating and realigning its operations to better
facilitate the execution of its recently developed business
growth strategy, better address the needs of its customers and
further strengthen the delivery of its solutions-based services.
Accordingly, effective July 1, 2004, the company
consolidated its five Systems and Services segment operating
groups into two organizations. The two new organizations
encompass all of the capabilities of the five former groups.
This realignment did not impact the company’s business
segments, as the new groups both provide solutions-based
services and are subject to similar regulations.
The Metrigraphics segment develops and builds components for
original equipment manufacturers in the computer peripheral
device, medical electronics, telecommunications and other
industries, with the focus on the custom design and manufacture
of miniature electronic parts that are intended to meet high
precision requirements through the use of electroforming, thin
film deposition and photolithography technologies.
The company evaluates performance and allocates resources based
on operating income. The operating income for each segment
includes amortization of intangible assets and selling,
engineering and administrative expenses directly attributable to
the segment. All corporate operating expenses are allocated
between the segments based on segment revenues, including
depreciation. However, depreciation related to corporate assets
that is subsequently allocated to the segment operating results
is included in the table below. Sales between segments represent
less than 1% of total revenue and are accounted for at cost.
Corporate assets are primarily comprised of cash and cash
equivalents, the company’s corporate headquarters facility
in Andover, Massachusetts, the PeopleSoft-based enterprise
business system, any deferred tax assets, certain corporate
prepaid expenses and other current assets, and valuation
allowances.
61
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
Results of operations information for the company’s
business segments for the years ended December 31, 2004,
2003 and 2002 are as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
|
2002 | |
| |
|
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
|
|
| |
|
| |
|
|
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Systems and Services
|
|
$ |
268,634 |
|
|
$ |
237,876 |
|
|
$ |
184,994 |
|
| |
Metrigraphics
|
|
|
7,072 |
|
|
|
6,932 |
|
|
|
7,616 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
$ |
275,706 |
|
|
$ |
244,808 |
|
|
$ |
192,610 |
|
| |
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Systems and Services
|
|
$ |
17,385 |
|
|
$ |
14,749 |
|
|
$ |
11,513 |
|
| |
Metrigraphics
|
|
|
122 |
|
|
|
640 |
|
|
|
1,134 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
$ |
17,507 |
|
|
$ |
15,389 |
|
|
$ |
12,647 |
|
| |
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Systems and Services
|
|
$ |
2,060 |
|
|
$ |
2,126 |
|
|
$ |
1,997 |
|
| |
Metrigraphics
|
|
|
466 |
|
|
|
546 |
|
|
|
602 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Depreciation of segment assets
|
|
|
2,526 |
|
|
|
2,672 |
|
|
|
2,599 |
|
| |
Depreciation of corporate assets
|
|
|
1,098 |
|
|
|
335 |
|
|
|
593 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
$ |
3,624 |
|
|
$ |
3,007 |
|
|
$ |
3,192 |
|
| |
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Systems and Services
|
|
$ |
1,436 |
|
|
$ |
1,246 |
|
|
$ |
2,174 |
|
| |
Metrigraphics
|
|
|
7 |
|
|
|
6 |
|
|
|
329 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Segment capital expenditures
|
|
|
1,443 |
|
|
|
1,252 |
|
|
|
2,503 |
|
| |
Corporate capital expenditures
|
|
|
3,101 |
|
|
|
6,911 |
|
|
|
844 |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
$ |
4,544 |
|
|
$ |
8,163 |
|
|
$ |
3,347 |
|
| |
|
|
|
|
|
|
|
|
|
Asset information for the company’s business segments and a
reconciliation of segment assets to the corresponding
consolidated amounts as of December 31, 2004 and 2003 is as
follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, | |
| |
|
| |
| |
|
2004 | |
|
2003 | |
| |
|
| |
|
| |
| |
|
(unaudited) | |
|
|
| |
|
| |
|
|
|
Segment assets
|
|
|
|
|
|
|
|
|
| |
Systems and Services
|
|
$ |
179,973 |
|
|
$ |
98,274 |
|
| |
Metrigraphics
|
|
|
1,859 |
|
|
|
2,004 |
|
| |
|
|
|
|
|
|
| |
|
Total segment assets
|
|
|
181,832 |
|
|
|
100,278 |
|
|
Corporate assets
|
|
|
23,302 |
|
|
|
20,792 |
|
| |
|
|
|
|
|
|
| |
|
$ |
205,134 |
|
|
$ |
121,070 |
|
| |
|
|
|
|
|
|
62
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
The increase in assets of the Systems and Services segment is
primarily the result of the September 1, 2004 acquisition
of Impact Innovations.
Revenue is attributed to geographic areas based on the
customer’s location. The company does not have locations
outside the United States; however, in rare instances, it may
have contracts with sales representatives located in foreign
countries and provide services at customer locations outside the
United States. Domestic revenues comprised approximately 99% of
revenues in 2004, and 98% of revenues in both 2003 and 2002.
Revenues from Department of Defense (“DoD”) customers
accounted for approximately 78% of total revenues in both 2004
and 2003, and approximately 80% of revenues in 2002. Revenues
earned from one significant DoD customer group in the Systems
and Services segment comprised approximately 17%, 12% and 15% of
the company’s total revenues in 2004, 2003 and 2002,
respectively. This customer’s accounts receivable balance
at December 31, 2004 was approximately $77,000. This
customer had no outstanding accounts receivable balance at
December 31, 2003. A second significant customer group in
the Systems and Services segment comprised approximately 11%,
18% and 11% of the company’s total revenues in 2004, 2003
and 2002, respectively. This customer had an accounts receivable
balance of $2.4 million at December 31, 2004 and
$1.6 million at December 31, 2003. The company had no
other customer in any of the three years ended December 31,
2004, that accounted for more than 10% of revenues.
The company has a 40% interest in HMR Tech, which it accounts
for using the equity method of accounting. This interest was
acquired as a result of the company’s May 31, 2002
acquisition of HJ Ford. Accordingly, HMR Tech is considered a
related party for the period subsequent to May 31, 2002.
Revenues from HMR Tech for the years ended December 31,
2004 and 2003, and the period from May 31, 2002 through
December 31, 2002 were approximately $1 million,
$473,000 and $211,000, respectively. The amounts due from HMR
Tech included in accounts receivable at December 31, 2004
and 2003 were approximately $192,000 and $501,000, respectively.
In response to lower than expected demand in certain sectors of
the company’s business, as well as the need to maintain a
competitive cost structure, the company incurred involuntary
separation costs for 85 employees in 2002. All operating groups
and functions of the company were affected. Costs associated
with these terminations totaled $0.8 million and are
included in the company’s operating results for the year
ended December 31, 2002. Of this amount, $0.6 million
is included in the caption “Cost of contract revenue”
and $0.2 million is included in “Selling, general and
administrative expenses” in the company’s Consolidated
Statement of Operations for that year. The accrual of
$0.2 million that remained at December 31, 2002 was
paid in the first half of 2003.
|
|
| NOTE 11. |
FINANCING ARRANGEMENTS |
On September 1, 2004, the company entered into a new
secured financing agreement (the “facility”) with a
bank group to restructure and increase the company’s credit
facilities to $100.0 million, inclusive of the current
mortgage on the company’s Andover, Massachusetts corporate
headquarters, which had a balance of $7.9 million at
closing (the “term loan”). The facility provides for a
$55.0 million, five-year term loan (the “acquisition
term loan”) with a seven-year amortization schedule for the
acquisition of Impact Innovations and a $37.0 million,
five-year revolving credit agreement for working capital (the
“revolver”). The bank group, led by Brown Brothers
Harriman & Co. as a lender and as administrative agent
(when acting in such capacity, the “Administrative
Agent”), also includes KeyBank National Association,
Banknorth, NA and Fleet National Bank, a Bank of America
company. The facility replaces the company’s previous
$50.0 million revolving credit agreement.
All of the obligations of the company and its subsidiaries under
the facility are secured by a security interest in substantially
all of the assets of the company and its subsidiaries granted to
the Administrative Agent. The agreement requires financial
covenant tests to be performed against the company’s annual
results beginning with the results for the year ending
December 31, 2005, that, if met, would result in the
release of all collateral securing the facility except for the
63
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
mortgage that secures the term loan. If the company’s
results do not meet specific financial ratio requirements, the
company and its subsidiaries will be required to perfect the
security interest granted to the Administrative Agent in all of
the government contracts of the company and its subsidiaries.
On an ongoing basis, the facility requires the company to meet
certain financial covenants, including maintaining a minimum net
worth and certain cash flow and debt coverage ratios. The
covenants also limit the company’s ability to incur
additional debt, pay dividends, purchase capital assets, sell or
dispose of assets, make additional acquisitions or investments,
or enter into new leases, among other restrictions. In addition,
the facility provides that the bank group may accelerate payment
of all unpaid principal and all accrued and unpaid interest
under the facility, upon the occurrence and continuance of
certain events of default, including, among others, the
following:
|
|
|
| |
• |
Any failure by the company and its subsidiaries to make any
payment of principal, interest and other sums due under the
facility within three calendar days of the date when such
payment is due; |
| |
| |
• |
Any breach by the company or any of its subsidiaries of certain
covenants, representations and warranties; |
| |
| |
• |
Any default and acceleration of any indebtedness owed by the
company or any of its subsidiaries to any person (other than the
bank group) which is in excess of $1,000,000; |
| |
| |
• |
Any final judgment against the company or any of its
subsidiaries in excess of $1,000,000 which has not been insured
to the reasonable satisfaction of the Administrative Agent; |
| |
| |
• |
Any bankruptcy (voluntary or involuntary) of the company or any
of its subsidiaries; and |
| |
| |
• |
Any material adverse change in the business or financial
condition of the company and its subsidiaries; or |
| |
| |
• |
Any change in control of the company. |
Acquisition term loan
The company used $53.4 million of the $55.0 million of
proceeds from the acquisition term loan to complete the
acquisition of Impact Innovations. The company repaid
$1.6 million of the $55.0 million financed on
September 1, 2004. The facility requires quarterly
principal payments on the acquisition term loan of approximately
$2 million, with a final payment of approximately
$16 million on September 1, 2009.
The company has the option of selecting an interest rate for the
acquisition term loan equal to either: (a) the then
applicable London Inter-Bank Offer Rate (the “LIBOR
Rate”) plus 1.75% to 3.25% per annum, depending on the
company’s most recently reported leverage ratio; or
(b) the base rate as announced from time to time by the
Administrative Agent (the “Base Rate”) plus up to
0.50% per annum, depending on the company’s most
recently reported leverage ratio. For those portions of the
acquisition term loan accruing at the LIBOR Rate, the company
has the option of selecting interest periods of 30, 60, 90
or 180 days.
Term loan
The company has a ten-year term loan as amended and restated on
September 1, 2004, with an outstanding principal
balance of $7.8 million, which is secured by a mortgage on
the company’s headquarters in Andover, Massachusetts. The
agreement requires quarterly principal payments of $125,000,
with a final payment of $5.0 million due on May 1,
2010. The company has the option of selecting an interest rate
for the term loan equal to either: (a) the then applicable
LIBOR Rate plus 1.50% to 3.00% per annum, depending on the
company’s most recently reported leverage ratio; or
(b) the Base Rate plus up to 0.50% per annum,
depending on the company’s most recently reported leverage
ratio. For those portions of the term loan accruing at the LIBOR
Rate, the company has the option of selecting interest periods
of 30, 60, 90 or 180 days.
64
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
Revolver
The revolver has a five-year term and is available to the
company for general corporate purposes, including strategic
acquisitions. The outstanding balance on the company’s
previous revolving credit facility was transferred to the new
revolver as part of the new financing arrangement. The fee on
the unused portion of the revolver ranges from 0.25% to 0.50%
per annum, depending on the company’s leverage ratio, and
is payable quarterly in arrears. The company has the option of
selecting an annual interest rate for the revolver equal to
either: (a) the then applicable LIBOR Rate plus 1.50% to
3.00% per annum, depending on the company’s most
recently reported leverage ratio; or (b) the Base Rate plus
up to 0.50% per annum, depending on the company’s
leverage ratio. For those portions of the revolver accruing at
the LIBOR rate, the company has the option of selecting interest
periods of 30, 60, 90 or 180 days. The revolver
matures on September 1, 2009.
Excess cash flow recapture payments
In addition to the principal payments required on the
acquisition term loan and the term loan, the company will also
make annual payments by February 15 of each year, commencing in
2006. The additional payment amount is equal to 50.0% of the
company’s excess cash flow, defined as EBITDA (earnings
before interest, taxes, depreciation and amortization) plus net
decreases in working capital or less net increases in working
capital, minus interest expense and principal payments on the
acquisition term loan and term loan, capital expenditures, and
all cash taxes and cash dividends paid for the most recently
completed fiscal year, commencing with the year ending
December 31, 2005. Each payment will be applied: first, to
the outstanding balance of the revolver, provided the
outstanding balance on the last day of the fiscal year compared
with the outstanding balance of the revolver on the last day of
the previous fiscal year does not already reflect such a
reduction; second, to the outstanding principal balance of the
acquisition term loan; and lastly, to the outstanding principal
balance of the term loan.
Outstanding borrowings
The company had outstanding debt of $69.9 million at
December 31, 2004, comprised of $52.1 million on the
acquisition term loan, $7.8 million on the term loan and
$10.0 million on the revolver. The interest rate on the
acquisition term loan was 5.41% at December 31, 2004, under
the 90 day LIBOR Rate option elected on November 1,
2004. The interest rate on the term loan was 5.16% at
December 31, 2004, under the 90 day LIBOR Rate option
elected on November 1, 2004. The interest rate on the
revolver was 5.28% at December 31, 2004, under the
30 day LIBOR Rate option elected on December 1, 2004.
The company’s outstanding debt of $16.8 million at
December 31, 2003, was comprised of $8.3 million on
the mortgage on the company’s headquarters facility and
$8.5 million under the company’s previous revolving
credit facility. At December 31, 2003, the interest rate on
the mortgage on the company’s headquarters facility was
3.15%, under a 90 day LIBOR option, elected on
October 14, 2003. At December 31, 2003, the interest
rate on $7.5 million of the outstanding principal balance
of the revolver was 3.17% under a 60 day LIBOR rate option
elected on December 15, 2003. The interest rate on the
remaining $1.0 million principal amount outstanding was
3.16% under a 30 day LIBOR rate option elected on
December 15, 2003. These rates and options were elected
under the company’s previous financing arrangements, which
were replaced by the new financing arrangement entered into on
September 1, 2004.
On December 26, 2002, the company entered into an
installment payment agreement in connection with the purchase of
its PeopleSoft-based enterprise business system software. The
company made the first payment on January 26, 2003, and the
second and final payment of $0.6 million on
January 26, 2004. The company had recorded the liability
using an imputed interest rate of 3.38%, which was its effective
borrowing rate at December 31, 2002. This purchase
commitment is included as a component of “Other accrued
expenses” in the company’s Consolidated Balance Sheet
as of December 31, 2003.
65
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
The company’s debt principal repayment commitments are due
as follows (in thousands) (unaudited):
| |
|
|
|
|
|
|
Year ending December 31,
|
|
|
|
|
| |
2005
|
|
$ |
18,357 |
|
| |
2006
|
|
|
8,357 |
|
| |
2007
|
|
|
8,357 |
|
| |
2008
|
|
|
8,357 |
|
| |
2009
|
|
|
21,164 |
|
| |
Thereafter
|
|
|
5,250 |
|
| |
|
|
|
| |
|
$ |
69,842 |
|
| |
|
|
|
The amounts above exclude the effect of any excess cash flow
recapture payments, as these amounts are not fixed.
|
|
| NOTE 12. |
PREFERRED STOCK PURCHASE RIGHTS |
On February 17, 1998, the company declared a dividend
distribution of one preferred stock purchase right (the
“Right”) for every outstanding share of common stock,
effective July 27, 1998. The Rights attach to all
outstanding shares of common stock, and no separate right
certificates will be issued. The Rights will become exercisable
upon the tenth business day following the earlier of:
(a) the date of a public announcement that a person or
group of affiliated or associated persons has acquired, or
obtained the right to acquire, beneficial ownership of 15% or
more of the outstanding shares of common stock of the company;
or (b) the commencement or announcement of an intention to
make a tender offer or exchange offer that would result in a
person or group owning 15% or more of the outstanding common
stock of the company.
When exercisable, each Right entitles the registered holder to
purchase from the company one-twelfth of a share of its
Series B Participating Preferred Stock, $0.10 par
value, at a price of $54.17 per each one-twelfth share of
preferred stock. Until a Right is exercised, the holder thereof,
as such, will have no rights as a shareholder of the company,
including, without limitation, the right to vote or to receive
dividends. Under certain circumstances, each share of the
Series B Participating Preferred Stock would be convertible
into a number of shares of the company’s common stock
having a value equal to twice the exercise price of the
preferred stock purchase right. The Rights may be redeemed by
the company at the discretion of the Board of Directors at a
price of $0.0083 per Right. The Rights expire on
July 27, 2008.
|
|
| NOTE 13. |
COMMITMENTS AND CONTINGENCIES |
The company conducts some of its operations in facilities that
are under long-term operating leases. These leases expire at
various dates through 2011, with various options to renew as
negotiated between the company and its landlords. It is expected
that in the normal course of business, leases that expire will
be renewed or replaced. Rent expense under these leases
(inclusive of real estate taxes and insurance) was
$5.0 million in 2004, $3.6 million in 2003 and
$4.2 million in 2002.
66
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
Contractual obligations at December 31, 2004 were as
follows (in thousands) (unaudited):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Payments due by period | |
| |
|
|
|
| |
| |
|
|
|
Less than | |
|
Two to | |
|
Four to | |
|
|
| |
|
Total | |
|
one year | |
|
three years | |
|
five years | |
|
Thereafter | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Revolver
|
|
$ |
10,000 |
|
|
$ |
10,000 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
Long-term debt
|
|
|
59,842 |
|
|
|
8,357 |
|
|
|
16,714 |
|
|
|
29,521 |
|
|
|
5,250 |
|
|
Operating leases
|
|
|
14,515 |
|
|
|
4,370 |
|
|
|
5,223 |
|
|
|
3,021 |
|
|
|
1,901 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Total contractual obligations
|
|
$ |
84,357 |
|
|
$ |
22,727 |
|
|
$ |
21,937 |
|
|
$ |
32,542 |
|
|
$ |
7,151 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amounts above related to the revolver and long-term debt do
not include interest payments on any outstanding principal
balance, because the interest rates on the company’s
financing arrangements are not fixed. Additionally, the amounts
above exclude the effect on the schedule of payments of the
application of any excess cash flow recapture payments, as
described in Note 11, “Financing Arrangements”,
to the outstanding principal balances of either the acquisition
term loan or the term loan (reported under the caption
“Long-term debt” in the table above), as these amounts
are not fixed.
The amounts above related to the operating leases include
payments on facilities that the company either no longer
occupies or is in the process of abandoning, for which the
company is contractually obligated.
The company currently expects to contribute $4.4 million in
2005 to fund its pension plan. This amount is not included in
the table above.
As part of the HJ Ford purchase, the company acquired a 40%
ownership interest in a small disadvantaged business, as defined
by the United States Government. This business is accounted for
using the equity method. The company has continuing business
relationships with this business and had provided a guarantee of
the business’s line of credit, under which its maximum
exposure was $0.2 million. On April 1, 2004, the
company was released as guarantor for this line of credit.
The company has change of control agreements with certain of its
employees that provide them with benefits should their
employment with the company be terminated other than for cause
or their disability or death, or if they resign for good reason,
as defined in these agreements, within a certain period of time
from the date of any change of control of the company.
As a defense contractor, the company is subject to many levels
of audit and review from various government agencies, including
the Defense Contract Audit Agency, various inspectors general,
the Defense Criminal Investigation Service, the General
Accounting Office, the Department of Justice and other
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. The company accrues for liabilities
associated with these activities when it becomes probable that
future expenditures will be made and such expenditures can be
reasonably estimated. The company’s evaluation of the
likelihood of expenditures related to these matters is subject
to change in future periods, depending on then current events
and circumstances, which could have material adverse effects on
the company’s business, financial position, results of
operations and cash flows.
As previously disclosed, on October 26, 2000, two former
company employees were indicted and charged with, among other
violations, wire fraud and a conspiracy scheme to defraud the
United States Air Force out of approximately $10 million
through kickbacks and overcharging for computer components and
services. The former employees collected the kickbacks and
overcharges through separate and independent businesses. The
company received no money from their scheme. When notified by
the government of the employees’ conspiracy, the company
fired the two employees and voluntarily cooperated with the
government’s investigation. The company was not charged in
the criminal case. Both former employees pled guilty and were
67
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
sentenced to prison. The company believes that the government
has recovered a substantial portion of the defrauded funds from
the co-conspirators. Notwithstanding the company’s efforts
to settle any claims against the company arising from the
co-conspirators’ scheme, on October 9, 2003, the
United States Attorney filed a civil complaint against the
company in the United States District Court for the District of
Massachusetts based in substantial part upon the actions and
omissions of the former employees which gave rise to the
criminal cases against them. In the civil action, the United
States Attorney has asserted on behalf of the government claims
against the company based upon the False Claims Act and the
Anti-Kickback Act, in addition to certain common law and
equitable claims. The United States Attorney seeks to recover up
to three times its actual damages and penalties under the False
Claims Act and double damages and penalties under the
Anti-Kickback Act and to recover costs and interest. The company
has filed a third party complaint, as part of the United States
Attorney’s civil action, including an affirmative multiple
damage claim for unfair and deceptive practices, against Storage
Engine, Inc. (“Storage Engine”), formerly known as
ECCS, Inc., and its president and director. The complaint
alleges that Storage Engine directly benefited from the kickback
scheme alleged by the United States Attorney. Storage Engine, a
supplier of computer components for the United States Air Force,
made payments to the company’s two former employees through
separate and independent businesses. Storage Engine and its
president have denied the allegations. The company’s claim
against Storage Engine, which filed for reorganization under
Chapter 11 of the United States Bankruptcy Code, presently
remains in effect as a claim against Storage Engine. The company
disputes the claims of the U.S. Attorney, believes it has
substantive defenses, and intends to vigorously defend itself.
The company and the United States Attorney have agreed to
non-binding mediation of this matter. However, the outcome of
such litigation, if unfavorable, could have a material adverse
effect on the company’s business, financial position,
results of operations and cash flows.
In 2002, a dispute arose between Genesis Tactical Group LLC
(“Genesis”), Lockheed Martin Corporation
(“Lockheed”) and DRC related to a contract for
services to Lockheed which DRC sold to Genesis in 2001. In the
first quarter of 2005, Genesis, Lockheed and the company settled
the outstanding issues related to this dispute. The settlement
did not have a material effect on the company’s business,
financial position, results of operations or cash flows.
The company has provided documents in response to a previously
disclosed grand jury subpoena issued on October 15, 2002 by
the United States District Court for the District of
Massachusetts, directing the company to produce specified
documents dating back to 1996. The subpoena relates to an
investigation, currently focused on the period from 1996 to
1999, by the Antitrust Division of the Department of Justice
into bidding and procurement activities involving the company
and several other defense contractors who have received similar
subpoenas and may also be subjects of the investigation.
Although the company is cooperating in the investigation, it
does not have a sufficient basis to predict the outcome of the
investigation. Should the company be found to have violated the
antitrust laws, the matter could have a material adverse effect
on the company’s business, financial position, results of
operations and cash flows.
In 2004, approximately 89% of the company’s revenues were
derived from sales to United States Government agencies,
primarily the Department of Defense. All of the company’s
United States Government contracts are subject to termination
for convenience in accordance with government regulations. In
2004, sales to agencies of state and local governments comprised
approximately 7% of revenues. Many of the contracts the company
has won are multi-year efforts. In accordance with state laws,
funding must be approved annually by the state’s
legislatures.
68
DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(INFORMATION SUBSEQUENT TO DECEMBER 31, 2003 IS
UNAUDITED)
|
|
| NOTE 14. |
QUARTERLY RESULTS (UNAUDITED) (in thousands, except per
share data) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
First | |
|
Second | |
|
Third | |
|
Fourth | |
| |
|
Quarter | |
|
Quarter | |
|
Quarter(2) | |
|
Quarter(3)(4) | |
| |
|
| |
|
| |
|
| |
|
| |
|
2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Revenues
|
|
$ |
62,068 |
|
|
$ |
64,950 |
|
|
$ |
70,451 |
|
|
$ |
78,237 |
|
| |
Gross profit
|
|
$ |
9,090 |
|
|
$ |
9,433 |
|
|
$ |
11,155 |
|
|
$ |
13,305 |
|
| |
Operating income
|
|
$ |
3,374 |
|
|
$ |
4,117 |
|
|
$ |
4,441 |
|
|
$ |
5,575 |
|
| |
Net income
|
|
$ |
2,044 |
|
|
$ |
2,199 |
|
|
$ |
2,268 |
|
|
$ |
2,862 |
|
| |
Earnings per common share — diluted(1)
|
|
$ |
0.23 |
|
|
$ |
0.24 |
|
|
$ |
0.25 |
|
|
$ |
0.31 |
|
| |
|
2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Revenues
|
|
$ |
58,606 |
|
|
$ |
62,138 |
|
|
$ |
62,432 |
|
|
$ |
61,632 |
|
| |
Gross profit
|
|
$ |
9,201 |
|
|
$ |
10,005 |
|
|
$ |
9,704 |
|
|
$ |
11,151 |
|
| |
Operating income
|
|
$ |
2,965 |
|
|
$ |
3,473 |
|
|
$ |
4,263 |
|
|
$ |
4,688 |
|
| |
Income from continuing operations
|
|
$ |
1,632 |
|
|
$ |
1,958 |
|
|
$ |
2,387 |
|
|
$ |
2,678 |
|
| |
Loss from discontinued operations
|
|
|
(357 |
) |
|
|
(856 |
) |
|
|
(147 |
) |
|
|
(275 |
) |
| |
Loss on disposal of discontinued operations
|
|
|
(233 |
) |
|
|
— |
|
|
|
— |
|
|
|
(115 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Net income
|
|
$ |
1,042 |
|
|
$ |
1,102 |
|
|
$ |
2,240 |
|
|
$ |
2,288 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
Earnings (loss) per common share — diluted(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Income from continuing operations
|
|
$ |
0.19 |
|
|
$ |
0.23 |
|
|
$ |
0.27 |
|
|
$ |
0.30 |
|
| |
|
Loss from discontinued operations
|
|
|
(0.04 |
) |
|
|
(0.10 |
) |
|
|
(0.02 |
) |
|
|
(0.03 |
) |
| |
|
Loss on disposal of discontinued operations
|
|
|
(0.03 |
) |
|
|
— |
|
|
|
— |
|
|
|
(0.01 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
Net earnings per common share
|
|
$ |
0.12 |
|
|
$ |
0.13 |
|
|
$ |
0.25 |
|
|
$ |
0.26 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
Income (loss) per share is computed independently for each of
the quarters presented; accordingly, the sum of the quarterly
income (loss) per share may not equal the total computed for the
year. |
| |
| (2) |
2004 amounts include results of operations of Impact Innovations
(acquired September 1, 2004) for the period subsequent to
its acquisition. During this period, revenues attributable to
Impact Innovations were $4.2 million. |
| |
| (3) |
2004 amounts include results of operations of Impact Innovations
for the entire fourth quarter. During this period, revenues
attributable to Impact Innovations were $11.9 million. |
| |
| (4) |
2004 amounts include approximately $0.8 million of revenue
adjustments related to rate changes on certain contracts with
the United States Government. |
69
DYNAMICS RESEARCH CORPORATION
SCHEDULE II — VALUATION AND QUALIFYING
ACCOUNTS AND RESERVES
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
Additions | |
|
|
|
|
| |
|
|
|
| |
|
|
|
|
| |
|
Balance at | |
|
Charged to | |
|
Charged to | |
|
Deductions | |
|
Balance at | |
| |
|
Beginning | |
|
Costs and | |
|
Other | |
|
and | |
|
End of | |
| |
|
of Period | |
|
Expenses | |
|
Accounts(A) | |
|
Write-Offs | |
|
Period | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| |
|
|
|
(in thousands of dollars) | |
|
|
|
Allowance for doubtful accounts and sales returns
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Year ended December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 (unaudited)
|
|
$ |
321 |
|
|
$ |
72 |
|
|
$ |
20 |
|
|
$ |
(17 |
) |
|
$ |
396 |
|
| |
|
2003
|
|
$ |
373 |
|
|
$ |
9 |
|
|
$ |
(30 |
) |
|
$ |
(31 |
) |
|
$ |
321 |
|
| |
|
2002
|
|
$ |
1,271 |
|
|
$ |
10 |
|
|
$ |
(402 |
) |
|
$ |
(506 |
) |
|
$ |
373 |
|
|
Restructuring reserve
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Year ended December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2004 (unaudited)
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
| |
|
2003
|
|
$ |
168 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
(168 |
) |
|
$ |
— |
|
| |
|
2002
|
|
$ |
— |
|
|
$ |
759 |
|
|
$ |
— |
|
|
$ |
(591 |
) |
|
$ |
168 |
|
|
|
| (A) |
Recovery of previously reserved amounts and other adjustments |
70
|
|
| Item 9. |
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE |
On November 13, 2003, the Audit Committee of the Board of
Directors dismissed KPMG LLP (“KPMG”) as the
independent accountants for the company, and on
December 23, 2003, engaged Grant Thornton LLP (“Grant
Thornton”) as its new independent accountants.
The audit report of KPMG on the company’s consolidated
financial statements as of and for the years ended
December 31, 2002 and 2001 did not contain an adverse
opinion or disclaimer of opinion, nor was such report qualified
or modified as to uncertainty, audit scope or accounting
principles.
In connection with the audits of the company’s consolidated
financial statements as of and for the years ended
December 31, 2002 and 2001 and the subsequent interim
period through November 13, 2003, there were no
disagreements with KPMG on any matter of accounting principles
or practices, financial statement disclosure, or auditing scope
or procedure, which disagreements, if not resolved to the
satisfaction of KPMG, would have caused KPMG to make reference
to the subject matter of the disagreement in connection with
their audit report. In addition, in connection with the audits
of the company’s financial statements as of and for the
years ended December 31, 2002, there were no reportable
events as defined in Item 302(a)(1)(v) of
Regulation S-K, except that KPMG, in its Management Letter
to the company following the completion of the audits, noted the
following conditions which it considered to be reportable
conditions as defined under standards established by the
American Institute of Certified Public Accountants:
|
|
|
| |
• |
KPMG noted deficiencies in the processes used by management to
review and document new customer contracts and modifications to
existing customer contracts for purposes of determining the
proper revenue recognition model. |
| |
| |
• |
KPMG noted deficiencies in the systems and processes used in the
preparation of the financial statements and the lack of proper
management review and account reconciliation and analysis. |
| |
| |
• |
It was noted that personnel responsible for accounting and
financial reporting did not have sufficient background or were
overloaded with normal day-to-day activities. It was also noted
that they lacked the Securities and Exchange Commission
(“SEC”) and Generally Accepted Accounting Principles
(“GAAP”) experience necessary to ensure compliance
with financial reporting and disclosure requirements. Among
other things, it was recommended that the company strengthen its
level of SEC and GAAP accounting experience. |
The company took a number of measures in 2003 intended to
effectively address these reportable conditions.
KPMG noted that none of these reportable conditions was believed
to be a material weakness, and it issued an unqualified audit
opinion on the financial statements as of and for the years
ended December 31, 2002 and 2001. All reportable conditions
were discussed with the company’s Audit Committee, and the
company authorized KPMG to respond fully to the inquiries, if
any, of its new accountant concerning these reportable
conditions.
During the fiscal years ended December 31, 2002 and 2001
and through the appointment of Grant Thornton, the company did
not consulted with Grant Thornton regarding any of the following:
|
|
|
| |
• |
the application of accounting principles to a specified
transaction, either completed or proposed; |
| |
| |
• |
the type of audit opinion that might be rendered on the
company’s financial statements; or |
| |
| |
• |
any matter that was either the subject of a disagreement, as
that term is defined in Item 304(a)(1)(iv) of
Regulation S-K and the related instructions to
Item 304 of Regulation S-K, or a reportable event, as
that term is defined in Item 304(a)(1)(v) of
Regulation S-K. |
|
|
| Item 9A. |
CONTROLS AND PROCEDURES |
(a) Evaluation of Disclosure Controls and Procedures
Our principal executive officer and principal financial officer,
based on their evaluation of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)) as of the end of the period covered by this Annual
Report on Form 10-K, have concluded that our disclosure
controls and procedures are effective for ensuring that
information required to be disclosed by us in the reports that
we file or submit under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms.
71
(b) Management’s Report on Internal Control over
Financial Reporting
Our management is responsible for establishing and maintaining
adequate internal control over financial reporting, as such term
is defined in Exchange Act Rules 13a-15(f). Our management
conducted an evaluation of the effectiveness of our internal
control over financial reporting, other than the internal
control of Impact Innovations Group LLC (“Impact
Innovations”), which we acquired on September 1, 2004,
based on the framework in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Currently management
has not identified any material weakness in the internal
controls over financial reporting or related disclosures so
reviewed by us, nor has Grant Thornton LLP reported the
existence of any material weakness in internal controls over
financial reporting to the company’s management or the
Audit Committee of our Board of Directors.
Grant Thornton LLP, the company’s independent registered
public accounting firm, has not completed its integrated audit
of the company’s consolidated financial statements and
internal controls as of the date of this filing. As a result,
the auditor opinions on the financial statements and internal
controls and auditor consents, as well as management’s
report on internal control over financial reporting, are not
included in this filing. The company anticipates that the audits
will be completed and that auditor opinions and consents will be
included in an amended Form 10-K filing, along with
management’s report, on or before March 31, 2005.
Notwithstanding, there currently can be no assurance the company
or Grant Thornton LLP will not identify material weaknesses as
the audit is completed, or that the audit will be completed by
March 31, 2005.
(c) Changes in Internal Control over Financial Reporting
In 2003, a significant deficiency related to the accrual of
liabilities for subcontractor work performed was identified.
During 2004, the company changed its accounting practice related
to the accrual of liabilities for subcontractor work performed.
In the fourth quarter of 2004, the company finalized its review
and implementation of control procedures with respect to
recording this liability and expects this implementation will
remediate the significant deficiency in future periods. In 2003,
a significant deficiency related to the company’s manually
intensive financial reporting process was also identified.
During 2004, the company installed an integrated
PeopleSoft-based enterprise business system. The company
believes that it also significantly strengthened its financial
staff in 2004. Management believes that this deficiency has been
remediated. The company’s auditors noted three deficiencies
at December 31, 2002, all of which the company believes
have been remediated.
Other than the foregoing matters, there have been no changes to
our internal controls over financial reporting during the
quarterly period ended December 31, 2004, that have
materially affected, or are reasonably likely to materially
affect, the company’s internal controls over financial
reporting.
PART III
|
|
| Item 10. |
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT |
Information with respect to Directors of the company required by
this item is hereby incorporated by reference to the
company’s definitive proxy statement to be filed by the
company within 120 days after the close of its fiscal year.
Information with respect to the Executive Officers of the
company is included in Part I Item 4 of this Annual
Report on Form 10-K.
A copy of the company’s code of ethics, which applies to
its principal executive officer, principal financial officer,
principal accounting officer and controller, may be obtained
free of charge through the company’s internet website at
http://www.drc.com.
|
|
| Item 11. |
EXECUTIVE COMPENSATION |
The information required by this Item 11 is hereby
incorporated by reference to the company’s definitive proxy
statement to be filed by the company within 120 days after
the close of its fiscal year.
72
|
|
| Item 12. |
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT |
Other than as set forth below, the information required by this
Item 12 is hereby incorporated by reference to the
company’s definitive proxy statement to be filed by the
company within 120 days after the close of its fiscal year.
Equity Compensation Plan Information
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Number of securities | |
| |
|
Number of securities | |
|
|
|
remaining available for | |
| |
|
to be issued upon | |
|
Weighted-average | |
|
future issuance under | |
| |
|
exercise of | |
|
exercise price of | |
|
equity compensation plans | |
| |
|
outstanding options, | |
|
outstanding options, | |
|
(excluding securities | |
| |
|
warrants and rights | |
|
warrants and rights | |
|
reflected in column (a)) | |
| Plan category |
|
(a) | |
|
(b) | |
|
(c) | |
| |
|
| |
|
| |
|
| |
|
Equity compensation plans approved by security holders(1)
|
|
|
1,149,105 |
|
|
$ |
9.39 |
|
|
|
606,522 |
|
| |
|
|
|
|
|
|
|
|
|
|
Equity compensation plans not approved by security holders:
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
(2)
|
|
|
250,000 |
|
|
$ |
4.44 |
|
|
|
— |
|
| |
(3)
|
|
|
100,000 |
|
|
$ |
12.14 |
|
|
|
— |
|
| |
|
|
|
|
|
|
|
|
|
| |
|
Total
|
|
|
1,499,105 |
|
|
$ |
8.75 |
|
|
|
606,522 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
(1) |
Includes the number of shares subject to options issued under
the following plans: 1993 Equity Incentive Plan, 1995 Stock
Option Plan for Non-Employee Directors, 2000 Incentive Plan,
2000 Employee Stock Purchase Plan and 2003 Incentive Plan. |
| |
| |
(2) |
In 1999, the company granted Mr. Regan 250,000
non-qualified stock options to purchase shares of the
company’s common stock. The option price is $4.44, which
was the fair market value of the common stock at the date of
grant. Twenty percent of the options vested immediately. An
additional 20% vest in each successive year from the date of
grant. The options expire ten years from the date of grant. |
| |
| |
(3) |
On February 19, 2003, the Board of Directors authorized the
grant of 100,000 non-qualified stock options as an inducement
for the hiring of a new executive officer. The grant was made on
April 7, 2003, to William C. Hoover, President and Chief
Operating Officer. The option price is $12.14, which was the
fair market value of the common stock at the date of grant. The
options will vest one-third on the first anniversary of
employment and one third on each successive anniversary. The
options expire ten years from the date of grant. |
|
|
| Item 13. |
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS |
The information required by this Item 13 is hereby
incorporated by reference to the company’s definitive proxy
statement to be filed by the company within 120 days after
the close of its fiscal year.
|
|
| Item 14. |
PRINCIPAL ACCOUNTING FEES AND SERVICES |
The information required by this Item 14 is hereby
incorporated by reference to the company’s definitive proxy
statement to be filed by the company within 120 days after
the close of its fiscal year.
73
PART IV
|
|
| Item 15. |
EXHIBITS, FINANCIAL STATEMENT SCHEDULE |
(a) (1) and (2) Financial Statements and
Financial Statement Schedule
The consolidated financial statements of the company and
Schedule II Valuation and Qualifying Accounts and Reserves
of the company are listed in the index under Part II,
Item 8, of this Annual Report on Form 10-K.
Other financial statements schedules are omitted because of the
absence of conditions under which they are required or because
the required information is given in the supplementary
consolidated financial statements or notes thereto.
(3) Exhibits
The exhibits that are filed with this Annual Report on
Form 10-K, or that are incorporated herein by reference,
are set forth in the Exhibit Index hereto.
74
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
|
| |
| |
/s/ James P. Regan |
| |
|
| |
James P. Regan, |
| |
Chairman and Chief Executive Officer |
Date: March 16, 2005
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
dates indicated.
| |
|
|
|
|
|
|
| |
/s/ James P. Regan
James
P. Regan |
|
Chairman and Chief Executive Officer |
|
March 16, 2005 |
| |
/s/ William C. Hoover
William
C. Hoover |
|
President and Chief Operating Officer |
|
March 16, 2005 |
| |
/s/ David Keleher
David
Keleher |
|
Senior Vice President and Chief Financial Officer (Principal
Financial Officer) |
|
March 16, 2005 |
| |
/s/ Francis Murphy
Francis
Murphy |
|
Corporate Controller and Chief Accounting Officer (Principal
Accounting Officer) |
|
March 16, 2005 |
| |
/s/ John S. Anderegg, Jr.
John
S. Anderegg, Jr. |
|
Director |
|
March 16, 2005 |
| |
/s/ Francis J. Aguilar
Francis
J. Aguilar |
|
Director |
|
March 16, 2005 |
| |
/s/ Gen. George T. Babbitt, Jr.
Gen.
George T. Babbitt, Jr. |
|
Director |
|
March 16, 2005 |
| |
/s/ Kenneth F. Kames
Kenneth
F. Kames |
|
Director |
|
March 16, 2005 |
| |
/s/ Lt. Gen. Charles P. McCausland
Lt.
Gen. Charles P. McCausland |
|
Director |
|
March 16, 2005 |
75
EXHIBIT INDEX
| |
|
|
|
|
|
|
| Exhibit No. | |
|
Description |
|
Reference |
| | |
|
|
|
|
| |
2.1 |
|
|
Stock Purchase Agreement, dated December 12, 2002, by and
among Dynamics Research Corporation, Andrulis Corporation and
the individuals listed on the signature page thereto. |
|
A** |
| |
| |
2.2 |
|
|
Equity Purchase Agreement among Dynamics Research Corporation
and Impact Innovations Group LLC and J3 Technology Services
Corp., dated August 2, 2004 |
|
Y** |
| |
| |
3.1 |
|
|
Restated Articles of Organization of the company, dated
May 22, 1987. |
|
B** |
| |
| |
3.2 |
|
|
By-Laws of the company, dated May 22, 1987. |
|
B** |
| |
| |
3.3 |
|
|
Certificate of Vote of Directors Establishing Series A
Preferred Stock, dated July 14, 1988. |
|
C** |
| |
| |
3.4 |
|
|
Certificate of Vote of Directors Establishing Series B
Preferred Stock, dated February 17, 1998. |
|
D** |
| |
| |
3.5 |
|
|
Amendment, dated September 10, 1998, to the Certificate of
Vote of Directors Establishing Series B Preferred Stock. |
|
E** |
| |
| |
3.6 |
|
|
Amendment, dated April 28, 1998, to the Articles of
Organization of the company. |
|
C** |
| |
| |
3.7 |
|
|
Amendment, dated April 25, 2000, to the Articles of
Organization of the company. |
|
C** |
| |
| |
4.1 |
|
|
Specimen certificate for shares of the company’s common
stock. |
|
F** |
| |
| |
4.2 |
|
|
Rights Agreement, dated February 17, 1998, between Dynamics
Research Corporation and the American Stock Transfer &
Trust Company, as Rights Agent. |
|
D** |
| |
| |
10.1 |
|
|
Form of indemnification agreement for directors of the company. |
|
G** |
| |
| |
10.2 |
|
|
Severance Agreement between John S. Anderegg, Jr. and the
company. |
|
G* ** |
| |
| |
10.3 |
|
|
Deferred Compensation Plan for Non-Employee Directors of the
company. |
|
G* ** |
| |
| |
10.4 |
|
|
Form of Consulting Agreement by and between the company and
Albert Rand. |
|
H* ** |
| |
| |
10.5 |
|
|
Form of Supplemental Retirement Pension Agreement by and between
the company and Albert Rand. |
|
H* ** |
| |
| |
10.6 |
|
|
Amended 1993 Equity Incentive Plan. |
|
I* ** |
| |
| |
10.7 |
|
|
Amended 1995 Stock Option Plan for Non-Employee Directors. |
|
H* ** |
| |
| |
10.8 |
|
|
Mortgage Security Agreement and Assignment, dated
February 10, 2000, by and among Dynamics Research
Corporation and Brown Brothers Harriman & Co. and
Family Bank, FSB. |
|
J** |
| |
| |
10.9 |
|
|
Amendment, dated June 12, 2000, to Mortgage Security
Agreement and Assignment, by and among Dynamics Research
Corporation and First Massachusetts Bank, N.A., f/k/a/ Family
Bank, FSB. |
|
K** |
| |
| |
10.10 |
|
|
Employment Agreement between the company and James P. Regan. |
|
L* ** |
| |
| |
10.11 |
|
|
Change of Control Agreement between the company and James P.
Regan. |
|
L* ** |
| |
| |
10.12 |
|
|
2000 Incentive Plan. |
|
M* ** |
| |
| |
10.13 |
|
|
Form of grant of stock options under the 2000 Incentive Plan. |
|
U* ** |
| |
| |
10.14 |
|
|
Form of grant of restricted stock under the 2000 Incentive Plan. |
|
U* ** |
| |
| |
10.15 |
|
|
Non-qualified Stock Option Agreement between the company and
James P. Regan. |
|
N* ** |
| |
| |
10.16 |
|
|
2000 Employee Stock Purchase Plan. |
|
F* ** |
| |
| |
10.17 |
|
|
Special Severance Plan. |
|
O* ** |
| |
| |
10.18 |
|
|
Senior Management Deferred Compensation Plan. |
|
P* ** |
| |
| |
10.19 |
|
|
Amended and Restated Loan Agreement, dated June 28, 2002,
by and among Dynamics Research Corporation, certain of its
subsidiaries, and Brown Brothers Harriman & Co.,
Banknorth, N.A. and Key Corporation Capital Inc. |
|
Q** |
| |
| |
10.20 |
|
|
Amendment, dated December 16, 2002, to the Amended and
Restated Loan Agreement, dated June 28, 2002, by and among
Dynamics Research Corporation, certain of its subsidiaries, and
Brown Brothers Harriman & Co., Banknorth, N.A. and Key
Corporation Capital Inc. |
|
A** |
| |
| |
10.21 |
|
|
Second Amendment, dated June 26, 2002, to the Mortgage
Security Agreement and Assignment, by and between Dynamics
Research Corporation and Banknorth N.A., f/k/a/ First
Massachusetts Bank, N.A., f/k/a Family Bank, FSB. |
|
C** |
| |
|
|
|
|
|
|
| Exhibit No. | |
|
Description |
|
Reference |
| | |
|
|
|
|
| |
| |
10.22 |
|
|
Amendment and Waiver, dated March 26, 2003, to the Amended
and Restated Loan Agreement, dated June 28, 2002, by and
among Dynamics Research Corporation, certain of its
subsidiaries, and Brown Brothers Harriman & Co.,
Banknorth, N.A. and Key Corporation Capital Inc. |
|
C** |
| |
| |
10.23 |
|
|
Dynamics Research Corporation Special Severance Plan, as amended
on May 14, 2003. |
|
S* ** |
| |
| |
10.24 |
|
|
2003 Incentive Plan. |
|
S* ** |
| |
| |
10.25 |
|
|
Form of grant of stock options under the 2003 Incentive Plan. |
|
U* ** |
| |
| |
10.26 |
|
|
Form of grant of restricted stock under the 2003 Incentive Plan. |
|
U* ** |
| |
| |
10.27 |
|
|
Third Amendment, dated December 23, 2003, to the Amended
and Restated Loan Agreement, dated June 28, 2002, by and
among Dynamics Research Corporation, certain of its
subsidiaries, and Brown Brothers Harriman & Co.,
Banknorth, N.A. and Key Corporate Capital Inc. |
|
S** |
| |
| |
10.28 |
|
|
Second Amended and Restated Loan Agreement by and among Dynamics
Research Corporation, DRC International Corporation, H.J. Ford
Associates, Inc., Andrulis Corporation and Impact Innovations
Group LLC as the Borrowers, and The Lenders Party hereto and
Brown Brothers Harriman & Co., as Administrative Agent
and Banknorth, N.A. as documentation Agent and Key Bank National
Association as Co-Syndication Agent and Fleet National Bank, a
Bank of America company as Co-Syndication Agent, as of
September 1, 2004. |
|
T** |
| |
| |
10.29 |
|
|
Master Unlimited Guaranty dated as of September 1, 2004 by
each of Dynamics Research Corporation, DRC International
Corporation, H.J. Ford Associates, Inc., Andrulis Corporation
and Impact Innovations Group LLC, in favor of Brown Brothers
Harriman & Co., for itself and as Administrative Agent
for each of the Lenders which are and which may become parties
to the Loan Agreement. |
|
T** |
| |
| |
10.30 |
|
|
Security Agreement among Brown Brothers Harriman & Co.,
as Administrative Agent for the Lenders Party to the Loan
Agreement and Dynamics Research Corporation, DRC International
Corporation, H.J. Ford Associates, Inc., Andrulis Corporation
and Impact Innovations Group LLC, dated September 1, 2004. |
|
T** |
| |
| |
10.31 |
|
|
Pledge Agreement by and between Dynamics Research Corporation
and Brown Brothers Harriman & CO., for itself and as
Administrative Agent for each of the Lenders which are and which
may become parties to the Loan Agreement, as of
September 1, 2004. |
|
T** |
| |
| |
10.32 |
|
|
Patent and Patent Application Security Agreement by Dynamics
Research Corporation and Brown Brothers Harriman & Co.,
as administrative agent for itself and for each of the other
Lenders as may become parties to the Loan Agreement, dated
September 1, 2004. |
|
T** |
| |
| |
10.33 |
|
|
Trademark and Trademark Application Security Agreement by
Dynamics Research Corporation and Brown Brothers
Harriman & Co., as administrative agent for itself and
for each of the other Lenders as may become parties to the Loan
Agreement, dated September 1, 2004. |
|
T** |
| |
| |
10.34 |
|
|
Non-qualified Stock Option Agreement between the company and
William Hoover, dated April 7, 2003. |
|
R* ** |
| |
| |
16.1 |
|
|
Letter regarding change in certifying accountant. |
|
S** |
| |
| |
21.1 |
|
|
Subsidiaries of the registrant. |
|
Filed herewith |
| |
| |
31.1 |
|
|
Certification of the Chief Executive Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934,
as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. |
|
Filed herewith |
| |
| |
31.2 |
|
|
Certification of the Chief Financial Officer pursuant to
Rule 13a-14(a) under the Securities Exchange Act of 1934,
as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. |
|
Filed herewith |
| |
| |
32.1 |
|
|
Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002. |
|
Filed herewith |
| |
| |
32.2 |
|
|
Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002. |
|
Filed herewith |
|
|
| A |
Incorporated by reference to the company’s Current Report
on Form 8-K filed on January 6, 2003. |
| |
| B |
Incorporated by reference to the company’s Quarterly Report
on Form 10-Q for the quarterly period ended June 17,
1987. |
| |
| C |
Incorporated by reference to the company’s Annual Report on
Form 10-K for the year ended December 31, 2002. |
| |
| D |
Incorporated by reference to the company’s Form 8-A
filed on June 25, 1998. |
| |
| E |
Incorporated by reference to the company’s Form 8-A/ A
filed on September 30, 1998. |
| |
| F |
Incorporated by reference to the company’s Registration
Statement on Form S-8 (Registration No. 333-59706)
filed on April 27, 2001. |
| |
| G |
Incorporated by reference to the company’s Annual Report on
Form 10-K for the year ended December 31, 1991. |
| |
| H |
Incorporated by reference to the company’s Quarterly Report
on Form 10-Q for the quarterly period ended March 31,
1997. |
| |
| I |
Incorporated by reference to the company’s Annual Report on
Form 10-K for the year ended December 31, 1998. |
| |
| J |
Incorporated by reference to the company’s Current Report
on Form 8-K filed on March 24, 2000. |
| |
| K |
Incorporated by reference to the company’s Current Report
on Form 8-K filed on June 27, 2000. |
| |
| L |
Incorporated by reference to the company’s Annual Report on
Form 10-K for the year ended December 31, 1999. |
| |
| M |
Incorporated by reference to the company’s
Schedule 14A filed on December 6, 1999. |
| |
| N |
Incorporated by reference to the company’s Registration
Statement on Form S-8 (Registration No. 333-47838)
filed on October 12, 2000. |
| |
| O |
Incorporated by reference to the company’s Annual Report on
Form 10-K for the year ended December 31, 2001. |
| |
| P |
Incorporated by reference to the company’s Quarterly Report
on Form 10-Q for the quarterly period ended March 31,
2002. |
| |
| Q |
Incorporated by reference to the company’s Quarterly Report
on Form 10-Q for the quarterly period ended June 30,
2002. |
| |
| R |
Incorporated by reference to the company’s Quarterly Report
on Form 10-Q for the quarterly period ended March 31,
2003. |
| |
| S |
Incorporated by reference to the company’s Annual Report on
Form 10-K for the year ended December 31, 2003. |
| |
| T |
Incorporated by reference to the company’s Current Report
on Form 8-K, dated September 1, 2004, and filed on
September 8, 2004. |
| |
| U |
Incorporated by reference to the company’s Quarterly Report
on Form 10-Q for the quarterly period ended
September 30, 2004. |
| |
| * |
Management contract or compensatory plan or arrangement. |
| |
| ** |
In accordance with Rule 12b-32 under the Securities
Exchange Act of 1934, as amended, reference is made to the
documents previously filed with the Securities and Exchange
Commission, which documents are hereby incorporated by reference. |