e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM TO
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 of Incorporation)
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(I.R.S. Employer Identification No.) |
60 FRONTAGE ROAD, ANDOVER, MASSACHUSETTS 01810-5498
(Address of Principal Executive Offices) (Zip Code)
978-475-9090
(Registrants Telephone Number, Including Area Code)
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 whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell Company (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ
As of April 30, 2006, there were 9,193,840 shares of the registrants common stock
outstanding.
DYNAMIC RESEARCH CORPORATION
FORM 10-Q
For the Quarterly Period Ended March 31, 2006
Table of Contents
Special Note on Factors Affecting Future Results
This Quarterly Report on Form 10-Q contains forward-looking statements regarding future events
and the future results of Dynamics Research Corporation (Dynamics Research) that are based on
current expectations, estimates, forecasts and projections about the industries in which Dynamics
Research operates and the beliefs and assumptions of the management of Dynamics Research. Words
such as expect, anticipate, target, goal, project, intend, plan, believe, seek,
estimate, and similar expressions are intended to identify such forward-looking statements.
These forward-looking statements are predictions and are subject to risks, uncertainties and
assumptions that are difficult to predict. Therefore, actual results may differ materially and
adversely from those expressed in any forward-looking statements. Factors that might cause or
contribute to such differences include, but are not limited to, those discussed in Dynamics
Researchs Annual Report on Form 10-K for the year ended December 31, 2005 under the section
entitled Risk Factors. Dynamics Research undertakes no obligation to revise or update publicly
any forward-looking statements for any reason.
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
DYNAMICS RESEARCH CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
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March 31, |
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December 31, |
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2006 |
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2005 |
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(unaudited) |
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(audited) |
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Assets |
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Current assets |
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Cash and cash equivalents |
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$ |
2,970 |
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$ |
1,020 |
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Accounts receivable, net of allowances of $567 at March 31, 2006 and
$588 at December 31, 2005 |
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37,988 |
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32,894 |
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Unbilled expenditures and fees on contracts in process |
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52,743 |
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60,210 |
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Prepaid expenses and other current assets |
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2,876 |
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1,483 |
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Total current assets |
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96,577 |
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95,607 |
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Noncurrent assets |
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Property, plant and equipment, net |
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12,523 |
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12,252 |
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Goodwill |
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63,055 |
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63,055 |
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Intangible assets, net |
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7,778 |
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8,480 |
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Other noncurrent assets |
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8,220 |
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8,359 |
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Total noncurrent assets |
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91,576 |
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92,146 |
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Total assets |
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$ |
188,153 |
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$ |
187,753 |
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Liabilities and stockholders equity |
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Current liabilities |
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Current portion of long-term debt |
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$ |
7,857 |
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$ |
10,170 |
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Accounts payable |
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23,807 |
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25,668 |
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Deferred taxes |
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17,855 |
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19,825 |
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Accrued compensation and employee benefits |
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18,109 |
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18,761 |
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Other accrued expenses |
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5,076 |
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6,392 |
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Total current liabilities |
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72,704 |
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80,816 |
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Long-term liabilities |
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Long-term debt, less current portion |
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21,314 |
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15,242 |
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Other long-term liabilities |
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17,490 |
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17,508 |
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Total long-term liabilities |
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38,804 |
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32,750 |
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Total liabilities |
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111,508 |
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113,566 |
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Commitments and contingencies |
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Stockholders equity |
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Preferred stock, $0.10 par value; 5,000,000 shares authorized; no shares
issued and outstanding |
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Common stock, $0.10 par value; 30,000,000 shares authorized;
9,188,867 and 9,096,893 shares issued and outstanding at March 31, 2006
and December 31, 2005, respectively |
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919 |
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910 |
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Capital in excess of par value |
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44,696 |
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45,571 |
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Unearned compensation |
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(1,850 |
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Accumulated other comprehensive loss |
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(10,768 |
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(10,768 |
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Retained earnings |
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41,798 |
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40,324 |
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Total stockholders equity |
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76,645 |
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74,187 |
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Total liabilities and stockholders equity |
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$ |
188,153 |
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$ |
187,753 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
3
DYNAMICS RESEARCH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except share and per share data)
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Three months ended |
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March 31, |
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2006 |
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2005 |
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Contract revenue |
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$ |
66,759 |
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$ |
71,839 |
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Product sales |
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1,454 |
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1,703 |
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Total revenue |
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68,213 |
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73,542 |
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Cost of contract revenue |
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56,945 |
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60,806 |
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Cost of product sales |
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1,298 |
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1,409 |
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Selling, general and administrative expenses |
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6,633 |
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6,021 |
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Amortization of intangible assets |
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702 |
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754 |
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Total operating costs and expenses |
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65,578 |
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68,990 |
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Operating income |
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2,635 |
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4,552 |
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Interest expense, net |
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(569 |
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(1,086 |
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Other income |
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339 |
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25 |
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Income before provision for income taxes |
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2,405 |
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3,491 |
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Provision for income taxes |
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1,015 |
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1,400 |
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Income before cumulative effect of accounting change |
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1,390 |
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2,091 |
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Cumulative
benefit of accounting change, net of income taxes of $62 |
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84 |
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Net income |
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$ |
1,474 |
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$ |
2,091 |
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Earnings per common share |
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Basic |
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Income before cumulative effect of accounting change |
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$ |
0.15 |
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$ |
0.24 |
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Cumulative
benefit of accounting change |
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0.01 |
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Net income |
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$ |
0.16 |
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$ |
0.24 |
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Diluted |
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Income before cumulative effect of accounting change |
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$ |
0.15 |
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$ |
0.23 |
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Cumulative
benefit of accounting change |
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0.01 |
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Net income |
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$ |
0.16 |
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$ |
0.23 |
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Weighted average shares outstanding |
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Basic |
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9,012,706 |
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8,695,638 |
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Diluted |
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9,396,644 |
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9,220,103 |
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The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
4
DYNAMICS RESEARCH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
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Three months ended |
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March 31, |
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2006 |
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2005 |
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Cash flows from operating activities: |
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Net income |
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$ |
1,474 |
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$ |
2,091 |
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Adjustments to reconcile net cash (used in) provided by operating activities |
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Depreciation |
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790 |
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942 |
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Amortization of intangible assets |
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702 |
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754 |
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Stock compensation expense, including cumulative effect of accounting
change |
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441 |
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224 |
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Non-cash interest expense |
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43 |
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49 |
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Investment income from equity interest |
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(44 |
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(55 |
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Tax benefit from stock options exercised |
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90 |
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Deferred income taxes |
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(1,970 |
) |
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(76 |
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Loss on disposal of long-lived assets |
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2 |
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Gain on sale of marketable securities |
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(211 |
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Change in operating assets and liabilities: |
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Accounts receivable, net |
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(5,094 |
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8,688 |
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Unbilled expenditures and fees on contracts in process |
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7,715 |
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(7,041 |
) |
Prepaid expenses and other current assets |
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(1,393 |
) |
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669 |
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Accounts payable |
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(1,861 |
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493 |
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Accrued payroll and employee benefits |
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(652 |
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(2,339 |
) |
Other accrued expenses |
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(1,480 |
) |
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(812 |
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Other long-term liabilities |
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(18 |
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(760 |
) |
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Net cash (used in) provided by continuing operations |
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(1,558 |
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2,919 |
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Net cash used in discontinued operations |
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(158 |
) |
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Net cash (used in) provided by operating activities |
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(1,558 |
) |
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2,761 |
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Cash flows from investing activities: |
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Additions to property, plant and equipment |
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(1,061 |
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(1,218 |
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Purchase of business |
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(111 |
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Proceeds from sale of marketable securities |
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211 |
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Dividends from equity investment |
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2 |
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60 |
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Increase in other assets |
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(110 |
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(125 |
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Net cash used in investing activities |
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(958 |
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(1,394 |
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Cash flow from financing activities: |
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Net borrowings (repayments) under revolving credit agreement |
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8,036 |
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(450 |
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Principal payments under loan agreements |
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(4,277 |
) |
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(2,089 |
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Proceeds from the exercise of stock options and issuance of common stock |
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600 |
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803 |
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Tax benefit from stock options exercised |
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107 |
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Net cash provided by (used in) financing activities |
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4,466 |
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(1,736 |
) |
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Net increase
(decrease) in cash and cash equivalents |
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1,950 |
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(369 |
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Cash and cash equivalents, beginning of period |
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1,020 |
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925 |
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Cash and cash equivalents, end of period |
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$ |
2,970 |
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$ |
556 |
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The
accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
5
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
NOTE 1. BASIS OF PRESENTATION
The
unaudited condensed consolidated financial statements of Dynamics Research Corporation
(DRC or the Company) and its subsidiaries
included herein, have been prepared in accordance with
accounting principles generally accepted in the United States of America. Effective January 1,
2005, the Company operates through the parent corporation and its wholly owned subsidiaries, HJ
Ford Associates, Inc. (HJ Ford) and DRC International Corporation.
The Company has a 40% ownership interest in a small disadvantaged business, as defined by the
United States Government, which is accounted for using the equity method. This ownership interest
is reported as a component of other noncurrent assets in the Companys Consolidated Balance Sheets.
In the opinion of management, all material adjustments that are of a normal and recurring
nature necessary for a fair presentation of the results for the periods presented have been
reflected. All material intercompany transactions and balances have been eliminated in
consolidation. The results of the three month period ended March 31, 2006 may not be indicative of
the results that may be expected for the year ending December 31, 2006. The accompanying financial
information should be read in conjunction with the consolidated financial statements and notes
thereto contained in the Companys Annual Report on Form 10-K, filed with the U.S. Securities and
Exchange Commission for the year ended December 31, 2005.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No.123 (revised 2004), Share-Based Payment (SFAS 123R),
which requires the measurement and recognition of compensation expense based on estimated fair
value for all share-based payment awards including stock options, employee stock purchases under
employee stock purchase plans, non-vested share awards (restricted stock) and stock appreciation
rights. SFAS 123R supersedes the Companys previous accounting under Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). In March 2005, the SEC
issued Staff Accounting Bulletin No. 107, which provides the Staffs views regarding implementation
issues related to SFAS 123R.
The Company adopted the provisions of SFAS 123R using the modified prospective transition
method beginning January 1, 2006, the first day of the first quarter of fiscal 2006. In accordance
with that transition method, the Company has not restated prior periods for the effect of
compensation expense calculated under SFAS 123R. The Company has continued to use the
Black-Scholes option-pricing model as the most appropriate method for determining the estimated
fair value of all our awards. Compensation expense for all share-based equity awards is being
recognized on a straight-line basis over the vesting period of the award. The adoption of SFAS
123R also requires additional accounting related to income taxes and earnings per share as well as
additional disclosure related to the cash flow effects resulting from share-based compensation.
The adoption of SFAS 123R had an unfavorable pre-tax impact of $148,
net of pre-tax cumulative benefit of accounting
change of $146, on the Companys condensed consolidated financial statements for the three months
ended March 31, 2006, and is expected to continue to impact our financial statements in the
foreseeable future. See Note 4, Share-based Compensation for more information on the impact of
the new standard.
NOTE 3. SHAREHOLDERS EQUITY
Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted average number of
shares of common stock outstanding during the period. 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.
Restricted shares of common stock that are subject to the satisfaction of certain conditions
are treated as contingently issuable shares until the conditions are satisfied. These shares are
excluded from the basic earnings per share calculation
and included in the diluted earnings per share calculation.
6
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
Due to their antidilutive effect, approximately 93,000 and 78,000 options to purchase common
stock were excluded from the calculation of diluted earnings per share for the three months ended
March 31, 2006 and 2005, respectively. However, these options could become dilutive in future
periods.
The following table illustrates the reconciliation of the weighted average shares outstanding:
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Three Months Ended |
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March 31, |
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2006 |
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2005 |
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Weighted average shares outstanding Basic |
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|
9,012,706 |
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|
8,695,638 |
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Dilutive effect of stock options and restricted stock grants |
|
|
383,938 |
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524,465 |
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Weighted average shares outstanding Diluted |
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9,396,644 |
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9,220,103 |
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Comprehensive Income
The components of comprehensive income (net of tax) are as follows:
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Three Months Ended |
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|
March 31, |
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2006 |
|
|
2005 |
|
Net income |
|
$ |
1,474 |
|
|
$ |
2,091 |
|
Change in
unrealized gain on investments available for sale |
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|
(412 |
) |
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Comprehensive income |
|
$ |
1,474 |
|
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$ |
1,679 |
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NOTE 4. SHARE-BASED COMPENSATION
Effective January 1, 2006, the Company adopted the provisions of SFAS 123R which require the
measurement and recognition of compensation expense for all share-based payment awards made to our
employees and directors including employee stock option awards, employee stock purchases made under
our Employee Stock Purchase Plan (ESPP) and restricted stock awards based on estimated fair
values. The Company previously applied the provisions of APB No. 25 and related Interpretations and
provided the required pro forma disclosures under SFAS 123, Accounting for Stock-Based
Compensation (SFAS 123). The unearned compensation balance of $1,850 as of December 31, 2005,
which was accounted for under APB 25, was reclassified into capital in excess of par value upon
adoption of FAS 123R.
Pro forma Information for Periods Prior to the Adoption of SFAS 123R
Prior to the adoption of SFAS 123R, the Company provided the disclosures required under SFAS
123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation Transition and
Disclosures. Forfeitures of awards were recognized as they occurred. Previously reported amounts
have not been restated. The pro forma information for the three months ended March 31, 2005 was as follows:
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended |
|
|
|
March 31, |
|
|
|
2005 |
|
Net income, as reported |
|
$ |
2,091 |
|
Add: Share-based employee compensation expense included
in reported net income, net of
related tax effects |
|
|
134 |
|
Deduct: Total share-based employee compensation expense
determined under the fair value
based method for all awards, net of related tax effects |
|
|
(379 |
) |
|
|
|
|
Pro forma net income |
|
$ |
1,846 |
|
|
|
|
|
7
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended |
|
|
|
March 31, |
|
|
|
2005 |
|
Earnings per common share: |
|
|
|
|
As reported: |
|
|
|
|
Basic |
|
$ |
0.24 |
|
Diluted |
|
$ |
0.23 |
|
|
|
|
|
|
Pro forma: |
|
|
|
|
Basic |
|
$ |
0.21 |
|
Diluted |
|
$ |
0.20 |
|
Compensation expense determined under the fair value based methods for all stock-based
awards, pro forma net income and pro forma earnings per common share amounts reflect
revised amounts for previously reported periods reflecting a revised estimate of vesting
period for performance-based stock options.
Impact of the Adoption of SFAS 123R
The Company adopted SFAS 123R using the modified prospective transition method beginning
January 1, 2006. Accordingly, during the three months ended March 31, 2006, the Company recorded
share-based compensation expense for awards granted prior to but not yet vested as of January 1,
2006 as if the fair value method required for pro forma disclosure under SFAS 123 were in effect
for expense recognition purposes adjusted for estimated forfeitures. The Company recorded a
pre-tax cumulative benefit of accounting change of $146 related to estimating forfeitures for
restricted stock awards that were unvested as of January 1, 2006. For share-based awards granted
after January 1, 2006, the Company recognized compensation expense based on the estimated grant
date fair value method required under SFAS 123R. For all awards the Company has recognized
compensation expense using a straight-line amortization method. As SFAS 123R requires that
share-based compensation expense be based on awards that are ultimately expected to vest, estimated
share-based compensation for the three months ended March 31, 2006 has been reduced for estimated
forfeitures.
The
impact on the Companys results of operating income, net income and earnings per share from
the adoption of SFAS 123R for the three months ended March 31, 2006 was as follows:
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
Stock options |
|
$ |
178 |
|
ESPP |
|
|
116 |
|
|
|
|
|
Impact on operating income |
|
|
294 |
|
Cumulative effect of accounting change |
|
|
(146 |
) |
|
|
|
|
Impact after cumulative effect of accounting change |
|
$ |
148 |
|
|
|
|
|
|
|
|
|
|
Impact on net income |
|
$ |
(86 |
) |
|
|
|
|
|
Impact on earnings per common share: |
|
|
|
|
Basic |
|
$ |
(0.01 |
) |
Diluted |
|
$ |
(0.01 |
) |
8
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
Total share-based compensation recorded in the Condensed Consolidated Statements of Operation
for the three months ended March 31, 2006 was as follows:
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
Cost of products and services |
|
$ |
302 |
|
Selling, general and administrative |
|
|
285 |
|
Cumulative effect of accounting change |
|
|
(146 |
) |
|
|
|
|
Total share-based compensation expense |
|
$ |
441 |
|
|
|
|
|
Valuation Assumptions
As of March 31, 2006 and 2005, the fair value of share-based awards for employee stock option
awards and employee stock purchases made under our ESPP was
estimated using the Black-Scholes option pricing model. The following weighted average assumptions
were used:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2006 (1) |
|
|
2005 |
|
Stock Options: |
|
|
|
|
|
|
|
|
Risk-free interest rate |
|
|
|
|
|
|
3.87 |
% |
Dividend yield |
|
|
|
|
|
|
|
|
Volatility |
|
|
|
|
|
|
66.38 |
% |
Expected life in years |
|
|
|
|
|
|
6.5 |
|
|
|
|
|
|
|
|
|
|
ESPP: |
|
|
|
|
|
|
|
|
Risk-free interest rate |
|
|
3.96 |
% |
|
|
1.75 |
% |
Dividend yield |
|
|
|
|
|
|
|
|
Volatility |
|
|
35.07 |
% |
|
|
32.38 |
% |
Expected life in months |
|
|
3.0 |
|
|
|
3.0 |
|
|
|
|
(1) |
|
During the three months ended March 31, 2006, the Company did not grant any stock
option awards. |
Share-Based Payment Award Activity
The following table summarizes equity share-based payment award activity for the three-month
periods ended March 31, 2006 and 2005:
9
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options |
|
|
Restricted Stock |
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Weighted |
|
|
|
Awards |
|
|
Average |
|
|
Awards |
|
|
Average |
|
|
|
Outstanding |
|
|
Exercise Price |
|
|
Outstanding |
|
|
Fair Value |
|
Balance at December 31, 2005 |
|
|
1,239,393 |
|
|
$ |
8.51 |
|
|
|
221,816 |
|
|
$ |
13.60 |
|
Granted |
|
|
|
|
|
$ |
|
|
|
|
52,400 |
|
|
$ |
14.17 |
|
Exercised |
|
|
(28,000 |
) |
|
$ |
6.23 |
|
|
|
(33,008 |
) |
|
$ |
17.35 |
|
Cancelled |
|
|
(28,884 |
) |
|
$ |
10.15 |
|
|
|
(11,934 |
) |
|
$ |
13.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at March 31, 2006 |
|
|
1,182,509 |
|
|
$ |
8.52 |
|
|
|
229,274 |
|
|
$ |
13.17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2004 |
|
|
1,499,105 |
|
|
$ |
8.75 |
|
|
|
192,408 |
|
|
$ |
12.90 |
|
Granted |
|
|
15,000 |
|
|
$ |
18.57 |
|
|
|
75,800 |
|
|
$ |
16.83 |
|
Exercised |
|
|
(48,229 |
) |
|
$ |
7.64 |
|
|
|
(32,104 |
) |
|
$ |
15.42 |
|
Cancelled |
|
|
(4,512 |
) |
|
$ |
17.37 |
|
|
|
(660 |
) |
|
$ |
18.10 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at March 31, 2005 |
|
|
1,461,364 |
|
|
$ |
8.86 |
|
|
|
235,444 |
|
|
$ |
13.81 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Information regarding cash proceeds received, the intrinsic value and the
total tax benefits realized resulting from option exercises was as follows:
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
Amounts realized or received from stock option exercises: |
|
|
|
|
Cash proceeds received |
|
$ |
175 |
|
Intrinsic value realized |
|
$ |
59 |
|
Income tax benefit realized |
|
$ |
96 |
|
For the three months ended March 31, 2006 the total tax benefit realized from
exercised stock options and ESPP was $107, which have been reported as financing cash
inflows in the accompanying condensed consolidated statement of cash flows. As of
March 31, 2006, the total unrecognized compensation cost related to stock options was
$1,559 which is expected to be recognized over a weighted-average period of 1.1 years.
The weighted average grant date fair value of restricted stock awards, as
determined under SFAS 123R, granted during the three months ended March 31, 2006 was
$14.17 per share. The total fair value of restricted shares vested during the three months ended
March 31, 2006 was $573. As of March 31, 2006, the total unrecognized compensation
cost related to restricted stock awards was $2,327 which is expected to be amortized
over a weighted-average period of 1.2 years.
Information regarding outstanding and exercisable stock options as of March 31, 2006,
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
Options Exercisable |
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
Weighted |
|
Average |
|
|
|
|
|
|
|
|
|
Weighted |
|
Average |
|
|
|
|
|
|
|
|
Average |
|
Remaining |
|
|
|
|
|
|
|
|
|
Average |
|
Remaining |
|
|
Range of |
|
Number |
|
Exercise |
|
Contractual |
|
Intrinsic |
|
Number |
|
Exercise |
|
Contractual |
|
Intrinsic |
Exercise Prices |
|
of Options |
|
Price |
|
Life |
|
Value |
|
of Options |
|
Price |
|
Life |
|
Value |
$3.13 $7.50
|
|
|
356,060 |
|
|
$ |
5.16 |
|
|
|
3.36 |
|
|
$ |
3,468 |
|
|
|
356,060 |
|
|
$ |
5.16 |
|
|
|
3.36 |
|
|
$ |
3,468 |
|
$7.51 $13.68
|
|
|
732,073 |
|
|
|
8.90 |
|
|
|
5.02 |
|
|
|
4,394 |
|
|
|
190,406 |
|
|
|
8.75 |
|
|
|
4.58 |
|
|
|
1,171 |
|
$13.69 $18.60
|
|
|
72,376 |
|
|
|
17.16 |
|
|
|
6.73 |
|
|
|
|
|
|
|
49,040 |
|
|
|
17.71 |
|
|
|
5.86 |
|
|
|
|
|
$18.61 $24.50
|
|
|
22,000 |
|
|
|
21.94 |
|
|
|
5.56 |
|
|
|
|
|
|
|
22,000 |
|
|
|
21.94 |
|
|
|
5.56 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,182,509 |
|
|
|
8.52 |
|
|
|
4.64 |
|
|
$ |
7,862 |
|
|
|
617,506 |
|
|
|
7.86 |
|
|
|
4.01 |
|
|
$ |
4,639 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
NOTE 5. SUPPLEMENTAL BALANCE SHEET INFORMATION
The composition of selected balance sheet accounts is as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Property, plant and equipment, net: |
|
|
|
|
|
|
|
|
Machinery and equipment |
|
$ |
32,109 |
|
|
$ |
31,307 |
|
Leasehold improvements |
|
|
1,269 |
|
|
|
1,011 |
|
|
|
|
|
|
|
|
Property, plant and equipment |
|
|
33,378 |
|
|
|
32,318 |
|
Less accumulated depreciation |
|
|
(20,855 |
) |
|
|
(20,066 |
) |
|
|
|
|
|
|
|
Property, plant and equipment, net |
|
$ |
12,523 |
|
|
$ |
12,252 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other noncurrent assets: |
|
|
|
|
|
|
|
|
Deferred tax asset |
|
$ |
3,916 |
|
|
$ |
3,916 |
|
Unbilled expenditures and fees on contracts in process |
|
|
1,301 |
|
|
|
1,549 |
|
Equity investment |
|
|
761 |
|
|
|
719 |
|
Other |
|
|
2,242 |
|
|
|
2,175 |
|
|
|
|
|
|
|
|
Other noncurrent assets |
|
$ |
8,220 |
|
|
$ |
8,359 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued compensation and employee benefits: |
|
|
|
|
|
|
|
|
Accrued pension liability |
|
$ |
5,220 |
|
|
$ |
5,818 |
|
Accrued vacation |
|
|
5,464 |
|
|
|
4,705 |
|
Other |
|
|
7,425 |
|
|
|
8,238 |
|
|
|
|
|
|
|
|
Accrued compensation and employee benefits |
|
$ |
18,109 |
|
|
$ |
18,761 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other accrued expenses: |
|
|
|
|
|
|
|
|
Accrued income taxes |
|
$ |
2,157 |
|
|
$ |
2,433 |
|
Other |
|
|
2,919 |
|
|
|
3,959 |
|
|
|
|
|
|
|
|
Other accrued expenses |
|
$ |
5,076 |
|
|
$ |
6,392 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Other long-term liabilities: |
|
|
|
|
|
|
|
|
Deferred gain on sale of building |
|
$ |
5,914 |
|
|
$ |
6,158 |
|
Accrued pension liability |
|
|
6,106 |
|
|
|
5,328 |
|
Other |
|
|
5,470 |
|
|
|
6,022 |
|
|
|
|
|
|
|
|
Other long-term liabilities |
|
$ |
17,490 |
|
|
$ |
17,508 |
|
|
|
|
|
|
|
|
NOTE 6. INVESTMENTS AVAILABLE FOR SALE
At December 31, 2005, 74,724 Lucent Technologies (Lucent) shares were held in escrow for
indemnification related to Lucents 2004 acquisition of Telica, Inc, which the Company obtained an
ownership interest in prior to the Lucents acquisition. 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 shares. During the first quarter of 2006, the shares held in escrow were released
to the Company. The Company subsequently sold all of the shares during the first quarter of 2006
and realized a gain of $211 included in other income in the
Companys Condensed Consolidated Statement of
Operations.
NOTE 7. GOODWILL AND INTANGIBLE ASSETS
Components of the Companys identifiable intangible assets are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2006 |
|
|
December 31, 2005 |
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
Accumulated |
|
|
|
Cost |
|
|
Amortization |
|
|
Cost |
|
|
Amortization |
|
Customer relationships |
|
$ |
12,800 |
|
|
$ |
(5,022 |
) |
|
$ |
14,200 |
|
|
$ |
(5,720 |
) |
Non-competition agreements |
|
|
|
|
|
|
|
|
|
|
1,740 |
|
|
|
(1,740 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
12,800 |
|
|
$ |
(5,022 |
) |
|
$ |
15,940 |
|
|
$ |
(7,460 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
During the first quarter of 2006, the Company wrote-off $3,140 of fully amortized intangible
assets that no longer had value to the Company. The Company recorded amortization expense for its
identifiable intangible assets of $702 and $754 for the three months March 31, 2006 and 2005,
respectively. Estimated amortization expense on the Companys identifiable intangible assets for
the remaining four fiscal years is as follows:
|
|
|
|
|
Remainder of 2006 |
|
$ |
2,107 |
|
2007 |
|
$ |
2,602 |
|
2008 |
|
$ |
2,038 |
|
2009 |
|
$ |
1,031 |
|
There were no changes in the carrying amount of goodwill for the three months ended March 31,
2006. The carrying amount of goodwill of $63,055 at March 31, 2006 and December 31, 2005 was
included in the Systems and Services segment.
NOTE 8. INCOME TAXES
For the quarter ended March 31, 2006, the effective income tax rate was 42.2% compared to 40.5%
for the year ended December 31, 2005. The
increase in the 2006 tax rate reflects the implementation of SFAS 123R for certain stock awards, a
lower state investment tax credit, a lower overall state effective tax rate due to the recently
implemented State of Ohio Commercial Activity Tax, but a higher graduated federal tax rate on
anticipated higher taxable profit. The deferred taxes on unbilled receivables totaled approximately
$17 million compared to $19 million at December 31, 2005. In the third quarter of 2005, the audits
of the Companys 2002 and 2003 federal income tax returns were settled, and the Internal Revenue
Service initiated an audit of the Companys 2004 income tax return. Under the terms of the 2002
and 2003 settlement, the Company agreed to change its tax accounting method to reflect certain
unbilled costs and fees in current period taxable income. The settlement also included an
agreement to apply the resulting adjustment of $16.8 million to taxable income over a four-year
period. The Company made payments in the first quarter of 2006 of approximately $1.2 million,
which were the actual federal and state taxes due on the
11
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
2003 installment. The 2004 installment
was included in the Companys 2004 tax filings in September 2005. Remaining payments, which total approximately $3.4 million, will be included in the
Companys tax filings for 2005 and 2006. Interest expense of $0.1 million related to the
settlement was accrued as of December 31, 2005 and paid in the first quarter of 2006. There were
no penalties related to the settlement.
NOTE 9. DEFINED BENEFIT PENSION PLAN
The components of net periodic benefit cost for the Companys defined benefit pension plan are
below:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
|
2005 |
|
Interest cost |
|
$ |
1,002 |
|
|
$ |
997 |
|
Expected return on plan assets |
|
|
(1,262 |
) |
|
|
(1,083 |
) |
Recognized acturial loss |
|
|
440 |
|
|
|
396 |
|
|
|
|
|
|
|
|
Net periodic benefit cost |
|
$ |
180 |
|
|
$ |
310 |
|
|
|
|
|
|
|
|
The Companys defined benefit pension plan is frozen. No credit is earned for current service
and no new participants are eligible to enter the plan; accordingly, the net periodic benefit costs
do not include any charges for service cost. The Company currently
expects to contribute approximately $5,200 in 2006 to fund its
pension plan.
NOTE 10. FINANCING ARRANGEMENTS
During the first quarter of 2006, the Company borrowed against its revolving credit facility
for general corporate purposes. Effective March 31, 2006, the Company entered into an amendment to
the September 1, 2004 secured financing agreement (facility) which released the bank groups
security interest in the assets of the Company. The September 1, 2004 facility, as amended, is now
an unsecured financing agreement. The Companys outstanding debt was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding |
|
|
Interest |
|
|
|
|
|
|
Principal |
|
|
Rate |
|
|
Interest Rate Option and Election Date |
|
March 31, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition term loan |
|
$ |
10,567 |
|
|
|
6.43 |
% |
|
90-day LIBOR Rate option elected on February 1, 2006 |
Acquisition term loan |
|
|
5,284 |
|
|
|
6.38 |
% |
|
60-day LIBOR Rate option elected on February 1, 2006 |
Acquisition term loan |
|
|
5,284 |
|
|
|
6.49 |
% |
|
60-day LIBOR Rate option elected on March 3, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
Total acquisition term loan |
|
|
21,135 |
|
|
|
|
|
|
|
|
|
Revolver |
|
|
8,036 |
|
|
|
7.75 |
% |
|
Base Rate option elected on March 31, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
Total Debt |
|
|
29,171 |
|
|
|
|
|
|
|
|
|
Less: Current portion of long-term debt |
|
|
(7,857 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt |
|
$ |
21,314 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition term loan |
|
$ |
23,100 |
|
|
|
6.17 |
% |
|
180-day LIBOR Rate option elected on August 1, 2005 |
Acquisition term loan |
|
|
2,312 |
|
|
|
7.25 |
% |
|
Base Rate option elected on December 30, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
Total Debt |
|
|
25,412 |
|
|
|
|
|
|
|
|
|
Less: Current portion of long-term debt |
|
|
(10,170 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt |
|
$ |
15,242 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
NOTE 11. BUSINESS SEGMENT, MAJOR CUSTOMERS AND RELATED PARTY INFORMATION
Business Segment
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 is comprised of two operating groups that provide similar
services and solutions and are 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.
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.
Results of operations information for the Companys business are as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
|
2005 |
|
Revenues from external customers |
|
|
|
|
|
|
|
|
Systems and Services |
|
$ |
66,759 |
|
|
$ |
71,839 |
|
Metrigraphics |
|
|
1,454 |
|
|
|
1,703 |
|
|
|
|
|
|
|
|
|
|
$ |
68,213 |
|
|
$ |
73,542 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
|
|
|
|
|
|
Systems and Services |
|
$ |
9,814 |
|
|
$ |
11,033 |
|
Metrigraphics |
|
|
156 |
|
|
|
294 |
|
|
|
|
|
|
|
|
|
|
$ |
9,970 |
|
|
$ |
11,327 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income |
|
|
|
|
|
|
|
|
Systems and Services |
|
$ |
2,760 |
|
|
$ |
4,550 |
|
Metrigraphics |
|
|
(125 |
) |
|
|
2 |
|
|
|
|
|
|
|
|
|
|
$ |
2,635 |
|
|
$ |
4,552 |
|
|
|
|
|
|
|
|
Major Customers
Revenues from Department of Defense (DoD) customers accounted for approximately 81% and 76%
of total revenues in the three months ended March 31, 2006 and 2005, respectively. Revenues earned
from two significant DoD customers and related accounts receivable are as follows:
13
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
Accounts Receivable |
|
|
2006 |
|
2005 |
|
March 31, |
|
December 31, |
|
|
Revenue |
|
% |
|
Revenue |
|
% |
|
2006 |
|
2005 |
Customer A |
|
$ |
11,971 |
|
|
|
18 |
% |
|
$ |
10,855 |
|
|
|
15 |
% |
|
$ |
4,167 |
|
|
$ |
4,740 |
|
Customer B |
|
$ |
5,347 |
|
|
|
8 |
% |
|
$ |
7,711 |
|
|
|
10 |
% |
|
$ |
3,750 |
|
|
$ |
1,770 |
|
The Company had no other customer in the first quarter of either 2006 or 2005 that accounted
for more than 10% of revenues.
Related Party
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 Companys 2002 acquisition of HJ Ford.
Accordingly, HMR Tech is considered a related party for all periods subsequent to the acquisition
date. Revenues from HMR Tech for the three months ended March 31, 2006 and 2005 were $90 and $240,
respectively. The amounts due from HMR Tech included in accounts receivable at March 31, 2006 and
December 31, 2005, were $28 and $1, respectively.
NOTE 12. COMMITMENTS AND CONTINGENCIES
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 Government Accountability Office, the
Department of Justice and Congressional Committees. Both related to and unrelated to its defense
industry involvement, the Company is, from time to time, involved in audits, lawsuits, claims,
administrative proceedings and investigations. 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. Except as noted below, the Company does not presently believe it is reasonably likely
that any of these matters would have a material adverse effect on the Companys business, financial
position, results of operations or cash flows. The Companys 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 Companys
business, financial position, results of operations and cash flows.
On October 26, 2000, two former Company employees were indicted and charged with conspiracy to
defraud the United States Air Force, 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 filed a
civil complaint in the United States District Court for the District of Massachusetts against the
Company based in substantial part upon the actions and omissions of the former employees 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 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. The United States Attorney 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 party, if unfavorable, could have a material adverse effect on the
Companys business, financial position, results of operations and 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
14
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
effect on the Companys
business, financial position, results of operations and cash flows.
On June 28, 2005, a suit, characterized as a class action employee suit, was filed in the U.S.
Federal Court for the District of Massachusetts alleging violations of the Fair Labor Standards Act
and certain provisions of Massachusetts General Laws. The Company believes that its practices
comply with the Fair Labor Standards Act and Massachusetts General Laws. The Company intends to
vigorously defend itself and has sought to have the complaint dismissed from Federal Court and
addressed in accordance with the Companys mandatory Dispute Resolution Program for the arbitration
of workplace complaints. On April 10, 2006, the U.S. Federal Court for the District of
Massachusetts entered an order granting in part the Companys motion to dismiss the civil action
filed in that court against the Company, and to compel compliance with its mandatory Dispute
Resolution Program. The Company intends to appeal a portion of the courts decision to the effect
that a class action waiver set forth in the dispute resolution program is not enforceable. The
outcome of this litigation, if unfavorable, could have a material adverse effect on the Companys
business, financial position, results of operations and cash flows.
15
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our condensed consolidated
financial statements and the related notes.
Overview
DRC, founded in 1955 and headquartered in Andover, Massachusetts, provides information
technology (IT), engineering and other services focused on national defense and intelligence,
public safety and citizen services for government customers. The government market is composed of
three sectors: national defense and intelligence, federal civilian agencies, and state and local
governments. The Companys core capabilities are focused on information technology, engineering
and technical subject matter expertise that pertain to the knowledge domains of the Companys core
customers.
According to a report published by Input, Inc., 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 $59.0 billion in fiscal 2005 to $78.6 billion in fiscal
2010, a compound annual growth rate of 5.9%. The Fiscal Year 2006 Mid-Session Review of the
Federal Budget, submitted to Congress by the U.S. Office of Management and Budget, shows the
fiscal 2006 discretionary budgets for national defense of $419.3 billion, an increase of
approximately 5% from fiscal year 2005. In the state and local government sector, Datamonitor, an
independent market analysis company, estimates state and local technology spending will grow from
a combined $55 billion in fiscal 2004 to $62 billion in fiscal 2009.
Effective January 1, 2006, the Company adopted the provisions of Statement of Financial
Accounting Standards No.123 (revised 2004), Share-Based Payment (SFAS 123R) using the modified
prospective transition method. In accordance with that transition method, the Company has not
restated prior periods for the effect of compensation expense calculated under SFAS 123R. The
Company has continued to use the Black-Scholes option-pricing model as the most appropriate method
for determining the estimated fair value of all our awards. Compensation expense for all
share-based equity awards is being recognized on a straight-line basis over the vesting period of
the award. The adoption of SFAS 123R had an impact of $0.1 million, net of cumulative effect of
accounting change of $0.1 million. The Company estimates SFAS 123R expense to be approximately $0.3
million in the second quarter of 2006 and approximately $1.1 million for fiscal year 2006. During
the first quarter of 2006, total share-based compensation was $0.4 million, compared to $0.2
million in the same period in 2005 which only included share-based compensation for restricted
stock awards. As of March 31, 2006, the total unrecognized
compensation cost related to stock options was $1.6 million
which is expected to be recognized over a weighted-average period of
1.1 years and the total unrecognized compensation cost related
to restricted stock awards was $2.3 million which is expected to
be amortized over a weighted-average period of 1.2 years.
Operating income for the first quarter of 2006 was $2.6 million compared to $4.6 million for
the same period in 2005. The operating margin for the first quarter of 2006 was 3.9% of total
revenue, compared to 6.2% of total revenue for the same period in 2005. The decline in operating
income was primarily due to a decline in revenue, costs associated with the adoption of SFAS 123R,
higher costs associated with business development and bid and proposal activities and increased
legal fees. The Company entered the year 2006 expecting improvement in the government fiscal
climate, the timeliness of awards and funding. The Company has not
yet seen this improvement. The
revenues we generated did not cover the additional business development investments made during
the quarter. This situation has been addressed and the necessary management actions are being
taken to bring indirect spending back in line with our current revenue projections for the
upcoming quarter and balance of the year 2006. On May 1, 2006,
the Company was notified that the current contract
coverage with the Air National Guard would expire in May. While the
Company anticipates that follow on
work will be funded at some point, the timing and outcome are uncertain. The Company has decided not to
continue with unfunded services. Revenue recorded under this contract for fiscal year 2005 was
$15.0 million and $4.5 million for the quarter ended March 31, 2006. The second quarter operating
income will be reduced by approximately $2.0 million by the expenses related to our indirect cost
reduction actions and by the change in expectations with the Air National Guard program.
The Company has two reportable business segments: Systems and Services, and Metrigraphics.
The Systems and Services segment accounted for 97.9% of total revenue and the Metrigraphics segment
accounted for 2.1% of total revenue in the first quarter of 2006.
16
Results of Operations
Operating results expressed as a percentage of segment and total revenue are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2006 |
|
|
2005 |
|
|
|
$ millions |
|
|
% |
|
|
$ millions |
|
|
% |
|
Contract revenue |
|
$ |
66.8 |
|
|
|
97.9 |
% |
|
$ |
71.8 |
|
|
|
97.7 |
% |
Product sales |
|
|
1.5 |
|
|
|
2.1 |
% |
|
|
1.7 |
|
|
|
2.3 |
% |
Total revenue |
|
$ |
68.2 |
|
|
|
100.0 |
% |
|
$ |
73.5 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit on contract revenue (1) |
|
$ |
9.8 |
|
|
|
14.7 |
% |
|
$ |
11.0 |
|
|
|
15.4 |
% |
Gross profit on product sales (1) |
|
|
0.2 |
|
|
|
10.7 |
% |
|
|
0.3 |
|
|
|
17.3 |
% |
Total gross profit (1) |
|
$ |
10.0 |
|
|
|
14.6 |
% |
|
$ |
11.3 |
|
|
|
15.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling general and administrative |
|
$ |
6.6 |
|
|
|
9.7 |
% |
|
$ |
6.0 |
|
|
|
8.2 |
% |
Amortization of intangible assets |
|
$ |
0.7 |
|
|
|
1.0 |
% |
|
$ |
0.8 |
|
|
|
1.0 |
% |
Operating income |
|
$ |
2.6 |
|
|
|
3.9 |
% |
|
$ |
4.6 |
|
|
|
6.2 |
% |
Interest expense, net |
|
$ |
(0.6 |
) |
|
|
(0.8 |
)% |
|
$ |
(1.1 |
) |
|
|
(1.5 |
)% |
Other income, net |
|
$ |
0.3 |
|
|
|
0.5 |
% |
|
$ |
|
|
|
|
0.0 |
% |
Provision for income taxes |
|
$ |
(1.0 |
) |
|
|
(1.5 |
)% |
|
$ |
(1.4 |
) |
|
|
(1.9 |
)% |
Net income |
|
$ |
1.5 |
|
|
|
2.2 |
% |
|
$ |
2.1 |
|
|
|
2.8 |
% |
|
|
|
(1) |
|
These amounts represent a percentage of contract revenues, product sales and total revenues, respectively. |
Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005
Revenues
The Company reported total revenues of $68.2 million and $73.5 million in the first quarters
of 2006 and 2005, respectively. The revenues for the first quarter of 2006 represent a decrease
of $5.3 million, or 7.2%, from the same period in 2005.
Contract Revenues
Contract revenues in the Companys Systems and Services segment represent 97.9% and 97.7% of
total revenues
in the first quarter of 2006 and 2005, respectively. Systems and Services revenues were
$66.8 million and $71.8 million in the first quarter of 2006 and 2005, respectively. The
Companys Systems and Services revenues were earned from the following sectors (in millions):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
|
2005 |
|
National defense and intelligence agencies |
|
$ |
55.0 |
|
|
$ |
56.0 |
|
Federal civilian agencies |
|
|
7.3 |
|
|
|
9.2 |
|
State and local government agencies |
|
|
4.3 |
|
|
|
5.7 |
|
Other |
|
|
0.2 |
|
|
|
0.9 |
|
|
|
|
|
|
|
|
|
|
$ |
66.8 |
|
|
$ |
71.8 |
|
|
|
|
|
|
|
|
The decrease in revenues from the defense and intelligence agencies in the current year was
primarily attributable to lower revenues from the Navy Strategic Systems Program. The decrease in
revenues from the federal civilian agencies
17
was primarily due to the loss of the Office of the
Assistant Secretary of Defense for Public Affairs re-competition which contributed approximately
$2 million in revenue per quarter in 2005. Revenues from state and local government agencies
decreased primarily due to the Companys contract with the State
of Ohio which a significant portion of the development work under the
contract has been completed.
The Companys contracts with the Aeronautical Systems Center (ASC) and the Air Force
Electronic Systems Center (ESC) provided approximately $12.0 million and $5.3 million,
respectively, of revenues in the first quarter of 2006, and $10.9 million and $7.7 million,
respectively, of revenues in the first quarter of 2005.
The services provided under the ASC/Blanket Purchase Agreement were subject to re-competition
in 2005 as the Consolidated Acquisition of Professional Services (CAPS) contract. The
competition for prime contract awards was restricted to small businesses. The Company
participated in the competition through HJ Ford, its wholly owned subsidiary. HJ Ford along with
HMR Tech has formed a small business joint venture for this competition. HJ Ford and HMR Tech are
participants in the U.S. Small Business Administration Mentor Protégé program. During the second
quarter of 2006, the joint venture was awarded the CAPS contract. The Company anticipates that a
successful transition to CAPS via the joint venture will enable DRC to retain and preserve profits
on substantially its entire labor base currently supporting these customers. The Company derived
approximately $24 million of annual revenues from work performed by subcontractors under the
Companys prime contract with the ASC. Upon completion of the transition of task orders from the
current contract to the new CAPS contract, it is anticipated that the Companys current
subcontractors would contract directly with the joint venture prime contractor entity. As a
result it is estimated that upon the completion of the task order transitions, the Companys
annual revenue will be reduced by approximately $24 million while positively affecting the profit
margin of the remaining revenue.
The services provided under the ESC contract were originally scheduled for re-competition in
2005. The re-competition was delayed and it is currently anticipated that the competition for a
portion of the work to be performed for ESC will be full-and-open to all qualified contractors and
the competition for the remainder of the work will be restricted to small businesses. It is now
anticipated that the government contract award and initial task order transitions will occur in
late 2006. The Company expects to participate in the competition primarily as a sub-contractor to
a qualified small business and that a successful re-competition would enable DRC to retain and
preserve profits on substantially its entire labor base currently
supporting these customers, and also increase profit margins. The full year revenue impact
of moving from a prime
contractor to a sub-contractor role is anticipated to be an approximate $11 million revenue
reduction. There can be no assurance that the Company will be successful in receiving the ESC
contract award.
Revenues by contract type as a percentage of Systems and Services revenues were as follows (in
millions):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, |
|
|
2006 |
|
2005 |
Time and materials |
|
|
61 |
% |
|
|
55 |
% |
Cost reimbursable |
|
|
21 |
% |
|
|
20 |
% |
Fixed price, including service type contracts |
|
|
18 |
% |
|
|
25 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
100 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime contract |
|
|
67 |
% |
|
|
70 |
% |
Sub-contact |
|
|
33 |
% |
|
|
30 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
100 |
% |
|
|
100 |
% |
|
|
|
|
|
|
|
|
|
Product Sales
Product sales for the Companys Metrigraphics segment represent 2.1% and 2.3% of total
revenues in the first quarter of 2006 and 2005, respectively. Metrigraphics sales were $1.5
million and $1.7 million in the first quarter of 2006 and 2005, respectively. The decrease of
$0.2 million, or 14.6%, in the first quarter of 2006, compared to the same period in 2005 was
primarily due to a temporary reduction in orders from a customer who is automating its processes.
The reduced level of orders is expected to continue through the
second quarter of 2006 and then return
to prior levels
18
thereafter.
Funded backlog
The Companys funded backlog was $144.2 million at March 31, 2006, $144.6 million at December
31, 2005 and $186.3 million at March 31, 2005. The Company expects that substantially all of its
backlog will generate revenue during the subsequent twelve month period.
The funded backlog generally is subject to possible termination at the convenience of the
contracting party. A portion of the Companys funded 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
The Companys total gross profit was $10.0 million, compared to $11.3 million in the same
period in 2005, resulting in a gross margin of 14.6% and 15.4% for the first quarters of 2006 and
2005, respectively.
The Companys gross profit on contract revenue was $9.8 million and $11.0 million for the
first quarter of 2006 and 2005, respectively. The decline in gross profit was primarily
attributable to a decline in revenue, share-based compensation costs and other increases in
indirect costs including costs associated with business development efforts. The decline in gross
margin to 14.7% in the first quarter of 2006 from 15.4% in the first quarter of 2005 resulted from
the share-based compensation costs, increased indirect costs and change in mix of contracts from
prime to sub-contractor.
The Companys gross profit on product sales was $0.2 million and $0.3 million for the first
quarter of 2006 and 2005, respectively. The slight decline in gross profit was primarily
attributable to lower level of orders. This resulted in a decline in
gross margin to 10.7% in the
first quarter of 2006 from 17.3% in the same period in 2005.
Selling, general and administrative expenses
The Companys total selling, general and administrative expenses were $6.6 million and $6.0
million in the first quarter of 2006 and 2005, respectively. Selling, general and administrative
expenses as a percent of total revenue in
the first quarter of 2006 was 9.7%, compared to 8.2% for the same period in 2005. Selling,
general and administrative expenses included charges of $0.3 million and $0.2 million for the
first quarter of 2006 and 2005, respectively, which were related to share-based compensation
expenses. The increase in selling, general and administrative expenses also included spending
associated with higher anticipated revenue than achieved in 2006. The Company
is currently reviewing its costs structure to reduce such spending.
Amortization of intangible assets
Amortization expense was $0.7 million and $0.8 million in the first quarter of 2006 and 2005,
respectively. Amortization expense relates to intangible assets acquired in the Companys 2004
acquisition of Impact Innovations Group LLC and is included in the Systems and Services segment.
The remaining amortization expense for the current fiscal year will
be approximately $2.1 million.
Interest expense, net
The Company incurred interest expense of $0.6 million and $1.1 million in the first quarter
of 2006 and 2005, respectively. The decrease in interest expense in 2006 was primarily due to
lower average borrowings. An increase in one percentage point in the Companys rates would result
in approximately $0.3 million of additional interest expense on an annual basis. Interest income
in the first quarters of 2006 and 2005 was immaterial.
Other income, net
The Company recorded net other income of $0.3 million in the first quarter of 2006. Included
in this amount was
19
income of
$0.2 million related to the sale of Lucent shares during the first
quarter of 2006.
Income tax provision
The Company recorded income tax provisions of $1.0 million, or 42.2% of pre-tax income, and
$1.4 million, or 40.1% of pre-tax income, in the first three months of 2006 and 2005,
respectively. The increase in the 2006 tax rate reflects the implementation of SFAS 123R for
certain stock awards, a lower state investment tax credit, a lower overall state effective tax
rate due to the recently implemented State of Ohio Commercial Activity Tax, but a higher
graduated federal tax rate on anticipated higher taxable profits. The 2006 rate increased from
the 2005 full year-end rate of 40.5%.
Net income
The Companys net income was $1.5 million and $2.1 million in the first quarter of 2006 and
2005, respectively. Net income as a percent of total revenue in the first quarter of 2006 was
2.2%, compared to 2.8% of total revenue in the same period in 2005.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2006 and December 31, 2005, the Company had cash and cash equivalents
aggregating $3.0 million and $1.0 million, respectively. The increase in cash and cash
equivalents is primarily the result of $4.5 million of net cash provided by financing activities,
including $8.0 million of net borrowings under the revolving credit, partially offset by $4.3
million of principal payments under the acquisition term loan. The net cash provided by financing
activities was partially offset by $1.6 million and $1.0 million of net cash used in operating
activities and investing activities, respectively.
Operating activities
Cash
used in operating activities totaled $1.6 million for the three months ended March 31,
2006, and is primarily attributable to cash used of $5.1 million for accounts receivable, $2.0
million for deferred taxes, $1.9 million for accounts payable, $1.5 million for accrued expenses
and $1.4 million for prepaid expenses. These amounts were partially offset by cash provided of
$7.7 million for unbilled expenditures during the first quarter of 2006.
Total accounts receivable and current and noncurrent unbilled expenditures and fees on
contracts in process were $92.0 million and $94.7 million at March 31, 2006 and December 31, 2005,
respectively. Billed accounts receivable increased $5.1 million in the first quarter of 2006,
while unbilled amounts decreased $7.7 million in the aggregate. Total accounts receivable
(including unbilled amounts) days sales outstanding, or DSO, was 121 days at March 31, 2006 and
119 days at December 31, 2005.
The increase in billed receivables was due primarily to the timing of billings which occurred
in the latter half of the first quarter of 2006. The decline in unbilled amounts was due to
achieving certain fixed price contract milestone levels and receipt of funding allowing the
Company to issue invoices. The decline also was affected by the decline in revenues from the
fourth quarter of 2005.
At March 31, 2006, the unbilled receivables balance includes $13.6 million related to the
Companys contract with the State of Ohio. Under the current terms of the contract, invoicing did
not begin until 2005 in accordance with anticipated completion of contract milestones.
At March 31, 2006, deferred taxes on unbilled receivables totaled approximately $17 million
compared to approximately $19 million at December 31, 2005. In the third quarter of 2005, the
audits of the Companys 2002 and 2003 federal income tax returns were settled, and the IRS
initiated an audit of the Companys 2004 income tax return. Under the terms of the 2002 and 2003
settlement, the Company agreed to change its tax accounting method to reflect certain unbilled
costs and fees in current period taxable income. The settlement also included an agreement to
apply the resulting adjustment of $16.8 million to taxable income over a four-year period. The
Company made a payment in the first quarter of 2006 of approximately
$1.2 million, which were the actual federal and state taxes due
on the 2003 installment. The 2004 installment was included in the Companys
2004 tax filings in September 2005. Remaining payments, which total approximately $3.4 million,
will be included in the Companys tax filings for 2005 and 2006. Interest expense of $0.1
20
million
related to the settlement was accrued as of December 31, 2005 and paid in the first quarter of
2006. There were no penalties related to the settlement. The Company anticipates estimated tax
payments of approximately $14 million in 2006, of which
$3.0 million was paid through March 31, 2006.
Stock compensation expense increased to $0.4 million in the first quarter of 2006, from $0.2
million in the same period last year. The Company adopted the provisions of SFAS 123R beginning
January 1, 2006, the first day of the first quarter of fiscal
2006. The Company estimates total
share-based compensation expense to be approximately $0.6 million in the second quarter of 2006
and approximately $2.3 million for fiscal year 2006.
Non-cash amortization expense of the Companys acquired intangible assets was $0.7 million
and $0.8 million in the first quarters of 2006 and 2005, respectively. The Company anticipates
that non-cash expense for the amortization of intangible assets will remain at this quarterly
level throughout 2006.
Investing activities
Net cash used in investing activities was $1.0 million in the first quarter of 2006. The net
cash used primarily comprised of capital expenditures aggregating $1.1 million, partially offset
by $0.2 million of proceeds from the sale of Lucent shares. The Companys capital expenditures,
excluding business acquisitions, if any, are expected to approximate $4 million in 2006.
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 Companys core capabilities and which complement the Companys 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, described below, as a source of
financing.
Financing activities
Net
cash provided by financing activities was $4.5 million in the first quarter of 2006.
This amount represents $8.0 million of net borrowings under the revolving credit agreement and
$0.6 million of proceeds from the issuance of
common stock through the exercises of stock options and employee stock purchase plan,
partially offset by principal payments under the acquisition term loan of $4.3 million.
During the first quarter of 2006, the Company borrowed against its revolving credit facility
for general corporate purposes. The average daily borrowing for the first quarter was $7.4
million at a weighted average interest rate of 7.42%. At March 31, 2006, the outstanding balance
of the revolver was $8.0 million with an interest rate of 7.75%.
During the first quarter of 2006, the Company made payments on its acquisition term loan
which included $4.3 million of principal payments. The remaining scheduled principal payments for
the current fiscal year will be approximately $5.9 million. Effective March 31, 2006, the Company
entered into an amendment to the September 1, 2004 secured financing agreement (facility) which
released the bank groups security interest in the assets of the Company. The September 1, 2004
facility, as amended, is now an unsecured financing agreement.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS
123R), which requires the measurement and recognition of compensation expense based on estimated
fair value for all share-based payment awards including stock options, employee stock purchases
under employee stock purchase plans, non-vested share awards (restricted stock) and stock
appreciation rights. SFAS 123R supersedes the Companys previous accounting under Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). In March
2005, the SEC issued Staff Accounting Bulletin No. 107, which provides the Staffs views regarding
implementation issues related to SFAS 123R.
The Company adopted the provisions of SFAS 123R using the modified prospective transition
method beginning January 1, 2006, the first day of the first quarter of fiscal 2006. In accordance
with that transition method, the Company
21
has not restated prior periods for the effect of
compensation expense calculated under SFAS 123R. The Company has continued to use the
Black-Scholes option-pricing model as the most appropriate method for determining the estimated
fair value of all our awards. Compensation expense for all share-based equity awards is being
recognized on a straight-line basis over the vesting period of the award. The adoption of SFAS
123R also requires additional accounting related to income taxes and earnings per share as well as
additional disclosure related to the cash flow effects resulting from share-based compensation.
The adoption of SFAS 123R had an unfavorable pre-tax impact of $148,
net of a pre-tax
cumulative benefit of accounting change of
$146, on the Companys condensed consolidated financial statements for the three months ended March
31, 2006, and is expected to continue to impact our financial statements in the foreseeable future.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to interest rate risk associated with our acquisition term loan and
revolver, where interest payments are tied to either the LIBOR or prime rate. The average
interest rate on the acquisition term loan under three LIBOR borrowings was 6.48% at March 31,
2006. The interest rate on the revolver was 7.75% at March 31, 2006, under the Base Rate option.
At any time, a modest rise in interest rates could have an adverse effect on net income as
reported in the Companys Consolidated Statements of Operations. An increase of one full
percentage point in the interest rate on the Companys acquisition term loan, term loan and
revolver would result in increases in annual interest expense aggregating $0.3 million.
The Company presently has no investments in debt securities 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.
Item 4. 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 Quarterly Report on Form 10-Q, 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 SECs rules and forms.
22
PART II. OTHER INFORMATION
Item 1. 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 Government Accountability Office, the
Department of Justice and congressional committees. Both related to and unrelated to its
defense industry involvement, the company is, from time to time, involved in audits, lawsuits,
claims, administrative proceedings and investigations. 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 is a party to or has property
subject to litigation and other proceedings referenced in Note 12 COMITTMENTS AND
CONTINGENCIES of the Notes to Condensed Consolidated Financial Statements (Unaudited) included
in this Form 10-Q and in the Companys Annual Report on Form 10-K for the year ended December
31, 2005. Except as noted therein the company does not presently believe it is reasonably
likely that any of these matters would have a material adverse effect on the companys
business, financial position, results of operations or cash flows. The companys 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 companys business, financial position, results of operations and cash flows
See the Legal Proceedings section of the Companys Annual Report on Form 10-K for the year
ended December 31, 2005 for a detailed description of previously reported actions.
Item 1A. RISK FACTORS
The Risk Factors included in the Companys Annual Report on Form 10-K for the fiscal year
ended December 31, 2005 have not materially changed other than as set forth below. The
information presented below updates and should be read in conjunction with the Risk Factors
included in the Companys Annual Report on Form 10-K.
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
Companys customers. These regulations require more frequent review and certification of small
business contractor status, so as to ensure that companies competing for contracts intended for
small business are qualified as such at the time of the competition.
The Companys contracts with the Aeronautical Systems Center (ASC), the Air Force Electronic
Systems Center (ESC) and the Internal Revenue Service (IRS), which provided approximately $49
million, $30 million and $10 million, respectively, of revenues in the year 2005, and approximately
$47 million, $31 million and $12 million, respectively, of revenues in the year 2004, were subject
to re-competition in 2005.
The services provided under the ASC/Blanket Purchase Agreement were subject to re-competition
in 2005 as the Consolidated Acquisition of Professional Services (CAPS) contract. The competition
for prime contract awards was restricted to small businesses. The Company participated in the
competition through HJ Ford, its wholly owned subsidiary. HJ Ford along with HMR Tech has formed a
small business joint venture for this competition. HJ Ford and HMR Tech are participants in the
U.S. Small Business Administration Mentor Protégé program. During the second quarter of 2006, the
joint venture was awarded the CAPS contract. The Company anticipates that a successful transition
to CAPS via the joint venture will enable DRC to retain and preserve profits on substantially its
entire labor base currently supporting these customers. The Company derived approximately $24
million of annual revenues from
work performed by subcontractors under the Companys prime contract with the ASC. Upon completion
of the transition of
23
task orders from the current contract to the new CAPS contract, it is
anticipated that the Companys current subcontractors would contract directly with the joint
venture prime contractor entity. As a result it is estimated that upon the completion of the task
order transitions, the Companys annual revenue will be reduced by approximately $24 million while
positively affecting the profit margin of the remaining revenue.
The services provided under the ESC contract were originally scheduled for re-competition in
2005. The re-competition was delayed. It is currently anticipated that the competition for a
portion of the work to be performed for ESC will be full-and-open to all qualified contractors and
the competition for the remainder of the work will be restricted to small businesses. It is now
anticipated that the government contract award and initial task order transitions will occur in
late 2006. The Company expects to participate in the competition primarily as a sub-contractor to a
qualified small business and that a successful re-competition would enable DRC to retain and
preserve profits on substantially its entire labor base currently supporting these customers, which
is expected to increase profit margins. The full year revenue impact of moving from prime
contractor to a sub-contractor role is anticipated to be an approximate $11 million revenue
reduction. There can be no assurance that the Company will be successful in receiving the ESC
contract award.
The base contract agreement covering the Companys work with the IRS was the subject of
re-competition in 2005. The Companys current task orders have been extended through May 2006.
Contract awards were announced in the fourth quarter of 2005. The Company did not receive a new
base contract award. After May 2006, the Company anticipates continuing work with the IRS either
through a United States General Services Administration (GSA) schedule contract or as a
sub-contractor. As a result of this transition, the Company anticipates that about $5 million of
sub-contractor revenues reflected in 2005 revenues will no longer be included in Company revenues.
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 Involved in Various Litigation Matters Which, If Not Resolved in Our Favor, Could Harm Our
Business.
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 Government Accountability Office, the
Department of Justice and Congressional Committees. Both related to and unrelated to its defense
industry involvement, the Company is, from time to time, involved in audits, lawsuits, claims,
administrative proceedings and investigations. 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. Except as noted below, the Company does not presently
believe it is reasonably likely that any of these matters would have a material adverse effect on
the Companys business, financial position, results of operations or cash flows. The Companys
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 Companys business, financial position, results of operations and cash
flows.
On October 26, 2000, two former Company employees were indicted and charged with conspiracy to
defraud the United States Air Force, and wire fraud, among other charges, arising out of a scheme
to defraud the United States out of
24
approximately $10 million. Both men subsequently pled guilty to
the principal charges against them. On October 9, 2003, the United States Attorney filed a civil
complaint in the United States District Court for the District of Massachusetts against the Company
based in substantial part upon the actions and omissions of the former employees 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 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. The United States Attorney 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 party, if unfavorable, could have a material adverse effect on the Companys business,
financial position, results of operations and 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 Companys
business, financial position, results of operations and cash flows.
On June 28, 2005 a suit, characterized as a class action employee suit, was filed in the U.S.
Federal Court for the District of Massachusetts alleging violations of the Fair Labor Standards Act
and certain provisions of Massachusetts General Laws. The Company believes that its practices
comply with the Fair Labor Standards Act and Massachusetts General Laws. The Company intends to
vigorously defend itself and has sought to have the complaint dismissed from Federal Court and
addressed in accordance with the Companys mandatory Dispute Resolution Program for the arbitration
of workplace complaints. On April 10, 2006, the U.S. Federal Court for the District of
Massachusetts entered an order granting in part the Companys motion to dismiss the civil action
filed in that court against the Company, and to compel compliance with its mandatory Dispute
Resolution Program. The Company intends to appeal a portion of the courts decision to the effect
that a class action waiver set forth in the dispute resolution program is not enforceable. The
outcome of this litigation, if unfavorable, could have a material adverse effect on the Companys
business, financial position, results of operations and cash flows.
25
Item 6. EXHIBITS
The following Exhibits are filed or furnished, as applicable, 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. |
|
|
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. |
|
|
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. |
|
|
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. |
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
|
|
|
|
|
|
|
DYNAMICS RESEARCH CORPORATION |
|
|
|
|
(Registrant) |
|
|
|
|
|
|
|
Date:
May 9, 2006
|
|
/s/ David Keleher
David Keleher
|
|
|
|
|
Senior Vice President and Chief Financial Officer |
|
|
|
|
|
|
|
|
|
/s/ Francis Murphy
Francis Murphy
|
|
|
|
|
Vice President, Corporate Controller and Chief
Accounting Officer |
|
|
27
EXHIBIT INDEX
|
|
|
|
|
Exhibit |
|
|
|
|
Number |
|
Exhibit Name |
|
Location |
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 |
28