-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, To3fT9be6GnKwCumGpnz8qkGSvccYa0cE9gcVHYj2L5EvdcvIc/hD96KamcZ8zY8 jFhGMg6XyxbG2hOD3AcmtQ== 0000030822-99-000002.txt : 19990402 0000030822-99-000002.hdr.sgml : 19990402 ACCESSION NUMBER: 0000030822-99-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DYNAMICS RESEARCH CORP CENTRAL INDEX KEY: 0000030822 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 042211809 STATE OF INCORPORATION: MA FISCAL YEAR END: 1229 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-02479 FILM NUMBER: 99581936 BUSINESS ADDRESS: STREET 1: 60 FRONTAGE ROAD CITY: ANDOVER STATE: MA ZIP: 01810-5498 BUSINESS PHONE: 9784759090 MAIL ADDRESS: STREET 1: 60 FRONTAGE ROAD CITY: ANDOVER STATE: MA ZIP: 01810-5498 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-7348 DYNAMICS RESEARCH CORPORATION (Exact Name of Registrant as Specified in Its Charter) Massachusetts 04-2211809 (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) 60 FRONTAGE ROAD ANDOVER, MASSACHUSETTS 01810-5498 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (978) 475-9090 Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange on Title of Each Class Which Registered NONE NOT APPLICABLE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.10 Par Value (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . (Continued) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of March 19, 1999, the aggregate market value of Common Stock held by nonaffiliates of the Registrant was $22,710,053 and the number of shares of Common Stock, $.10 par value, of the Registrant outstanding was 7,356,090. Documents Incorporated By Reference Portions of the 1998 Annual Report to Shareholders are incorporated by reference in Parts I and II. Portions of the Registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders are incorporated by reference in Part III. The Exhibit Index is on pages 25 and 26. DYNAMICS RESEARCH CORPORATION Form 10-K For the Fiscal Year Ended December 31, 1998 Part I Page Item 1. Business 4 2. Properties 11 3. Legal Proceedings 11 4. Submission of Matters to a Vote of Security Holders 11 4A. Executive Officers of the Registrant 11 Part II 5. Market for Registrant's Common Equity and Related Stockholder Matters 12 6. Selected Financial Data 12 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 8. Financial Statements and Supplementary Data 13 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 13 Part III 10. Directors and Executive Officers of the Registrant 14 11. Executive Compensation 14 12. Security Ownership of Certain Beneficial Owners and Management 14 13. Certain Relationships and Related Transactions 14 Part IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 15 PART I Item 1. Business Dynamics Research Corporation (referred to as DRC or the Company) was organized in 1955 under the laws of the Commonwealth of Massachusetts. The Company develops and operates computer and communication-intensive information systems, provides engineering, management support and information technology services, and produces precision manufactured components for industrial measurement and control. The Company's Systems and Services segment represents 85% of revenue from continuing operations for the year ended December 31, 1998. Precision manufactured products represent 15% of 1998 revenue from continuing operations and include encoders and electroformed parts. The Company was also engaged in the development and sale of telecommunications fraud control systems and object-oriented software development technology. Systems and Services Segment DRC provides systems analysis, integration, and software design and development services. The Segment's information technology offerings also include installation, systems operation, and maintenance. Systems built by DRC are used for aircraft maintenance and parts tracking; supply chain management; training requirements; and for managing state government health and human services commitments. The Company's major Department of Defense (referred to as DoD) information systems programs are often referred to as logistics information systems. These DRC-developed product management information systems manage data related to inventory requirements and control, maintenance and repair, warranty analysis, supply, and distribution of numerous products and parts. For nearly 30 years, the Company has assisted the U.S. Navy Fleet Ballistic Missile program office in the design, development, and operation of inertial systems. The Company has extensive experience with the Polaris, Poseidon, and Trident missile guidance systems and submarine inertial navigation systems. The Company develops and maintains performance, reliability, and logistics databases for the inertial guidance instruments housed in those systems. These databases track detailed information on thousands of component parts comprising the systems. In connection with these databases, the Company has successfully integrated customer workflow and database activity information with Internet technology. This information is used by the customer for a wide range of operating management tasks and decision making. The Company provides independent analysis and monitoring of submarine-based, inertial guidance systems and electronic modules for the U.S. Navy Fleet Ballistic Missile Program Office. DRC's Inertial Instrument Test Laboratory is equipped for full-scale performance testing of navigational quality inertial instruments. The Company designs, constructs, installs, trains, and supports test equipment used in the U.S. Navy Trident program. DRC is also involved in the design of a closed-loop system used in the field of parameter control in semiconductor manufacture. This process is being developed along with other companies under the auspices of the U.S. Navy in the San Diego, California, Space and Naval Warfare Systems Center. DRC performs computer-aided, semiconductor circuit analysis for its Navy customer as well as commercial companies. The DRC-developed Weapon Systems Management Information System (WSMIS) assesses the "health" and capability of the U.S. Air Force weapon systems to meet wartime objectives. DRC has served as the overall functional integrator of WSMIS and the developer of most WSMIS modules. The Company currently provides WSMIS operational and software development support. As a decision-support tool for assessing the impacts of logistics status on potential wartime capabilities, WSMIS computes inventory requirements, purchasing needs, and logistics capability assessments for complex, high-priced aircraft spare parts necessary to meet aircraft availability requirements. A major component of the Company's DoD business consists of a wide variety of engineering, technical assistance and management support services performed under various indefinite order, indefinite quantity contracts. Work performed under these contracts is generally done on a time and materials basis utilizing a wide range of the Company's technical and management skills to plan, analyze, design, test, support, train, maintain, and dispose of a variety of complex systems. Systems include radar, missile, aircraft, information, software, and munitions. The Company provides support at all stages of a system's life cycle. In response to emerging requirements, the Company helps its Federal Government customers define, develop, and initiate new programs. The Company also helps customers obtain program approval, conduct strategic planning, and evaluate proposals from private contractors. After prime contract awards, the Company helps monitor contractor activities, evaluate progress, and measure performance against program requirements. Products and services include computer-based training, systems integration, and business process improvement/reengineering. Under a variety of contracts, DRC supports the U.S. Air Force at bases such as Hanscom Air Force Base, Scott Air Force Base, Langley Air Force Base, Maxwell Air Force Base, Gunter Annex, and Peterson Air Force Base. In 1995, the U.S. Air Force awarded DRC a five-year contract for Technology Task-Order Engineering Services (TTOES). Originally valued at up to $23.7 million, in 1997 the contract ceiling was increased to $31.2 million. DRC has provided engineering, logistics, and software support on programs such as the B-1B, the B-2, the B-52, the KC-135, and the E-3A aircraft repair, maintenance, and upgrade programs. From its origin at the Oklahoma City Air Logistics Center (ALC), DRC has expanded its TTOES task orders to include work at other ALC's located at Warner Robins, GA; Ogden, UT; and San Antonio, TX. Additional tasking has centered on providing support to Air Force reengineering and business process improvement initiatives at these ALC's. Since 1993, DRC has provided the US Army Aviation and Missile Command with specialized studies and analyses in aviation/missile system development, acquisition and sustainment. Since 1996, the Company has been a prime contractor on a five-year, $33 million contract under a U.S. Army program known as Programmatic and Technical Support. DRC supports a broad range of helicopter and missile systems in varying life cycle stages. Additionally, DRC supports other U.S. Army activities with acquisition logistics, systems engineering and other related program management services from its office in Huntsville, Alabama. Combining its expertise in weapon system acquisition processes with its expertise in systems analysis, design, training and simulation and human factors, DRC performs human-systems integration and force analysis. Since 1987, DRC has provided force analysis support to the Army Research Laboratory. These activities are focused on developing tools that support analyzing soldier and system effectiveness, identifying and assessing force improvement options (doctrine, training, leader development, organization and material), and ensuring soldier considerations are addressed in force improvements. Also, under contract from the U.S. Army Research Laboratory, DRC provides analysis, system development and support in several functional areas which include assessment of manpower, personnel and training issues; analysis of soldier systems performance; and integration of methods and databases for use by system designers. DRC is the developer of the Training System Requirements Analysis (TSRA) Tools, which are a set of computer programs designed to help instructional designers perform the initial phases of the Instructional Systems Development (ISD) process. The TSRA Tools have been developed with the Naval Air Warfare Center Training Systems Division (NAWCTSD) and are widely used throughout the DoD by government and contractor organizations. The market for DRC's TSRA Tools has expanded beyond the military to include the Federal Aviation Administration and National Mine Health and Safety Academy. As a subcontractor to Lockheed Martin, DRC is supporting the U.S. Army's Warfighter Simulation 2000, a simulation system supporting the training of commanders and staff under a wide variety of battlefield scenarios. DRC services include providing military subject matter experts, software and human factors engineering, database development for equipment and knowledge acquisition, as well as manpower staffing reduction analysis. DRC is also a subcontractor to Lockheed Martin for the Close Combat Tactical Trainer (CCTT) program. CCTT simulates Army tank and mechanized infantry units from vehicle crews to the battalion level. CCTT uses distributed, interactive simulation technology to provide a "virtual" training environment. DRC conducts all manpower and personnel integration activities associated with the CCTT. DRC is playing a similar role as a subcontractor to Lockheed Martin on the United Kingdom Combined Arms Tactical Trainer, the UK's version of the CCTT. DRC is a subcontractor to Raytheon on the U.S. Air Force National Air and Space Model (NASM). The Company is developing conceptual models and collecting data on mission space objects and processes. The Company is in its third year of a U.S. Army, four-year contract, valued at approximately $13.0 million, to implement, apply, and manage DRC-developed teamwork training principles to improve performance in high-pressure environments. The project focus is on improving teamwork in emergency-room settings at more than 15 civilian and military hospitals. In March 1998, DRC was awarded a contract under the Air Force Aeronautical Systems Center Advisory and Assistance Services (A&AS) Omnibus program. The purpose of this contract is to provide support for engineering, manufacturing, configuration/data management, acquisition management and test and evaluation required in the acquisition, development, production and sustainment of various equipment and weapons systems. The contract provides DRC the opportunity to compete against other companies for tasks under the A&AS Omnibus program over three years. In recent years, the Company has expanded beyond the DoD marketplace and won various state and Federal agency contracts. The Company implemented a distributed computer-based Statewide Automated Child Welfare Information System (SACWIS) for the State of New Hampshire. This system manages child welfare cases handled by the State's Department of Health and Human Services. Under ongoing contracts DRC provides additional functional and technical enhancements to the SACWIS system as well as other information technology services. In February 1997, DRC was awarded a contract to design, deliver, install and maintain a statewide information technology (IT) infrastructure that supports the Ohio Child Support Enforcement Tracking System (SETS). The IT infrastructure the Company is developing automates the work of more than 4,250 Child Support Enforcement workers throughout Ohio's 88 counties. In November 1997, the State of Ohio awarded the Company a contract for additional computer network infrastructure and related services. DRC continues to provide computer hardware and software, site preparation and installation, and technical support services for the SACWIS and Ohio Works First System that support Ohio's welfare reform initiatives. In December 1997, DRC received a three-year contract from the State of Colorado Department of Human Services to serve as a prime contractor for its Children, Youth and Families project. The contract is a result of a competitive procurement for the design, development and implementation of a child welfare and youth corrections system consisting of software, training and a state-wide computer network infrastructure. The contract includes options for four additional years of system maintenance and support. The Company continues to provide the U.S. Department of Treasury with information technology services for the Internal Revenue Service and other Treasury departments. Year 2000 software and system certification projects represent the majority of activity under this contract. Critical to the development of information systems is the Company's software development process and related tools. The Company's approach to mission-critical software stresses principles of continuous software quality evaluation and increased visibility throughout the software development life cycle. To this end, DRC has achieved Level-2 certification under the standards of the Software Engineering Institute and is actively pursuing Level-3 certification. Precision Manufactured Products The commercial operations of DRC's Precision Products Group consists of two divisions: Encoder Division and Metrigraphics Division. DRC's Encoder Division designs, manufactures, and markets a line of digital encoders that convert analog motion and position information into digital signals used in a wide variety of industrial products and systems which include: machine tools, robotics, engine fuel-control systems, packaging equipment and pick-and-place machines. DRC's digital encoding devices are essential elements of today's electronically- controlled systems and equipment. The Encoder Division manufactures an encoder used in engine fuel pumps for diesel powered sport utility vehicles, pickup trucks and commercial vans. The encoder is a critical component of a computer control system that gauges the amount of fuel injected into the cylinders, optimizing usage and minimizing the amount of unburned fuel and resultant exhaust fumes. The Metrigraphics Division uses photolithographic processes to manufacture optical discs, scales and reticles that are used for precision measurement. Metrigraphics also uses various metal deposition processes, including electroplating and electroforming, to produce a variety of precision components. Products include printheads and oriface plates used in electronic printers and circuitry used in certain medical instruments. Metrigraphics' superior ability to design and manufacture components and maintain critical tolerances is an important driver for a wide range of high-technology applications. Metrigraphics' largest market is currently for nozzles used in inkjet printer cartridges. In addition to its electroform parts for printers and medical instruments, Metrigraphics manufactures precision glass parts for computer peripherals, factory automation equipment, electronic instrumentation and semiconductor equipment. Telecommunications Fraud Control Systems Since 1996, the Company has been licensed to enhance, market and maintain a telecommunications fraud control system developed by Pacific Bell Telephone Company. DRC has made significant investments in this and related systems and software technologies to broaden the types of telephone fraud detected and to position the product for sale to competitive local exchange carriers and others. The Company's customers include the regional Bell operating telephone companies. A number of recent changes in the telecommunications marketplace have delayed near-term sales goals and increased the estimated capital required to take advantage of this expanding market. In December 1998, the Company adopted a plan to exit this business during 1999. Software Development Technology Over a number of years, DRC has invested in the research and development of VisualMagic, an object-oriented development environment. This development environment was useful in the design of Internet applications. During 1998, the Company acquired an interest in Empresa, Inc. (formerly Electronic Press Services Group, Inc.) in exchange for an exclusive license to VisualMagic in certain fields, cash and the assets of the business. Empresa also hired DRC's staff. DRC does not expect to continue its development of Visual Magic. Empresa provides e-commerce solutions for small to medium size merchants, banks, and other customers seeking a competitive advantage by being on-line. Empresa's solutions include turnkey on-line storefronts and transaction processing capabilities highly customized to integrate with a customer's existing internal systems and with financial institutions. Sales & Marketing Contracts with defense, state and other government agency customers are obtained by marketing and technical personnel employed by the Company. The Company's other products are sold by sales personnel employed by the Company and outside sales representatives. Government Contracts During 1998, the Company's revenues from contracts with the DoD, either as prime contractor or subcontractor, accounted for approximately 59% of the Company's total revenues. During 1998, the Company's U.S. Government business consisted of approximately 101 separate contracts on 16 different programs. The Company's contracts with the Government are generally subject to termination at the convenience of the Government; however, the Company would be reimbursed for its allowable costs to the time of termination and would be paid a proportionate amount of the stipulated profit attributable to the work actually performed. Although Government contracts may extend for several years, they are generally funded on an annual basis and are subject to reduction or cancellation in the event of changes in Government requirements or budgetary concerns. If the U.S. Government curtails expenditures for research, development and consulting activities, such curtailment might have an adverse impact on the Company's sales and earnings. The Company's revenues from contracts with four different states accounted for approximately 22% of 1998 revenues. Revenues under various contracts with the State of Ohio accounted for approximately 13.6% of 1998 revenues. The Company's state contracts are generally either fixed-price or time and material. In certain instances, funding for these contracts is subject to annual state legislative approval. The Company's government contracts fall into one of three categories: (1) fixed-price, (2) time and materials, and (3) cost plus fixed-fee. Under a fixed-price contract, the government pays an agreed upon price for the Company's services or products, and the Company bears the risk that increased or unexpected costs may reduce its profits or cause it to incur a loss. Conversely, to the extent the Company incurs actual costs below anticipated costs on these contracts, the Company could realize greater profits. Under a time and materials contract, the government pays the Company a fixed hourly rate intended to cover salary costs and related indirect expenses plus a profit margin. Under a cost plus fixed-fee contract, the government reimburses the Company for its allowable direct expenses and allowable and allocable indirect costs and pays a negotiated fee. In 1998, approximately 58% of the Company's state and federal government contract revenue was under fixed-price or time and material contracts, while approximately 42% of revenue was under costs plus fixed-fee contracts. Backlog At December 31, 1998, the Company's backlog of unfilled orders was approximately $105.4 million compared with $110.0 million at December 31, 1997. The Company expects that substantially all of its backlog at December 31, 1998 will be filled during the year ending December 31, 1999. The Company has a number of multi-year contracts with agencies of the U.S. and state governments on which actual funding generally occurs on an annual basis. The Company's business does not have seasonal characteristics but a portion of its funded backlog is based on annual purchase contracts, and the amount of funded backlog as of any date can be affected by the timing of order receipts and deliveries thereunder. Competition The Company competes with both domestic and foreign firms, including larger diversified companies and smaller specialized firms. The U.S. Government's own in-house capabilities are also, in effect, competitors because various agencies perform certain types of services which might otherwise be performed by the Company. The principal competitive factors for systems and services are price, performance, technical competence and reliability. In the commercial businesses, the Company competes with other manufacturers of encoders, electroform vendors and suppliers of precision measurement scales. The principal competitive factors affecting the precision components manufacturing businesses are price, product quality and custom engineering to meet customers' system requirements. Research and Development The Company expended approximately $2.7 million (inclusive of overhead and other indirect costs) on new product and service development during the year ended December 31, 1998, as compared to expenditures of $1.2 million during 1997 and $2.2 million during 1996. Raw Materials Raw materials and components are purchased from a large number of independent sources and are generally available in sufficient quantities to meet current requirements. Environmental Matters Compliance with federal, state and local provisions relating to the protection of the environment has not had and is not expected to have a material effect upon the capital expenditures, earnings or competitive position of the Company. Employees At December 31, 1998, the Company had 1,557 employees. Proprietary Information Patents, trademarks and copyrights are not materially important to the business of the Company. The U.S. Government has certain proprietary rights in processes and data developed by the Company in its performance of government contracts. Item 2. Properties The Company leases offices and other facilities, totaling approximately 333,000 square feet, which are utilized for its federal and state government services, manufacturing and warehousing operations as well as its marketing and engineering offices. The Company has manufacturing and office space in Wilmington, Massachusetts under three leases totaling 113,000 square feet, expiring in 2000, with options to the year 2005. The remaining leased facilities consist of offices in 29 locations across the United States. The Company owns a 135,000 square foot facility in Andover, Massachusetts that is utilized for its defense service operations and corporate administrative offices. The Company's total rental cost for 1998 was $3.6 million. The Company believes its properties are adequate for its present needs. Item 3. Legal Proceedings The Company is not a party to any material litigation. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. Item 4A. Executive Officers of the Registrant The following is a list of the names and ages of the executive officers of the Company indicating all positions and offices held by each person and each person's principal occupations or employment during the past five years. The executive officers were elected by the Board of Directors and will hold office until the next annual election of officers and their successors are elected and qualified, or until their earlier resignation or removal by the Board of Directors. There are no family relationships between any executive officers and directors. Age Position John S. Anderegg, Jr. 75 Chairman and Director Albert Rand 72 President, Chief Executive Officer and Director John L. Wilkinson 59 Vice President, Human Resources and Clerk Douglas R. Potter 48 Vice President of Finance, Chief Financial Officer Chester Ju 49 Vice President, Encoder Division and Metrigraphics Division Each of the persons named above has served in the position indicated for more than five years. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The common stock of the Company is traded on the NASDAQ National Market under the symbol (DRCO). The high and low prices for the quarters in 1997 and 1998 are listed below. 1998 1997 High Low High Low First quarter $11.04 $ 8.75 $ 7.58 $ 6.35 Second quarter 12.25 9.90 7.71 6.44 Third quarter 12.13 6.50 9.38 6.77 Fourth quarter 7.00 4.63 11.88 8.75 The number of holders of record of the Company's common stock are described in the Company's Annual Report to Shareholders for 1998 under the caption "Number of Shareholders," and such information is incorporated herein by reference. In September 1984, the Board of Directors indicated its intention not to declare cash dividends to preserve cash for the future growth and development of the Company. The Company did not declare any cash dividends between 1984 and 1998 and does not anticipate doing so for the foreseeable future. Item 6. Selected Financial Data The section entitled, "Five Year Summary of Selected Financial Data" in the Company's Annual Report to Shareholders for 1998 is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report to Shareholders for 1998 is incorporated herein by reference. The Company has made and may make statements from time to time which constitute or contain forward looking information as that term is defined within the meaning of the Federal securities laws. These statements may be identified by such forward-looking words or other forward-looking terminology. Forward-looking statements are not guarantees of future performance and actual results may differ materially from those in the forward-looking statements as the results of risks and uncertainties including those identified in Exhibit 99. The Company assumes no obligation to update any forward-looking information. Item 8. Financial Statements and Supplementary Data The following financial statements are filed as part of this Annual Report: Report of Independent Public Accountants Consolidated Balance Sheets at December 31, 1998, December 31, 1997 and December 28, 1996 Consolidated Statements of Operations for the three years ended December 31, 1998 Consolidated Statements of Shareholders' Investment for the three years ended December 31, 1998 Consolidated Statements of Cash Flows for the three years ended December 31, 1998 Notes to Consolidated Financial Statements (The consolidated financial statements and related notes listed above are incorporated by reference to the Company's Annual Report to Shareholders for the year 1998.) Report of Independent Public Accountants on Schedules to Consolidated Financial Statements Schedule VIII - Valuation and Qualifying Accounts for the three years ended December 31, 1998 The foregoing report of independent public accountants and schedule is included as part of Item 14 of this Annual Report on Form 10-K and are set forth on page F-1 and F-2 filed herewith. All other financial statements and schedules have been omitted because the information required to be submitted has been included in the financial statements and related notes or they are either not applicable or not required under the rules of Regulation S-X. Quarterly financial data presented on page 16, and Management's Discussion and Analysis of Financial Condition and Results of Operations presented on pages 17-22, of the Company's Annual Report to Shareholders for the year 1998, are also incorporated herein by reference. With the exception of the portions listed in the above index, the Annual Report referred to above is not to be deemed filed as part of the financial statements. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant Information with respect to Directors of the Registrant in the section entitled "Election of Directors" in the Company's definitive proxy Statement for the 1998 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 31, 1998, is incorporated herein by reference. Information relating to the Executive Officers of the Company is included in Item 4A of Part I of this Form 10K. Item 11. Executive Compensation Information called for by this item is incorporated by reference from the section entitled "Compensation and Related Matters" in the Company's definitive Proxy Statement for the 1999 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 31, 1998. Item 12. Security Ownership of Certain Beneficial Owners and Management Information called for by this item is incorporated by reference from the sections entitled "Common Stock Ownership of Certain Beneficial Owners and Management" in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 31, 1998. Item 13. Certain Relationships and Related Transactions Not applicable. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) (1) and (2) Financial Statements and Schedules - See Item 8. (a) (3) Exhibits. The exhibits that are filed with this Form 10-K, or that are incorporated herein by reference, are set forth in the Exhibit Index, which appears in Part IV of this report on pages 24 and 25. (b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during the last quarter of fiscal 1998. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES TO CONSOLIDATED FINANCIAL STATEMENTS To Dynamics Research Corporation: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Dynamics Research Corporation's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 18, 1999. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the accompanying index is the responsibility of the company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Boston, Massachusetts, February 18, 1999 Exhibit 99 IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS The following factors, among others, could cause the Company's actual results and performance to differ materially from those contained in forward-looking statements made in this report and presented elsewhere by or on behalf of the Company from time to time. Uncertainties as to Department of Defense and Other Federal Agency Budgets In 1998, approximately 59% of the Company's revenue was with the DoD and its Services. In the past, the Company's defense business has been adversely affected by significant changes in defense spending during periods of declining U.S. defense budgets. Among the effects of this general decline has been increased competition within a consolidating defense industry. It is not possible for the Company to predict whether defense budgets will increase or decline in the future. Further, changing missions and priorities in the defense budget may have adverse effects on the Company's business. Funding limitations could result in a reduction, delay, or cancellation of existing or emerging programs. The Company anticipates there will continue to be significant competition when the Company's defense contracts are rebid as well as significant competitive pressure to lower prices, which may reduce profitability in this area of the Company's business. Any reduction in the level or profitability of the Company's defense business, if not offset by new commercial business or other business, will adversely affect the Company's business, financial condition and results of operations. Government Contracting Risks The Company has historically derived a substantial portion of its revenue from contract and subcontracts with the U.S. Government. In recent years, the Company has entered into significant information technology services contracts with various state governments. A significant portion of the Company's federal and state government contracts are of a time and materials nature, with fixed hourly rates that are intended to cover salaries, benefits, other indirect costs of operating the business and profit. The pricing of such contracts is based upon estimates of future costs and assumptions as to the aggregate volume of business that the Company will perform in a certain business division or other relevant unit. For long term contracts, the Company must estimate the costs necessary to complete the defined statement of work and recognize revenues or losses in accordance with such estimates. Actual costs may vary materially from the estimates made from time to time, necessitating adjustments to reported revenue and net income. Underestimates of the costs associated with a project could adversely affect the Company's overall profitability and could have a material adverse effect on the Company's business, financial condition and results of operations. A significant portion of the Company's 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 or other appovals by U.S. Government, state legislature or others on an annual or more frequent basis. As a result, the Company's business could experience material adverse consequences should such funding actions or other approvals not be taken. Governmental awards of contracts are subject to regulations and procedures that permit formal protests by losing bidders. Such protests may result in significant delays in the commencement of expected contractual effort, or the reversal of a previous award decision, which could have a material adverse effect on the Company's business, financial condition and results of operations. Because of the complexity and scheduling of contracting with government agencies, from time to time costs are incurred in advance of contractual funding. In some circumstances, such costs may not be recovered in whole or in part under subsequent contractual actions. Failure to collect such amounts may have material adverse consequences on the Company's business, financial condition and results of operations. Costs incurred in connection with government contracts are generally subject to audits. Such audits may result in material disallowances, which could have an adverse effect on the Company's business, financial condition and results of operations. A substantial portion of the Company's U.S. Government business is as a subcontractor. In such circumstances, the Company generally bears the risk that the prime contractor will meet its performance obligations to the U.S. Government under the prime contract and that the prime contractor will have the financial capability to pay the Company amounts due under the subcontract. The inability of a prime contractor to perform or make required payments could have a material adverse effect on the Company's business, financial condition and results of operations. The U.S. Government has the right to terminate contracts for convenience. In such a termination, the Company would generally recover costs incurred up to termination, costs required to be incurred in connection with the termination, and a portion of the fee earned commensurate with the work performed to termination. However, significant adverse effects on the Company's indirect cost pools may not be recoverable in connection with a termination for convenience. Contracts with state and other governmental entities are subject to the same or similar risks. Dependence on Key Personnel The Company is dependent on its key technical personnel. In addition, certain technical contributors may have specific knowledge and experience related to various government customer operations that would be difficult to replace in a timely fashion. The loss of the services of key personnel could have a material adverse effect on the Company's ability to perform required services under certain contracts, or to retain such business after the expiration of the current contract, or to win new business where certain personnel have been identified as key personnel in the proposal, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. Competition The government contracting business is subject to intense competition, both technical and pricing, from numerous companies, many of which have significantly greater financial, technical and marketing resources than the Company. Competition in the market for the Company's commercial products is also intense. There is a significant lead time for developing such business, and it involves significant capital investment including development of prototypes and investment in manufacturing equipment. The Company's precision products business has a number of competitors, many of which have significantly greater financial, technical and marketing resources than the Company. Risks Associates with New Markets and New Products In its efforts to enter new markets, including Government agencies other than the DoD and commercial markets, the Company faces significant competition from other companies that have prior experience with such potential customers as well as significantly greater financial, technical and marketing resources than the Company. As a result, the Company's efforts to enter such new markets may not achieve the level of success sought by the Company. The Company has licensed its object-oriented software technology to a third party and made an investment in that company. There is no assurance that the investee company's products and services will meet with market acceptance or that they will be able to compete in the development and distribution of such products with competitors that have significantly greater resources and experience. Failure to operate profitably or to raise new capital, if required, may adversely affect the Company's investment. Concentration of Customers Within the DoD, individual services and program offices account for a significant portion of the Company's Government business. One state customer accounts for a significant portion of the Company's revenue. Two customers account for a significant portion of the revenue of the Company's commercial manufacturing divisions. No assurance can be provided that any of these customers will continue as such or will continue at current levels. A decrease in orders from any of these customers would have an adverse effect on the Company's profitability, and the loss of any large customer could have a material adverse effect on the Company's business, financial condition and results of operations. Risk of Product Claims The Company's precision manufactured products are generally designed to operate as important components of complex systems or products and defects in DRC products could cause the customer's product or systems to fail or perform below expectations. Like other manufacturing companies, the Company may be subject to claims for alleged performance issues related to its products. There can be no assurance any such claims, if made, will not have a material adverse effect on the Company's business, financial conditions or results of operations. Risk of Economic Events Effecting the Company's Business Segments Certain of the Company's precision products are components of commercial products. Factors that affect the production and demand for such products, including economic events both domestically and in other regions of the world, competition, technological change and production disruption, could adversely affect demand for the Company's products. Certain of the Company's products are incorporated into capital equipment, such as machine tools and other automated production equipment, used in the manufacture of other products. As a result, this portion of the Company's business may be subject to fluctuations in the manufacturing sector of the overall economy. An economic recession, either in the U.S. or elsewhere in the world, could have a material adverse effect on the rate of orders received by the commercial divisions. Significantly lower production volumes resulting in under- utilization of the Company's manufacturing would adversely affect the Company's business financial condition and results of operations. Technological Change The Company's knowledge base and skills in the government contracting area are sophisticated and involve areas in which there have been and are expected to continue to be significant technological change. There is no assurance that the Company will continue to be able to offer services that satisfy its customers' requirements at a competitive price. Many of the Company's products are incorporated into sophisticated machinery, equipment or electronic systems. Technological changes may be incorporated into competitors' products that may adversely affect the market for the Company's products. Further, there can be no assurance that the Company's research and product development efforts will be successful or result in new or improved products that may be required to sustain the Company's market position. Uncertainty of Future Financing Although the Company has no immediate plans to raise additional capital, in the future it may need to raise additional funds through public or private debt or equity financing. There can be no assurance that any such funding will be available or of the terms or timing of any such funding. SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 30, 1999 DYNAMICS RESEARCH CORPORATION by: /s/ Albert Rand Albert Rand, President (Principal Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 30th of March, 1999. /s/ Albert Rand Albert Rand Director, President, Chief Executive Officer /s/ Douglas R. Potter Douglas R. Potter Vice President of Finance, Chief Financial Officer (Principal Financial and Accounting Officer) /s/ John S. Anderegg, Jr. John S. Anderegg, Jr. Director, Chairman /s/ Francis J. Aguilar Dr. Francis J. Aguilar Director /s/ Martin V. Joyce, Jr. Martin V. Joyce, Jr. Director /s/ Kenneth F. Kames Kenneth F. Kames Director /s/ James P. Mullins Gen. James P.Mullins Director SCHEDULE VIII DYNAMICS RESEARCH CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED DECEMBER 31, 1998 (in thousands of dollars) ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURNS Balance, December 30, 1995 $402 Additions charged to expense 54 Write-off of uncollectible accounts, net (116) Balance, December 28, 1996 $340 Additions charged to expense 86 Write-off of uncollectible accounts, net (209) Balance, December 31, 1997 $217 Additions charged to expense 149 Write-off of uncollectible accounts, net (50) Balance, December 31, 1998 $316 ACCRUAL OF LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS Balance, December 31, 1997 $ - Additions charged to discontinued operations expense 4,418 Balance, December 31, 1998 $4,418 EXHIBIT INDEX 3.0 Certificate of Incorporation and By-Laws. 3.1 Restated Articles of Organization dated May 22, 1987. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/13/87) 3.2 By-Laws dated May 22, 1987. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/13/87) 4.0 Instruments defining the rights of security holders, including indentures. 4.1 Common stock certificate. 4.2 Certificate of Vote of Directors Establishing Series B Preferred Stock (Incorporated by reference to the Registrant's Form 8-K on June 25, 1998). 4.3 Amendment to Certificate of Vote Establishing Series B Preferred Stock. 4.4 Rights Agreement dated as of February 17, 1998 between the Company and American Stock Transfer & Trust Company, as Rights Agent. (Incorporated by reference to the Registrant's Form 8-K on June 25, 1998) 10.0 Material Contracts 10.1 Amended 1983 Stock Option Plan. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/27/87) 10.2 Form of Dynamics Research Corporation Indemnification Agreement for Directors. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91) 10.3 Form of Dynamics Research Corporation Severance Agreement for Messrs. Anderegg and Rand. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91) 10.4 Dynamics Research Corporation Deferred Compensation Plan for Non-Employee Directors. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91) 10.5 Form of Consulting Agreement between Dynamics Research Corporation and Albert Rand. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 3/31/97) 10.6 Form of Supplemental Retirement Pension Agreement between Dynamics Research Corporation and Albert Rand. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 3/31/97) 10.7 Amended 1993 Equity Incentive Plan. 10.8 Amended 1995 Stock Option Plan for Non-Employee Directors. 10.9 Amended and Restated Revolving Credit Agreement dated as of December 31,1998 between Dynamics Research Corporation and a syndicate of banks and financial institutions, with Brown Brothers Harriman and Company as the agent. 10.10 First Amendment to Amended and Restated Revolving Credit Agreement dated as of December 31, 1998 between Dynamics Research Corporation and a syndicate of banks and financial institutions, with Brown Brothers Harriman and Company as the agent. 13.0 Annual Report to security holders, Form 10-Q or quarterly reports to security holders. 13.1 The Company's Annual Report to Shareholders for the year ended December 31, 1998 filed herewith with the exception of the information incorporated by reference in parts I, II and IV of this Form 10-K is not deemed to be filed as part of this report. 23.0 Consents of experts and counsel 23.1 Consent of Independent Accountants (Arthur Andersen LLP) dated March 26, 1999 filed herewith. 99.0 Important Factors Regarding Forward-Looking Statements. All documents incorporated by reference may be found at Commission file number 1-7348. EX-13 2 Dynamics Research Corporation 1998 Annual Report Dynamics Research Corporation provides information technology services for government and private-sector clients. The Company develops and operates complex computer systems and communications networks, and provides engineering and management consulting services. It also designs and manufactures high-precision components for industrial measurement and control. Dynamics Research Corporation is traded on the Nasdaq National Market under the symbol DRCO. Financial Highlights** 1998 1997 1996 (In thousands of dollars, except per share and employee data) Revenue $ 182,344 $ 156,733 $ 129,997 Income from continuing operations 491 5,177 2,311 Net (loss) income (5,971) 4,129 1,729 Income from continuing operations per share - basic* .07 .69 .31 Income from continuing operations per share - diluted* .06 .66 .30 Net (loss) income per share - basic* (.80) .55 .23 Net (loss) income per share - diluted* (.77) .53 .22 Backlog 105,427 110,001 73,200 Number of employees 1,557 1,455 1,349 Number of shares outstanding* 7,369,190 7,546,646 7,515,630 * Restated for the May 1998 20% stock dividend. ** As discussed further in Management's Discussion and Analysis, in the fourth quarter of 1998, the Company decided to discontinue operations of its Telecommunications business. Accordingly, the results of operations of this segment have been excluded from revenue, operating income and income from continuing operations in this schedule. To Our Shareholders While we recorded a 16 percent increase in revenues and achieved healthy growth in most business areas during 1998, it was a challenging year for Dynamics Research Corporation (DRC). Investments in certain new businesses created a drain on operations, leading to an interruption in the growth in net income achieved over the past four years. We have moved expeditiously to eliminate unprofitable business initiatives and are fully focused on resuming our track record of earnings growth in 1999. Financial Results Revenues from continuing operations for the year ended December 31, 1998 increased to $182,344,000 from $156,733,000 in 1997. Income from continuing operations was $491,000, or $.06 per diluted share, versus $5,177,000, or $.66 per diluted share, last year. At the end of 1998, we decided to exit the telecommunications business. As a result, we incurred an after-tax charge of $2,572,000 to provide for the estimated loss on the disposal of this business area during 1999. Results for 1997 and 1996 have been restated to reflect continuing operations. Included in 1997 results is a one-time net income benefit of $1,000,000, or $.16 per share, related to a research and development tax credit. Including results from discontinued operations, DRC recorded a net loss for 1998 of $5,971,000, or $.77 per diluted share. Sales for the Systems and Test Equipment divisions totaled $154,336,000, representing 85 percent of revenues, while sales for the Precision Manufactured Products divisions equaled $28,008,000. One of DRC's long-stated objectives is to diversify its revenue base toward a 50/50 balance between defense and non-defense business. In 1998, non-defense projects accounted for approximately 41 percent of sales-up from 34 percent last year. New Business Initiatives One of DRC's strengths is its ability to successfully incubate new business initiatives. Outstanding examples include the extension of our logistics expertise into new Air Force programs, the rapid growth of information technology services for state government agencies, and high volume production contracts for our precision manufactured devices. One of the more exciting technologies we have developed is a highly advanced object-oriented software development environment for Internet applications, known internally as VisualMagic. Recognizing that we needed Internet commerce and marketing expertise to realize the full commercial potential of this powerful tool, at year-end we acquired an interest in Empresa, Inc. (formerly Electronic Press Services Group, Inc.) and transferred our VisualMagic development staff to the company. Based in Cambridge, Massachusetts, Empresa is a privately held developer of electronic storefronts and the infrastructure behind Internet transactions for the financial services and publishing industries. We believe this is an excellent opportunity to participate in the growth of Internet commerce and look forward to reaping the benefits of this transaction in years to come. DRC's ethic of enabling new ideas to come to the fore has produced outstanding results. It is inevitable, however, that some initiatives won't succeed, or will require a level of investment beyond our means. Recently, we announced plans to exit our telecommunications fraud control systems business. We arrived at this decision after encountering changes in the telecommunications marketplace that delayed near-term sales and increased the amount of capital required for taking full advantage of this market opportunity. We will continue to support new concepts and technologies that have a significant potential for profitable growth, and move swiftly to attach ourselves to new markets and technologies where there are clear needs for our products and services. We are, however, instituting a more rigorous internal screening system for scrutinizing and qualifying the payback potential of future growth initiatives. 1998 Growth Drivers State Health & Human Services Providing information technology services for state government agencies was one of our primary sources of growth in 1998. We doubled sales in this area during the year, winning and fulfilling major contracts for Colorado's child protection and juvenile justice agencies and for a variety of agencies in Ohio. We expect to record significant revenues from Colorado and Ohio in 1999 as well. In addition to expanding programs within the states we currently serve, we are focused on establishing relationships with other states. Recently, we won a $1,400,000 contract to support Arkansas' child welfare information system, and are bidding on projects in additional states. Defense Capabilities Our defense business increased 4 percent in 1998, due to the expansion of our field offices. One of our most important wins this year was an omnibus contract with the U.S. Air Force Aeronautical Systems Center at the Wright-Patterson base in Dayton. During the year we booked $8,000,000 in new orders under this contract. This program is similar to the work we have performed for the Air Force Electronics System Center, and is a significant example of our ability to expand relationships with existing customers. Similar to our growing business with the U.S. Air Force Air Logistics Centers, we are increasing engineering and logistics support for the U.S. Army Aviation and Missile Command. Conducted primarily out of our Huntsville office, much of our work for the Army involves providing engineering and logistics support for the Black Hawk and Comanche helicopters, as well as sophisticated electronics and communications systems. Our Test Equipment Division was awarded a $1,000,000 contract from Lockheed Martin for tactical communications processing software for a system they are developing for the Australian Defense Forces. This contract is a validation of the international market for our workstation for testing devices that receive and synthesize tactical data and positioning information from diverse military sources. The systems and test work we perform for the Navy on navigation systems for Trident missiles remains a major program at DRC. Commercial Sector Systems & Support Opportunities Building business in the systems and services area for commercial customers has been a long-stated goal, and DRC continues to make inroads into this sector. Work for commercial clients includes year 2000 computer system date change test and validation programs for a division of the General Electric Company and a New England bank, as well as re-engineering work for the manufacturing operations of a commercial aircraft equipment company. We have proposals out on several similar projects and hope to make good progress on expanding our systems business in the commercial arena in 1999. Precision Manufactured Products Results for the Precision Manufactured Products divisions were impacted by the Asian financial crisis and a related downturn in customer spending on encoder sensor devices for semiconductor and other capital equipment. However, we are teaming with product development engineers at prospective customer organizations in the automotive, medical, high technology and telecommunications sectors to create new applications for our encoder and precision electroformed devices. We expect to go into mass production with several of these devices over the next two years. Acquisition Opportunities Much of our growth over the past five years has been generated internally. We are also seeking to expand through acquisitions of profitable organizations. Criteria for potential acquisition targets are that they should offer DRC entree into a new market, specific expertise or key people that complement or extend our existing business. 1999 Objectives and Outlook Our primary objective for 1999 is to resume the earnings growth trend of the previous four years. We will accomplish this by continuing the expansion of our systems and support services into U.S. defense agencies, state health and human services divisions and the commercial sector. We are looking to increase Metrigraphics and Encoder divisions' sales with new high volume products. The defense budget has a $12 billion proposed increase in military spending for the next fiscal year and $110 billion over six years, initiatives that may well contribute to the growth of our defense business. Regardless of the outcome of these proposals, there will always be a mandate for our armed forces to control costs and operate more efficiently. DRC has key capabilities for enabling the military to maintain and manage its resources at lower costs, and we provide an invaluable repository of knowledge of the evolution and operations of large, sophisticated systems. As always, we have been buoyed along this year by the initiative, dedication and creativity of our employees. We thank them, and our shareholders, for their support. Sincerely, Albert Rand President and Chief Executive Officer John S. Anderegg, Jr. Chairman Transferring Core Competencies into New Markets Doing superlative work and winning new contracts from existing customers is a fundamental aspect of top-line growth at Dynamics Research Corporation (DRC). But aggressive growth targets call for identifying and branching out into new markets and establishing relationships with new customers. A hallmark of DRC's success has been its ability to transfer core ompetencies-disciplines in which it has proven expertise and a strong record of success-into entirely new markets or types of customers. Core competencies at DRC include providing information technology, logistics, engineering, simulation and training services for government and commercial customers, and high- precision device manufacturing for a broad variety of applications. This strategy of extending core competencies has enabled the Company to achieve an annual revenue growth rate of more than 20 percent over the past four years, and has resulted in greater diversification. In 1998, revenues derived from non-defense sources represented 41 percent of total revenues, versus 34 percent in 1997. In the pages that follow, we focus on only a few of the many ways DRC is extending its core competencies into new markets and new customers. Extending Expertise into Army Aviation Core Competency Case Study #1 Logistics and Support DRC has longstanding expertise in providing logistics and engineering services to support the maintenance and combat readiness of U.S. Air Force aircraft and Navy weapons systems. In 1996, DRC broke into a new market as a prime contractor on a five- year, $33 million contract under a U.S. Army program known as Programmatic and Technical Support (PATS). Conducted primarily out of Huntsville and Daleville, Alabama, and St. Louis, Missouri offices, DRC's work focuses on sustaining the readiness of helicopters and fixed-wing aircraft for the U.S. Army Aviation & Missile Command headquartered at nearby Redstone Arsenal. One of the main systems the Company supports is the UH-60 Black Hawk Helicopter, as well as Comanche and Apache Attack helicopters. DRC engineers and managers, half of whom are former Army helicopter pilots, assess readiness issues, conduct operating cost analyses and risk assessments, and provide acquisition support. In addition, they analyze design flaws, forecast parts availability and determine ways to integrate variant aircraft into the fleet to minimize repair and maintenance costs. Because of their experience as pilots, DRC engineers are well versed in how equipment additions or modifications may affect performance and flight characteristics. DRC also supports the Army Airborne Command and Control System, a suite of highly sophisticated electronics and communications gear installed on some Black Hawks, as well as the Tactical Airspace Integration System that helps field commanders manage a highly complex battlefield environment. Revenue under the PATS contract was approximately $8.5 million in 1998, up from $6.5 million in 1997. Recently, DRC won an additional subcontract to provide logistics and engineering support for the Army Tank, Automotive and Armaments Command (TACOM) in Warren, Michigan. Broadening Health and Human Service Markets Core Competency Case Study #2 Information Technology DRC first targeted the burgeoning market for non-defense government information technology (IT) services in 1995. Since then, propelled by federal legislation that mandates computerized tracking and management capabilities at state health and human service agencies, DRC's IT business for state governments has grown from $4.5 million in revenues in 1996 to more than $40 million in 1998. One of DRC's primary growth strategies is expanding its market penetration both vertically and horizontally within current customer agencies, into other agencies and departments, as well as into new states. DRC's work for the State of Ohio is an excellent case in point. Starting initially with a contract to provide computer hardware and networks for Ohio's Support Enhancement Tracking System, a program that keeps tabs on "deadbeat parents," DRC has expanded its work into a variety of departments. These include Ohio Works First, a training program for Welfare recipients, the Human Resources Management System, which tracks payroll for all state employees, and the Division of Acquisition Services. DRC has also introduced its logistics and supply chain management capabilities into the State government, by providing warehouse and inventory management for the Division of Health and Human Services' computer equipment and peripherals. Colorado's Department of Human Services represented a major portion of DRC's state IT work in 1998. Last June, the Company won a contract to assist the State of Arkansas with enhancement of its child welfare information system. Proposals are on the table for other major contracts with Colorado and Ohio, as well as additional states. Providing Improved Decision Analysis Tools Core Competency Case Study #3 Simulation and Modeling Warfare in the Information Age demands that leaders make crucial, high-risk decisions consistently and rapidly. An important new training tool being developed for the U.S. Army is the Warfighters' Simulation 2000, also known as WARSIM 2000. This simulation system will support the training of commanders and staff from battalion through theater-level. WARSIM 2000 will provide land warfare information for a joint services initiative intended to create a common, seamless training environment. The system will create a wide variety of battlefield scenarios across the spectrum of operations. Working as a subcontractor to Lockheed Martin, DRC subject matter experts, engineers and managers comprise more than 17 percent of WARSIM 2000 development staff, providing leadership and expertise in crucial areas.These include software and human factors engineering, database development for equipment and knowledge acquisition, as well as manpower staffing reduction analysis. In addition to its work on WARSIM, DRC is carving out a niche for itself in developing computer simulation models for re- engineering plant layout for large aircraft equipment repair shops for both military and commercial operations. DRC's work in this area began by designing computer models that analyze and improve the workflow for landing gear repair shops. The Company is currently re-engineering a plant layout for an equipment manufacturer of commercial and military aircraft, and has proposals for similar projects before several other commercial aircraft repair facilities. Developing New Applications Core Competency Case Study #4 Precision Products When Motorola-backed Iridium LLC launched the world's first satellite-based global wireless telephone and messaging system, it tapped DRC's Encoder Division to develop devices that help control antenna position for satellite-to-satellite and satellite-to-ground station communications. Collaborating closely with Iridium engineers, DRC custom designed and assembled devices that precisely calibrate and control antenna motion. Today, each of Iridium's 66 low-orbiting satellites carries 15 DRC encoders. The satellite development community looks to suppliers with proven expertise, and there are many potential applications for encoder devices. DRC is now working on several new satellite antenna-positioning applications for its encoder products. DRC's Encoder Division produces customized electro-mechanical devices that measure position in a wide range of high technology capital equipment requiring high-precision motion control. Today, DRC encoders are used in a variety of applications from semiconductor manufacturing equipment to automotive diesel fuel injection pumps. This tradition of developing devices in collaboration with customer teams carries over to DRC's Metrigraphics Division, which designs and manufactures high-precision miniature components. Metrigraphics' products are created through a process known as electroforming, whereby a thin, flexible metal film is deposited on glass, metal or other substrates. These devices are incorporated in electronic circuitry for heart catheters and ink deposition nozzles for consumer and commercial grade ink-jet printers. Currently, a variety of new applications are under development, including flexible miniature circuits for medical uses, advanced semiconductor devices and high-density disk drive components for personal computers. Supporting the Air Force Materiel Command Core Competency Case Study #5 Technical and Engineering Services Last spring, DRC won its third major contract with the U.S. Air Force Materiel Command, whose mission is to develop, deliver and maintain all Air Force systems and equipment. Under this latest contract, DRC is providing technical, engineering and administrative support for the Aeronautical Systems Center at Wright-Patterson Air Force Base in Dayton, Ohio. One of the factors contributing to DRC winning the contract was the work it performs for the Electronic Systems Center at Hanscom Air Force Base in Massachusetts and for the Air Logistics Centers' five U.S. maintenance depots. Under these earlier contracts, DRC supervises the acquisition of advanced radar, communications and computer equipment, and the logistics for locating and moving repair parts to and among the five depots. The Aeronautical Systems Center is responsible for research, development, test, evaluation and initial acquisition of aeronautical systems and related equipment for the Air Force. Its major active programs are the B-2 and B-1B bombers, C-17 airlifter, F-15, F-16 and F-22 fighters, training systems, aircraft engines, special operations forces and litigation support. Two of the programs DRC supports at Wright-Patterson are the Joint Airborne Signal Intelligence (SIGINT) and Reconnaissance Mission Area Group. DRC's team provides systems engineering, security management, test and evaluation, acquisition management, configuration and data management, and administrative support for these programs. Projects include providing hardware and software support for SIGINT computer platforms, communications acquisition support for encrypted data transfer, and the development of electro-optical multi-spectral imagery road maps. Five Year Summary of Selected Financial Data** 1998 1997 1996 1995 1994 (in thousands of dollars, except per share, share and employee data) Revenue $ 182,344 $ 156,733 $ 129,997 $ 103,941 $ 102,964 Operating income 2,459 7,807 4,283 1,018 632 Income from continuing operations 491 5,177 2,311 1,018 632 Net (loss) income (5,971) 4,129 1,729 559 224 Income from continuing operations per common share - basic* .07 .69 .31 .08 .03 Income from continuing operations per common share - diluted* .06 .66 .30 .07 .03 Net (loss) income per common share - basic* (.80) .55 .23 .08 .03 Net (loss) income per common share - diluted* (.77) .53 .22 .07 .03 Total assets 88,067 77,629 70,950 53,946 53,977 Long-term debt (excluding current portion) 26,800 10,000 300 1,500 2,717 Shareholders' investment 31,246 39,147 35,239 33,206 32,713 Shareholders' investment per share* 4.24 5.19 4.69 4.47 4.40 Return on shareholders' investment(%) (19.1) 10.6 4.9 1.7 .7 Backlog 105,427 110,001 73,200 61,284 43,679 Cash flow from operations (11,406) 7,980 1,035 7,499 5,721 Research and development expense 2,739 1,249 2,189 1,611 224 Capital expenditures 3,171 5,104 9,266 4,441 2,444 Number of shares outstanding at end of year* 7,369,190 7,546,646 7,515,630 7,422,059 7,433,512 Number of employees 1,557 1,455 1,349 1,249 1,130 Quarterly Data** 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr*** (in thousands of dollars, except per share data) unaudited 1998 Revenue $ 41,988 $ 48,317 $ 44,379 $ 47,660 Operating income (loss) 2,408 2,056 1,419 (3,424) Income (loss) from continuing operations 1,203 955 579 (2,246) Net income (loss) 637 (344) (505) (5,759) Income (loss) from continuing operations per common share - basic* .16 .13 .08 (.30) Income (loss) from continuing operations per common share - diluted* .15 .12 .07 (.30) Net income (loss) per common share - basic* .08 (.05) (.07) (.78) Net income (loss) per common share - diluted* .08 (.05) (.07) (.77) 1997 Revenue $ 32,514 $ 39,651 $ 42,649 $ 41,919 Operating income 1,144 2,061 1,938 2,664 Income from continuing operations 548 1,088 2,138 1,403 Net income 326 824 1,723 1,256 Income from continuing operations per common share - basic* .07 .14 .28 .19 Income from continuing operations per common share - diluted* .07 .14 .27 .18 Net income per common share - basic* .04 .11 .23 .17 Net income per common share - diluted* .04 .11 .22 .16 * Restated for the May 1998 20% stock dividend. ** As discussed further in Management's Discussion and Analysis, in the fourth quarter of 1998, the Company decided to discontinue operations of its Telecommunications business. Accordingly, the results of operations of this segment have been excluded from revenue, operating income and income from continuing operations in these schedules. *** Fourth quarter 1998 operating income includes $4.3 million of pre-tax charges. See Management's Discussion and Analysis of Financial Condition and Operating Results for further discussion. Management's Discussion and Analysis Results of Operations This discussion and analysis should be read in conjunction with and is intended to supplement the information set forth in the Company's consolidated financial statements and related notes. The following table sets forth, for the periods indicated, the percentage which certain items in the Consolidated Statements of Operations bear to revenue: 1998 1997 1996 Revenue: Contract revenue 84.6% 82.4% 77.5% Product sales 15.4 17.6 22.5 Total revenue 100.0 100.0 100.0 Cost of contract revenue* 91.1 88.7 90.8 Cost of goods* 78.7 75.0 69.9 Total cost of sales 89.2 86.3 86.1 Selling, engineering and administrative expenses 9.4 8.7 10.6 Total operating costs 98.6 95.0 96.7 Operating income 1.4 5.0 3.3 Interest expense, net 0.9 0.1 0.4 Income from continuing operations before provision for income taxes 0.5% 4.9% 2.9% *These amounts represent a percentage of contract revenue and product sales, respectively. The following comments should be read in conjunction with the foregoing table: Year Ended December 31, 1998 Compared to Year Ended December 31, 1997 Total revenues from continuing operations increased 16.3% to $182,344,000 for the year ended December 31, 1998 compared with $156,733,000 for the year ended December 31, 1997. Contract revenue for the systems and service segment increased by 19.5% or $25,201,000 in 1998 over 1997. Growth in the systems and services segment was principally attributable to performance on two major state contracts as well as broad based growth in the Company's defense business. The Company is providing the State of Ohio's Department of Health and Human Services with statewide computer network infrastructure. DRC is providing similar infrastructure, as well as software implementation services to the State of Colorado's child protection and juvenile justice agencies. Much of the Company's revenue relates to the development and operation of computer-based management information and logistics support systems, as well as other information technology services. Product sales increased 1.5% or $410,000 in 1998 as compared with 1997. In 1998, the Company achieved higher sales of electroformed components to several customers, including the Company's primary customer in the inkjet printer market, and increased sales to a customer in the automotive industry. This growth was substantially offset by reduced sales of encoders which were adversely affected by the Asian financial and economic crisis during 1998. Cost of contract revenue as a percentage of contract revenue increased to 91.1% in 1998 from 88.7% in 1997. In the fourth quarter of 1998, after a thorough evaluation of program performance and negotiations with the customer, the Company recorded a charge of $2,600,000 that relates to an estimated overrun on a state contract. Also included in the fourth quarter is a charge of $1,700,000 to cover certain defense contract overruns and other expenses. These charges are all reflected in the systems and services segment. Cost of goods as a percentage of product sales increased from 75.0% in 1997 to 78.7% in 1998. This increase is the result of an increase in per unit depreciation expense of certain equipment, costs related to the installation of new manufacturing software and reductions in encoder sales, offset somewhat by higher sales of electroformed components. During 1997, a large customer reduced its estimated purchases from DRC. As a result of the reduction in this estimate, beginning in the fourth quarter of 1997, management increased the per unit depreciation of equipment used to manufacture this product. The effect of this change was to increase depreciation expense $1,163,000 in 1998 and $219,000 in 1997. Included in cost of goods is $887,000 and $979,000 in 1998 and 1997, respectively, related to effort on the Company's VisualMagic software development environment product. At the end of 1998, the Company adopted a plan to sell the telecommunications fraud control business unit as the result of changes in the telecommunications marketplace that delayed near- term sales goals and increased the Company's estimate of the capital required to take advantage of this market. Accordingly, results from the telecommunications business are shown as discontinued operations and prior years have been restated to conform to this presentation. The total loss from discontinued operations includes operating losses incurred through the date on which the discontinuance plan was adopted, estimated future operating losses through September 1999, as well as other estimated costs associated with the disposal of the business. Estimated operating losses of $3,487,000 for the period subsequent to the adoption of the exit plan through the anticipated date of sale are included in the loss on disposal. The results of discontinued operations do not reflect any interest expense or any allocation of corporate management expense. Revenues of the telecommunications business were $2,775,000, $2,644,000 and $166,000 for the years ended December 31, 1998, 1997 and December 28, 1996, respectively. Net operating losses of the telecommunications business were $5,879,000, $1,562,000 and $938,000 for the years ended December 31, 1998, 1997 and December 28, 1996, respectively. These amounts are not included in sales or operating income as reported in the Consolidated Statements of Income. Selling, engineering and administrative expenses increased by 26.3% or $3,580,000 in 1998 from 1997. This increase is the result of a number of factors. The increase in revenues generated overall growth in corporate, accounting and financial salaries, wages and expenses to support the resultant increase in transaction processing. During 1998, and to a lesser extent in 1997, the Company realized an increase in consulting expenses and temporary labor related to accounting system changes. During 1998, the systems and services segment expended a significant amount of effort on developing a new software product for sale to the U.S. Air Force and other defense contractors. Included in selling, engineering and administrative expenses is $972,000 and $1,029,000 in 1998 and 1997, respectively, related to the VisualMagic selling effort. In the fourth quarter of 1998, the Company entered into an agreement with Empresa, Inc. (Empresa), formerly Electronic Press Services Group, Inc., to acquire an interest in Empresa in exchange for a perpetual license to VisualMagic, cash and the assets of the business. The terms of the agreement provide for the Company to make three cash investments: one at the closing December 23, 1998, the second in February 1999 and the last in May 1999. Interest expense, net, increased to $1,612,000 in 1998 from $108,000 in 1997 as a result of the Company's higher average borrowing in 1998. Interest expense in 1997 benefited from an interest credit of $740,000 related to a refund of federal taxes. Substantial revenue growth and delays in billing certain state customers in 1998 were the principal factors requiring higher working capital that was funded with additional borrowing. Capital expenditures in 1998 of $3,171,000 consist mainly of spending on information technology equipment, office facilities and manufacturing equipment. The provision for income taxes was 42.0% of income from continuing operations before taxes in 1998, compared to 32.8% in 1997. The Company's 1997 tax provision reflects a one-time benefit of $747,000 resulting from a refund of income taxes relating to prior years' research and development expenses. The Company's backlog of unfilled orders at the end of 1998 decreased 4.2% to $105,427,000 compared to $110,001,000 at the end of 1997. The 1997 balance included a $28,300,000 state contract award with a 2 1/2 year period of performance. A portion of the Company's backlog is based on annual purchase contracts and the amount of the backlog as of any date can be affected by the timing of such order receipts and deliveries thereunder. Year Ended December 31, 1997 Compared to Year Ended December 28,1996 Total revenues from continuing operations increased 20.6% to $156,733,000 for the year ended December 31, 1997 compared to $129,997,000 for the year ended December 28, 1996. Approximately 60% of the increase in the systems and services segment contract revenue is attributable to the major contracts with the states of Ohio and Colorado, discussed above. The remainder of the increase was broad-based with growth contributions from additional work received under the Company's long running core Navy program, technical and management services programs for the U.S. Army, Air Force and Navy and services for the U.S. Department of the Treasury. Product sales decreased 5.8% to $27,598,000 for the year ended December 31, 1997 compared to $29,285,000 for the year ended December 28, 1996. The decrease is principally the result of decreased sales of electroformed components, partially offset by increased sales of custom encoders. Cost of contract revenue as a percentage of contract revenue decreased to 88.7% in 1997 from 90.8% in 1996. In the fourth quarter of 1996, the Company incurred a pre-tax charge of $1,800,000 for unrecoverable costs associated with an Air Force contract. Cost of goods as a percentage of product sales increased from 69.9% in 1996 to 75.0% in 1997. The decreased gross margin percentage is primarily the result of lower sales of electroformed components. Included in cost of goods is $979,000 and $2,095,000 in 1997 and 1996, respectively, related to effort on the Company's VisualMagic software development environment product. Selling, engineering and administrative expenses as a percentage of revenues decreased from 10.6% in 1996 to 8.7% in 1997, reflecting a minimal decrease in overall expenditures while revenues grew 20.6%. Included in selling, engineering and administrative expenses is $1,029,000 and $0 in 1997 and 1996, respectively, related to the VisualMagic selling effort. Interest expense, net, decreased 80.3% to $108,000 in 1997 from $547,000 in 1996. Included in 1997 net interest expense is interest income of $740,000 related to an income tax credit received during the year, partially offset by increased interest expense resulting from an increase in the Company's average borrowing level. Capital expenditures decreased to $5,104,000 in 1997 compared to $9,266,000 in 1996. Included in 1996 capital expenditures are approximately $4,900,000 to increase electroforming manufacturing capacity. In January 1996, the Company acquired the local operations of a defense services business for $2,000,000. The Company's effective tax rate for 1997 was 32.8% compared to 38.2% for 1996. As discussed previously, the Company's 1997 tax provision reflects a one-time benefit of $747,000 resulting from a refund of income taxes related to prior years' research and development credits. The Company's backlog at the end of 1997 was $110,001,000 compared with $73,200,000 at the end of 1996 reflecting the December 1997 award of a $28,300,000 contract with the State of Colorado. Liquidity and Capital Resources During 1998, the Company's primary source of liquidity has been its revolving credit facility. Working capital requirements, primarily related to the substantial increase in sales and delays in billing certain government customers, have been funded with additional borrowings under the Company's credit facility. Working capital increased to $39,223,000 at December 31, 1998 from $27,394,000 at December 31, 1997. This increase was primarily attributable to increases in receivables. Debt increased $16,800,000 to $26,800,000 to support the increase in working capital. The Company spent $2,272,000 during 1998 for the purchase of treasury shares compared with $768,000 during 1997. At December 31, 1998, $13,200,000 was available for working capital purposes under the Company's revolving credit facility. The Company believes that its current assets, cash flow from operations and available bank lines of credit will be sufficient to support its normal operating and capital requirements for 1999. The Company did not have any significant capital commitments at December 31, 1998 outside the ordinary course of business. Impact of Inflation and Changing Prices Overall, inflation has not had a material impact on the Company's operations. In addition, the terms of Defense contracts, which accounted for approximately 59% of the Company's revenues in 1998, are generally for one year and include salary increase factors for future years, thus reducing the potential impact of inflation on the Company. Year 2000 Disclosure Many existing computer programs use only two digits, rather than four, to represent a year. Date-sensitive software or hardware written or developed in this fashion may not be able to distinguish between 1900 and 2000, and programs written in this manner that perform arithmetic operations, comparisons or sorting of date fields may yield incorrect results when processing a Year 2000 date. This Year 2000 problem could potentially cause system failures or miscalculations that could disrupt operations. The Company's State of Readiness The Company is in the process of identifying and remediating Year 2000 issues in four areas: (i) information technology ("IT") and financial systems, (ii) non-IT systems, (iii) third-party vendors and suppliers and (iv) systems it has implemented and maintains for various customers. The Company believes its IT and non-IT systems will be Year 2000 compliant by the end of 1999. The Company has completed a review of its financial and other significant IT systems and is in the process of remediating identified material Year 2000 problems. The primary required hardware and operating system platform upgrade was completed in February 1999. Necessary application upgrades or remediation and testing are expected to be completed by mid-1999. The Company also conducted a review of all its other computers earlier in 1998 (including desktops, servers and mainframes) and has addressed all material Year 2000 problems. The Company's computer and equipment vendors have been contacted to verify Year 2000 compliance. Based on their responses, products requiring replacement or upgrade are expected to be Year 2000 compliant by mid-1999. In the case of third party licensed commercial off-the-shelf products, the Company has determined that they are either Year 2000 compliant or the licensor has released a compliant version that the Company will migrate to by mid-1999. While the Company expects that all financial and significant IT-related systems will be Year 2000 compliant by mid-1999, there can be no assurance that corrective actions will be completed in a timely manner. The Company has completed a full review of all process control components, including safety equipment, in manufacturing and production facilities. Currently, the Company is in the process of upgrading or replacing certain components of the phone, security, building access, HVAC and lighting systems, which is expected to be completed by mid-1999. The Company anticipates that all other process control components will be Year 2000 compliant by mid-1999. However, there can be no assurance that such upgrades and replacements will occur in a timely manner. The Company requested Year 2000 compliance information from its employee benefit service suppliers and received responses from all suppliers in early 1999. The Company is currently aware of one supplier that has a Year 2000 compliance issue and is working toward a resolution of such issue by mid-1999. The Company is also in the process of developing Year 2000 questionnaires to be sent to its major power, energy and communications service suppliers beginning in early 1999. The Company expects to have addressed all Year 2000 issues with third party suppliers by mid-year 1999. The Company has contacted its suppliers of financial services regarding computer interface changes and has requested the status of their Year 2000 programs, if this information is not readily available on their web-sites. Any necessary interface upgrades are expected to be completed by mid-1999, although the completion of such upgrades in a timely manner depends upon the readiness and willingness of suppliers to cooperate and provide this information in a timely manner, and cannot be assured. However, the Company intends to identify and prioritize critical suppliers and communicate with them regarding their plans and progress in addressing Year 2000 issues. The Company is in the process of completing its Year 2000 remediation, validation testing and implementation activities for systems it had previously implemented and has continued to maintain for various customers. This process was completed and tested in early 1999. The Company previously developed and marketed commercial off-the-shelf products which are currently Year 2000 compliant. The Company's Year 2000 Risk Based on the efforts described above, the Company currently believes that its systems will be Year 2000 compliant in a timely manner. The Company has completed the process of identifying Year 2000 issues in its IT and non-IT systems and expects to complete any remediation efforts by mid-1999. However, there can be no assurance that all Year 2000 problems will be successfully identified, or that the necessary corrective actions will be completed in a timely manner. Failure to successfully identify and remediate Year 2000 problems in critical systems in a timely manner could have a material adverse effect on the Company's results of operations, financial position or cash flow. In addition, the Company believes that there is risk relating to significant service suppliers' failure to remediate their Year 2000 issues in a timely manner. Although the Company is communicating with its suppliers regarding the Year 2000 problem, the Company does not know whether these suppliers' systems will be Year 2000 compliant in a timely manner. If one or more significant suppliers are not Year 2000 compliant, this could have a material adverse effect on the Company's results of operations, financial position or cash flow. The Company's Contingency Plans The Company intends by mid-year 1999 to develop contingency plans to be implemented in the event planned solutions prove ineffective in solving Year 2000 compliance. If it were to become necessary for the Company to implement a contingency plan, it is uncertain whether such plan would succeed in avoiding a Year 2000 issue which may otherwise have a material adverse effect on the Company's results of operations, financial position or cash flow. The Company's Costs of Year 2000 Remediation The Company anticipates the total identified cost of its Year 2000 effort will be between $380,000 and $475,000, of which it has expensed approximately $148,000 as of December 31, 1998. The estimate excludes labor costs which predated the formal corporate Year 2000 effort and certain current labor costs at the divisional level which would be difficult to track. The total cost estimate includes estimated and actual amounts to remediate or replace certain software, routers, security chips, the phone system and any other items or systems identified in the Year 2000 effort, consulting fees for a Year 2000 review, and approximately $200,000 of redeployed labor expense. The total estimated cost of redeployed labor within the corporate information systems department is equal to approximately 9% of that department's total maintenance labor budget through the end of the Year 2000 effort. There can be no assurance that the costs associated with the Year 2000 problem will not be greater than anticipated. The Company has deferred a financial and project accounting system upgrade due to its Year 2000 efforts, but does not believe such deferral will have a material adverse effect on the Company's business. Forward-Looking Information This report includes certain forward-looking statements about the Company's business including the effect of the federal budget on the Company's sales, response to the Company's product and services offerings, growth in revenues, expected performance under certain contracts, capital spending, research and development spending and customer mix. Such forward-looking statements are subject to risk and uncertainties that could cause the actual results to vary materially. These risks and uncertainties, discussed in more detail in the Company's Form 10-K for the year ended December 31, 1998, include possible reductions in federal and state funding for the Company's customers and potential customers, concentration of customers, risks of sustaining existing contracts and orders thereunder at the same or increasing levels and obtaining of new contracts, high levels of competition and difficulties of entering new markets, government contracting issues including audit adjustments and costs of completing fixed price contracts, supply difficulties, warranty claims, and factors affecting the business segments in which the Company operates and the economy generally. Consolidated Balance Sheets At December 31, l998, December 31, 1997 and December 28, 1996 1998 1997 1996 (in thousands of dollars, except share data) Assets Current assets: Cash and cash equivalents $ 97 $ 542 $ 234 Receivables, less allowances of $316, $217 and $340 33,016 17,100 19,436 Unbilled expenditures and fees on contracts in process 32,169 32,297 22,690 Inventories 2,647 3,377 3,211 Refundable income taxes 9 878 1,436 Prepaid expenses and other current assets 958 1,657 1,236 Total current assets 68,896 55,851 48,243 Property, plant and equipment, at cost: Land 1,126 1,126 1,126 Building 7,774 7,774 7,774 Machinery and equipment 39,790 37,933 38,703 Leasehold improvements 2,481 2,296 2,109 Total property, plant and equipment, at cost 51,171 49,129 49,712 Less-accumulated depreciation and amortization 32,742 27,945 28,249 Net property, plant and equipment 18,429 21,184 21,463 Other non-current assets 742 594 1,244 Total assets $ 88,067 $ 77,629 $ 70,950 Liabilities and Shareholders' Investment Current liabilities: Notes payable $ - $ - $ 10,600 Accounts and drafts payable 10,300 8,355 8,925 Accrued payroll and employee benefits 7,782 7,981 6,991 Other accrued expenses 2,630 4,251 894 Current deferred income taxes 7,189 9,048 6,091 Net liabilities (assets) of discontinued operations 1,772 (1,178) (139) Current portion of long-term debt - - 1,201 Total current liabilities 29,673 28,457 34,563 Long-term debt, less current portion 26,800 10,000 300 Deferred income taxes 348 25 848 Commitments and contingencies Shareholders' Investment Preferred stock, par value $.10 per share, 5,000,000 shares authorized, none issued Common stock, par value $.10 per share: Authorized - 30,000,000 shares Issued - 8,733,016 shares at December 31, 1998, 7,366,484 shares at December 31, 1997 and 6,689,767 shares at December 28, 1996 873 737 669 Less: Treasury stock - 1,363,826 shares at December 31, 1998, 1,077,612 shares at December 31, 1997 and 996,108 shares at December 28, 1996, at par value (136) (108) (100) Capital in excess of par value 27,474 14,506 9,516 Retained earnings 3,035 24,012 25,154 Total shareholders' investment 31,246 39,147 35,239 Total liabilities and shareholders' investment $ 88,067 $ 77,629 $ 70,950 The accompanying notes are an integral part of these consolidated financial statements. Consolidated Statements of Operations For the three years ended December 31, 1998 1998 1997 1996 (in thousands of dollars, except per share and share data) Revenue: Contract revenue $154,336 $129,135 $100,712 Product sales 28,008 27,598 29,285 Total revenue 182,344 156,733 129,997 Costs and expenses: Cost of contract revenue 140,653 114,603 91,408 Cost of goods 22,029 20,700 20,476 Selling, engineering and administrative expenses 17,203 13,623 13,830 Total operating costs and expenses 179,885 148,926 125,714 Operating income 2,459 7,807 4,283 Interest expense, net 1,612 108 547 Income from continuing operations before provision for income taxes 847 7,699 3,736 Provision for income taxes 356 2,522 1,425 Income from continuing operations 491 5,177 2,311 Loss from discontinued operations, net of applicable tax benefit of $1,989, $514 and $356 in 1998, 1997 and 1996, respectively (3,890) (1,048) (582) Loss on disposal of discontinued operations, net of applicable benefit for income taxes of $1,576 in 1998 (2,572) - - Loss from discontinued operations (6,462) (1,048) (582) Net income (loss) $ (5,971) $ 4,129 $ 1,729 Per share data Per common share - basic Income from continuing operations* $ .07 $ .69 $ .31 Net income (loss)* $ (.80) $ .55 $ .23 Per common share - diluted Income from continuing operations* $ .06 $ .66 $ .30 Net income (loss)* $ (.77) $ .53 $ .22 Weighted average shares Basic* 7,501,604 7,530,546 7,491,804 Diluted* 7,771,315 7,807,216 7,760,209 * Restated for the May 1998 20% stock dividend. The accompanying notes are an integral part of these consolidated financial statements. Consolidated Statements of Shareholders' Investment For the three years ended December 31, 1998 Common Stock Capital in Issued Treasury Stock Excess of Retained Shares Par Value Shares Par Value Par Value Earnings (in thousands) Balance at December 30, 1995 6,619 $ 662 (996) $ (100) $ 9,219 $ 23,425 Year 1996 Stock options exercised 71 7 - - 297 - Net income - - - - - 1,729 Balance at December 28, 1996 6,690 $ 669 (996) $ (100) $ 9,516 $ 25,154 Year 1997 Stock options exercised 107 11 - - 540 - Treasury stock acquired - - (82) (8) (760) - 10% Stock dividend 569 57 - - 5,210 (5,271) Net income - - - - - 4,129 Balance at December 31, 1997 7,366 $ 737 (1,078) $ (108) $ 14,506 $ 24,012 Year 1998 Stock options exercised 103 10 - - 581 - Treasury stock acquired - - (286) (28) (2,489) - 20 % Stock dividend 1,264 126 - - 14,876 (15,006) Net loss - - - - - (5,971) Balance at December 31, 1998 8,733 $ 873 (1,364) $ (136) $ 27,474 $ 3,035 The accompanying notes are an integral part of these consolidated financial statements. Consolidated Statements of Cash Flows For the three years ended December 31, 1998 1998 1997 1996 (in thousands of dollars) Cash provided by operations: Net (loss) income $ (5,971) $ 4,129 $ 1,729 Adjustments to reconcile net income to cash provided by operating activities: Loss from discontinued operations 6,462 1,048 582 Depreciation and amortization 6,219 5,240 4,910 Increase (decrease) in deferred income taxes 323 (823) (128) Provision for receivable reserves 99 (123) (62) 7,132 9,471 7,031 Cash provided by (used for) working capital: Receivables (16,015) 2,459 (3,279) Unbilled expenditures and fees on contracts in process 128 (9,607) (6,307) Inventories 730 (166) (599) Refundable income taxes 869 558 (1,150) Prepaid expenses and other current assets 699 (421) 48 Accounts and drafts payable 1,945 (570) 5,375 Accrued payroll and employee benefits (199) 990 575 Other accrued expenses (1,621) 3,357 (1,780) Current deferred income taxes (1,859) 2,957 1,684 (15,323) (443) (5,433) Net cash (used for) provided by continuing operations (8,191) 9,028 1,598 Net cash used for discontinued operations (3,215) (1,048) (563) Cash (used for) provided by operating activities (11,406) 7,980 1,035 Cash used for investing activities: Additions to property and equipment related to continuing operations, net (2,874) (4,065) (9,108) Additions to property and equipment related to discontinued operations, net (297) (1,039) (158) Investments and acquisitions (742) (250) (2,000) Net cash used for investing activities (3,913) (5,354) (11,266) Cash provided by (used for) financing activities: Net borrowings (repayments) under line of credit agreements 16,800 (10,600) 10,600 Principal payment under long-term borrowings - 8,499 (1,216) Proceeds from exercise of stock options 346 551 304 Purchase of treasury shares (2,272) (768) - Net cash provided by (used for) financing activities 14,874 (2,318) 9,688 Net increase (decrease) in cash and cash equivalents (445) 308 (543) Cash and cash equivalents at the beginning of the year 542 234 777 Cash and cash equivalents at the end of the year $ 97 $ 542 $ 234 Supplemental disclosures of cash flow information and non-cash items: Cash paid during the year for: Interest $ 1,640 $ 792 $ 635 Income taxes $ 150 $ 430 $ 1,237 Cashless option exercise $ 245 $ - $ - The accompanying notes are an integral part of these consolidated financial statements. Notes to Consolidated Financial Statements 1. Nature of the Business and Summary of Significant Accounting Policies Nature of the Business Founded in 1955, Dynamics Research Corporation ("the Company" or "DRC") develops and operates computer and communications- intensive information systems, provides engineering, management support and information technology services, and produces precision manufactured components for industrial measurement and control. Principles of Consolidation The accompanying consolidated financial statements include the accounts of Dynamics Research Corporation and its wholly-owned subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation. Revenue Recognition and Unbilled Expenditures and Fees on Contracts in Process The Company provides services under fixed-price, cost- reimbursement, time and material, and level of effort contracts. Revenues under cost-reimbursement and fixed-price contracts are recognized as costs are incurred and include applicable fees in the proportion that costs incurred bear to total estimated costs. When a loss is indicated on any contract in process, provision for the total estimated loss is made at that time. For time and material and level of effort types of contracts, revenues are recorded as the costs are incurred. Unbilled expenditures and fees on contracts in process represent the recoverable amounts of contract revenue under contracts in process which were not billable at the balance sheet date. Such amounts generally become billable upon completion of a specific phase of the contract, negotiation of contract modifications, completion of government audit or upon acceptance by the government. Unbilled expenditures and fees on contracts in process with the U.S. Government at December 31, 1998 were $18,230,000 compared to $26,083,000 at December 31, 1997, and $16,904,000 at December 28, 1996. Unbilled expenditures and fees on contracts in process with state governments were $12,833,000, $2,839,000 and $469,000 at December 31, 1998 and 1997 and December 28, 1996, respectively. Costs related to certain contracts, including applicable indirect costs, are subject to audit by the U.S. Government. Revenues from such contracts have been recorded at amounts expected to be realized upon final settlement. Overhead and general and administrative costs charged to U.S. Government contracts are subject to audit for years after 1996. Revenue from sales of precision products is recorded at the time the goods are shipped or when title passes. Income Taxes The Company accounts for income taxes using the liability method as set forth in Statement of Financial Accounting Standards No. 109 (SFAS No. 109), "Accounting for Income Taxes." Under the liability method, deferred taxes are determined based upon the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The deferred tax provision represents the change in the deferred tax asset/liability balance. Cash and Cash Equivalents The Company considers all cash investments with original maturities of three months or less to be cash equivalents. U.S. Government Contracts The approximate number of U.S. Government contracts has varied between 100 and 150 during the past five years, with 101 contracts open at December 31, 1998. Receivables under U.S. Government contracts at December 31, 1998 were $18,508,000 compared to $8,808,000 at December 31, 1997, and $14,363,000 at December 28, 1996. Inventories Inventories are stated at the lower of cost (first-in, first-out) or market, and consist of materials, labor and overhead. There are no amounts in inventories relating to contracts having production cycles longer than one year. 1998 1997 1996 (in thousands of dollars) Work in process $ 475 $ 1,364 $ 1,411 Raw materials and subassemblies 2,172 2,013 1,800 Total $ 2,647 $ 3,377 $ 3,211 Property, Plant & Equipment Property, plant and equipment are recorded at cost. Depreciation and amortization are provided in amounts sufficient to amortize the cost of such assets over their estimated useful lives using principally the straight-line method for plant and equipment. Certain manufacturing equipment is depreciated under a units of production method. Late in 1997, based on a reduced estimate of future purchases by certain customers, management increased the per unit depreciation charge accordingly. The result of this change in estimate was to increase depreciation expense by approximately $1,163,000 during 1998. The effect upon 1997 depreciation expense was to increase depreciation expense $219,000. Leasehold improvements are amortized over the remaining term of the lease or the life of the related asset, whichever is shorter. Fair Value of Financial Instruments SFAS No. 107, "Disclosure About Fair Value of Financial Instruments," requires certain disclosures regarding the fair value of financial instruments. Cash and cash equivalents, accounts receivable, unbilled expenditures and fees on contracts in process, accounts payable and accrued liabilities are reflected in the consolidated financial statements at fair value because of the short-term maturity of these instruments. The fair value of long- term debt approximates carrying value as the debt bears interest at a variable market rate. New Accounting Pronouncements The Company adopted SFAS No. 130, "Reporting Comprehensive Income," in the first quarter of 1998. SFAS No. 130 requires the reporting and presentation of comprehensive income. The adoption of SFAS No. 130 did not have a material effect on the Company's financial statements. DRC adopted SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits" during 1998. Note 4, Employee Benefit Plans, includes the disclosures required under SFAS No. 132. Reclassifications Certain prior period amounts have been reclassified to conform to the current year presentation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Stock-Based Compensation The Company accounts for its stock-based compensation plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS No. 123, "Accounting for Stock-Based Compensation" establishes a fair value based method of accounting for stock-based compensation plans. The Company adopted the disclosure alternative under SFAS No. 123, which requires the presentation of the pro forma effects on earnings and earnings per share as if SFAS No. 123 had been adopted, as well as the disclosure of certain other information. See Note 6, Stock Option Plans, for required disclosures. Net Income Per Common Share SFAS No. 128, "Earnings per Share," requires the computation of basic and diluted 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 year. Diluted earnings per share is determined by giving effect to the exercise of stock options using the treasury stock method. Year Ended December 1998 1997 1996 (in thousands of dollars, except per share data) Income from continuing operations $ 491 $ 5,177 $ 2,311 Net (loss) Income (5,971) 4,129 1,729 Weighted-average shares* 7,502 7,531 7,492 Dilutive effect of options* 269 276 268 Adjusted weighted-average shares 7,771 7,807 7,760 Income from continuing operations per share - basic* $ .07 $ .69 $ .31 Net (loss) income per share - basic* $ (.80) $ .55 $ .23 Income from continuing operations per share - diluted* $ .06 $ .66 $ .30 Net (loss) income per share - diluted* $ (.77) $ .53 $ .22 *Restated for the May 1998 20% stock dividend. 2. Discontinued Operations Since 1996, the Company has been licensed to enhance, market and maintain a telecommunications fraud control system developed by Pacific Bell Telephone Company. DRC has made significant investments in this and related systems and software technologies to broaden the types of telephone fraud detected and to position the product for sale to competitive local exchange carriers and others. The Company's customers include the regional Bell operating telephone companies. A number of recent changes in the telecommunications marketplace have delayed near-term sales goals and increased the estimated capital required to take advantage of this expanding market. After careful analysis, management proposed to the Board of Directors that the Company exit the Telecommunications business. In December 1998, with the Board's approval, the Company adopted an overall plan of disposal. The plan of disposal includes estimated operating losses through September 1999, and proceeds from the sale of the business. Accordingly, results from the Telecommunications business are shown as discontinued operations and prior years are restated to conform to this presentation. Estimated operating losses of $3,487,000 for the period subsequent to the adoption of the exit plan through the anticipated date of sale are included in the loss on disposal. The results of discontinued operations do not reflect any interest expense or any allocation of corporate management expense. Revenues of the Telecommunications business were $2,775,000, $2,644,000 and $166,000 for the years ended December 31, 1998, 1997 and December 28, 1996, respectively. Net operating losses of the Telecommunications business were $5,879,000, $1,562,000 and $938,000 for the years ended December 31, 1998, 1997 and December 28, 1996, respectively. The consolidated financial statements of DRC have been restated to reflect the discontinuation of the Telecommunications business. Accordingly, the revenues, costs and expenses, assets and liabilities and cash flows of the Telecommunications business have been excluded from the respective captions in the Consolidated Statements of Operations, Consolidated Balance Sheets and Consolidated Statements of Cash Flows, and have been reported as "Loss from discontinued operations," net of applicable income taxes; as "Net liabilities (assets) of discontinued operations," and as "Net cash used for discontinued operations" for all periods presented. 3. Income Taxes The components of the provisions (benefit) for federal and state income taxes are as follows: 1998 1997 1996 (in thousands of dollars) Currently payable (refundable) Federal $ 1,301 $ (747) $ (189) State 402 - (101) Total 1,703 (747) (290) Deferred Federal (1,073) 2,881 1,286 State (274) 388 429 Total (1,347) 3,269 1,715 Total provision $ 356 $ 2,522 $ 1,425 The major items contributing to the difference between the statutory U.S. federal income tax rate of 34% and the Company's effective tax rates are as follows: 1998 1997 1996 (in thousands of dollars) Provision on income from continuing operations at statutory rate $ 288 $ 2,618 $ 1,270 State income tax, net of federal tax benefit 50 457 222 Tax credit refund - (747) - Other, net 18 194 (67) Provision for income taxes $ 356 $ 2,522 $ 1,425 The tax effects of significant temporary differences that comprise the deferred tax assets and liabilities as of December 31, 1998 and 1997 and December 28, 1996 are as follows: 1998 1997 1996 (in thousands of dollars) Unbilled costs and fees and deferred contract revenue, net $ (10,279) $ (11,123) $ (8,730) Accrued expenses 2,422 1,961 2,044 Receivable reserves 127 88 130 Inventory reserves 608 16 239 Other (67) 10 226 Current deferred tax liabilities, net (7,189) (9,048) (6,091) Accelerated tax depreciation (319) 54 (279) State net operating loss carryforwards 392 213 - Other (421) (292) (569) Non-current deferred tax liabilities (348) (25) (848) Total deferred tax liabilities, net $ (7,537) $ (9,073) $ (6,939) Total deferred tax assets and total deferred tax liabilities were $6,592,000 and $14,129,000, respectively at December 31, 1998 compared with $4,934,000 and $14,007,000, and $2,639,000 and $9,578,000 respectively at December 31, 1997 and December 28, 1996. 4. Employee Benefit Programs The Company has a noncontributory defined benefit pension plan covering substantially all of its employees. Pension plan benefits are generally based on years of service and compensation during final years of employment. The Company's funding policy is to contribute at least the minimum amount required by the Employee Retirement Income Security Act of 1974 or additional amounts to assure that plan assets will be adequate to provide retirement benefits. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. Net periodic pension cost included the following components: 1998 1997 1996 (in thousands of dollars) Service cost - benefits earned during the period $ 1,933 $ 1,555 $ 1,380 Interest cost on projected benefit obligation 2,499 2,235 2,031 Expected return on plan assets (2,723) (2,304) (2,079) Amortization of prior service cost 220 220 220 Amortization of transition obligation 35 35 35 Net periodic pension cost $ 1,964 $ 1,741 $ 1,587 The following table sets forth the changes in the plan's funded status and the amounts recognized in the Company's consolidated balance sheet at December 31, 1998 and 1997 and December 28, 1996: 1998 1997 1996 (in thousands of dollars) Actuarial present value of benefit obligations: Accumulated benefit obligations $ 35,461 $ 30,226 $ 27,098 Projected benefit obligations at beginning of year $ 35,693 $ 30,832 $ 28,013 Service cost-benefits earned during the period 1,933 1,555 1,380 Interest cost on projected benefit obligation 2,499 2,235 2,031 Benefits paid (934) (760) (642) Actuarial loss 2,881 1,831 50 Projected benefit obligations at end of year 42,072 35,693 30,832 Fair value of plan assets at beginning of year 30,256 25,609 23,104 Actual return on plan assets 2,998 3,486 1,599 Employer contributions 2,276 1,921 1,548 Benefits paid (934) (760) (642) Fair value of plan assets at end of year 34,596 30,256 25,609 Plan assets less than projected benefit obligation 7,476 5,437 5,223 Unrecognized net transition asset (105) (140) (175) Unrecognized prior service costs (1,479) (1,699) (1,919) Unrecognized net actuarial loss (3,983) (1,377) (727) Accrued pension liability 1,909 2,221 2,402 Weighted average assumptions: Discount rate 6.5% 7.0% 7.3% Rate of compensation increase 4.0% 4.0% 3.5% Expected rate of return on assets 9.0% 9.0% 9.0% Plan assets consist primarily of equity and fixed income securities. Fluctuations in the fair market value of plan assets will affect pension expense in future years. The Company has established a Supplemental Executive Retirement Plan ("SERP") for a certain key employee providing for annual benefits commencing on the sixth anniversary of the Executive's retirement. The cost of these benefits is being charged to expense and accrued using a projected unit credit method. Expense related to this plan was $0 and $203,000 for the years ended December 31, 1998 and 1997, respectively. The Company maintains a cash or deferred savings plan (401(k) plan), under which employees may reduce their compensation and have such "elective deferrals" contributed to the plan on their behalf. The Company contributes to the plan an amount equal to 25% of the first 6% of an employee's elective deferrals. The Company contributed $882,481 to the plan for 1998, $719,099 for 1997 and $634,462 for 1996. The elective deferrals are invested in one or more collective investment funds at the participant's direction. The Company's contributions are invested in guaranteed investment contracts and are paid to the employee upon termination, subject to forfeiture of any non-vested portion if termination occurs within the first five years of employment. 5. Lines of Credit and Long-Term Debt Long-term debt at December 31, 1998 and 1997 and December 28, 1996 consists of the following: 1998 1997 1996 (in thousands of dollars) Long-term credit facility $ 26,800 $ 10,000 $ - Mortgage note payable - - 1,500 Other - - 1 Less - current portion - - (1,201) $ 26,800 $ 10,000 $ 300 The Company amended its existing long-term credit agreement with a syndicate of banks and financial institutions during 1998. The amended agreement provides an unsecured working capital loan of up to $40 million. The agreement expires in October 2000 and is renewable annually. Interest on outstanding balances is at the prime rate plus an applicable margin or, at the Company's option, LIBOR rate plus an applicable margin based upon the Company's debt coverage ratio. A fee of 0.375% is assessed upon any unused portion of the credit line. The agreement subjects the Company to various financial covenants, including maintaining a minimum tangible net worth as well as cash flow and debt coverage ratios. The mortgage note payable to a bank was secured by certain land and buildings and was paid in full in May 1997. The mortgage bore interest at LIBOR plus 1%, adjusted quarterly, and was due in quarterly payments of $300,000. The Company had unsecured lines of credit at December 28, 1996, with various banks that provided for maximum borrowings of $19,000,000, of which $10,600,000 was utilized. Borrowings under these lines of credit were payable upon demand with interest at the prevailing prime interest rate or at a lower rate quoted by the respective banks. The Company's average interest rate on outstanding borrowings at December 31, 1998 and 1997 and December 28, 1996 was 8.0%, 6.4% and 6.3%, respectively. 6. Stock Option Plans The Compensation Committee of the Board of Directors administers the Company's stock option plans and determines the employees who will receive options as well as the number and exercise price of each such option. The 1993 Equity Incentive Plan permits the Company to grant stock options, stock appreciation rights, awards of nontransferable shares of restricted common stock and deferred grants of common stock. Options also remain outstanding under the Company's 1983 Stock Option Plan, which terminated in 1993. Options granted under both plans may be either incentive stock options or non-qualified stock options. The option price may not be less than the fair market value at the date of grant in the case of incentive stock options, and the option period may not exceed 10 years from the date of grant. Options granted under the plans are generally exercisable in three equal installments commencing one year from the date of the grant. The Company's 1995 Stock Option Plan for Non-Employee Directors provides for each outside director to receive options to purchase 5,000 shares of Common Stock at the first annual meeting at which such director is elected, and options to purchase 1,000 shares of Common Stock at each annual meeting thereafter so long as he or she remains an eligible director. Such directors cannot be an employee of the Company or one of its subsidiaries or a holder of five percent or more of the Company's Common Stock. The exercise price of such options is equal to the fair market value of the Common Stock on the date of grant. Each option is non-transferable except upon death, expires 10 years after the date of grant and becomes exercisable in three equal installments on the first, second and third anniversary of the date of grant. A total of 132,000 shares has been reserved for issuance of which 89,040 shares remained available at December 31, 1998. Transactions involving the plans are summarized as follows:* 1998 1997 1996 Weighted Weighted Weighted Number Average Number Average Number Average of shares Price of shares Price of shares Price Outstanding at beginning of year 687,163 $ 4.93 746,841 $ 4.53 659,348 $ 3.93 Granted 99,800 8.66 71,220 7.54 183,480 6.04 Exercised (118,413) 3.69 (130,898) 4.14 (93,571) 3.23 Canceled (40,920) 7.78 - - (2,416) 4.39 Outstanding at end of year 627,630 $ 5.32 687,163 $ 4.93 746,841 $ 4.53 Exercisable at end of year 441,190 415,744 401,002 *Restated for the May 1998 20% stock dividend. Under the 1993 Plan, 1,200,000 shares have been reserved, of which 654,820 shares were available for future grants at December 31, l998. The Company has computed the pro forma disclosures required under SFAS No. 123 for options granted subsequent to December 31, 1994 using the Black-Scholes option pricing model prescribed by SFAS No. 123. Assumptions used in Black-Scholes option pricing model: 1998 1997 1996 Risk free interest rate 6% 6% 6% Expected option life 8.8 years 9.2 years 9.5 years Stock volatility 71.01% 69.70% 71.00% Options to purchase 99,800 shares were granted in 1998 with a weighted average fair value of $6.75 and options to purchase 71,220 shares were granted in 1997 with a weighted average fair value of $5.92. Options to purchase 183,480 shares were granted in 1996 with a weighted average fair value of $4.71. The Company accounts for the Stock Option Plan under APB Opinion No. 25 under which no compensation cost has been recognized. Had compensation costs for these plans been determined consistent with SFAS No. 123, the Company's net (loss) income and net (loss) income per share would have been reduced to the following pro forma amounts: 1998 1997 1996 (in thousands of dollars, except per share data) Income (loss) from continuing operations As reported $ 491 $ 5,177 $ 2,311 Pro forma (222) 4,522 1,893 Income (loss) from continuing operations per share - basic As reported* .07 .69 .31 Pro forma* (.03) .60 .25 Income (loss) from continuing operations per share - diluted As reported* .06 .66 .30 Pro forma* (.03) .56 .24 Net (loss) income As reported (5,971) 4,129 1,729 Pro forma (6,684) 3,474 1,311 Net (loss) income per share - basic As reported* (.80) .55 .23 Pro forma* (.89) .46 .18 Net (loss) income per share - diluted As reported* (.77) .53 .22 Pro forma* (.84) .43 .16 * Restated for the May 1998 20% stock dividend. Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. 7. Commitments and Contingencies The Company conducts certain of its operations in facilities which are under long-term operating leases expiring at various dates through 2004, with various options to renew through 2005. It is expected that in the normal course of business, leases that expire will be renewed or replaced. Rent expense under these leases (exclusive of real estate taxes, and insurance) was approximately $3,589,000 in 1998, $2,524,000 in 1997, and $2,130,000 in 1996. The aggregate minimum lease commitment for the Company's facilities on December 31, 1998 was $9,964,000, payable as follows: $3,445,000 in 1999, $2,719,000 in 2000, $1,508,000 in 2001, $1,207,000 in 2002, $848,000 in 2003 and $237,000 in 2004. 8. Preferred Stock Purchase Rights During 1998, the Company renewed its Shareholder Rights Plan, which expired July 27, 1998. Pursuant to this renewal, on February 17, 1998, the Company declared a dividend distribution of one preferred stock purchase right (Right) for every outstanding share of common stock, effective July 27, 1998. The Rights attach to all outstanding shares of common stock, and no separate Rights certificates will be issued. The Rights will become exercisable upon the tenth business day following the earlier of (i) the date of a public announcement that a person or group of affiliated or associated persons has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of common stock of the Company, or (ii) the commencement or announcement of an intention to make a tender offer or exchange offer that would result in a person or group owning 15% or more of the outstanding common stock of the Company. When exercisable, each Right entitles the registered holder to purchase from the Company one twelfth of a share of its Series B Participating Preferred Stock, $.10 par value, at a price of $54.17 per each one twelfth share of preferred stock. Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the Company including, without limitation, the right to vote or to receive dividends. Under certain circumstances, each share of the Series B Participating Preferred Stock would be convertible into a number of shares of the Company's common stock having a value equal to twice the exercise price of the preferred stock purchase right. The Rights may be redeemed by the Company at the discretion of the Board of Directors, at a price of $.0083 per Right. The Rights expire on July 27, 2008. The terms of the current Shareholder Rights Plan are substantially the same as those of the former plan, with the exception that under the former plan, a right entitled the registered holder to acquire one-tenth of a share of Series A Participating Preferred Stock, $.10 par value, at a price of $40.00 per each one-tenth share. 9. Acquisition On January 23, 1996 the Company acquired the Massachusetts-based operations of Support Systems Associates, Inc. (SSAI), a private company headquartered in Hauppauge, New York. The Company paid $2,000,000 in cash for the acquired business, which had revenue of approximately $5,900,000 in 1995. The acquired assets included a prime contract to provide services to the U.S. Air Force. In January 1997, the Company made additional payments of $250,000 to SSAI based upon the achievement of certain thresholds as provided in the acquisition agreement. The acquisition was accounted for as a purchase. The excess of the purchase price over the fair market value of the net assets acquired was amortized over 30 months, and was fully amortized at December 31, 1998. 10. Business Segments The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," during the fourth quarter of 1998. SFAS No. 131 establishes standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosure about products and services, and geographic areas. The Company has five reportable segments: Systems and Services, Metrigraphics, Encoder, Visual Magic and Telecommunications. Each of the segments represents a separate product line, has different customer requirements and production processes and they operate in different industries. The Systems and Services segment is the aggregation of two divisions that provide similar services to the Department of Defense and operate in the same regulatory environment. The segments follow the same accounting policies described in Note 1, Summary of Significant Accounting Policies. Certain general and administrative expenses, including provisions for doubtful accounts and legal expenses, are recorded as corporate expenses when recognized and are only included in segment profit or loss when amounts are written off or paid. The Company evaluates performance based upon profit or loss before interest and taxes. Intersegment sales represent less than 1% of total revenues and are accounted for at cost. Revenues are attributed to geographic areas based upon the customer's location. The Company does not have locations outside the United States, but does contract with sales representatives located in foreign countries and DRC employees and subcontractors provide services at customer locations outside the U.S. Domestic revenues represent 91.1%, 91.1% and 98.8% of revenue from continuing operations in 1998, 1997 and 1996, respectively. Systems and Services The Systems and Services segment provides specialized technical services to the Department of Defense, federal agencies, state governments and other customers and produced approximately 83% of total Company revenues in 1998. These services include engineering services, development and operation of computer-based management systems and other management services. The Systems and Services segment provides network infrastructure for state human services systems as well as software system implementation services. Metrigraphics The Metrigraphics Division uses photolithographic and material deposition processes to manufacture optical discs, scales and reticles that are used for precision measurement. Metrigraphics produces a variety of precision components including printheads and orifice plates used in electronic printers and fine line circuits used in certain medical instruments. Encoder The Encoder Division designs, manufactures and markets a line of digital encoders that convert analog motion and position information into digital signals used in a wide variety of industrial products and systems which include: machine tools, robotics systems, engine fuel-control systems, packaging equipment and other capital equipment. Encoder's digital encoding devices are essential elements of today's electronically controlled systems and equipment. Telecommunications Since 1996, the Company has operated under an exclusive license to enhance, develop and market a telephone fraud-detection control system. Telecommunications customers include five regional Bell operating companies. As discussed further in Note 2, Discontinued Operations, during 1998 the Company adopted a plan to exit the Telecommunications business. VisualMagic Over a number of years, DRC has invested in the research and development of VisualMagic, an object-oriented development environment. This development environment has proven to be especially useful in the design of Internet applications. As discussed further in Note 11, during 1998, the Company acquired an interest in Empresa, Inc., formerly Electronic Press Services Group, Inc., in exchange for a license to VisualMagic, cash and the assets of the segment. Empresa also hired most of the segment's employees. Identifiable assets by business segment include both assets directly identified with those operations and an allocable share of jointly used assets. Summarized financial information by business segment for 1998, 1997 and 1996 are as follows: Identifiable Systems Continuing Telecom- Identifi- and Metri- Visual Operations munica- able Services Encoder graphics Magic Total tions1 Total (in thousands of dollars) 1998 Net sales2 $154,336 $ 16,842 $ 11,166 $ - $182,344 $ 2,775 $185,119 Operating profit (loss) 1,077 254 3,160 (1,859) 2,632 (5,879) (3,247) Identifiable assets at year end 67,030 5,892 4,680 - 77,602 1,425 79,027 Depreciation and amortization expense 2,411 681 2,323 103 5,518 272 5,790 Capital expenditures 2,172 261 277 54 2,764 296 3,060 1997 Net sales2 $129,135 $ 18,226 $ 9,344 $ 28 $156,733 $ 2,644 $159,377 Operating profit (loss) 5,329 1,316 3,142 (1,980) 7,807 (1,562) 6,245 Identifiable assets at year end 51,055 7,435 6,898 239 65,627 1,230 66,857 Depreciation and amortization expense 2,831 693 1,147 108 4,779 136 4,915 Capital expenditures 2,204 518 547 42 3,311 1,040 4,351 1996 Net sales2 $100,712 $ 18,025 $ 11,260 $ - $129,997 $ 166 $130,163 Operating profit (loss) 771 1,320 4,288 (2,096) 4,283 (938) 3,345 Identifiable assets at year end 44,141 8,462 7,094 304 60,001 151 60,152 Depreciation and amortization expense 2,832 566 1,074 110 4,582 16 4,598 Capital expenditures 2,445 953 5,046 190 8,634 148 8,782 1 As discussed in Note 2, Discontinued Operations, in 1998 the Company adopted a plan to sell the Telecommunications business during 1999. Accordingly, the results of the Telecommunications unit are presented as discontinued operations in the consolidated statement of operations. Total 1998 Telecommunications results exclude the estimated loss on the disposal of the business. 2 Net sales and operating profit are presented after the elimination of intersegment transactions. Reconciliations of amounts related to indentifiable continuing operations to amounts included in the Consolidated Balance Sheets, Consolidated Statements of Operations and Consolidated Statements of Cash Flows follow: As of and for the years ended December 31, 1998, December 31, 1997 and December 28, 1996 1998 1997 1996 (in thousands of dollars) Identifiable operating profit $ 2,632 $ 7,807 $ 4,283 Other corporate income and expense (173) - - Income from continuing operations Before interest and income taxes $ 2,459 $ 7,807 $ 4,283 Identifiable assets $ 77,602 $ 65,627 $ 60,001 Corporate assets 10,465 12,002 10,949 Total assets $ 88,067 $ 77,629 $ 70,950 Identifiable depreciation and amortization $ 5,518 $ 4,779 $ 4,582 Corporate depreciation and amortization 701 461 328 Total depreciation and amortization $ 6,219 $ 5,240 $ 4,910 Identifiable capital expenditures $ 2,764 $ 3,311 $ 8,634 Corporate capital expenditures 111 754 474 Total capital expenditures $ 2,874 $ 4,065 $ 9,108 General corporate assets consist primarily of cash and the Company's Andover, MA corporate headquarters. One customer accounted for 13.6%, 11.3% and 0% of total revenue from continuing operations in 1998, 1997 and 1996, respectively. During 1998, 1997 and 1996, revenues from Department of Defense (DoD) customers represent approximately 59%, 66% and 74% of total revenues from continuing operations, respectively. Revenues earned from one significant DoD contract represent 13.6%, 17.7% and 21.4% of revenues from continuing operations in 1998, 1997 and 1996, respectively. 11. Investment in Empresa, Inc. On December 23, 1998, the Company agreed to make an investment in Empresa, Inc., a privately held company based in Cambridge, Massachusetts, engaged in electronic commerce services. DRC contributed a perpetual license to the VisualMagic development environment, the assets of the VisualMagic segment and cash. The cash contributions were made in December 1998 and February 1999 and a third payment will be required in May 1999, subject to achievement of certain performance requirements. DRC's VisualMagic development staff transferred to Empresa. At December 31, 1998, the Company held non-voting preferred shares of Empresa. An executive officer agreed to acquire an investment in Empresa. Empresa's Amended and Restated Articles of Incorporation limit the voting rights of DRC and its executive officers to less than 20% of the outstanding voting stock. Accordingly, the Company is accounting for this transaction as a cost-based investment. 12. Risks and Uncertainties In 1998, 62% of the Company's sales were to U.S. Government agencies, primarily the DoD. All of DRC's government contracts are subject to termination for convenience in accordance with government regulations. Costs incurred under cost-reimbursable contracts are subject to audit by the government. The results of prior audits, completed through 1996 have not had a material effect on the Company. In 1998, 22% of the Company's sales were to agencies of state governments. The cost-reimbursable and fixed-price contracts the Company has won are generally multi-year efforts. In accordance with state laws, funding must be approved annually by the states' legislatures. During the second half of 1998 the economic and financial crisis in Asia adversely impacted Encoder Division sales and profits. Management has addressed these issues by reducing certain costs and does not anticipate that there will be a material impact on future operations. Management's Responsibility for Financial Statements The management of Dynamics Research Corporation is responsible for the accuracy and internal consistency of all information contained in this annual report, including the consolidated financial statements. Management has followed those generally accepted accounting principles which it believes to be most appropriate to the circumstances of the Company, and has made what it believes to be reasonable and prudent judgments and estimates where necessary. Dynamics Research Corporation operates under a system of internal accounting controls designed to provide reasonable assurance that its financial records are accurate, that the assets of the Company are protected, and that the financial statements present fairly the financial position and results of operations of the Company. The internal accounting control system is tested, monitored and revised as necessary. Three directors of the Company, not members of management, serve as the Audit Committee of the Board of Directors and are the principal means through which the Board supervises the performance of the financial reporting duties of management. The Audit Committee meets with management and the Company's independent auditors several times a year to review the results of external audits of the Company and to discuss plans for future audits. At these meetings the Audit Committee also meets privately with the independent auditors to assure its free access to them. The Company's independent auditors, Arthur Andersen LLP, audited the financial statements prepared by the management of Dynamics Research Corporation. Their report on these statements is presented below. Albert Rand President, Chief Executive Officer Douglas R. Potter Vice President of Finance, Chief Financial Officer Report of Independent Public Accountants To Dynamics Research Corporation: We have audited the accompanying consolidated balance sheets of Dynamics Research Corporation (a Massachusetts corporation) and subsidiaries as of December 31, 1998, 1997 and December 28, 1996, and the related consolidated statements of operations, shareholders' investment and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Dynamics Research Corporation and subsidiaries as of December 31, 1998, 1997 and December 28, 1996, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. Arthur Andersen LLP Boston, Massachusetts, February 18, 1999 Directors and Officers Directors Dr. Francis J. Aguilar* Professor of Business Administration, Emeritus, Harvard University, Graduate School of Business Administration John S. Anderegg, Jr. Chairman, Dynamics Research Corporation Martin V. Joyce, Jr.+ Vice President, A.T. Kearney, Inc. Kenneth F. Kames*+ Vice President, New Business Development, The Gillette Company General James P. Mullins* USAF retired Albert Rand President and Chief Executive Officer, Dynamics Research Corporation *Member of the Audit Committee +Member of the Compensation Committee Officers John S. Anderegg, Jr. Chairman Albert Rand President, Chief Executive Officer Richard Basque Vice President, Logistics Operations, Systems Division Arthur Brown Vice President, Contracts, Systems Division William G. Clautice Vice President, Strategic Programs, Test Equipment Division Victor Garber Vice President, Acquisition Engineering, Systems Division Dr. Joseph W. Griffin, Jr. Vice President, Systems Development, Systems Division Edward C. Johnson Vice President, Marketing, Systems Division Chester Ju Vice President, Encoder Division and Metrigraphics Division Sharin Luti Vice President, Information Technology, Systems Division John M. Nauseef Vice President, Dayton Operations, Systems Division Michael Perro Vice President, Washington Operations, Systems Division Douglas R. Potter Vice President of Finance and Chief Financial Officer Richard P. Rappaport Vice President, Test Equipment Division John L. Wilkinson Vice President, Human Resources, Clerk David C. Proctor Treasurer, Assistant Clerk Robert Smith Vice President, Huntsville Operations, Systems Division Corporate Information Corporate Headquarters 60 Frontage Road Andover, Massachusetts 01810-5498 Telephone: (978) 475-9090, Fax: (978) 475-8205 Internet: www.drc.com Auditors Arthur Andersen LLP 225 Franklin Street, Boston, Massachusetts 02110 Legal Counsel Ropes & Gray One International Place, Boston, Massachusetts 02110 Transfer Agent American Stock Transfer & Trust Company 46th floor, 40 Wall Street, New York, New York 10005, Telephone: (800) 937-5449 Stock Prices Bid price by quarter* 1998 1997 High Low High Low First quarter $ 10.02 $ 9.72 $ 8.44 $ 6.88 Second quarter 11.47 11.18 9.82 6.46 Third quarter 9.43 9.06 9.58 6.78 Fourth quarter 6.00 5.52 11.88 8.13 *Restated for the May 1998 20% stock dividend. The bid and asked prices of the Company's common stock on March 18, 1999 were $3.625 and $3.6875, respectively. Prices shown reflect inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions. Source: Monthly Statistical Report of the National Association of Securities Dealers, Inc. - NASDAQ. Common Stock The Company's stock is traded on the NASDAQ National Market System, Symbol: DRCO; and listed in newspapers as DynamR., DynRsh. or DynRsearch. Number of Shareholders The approximate number of shareholders of record at March 18, 1999 was 869. As of March 18, 1999 there were 7,356,090 common shares outstanding. Form 10-K A copy of DRC's Form 10-K, which is filed annually with the Securities and Exchange Commission, will be sent without charge to any shareholder requesting it in writing to the Treasurer's office, Dynamics Research Corporation, 60 Frontage Road, Andover, Massachusetts 01810-5498. Annual Meeting The 1999 Annual Meeting of Shareholders will be held at 3:30 PM on April 27, 1999 at the State Street Bank and Trust Building, 33rd floor, 225 Franklin Street, Boston, Massachusetts 02110. Dynamics Research Corporation 60 Frontage Road Andover, Massachusetts 01810-5498 (978) 475-9090 EX-27 3
5 1,000 12-MOS DEC-31-1998 DEC-31-1998 97 0 65,185 0 2,647 68,896 51,171 32,742 88,067 29,673 26,800 0 0 873 30,373 88,067 28,008 182,344 22,029 162,682 17,203 0 1,612 847 356 491 (6,462) 0 0 (5,971) (.80) (.77)
EX-10 4 Amended as of February 17, 1998 DYNAMICS RESEARCH CORPORATION 1993 EQUITY INCENTIVE PLAN 1. PURPOSE The purpose of this 1993 Equity Incentive Plan (the "Plan") is to advance the interests of Dynamics Research Corporation (the "Company") by enhancing its ability to attract and retain employees and other persons or entities who are in a position to make significant contributions to the success of the Company and its subsidiaries through ownership of shares of the Company's common stock ("Stock"). The Plan is intended to accomplish these goals by enabling the Company to grant Awards in the form of Options, Stock Appreciation Rights, Restricted Stock or Unrestricted Stock Awards, Deferred Stock Awards, Performance Awards, Loans or Supplemental Grants, or combinations thereof, all as more fully described below. 2. ADMINISTRATION The Plan will be administered by the Compensation Committee (the "Committee") of the Board of Directors of the Company (the "Board"). The Committee will have authority, not inconsistent with the express provisions of the Plan and in addition to other authority granted under the Plan, to (a) grant Awards at such time or times as it may choose; (b) determine the size of each Award, including the number of shares of Stock subject to the Award; (c) determine the type or types of each Award; (d) determine the terms and conditions of each Award; (e) waive compliance by a Participant (as defined below) with any obligations to be performed by the Participant under an Award and waive any term or condition of an Award; (f) amend or cancel an existing Award in whole or in part (and if an award if canceled, grant another Award in its place on such terms as the Committee shall specify), except that the Committee may not, without the consent of the holder of an Award, take any action under this clause with respect to such Award if such action would adversely affect the rights of such holder; (g) prescribe the form or forms of instruments that are required or deemed appropriate under the Plan, including any written notices and elections required of Participants, and change such forms from time to time; (h) adopt, amend and rescind rules and regulations for the administration of the Plan; and (i) interpret the Plan and decide any questions and settle all controversies and disputes that may arise in connection with the Plan. Such determinations and actions of the Committee, and all other determinations and actions of the Committee made or taken under authority granted by any provision of the Plan, will be conclusive and will bind all parties. Nothing in this paragraph shall be construed as limiting the power of the Committee or the Board to make adjustments under Section 7.3 or Section 8.6. 3. EFFECTIVE DATE AND TERM OF PLAN The Plan will become effective on the date on which it is approved by the stockholders of the Company. Grants of Awards under the plan may be made prior to that date (but after Board adoption of the Plan), subject to such approval of the Plan. No Award may be granted under the Plan after April 27, 2003, but Awards previously granted may extend beyond that date. 4. SHARES SUBJECT TO THE PLAN Subject to adjustment as provided in Section 8.6 below, the aggregate number of shares of Stock that may be delivered under the Plan will be 1,000,000. If any Award requiring exercise by the Participant for delivery of Stock terminates without having been exercised in full, or if any Award payable in Stock or cash is satisfied in cash rather than Stock, the number of shares of Stock as to which such Award was not exercised or for which cash was substituted will be available for future grants. Stock delivered under the Plan may be either authorized but unissued Stock or previously issued Stock acquired by the Company and held in treasury. No fractional shares of Stock will be delivered under the Plan. 5. ELIGIBILITY AND PARTICIPATION Those eligible to receive Awards under the Plan ("Participants") will be persons in the employ of the Company or any of its subsidiaries ("Employees") and other persons or entities (including without limitation non-Employee directors of the Company or a subsidiary of the Company) who, in the opinion of the Committee, are in a position to make a significant contribution to the success of the Company or its subsidiaries. A "subsidiary" for purposes of the Plan will be a corporation in which the Company owns, directly or indirectly, stock possessing 50% or more of the total combined voting power of all classes of stock. 6. TYPES OF AWARDS 6.1. OPTIONS (a) Nature of Options. An Option is an Award entitling the recipient on exercise thereof to purchase Stock at a specified exercise price. Both "incentive stock options," as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the "Code") (any Option intended to qualify as an incentive stock option being hereinafter referred to as an "ISO"), and Options that are not incentive stock options, may be granted under the Plan. ISOs shall be awarded only to Employees. (b) Exercise Price. The exercise price of an Option will be determined by the Committee subject to the following: (1) The exercise price of an ISO shall not be less than 100% (110% in the case of an ISO granted to a ten-percent shareholder) of the fair market value of the Stock subject to the Option, determined as of the time the Option is granted. A "ten-percent shareholder" is any person who at the time of grant owns, directly or indirectly, or is deemed to own by reason of the attribution rules of section 424(d) of the Code, stock possessing more than 10% of the total combined voting power of all classes of stock of the Company or of any of its subsidiaries. (2) In no case may the exercise price paid for Stock which is part of an original issue of authorized Stock be less than the par value per share of the Stock. (3) The Committee may reduce the exercise price of an Option at any time after the time of grant, but in the case of an Option originally awarded as an ISO, only with the consent of the Participant. (c) Duration of Options. The latest date on which an Option may be exercised will be the tenth anniversary (fifth anniversary, in the case of an ISO granted to a ten-percent shareholder) of the day immediately preceding the date the Option was granted, or such earlier date as may have been specified by the Committee at the time the Option was granted. (d) Exercise of Options. Options granted under any single Award will become exercisable at such time or times, and on such conditions, as the Committee may specify. The Committee may at any time and from time to time accelerate the time at which all or any part of the Option may be exercised. Any exercise of an Option must be in writing, signed by the proper person and delivered or mailed to the Company, accompanied by (1) any documents required by the Committee and (2) payment in full in accordance with paragraph (e) below for the number of shares for which the Option is exercised. (e) Payment for Stock. Stock purchased on exercise of an Option must be paid for as follows: (1) in cash or by check (acceptable to the Company in accordance with guidelines established for this purpose), bank draft or money order payable to the order of the Company or (2) if so permitted by the instrument evidencing the Option (or in the case of an Option which is not an ISO, by the Committee at or after grant of the Option), (i) through the delivery of shares of Stock which have been outstanding for at least six months (unless the Committee expressly approves a shorter period) and which have a fair market value on the last business day preceding the date of exercise equal to the exercise price, or (ii) by delivery of a promissory note of the Option holder to the Company, payable on such terms as are specified by the Committee, or (iii) by delivery of an unconditional and irrevocable undertaking by a broker to deliver promptly to the Company sufficient funds to pay the exercise price, or (iv) by any combination of the permissible forms of payment; provided, that if the Stock delivered upon exercise of the Option is an original issue of authorized Stock, at least so much of the exercise price as represents the par value of such Stock must be paid other than by the Option holder's promissory note or personal check. (f) Discretionary Payments. If the market price of shares of Stock subject to an Option (other than an Option which is in tandem with a Stock Appreciation Right as described in Section 6.2 below) exceeds the exercise price of the Option at the time of its exercise, the Committee may cancel the Option and cause the Company to pay in cash or in shares of Common Stock (at a price per share equal to the fair market value per share) to the person exercising the Option an amount equal to the difference between the fair market value of the Stock which would have been purchased pursuant to the exercise (determined on the date the Option is cancelled) and the aggregate exercise price which would have been paid. The Committee may exercise its discretion to take such action only if it has received a written request from the person exercising the Option, but such a request will not be binding on the Committee. 6.2. Stock Appreciation Rights. (a) Nature of Stock Appreciation Rights. A Stock Appreciation Right is an Award entitling the recipient on exercise of the Right to receive an amount, in cash or Stock or a combination thereof (such form to be determined by the Committee), determined in whole or in part by reference to appreciation in Stock value. In general, a Stock Appreciation Right entitles the Participant to receive, with respect to each share of Stock as to which the Right is exercised, the excess of the share's fair market value on the date of exercise over its fair market value on the date the Right was granted. However, the Committee may provide at the time of grant that the amount the recipient is entitled to receive will be adjusted upward or downward under rules established by the Committee to take into account the performance of the Stock in comparison with the performance of other stocks or an index or indices of other stocks. The Committee may also grant Stock Appreciation Rights that provide, in such limited circumstances following a change in control as the Committee may specify (as determined by the Committee) the holder of such Right will be entitled to receive, with respect to each share of Stock subject to the Right, an amount equal to the excess of a specified value (which may include an average of values) for a share of Stock during a period preceding such change in control over the fair market value of a share of Stock on the date the Right was granted. (b) Grant of Stock Appreciation Rights. Stock Appreciation Rights may be granted in tandem with, or independently of, Options granted under the Plan. A Stock Appreciation Right granted in tandem with an Option which is not an ISO may be granted either at or after the time the Option is granted. A Stock Appreciation Right granted in tandem with an ISO may be granted only at the time the Option is granted. (c) Rules Applicable to Tandem Awards. When Stock Appreciation Rights are granted in tandem with Options, the following will apply: (1) The Stock Appreciation Right will be exercisable only at such time or times, and to the extent, that the related Option is exercisable and will be exercisable in accordance with the procedure required for exercise of the related Option. (2) The Stock Appreciation Right will terminate and no longer be exercisable upon the termination or exercise of the related Option, except that a Stock Appreciation Right granted with respect to less than the full number of shares covered by an Option will not be reduced until the number of shares as to which the related Option has been exercised or has terminated exceeds the number of shares not covered by the Stock Appreciation Right. (3) The Option will terminate and no longer be exercisable upon the exercise of the related Stock Appreciation Right. (4) The Stock Appreciation Right will be transferable only with the related Option. (5) A Stock Appreciation Right granted in tandem with an ISO may be exercised only when the market price of the Stock subject to the Option exceeds the exercise price of such option. (d) Exercise of Independent Stock Appreciation Rights. A Stock Appreciation Right not granted in tandem with an Option will become exercisable at such time or times, and on such conditions, as the Committee may specify. The Committee may at any time accelerate the time at which all or any part of the Right may be exercised. Any exercise of an independent Stock Appreciation Right must be in writing, signed by the proper person and delivered or mailed to the Company, accompanied by any other documents required by the Committee. 6.3. Restricted and Unrestricted Stock. (a) Nature of Restricted Stock Award. A Restricted Stock Award entitles the recipient to acquire, for a purchase price equal to par value, shares of Stock subject to the restrictions described in paragraph (d) below ("Restricted Stock"). (b) Acceptance of Award. A Participant who is granted a Restricted Stock Award will have no rights with respect to such Award unless the Participant accepts the Award by written instrument delivered or mailed to the Company accompanied by payment in full of the specified purchase price, if any, of the shares covered by the Award. Payment may be by certified or bank check or other instrument acceptable to the Committee. (c) Rights as a Stockholder. A Participant who receives Restricted Stock will have all the rights of a stockholder with respect to the Stock, including voting and dividend rights, subject to the restrictions described in paragraph (d) below and any other conditions imposed by the Committee at the time of grant. Unless the Committee otherwise determines, certificates evidencing shares of Restricted Stock will remain in the possession of the Company until such shares are free of all restrictions under the Plan. (d) Restrictions. Except as otherwise specifically provided by the Plan, Restricted Stock may not be sold, assigned, transferred, pledged or otherwise encumbered or disposed of, and if the Participant ceases to be an Employee or otherwise suffers a Status Change (as defined at Section 7.2(a) below) for any reason, must be offered to the Company for purchase for the amount of cash paid for the Stock, or forfeited to the Company if no cash was paid. These restrictions will lapse at such time or times, and on such conditions, as the Committee may specify. The Committee may at any time accelerate the time at which the restrictions on all or any part of the shares will lapse. (e) Notice of Election. Any Participant making an election under Section 83(b) of the Code with respect to Restricted Stock must provide a copy thereof to the Company within 10 days of the filing of such election with the Internal Revenue Service. (f) Other Awards Settled with Restricted Stock. The Committee may, at the time any Award described in this Section 6 is granted, provide that any or all the Stock delivered pursuant to the Award will be Restricted Stock. (g) Unrestricted Stock. The Committee may, in its sole discretion, approve the sale to any Participant of shares of Stock free of restrictions under the Plan for a price which is not less than the par value of the Stock. 6.4. Deferred Stock. A Deferred Stock Award entitles the recipient to receive shares of Stock to be delivered in the future. Delivery of the Stock will take place at such time or times, and on such conditions, as the Committee may specify. The Committee may at any time accelerate the time at which delivery of all or any part of the Stock will take place. At the time any Award described in this Section 6 is granted, the Committee may provide that, at the time Stock would otherwise be delivered pursuant to the Award, the Participant will instead receive an instrument evidencing the Participant's right to future delivery of Deferred Stock. 6.5. Performance Awards; Performance Goals. (a) Nature of Performance Awards. A Performance Award entitles the recipient to receive, without payment, an amount in cash or Stock or a combination thereof (such form to be determined by the Committee) following the attainment of Performance Goals. Performance Goals may be related to personal performance, corporate performance, departmental performance or any other category of performance deemed by the Committee to be important to the success of the Company. The Committee will determine the Performance Goals, the period or period during which performance is to be measured and all other terms and conditions applicable to the Award. (b) Other Awards Subject to Performance Condition. The Committee may, at the time any Award described in this Section 6 is granted, impose the condition (in addition to any conditions specified or authorized in this Section 6 or any other provision of the Plan) that Performance Goals be met prior to the Participant's realization of any payment or benefit under the Award. 6.6. Loans and Supplemental Grants. (a) Loans. The Company may make a loan to a Participant ("Loan"), either on the date of or after the grant of any Award to the Participant. A Loan may be made either in connection with the purchase of Stock under the Award or with the payment of any Federal, state and local income tax with respect to income recognized as a result of the Award. The Committee will have full authority to decide whether to make a Loan and to determine the amount, terms and conditions of the Loan, including the interest rate (which may be zero), whether the Loan is to be secured or unsecured or with or without recourse against the borrower, the terms on which the Loan is to be repaid and the conditions, if any, under which it may be forgiven. However, no Loan may have a term (including extensions) exceeding ten years in duration. (b) Supplemental Grants. In connection with any Award, the Committee may at the time such Award is made or at a later date, provide for and grant a cash award to the Participant ("Supplemental Grant") not to exceed an amount equal to (1) the amount of any federal, state and local income tax on ordinary income for which the Participant may be liable with respect to the Award, determined by assuming taxation at the highest marginal rate, plus (2) an additional amount on a grossed-up basis intended to make the Participant whole on an after-tax basis after discharging all the Participant's income tax liabilities arising from all payments under this Section 6. Any payments under this subsection (b) will be made at the time the Participant incurs Federal income tax liability with respect to the Award. 7. EVENTS AFFECTING OUTSTANDING AWARDS 7.1. Death. If a Participant dies, the following will apply: (a) All Options and Stock Appreciation Rights held by the Participant immediately prior to death, to the extent then exercisable, may be exercised by the Participant's executor or administrator or the person or persons to whom the Option or Right is transferred by will or the applicable laws of descent and distribution, at any time within the one year period ending with the first anniversary of the Participant's death (or such shorter or longer period as the Committee may determine), and shall thereupon terminate. In no event, however, shall an Option or Stock Appreciation Right remain exercisable beyond the latest date on which it could have been exercised without regard to this Section 7. Except as otherwise determined by the Committee, all Options and Stock Appreciation Rights held by a Participant immediately prior to death that are not then exercisable shall terminate at death. (b) Except as otherwise determined by the Committee, all Restricted Stock held by the Participant must be transferred to the Company (and, in the event the certificates representing such Restricted Stock are held by the Company, such Restricted Stock will be so transferred without any further action by the Participant) in accordance with Section 6.3 above. (c) Any payment or benefit under a Deferred Stock Award, Performance Award, or Supplemental Grant to which the Participant was not irrevocably entitled prior to death will be forfeited and the Award canceled as of the time of death, unless otherwise determined the Committee. 7.2. Termination of Service (Other Than By Death). If a Participant who is an Employee ceases to be an Employee for any reason other than death, or if there is a termination (other than by reason of death) of the consulting, service or similar relationship in respect of which a non-Employee Participant was granted an Award hereunder (such termination of the employment or other relationship being hereinafter referred to as a "Status Change"), the following will apply: (a) Except as otherwise determined by the Committee, all Options and Stock Appreciation Rights held by the Participant that were not exercisable immediately prior to the Status Change shall terminate at the time of the Status Change. Any Options or Rights that were exercisable immediately prior to the Status Change will continue to be exercisable for a period of three months (or such longer period as the Committee may determine), and shall thereupon terminate, unless the Award provides by its terms for immediate termination in the event of a Status Change or unless the Status Change results from a discharge for cause which in the opinion of the Committee casts such discredit on the Participant as to justify immediate termination of the Award. In no event, however, shall an Option or Stock Appreciation Right remain exercisable beyond the latest date on which it could have been exercised without regard to this Section 7. For purposes of this paragraph, in the case of a Participant who is an Employee, a Status Change shall not be deemed to have resulted by reason of (i) a sick leave or other bona fide leave of absence approved for purposes of the Plan by the Committee, so long as the Employee's right to reemployment is guaranteed either by statute or by contract, or (ii) a transfer of employment between the Company and a subsidiary or between subsidiary, or to the employment of a corporation (or a parent or subsidiary corporation of such corporation) issuing or assuming an option in a transaction to which section 424(a) of the Code applies. (b) Except as otherwise determined by the Committee, all Restricted Stock held by the Participant at the time of the Status Change must be transferred to the Company (and, in the event the certificates representing such Restricted Stock are held by the Company, such Restricted Stock will be so transferred without any further action by the Participant) in accordance with Section 6.3 above. (c) Any payment or benefit under a Deferred Stock Award, Performance Award, or Supplemental Grant to which the Participant was not irrevocably entitled prior to the Status Change will be forfeited and the Award cancelled as of the date of such Status Change unless otherwise determined by the Committee. 7.3. Certain Corporate Transactions. In the event of a consolidation or merger in which the Company is not the surviving corporation or which results in the acquisition of substantially all the Company's outstanding Stock by a single person or entity or by a group of persons and/or entities acting in concert, or in the event of the sale or transfer of substantially all the Company's assets or a dissolution or liquidation of the Company (a "covered transaction"), all outstanding Awards (except as provided below) will terminate as of the effective date of the covered transaction; provided, however, that: (a) all outstanding Options shall become exercisable immediately prior to such covered transaction; (b) the Committee may in its sole discretion, prior to the effective date of such covered transaction, (i) make each outstanding Stock Appreciation Right exercisable in full, (ii) remove the restrictions from each outstanding share of Restricted Stock, (iii) cause the Company to make any payment and provide any benefit under each outstanding Deferred Stock Award, Performance Award and Supplemental Grant which would have been made or provided with the passage of time had such covered transaction not occurred and the Participant not suffered a Status Change (or died), and (iv) forgive all or any portion of the principal of or interest on a Loan; and (c) the Committee may arrange, subject to consummation of such covered transaction, for the assumption of any or all Awards by the surviving or acquiring corporation or an affiliate thereof or for the grant of replacement awards for any or all Awards which, in the judgment of the Committee, are substantially equivalent and which in the case of incentive options shall satisfy the requirements of section 424(a) of the Code. 8. GENERAL PROVISIONS 8.1. Documentation of Awards. Awards will be evidenced by such written instruments, if any, as may be prescribed by the Committee from time to time. Such instruments may be in the form of agreements to be executed by both the Participant and the Company, or certificates, letters or similar instruments, which need not be executed by the Participant but acceptance of which will evidence agreement to the terms thereof. 8.2. Rights as a Stockholder, Dividend Equivalents. Except as specifically provided by the Plan, the receipt of an Award will not give a Participant rights as a stockholder; the participant will obtain such rights, subject to any limitations imposed by the Plan or the instrument evidencing the Award, upon actual receipt of Stock. However, the Committee may, on such conditions as it deems appropriate, provide that a Participant will receive a benefit in lieu of cash dividends that would have been payable on any or all Stock subject to the Participant's Award had such Stock been outstanding. Without limitation, the Committee may provide for payment to the Participant of amounts representing such dividends, either currently or in the future, or for the investment of such amounts on behalf of the Participant. 8.3. Conditions on Delivery of Stock. The Company will not be obligated to deliver any shares of Stock pursuant to the Plan or to remove restriction from shares previously delivered under the Plan (a) until all conditions of the Award have been satisfied or removed, (b) until, in the opinion of the Company's counsel, all applicable federal and state laws and regulation have been complied with, (c) if the outstanding Stock is at the time listed on any stock exchange, until the shares to be delivered have been listed or authorized to be listed on such exchange upon official notice of notice of issuance, and (d) until all other legal matters in connection with the issuance and delivery of such shares have been approved by the Company's counsel. If the sale of Stock has not been registered under the Securities Act of 1933, as amended, the Company may require, as a condition to exercise of the Award, such representations or agreements as counsel for the Company may consider appropriate to avoid violation of such Act and may require that the certificates evidencing such Stock bear an appropriate legend restricting transfer. If an Award is exercised by the Participant's legal representative, the Company will be under no obligation to deliver Stock pursuant to such exercise until the Company is satisfied as to the authority of such representative. 8.4. Tax Withholding. The Company will withhold from any cash payment made pursuant to an Award an amount sufficient to satisfy all federal, state and local withholding tax requirements (the "withholding requirements"). In the case of an Award pursuant to which Stock may be delivered, the Committee will have the right to require that the Participant or other appropriate person remit to the Company an amount sufficient to satisfy the withholding requirements, or make other arrangements satisfactory to the Committee with regard to such requirements, prior to the delivery of any Stock. If and to the extent that such withholding is required, the Committee may permit the Participant or such other person to elect at such time and in such manner as the Committee provides to have the Company hold back from the shares to be delivered, or to deliver to the Company, Stock having a value calculated to satisfy the withholding requirement. If at the time an ISO is exercised the Committee determines that the Company could be liable for withholding requirements with respect to a disposition of the Stock received upon exercise, the Committee may require as a condition of exercise that the person exercising the ISO agree (a) to inform the Company promptly of any disposition (within the meaning of section 424(c) of the Code) of Stock received upon exercise, and (b) to give such security as the Committee deems adequate to meet the potential liability of the Company for the withholding requirements and to augment such security from time to time in any amount reasonably deemed necessary by the Committee to preserve the adequacy of such security. 8.5. Nontransferability of Awards. No Award (other than an Award in the form of an outright transfer of cash or Unrestricted Stock) may be transferred other than by will or by the laws of descent and distribution, and during an employee's lifetime an Award requiring exercise may be exercised only by the Participant (or in the event of the Participant's incapacity, the person or persons legally appointed to act on the Participant's behalf). 8.6. Adjustments in the Event of Certain Transactions. (a) In the event of a stock dividend, stock split or combination of shares, recapitalization or other change in the Company's capitalization, or other distribution to common stockholders other than normal cash dividends, after the effective date of the Plan, the Committee will make any appropriate adjustments to the maximum number of shares that may be delivered under the Plan under Section 4 above. (b) In any event referred to in paragraph (a), the Committee will also make any appropriate adjustments to the number and kind of shares of stock or securities subject to Awards then outstanding or subsequently granted, any exercise prices relating to Awards and any other provision of Awards affected by such change. The Committee may also make such adjustments to take into account material changes in law or in accounting practices or principles, mergers, consolidations, acquisitions, dispositions or similar corporate transactions, or any other event, if it is determined by the Committee that adjustments are appropriate to avoid distortion in the operation of the Plan. 8.7. Employment Rights, Etc. Neither the adoption of the Plan nor the grant of Awards will confer upon any person any right to continued retention by the Company or any subsidiary as an Employee or otherwise, or affect in any way the right of the Company or subsidiary to terminate an employment, service or similar relationship at any time. Except as specifically provided by the Committee in any particular case, the loss of existing or potential profit in Awards granted under the Plan will not constitute an element of damages in the event of termination of an employment, service or similar relationship even if the termination is in violation of an obligation of the Company to the Participant. 8.8. Deferral of Payments. The Committee may agree at any time, upon request of the Participant, to defer the date on which any payment under an Award will be made. 8.9. Past Services as Consideration. Where a Participant purchases Stock under an Award for a price equal to the par value of the Stock the Committee may determine that such price has been satisfied by past services rendered by the Participant. 9. EFFECT, DISCONTINUANCE, CANCELLATION, AMENDMENT AND TERMINATION Neither adoption of the Plan nor the grant of Awards to a Participant will affect the Company's right to grant to such Participant awards that are not subject to the Plan, to issue to such Participant Stock as a bonus or otherwise, or to adopt other plans or arrangements under which Stock be issued to Employees. The Board may at any time or times amend the Plan or any outstanding Award for any purpose which may at the time be permitted by law, or may at any time terminate the Plan as to any further grants of Awards, provided that (except to the extent expressly required or permitted by the Plan) no such amendment will, without the approval of the stockholders of the Company, effectuate a change for which stockholder approval is required in order for the Plan to continue to qualify for the award of ISOs under section 422 of the Code and to continue to qualify under Rule 16b-3 promulgated under Section 16 of the 1934 Act. EX-10 5 Amended as of February 17, 1998 DYNAMICS RESEARCH CORPORATION 1995 STOCK OPTION PLAN FOR NON-EMPLOYEE DIRECTORS 1. PURPOSE The purpose of this 1995 Stock Option Plan for Non-Employee Directors (the "Plan") is to advance the interests of Dynamics Research Corporation (the "Company") by enhancing the ability of the Company to attract and retain non-employee directors who are in a position to make significant contributions to the success of the Company and to align the interest of those directors more closely with the stockholders. 2. ADMINISTRATION The Plan shall be administered by a committee (the "Committee") of the Board of Directors (the "Board") of the Company designated by the Board for that purpose. Unless and until a Committee is appointed the Plan shall be administered by the entire Board, and references in the Plan to the "Committee" shall be deemed references to the Board. The Committee shall have authority, not inconsistent with the express provisions of the Plan, (a) to grant options in accordance with the Plan to such directors as are eligible to receive options; (b) to prescribe the form or forms of instruments evidencing options and any other instruments required under the Plan and to change such forms from time to time; (c) to adopt, amend and rescind rules and regulations for the administration of the Plan; (d) to accelerate the vesting of or otherwise change the terms of any option granted hereunder; and (e) to interpret the Plan and to decide any questions and settle all controversies and disputes that may arise in connection with the Plan. Such determinations of the Committee shall be conclusive and shall bind all parties. 3. EFFECTIVE DATE AND TERM OF PLAN The Plan shall become effective on the date on which the Plan is approved by the Board of Directors of the Company, subject to approval by the shareholders of the Company. No option shall be granted under the Plan after the completion of ten years from the date on which the Plan was adopted by the Board, but options previously granted may extend beyond that date. 4. SHARES SUBJECT TO THE PLAN (a) Number of Shares. Subject to adjustment as provided in Section 4(c), the aggregate number of shares of the Company's common stock (the "Stock") that may be delivered upon the exercise of options granted under the Plan shall be 100,000. If any option granted under the Plan terminates without having been exercised in full, the number of shares of Stock as to which such option was not exercised shall be available for future grants within the limits set forth in this Section 4(a). (b) Shares to be Delivered. Shares delivered under the Plan shall be authorized but unissued Stock or, if the Board so decides in its sole discretion, previously issued Stock acquired by the Company and held in treasury. No fractional shares of Stock shall be delivered under the Plan. (c) Changes in Stock. In the event of a stock dividend, stock split or combination of shares, recapitalization or other change in the Company's capital stock, after the effective date of the Plan, the number and kind of shares of stock or securities of the Company subject to options then outstanding or subsequently granted under the Plan, the maximum number of shares or securities that may be delivered under the Plan, the exercise price, and other relevant provisions shall be appropriately adjusted by the Committee, whose determination shall be binding on all persons. 5. ELIGIBILITY FOR OPTIONS Directors eligible to receive options under the Plan ("Eligible Directors") shall be those directors who are not employees of the Company or of any subsidiary of the Company. 6. TERMS AND CONDITIONS OF OPTIONS (a) Number of Options. On the date of the first annual meeting of stockholders following the adoption of this Plan each Eligible Director who is elected, reelected or continuing as a director on such date shall be awarded on such date an option covering 5,000 shares of Stock; thereafter, at each annual meeting or meeting of the board of directors at which a new Eligible Director is elected to the Board or following the election by the Board of a new Eligible Director to the Board, he or she shall be awarded an option covering 5,000 shares of Stock; and at each annual meeting subsequent to the annual meeting at which the initial grant was made to an Eligible Director and at which he or she is reelected or is continuing as a director, he or she shall be awarded an additional option covering 1,000 shares of Stock. (b) Exercise Price. The exercise price of each option shall be 100% of the fair market value per share of the Stock on the date the option is granted. In no event, however, shall the option price be less, in the case of an original issue of authorized stock, than par value per share. For purposes of this paragraph, (A) the fair market value of a share of Stock on any date shall be the Closing Price on such day or, if there was no Closing Price on such day, the latest day prior thereto on which there was a Closing Price; and (B) the "Closing Price" of the Stock on any business day will be the last sale price as reported on the principal market on which the Stock is traded or, if no last sale is reported, then the mean between the highest bid and lowest asked prices on that day. (c) Duration of Options. The latest date on which an option may be exercised (the "Final Exercise Date") shall be the date which is ten years from the date the option was granted. (d) Exercise of Options. (1) Each option shall become exercisable to the extent of one-third of the shares covered thereby on the date of the Annual Meeting held in each of the first, second and third years following the date of grant, except that options granted on dates other than the date of the Annual Meeting shall become exercisable to the extent of one- third of the shares covered thereby on each of the first, second and third anniversaries of the date of the grant. (2) Any exercise of an option shall be in writing, signed by the proper person and delivered or mailed to the Company, accompanied by (i) any documentation required by the Committee and (ii) payment in full for the number of shares for which the option is exercised. (3) The Committee shall have the right to require that the individual exercising the option remit to the Company an amount sufficient to satisfy any federal, state, or local withholding tax requirements (or make other arrangements satisfactory to the employer with regard to such taxes) prior to the delivery of any Stock pursuant to the exercise of the option. If permitted by the Committee the individual exercising the option may elect, at such time and in such manner as the Committee may prescribe, to have the Company hold back from the transfer Stock having a value calculated to satisfy such withholding obligation. In the case of an individual subject to Section 16(b) of the Exchange Act, no such election shall be effective unless made in compliance with the applicable requirements of Rule 16b- 3 or any successor Rule under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). (4) If an option is exercised by the executor or administrator of a deceased director, or by the person or persons to whom the option has been transferred by the director's will or the applicable laws of descent and distribution, the Company shall be under no obligation to deliver Stock pursuant to such exercise until the Company is satisfied as to the authority of the person or persons exercising the option. (e) Payment for and Delivery of Stock. Stock purchased under the Plan shall be paid for as follows: (i) in cash or by check (acceptable to the Company in accordance with guidelines established for this purpose), bank draft or money order payable to the order of the Company; (ii) through the delivery of shares of Stock (which, in the case of shares of Stock acquired from the Company, have been outstanding for at least six months) having a fair market value on the last business day preceding the date of exercise equal to the purchase price; (iii) by having the Company hold back from the shares transferred upon exercise Stock having a fair market value on the last business day preceding the date of exercise equal to the exercise price; (iv) by delivery of an unconditional and irrevocable undertaking by a broker to deliver promptly to the Company sufficient funds to pay the purchase price; or (v) by any combination of the permissible forms of payment; provided, that if the Stock delivered upon exercise of the option is an original issue of authorized Stock, at least so much of the exercise price as represents the par value of such Stock shall be paid other than with a personal check or promissory note of the option holder. An option holder shall not have the rights of a shareholder with regard to awards under the Plan except as to Stock actually received by him or her under the Plan. The Company shall not be obligated to deliver any shares of Stock (a) until, in the opinion of the Company's counsel, all applicable federal and state laws and regulations have been complied with, and (b) if the outstanding Stock is at the time listed on any stock exchange, until the shares to be delivered have been listed or authorized to be listed on such exchange upon official notice of issuance, and (c) until all other legal matters in connection with the issuance and delivery of such shares have been approved by the Company's counsel. If the sale of Stock has not been registered under the Securities Act of 1933, as amended, the Company may require, as a condition to exercise of the option, such representations or agreements as counsel for the Company may consider appropriate to avoid violation of such Act and may require that the certificates evidencing such Stock bear an appropriate legend restricting transfer. (f) Nontransferability of Options. No option may be transferred other than by will or by the laws of descent and distribution, and during a director's lifetime an option may be exercised only by him or her. (g) Death. Upon the death of any Eligible Director granted options under this Plan, all options not then exercisable shall terminate. All options held by the director that are exercisable immediately prior to death may be exercised by his or her executor or administrator, or by the person or persons to whom the option is transferred by will or the applicable laws of descent and distribution, at any time within one year after the director's death (subject, however, to the limitations of Sec- tion 6(c) regarding the maximum exercise period for such option). After completion of that one-year period, such options shall terminate to the extent not previously exercised. (h) Other Termination of Status of Director. If a director's service with the Company terminates for any reason other than death, all options held by the director that are not then exercisable shall terminate. Options that are exercisable on the date of termination shall continue to be exercisable for a period of three months (subject to Section 6(c)). After completion of that three-month period, such options shall terminate to the extent not previously exercised, expired or terminated. (i) Mergers, etc. In the event of a consolidation or merger in which the Company is not the surviving corporation or which results in the acquisition of substantially all the Company's outstanding Stock by a single person or entity or by a group of persons and/or entities acting in concert, or in the event of a sale or transfer of substantially all of the Company's assets or a dissolution or liquidation of the Company, all options hereunder will terminate; provided, that immediately prior to any such merger, consolidation sale, dissolution, or liquidation, all options outstanding hereunder that are not otherwise exercisable shall become exercisable; and provided, further that in the event such a transaction is to be accounted for as a pooling of interests, the Company shall provide for the surviving or acquiring corporation or an affiliate thereof to assume such options or to grant each holder of an option hereunder outstanding at the time of the transaction replacement options on substantially equivalent terms, in each case without a requirement that such director continue to serve as a director of the surviving or acquiring corporation or an affiliate thereof. 7. EFFECT, DISCONTINUANCE, CANCELLATION, AMENDMENT, TERMINATION AND EFFECTIVENESS Neither adoption of the Plan nor the grant of options to a director shall affect the Company's right to grant to such director options that are not subject to the Plan, to issue to such directors Stock as a bonus or otherwise, or to adopt other plans or arrangements under which Stock may be issued to directors. The Committee may at any time terminate the Plan as to any further grants of options. The Committee may at any time or times amend the Plan for any purpose which may at the time be permitted by law. EX-10 6 AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT Dated as of December 31, 1998 by and among DYNAMICS RESEARCH CORPORATION, DRC ENCODER, INC., DRC METRIGRAPHICS, INC., DRC SOFTWARE, INC. and DRC TELECOM, INC., as the Borrowers, and THE LENDERS PARTY HERETO and BROWN BROTHERS HARRIMAN & CO., as Agent and as Swing Line Lender DYNAMICS RESEARCH CORPORATION CREDIT AGREEMENT TABLE OF CONTENTS SECTION PAGE 1. DEFINITIONS AND RULES OF INTERPRETATION 1 1.1. Definitions 1 1.2. Rules of Interpretation 10 2. THE CREDIT FACILITIES 11 2.1. Amounts and Terms 11 2.2. Fees 13 2.3. Reduction of Commitments 14 2.4. Revolving Credit Note 14 2.5. Swing Line Note 14 2.6. Interest on Loans 15 2.7. Requests for Loans 16 2.8. Conversion and Continuation 16 2.9. Funds for Loans 18 3. PREPAYMENT OF THE LOANS; RESERVES 18 3.1. Voluntary Prepayments 18 3.2. Mandatory Prepayments 18 4. CERTAIN GENERAL PROVISIONS 18 4.1. Funds for Payments 18 4.2. Computations 19 4.3. Inability to Determine Adjusted LIBOR 19 4.4. Illegality 20 4.5. Additional Costs, Etc 20 4.6. Capital Adequacy 21 4.7. Certificate 22 4.8. Indemnity 22 4.9. Interest on Overdue Amounts 22 4.10. Mitigation 22 4.11. Joint and Several Obligations 22 5. REPRESENTATIONS AND WARRANTIES 23 5.1 Organization, Standing, etc. of the Borrowers 23 5.2 Subsidiaries 23 5.3 Qualification 23 5.4 Financial Information; Disclosure, etc. 23 5.5 Licenses, etc. 24 5.6 Material Agreements 24 5.7 Tax Returns and Payments 24 5.8 Indebtedness, Liens and Investments, etc. 24 5.9 Title to Properties; Liens 25 5.10 Litigation, etc. 25 5.11 Authorization; Compliance with Other Instruments 25 5.12 Governmental Consent 25 5.13 Regulation U, etc 26 5.14 Employee Retirement Income Security Act of 1974 26 5.15 Environmental Matters 26 5.16 Use of Proceeds 27 5.17 Investment Company Act; Public Utility Holding Company Act 27 6. AFFIRMATIVE COVENANTS OF THE BORROWERS 27 6.1 Records and Accounts 27 6.2 Financial Statements, Certificates and Information 27 6.3 Legal Existence; Compliance with Laws, etc. 29 6.4 Insurance 29 6.5 Payment of Taxes 30 6.6 Payment of Other Indebtedness, etc. 30 6.7 Further Assurances 30 6.8 Depository Account 30 6.9 Use of Proceeds 30 6.10 No Further Negative Pledges 30 6.11 Regulation U 31 7. CERTAIN NEGATIVE COVENANTS OF THE BORROWERS 31 7.1 Indebtedness 31 7.2 Mortgages, Liens, etc. 32 7.3 Loans, Guarantees and Investments 33 7.4 Leases 34 7.5 Mergers and Consolidations 35 7.6 Sale of Assets 35 7.7 Capital Expenditures 36 7.8 Distributions 36 7.9 Compliance with ERISA 36 7.10 Transactions with Affiliates 37 7.11 Observance of Subordination Provisions, etc. 37 7.12 Environmental Liabilities 37 7.13 Subsidiaries 37 7.14 Material Adverse Change 37 8. FINANCIAL COVENANTS 37 9. DEFAULTS; REMEDIES 38 9.1 Events of Default; Acceleration 38 9.2 Remedies on Default, etc. 40 10. CLOSING CONDITIONS 41 10.1. Loan Documents, etc 41 10.2. Corporate Action 41 10.3. Incumbency Certificate 41 10.4. Opinions of Counsel 41 10.5. Payment of Fees 41 11. CONDITIONS TO ALL LOANS 41 11.1. Accuracy of Representations; No Event of Default 41 11.2. No Legal Impediment 42 12 THE AGENT 42 12.1 Appointment, Powers and Immunities 42 12.2 Reliance by Agent 42 12.3 Defaults 43 12.4 Rights as a Lender 43 12.5 Indemnification 43 12.6 Non-Reliance on Agent and Other Lenders 43 12.7 Failure to Act 44 12.8 Resignation of Agent 44 12.9 Cooperation of Lenders 44 12.10 Amendment of 12 45 12.11 Reliance 45 13. SETOFF, ETC 45 14. EXPENSES 45 15. INDEMNIFICATION 46 16. SURVIVAL OF COVENANTS, ETC 46 17. ASSIGNMENT AND PARTICIPATION 47 17.1. Assignment by the Lenders 47 17.2. Assignment by Borrowers 47 17.3 Participations by the Lenders 47 17.4 Replacement of Lender 47 18. FOREIGN LENDER 48 19. NOTICES, ETC 49 20. GOVERNING LAW 50 21. HEADINGS 51 22. COUNTERPARTS 51 23. ENTIRE AGREEMENT, ETC 51 24. WAIVER OF JURY TRIAL 51 25. CONSENTS, AMENDMENTS, WAIVERS, ETC 52 26. CONFIDENTIALITY 52 27. SEVERABILITY 53 28. NATURE OF LENDER'S OBLIGATIONS 53 SCHEDULES AND EXHIBITS Schedule 5.2 Subsidiaries Schedule 5.4 Financial Statements Schedule 5.5 Licenses Schedule 5.6 Material Agreements Schedule 5.8 Existing Indebtedness Schedule 5.10 Litigation Schedule 5.12 Consents Schedule 5.15 Hazardous Materials Schedule 7.2 Encumbrances Exhibit A Form of Swing Line Loan Participation Certificate Exhibit B-1 Form of Revolving Credit Note Exhibit B-2 Form of Swing Line Note Exhibit C Form of Loan Request Exhibit D Form of Compliance Certificate Exhibit E Form of Opinion of Borrowers' Counsel AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT This AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT is made as of the 31st day of December, 1998, by and among DYNAMICS RESEARCH CORPORATION, a Massachusetts corporation ("DRC"), DRC ENCODER, INC., a Massachusetts corporation ("Encoder"), DRC METRIGRAPHICS, INC., a Massachusetts corporation ("Metrigraphics"), DRC SOFTWARE, INC., a Massachusetts corporation ("Software"), DRC TELECOM, INC., a Massachusetts corporation ("Telecom"), and BROWN BROTHERS HARRIMAN & CO., a New York limited partnership ("BBH&Co"), as a Lender (as defined below), as Agent (as defined below) for itself and the other Lenders and as Swing Line Lender (as defined below), BANKBOSTON, N.A., a national banking association ("BankBoston"), THE CHASE MANHATTAN BANK, a New York banking corporation ("Chase"), STATE STREET BANK AND TRUST COMPANY, a Massachusetts trust company ("State Street"), CITIZENS BANK OF MASSACHUSETTS, a Massachusetts financial institution ("Citizens") and the other Lenders from time to time party hereto. 1. DEFINITIONS AND RULES OF INTERPRETATION. 1.1. Definitions. The following terms shall have the meanings set forth in this 1 or elsewhere in the provisions of this Credit Agreement referred to below: Additional Extraordinary Charges. Extraordinary charges by the Borrowers in an aggregate amount of up to $4,500,000 resulting from (i) extraordinary charges by the Borrowers on account of the discontinuance of the telephone fraud detection and control business, (ii) any write-up or write-down of any capital stock of Electronic Press owned by DRC, and (iii) any write-up or write-down of any capital stock of Telica owned by DRC, but only to the extent that all such extraordinary charges are taken on or prior to June 30, 1999; provided, however, that the aggregate amount of such extraordinary charges shall be calculated on a cumulative basis and shall be net of all credits and gains resulting from such events. Adjusted LIBOR. With respect to any LIBOR Loan for any Interest Period, an interest rate per annum (rounded upwards, if necessary, to the next 1/100 of 1%) equal to (a) the LIBOR for such Interest Period multiplied by (b) the Statutory Reserve Rate. Affected Lender. The meaning specified in 17.4. Affiliate. As applied to any Person, a spouse of such Person, any relative (by blood, adoption or marriage) of such Person within the third degree, any managing member, director or officer of such Person, any corporation, association, firm or other entity of which such Person is a managing member, director or officer and any other Person directly or indirectly controlling, controlled by or under direct or indirect common control with such Person. Agent. BBH&Co in its capacity as agent for the Lenders hereunder, as well as its successors and assigns in such capacity pursuant to 12.8. Available Total Commitment. The Total Commitment less the sum of (i) the outstanding principal amounts advanced as Revolving Credit Loans and (ii) the outstanding principal amounts advanced as Swing Line Loans. Base Rate. For any date, a rate per annum equal to the higher of (i) the Federal Funds Effective Rate in effect on such day plus one-half of one percent (.50%) or (ii) the annual rate of interest publicly announced from time to time by the Agent as its "commercial base rate" in effect on such day. Base Rate Loans. Loans bearing interest calculated by reference to the Base Rate. Base Rate Margin. The meaning specified in 2.6(a). Borrower. Each of DRC, Encoder, Metrigraphics, Software and Telecom. Business Day. Any day on which banking institutions in Boston, Massachusetts are open for the transaction of banking business and, in the case of LIBOR Loans, also a day which is a LIBOR Business Day. Capital Expenditures. Any payment made directly or indirectly by DRC or any of its Subsidiaries for the purpose of acquiring or constructing fixed assets, real property or equipment which in accordance with GAAP would be added as a debit to the Consolidated fixed asset account of DRC and its Subsidiaries, including without limitation amounts paid or payable under any conditional sale or other title retention agreement or under any lease or other periodic payment arrangement which is of such a nature that payment obligations of a Borrower thereunder would be required by GAAP to be capitalized and shown as liabilities on the Consolidated balance sheet of DRC and its Subsidiaries. Capitalization. As of the date of any determination thereof, the sum of (a) Tangible Net Worth and (b) Indebtedness for borrowed money of DRC and its Subsidiaries on a Consolidated basis. Capitalized Leases. Leases under which a Person is the lessee or obligor, the discounted future rental payment obligations under which are required to be capitalized on the balance sheet of such Person in accordance with GAAP. Change in Control. Shall be deemed to have occurred if any Person or group (within the meaning of Rule 13d-5 of the Securities and Exchange Commission as in effect on the date hereof) shall own directly or indirectly, beneficially or of record, shares representing more than 50%, on a fully-diluted basis, of the aggregate ordinary voting power of DRC. Closing Date. The first date on which the conditions set forth in 10 and 11 have been satisfied and any Loans are made. Code. The Internal Revenue Code of 1986, as amended. Commitment. As to any Lender, such Lender's portion of the Total Commitment equal to such Lender's Percentage. Commitment Fee. The meaning specified in 2.2(a) Consolidated. With reference to any term herein, shall mean that term as applied to the accounts of DRC and its Subsidiaries, consolidated in accordance with GAAP. Credit Agreement. This Amended and Restated Credit Agreement, including the Schedules and Exhibits hereto. Current Lines of Business. The lines of business conducted by the Borrower and its Subsidiaries on the Closing Date and any business and activities incidental thereto, including: (i) the provision of computer systems services and other engineering and management support services to the Department of Defense and other customers, including the development and operation of computer-based management information systems in which software programs are applied to collect, analyze, store and retrieve information relating to component parts of weapons systems; (ii) the manufacture of position and motion sensors and other precision components, including encoders that measure movement, and precision-patterned glass and electroformed metal products; (iii) the telephone fraud detection and control business; and (iv) the object-oriented development software business. Debt Coverage Certificate. The meaning specified in 2.6(a) Debt Coverage Ratio. The meaning specified in 2.6(a). Dollars or $. Dollars in lawful currency of the United States of America. Drawdown Date. The date on which any Loan is made or is to be made, and the date on which any Loan is converted or continued in accordance with 2.8. EBITDA. For any period, the Consolidated Net Income of DRC and its Subsidiaries for such period adjusted by adding back thereto amounts deducted in computing such Consolidated Net Income in respect of (a) Interest Expense of DRC and its Subsidiaries, (b) taxes in respect of income and profits of DRC and its Subsidiaries and (c) depreciation and amortization of DRC and its Subsidiaries. Electronic Press. Electronic Press Services Group, Inc., a Delaware corporation. Employee Benefit Plan. Any employee benefit plan within the meaning of Section 3(3) of ERISA maintained or contributed to by a Borrower or any ERISA Affiliate, or with respect to which a Borrower or any ERISA Affiliate has actual or contingent liability, in each case other than a Multiemployer Plan. Environmental Laws. Any and all applicable current and future treaties, laws, rules, regulations, codes, ordinances, orders, decrees, judgments, injunctions, notices or binding agreements issued, promulgated or entered into by any governmental authority, relating in any way to the environment, preservation or reclamation of natural resources or human exposure to or the management or Release or threatened Release of any Hazardous Material. ERISA. The Employee Retirement Income Security Act of 1974, as amended. ERISA Affiliate. Any Person which is treated as a single employer with a Borrower under Section 414 of the Code or Section 4001 of ERISA. ERISA Reportable Event. A reportable event with respect to a Guaranteed Pension Plan within the meaning of 4043 of ERISA and the regulations promulgated thereunder as to which the requirement of notice has not been waived. Event of Default. The meaning specified in 9.1. Federal Funds Effective Rate. For any day, the weighted average (rounded upwards, if necessary, to the next 1/100 of 1%) of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published on the next succeeding Business Day by the Federal Reserve Bank of New York, or, if such rate is not so published for any day that is a Business Day, the average (rounded upwards, if necessary, to the next 1/100 of 1%) of the quotations for such day for such transactions received by the Agent from three Federal funds brokers of recognized standing selected by it. GAAP. Generally accepted accounting principles in the United States of America. Guaranteed Pension Plan. Any Employee Benefit Plan the benefits of which are guaranteed on termination in full or in part by the PBGC pursuant to Title IV of ERISA. Hazardous Materials. All explosive or radioactive substances or wastes, hazardous or toxic substances or wastes, pollutants, solid, liquid or gaseous wastes, including petroleum or petroleum distillates, asbestos or asbestos-containing materials, polychlorinated biphenyls or materials or equipment containing polychlorinated biphenyls, radon gas, infectious or medical wastes and all other substances or wastes of any nature regulated pursuant to any Environmental Law. Indebtedness. All obligations, contingent and otherwise, that in accordance with GAAP should be classified upon a Person's balance sheet as liabilities, including: (a) all debt and similar monetary obligations, whether direct or indirect; (b) all liabilities secured by any mortgage, pledge, security interest, lien, charge, or other encumbrance existing on property owned or acquired by such Person subject thereto, whether or not the liability secured thereby shall have been assumed; (c) all obligations in respect of Capitalized Leases; and (d) all guarantees, endorsements and other contingent obligations whether direct or indirect in respect of indebtedness owed by others, including any obligation to supply funds to or in any manner to invest in, directly or indirectly, the debtor, to purchase indebtedness, or to assure the owner of indebtedness against loss, through an agreement to purchase goods, supplies, or services for the purpose of enabling the debtor to make payment of the indebtedness held by such owner or otherwise, and the obligations to reimburse the issuer in respect of any letters of credit. Interest Expense. For any period, the aggregate amount (determined in accordance with GAAP) of interest paid or payable during such period by any Person in respect of all Indebtedness for borrowed money, Capitalized Leases and the deferred purchase price of property. Interest Payment Date. (a) As to any Base Rate Loan, March 31, June 30, September 30 and December 31 and any date on which such Base Rate Loan is converted to a LIBOR Loan; and (b) as to any LIBOR Loan, the last day of the Interest Period relating to such LIBOR Loan; provided, that in the event that such Interest Period is 180 days, the 90th day and the last day of such Interest Period. Interest Period. With respect to each LIBOR Loan, the period of one, two, three or six months, as selected by a Borrower commencing on the Drawdown Date of such LIBOR Loan; provided that the foregoing provisions relating to Interest Periods are subject to the following: (a) if any Interest Period would otherwise end on a day that is not a LIBOR Business Day, that Interest Period shall be extended to the next succeeding LIBOR Business Day unless the result of such extension would be to carry such Interest Period into another calendar month, in which event such Interest Period shall end on the immediately preceding LIBOR Business Day; and (b) any Interest Period that would otherwise extend beyond the Maturity Date shall end on the Maturity Date. Investments. All expenditures made and all liabilities incurred (contingently or otherwise), without duplication, for the acquisition of stock or Indebtedness of, or for loans, advances, capital contributions or transfers of property to, or in respect of any guaranties (or other commitments as described under Indebtedness), or obligations of, any Person. In determining the aggregate amount of Investments outstanding at any particular time: (a) the amount of any Investment represented by a guaranty shall be taken at not less than the principal amount of the obligations guaranteed and still outstanding; (b) there shall be included as an Investment all interest accrued with respect to Indebtedness constituting an Investment unless and until such interest is paid; (c) there shall be deducted in respect of each such Investment any amount received as a return of capital (but only by repurchase, redemption, retirement, repayment, liquidating dividend or liquidating distribution); (d) there shall not be deducted in respect of any Investment any amounts received as earnings on such Investment, whether as dividends, interest or otherwise, except that accrued interest included as provided in the foregoing clause (b) may be deducted when paid; and (e) there shall not be deducted from the aggregate amount of Investments any decrease in the value thereof. Lenders. Each Person (including the Swing Line Lender) which may from time to time own a Percentage of the Total Commitment, including BBH&Co in its capacity as a Lender and as the Swing Line Lender; provided, however, that the term "Lender" shall not include any Participant. LIBOR. With respect to any LIBOR Loan for any Interest Period, the rate appearing on Page 3750 of the Telerate Service (or on any successor or substitute page of such Service, or any successor to or substitute for such Service, providing rate quotations comparable to those currently provided on such page of such Service, as determined by the Agent from time to time for purposes of providing quotations of interest rates applicable to Dollar deposits in the London interbank market) at approximately 11:00 a.m., London time, three Business Days prior to the commencement of such Interest Period, as the rate for U.S. dollar deposits with a maturity comparable to such Interest Period. In the event that such rate is not available at such time for any reason, the "LIBOR" with respect to such LIBOR Loan for such Interest Period shall be the rate at which dollar deposits of $5,000,000 and for a maturity comparable to such Interest Period are offered by the principal London office of the Agent (or, if the Agent does not have such an office, such office of any other Lender, as selected by the Agent) in immediately available funds in the London interbank market at approximately 11:00 a.m., London time, three Business Days prior to the commencement of such Interest Period. LIBOR Business Day. Any Business Day on which commercial banks are open for international business (including dealings in Dollar deposits) in London, England. LIBOR Loans. Loans bearing interest calculated by reference to the Adjusted LIBOR. LIBOR Margin. The meaning specified in 2.6(a). Licenses. The meaning specified in 5.5. Loan Documents. This Credit Agreement, the Notes and any other document executed and delivered in connection herewith. Loan Request. The meaning specified in 2.7. Loans. The Swing Line Loans and the Revolving Credit Loans. Maturity Date. October 1, 2000, subject to extension pursuant to 2.4. Moody's. Moody's Investors Service, Inc. Multiemployer Plan. Any multiemployer plan within the meaning of Section 3(37) of ERISA maintained or contributed to by a Borrower or any ERISA Affiliate or with respect to which a Borrower or any ERISA Affiliate has actual or contingent liability. Net Income. Income (or loss), excluding extraordinary items of income (or loss), of a Person for the period in question (taken as a cumulative whole), after deducting therefrom all operating expenses, reserves and other proper deductions (including any minority interest expense), all determined in accordance with GAAP. For purposes hereof, the Consolidated Net Income of DRC and its Subsidiaries (a) shall include the Net Income of any other Persons acquired prior to the date that it either becomes a Subsidiary of such Borrower, is merged into or consolidated with such Borrower, or such other Person's assets are assigned, directly or indirectly, to such Borrower, provided that, in the case of each of the foregoing, (i) the Net Income of such other Person shall only be so included to the extent that such Net Income is attributable to such other Person or to such assets as are acquired from such other Person for the relevant period, all to the satisfaction of the Agent, and (ii) any discrepancies in accounting treatment between such Borrower and such other Person are conformed so as to make the foregoing determination, to the satisfaction of the Agent and (b) shall not include Additional Extraordinary Charges, without duplication with extraordinary items permitted to be excluded from the calculation of income (or loss) in accordance with GAAP as set forth above. Notes. The Swing Line Note and the Revolving Credit Note. Obligations. All indebtedness, obligations and liabilities of the Borrowers to the Lenders, individually or collectively, existing on the date of this Credit Agreement or arising thereafter, direct or indirect, joint or several, absolute or contingent, matured or unmatured, liquidated or unliquidated, secured or unsecured, arising by contract, operation of law or otherwise, arising or incurred under the Loan Documents or in respect of any of the Loans or the Notes or other instruments at any time evidencing any thereof. Outstanding. With respect to the Loans, the aggregate unpaid principal thereof as of any date of determination. Participant. The meaning specified in 17.3. PBGC. The Pension Benefit Guaranty Corporation created by 4002 of ERISA and any successor entity or entities having similar responsibilities. Percentage. The meaning specified in 2.1(a). Permitted Liens. The meaning specified in 7.2. Person. Any individual, corporation, partnership, limited liability company, trust, unincorporated association, joint venture, organization, business, or other legal entity, and any government or any governmental agency or political subdivision thereof. Projections. DRC's forecasted balance sheets and statements of income and surplus and cash flow, all prepared on a basis consistent with DRC's historical financial statements, together with appropriate supporting details and statements of underlying assumptions. Qualified Plan. A pension plan (as defined in Section 3(2) of ERISA) intended to be tax-qualified under Section 401(a) of the IRC which a Borrower or any ERISA Affiliate sponsors, maintains, or to which any such Person makes, is making, or is obligated to make, contributions, or, in the case of a multiple-employer plan (as described in Section 4064(a) of ERISA), has made contributions at any time during the immediately preceding period covering at least five (5) plan years, but excluding any Multiemployer Plan. Record. The grid attached to the Revolving Credit Note, or the continuation of such grid, or any other similar record, including computer records, maintained by the Agent with respect to any Revolving Credit Loan referred to in the Revolving Credit Note. Refunded Swing Line Loan. The meaning specified in 2.1(c). Release. Any spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, dumping, disposing, depositing, dispersing, emanating or migrating of any Hazardous Material in, into, onto or through the environment. Replacement Lender. The meaning specified in 17.4. Required Lenders. Any two or more Lenders holding in the aggregate at least sixty-six and two-thirds percent (66 2/3%) of the amounts Outstanding on the Loans or, if no amounts are Outstanding hereunder, of the Percentages of the Total Commitment. Revolving Credit Loan. Any revolving credit loan made pursuant to 2.1(b). Revolving Credit Note. The meaning specified in 2.4. S&P. Standard & Poor's Ratings Group, a division of the McGraw Hill Companies, Inc. Senior Debt. All Indebtedness of a Person and its Subsidiaries (without duplication) in respect of borrowed money, Capitalized Leases and the deferred purchase price of property, other than Subordinated Debt. Statutory Reserve Rate. A fraction (expressed as a decimal), the numerator of which is the number one and the denominator of which is the number one minus the aggregate of the maximum reserve percentages (including any marginal, special, emergency or supplemental reserves) expressed as a decimal established by the Board of Governors of the Federal Reserve System of the United States to which any of the Lenders is subject for eurocurrency funding (currently referred to as "Eurocurrency Liabilities" in Regulation D of such Board), as appropriately adjusted by mutual agreement of the Agent and the Required Lenders to the extent that any Lender is not subject to, or is subject to different reserve requirements under, such regulations. Such reserve percentages shall include those imposed pursuant to such Regulation D. LIBOR Loans shall be deemed to constitute eurocurrency funding and to be subject to such reserve requirements without benefit of or credit for proration, exemptions or offsets that may be available from time to time to any Lender under such Regulation D or any comparable regulation. The Statutory Reserve Rate shall be adjusted automatically on and as of the effective date of any change in any reserve percentage. Subordinated Debt: (a) The existing Indebtedness of the Borrowers which is designated as "Subordinated Debt" in Schedule 5.8 attached hereto, and (b) any other Indebtedness of a Borrower which matures in its entirety and by its terms (or by the terms of the instrument under which it is outstanding and to which appropriate reference is made in the instrument evidencing such Subordinated Debt) is made subordinate and junior in right of payment to the Notes and to each Borrower's other obligations to the Lenders hereunder by provisions reasonably satisfactory in form and substance to the Required Lenders and their counsel. Subsidiary. Any partnership, corporation, association, trust, or other business entity of which DRC shall at any time own directly or indirectly through a Subsidiary or Subsidiaries at least a majority (by number of votes) of the outstanding Voting Interests. Swing Line Availability. The meaning specified in 2.1(c). Swing Line Lender. BBH&Co. Swing Line Loan. The meaning specified in 2.1(c). Swing Line Note. The meaning specified in 2.5. Tangible Net Worth. As of the date of any determination thereof, the difference of: (a) DRC's stockholders' equity; minus (b) the sum of: (i) all intangible assets of DRC and its Subsidiaries; and (ii) all amounts due to DRC from any of its Affiliates (other than any other Borrower), in each case calculated on a Consolidated basis. For purposes hereof, Consolidated Net Worth shall be increased by the amount of Additional Extraordinary Charges, without duplication with other extraordinary items determined in accordance with GAAP. Telica. Telica, Inc., a Massachusetts corporation. Total Commitment. The meaning specified in 2.1(a). Unfunded Benefit Liability means the excess of a Qualified Plan's or a Multiemployer Plan's benefit liabilities (as defined in Section 4001(a) (16) of ERISA) over the current value of such plan's assets, determined in accordance with the assumptions used by the plan's actuaries for funding the plan pursuant to Section 412 of the Code for the applicable plan year. Voting Interests. Stock or similar interests, of any class or classes (however designated), the holders of which are at the time entitled, as such holders, to vote for the election of a majority of the directors (or persons performing similar functions) of the partnership, corporation, association, trust or other business entity involved, whether or not the right so to vote exists by reason of the happening of a contingency. 1.2. Rules of Interpretation. (a) A reference to any document or agreement shall include such document or agreement as amended, modified or supplemented from time to time in accordance with its terms and the terms of this Credit Agreement. (b) The singular includes the plural and the plural includes the singular. (c) A reference to any law includes any amendment or modification to such law. (d) A reference to any Person includes its permitted successors and permitted assigns. (e) Accounting terms not otherwise defined herein have the meanings assigned to them by GAAP applied on a consistent basis by the accounting entity to which they refer. (f) The words "include", "includes" and "including" are not limiting. (g) Reference to a particular section refers to that section of this Credit Agreement unless otherwise indicated. (h) The words "herein", "hereof", "hereunder" and words of like import shall refer to this Credit Agreement as a whole and not to any particular section or subdivision of this Credit Agreement. (i) Except as otherwise expressly provided herein, all terms of an accounting or financial nature shall be construed in accordance with GAAP, as in effect from time to time; provided that, if a Borrower notifies the Agent that such Borrower requests an amendment to any provision hereof to eliminate the effect of any change occurring after the date hereof in GAAP or in the application thereof on the operation of such provision (or if the Agent notifies a Borrower that the Required Lenders request an amendment to any provision hereof for such purpose), regardless of whether any such notice is given before or after such change in GAAP or in the application thereof, then such provision shall be interpreted on the basis of GAAP as in effect and applied immediately before such change shall have become effective until such notice shall have been withdrawn or such provision amended in accordance herewith. 2. THE CREDIT FACILITIES. 2.1. Amounts and Terms of the Facilities. (a) Commitments. The Borrowers wish to establish a revolving credit facility with the Lenders in an aggregate principal amount at any one time outstanding not in excess of $40,000,000 (as such amount may be reduced from time to time pursuant to 2.3) (the "Total Commitment"). Each Lender is severally willing to establish such revolving credit facility on behalf of the Borrowers, subject to the terms and conditions hereafter set forth, in the aggregate maximum amounts at any one time outstanding set forth opposite each Lender's name and in the respective percentages set forth opposite each Lender's name which shall be applicable to such revolving credit facility hereunder (hereinafter referred to as such Lender's "Percentage"): Lender Commitment Percentage of Total Commitment BBH&Co $10,668,000 26.67% BankBoston $8,000,000 20.00% Chase $8,000,000 20.00% State Street $8,000,000 20.00% Citizens $5,332,000 13.33% TOTAL $40,000,000 100.00% (b) Revolving Loans. Subject to the terms and conditions set forth in this Credit Agreement, each Lender hereby severally establishes a revolving credit facility in favor of the Borrowers in the individual principal amount of such Lender's Percentage of the Total Commitment. Each Lender agrees to lend to any Borrower, and any Borrower may borrow, repay, and reborrow from time to time between the Closing Date and the Maturity Date, upon notice by any Borrower to the Agent given in accordance with 2.7, such sums as are requested by such Borrower up to a maximum aggregate principal amount outstanding (after giving effect to all amounts requested) at any one time equal to such Lender's Percentage of the Available Total Commitment; provided, however, that the proceeds of any and all borrowings and reborrowings hereunder shall be used solely for the purposes described in 5.16. All Revolving Credit Loans shall be made as LIBOR Loans or Base Rate Loans, at a Borrower's option. Base Rate Loans may be converted to LIBOR Loans; and LIBOR Loans may be continued or converted to Base Rate Loans under the circumstances, and subject to the conditions, specified in 2.8. Each request for a Revolving Credit Loan hereunder shall constitute a representation and warranty by each of the Borrowers that the conditions set forth in 10 and 11, in the case of the initial Revolving Credit Loans to be made on the Closing Date, and 11, in the case of all other Revolving Credit Loans, have been satisfied on the date of such request. (c) Swing Line Loans. (i) On any date prior to the Maturity Date on which the Agent receives any Loan Request in respect of the Available Total Commitment pursuant to 2.7, designated as a Swing Line Loan, the Agent promptly shall notify the Swing Line Lender and, subject to the terms and conditions hereof, the Swing Line Lender shall, on the date the Agent receives such Loan Request, make an advance (each a "Swing Line Loan") in accordance with any such notice. The aggregate amount of Swing Line Loans at any time outstanding shall not exceed the lesser of (A) $3,000,000 and (B) the Available Total Commitment ("Swing Line Availability"). Until the Maturity Date, any Borrower may from time to time borrow, repay and reborrow under this 2.1(c). Each Swing Line Loan shall be made pursuant to a Loan Request in respect of the Available Total Commitment pursuant to 2.7. Each such Loan Request must be given no later than 12:00 p.m. (Boston time) on the Business Day of the proposed Swing Line Loan. Notwithstanding any other provision of this Agreement or the other Loan Documents, the Swing Line Loans shall constitute Base Rate Loans. The Borrowers shall repay the aggregate outstanding principal amount of each Swing Line Loan upon demand therefor by the Agent, provided that (i) absent an Event of Default or any other event which, with the giving of notice or passage of time or both, would constitute an Event of Default, the Agent shall not make such demand prior to the Business Day next succeeding the date on which such Swing Line Loan is made and (ii) all amounts of principal and accrued interest outstanding on the Maturity Date or the earlier maturity by acceleration or otherwise shall be paid in full on such date. (ii) The Swing Line Lender, at any time and from time to time in its sole and absolute discretion, may on behalf of each Borrower (and each Borrower hereby irrevocably authorizes the Swing Line Lender to so act on its behalf) request each Lender (including the Swing Line Lender in its capacity as a Lender) to make a Revolving Credit Loan to such Borrower (which shall be a Base Rate Loan) in an amount equal to such Lender's Percentage of the aggregate principal amount of the Swing Line Loans made to such Borrower (the "Refunded Swing Line Loan") outstanding on the date such notice is given. Unless any of the events described in 9.1(f) or 9.1(g) shall have occurred (in which event the procedures of 2.1(c)(iii) shall apply) and regardless of whether the conditions precedent set forth in this Credit Agreement to the making of a Revolving Credit Loan are then satisfied, each Lender shall disburse directly to the Agent such Lender's Percentage of the Refunded Swing Line Loan on behalf of the Swing Line Lender, prior to 1:00 p.m. (Boston time), in immediately available funds on the Business Day next succeeding the date such notice is given. The proceeds of such Revolving Credit Loans shall be immediately paid to the Swing Line Lender and applied to repay the Refunded Swing Line Loan. (iii) If, prior to refunding any Swing Line Loan pursuant to 2.1(c)(ii), one of the events described in 9.1(f) or 9.1(g) shall have occurred, then, subject to the provisions of 2.1(c)(iv) below, each Lender will, on the date such Revolving Credit Loan was to have been made for the benefit of a Borrower, purchase from the Swing Line Lender an undivided participation interest in the Swing Line Loan in an amount equal to its Percentage of such Swing Line Loan. Upon request, each Lender will promptly transfer to the Swing Line Lender, in immediately available funds, the amount of its participation and upon receipt thereof the Swing Line Lender will deliver to such Lender a Swing Line Loan Participation Certificate, substantially in the form of Exhibit A attached hereto, dated the date of receipt of such funds and in such amount. (iv) Each Lender's obligation to make Revolving Credit Loans and topurchase participating interests in accordance with this 2.1(c) shall be absolute and unconditional and shall not be affected by any circumstance, including (A) any setoff, counterclaim, recoupment, defense or other right which such Lender may have against the Swing Line Lender, the Agent, any Borrower or any other Person for any reason whatsoever, (B) the occurrence or continuance of any Event of Default or any event which, with the giving of notice or passage of time or both would constitute an Event of Default, (C) any inability of a Borrower to satisfy the conditions precedent to borrowing set forth in this Credit Agreement on the date upon which such participating interest is to be purchased or (D) any other circumstance, happening or event whatsoever, whether or not similar to any of the foregoing. If any Lender does not make available to the Agent or the Swing Line Lender, as applicable, the amount required pursuant to 2.1(c) (ii) or 2.1(c)(iii), as the case may be, the Swing Line Lender shall be entitled to recover such amount on demand from such Lender, together with interest thereon for each day from the date of non-payment until such amount is paid in full at a rate equal to the Base Rate plus the Base Rate Margin. 2.2. Fees. (a) Commitment Fee. The Borrowers agree to pay to the Agent for the ratable account of each Lender, on each date that DRC delivers to the Agent a Debt Coverage Certificate pursuant to 2.6(a) and on the Maturity Date, a commitment fee (the "Commitment Fee") calculated at a rate per annum of 0.375% on the daily average unused portion of such Lender's portion of the Available Total Commitment during the immediately preceding fiscal quarter of DRC (adjusted as appropriate for any reduction or termination of any portion of the Total Commitment pursuant to 2.3 during the immediately preceding fiscal quarter or portion thereof). The Commitment Fee shall be computed on the basis of the actual number of days elapsed in a year of 360 days and shall be payable in arrears. (b) Agent's Fees. The Borrowers agree to pay to the Agent, for the Agent's own account, such other fees as DRC and the Agent have heretofore agreed upon in writing. (c) Amendment Fee. The Borrowers agree to pay to the Agent, for the pro rata benefit of the Lenders, an amendment fee in the amount of $100,000. 2.3. Reduction of Commitments. Subject to the terms and conditions of 3, each Borrower shall have the right at any time and from time to time upon three (3) Business Days' prior written notice to the Agent (which shall in turn give prompt written notice to each Lender) to reduce by $1,000,000 or a multiple of $1,000,000 in excess thereof or terminate entirely any portion of the Total Commitment, pro rata in accordance with each Lender's Percentage, whereupon the Total Commitment shall be reduced accordingly or, as the case may be, terminated. Upon the effective date of any such reduction or termination, the Borrowers shall pay to the Agent for the ratable account of each Lender the full amount of any Commitment Fee payable pursuant to 2.2(a) then accrued on the amount of the reduction. No reduction of the Total Commitment may be reinstated. 2.4. Revolving Credit Note. The Revolving Credit Loans made by the Lenders hereunder shall be evidenced by a single promissory note of the Borrowers in substantially the form of Exhibit B-1 attached hereto (the "Revolving Credit Note"), dated as of the Closing Date and completed with appropriate insertions. The Revolving Credit Note shall be payable to the order of the Agent for the ratable account of each Lender in principal amounts equal to the Total Commitment, or, if less, the aggregate outstanding amount of all Revolving Credit Loans made by the Lenders hereunder, plus interest accrued thereon, as set forth below. The Borrowers irrevocably authorize the Agent to make or cause to be made, at or about the time of the Drawdown Date of any Revolving Credit Loan or at the time of receipt of any payment of principal or interest on the Revolving Credit Note, an appropriate notation on its Record reflecting the making of such Revolving Credit Loan or (as the case may be) the receipt of such payment and the respective pro-rata allocations to each Lender in accordance with its respective Percentage of the Total Commitment. The Agent shall record the outstanding amount of the Revolving Credit Loans on the Record as prima facie evidence of the principal amount thereof owing and unpaid to the Agent for the ratable account of the Lenders, but the failure to record, or any error in so recording, any such amount on the Record shall not limit or otherwise affect the obligations of the Borrowers hereunder or under the Revolving Credit Note to make payments of principal of or interest on the Revolving Credit Note when due. The Revolving Credit Note shall be due and payable on the Maturity Date, provided that the Maturity Date may, with the approval of all of the Lenders, be extended annually thereafter for each of the next two twelve-month periods following the Maturity Date. 2.5. Swing Line Note. The Swing Line Loans shall be evidenced by a single promissory note in the form attached hereto as Exhibit B-2 (the "Swing Line Note"), payable to the order of the Agent for the account of the Swing Line Lender, dated as of the Closing Date and in the aggregate principal amount of $3,000,000 or, if less, the aggregate outstanding amount of all Swing Line Loans. 2.6. Interest on Loans. (a) DRC shall deliver to the Agent on the Closing Date and on or before the 45th day immediately following the end of each fiscal quarter of DRC a certificate duly signed by the chief financial officer or treasurer of DRC and reasonably satisfactory in form and substance to the Lenders (a "Debt Coverage Certificate") setting forth the ratio of (i) the Consolidated Senior Debt of DRC and its Subsidiaries for the immediately preceding fiscal quarter-end to (ii) Consolidated EBITDA and its Subsidiaries for the four (4) consecutive quarters ending on such fiscal quarter-end (the "Debt Coverage Ratio"). Loans shall bear interest at a rate per annum equal to the Adjusted LIBOR or Base Rate, as the case may be, plus the applicable margin set forth below based on the Debt Coverage Ratio (which margin is referred to, in the case of Base Rate Loans, as the "Base Rate Margin" and, in the case of LIBOR Loans, as the "LIBOR Margin"). Subject to subparagraph (b) below, each change in the applicable margin based on a change in the Debt Coverage Ratio shall be effective, with respect to all Loans outstanding on or after the date of delivery of a Debt Coverage Certificate, from and including the date of delivery of such certificate until the date immediately preceding the next date of delivery of a Debt Coverage Certificate indicating another such change. Debt Coverage Ratio Base Rate Margin LIBOR Margin < 1.5 0.0% 2.00% > 1.5 to < 2.0 0.0% 2.25% > 2.0 to < 2.5 0.25% 2.50% > 2.5 0.50% 3.00% ; provided, however; that if the Net Income set forth on the Consolidated income statement delivered pursuant to clause (ii) of Section 6.2(a) for the fiscal year ending December 31, 1999 is equal to or more than eighty percent (80%) of the Net Income set forth on the Projections for such fiscal year delivered by the Borrowers to the Lenders on November 2, 1998, pursuant to Section 6.2(e), then from and after April 1, 2000, the foregoing LIBOR Margin based on the Debt Coverage Ratio shall be replaced in its entirety by the following: Debt Coverage Ratio LIBOR Margin < 1.5 1.50% > 1.5 to < 2.0 1.75% > 2.0 to < 2.5 2.00% > 2.5 2.50% (b) During any period when an Event of Default shall have occurred and be continuing or in the event that DRC fails to provide the Agent with the Debt Coverage Certificate for any fiscal quarter of DRC, then until such Event of Default is cured or waived or such certificate is provided, as the case may be, the applicable margin over the Base Rate shall be one-half percent (0.50%) and the applicable margin over the Adjusted LIBOR shall be three percent (3.00%). (c) Interest on each Base Rate Loan and LIBOR Loan shall be computed on the basis of the actual number of days elapsed in a year of 360 days, in each case without duplication of any day in successive Interest Periods. (d) The Borrowers agree to pay to the Agent, for the pro rata benefit of the Lenders, interest on each Loan in arrears on each Interest Payment Date with respect thereto. 2.7. Requests for Loans. A Borrower shall give to the Agent written notice in the form of Exhibit C hereto (or telephonic notice confirmed in a writing in the form of Exhibit C hereto) of the Loans requested from the Lenders hereunder (a "Loan Request"), no later than 12:00 noon, Boston time, (i) no less than one (1) Business Day prior to the proposed Drawdown Date of any Base Rate Loan and (ii) no less than three (3) LIBOR Business Days prior to the proposed Drawdown Date of any LIBOR Loans; provided, however, that a Borrower may give to the Agent a Loan Request for a Swing Line Loan at any time prior to 12:00 noon, Boston time on the proposed Drawdown Date of such Swing Line Loan. Each such notice shall specify (i) the aggregate principal amount of the Loans requested from the Lenders specifying whether such Loans are Revolving Credit Loans or Swing Line Loans (and in any event not in excess of the unused portion of the Available Total Commitment), (ii) whether such Loans are to be LIBOR Loans or Base Rate Loans, (iii) the proposed Drawdown Date of such Loans, (iv) in the case of LIBOR Loans, the Interest Period for such Loans, (v) the purpose or purposes to which the proceeds of such Loans shall be applied, and (vi) such other matters as are set forth on Exhibit C. Each Loan Request shall be in a minimum aggregate amount of $1,000,000 or a higher integral multiple of $500,000; provided, however, that each Loan Request for a Swing Line Loan shall be in a minimum aggregate amount of $100,000 or a higher integral multiple of $50,000. The Agent shall then promptly notify each Lender by written notice of its respective Percentage of the Loans requested. 2.8. Conversion and Continuation. Each Borrower shall have the right at any time upon prior irrevocable notice to the Agent (a) not later than 12:00 noon, Boston time, one (1) Business Day prior to the date of conversion, to convert any LIBOR Loan into a Base Rate Loan, (b) not later than 12:00 noon, Boston time, three (3) LIBOR Business Days prior to conversion or continuation, to convert any Base Rate Loan into a LIBOR Loan or to continue any LIBOR Loan as a LIBOR Loan for an additional Interest Period, and (c) not later than 12:00 noon, Boston time, three (3) Business Days prior to conversion, to convert the Interest Period with respect to any LIBOR Loan to another permissible Interest Period, subject in each case to the following: (i) each conversion or continuation shall be made pro rata among the Lenders in accordance with the respective principal amounts of the Loans comprising the converted or continued Loans; (ii) if less than all the outstanding principal amount of any Loans shall be converted or continued, then the resulting Loans shall satisfy the limitations specified in the penultimate sentence of 2.7 regarding the principal amount of Loans; (iii) each conversion shall be effected by the Agent by recording for the account of each Lender the new Loan of such Lender resulting from such conversion and reducing the Loan (or portion thereof) of such Lender being converted by an equivalent principal amount; (iv) accrued interest on a LIBOR Loan (or portion thereof) being converted or continued shall be paid by the Borrowers at the time of conversion or continuation; (v) LIBOR Loans may only be converted at a time that is the end of the Interest Period applicable thereto; (vi) any portion of a Loan maturing or required to be repaid in less than one month may not be converted into or continued as a LIBOR Loan; (vii) any portion of a LIBOR Loan that cannot be converted into or continued as a LIBOR Loan by reason of the immediately preceding clause shall be automatically converted at the end of the Interest Period in effect for such Loan into a Base Rate Loan; and (viii) no Event of Default and no event which, with the giving of notice or passage of time or both, would constitute an Event of Default has occurred and is continuing; provided, however, that the condition set forth in this clause (viii) shall not be applicable to the conversion of any LIBOR Loan into a Base Rate Loan pursuant to 2.8(a). Each notice pursuant to this 2.8 shall be irrevocable and shall refer to this Agreement and specify (i) the identity and amount of the Loan that a Borrower requests be converted or continued, (ii) whether such Loan is to be converted to or continued as a LIBOR Loan or a Base Rate Loan, (iii) if such notice requests a conversion, the date of such conversion (which shall be a LIBOR Business Day) and (iv) if such Loan is to be converted to or continued as a LIBOR Loan, the Interest Period with respect thereto. If no Interest Period is specified in any such notice with respect to any conversion to or continuation as a LIBOR Loan, the Borrower shall be deemed to have selected an Interest Period of one month's duration. The Agent shall promptly advise the other Lenders of any notice given pursuant to this 2.8 and of each Lender's portion of any converted or continued Loans. If the Borrower shall not have given notice in accordance with this 2.8 to continue any LIBOR Loans into a subsequent Interest Period (and shall not otherwise have given notice in accordance with this 2.8 to convert such LIBOR Loans), such LIBOR Loans shall, at the end of the Interest Period applicable thereto (unless repaid pursuant to the terms hereof), automatically be converted into Base Rate Loans. 2.9. Funds for Loans. Subject to the satisfaction of the other conditions set forth herein, to the extent applicable (including 2.7), each Lender will make available to the Agent on the proposed date of any Loan (other than a Swing Line Loan) by wire transfer of immediately available funds not later than 1:00 P.M., Boston time, the aggregate amount of its Percentage of such Loans requested by the Borrowers, and the Agent shall credit the aggregate amount so received to the respective accounts designated by the Borrowers or, if a Borrower does not designate any account, to DRC's regular deposit account with the Agent. 3. PREPAYMENT OF THE LOANS; RESERVES. 3.1. Voluntary Prepayments. Each Borrower shall have the right, at its election, to prepay the outstanding amount of any Loans, as a whole or in part, at any time without penalty or premium, except as provided in 4.8. A Borrower shall give irrevocable written notice to the Agent, no later than 12:00 noon, Boston time, one Business Day prior to any proposed prepayment of Base Rate Loans pursuant to this 3 and no later than 11:00 a.m., Boston time, three LIBOR Business Days prior to any proposed prepayment of LIBOR Rate Loans pursuant to this 3, in each case specifying the proposed date of prepayment of the Loans and the principal amount and accrued interest to be prepaid, and the Agent shall promptly give notice thereof to each Lender. Each such prepayment of the Base Rate Loans shall be in a minimum amount of the lesser of (i) $1,000,000 and (ii) the aggregate amount outstanding under the Notes being prepaid, and shall be accompanied by the payment of accrued interest on the principal prepaid to the date of such prepayment. 3.2. Mandatory Prepayments. If at any time the outstanding principal amount of all Loans exceeds (or, in the case of any notice of reduction of the Total Commitment pursuant to 2.3, would exceed) the Total Commitment, the Borrowers will immediately prepay the applicable Note or Notes, subject to 4.8, in an amount necessary to cause the outstanding principal amount of all Loans not to exceed the Total Commitment. 4. CERTAIN GENERAL PROVISIONS. 4.1. Funds for Payments. (a) All payments of principal, interest, fees and any other amounts due hereunder or under any of the other Loan Documents shall be made to the Agent for the ratable account of the Lenders at 40 Water Street, Boston, Massachusetts 02109, or at such other location as the Agent may from time to time designate, in each case in Dollars constituting immediately available funds. (b) All payments by the Borrowers hereunder and under any of the other Loan Documents shall be made without setoff or counterclaim and free and clear of and without deduction for any taxes, levies, imposts, duties, charges, fees, deductions, withholdings, compulsory loans, restrictions or conditions of any nature now imposed or levied by any jurisdiction or any political subdivision thereof or taxing or other authority therein unless a Borrower is compelled by law to make such deduction or withholding or if the taxes are based upon or measured by the income or profits of the Lenders, including profits or receipts with respect to the Loans. If any such obligation is imposed upon a Borrower with respect to any amount payable by it hereunder or under any of the other Loan Documents, the Borrowers will pay to the Agent for the ratable account of the Lenders on the date on which such amount is due and payable hereunder or under such other Loan Document, such additional amount in Dollars as shall be necessary to enable the Lenders to receive the same net amount which the Lenders would have received on such due date had no such obligation been imposed upon such Borrower. The Borrowers will deliver promptly to the Agent certificates or other valid vouchers for all taxes or other charges deducted from or paid with respect to payments made by the Borrowers hereunder or under such other Loan Document. In the event any Lender receives a refund of any taxes or other amounts for which it has received payment from a Borrower pursuant to this 4.1(b), such Lender shall, within 30 days from the date of such receipt, pay the amount of such refund to such Borrower but only to the extent of payments made by such Borrower pursuant to this 4.1(b) and net of all costs and expenses of the Agent and such Lender relating thereto and without interest (other than interest, if any, paid by the relevant government authority with respect to such refund); provided, however, that the Borrowers upon request of the Agent or any Lender, agree to repay the amount paid to a Borrower to the Agent or such Lender if the Agent or such Lender is required to repay such refund to such governmental authority. 4.2. Computations. All computations of interest on the LIBOR Loans and the Base Rate Loans and of commitment or other fees shall be based on a 360-day year and paid for the actual number of days elapsed. Except as otherwise provided in the definition of the term "Interest Period" with respect to LIBOR Loans, whenever a payment hereunder or under any of the other Loan Documents becomes due on a day that is not a Business Day, the due date for such payment shall be extended to the next succeeding Business Day, and interest shall accrue during such extension. 4.3. Inability to Determine Adjusted LIBOR. In the event, prior to the commencement of any Interest Period relating to any LIBOR Loan, the Agent shall determine that adequate and reasonable methods do not exist in the marketplace for ascertaining the Adjusted LIBOR that would otherwise determine the rate of interest to be applicable to any LIBOR Loan during any Interest Period, the Agent shall give notice of such determination (which shall be conclusive and binding on the Borrowers) to the Borrowers. In such event (a) any Loan Request with respect to LIBOR Loans shall be automatically withdrawn and shall be deemed a request for Base Rate Loans, (b) each LIBOR Loan will automatically, on the last day of the then current Interest Period thereof, become a Base Rate Loan, and (c) the obligations of the Lenders to make LIBOR Loans shall be suspended until the Agent determines that the circumstances giving rise to such suspension no longer exist, whereupon the Agent shall so notify the Borrowers. 4.4. Illegality. Notwithstanding any other provisions herein, if any present or future law, regulation, treaty or directive or change in the interpretation or application thereof shall make it unlawful for any Lender to make or maintain LIBOR Loans, such Lender shall forthwith give notice of such circumstances to the Agent who shall in turn notify the Borrowers and thereupon (a) the commitment of such Lender to make LIBOR Loans shall forthwith be suspended and (b) the Loans then outstanding as LIBOR Loans from such Lender, if any, shall be converted automatically to Base Rate Loans on the last day of each Interest Period applicable to such LIBOR Loans or within such earlier period as may be required by law. The Borrowers hereby agree promptly to pay the Agent on behalf of such Lender, upon demand by such Lender accompanied by a certificate setting forth in reasonable detail such costs, any additional amounts necessary to compensate such Lender for any costs incurred by such Lender in making any conversion in accordance with this 4.4, including any interest or fees payable by such Lender to lenders of funds obtained by it in order to make or maintain its LIBOR Loans hereunder; provided, that to the extent permitted by applicable law, each Lender shall maintain each LIBOR Loan until the last day of an Interest Period. 4.5. Additional Costs, Etc. If any change in any present applicable law or if any future applicable law, which expression, as used herein, includes statutes, rules and regulations thereunder and interpretations thereof by any competent court or by any governmental or other regulatory body with the administration or the interpretation thereof and directives, instructions and notices at any time or from time to time hereafter made upon or otherwise issued to any Lender by any central bank or other fiscal, monetary or other authority (whether or not having the force of law, but only if it is mandatory that such Lender comply), shall: (a) subject such Lender to any tax, levy, impost, duty, charge, fee, deduction or withholding of any nature with respect to this Credit Agreement, the other Loan Documents, or the Loans (other than taxes based upon or measured by the income or profits of such Lender, including without limitation profits or receipts with respect to the Loans and other than any withholding tax imposed on any payments by the Borrowers to such Lender); or (b) materially change the basis of taxation (except for changes in taxes on income or profits and except for any withholding tax imposed on any payments by the Borrowers to the Lenders) of payments to such Lender of the principal of or the interest on any Loans or any other amounts payable to such Lender under this Credit Agreement or the other Loan Documents; or (c) impose or increase or render applicable (other than to the extent specifically provided for elsewhere in this Credit Agreement) any special deposit, reserve, assessment, liquidity, capital adequacy or other similar requirements (whether or not having the force of law, but only if it is mandatory that such Lender comply) against assets held by, or deposits in or for the account of, or loans by, or commitments of an office of such Lender; or (d) impose on such Lender any other conditions or requirements with respect to this Credit Agreement, the other Loan Documents, the Loans, or any class of loans or commitments of which any of the Loans forms a part; and the result of any of the foregoing is to: (i) increase the cost to such Lender of making, funding, issuing or maintaining any of the Loans or its Percentage of the Total Commitment; or (ii) reduce the amount of principal, interest or other amount payable to such Lender hereunder on account of any of the Loans or its Percentage of the Total Commitment; or (iii) require such Lender to make any payment or to forego any interest or other sum payable hereunder, the amount of which payment or foregone interest or other sum is calculated by reference to the gross amount of any sum receivable or deemed received by such Lender from the Borrower hereunder; then, and in each such case, the Borrower will, within ten (10) Business Days following receipt of written notice from the Agent on behalf of such Lender, which written notice shall include a description of the relevant change in law, calculations of the amounts payable, pay to the Agent on behalf of such Lender such additional amounts as will be sufficient to compensate such Lender for such additional cost, reduction, payment or foregone interest or other sum. 4.6. Capital Adequacy. If any change in any present law, governmental rule, regulation, policy, guideline or directive or if any future law, governmental rule, regulation, policy, guideline or directive (in each case whether or not having the force of law, but only if it is mandatory that the Lender comply) or the interpretation thereof by a court or governmental authority with appropriate jurisdiction or any change in any such law or interpretation (including, without limitation, any change according to a prescribed schedule of increasing requirements, whether or not known on the date of this Credit Agreement) affects the amount of capital required or expected to be maintained by any Lender or any corporation controlling such Lender and such Lender determines that the amount of capital required to be maintained by it is increased by or based upon the existence of the Commitments or Loans made pursuant hereto, then the Agent on behalf of such Lender may notify the Borrower of such fact. To the extent the costs of such increased capital requirements are not reflected in the applicable rate(s) of interest on the Loans, the Borrower and the Agent on behalf of such Lender shall thereafter attempt to negotiate in good faith, within thirty (30) days of the day on which the Borrower receives such notice, an adjustment payable hereunder that will adequately compensate such Lender in light of these circumstances. If the Borrower and the Agent on behalf of such Lender are unable to agree to such adjustment within thirty (30) days of the date on which the Borrower receives such notice, then commencing on the date Borrower received such notice (but not earlier than the effective date of any such increased capital requirement), from time to time the Borrower will pay to the Agent, on behalf of such Lender after consultation with the affected Lender, such additional amount that will, in the Agent's reasonable determination, provide adequate compensation to such Lender. Such Lender shall allocate such cost increases among its customers in good faith and on an equitable basis. 4.7. Certificate. A certificate setting forth any additional amounts payable pursuant to 4.5, 4.6 or 4.8 and a reasonably detailed explanation of such amounts which are due, including calculation of such amounts, submitted by the Agent on behalf of any Lender to the Borrowers, shall be conclusive, absent manifest error, that such amounts are due and owing. 4.8. Indemnity. The Borrowers agree to indemnify each Lender and to hold each Lender harmless from and against any loss, cost or expense that such Lender may sustain or incur resulting from (a) a default by a Borrower in payment of the principal amount of or any interest on any Loans as and when due and payable, including any such loss or expense arising from interest or fees payable by such Lender to lenders of funds obtained by it in order to maintain its Loans, (b) a default by a Borrower in making a borrowing after such Borrower has given (or is deemed to have given) a Loan Request relating thereto in accordance with 2.7 or (c) the making of any payment or prepayment of a Loan or the conversion of any LIBOR Loan to a Base Rate Loan on a day that is not the last day of the applicable Interest Period with respect thereto, including interest or fees payable by such Lender to lenders of funds obtained by it in order to maintain any such Loans. 4.9. Interest on Overdue Amounts. Overdue principal and (to the extent permitted by applicable law) interest on the Loans and all other overdue amounts payable hereunder or under any of the other Loan Documents shall bear interest payable on demand at a rate per annum equal to (i) in the case of overdue principal and interest (to the extent permitted by law) of any Loan, 2% plus the rate otherwise applicable to such Loan as provided in 2.6 or (ii) in the case of any other amount, 2% plus the then prevailing Base Rate plus the then prevailing applicable margin, in each case until such amount shall be paid in full (after as well as before judgment). 4.10. Mitigation. Each Lender shall take commercially reasonable efforts (which shall not require such Lender to incur an unreimbursed loss or unreimbursed cost or expense or otherwise take any action inconsistent with its internal policies or suffer any disadvantage or burden deemed by it to be significant) to assign its rights and delegate and transfer its obligations hereunder to another of its offices to the extent that such assignment, delegation and transfer would reduce amounts otherwise payable by the Borrowers to such Lender pursuant to 4.1(b), 4.4, 4.5, 4.6 and 4.8 or to make or maintain LIBOR Loans hereunder. The Borrowers agree to pay all costs and expenses incurred by any Lender in connection with any such assignment, delegation and transfer. 4.11. Joint and Several Obligations. Notwithstanding any other provision of this Credit Agreement, (i) each of the covenants, agreements and obligations of any Borrower set forth in this Credit Agreement or in any other Loan Document shall be the joint and several covenants, agreements and obligations of all of the Borrowers, regardless of whether a Borrower was the actual recipient of the proceeds of a Loan, (ii) all representations and warranties of any Borrower contained in this Credit Agreement or in any other Loan Document shall be deemed to be separately made by each of the Borrowers and (iii) any notice, request, consent, report or other information or agreement delivered by any Borrower shall be deemed for all purposes to be consented to, ratified and delivered by each of the Borrowers. In furtherance of the foregoing, each Borrower acknowledges and agrees that each covenant, agreement and obligation of any or all of the Borrowers in this Credit Agreement or any other Loan Document is enforceable against all Borrowers, jointly, or against any Borrower, severally. 5. REPRESENTATIONS AND WARRANTIES. In order to induce the Lenders to enter into this Credit Agreement and to make the Loans provided for hereunder, each Borrower makes the following representations and warranties, which shall survive the execution and delivery hereof and of the Notes: 5.1 Organization, Standing, etc. of the Borrowers. Each Borrower is a corporation duly organized, validly existing and in good standing under the laws of The Commonwealth of Massachusetts and has all requisite corporate power and authority to own and operate its properties, to carry on its business as now conducted and proposed to be conducted, to enter into this Agreement, the other Loan Documents and all other documents to be executed by it in connection with the transactions contemplated hereby, to issue the Notes and to carry out the terms hereof and thereof. Each of this Agreement and the other Loan Documents is the legal, valid and binding obligation of each Borrower enforceable against such Borrower in accordance with its terms. 5.2 Subsidiaries. Schedule 5.2 attached hereto correctly sets forth as to each Subsidiary, its name, the jurisdiction of its incorporation, the number of shares of its capital stock of each class outstanding and the number of such outstanding shares owned by DRC and its other Subsidiaries. Each such Subsidiary is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation and has all requisite corporate power and authority to own and operate its properties and to carry on its business as now conducted and proposed to be conducted. All of the outstanding capital stock of each Subsidiary is validly issued, fully-paid and nonassessable, and is owned by DRC or its Subsidiaries as specified in Schedule 5.2, in each case free of any mortgage, pledge, lien, security interest, charge, option or other encumbrance, other than restrictions imposed by applicable federal and state securities laws. 5.3 Qualification. Each Borrower and its Subsidiaries are duly qualified or licensed and in good standing as foreign corporations duly authorized to do business in each jurisdiction in which the character of the properties owned or the nature of the activities conducted makes such qualification or licensing necessary. 5.4 Financial Information; Disclosure, etc. The Borrowers have furnished the Lenders with the financial statements and other reports listed in Schedule 5.4 attached hereto. Such financial statements have been prepared in accordance with GAAP applied on a consistent basis and fairly present the financial position and results of operations of the Persons to which they purport to relate as of the dates and for the periods indicated. Since the end of the most recent fiscal period shown in such financial statements or in the most recent financial statements delivered by DRC under 6.2(a), there has not been any material adverse change in the business, operations, condition (financial or otherwise) or properties of Borrowers and their Subsidiaries, taken as a whole. Neither this Agreement nor any financial statements, reports, projections or other documents or certificates furnished to the Lenders by the Borrowers in connection with the transactions contemplated hereby contain as of their respective dates any untrue statement of a material fact or omit to state any material fact necessary to make the statements herein or therein contained not misleading. None of the Loans will render any Borrower unable to pay its debts as they become due; no Borrower is contemplating either the filing of a petition by it under any state or federal bankruptcy or insolvency laws or, except as set forth on Schedule 5.4, the liquidation of all or a major portion of its property; and no Borrower has knowledge of any Person contemplating the filing of any such petition against it. 5.5 Licenses, etc. Schedule 5.5 attached hereto accurately and completely lists all authorizations, licenses, permits and franchises of any public or governmental regulatory body which are necessary for the conduct of the business of each Borrower and its Subsidiaries as now conducted and the absence of which would result, either in any case or in the aggregate, in a material adverse change in the business, operations, affairs, condition (financial or otherwise) or properties of (i) DRC and its Subsidiaries, taken as a whole, (ii) Encoder and its Subsidiaries, taken as a whole, or (iii) Metrigraphics and its Subsidiaries, taken as a whole (such authorizations, licenses, permits and franchises, together with any extensions or renewals thereof, being herein sometimes referred to collectively as the "Licenses"). All of such Licenses are in full force and effect and each Borrower and its Subsidiaries have fulfilled and performed all of their obligations with respect thereto and have full power and authority to operate thereunder. 5.6 Material Agreements. Schedule 5.6 attached hereto accurately and completely lists all material agreements and contracts which are presently in effect in connection with the conduct of the business of any Borrower and which were or are required to be filed with the Securities and Exchange Commission as a "material contract" pursuant to Item 601(b)(10) of Registration S-K promulgated by the Securities and Exchange Commission. 5.7 Tax Returns and Payments. Each Borrower and its Subsidiaries have filed all tax returns required by law to be filed and have paid all material taxes, assessments and other governmental charges levied upon any of their respective properties, assets, income or franchises, other than those not yet delinquent and those, not material in aggregate amount, being or about to be contested as provided in 6.7. The charges, accruals and reserves on the books of each Borrower and its Subsidiaries in respect of their respective taxes are adequate in the opinion of the Borrowers, and the Borrowers know of no unpaid assessment for additional taxes or of any basis therefor. 5.8 Indebtedness, Liens and Investments, etc. Schedule 5.8 attached hereto sets forth, as of the date hereof, (a) the amounts of all outstanding Indebtedness of each Borrower and its Subsidiaries in respect of borrowed money, Capitalized Leases and the deferred purchase price of property, (b) all existing mortgages, liens and security interests in respect of such Indebtedness, (c) all agreements which directly or indirectly require any Borrower or its Subsidiaries to make any material investments, loans or advances and (d) all existing material guarantees by each Borrower and its Subsidiaries. 5.9 Title to Properties; Liens. Each Borrower and its Subsidiaries have good and marketable title to all of their respective properties and assets, and none of such properties or assets is subject to any mortgage, pledge, lien, security interest, charge or encumbrance except for (i) Permitted Liens and (ii) minor liens and encumbrances which in the aggregate are not substantial in amount, do not in any case materially detract from the value of the property subject thereto or materially impair the operations of any Borrower and its Subsidiaries and have not arisen otherwise than in the ordinary course of business. Each Borrower and its Subsidiaries enjoy quiet possession under all leases to which they are parties as lessees, and, to the knowledge of each Borrower, all of such leases are valid, subsisting and in full force and effect. None of such leases contains any provision restricting the incurrence of indebtedness by the lessee. 5.10 Litigation, etc. Except as set forth in Schedule 5.10 attached hereto, there is no action, proceeding or investigation pending or threatened (or any basis therefor known to any Borrower) which questions the validity of this Credit Agreement, the Notes or the other documents executed in connection herewith, or any action taken or to be taken pursuant hereto, or which could reasonably be expected to result, either in any case or in the aggregate, in any material adverse change in the business, operations, affairs, condition (financial or otherwise) or properties of DRC and the Subsidiaries, taken as a whole, or any of their respective properties or in any material liability on the part of DRC and the Subsidiaries, taken as a whole. 5.11 Authorization; Compliance with Other Instruments. The execution, delivery and performance of this Agreement and the Notes have been duly authorized by all necessary corporate action on the part of each Borrower, will not result in any violation of or be in conflict with or constitute a default under any term of the charter or by-laws of any Borrower, or of any agreement, instrument, judgment, decree, order, statute, rule or governmental regulation applicable to any Borrower, or result in the creation of any mortgage, lien, charge or encumbrance upon any of the properties or assets of any Borrower pursuant to any such term. Neither any Borrower nor any Subsidiary is in violation of any term of its charter or by-laws, or of any term of any material agreement or instrument to which it is a party, or, to each Borrower's knowledge, of any judgment, decree, order, statute, rule or governmental regulation applicable to it. 5.12 Governmental Consent. Except as specified in Schedule 5.12 attached hereto, no order, consent, approval or authorization of, or declaration to or filing with, any governmental authority (collectively, "Consents") is required to be obtained or made by any Borrower or by any Subsidiary in connection with the execution and delivery of this Agreement and the issuance and delivery of the Notes pursuant hereto. Except as set forth in Schedule 5.12, all of the Consents have been obtained and are in full force and effect. 5.13 Regulation U, etc. Neither any Borrower nor any Subsidiary owns or has any present intention of acquiring any "margin stock" within the meaning of Regulation U (12 CFR Part 221) of the Board of Governors of the Federal Reserve System (herein called "margin stock"). None of the proceeds of the Loans will be used, directly or indirectly, by any Borrower or any Subsidiary for the purpose of purchasing or carrying, or for the purpose of reducing or retiring any indebtedness which was originally incurred to purchase or carry, any margin stock or for any other purpose which might constitute the transactions contemplated hereby a "purpose credit" within the meaning of said Regulation U, or cause this Agreement to violate Regulation U, Regulation T, Regulation X, or any other regulation of the Board of Governors of the Federal Reserve System or the Securities Exchange Act of 1934. 5.14 Employee Retirement Income Security Act of 1974. Each Employee Benefit Plan and, to each Borrower's knowledge, each Multiemployer Plan, is in material compliance with applicable provisions of ERISA and the Code. No ERISA Reportable Event has occurred or, to each Borrower's knowledge, is imminent or likely to occur. No Borrower or ERISA Affiliate has incurred any material liability to the PBGC or any Employee Benefit Plan or Multiemployer Plan on account of any failure to meet the contribution requirements of any such plan, minimum funding requirements or prohibited transactions under ERISA or the Code, termination of a single employer plan, partial or complete withdrawal from a Multiemployer Plan, or the insolvency, reorganization or termination of any Multiemployer Plan, and no event has occurred or conditions exist which present a material risk that any Borrower or ERISA Affiliate will incur any material liability on account of any of the foregoing circumstances. The consummation of the transactions contemplated by this Agreement will not result in any prohibited transaction under ERISA or the Code for which an exemption is not available. 5.15 Environmental Matters. Except as set forth in Schedule 5.15 attached hereto, neither any Borrower nor any Subsidiary nor, to each Borrower's knowledge, any other Person has ever caused or permitted any Hazardous Material to be disposed of on or under any real property owned, leased or operated by any Borrower or any Subsidiary or in which any Borrower or any Subsidiary has ever held, directly or indirectly, any legal or beneficial interest or estate, and no such real property has ever been used (either by any Borrower or any Subsidiary or, to each Borrower's knowledge, by any other Person) as (i) a disposal site or permanent storage site for any Hazardous Material or (ii) a temporary storage site for any Hazardous Material. Each Borrower and each of its Subsidiaries have been issued and are in compliance with all material permits, certificates, licenses, approvals and other authorizations relating to environmental matters and necessary or desirable for their respective businesses, and have filed all notifications and reports relating to chemical substances, air emissions, underground storage tanks, effluent discharges and Hazardous Material waste storage, treatment and disposal required in connection with the operation of their respective businesses, the failure to have or comply with which would, individually or in the aggregate, have a material adverse effect on any Borrower or any Subsidiary. All Hazardous Materials used or generated by any Borrower or any Subsidiary or any business merged into or otherwise acquired by any Borrower or any Subsidiary have been generated, accumulated, stored, transported, treated, recycled and disposed of in compliance with all applicable laws and regulations, the violation of which has any reasonable likelihood of having a material adverse effect on any Borrower or any Subsidiary. Neither any Borrower nor any Subsidiary has any liabilities with respect to Hazardous Materials and no facts or circumstances exist which could give rise to liabilities with respect to Hazardous Materials, which in either case, individually or in the aggregate, could have any reasonable likelihood of having a material adverse effect on any Borrower or any Subsidiary. 5.16 Use of Proceeds. Each Borrower will use the proceeds of the Loans solely for working capital and other general corporate purposes of the Borrowers. 5.17 Investment Company Act; Public Utility Holding Company Act. Neither any Borrower nor any Subsidiary is (a) an "investment company" as defined in, or subject to regulation under, the Investment Company Act of 1940 or (b) a "holding company" as defined in, or subject to regulation under, the Public Utility Holding Company Act of 1935. 6. AFFIRMATIVE COVENANTS OF THE BORROWERS. Each Borrower covenants and agrees that, so long as any Loan or Note is outstanding or the Lenders have any Available Total Commitment: 6.1 Records and Accounts. Each Borrower will (a) keep true and accurate records and books of account in which full, true and correct entries will be made in accordance with GAAP and (b) maintain adequate accounts and reserves for all taxes (including income taxes), depreciation, depletion, obsolescence and amortization of its properties, contingencies, and other reserves, all in accordance with GAAP. 6.2 Financial Statements, Certificates and Information. Each Borrower will furnish or cause to be furnished to each Lender: (a) Within 90 days after the end of each fiscal year of DRC, (i) the consolidated and consolidating balance sheets of DRC and its Subsidiaries as at the end of such year and (ii) the related consolidated and consolidating statements of income and surplus and cash flow for such year, setting forth in comparative form with respect to such consolidated financial statements figures for the previous fiscal year, all in reasonable detail, together with the opinion thereon of independent public accountants selected by DRC and satisfactory to the Lenders, which opinion shall be in a form generally recognized as unqualified and shall state that the financial statements have been prepared in accordance with generally accepted accounting principles applied on a basis consistent with that of the preceding fiscal year (except for changes, if any, which shall be specified and approved in such opinion) and that the audit by such accountants in connection with such financial statements has been made in accordance with generally accepted auditing standards related to reporting; provided, however, that the Borrowers shall be required to furnish the consolidating financial statements referred to above only to the extent that the same are required to be prepared by GAAP or by the Securities and Exchange Commission or by any other applicable regulatory authority; (b) Within 45 days after the end of each of the first three quarterly accounting periods in each fiscal year of DRC, (i) the unaudited consolidated and consolidating balance sheets of DRC and its Subsidiaries as at the end of such period, and (ii) the related unaudited consolidated and consolidating statements of income and surplus and cash flows for such period and for the period from the beginning of the current fiscal year to the end of such period, all in reasonable detail and signed by the chief financial officer or treasurer of DRC; provided, however, that the Borrowers shall be required to furnish the consolidating financial statements only to the extent that the same are required to be prepared by GAAP or by the Securities and Exchange Commission or by any other applicable regulatory authority; (c) Together with the financial statements delivered pursuant to subparagraph (a) above, a statement signed by the accountants who have reported on the same to the effect that in connection with their examination of such financial statements they have reviewed the provisions of this Agreement and have no knowledge of any event or condition which constitutes an Event of Default or which, after notice or expiration of any applicable grace period or both, would constitute such an Event of Default or, if they have such knowledge, specifying the nature and period of existence thereof; provided, however, that in issuing such statement, such independent accountants shall not be required to go beyond normal auditing procedures conducted in connection with their opinion referred to above; (d) Together with the financial statements delivered pursuant to subparagraph (a) above, a detailed list of each Borrower's backlog of revenue-generating government contracts showing services to be provided by each Borrower in connection therewith as of the date of such financial statements; (e) Together with the financial statements delivered pursuant to subparagraph (a) above, DRC's Projections for the next succeeding three (3) fiscal years, year by year, and for the next succeeding fiscal year, quarter by quarter; (f) Together with the financial statements delivered pursuant to subparagraphs (a) and (b) above, a compliance certificate substantially in the form of Exhibit D attached hereto signed by the chief financial officer or treasurer of DRC; (g) Promptly after the same become publicly available, copies of all periodic and other reports, proxy statements and other materials filed by DRC with the Securities and Exchange Commission, or any governmental authority succeeding to any of or all of the functions of said Commission, or with any national securities exchange, or distributed to its shareholders generally, as the case may be (with the exhibits relating thereto to be provided, at DRC's expense, upon the request of the Agent or any Lender); (h) Promptly upon their becoming available, copies of any periodic or special reports filed by any Borrower or any Subsidiary with any federal, state or local governmental agency or authority, if such reports indicate any material change in the business, operations, affairs or condition (financial or otherwise) of the Borrowers and the Subsidiaries, taken as a whole, or if copies thereof are requested by any Lender, and copies of any materially adverse notices and communications from any federal, state or local governmental agency or authority which specifically relate to a Borrower or any Subsidiary; (i) Forthwith upon any officer of any Borrower obtaining knowledge of any condition or event which constitutes an Event of Default or which, after notice or lapse of time or both, would constitute an Event of Default, a certificate signed by such officer specifying in reasonable detail the nature and period of existence thereof and what action any Borrower has taken or proposes to take with respect thereto; and (j) Such other information regarding the business, affairs and condition of the Borrowers and their respective Subsidiaries as such Lender may from time to time reasonably request. Each Borrower will permit each Lender to inspect the books and any of the properties or assets of such Borrower and its Subsidiaries at such reasonable times as such Lender may from time to time request. All costs and expenses of any Lender in connection with or relating to any request made under this 6.2(j) shall, if no Event of Default has occurred and is continuing, be paid by the Lender making such request and, upon the occurrence and during the continuance of an Event of Default, be paid by the Borrowers. 6.3 Legal Existence; Compliance with Laws, etc. Except (a) for the dissolution of Dynamics Research Investment Corporation, a Massachusetts corporation and wholly-owned Subsidiary, and (b) as otherwise permitted under this Credit Agreement, each Borrower will, and will cause each Subsidiary to: maintain its corporate existence and business; maintain all properties which are reasonably necessary for the conduct of such business, now or hereafter owned, in good repair, working order and condition; take all actions necessary to maintain and keep in full force and effect its Licenses; in the case of DRC, take all steps necessary to maintain its status as a public company and to maintain its status as a company listed on the NASDAQ National Market or a national stock exchange; and, except as otherwise provided herein, comply with all applicable statutes, rules, regulations and orders of, and all applicable restrictions imposed by, all governmental authorities in respect of the conduct of its business and the ownership of its properties; in each case except to the extent that the failure to comply would not, individually or in the aggregate, have a material adverse effect on the business, operations, affairs or condition (financial or otherwise) of the Borrowers and their Subsidiaries, taken as a whole; or any Subsidiary; provided that neither any Borrower nor any Subsidiary shall be required by reason of this 6.3 to comply therewith at any time while such Borrower or such Subsidiary shall be contesting its obligations to do so in good faith by appropriate proceedings promptly initiated and diligently conducted, and if it shall have set aside on its books such reserves, if any, with respect thereto as are required by GAAP and deemed adequate by such Borrower and its independent public accountants. Neither any Borrower nor any Subsidiary will, without the prior written consent of the Lenders, engage in any business other than the Current Lines of Business. 6.4 Insurance. Each Borrower will maintain or cause to be maintained on all insurable properties now or hereafter owned by such Borrower or any Subsidiary insurance against loss or damage by fire or other casualty to the extent customary with respect to like properties of companies conducting similar businesses and will maintain or cause to be maintained public liability and workmen's compensation insurance insuring such Borrower and its Subsidiaries to the extent customary with respect to companies conducting similar businesses and, upon request, will furnish to the Lenders satisfactory evidence of the same. 6.5 Payment of Taxes. Each Borrower will, and will cause each Subsidiary to, pay and discharge promptly as they become due and payable all taxes, assessments and other governmental charges or levies imposed upon it or its income or upon any of its properties or assets, or upon any part thereof, as well as all lawful claims of any kind (including claims for labor, materials and supplies) which, if unpaid, might by law become a lien or a charge upon its property; provided that neither any Borrower nor any Subsidiary shall be required to pay any such tax, assessment, charge, levy or claim if the amount, applicability or validity thereof shall currently be contested in good faith by appropriate proceedings promptly initiated and diligently conducted and if such Borrower or such Subsidiary, as the case may be, shall have set aside on its books such reserves, if any, with respect thereto as are required by GAAP and deemed appropriate by such Borrower and its independent public accountants. 6.6 Payment of Other Indebtedness, etc. Except as to matters being contested in good faith and by appropriate proceedings, each Borrower will, and will cause each Subsidiary to, pay promptly when due, or in conformance with customary trade terms, all other Indebtedness and obligations incident to the conduct of its business. 6.7 Further Assurances. From time to time hereafter, each Borrower will execute and deliver, or will cause to be executed and delivered, such additional instruments, certificates or documents, and will take all such actions, as the Lenders may reasonably request, for the purposes of implementing or effectuating the provisions of this Agreement or the other Loan Documents. Upon the exercise by the Lenders (or the Agent on their behalf) of any power, right, privilege or remedy pursuant to this Agreement or the other Loan Documents which requires any consent, approval, registration, qualification or authorization of any governmental authority or instrumentality, each Borrower will execute and deliver, or will cause the execution and delivery of, all applications, certifications, instruments and other documents and papers that the Lenders may be required to obtain for such governmental consent, approval, registration, qualification or authorization. 6.8 Depository Account. Each Borrower will maintain its principal operating accounts with one or more of the Lenders (including BBH&Co). 6.9 Use of Proceeds. Each Borrower will use the proceeds of the Loans only for the purposes not prohibited by, and subject to the terms and conditions of, 5.13 and 5.16. 6.10 No Further Negative Pledges. Each Borrower hereby covenants and agrees, at all times while any Loans remain outstanding or while there is any Available Total Commitment, not to enter into any agreement prohibiting the creation or assumption of any mortgage, deed of trust, lien, pledge, hypothecation, encumbrance, charge or security interest in favor of the Lenders in assets or properties owned by any Borrower, except for purchase money agreements which contain such provisions, provided that (i) such provisions relate only to the assets being purchased thereunder and (ii) such agreements are entered into by any Borrower in the ordinary course of its business. 6.11 Regulation U. If requested by any Lender, each Borrower will promptly furnish such Lender with a statement in conformity with the requirements of Federal Reserve Form U-1 referred to in said Regulation U. 7. CERTAIN NEGATIVE COVENANTS OF THE BORROWERS. Each Borrower covenants and agrees that, so long as any Loan or Note is outstanding or the Lenders have any Available Total Commitment: 7.1 Indebtedness. None of the Borrowers will, nor will any Borrower permit any Subsidiary to, create, incur, assume or become or remain liable in respect of any Indebtedness, except: (a) Indebtedness to the Lenders hereunder; (b) Indebtedness of any wholly-owned Subsidiary to a Borrower or any other wholly-owned Subsidiary and of a Borrower to any wholly-owned Subsidiary; provided, however, that (i) all moneys due from a Borrower to any Subsidiary which is not a Borrower will be expressly constituted as Subordinated Debt and (ii) no Borrower shall repay any such moneys due to any Subsidiary at any time unless no Event of Default exists and no event which, with the giving of notice or lapse of time or both, would constitute an Event of Default exists or will exist after such repayment; (c) Current liabilities of a Borrower or any Subsidiary (other than for borrowed money) incurred in the ordinary course of its business and in accordance with customary trade practices; (d) Existing Indebtedness of a Borrower or any Subsidiary referred to in Schedule 5.8 attached hereto, and renewals and extensions thereof, provided that (i) the aggregate principal amount of such Indebtedness is not at any time increased, (ii) no material terms applicable to such Indebtedness shall be more favorable to the renewal or extension lenders than the terms that are applicable to the holders of such Indebtedness on the date hereof and (iii) the interest rate applicable to such Indebtedness shall be a market interest rate as of the time of such renewal or extension; (e) Indebtedness of a Borrower or any Subsidiary secured by Permitted Liens; (f) Indebtedness of a Borrower or any Subsidiary in respect of guarantees to the extent the underlying Indebtedness is permitted by this 7.1; and (g) Subordinated Debt; (h) Unfunded Benefit Liabilities so long as each Borrower is in compliance with 7.9, provided that the aggregate amount thereof at any one time shall not exceed $5,000,000; (i) To the extent payment thereof shall not at the time be required by 6.5, Indebtedness in respect of taxes, assessments, governmental changes and claims for labor, material and supplies; (j) Indebtedness in respect of judgments or awards (i) which have been in force for less than the applicable appeal period or (ii) in respect to which any Borrower or any Subsidiary shall at the time in good faith be prosecuting an appeal or proceedings for review, and in each case such Borrower or such Subsidiary shall have taken appropriate reserves therefor in accordance with GAAP; (k) Indebtedness in respect of deferred taxes arising in the ordinary course of business; and (l) Indebtedness of the Borrowers and their respective Subsidiaries (other than for borrowed money) in addition to the foregoing; provided, however, that the aggregate amount of all such Indebtedness at any one time outstanding shall not exceed $750,000. 7.2 Mortgages, Liens, etc. None of the Borrowers will, nor will any Borrower permit any Subsidiary to, directly or indirectly, create, incur, assume or suffer to exist, any mortgage, lien, charge or encumbrance on, or security interest in, or pledge of, or conditional sale or other title retention agreement (including any Capitalized Lease) with respect to, any property or asset now owned or hereafter acquired by any Borrower or any Subsidiary, except for the following (collectively, "Permitted Liens"): (a) Subject to 7.1(b), any lien on property of (i) a Subsidiary securing Indebtedness of such Subsidiary to a Borrower and (ii) a Borrower securing Indebtedness to any other Borrower; (b) The mortgages and security interests referred to in Schedule 7.2 attached hereto, or any renewal, extension or refunding of any such mortgage or security interest in an amount not exceeding the amount thereof remaining unpaid immediately prior to such renewal, extension or refunding; (c) Purchase money mortgages, liens and other security interests, including Capitalized Leases, created in respect of property acquired by a Borrower or any Subsidiary after the date hereof or existing in respect of property so acquired at the time of acquisition thereof, provided that (i) each such lien shall at all times be confined solely to the item or items of property so acquired, and (ii) the aggregate principal amount of Indebtedness secured by all such liens shall at no time exceed $500,000; (d) Liens for taxes and other amounts not yet delinquent or being contested in good faith as provided in 6.5; liens in connection with workmen's compensation, unemployment insurance or other social security obligations; liens securing the performance of bids, tenders, contracts, leases, statutory obligations, surety and appeal bonds, liens to secure progress or partial payments and other liens of like nature arising in the ordinary course of business; mechanics', workmen's, materialmen's or other like liens arising in the ordinary course of business in respect of obligations which are not yet due or which are being contested in good faith; and other liens or encumbrances incidental to the conduct of the business of any Borrower or any Subsidiary or to the ownership of their respective properties or assets, which were not incurred in connection with the borrowing of money or the obtaining of credit and which do not, individually or in the aggregate, materially detract from the value of the properties or assets of the Borrowers and their Subsidiaries or materially affect the use thereof in the operation of their business; (e) Encumbrances in the nature of (i) zoning restrictions, (ii) easements, (iii) restrictions of record on the use of real property, (iv) landlords' and lessors' Liens on rented premises and (v) restrictions on transfers or assignments of leases, which in each case do not, individually or in the aggregate, materially detract from the value of the encumbered property or impair the use thereof in the business of any Borrower or any Subsidiary; (f) Liens in respect of judgments or awards, to the extent that such judgments or awards are permitted by 7.1(j); (g) Restrictions under federal and state securities laws on the transfer of securities; and (h) Restrictions under foreign trade regulations on the transfer or licensing of certain assets of the Borrowers and their Subsidiaries. 7.3 Loans, Guarantees and Investments. None of the Borrowers will, nor will any Borrower permit any Subsidiary to, make or permit to remain outstanding any loan or advance to, or guarantee or endorse (except as a result of endorsing negotiable instruments for deposit or collection in the ordinary course of business) or otherwise assume or remain liable with respect to any obligation of, or make or own any investment in, or acquire (except in the ordinary course of business) the properties or assets of, any Person, except: (a) Extensions of credit by a Borrower or any Subsidiary in the ordinary course of business in accordance with customary trade practices; (b) The presently outstanding investments, loans and advances, if any, and the presently existing guarantees, if any, of any Borrower and its Subsidiaries all to the extent set forth on Schedule 5.8 attached hereto and any renewal, extension or refunding thereof, provided that (i) the aggregate principal amount thereof is not at any time increased, (ii) no material terms applicable thereto shall be more favorable to the renewal or extension borrower or recipient, as the case may be, than the terms that are applicable to the borrower or recipient, as the case may be, on the date hereof and (iii) the interest rate (if any) applicable thereto shall be a market interest rate as of the time of such renewal or extension; (c) Direct obligations of the United States of America or any department or agency thereof maturing not more than one year from the date of acquisition thereof; (d) Certificates of deposit, repurchase agreements, time deposits (including sweep accounts), demand deposits, bankers' acceptances, money market deposits or other similar types of investments maturing not more than one year from the date of acquisition thereof and evidencing direct obligations of any Lender or any lender within the United States of America having capital surplus and undivided profits in excess of $50,000,000; (e) Investments in commercial paper maturing within ninety (90) days from the date of acquisition thereof and having, at such date of acquisition, the highest credit rating obtainable from Moody's or S&P; (f) Any mutual fund or other pooled investment vehicle which invests principally in obligations described in subparagraphs (c), (d) or (e) above and having, at the date of investment in such fund or vehicle, one of the two highest credit ratings from Moody's or S&P; (g) Equity investments by any Borrower's wholly-owned Subsidiaries in any other wholly-owned Subsidiary and of a Borrower in any of its wholly-owned Subsidiaries; (h) Loans to the extent permitted by 7.1(b); (i) Acquisitions by a Borrower and its Subsidiaries of all or substantially all of the capital stock or assets of other Persons, provided that without the consent of the Required Lenders (i) the aggregate amount of cash consideration paid by the Borrower and the Subsidiaries in such acquisitions shall not exceed $15,000,000 and (ii) the proceeds of any Loans used in connection with each such acquisition are used as provided in 5.16; (j) Guarantees by a Borrower of Indebtedness and other obligations incurred by Subsidiaries to the extent permitted by 7.1; and (k) Capital Expenditures to the extent permitted by 7.7. 7.4 Leases. None of the Borrowers will, nor will any Borrower permit any Subsidiary to, enter into any Capitalized Lease, except as otherwise permitted under 7.1 and 7.2. Each Borrower will not, and will not permit any Subsidiary to, enter into any lease (other than Capitalized Leases) as lessee if, immediately after giving effect thereto, the aggregate rental obligations (excluding payments required to be made by the lessee in respect of taxes and insurance whether or not denominated as rent) of all of the Borrowers and their respective Subsidiaries for any succeeding 12-month period under all such leases then in effect shall exceed $3,500,000 in the aggregate. 7.5 Mergers and Consolidations. None of the Borrowers will, nor will any Borrower permit any Subsidiary to, enter into any merger or consolidation, except the following: (a) Any wholly-owned Subsidiary of a Borrower may merge or be liquidated into a Borrower or any other wholly-owned Subsidiary of a Borrower so long as after giving effect to any such merger to which a Borrower is a party such Borrower shall be the surviving or resulting Person; and (b) Mergers constituting investments permitted by 7.3(i) so long as after giving effect to any such merger to which a Borrower is a party such Borrower shall be the surviving or resulting Person;. 7.6 Sale of Assets. None of the Borrowers will, nor will any Borrower permit any Subsidiary to, sell, lease or otherwise dispose of all or any substantial part of its properties or assets, except the following: (a) Each Borrower and its Subsidiaries may sell or otherwise dispose of (i) inventory in the ordinary course of business, (ii) assets that are no longer used or useful in the Business of the applicable Borrower or Subsidiary, (iii) the properties and assets constituting the Visual Magic software business (including the licenses to the Visual Magic software), (iv) the properties and assets constituting the telephone fraud detection and control business and (v) capital stock of Software and Telecom; provided, however, that, in the case of the foregoing clauses (iii), (iv) and (v), immediately before and after giving effect thereto no Event of Default exists and no event exists which, with the giving of notice or passage of time or both, would constitute an Event of Default; (b) DRC may sell, lease or otherwise transfer any of its properties or assets to any other Borrower, provided that (i) the Borrowers provide a notice thereof to the Agent prior to each such transfer (which notice shall include a description and a good faith estimate of the fair market value of the property or assets being so transferred and, to the extent applicable, the revenues that were generated by such property or assets in the immediately preceding fiscal year of DRC), (ii) such transfers relate solely to a transfer by DRC of its encoder line of business to Encoder, its metrigraphics line of business to Metrigraphics, its Visual Magic software line of business to Software and/or its telephone fraud control line of business to Telecom and (iii) immediately before and after giving effect thereto no Event of Default exists; (c) Each Borrower and its Subsidiaries may license products and intangible assets for fair market value in the ordinary course of business; and (d) In addition to the foregoing, so long as immediately before and after giving effect thereto no Event of Default and no event exists which, with the giving of notice or passage of time or both, would constitute an Event of Default, each Borrower and its Subsidiaries may sell assets (other than inventory) having a fair market value not exceeding, and yielding an aggregate amount of sale proceeds not exceeding, $250,000 in any fiscal year of DRC. 7.7 Capital Expenditures. None of the Borrowers will, nor will any Borrower permit any Subsidiary to, make any Capital Expenditures during any fiscal year of DRC unless the aggregate amount of all Capital Expenditures made by all Borrowers and their respective Subsidiaries in such fiscal year does not exceed $6,250,000; provided, however, that the amount of permitted Capital Expenditures in respect of any fiscal year shall be increased by 50% of the unused permitted Capital Expenditures for the immediately preceding fiscal year (less an amount equal to any unused Capital Expenditures carried forward to such preceding fiscal year). 7.8 Distributions. DRC will not make any distribution or declare or pay any cash dividends on, or purchase, acquire or redeem or retire any of its capital stock, of any class, whether now or hereafter outstanding, except that so long as immediately before and after giving effect thereto no Event of Default exists, DRC may make cash distributions to its stockholders and repurchase shares of its common stock at a price not to exceed the then-current market value for such stock, in an aggregate amount which shall not exceed (i) in the fiscal year ending December 31, 1998, the sum of (x) fifty percent (50%) of the Consolidated Net Income of DRC and its Subsidiaries (if positive) for the immediately preceding fiscal year and (y) $210,000, and (ii) in the fiscal year ending December 31, 1999 and each fiscal year thereafter, fifty percent (50%) of the Consolidated Net Income of DRC and its Subsidiaries (if positive) for the immediately preceding fiscal year; provided that such amount shall not include shares of capital stock surrendered upon the exercise of any stock options or other convertible securities; and further provided that in the fiscal year ending December 31, 1999, if fifty percent (50%) of the Consolidated Net Income of DRC and its Subsidiaries (if positive) for the fiscal year ending December 31, 1998 is less than $250,000, then DRC may repurchase shares of its common stock as aforesaid in an aggregate amount which shall not exceed $250,000. 7.9 Compliance with ERISA. Each Borrower will make, and will cause all ERISA Affiliates to make, all payments or contributions to Employee Benefit Plans and Multiemployer Plans required under the terms thereof and in accordance with applicable minimum funding requirements of ERISA and the Code and applicable collective bargaining agreements. Each Borrower will cause all Employee Benefit Plans sponsored by it or any ERISA Affiliates to be maintained in material compliance with ERISA and the Code. None of the Borrowers will engage, and will not permit or suffer any ERISA Affiliate or any Person entitled to indemnification or reimbursement from a Borrower or any ERISA Affiliate to engage, in any prohibited transaction under ERISA or the Code for which an exemption is not available. No Borrower or ERISA Affiliate will terminate, or permit the PBGC to terminate, any Employee Benefit Plan or withdraw from any Multiemployer Plan, in any manner which could result in material liability of a Borrower or any ERISA Affiliate. 7.10 Transactions with Affiliates. No Borrower will, nor will any Borrower permit any Subsidiary to, directly or indirectly, enter into any lease or other transaction with any Affiliate of such Borrower or such Subsidiary (other than any other Borrower) on terms that are less favorable to such Borrower or such Subsidiary than those which could reasonably be obtained at the time from a non-Affiliate. 7.11 Observance of Subordination Provisions, etc. No Borrower will make, nor will any Borrower cause or permit to be made, any payments in respect of any Subordinated Debt, in contravention of the subordination provisions contained in the evidence of such Subordinated Debt or in contravention of any written agreement pertaining thereto, nor will any Borrower (a) amend, modify or change in any manner any of such subordination provisions or (b) amend, modify or change in any manner adverse to the interests of the Lenders any of the other provisions set forth in the agreements under which such Subordinated Debt is outstanding or contained in the evidence of such Subordinated Debt. 7.12 Environmental Liabilities. No Borrower will, nor will any Borrower permit any Subsidiary to, violate any requirement of any material law, rule or regulation regarding Hazardous Materials; and, without limiting the foregoing, no Borrower will, nor will any Borrower permit any Subsidiary or any other Person to, dispose of any Hazardous Material into or onto, or (except in accordance with applicable law) from, any real property owned, leased or operated by any Borrower or any Subsidiary or in which any Borrower or any Subsidiary holds, directly or indirectly, any legal or beneficial interest or estate, nor allow any lien imposed pursuant to any law, regulation or order relating to Hazardous Materials or the disposal thereof to be imposed or to remain on such real property, except for liens being contested in good faith by appropriate proceedings and for which adequate reserves have been established and are being maintained on the books of a Borrower and its Subsidiaries. 7.13 Subsidiaries. No Borrower will create any new Subsidiaries. 7.14 Material Adverse Change. None of the Borrowers will take nor fail to take any action that could reasonably be expected to result in a material adverse change in a Borrower's business, assets or condition (financial or otherwise). 8. FINANCIAL COVENANTS. Each Borrower covenants and agrees that, so long as any Loan or Note is outstanding or the Lenders have any Available Total Commitment, DRC and its Subsidiaries shall maintain at all times, on a Consolidated basis, each of the following: (a) Tangible Net Worth. Tangible Net Worth, measured on a fiscal quarter-end basis, of the sum of (x) $34,505,000 plus (y) fifty percent (50%) of the Net Income of DRC and its Subsidiaries (if positive) for each fiscal quarter, including the fiscal quarter in which the Closing Date occurs; (b) Maximum Leverage. A ratio of Indebtedness for borrowed money of DRC and its Subsidiaries to Capitalization of DRC and its Subsidiaries of less than or equal to one to two (1.0:2.0), measured on a fiscal quarter-end basis; (c) Debt Coverage. A ratio of Senior Debt of DRC and its Subsidiaries to EBITDA of DRC and its Subsidiaries not to exceed (i) for each fiscal quarter ending on or before December 31, 1999, three and one-quarter to one (3.25:1.0) and (ii) for each fiscal quarter ending after December 31, 1999, three to one (3.0:1.0), with each such ratio measured on a fiscal quarter-end basis and with EBITDA of DRC and its Subsidiaries based on the period of four (4) consecutive fiscal quarters ending on such fiscal quarter-end; (d) Cash Flow Coverage. A ratio of (i) EBITDA of DRC and its Subsidiaries less Capital Expenditures of DRC and its Subsidiaries not funded by Indebtedness for borrowed money less taxes on income and profits paid in cash by DRC and its Subsidiaries to (ii) required interest and principal payments made by DRC and its Subsidiaries on all Indebtedness of at least (x) for each fiscal quarter ending on or before December 31, 1999, two to one (2.0:1.0) and (y) for each fiscal quarter ending after December 31, 1999, two and one-quarter to one (2.25:1.0), with each such ratio measured on a fiscal quarter-end basis and based on the period of four (4) consecutive fiscal quarters ending on such fiscal quarter-end; and (e) Net Income. Consolidated Net Income must equal at least $1, for each fiscal quarter that commences on or after January 1, 1999, measured on a fiscal quarter-end basis. 9. DEFAULTS; REMEDIES. 9.1 Events of Default; Acceleration. If any of the following events (each an "Event of Default") shall occur: (a) Any Borrower shall default in the payment of principal of or interest on any Note or any other fee due hereunder, whether at maturity or at a date fixed for the payment of any installment or prepayment thereof or otherwise, and in the case of any such fee payment default, such default shall continue for a period of three (3) Business Days following the date of such default; or (b) Any Borrower shall default in the performance of or compliance with any term contained in 6.2(g), 6.2(h), 6.2(i), 6.3, 6.9, 6.10 and 7.1 to and including 7.14, and 8; or (c) Any Borrower shall default in the performance of or compliance with any term, condition, covenant or agreement (other than those listed in 9.1(b)) to be performed or observed by it under this Credit Agreement or under any other Loan Document and such default shall continue for a period of thirty (30) days or more; or (d) Any representation or warranty made by any Borrower herein or pursuant hereto shall prove to have been false or incorrect in any material respect when made or when deemed to have been made; or (e) Any Borrower or any Subsidiary shall default in (i) the payment of any Indebtedness in respect of borrowed money (other than the Loans), any Capitalized Lease or the deferred purchase price of any property and such default (A) shall continue after giving effect to any applicable grace periods and (B) shall be in respect of an aggregate amount of principal (whether or not due) and accrued interest exceeding $250,000; or (ii) the performance or compliance with any term of any agreement or instrument relating to such Indebtedness and such default (A) shall continue, without having been duly cured, waived or consented to, beyond the period of grace, if any, specified in such agreement or instrument, and (B) shall permit the acceleration of such Indebtedness prior to its stated maturity; or (f) Except as permitted by 6.3(a) or 7.5, any Borrower or any Subsidiary shall discontinue its business or shall make an assignment for the benefit of creditors, or shall fail generally to pay its debts as such debts become due, or shall apply for or consent to the appointment of or taking possession by a trustee, receiver or liquidator (or other similar official) of any Borrower or such Subsidiary or any substantial part of the property of any Borrower or such Subsidiary, or shall commence a case or have an order for relief entered against it under the federal bankruptcy laws, as now or hereafter constituted, or any other applicable federal or state bankruptcy, insolvency or other similar law, or if any Borrower or any Subsidiary shall take any action to dissolve or liquidate any Borrower or such Subsidiary; or (g) If, within sixty (60) days after the commencement against any Borrower or any Subsidiary of a case under the federal bankruptcy laws, as now or hereafter constituted, or any other applicable federal or state bankruptcy, insolvency or other similar law, such case shall have been consented to or shall not have been dismissed or all orders or proceedings thereunder affecting the operations or the business of any Borrower and such Subsidiary stayed, or if the stay of any such order or proceeding shall thereafter be set aside, or if within sixty (60) days after the entry of a decree appointing a trustee, receiver or liquidator (or other similar official) of any Borrower or any Subsidiary or any substantial part of the property of any Borrower or such Subsidiary, such appointment shall not have been vacated; or (h) A final judgment which, with other outstanding final judgments against any or all of the Borrowers and its Subsidiaries, exceeds an aggregate of $250,000 shall be rendered against any Borrower or any Subsidiary and if, within sixty (60) days after entry thereof, such judgment shall not have been discharged or execution thereof stayed pending appeal, or if, within sixty (60) days after the expiration of any such stay, such judgment shall not have been discharged, or if any such judgment shall not be discharged forthwith upon the commencement of proceedings to foreclose any lien, attachment or charge which may attach as security therefor and before any of the property or assets of any Borrower or any Subsidiary shall have been seized in satisfaction thereof; or (i) Any Borrower or any Subsidiary loses, fails to keep in force, suffers the termination or revocation of or terminates, forfeits or suffers an amendment to any License which would have a material adverse effect on the operations of such Borrower or such Subsidiary; or (j) There shall have occurred a Change in Control; or (k) If with respect to any Employee Benefit Plans or Multiemployer Plans, there shall occur any of the following which could reasonably be expected to have a material adverse effect on the financial condition of any Borrower: (i) the violation of any of the provisions of ERISA; (ii) the loss by such a plan intended to be a Qualified Plan of its qualification under Section 401(a) of the Code; (iii) the incurrence of liability under Title IV of ERISA; (iv) a failure to make full payment when due of all amounts which, under the provisions of any such plan or applicable law, any Borrower or any ERISA Affiliate is required to make; (v) the filing of a notice of intent to terminate such a plan under Sections 4041 or 4041A of ERISA; (vi) a complete or partial withdrawal of a Borrower or an ERISA Affiliate from any such plan; (vii) the receipt of a notice by the plan administrator of such a plan that the PBGC has instituted proceedings to terminate such plan or appoint a trustee to administer such plan; (viii) a commencement or increase of contributions to, or the adoption of or the amendment of, such a plan; and (ix) the assessment against a Borrower or any ERISA Affiliate of a tax under Section 4980B of the code then, and in any such event, and at any time thereafter, if any Event of Default (other than an event described in 9(f) or 9(g) shall then be continuing, the Required Lenders may direct the Agent to, by written notice to any Borrower, (i) declare the principal of and accrued interest in respect of the Notes to be forthwith due and payable, whereupon the principal of and accrued interest in respect of the Notes, and all other amounts then due hereunder, shall become forthwith due and payable without presentment, demand, protest or other notice of any kind, all of which are hereby expressly waived by each Borrower, and/or (ii) terminate the Total Commitment, whereupon the Total Commitment of the Lenders (and the Commitment of each individual Lender) to make Loans hereunder shall forthwith terminate without any other notice of any kind; and with respect to any event described in 9(f) or 9(g) above, the Commitments shall automatically terminate and the principal of the Notes then outstanding, together with accrued interest thereon and all other amounts then due hereunder, shall automatically become due and payable, without presentment, demand, protest or any other notice of any kind, all of which are hereby expressly waived by each of the Borrowers, anything contained herein or in any other Loan Document to the contrary notwithstanding. 9.2 Remedies on Default, etc. In case any one or more Events of Default shall occur and be continuing, the Lenders may proceed to protect and enforce their rights by an action at law, suit in equity or other appropriate proceeding, whether for the specific performance of any agreement contained herein or in any other Loan Document, or for an injunction against a violation of any of the terms hereof or thereof, or in aid of the exercise of any power granted hereby or thereby or by law. In case of a default in the payment of any principal of or interest on any Note, or in the payment of any fee due hereunder, each Borrower will pay to the Lenders such further amount as shall be sufficient to cover the cost and expense of collection, including the Lenders' attorneys' fees, expenses and disbursements. No course of dealing and no delay on the part of the Lenders in exercising any right shall operate as a waiver thereof or otherwise prejudice the Lenders' rights. No right conferred hereby or by any other Loan Document upon the Lenders shall be exclusive of any other right referred to herein or therein or now or hereafter available at law, in equity, by statute or otherwise. 10. CLOSING CONDITIONS. The obligations of the Lenders to make the initial Loans shall be subject to the satisfaction of the following conditions precedent: 10.1. Loan Documents, etc. Each of the Loan Documents shall have been duly executed and delivered by each of the Borrowers, shall be in full force and effect and shall be in form and substance reasonably satisfactory to the Lenders. The Agent and each Lender shall have received a fully executed copy of each such document. 10.2. Corporate Action. All corporate action necessary for the valid execution, delivery and performance by each Borrower of this Credit Agreement and the other Loan Documents shall have been duly and effectively taken, and evidence thereof reasonably satisfactory to the Agent shall have been provided to the Agent. 10.3. Incumbency Certificate. The Agent shall have received from each Borrower an incumbency certificate, dated as of the Closing Date, signed by a duly authorized officer of such Borrower and giving the name and bearing a specimen signature of each individual who shall be authorized in the name and on behalf of such Borrower, (a) to sign each of the Loan Documents; (b) to make Loan Requests; and (c) to give notices and to take other action under the Loan Documents. 10.4. Opinions of Counsel. The Agent shall have received a favorable opinion addressed to the Lenders, dated as of the Closing Date, in the form of Exhibit E attached hereto, from Ropes & Gray as counsel for the Borrowers. 10.5. Payment of Fees. The Borrowers shall have paid to the Agent (i) the fees and expenses of the Agent's counsel in connection with the documentation of the transactions described in this Credit Agreement and (ii) all fees then due and payable pursuant to 2.2(b) and 2.2(c). 11. CONDITIONS TO ALL LOANS. The obligations of the Lenders to make any Loan whether on or after the Closing Date, shall also be subject to the satisfaction of the following conditions precedent: 11.1. Accuracy of Representations; No Event of Default. After giving effect to the Loans proposed to be made on such Drawdown Date, (i) all representations and warranties of each Borrower contained in this Credit Agreement, the other Loan Documents or in any document or instrument delivered pursuant to or in connection with this Credit Agreement shall be true and correct as of the date as of which they were made and shall also be true and correct at and as of the time of the making of such Loan, with the same effect as if made at and as of that time (except to the extent of changes resulting from transactions contemplated or permitted by this Credit Agreement and the other Loan Documents, or to the extent that such representations and warranties relate expressly to an earlier date) and (ii) no Event of Default or other event which, with the giving of notice or passage of time, would constitute an Event of Default shall have occurred and be continuing. On or before the date of the Loans, the Agent, on behalf of the Lenders, shall have received a certificate of DRC signed by the chief financial officer or treasurer of DRC to such effect. 11.2. No Legal Impediment. No change shall have occurred in any law or regulations thereunder or interpretations thereof that in the reasonable opinion of any Lender would make it illegal for such Lender to make such Loan. 12. THE AGENT. 12.1. Appointment, Powers and Immunities. Each Lender hereby irrevocably appoints and authorizes the Agent to act as its agent hereunder and under each of the Loan Documents with such powers as are specifically delegated to the Agent by the terms of this Credit Agreement and the Loan Documents, together with such other powers as are reasonably incidental thereto. The Agent (which term as used in this sentence and in 12.5 and the first sentence of 12.6 shall include reference to its Affiliates and the respective officers, directors, employees and agents of the Agent and its Affiliates): (a) shall have no duties or responsibilities except those expressly set forth in this Credit Agreement to be a trustee for any Lender; (b) shall not be responsible to the Lenders for any recitals, statements, representations or warranties contained in this Credit Agreement, or in any certificate or other document referred to or provided for in, or received by any of them under, this Credit Agreement, or for the value, validity, effectiveness, genuineness, enforceability, perfection or sufficiency of this Credit Agreement, any Note or any other document referred to or provided for herein or for any failure by any Borrower or any other Person to perform any of its obligations hereunder or thereunder; (c) shall not be required to initiate or conduct any litigation or collection proceedings hereunder except to the extent requested by or consented to by the Required Lenders; and (d) shall not be responsible for any action taken or omitted to be taken by it hereunder or under any other document or instrument referred to or provided for herein or in connection herewith, except for its own gross negligence or willful misconduct. The Agent may employ agents and attorneys-in-fact and shall not be responsible for the negligence or misconduct of any such agents or attorneys-in-fact selected by it with reasonable care. Subject to the foregoing, the Agent shall, on behalf of the Lenders, exercise any and all rights, powers and remedies of the Lenders under this Credit Agreement and any other Loan Documents, including the giving of any consent or waiver or the entering into of any amendment, subject to the provisions of 25. 12.2. Reliance by Agent. The Agent shall be entitled to rely upon any certifications, notices or communications (including any communications by telephone, telex, telegram or cable) believed by it to be genuine and correct and to have been signed or sent by or on behalf of the proper Person or Persons, and upon advice and statements of legal counsel, independent accountants and other experts selected by the Agent. As to any matters not expressly provided for by this Credit Agreement, the Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder in accordance with the instructions of the Lenders, and any action taken or failure to act pursuant thereto shall be binding on all of the Lenders. 12.3. Defaults. The Agent shall not be deemed to have knowledge of the occurrence of an Event of Default (other than the nonpayment of principal of or interest on the Notes) unless the Agent has received written notice from a Borrower specifying such Event of Default. In the event that the Agent receives such a notice of the occurrence of an Event of Default, the Agent shall give notice thereof to the Lenders (and shall give each Lender prompt notice of each such nonpayment). The Agent shall (subject to the provisions of 24 and 12.7) take such action with respect to such Event of Default as shall be directed by the Lenders, provided that, unless and until the Agent shall have received such directions, the Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Event of Default as it shall deem advisable and in the best interests of the Required Lenders. 12.4. Rights as a Lender. With respect to its Percentage of the Total Commitment and the Loans made by it, BBH&Co, in its capacity as a Lender hereunder shall have the same rights and powers hereunder as any other Lender and may exercise the same as though it were not acting as the Agent, and the term "Lender" or "Lenders" shall, unless the context otherwise indicates, include the Agent in its individual capacity. The Agent and its Affiliates may (without having to account therefor to any Lender) accept deposits from, lend money to and generally engage in any kind of banking, trust or other business with any Borrower or any of its Affiliates, as if the Agent were not acting as the agent hereunder, and the Agent may accept fees and other consideration from any of such Persons for services as the Agent or otherwise without having to account for the same to the Lenders. 12.5. Indemnification. The Lenders agree to indemnify the Agent ratably in accordance with the aggregate principal amount of the Notes held by the Lenders (or, if no such principal is at the time outstanding, ratably in accordance with their respective Percentages), for any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind and nature whatsoever which may be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of this Credit Agreement or referred to herein or the transactions contemplated by or referred to herein or therein (including the costs and expenses which any Borrower is obligated to pay but excluding, unless an Event of Default has occurred and is continuing, normal administrative costs and expenses incident to the performance of its agency duties hereunder) or the enforcement of any of the terms of this Credit Agreement or of any such other documents, provided that no Lender shall be liable for any of the foregoing to the extent they arise from the gross negligence or willful misconduct of the Agent. 12.6. Non-Reliance on Agent and Other Lenders. Each Lender agrees that it has, independently and without reliance on the Agent or any other Lender, and based on such documents and information as it has deemed appropriate, made its own credit analysis of the Borrowers and its own decision to enter into this Credit Agreement and that it will, independently and without reliance upon the Agent or any other Lender, and based on such documents and information as it shall deem appropriate at the time, continue to make its own analysis and decisions in taking or not taking action under this Credit Agreement. The Agent shall not be required to keep itself informed as to the performance or observance by the Borrowers of this Credit Agreement or any other document referred to or provided for herein or to inspect the properties or books of the Borrowers. Except for notices, reports and other documents and information expressly required to be furnished to the Lenders by the Agent hereunder, the Agent shall not have any duty or responsibility to provide any Lender with any credit or other information concerning the affairs, financial condition or business of the Borrowers which may come into the possession of the Agent or any of its Affiliates. Notwithstanding the foregoing, the Agent will use its best efforts to provide to the Lenders any and all information reasonably requested by them and reasonably available to the Agent promptly upon such request. 12.7. Failure to Act. Except for action expressly required of the Agent hereunder, the Agent shall in all cases be fully justified in failing or refusing to act hereunder unless it shall be indemnified to its satisfaction by the Lenders against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. 12.8. Resignation of Agent. Subject to the appointment and acceptance of a successor Agent as provided below, the Agent may resign at any time by giving notice thereof to the Lenders and DRC. Upon any such resignation, the Lenders shall appoint a successor Agent which shall be reasonably satisfactory to DRC. If no successor Agent shall have been so appointed by the Lenders and shall have accepted such appointment within 30 days after the retiring Agent's giving of notice of resignation, then the retiring Agent may, on behalf of the Lenders, appoint a successor Agent which shall be a Lender which has a combined capital and surplus of at least $500,000,000 and which shall be reasonably satisfactory to DRC. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent, and the retiring Agent shall be discharged from its duties and obligations hereunder. After the retiring Agent's resignation hereunder as Agent, the provisions of this 12 shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as the Agent. 12.9. Cooperation of Lenders. Each Lender shall (a) endeavor to and shall not be liable for any failure to promptly notify the other Lenders and the Agent of any Events of Default known to such Lender under this Credit Agreement and not reasonably believed to have been previously disclosed to the other Lenders; and (b) provide the other Lenders and the Agent with such information and documentation as such other Lender or the Agent shall reasonably request in the performance of their respective duties hereunder, including all information relative to the outstanding balance of principal, interest and other sums owed to such Lender. 12.10. Amendment of 12. Each Borrower hereby agrees that the provisions of this 12 (other than 12.8 and 12.11) generally constitute an agreement among the Agent and the Lenders and that any and all of the provisions of this 12 (other than 12.8 and 12.11) may be amended at any time by the Lenders without the consent or approval of, or notice to, any Borrower (other than the requirement of notice to DRC of the resignation of the Agent and other than any provision in addition to 12.8 and 12.11 which directly affects the Borrowers). 12.11. Reliance. As to any consent that is granted or any other action that is taken by the Agent hereunder, or under the Loan Documents, the Borrowers shall be entitled to rely upon any of the foregoing granted, delivered or taken by the Agent and the Lenders shall be bound thereby, without the necessity of inquiring or confirming the Agent's authority. 13. SETOFF, ETC. Regardless of the adequacy of any collateral, during the continuance of any Event of Default, any deposits or other sums credited by or due from any Lender to any Borrower and any securities or other property of any Borrower in the possession of any Lender may be applied to or set off against the pro rata payment of Obligations and any and all other liabilities, direct, or indirect, absolute or contingent, due or to become due, now existing or hereafter arising, of the Borrowers to the Lenders. The Lenders agree among themselves that, with respect to all sums received by the Lenders applicable to the payment of principal of or interest on the Notes, equitable adjustment will be made among the Lenders so that, in effect, all such sums shall be shared ratably by each of the Lenders whether received by voluntary payment, by the exercise of the right of setoff or banker's lien, by counterclaim or crossclaim or by the enforcement of any or all of the Notes. If any Lender receives any payment on its Notes of a sum or sums in excess of its pro rata portion, then such Lender receiving such excess payment shall purchase for cash from the other Lenders an interest in their Notes in such amounts as shall result in a ratable participation by each of the Lenders in the aggregate unpaid amount of the Notes then outstanding; provided, however, that if all or any portion of such excess payment is thereafter recovered from such Lender, the purchase shall be rescinded and the purchase price restored to the extent of such recovery, but without interest. 14. EXPENSES. Whether or not the transactions contemplated hereby shall be consummated, each Borrower agrees to pay (a) the reasonable direct, out-of-pocket costs of reproducing this Credit Agreement, the other Loan Documents and the other agreements at and instruments mentioned herein, (b) any taxes (including any interest and penalties in respect thereto) payable by the Lenders (other than taxes based upon the Lender's net income) on or with respect to the transactions contemplated by this Credit Agreement (the Borrowers hereby agreeing to indemnify the Lenders with respect thereto), (c) the fees, expenses and disbursements of the Agent's counsel incurred in connection with the preparation of the Loan Documents and other instruments mentioned herein and the reasonable fees, expenses and disbursements of the Agent's counsel and any local counsel to the Lenders in connection with any amendments, modifications, approvals, consents, waivers or Replacement Lenders hereto or hereunder and (d) all reasonable out-of-pocket expenses (including attorney fees and costs for external counsel to the Lenders and the allocated costs and disbursements of internal counsel of the Lenders) incurred by the Lenders in connection with (i) the enforcement of or preservation of rights under any of the Loan Documents against the Borrowers or the administration thereof after the occurrence of an Event of Default or any event which, with the giving of notice or passage of time or both, would constitute an Event of Default, (ii) any replacement of a Lender pursuant to 17.4 and (iii) any litigation, proceeding or dispute arising hereunder; provided, however, that the Borrowers shall have no obligation to pay for the expenses of the Agent or the Lenders to the extent such expenses result from the Agent's or any Lender's gross negligence, fraud or willful misconduct. 15. INDEMNIFICATION. Each Borrower agrees to indemnify and hold harmless each Lender from and against any and all claims, actions and suits whether groundless or otherwise, and from and against any and all liabilities, losses, damages and expenses of every nature and character arising out of this Credit Agreement or any of the other Loan Documents or the transactions contemplated hereby or thereby, including (a) any actual or proposed use by any Borrower of the proceeds of any of the Loans, (b) any Borrower entering into or performing this Credit Agreement or any of the other Loan Documents or (c) with respect to any Borrower and its properties and assets, the violation of any Environmental Law, the presence, disposal, escape, seepage, leakage, spillage, discharge, emission, release or threatened release of any Hazardous Substances or any action, suit, proceeding or investigation brought or threatened with respect to any Hazardous Substances (including, but not limited to claims with respect to wrongful death, personal injury or damage to property), in each case including the reasonable fees and disbursements of counsel for the Agent, incurred in connection with any such investigation, litigation or other proceeding; provided, however, that no Borrower shall have any obligation to indemnify the Agent or the Lenders for any liabilities, losses, damages or other expenses (I) incurred in connection with any litigation commenced by any Borrower against the Agent or any Lender, or by the Agent or any Lender against any Borrower, which seeks enforcement of any rights hereunder or under any other Loan Document and is determined adversely to the Agent or the Lenders in a final nonappealable judgment or (II) to the extent such liabilities, losses, damages or other expenses result from the Agent's or any Lender's gross negligence, fraud or willful misconduct. If, and to the extent that the obligations of any Borrower under this 15 are unenforceable for any reason, each Borrower hereby agrees to make the maximum contribution to the payment in satisfaction of such obligations which is permissible under applicable law. 16. SURVIVAL OF COVENANTS, ETC. All covenants, agreements, representations and warranties made herein in any of the other Loan Documents or in any documents or other papers delivered by or on behalf of each Borrower pursuant hereto shall be deemed to have been relied upon by each Lender, notwithstanding any investigation heretofore or hereafter made by it, and shall survive the making by the Lenders of the Loans, as herein contemplated, and shall continue in full force and effect so long as any amount due under this Credit Agreement or any of the other Loan Documents remains outstanding or the Lenders have any obligation to make any Loans. All statements contained in any certificate or other paper delivered to the Lenders at any time by or on behalf of any Borrower pursuant hereto shall constitute representations and warranties as of the date thereof by the Borrowers hereunder. 17. ASSIGNMENT AND PARTICIPATION. 17.1. Assignment by the Lenders. No Lender shall assign or transfer any of its rights or obligations under any of the Loan Documents (i) without the prior written consent of DRC, which shall not be unreasonably withheld or delayed, and (ii) in amounts of less than $5,000,000 unless such Lender assigns its entire remaining interest under the Loan Documents; provided, however, that any Lender may, at any time and from time to time, sell, transfer, assign or otherwise grant an interest in any Loan to a Subsidiary or any Affiliate of such Lender or to a Federal Reserve Bank of the United States; and provided, further, that upon the occurrence and during the continuance of an Event of Default, no consent of DRC shall be required to any assignment. 17.2. Assignment by Borrowers. No Borrower shall assign or transfer any of its rights or obligations under any of the Loan Documents without the prior written consent of the Lenders. 17.3 Participations by the Lenders. Any Lender may, without the consent of any Borrower, the Agent or any other Lender, sell participations to one or more banks or other entities (each a "Participant") in all or a portion of such Lender's rights and obligations under this Credit Agreement (including all or a portion of its Commitment and the Loans owing to it); provided, however, that (i) such Lender's obligations under this Credit Agreement shall remain unchanged, (ii) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, (iii) each Borrower, the Agent, and the other Lenders shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under this Credit Agreement and (iv) such participation shall be in an amount of not less than $5,000,000. Any agreement or instrument pursuant to which a Lender sells such a participation shall provide that such Lender shall retain the sole right to enforce this Credit Agreement and to approve any amendment, modification or waiver of any provision of this Credit Agreement. Each Borrower agrees that each Participant shall be entitled to the benefits of 4.5 to the same extent as if it were a Lender and had acquired its interest by assignment pursuant to 17.1. 17.4 Replacement of Lender. In the event that any Lender (other than the Agent in its capacity as a Lender) or, to the extent applicable, any Participant (the "Affected Lender"): (a) fails to perform its obligations to fund any portion of any Loan on or after the Closing Date when required to do so by the terms of this Credit Agreement, or fails to provide its portion of any LIBOR Loan pursuant to 2 or on account of any legal requirement as contemplated by 4.4; (b) refuses to consent to a proposed extension of the Maturity Date that is consented to by all of the other Lenders; or (c) refuses to consent to a proposed amendment, modification, waiver or other action requiring consent of all of the Lenders under 25 that is consented to by Lenders owning at least 75% of the Percentages of the Total Commitment; then, so long as no Event of Default exists, DRC shall have the right to seek, at its own cost and expense, a replacement lender which is reasonably satisfactory to the Agent and the Required Lenders (the "Replacement Lender"). The Replacement Lender shall purchase the interests of the Affected Lender in the Loans and its Commitment and shall assume the obligations of the Affected Lender hereunder and under the other Loan Documents upon execution by the Replacement Lender of an assignment agreement in form and substance reasonably satisfactory to the Replacement Lender and Affected Lender, and the tender by the Replacement Lender to the Affected Lender of a purchase price agreed between the Replacement Lender and the Affected Lender. Such assignment by any Affected Lender who has performed its obligations hereunder shall be deemed an early termination of any Loans to the extent of such Affected Lender's portion thereof, and the Borrowers will pay to such Affected Lender any resulting amounts due under 4.8. Upon consummation of such assignment, (i) the Replacement Lender shall become party to this Credit Agreement as a signatory hereto and shall have all the rights and obligations of the Affected Lender under this Credit Agreement and the other Loan Documents with a Percentage equal to the Percentage of the Affected Lender, (ii) the Affected Lender shall be released from its obligations hereunder and under the other Loan Documents and (iii) no further consent or action by any party shall be required. The Borrowers shall sign such documents and take such other actions reasonably requested by the Replacement Lender to enable it to share in the benefits of the rights created by the Loan Documents. Until the consummation of an assignment in accordance with the foregoing provisions of this 17.4, the Borrowers shall continue to pay to the Affected Lender any Obligations as they become due and payable. 18. FOREIGN LENDER. If any Lender is not incorporated or organized under the laws of the United States of America or a state thereof, such Lender shall deliver to DRC and the Agent the following: (a) Two duly completed copies of United States Internal Revenue Service Form 1001 or 4224 or successor form, as the case may be, certifying in each case that such Lender is entitled to receive payments under this Credit Agreement and the Notes without deduction or withholding of any United States federal income taxes; provided, however, that if such Lender is not a "bank" within the meaning of Section 881(c)(3)(A) of the Code and cannot deliver Form 1001 or 4224, such Lender shall deliver to DRC and the Agent a certificate to such effect; and (b) A duly completed Internal Revenue Service Form W-8 or W-9 or successor form, as the case may be, to establish an exemption from United States backup withholding tax. Each such Lender that delivers to DRC and the Agent a Form 1001 or 4224 and Form W-8 or W-9 pursuant to this 18 further undertakes to deliver to DRC and the Agent two further copies of Form 1001 or 4224 and Form W-8 or W-9, or successor applicable form, or other manner of certification, as the case may be, on or before the date that any such form expires or becomes obsolete or after the occurrence of any event requiring a change in the most recent form previously delivered by it to DRC and the Agent. Such Forms 1001 or 4224 shall certify that such Lender is entitled to receive payments under this Credit Agreement without deduction or withholding of any United States federal income taxes. The foregoing documents need not be delivered in the event any change in treaty, law or regulation or official interpretation thereof has occurred which renders all such forms inapplicable or which would prevent such Lender from delivering any such form with respect to it, or such Lender advises DRC that it is not capable of receiving payments without any deduction or withholding of United States federal income tax and, in the case of a Form W-8 or W-9, establishing an exemption from United States backup withholding tax. Until such time as DRC and the Agent have received such forms indicating that payments hereunder are not subject to United States withholding tax or are subject to such tax at a rate reduced by an applicable tax treaty, the Borrowers shall withhold taxes from such payments at the applicable statutory rate without regard to 4.1(b). 19. NOTICES, ETC. Except as otherwise expressly provided in this Credit Agreement, all notices and other communications made or required to be given pursuant to this Credit Agreement or the other Loan Documents shall be in writing and shall be delivered in hand, mailed by United States registered or certified first class mail, postage prepaid, sent by overnight courier, or sent by telecopy, and confirmed by delivery via courier or registered or certified first class mail, postage prepaid, addressed as follows: (a) if to any Borrower, to such Borrower c/o Dynamics Research Corporation, 60 Frontage Road, Andover, MA 01810, Attention: Chief Financial Officer (Telecopy No. (978) 475-8205), or at such other address for notice as such Borrower shall last have furnished in writing to the Person giving the notice; with a copy to: Ropes & Gray One International Place Boston, MA 02110 Telecopy No. (617) 951-7050 Attention: Mary E. Weber, Esq. (b) if to the Agent or BBH&Co in its capacity as a Lender, at Brown Brothers Harriman & Co., 40 Water Street, Boston, MA 02109, Attention: Timothy T. Telman, Deputy Manager (Telecopy No. (617) 772-1138) or such other address for notice as BBH&Co shall last have furnished in writing to the Person giving the notice; with a copy to: Choate, Hall & Stewart Exchange Place 53 State Street Boston, MA 02109 Telecopy No. (617) 248-4000 Attention: Lyman G. Bullard, Jr., Esq. (c) if to BankBoston, at BankBoston, N.A., 100 Federal Street, Boston, MA 02110, Attention: Daniel R. Gillette, Vice President (Mail Stop: MA BOS 01-07-04) (Telecopy No. (617) 434-5825), or such other address for notice as BankBoston shall last have furnished in writing to the Person giving the notice; (d) if to State Street, at State Street Bank and Trust Company, High Technology Group, 225 Franklin Street, Boston, MA 02110, Attention: Mark Trachy, Vice President (Telecopy No. (617) 664-4971), or such other address as State Street shall last have furnished in writing to the Person giving the notice; (e) if to Chase, at The Chase Manhattan Bank, 999 Broad Street, Bridgeport, CT 06604, Attention: A. Neil Sweeny, Vice President (Telecopy No. (203) 382-6573), or such other address as Chase shall last have furnished in writing to the Person giving the notice; and (f) if to Citizens, at Citizens Bank of Massachusetts, 28 State Street, Boston, MA 02109, Attention: R.E. James Hunter, Vice President (Telecopy No. (617) 725-5790), or such other address as Citizens shall last have furnished in writing to the Person giving the notice. Any such notice or demand shall be deemed to have been duly given or made and to have become effective (i) if delivered by hand, overnight courier or facsimile (so long as a confirmation receipt is received) to a responsible officer of the party to which it is directed, at the time of the receipt thereof by such officer or the sending of such facsimile and ( ii) if sent by registered or certified first-class mail, postage prepaid, on the third Business Day following the mailing thereof. 20. GOVERNING LAW. THIS CREDIT AGREEMENT AND EACH OF THE OTHER LOAN DOCUMENTS ARE CONTRACTS UNDER THE LAWS OF THE COMMONWEALTH OF MASSACHUSETTS AND SHALL FOR ALL PURPOSES BE CONSTRUED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF SAID COMMONWEALTH OF MASSACHUSETTS (EXCLUDING THE LAWS APPLICABLE TO CONFLICTS OR CHOICE OF LAW). EACH OF THE BORROWERS, THE AGENT AND THE LENDERS AGREES THAT ANY SUIT FOR THE ENFORCEMENT OF THIS CREDIT AGREEMENT OR ANY OF THE OTHER LOAN DOCUMENTS MAY BE BROUGHT IN THE COURTS OF THE COMMONWEALTH OF MASSACHUSETTS OR ANY FEDERAL COURT SITTING THEREIN AND CONSENTS TO THE NONEXCLUSIVE JURISDICTION OF SUCH COURTS AND THE SERVICE OF PROCESS IN ANY SUCH SUIT BEING MADE UPON SUCH PERSON BY MAIL AT ITS ADDRESS SPECIFIED IN 19. EACH OF THE BORROWERS, THE AGENT AND THE LENDERS HEREBY WAIVES ANY OBJECTION THAT IT MAY NOW OR HEREAFTER HAVE TO THE VENUE OF ANY SUCH SUIT OR ANY SUCH COURT OR THAT SUCH SUIT IS BROUGHT IN AN INCONVENIENT COURT. 21. HEADINGS. The captions in this Credit Agreement are for convenience of reference only and shall not define or limit the provisions hereof. 22. COUNTERPARTS. This Credit Agreement and any amendment hereof may be executed in several counterparts and by each party on a separate counterpart, each of which when so executed and delivered shall be an original, and all of which together shall constitute one instrument. In proving this Credit Agreement it shall not be necessary to produce or account for more than one such counterpart signed by the party against whom enforcement is sought. 23. ENTIRE AGREEMENT, ETC. The Loan Documents and any other documents executed in connection herewith or therewith express the entire understanding of the parties with respect to the transactions contemplated hereby and thereby. Neither this Credit Agreement nor any term hereof may be changed, waived, discharged or terminated, except as provided in 25. 24. WAIVER OF JURY TRIAL. EACH OF THE BORROWERS, THE AGENT AND THE LENDERS HEREBY WAIVES ITS RIGHT TO A JURY TRIAL WITH RESPECT TO ANY ACTION OR CLAIM ARISING OUT OF ANY DISPUTE IN CONNECTION WITH THIS CREDIT AGREEMENT OR ANY OF THE OTHER LOAN DOCUMENTS, ANY RIGHTS OR OBLIGATIONS HEREUNDER OR THEREUNDER OR THE PERFORMANCE OF SUCH RIGHTS AND OBLIGATIONS. EXCEPT AS PROHIBITED BY LAW, AND, EXCEPT IN THE CASE OF THE GROSS NEGLIGENCE, FRAUD, BAD FAITH OR WILLFUL MISCONDUCT OF THE AGENT OR ANY LENDER. EACH BORROWER HEREBY WAIVES ANY RIGHT IT MAY HAVE TO CLAIM OR RECOVER IN ANY LITIGATION REFERRED TO IN THE PRECEDING SENTENCE ANY SPECIAL, EXEMPLARY, PUNITIVE OR CONSEQUENTIAL DAMAGES OR ANY DAMAGES OTHER THAN, OR IN ADDITION TO, ACTUAL DAMAGES. EACH BORROWER (A) CERTIFIES THAT NO REPRESENTATIVE, AGENT OR ATTORNEY OF THE AGENT OR THE LENDERS HAS REPRESENTED, EXPRESSLY OR OTHERWISE, THAT EACH OF THE AGENT AND THE LENDERS WOULD NOT, IN THE EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVERS AND (B) ACKNOWLEDGES THAT EACH OF THE LENDERS HAVE BEEN INDUCED TO ENTER INTO THIS CREDIT AGREEMENT AND THE OTHER LOAN DOCUMENTS TO WHICH IT IS A PARTY BY, AMONG OTHER THINGS, THE WAIVERS AND CERTIFICATIONS CONTAINED HEREIN. 25. CONSENTS, AMENDMENTS, WAIVERS, ETC. Except as otherwise expressly provided in this Credit Agreement, any consent or approval required or permitted by this Credit Agreement to be given by the Lenders or the Agent may be given, and any term of this Credit Agreement or of any other instrument related hereto or mentioned herein may be amended, and the performance or observance by any Borrower of any terms of this Credit Agreement or such other instrument or the continuance of any Default or Event of Default may be waived (either generally or in a particular instance and either retroactively or prospectively) with, but only with, the written consent of DRC and the written consent of the Required Lenders. Notwithstanding the foregoing, no amendment or waiver shall, without the prior written consent of the Agent and all of the Lenders, (a) extend the fixed maturity or reduce the principal amount of, or reduce the rate or extend the time of payment of interest on, or reduce the amount or extend the time of payment of any principal or interest of, any Note (including any extensions of the Maturity Date pursuant to 2.4); (b) change or waive the Total Commitment (other than reductions in the Total Commitments pursuant to 2.3) or Percentage; (c) amend or waive this 25 or amend or waive the definition of Required Lenders; (d) change or waive the amount or payment terms of any fees due hereunder; or (e) amend or waive 8(c) or 9.1(a), (f) or (g) or 11. No waiver shall extend to or affect any obligation not expressly waived nor impair any right consequent thereon. No course of dealing or delay or omission on the part of the Lenders in exercising any right shall operate as a waiver thereof or otherwise be prejudicial thereto. No notice to or demand upon a Borrower shall entitle a Borrower to other or further notice or demand in similar or other circumstances. 26. CONFIDENTIALITY. No Lender will make any disclosure of confidential information furnished to it any Borrower or any of its Subsidiaries unless such information shall have become public, except: (a) in connection with operations under or the enforcement of or the protection of a Lender's interest in this Credit Agreement or any other Loan Document to Persons who have a reasonable need to be furnished such information; (b) pursuant to any law, rule or statutory or regulatory requirement or any court order, subpoena or other legal process; (c) to any parent or corporate Affiliate of such Lender or to any Participant, proposed Participant, assignee, proposed assignee, Replacement Lender or proposed Replacement Lender; provided, however, that any such Person shall agree to comply with the restrictions set forth in this 26 with respect to such information; (d) to its directors, officers, employees, agents, independent counsel, auditors and other professional advisors and consultants with an instruction to such Person to keep such information confidential; (e) to any other Lender and to the Agent and any successor Agent or prospective successor Agent; and (f) with the prior written consent of the Borrower, to any other Person. 27. SEVERABILITY. The provisions of this Credit Agreement are severable and if any one clause or provision hereof shall be held invalid or unenforceable in whole or in part in any jurisdiction, then such invalidity or unenforceability shall affect only such clause or provision, or part thereof, in such jurisdiction, and shall not in any manner affect such clause or provision in any other jurisdiction, or any other clause or provision of this Credit Agreement in any jurisdiction. 28. NATURE OF LENDER'S OBLIGATIONS. The Lenders obligations to make their respective Loans are several and not joint or joint and several. Any Lender which is not in default in the performance of its obligations may, in its discretion, assume the obligations of any other Lender which is in default. IN WITNESS WHEREOF, the undersigned have duly executed this Credit Agreement as a sealed instrument as of the date first set forth above. DYNAMICS RESEARCH CORPORATION By: Name: Douglas R. Potter Title: Vice President of Finance and Chief Financial Officer DRC ENCODER, INC. By: Name: Title: DRC METRIGRAPHICS, INC. By: Name: Title: DRC SOFTWARE, INC. By: Name: Title: DRC TELECOM, INC. By: Name: Title: per pro BROWN BROTHERS HARRIMAN & CO. By: Name: Timothy T. Telman Title: Deputy Manager BANKBOSTON, N.A. By: Name: Daniel R. Gillette Title: Vice President THE CHASE MANHATTAN BANK By: Name: A. Neil Sweeny Title: Vice President STATE STREET BANK AND TRUST COMPANY By: Name: Mark Trachy Title: Vice President CITIZENS BANK OF MASSACHUSETTS By: Name: R. E. James Hunter Title: Vice President EX-10 7 FIRST AMENDMENT TO AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT Reference is hereby made to the Amended and Restated Revolving Credit Agreement, dated as of December 31, 1998 (the "Credit Agreement"), by and among Dynamics Research Corporation, a Massachusetts corporation ("DRC"), DRC Encoder, Inc., a Massachusetts corporation, DRC Metrigraphics, Inc., a Massachusetts corporation, DRC Software, Inc., a Massachusetts corporation, DRC Telecom, Inc., a Massachusetts corporation, and Brown Brothers Harriman & Co., a New York limited partnership, as a Lender, as Agent for itself and the other Lenders, and as Swing Line Lender, BankBoston, N.A., a national banking association, The Chase Manhattan Bank, a New York banking corporation, State Street Bank and Trust Company, a Massachusetts trust company, Citizens Bank of Massachusetts, a Massachusetts financial institution, and the other Lenders from time to time party thereto. The parties to the Credit Agreement now desire to amend the Credit Agreement, pursuant to 25 thereof, as set forth in this First Amendment, dated as of December 31, 1998 (the "Amendment"), and hereby agree as follows: 1. EFFECTIVE DATE, DEFINITIONS. This Amendment shall be effective as of December 31, 1998 (the "Effective Date"). Capitalized terms used herein but not defined herein shall have the meanings assigned thereto in the Credit Agreement, as amended hereby. II. AMENDMENTS. (A) Amendment to Definition of "Net Income". The definition of "Net Income" set forth in 1.1 of the Credit Agreement is hereby amended by adding the following text at the beginning of clause (b) of such definition: "with respect to calculations of Net Income for periods ending on or before December 31, 1998 and thereafter for purposes only of calculating the Debt Coverage Ratio pursuant to 2.6(a) (but not for purposes of 8),". (B) Amendment to Definition of "Tangible Net Worth". The definition of "Tangible Net Worth" set forth in 1.1 of the Credit Agreement is hereby amended by deleting the last sentence of such definition in its entirety. (C) Amendment to 7.8 of the Credit Agreement. The text of 7.8 of the Credit Agreement is hereby amended by deleting the same and replacing it with the following: DRC will not make any distribution or declare or pay any cash dividends on, or purchase, acquire or redeem or retire any of its capital stock, of any class, whether now or hereafter outstanding, except that so long as immediately before and after giving effect thereto no Event of Default exists, DRC may make cash distributions to its stockholders and repurchase shares of its common stock at a price not to exceed the then-current market value for such stock, in an aggregate amount which shall not exceed: (i) in the fiscal year ending December 31, 1998, the sum of (x) fifty percent (50%) of the Consolidated Net Income of DRC and its Subsidiaries (if positive) for the immediately preceding fiscal year and (y) $2 10,000; (ii) in the fiscal year ending December 31, 1999, (x) (1) fifty percent (50%) of the Consolidated Net Income of DRC and its Subsidiaries (if positive) for the period commencing on January 1, 1999 and ending on the last day of the most recently completed fiscal quarter ending on or prior to December 31, 1999, minus (II) the portion of such Consolidated Net Income of DRC and its Subsidiaries which provided the basis for any prior distribution or repurchase during the fiscal year ending December 31, 1999, plus (y) $250,000; provided that the total amount of cash distributions and repurchases of shares by DRC during the fiscal year ending December 31, 1999 shall not exceed $750,000; and (iii) in each fiscal year ending after December 31, 1999, fifty percent (50%) of the Consolidated Net Income of DRC and its Subsidiaries (if positive) for the immediately preceding fiscal year; and further provided that, for purposes of clauses (i), (ii) and (iii) above, such amount shall not include shares of capital stock surrendered upon the exercise of any stock options or other convertible securities. (D) Amendment to 8(a) of the Credit Agreement. The text of 8(a) of the Credit Agreement is hereby amended by deleting the same and replacing it with the following: Tangible Net Worth, measured on a fiscal quarter-end basis, for (i) the fiscal quarter ending December 31, 1998, of $31,200,000 and (ii) each fiscal quarter ending after December 31, 1998, of (x) fifty percent (50%) of the cumulative Net Income of DRC and its Subsidiaries (if positive) for each fiscal quarter ending after December 31, 1998, plus (y) $31,200,000. (E) Amendment to 8(c) of the Credit Agreement. The text of 8(c) of the Credit Agreement is hereby amended by deleting the same and replacing it with the following: A ratio of Senior Debt of DRC and its Subsidiaries to EBITDA of DRC and its Subsidiaries not to exceed: (i) for the fiscal quarter ending on December 31, 1998, seven and eighty-six one-hundredths to one (7.86:1.00); (ii) for the fiscal quarter ending on March 31, 1999, two and three-quarters to one (2.75:1.00); (iii) for the fiscal quarters ending on June 30, 1999 and September 30, 1999, two and one-half to one (2.50:1.00); and (iv) for each fiscal quarter ending after September 30, 1999, two and one-quarter to one (2.25:1.00); with each such ratio measured on a fiscal quarter-end basis, and with EBITDA of DRC and its Subsidiaries based on (I) for the fiscal quarter ending on December 31, 1998, the period of four (4) consecutive fiscal quarters ending on December 31, 1998; (II) for the fiscal quarter ending on March 31, 1999, EBITDA for such quarter multiplied by four (4); (III) for the fiscal quarter ending on June 30, 1999, EBITDA for the period of two (2) consecutive fiscal quarters ending on June 30, 1999, multiplied by two (2); (IV) for the fiscal quarter ending on September 30, 1999, EBITDA for the period of three (3) consecutive fiscal quarters ending on September 30, 1999, multiplied by four-thirds (4/3); and (V) for each fiscal quarter ending after September 30, 1999, the period of four (4) consecutive fiscal quarters ending on such fiscal quarter-end. (F) Amendment to 8(d) of the Credit Agreement. The text of 8(d) of the Credit Agreement is hereby amended by deleting the same and replacing it with the following: A ratio, measured on fiscal quarter-end basis, of (x) EBITDA of DRC and its Subsidiaries less Capital Expenditures of DRC and its Subsidiaries not funded by Indebtedness for borrowed money less taxes on income and profits paid in cash by DRC and its Subsidiaries ("Cash Flow") to (y) required interest and principal payments made by DRC and its Subsidiaries on all Indebtedness ("Required Payments") of at least: (i) for the fiscal quarter ending December 31, 1998, one-twentieth to one (0.05:1.00), based on Cash Flow and Required Payments for the period of four (4) consecutive fiscal quarters ending December 31, 1998; (ii) for each fiscal quarter ending after December 31, 1998 but on or before December 31, 1999, two to one (2.00:1.00), based on (I)(A) for the fiscal quarter ending March 31, 1999, Cash Flow for such quarter multiplied by four (4), (B) for the fiscal quarter ending June 30, 1999, Cash Flow for the period of two (2) consecutive fiscal quarters then ending multiplied by two (2), (C) for the fiscal quarter ending September 30, 1999, Cash Flow for the period of three (3) consecutive fiscal quarters then ending multiplied by four-thirds (4/3) and (D) for the fiscal quarter ending December 31, 1999, Cash Flow for the period of four (4) consecutive fiscal quarters then ending and (II) Required Payments for the period of four (4) consecutive fiscal quarters then ending; and (iii) for each fiscal quarter ending after December 31, 1999, two and one-quarter to one (2.25:1.00), based on Cash Flow and Required Payments for the period of four (4) consecutive fiscal quarters then ending. III. CONDITIONS; NO DEFAULT; REPRESENTATIONS AND WARRANTIES, ETC. Each Borrower hereby represents and warrants to the Lenders that all of the conditions of lending specified in 11 of the Credit Agreement and Section III of this Amendment have been satisfied in all material respects as of the Effective Date. Without limiting the generality of the foregoing, each Borrower hereby confirms that: (i) the representations and warranties of the Borrowers contained in 5 of the Credit Agreement, as amended by and through this Amendment, are true on and as of the Effective Date as if made on such date (except to the extent that such representations and warranties expressly relate to an earlier date); (ii) each Borrower is in compliance in all material respects with all of the terms and provisions set forth in the Credit Agreement, as amended by and through this Amendment, on its part to be observed or performed on or prior to the Effective Date; and (iii) no Event of Default specified in 9 of the Credit Agreement, as amended by and through this Amendment, nor any event which with the giving of notice or expiration of any applicable grace period or both would constitute such an Event of Default has occurred and is continuing. All fees and expenses of the Lenders shall be paid by the Borrowers pursuant to the side letter from the Agent to the Borrowers before this Amendment shall become effective. IV. AMENDED TERMS. For all purposes hereafter, the term "Credit Agreement" shall mean the Credit Agreement as amended by and through this Amendment. For all purposes hereafter, the terms "Net Income" and "Tangible Net Worth" shall have the meanings set forth for such terms in the Credit Agreement, as amended by and through this Amendment. V. MISCELLANEOUS. Except as expressly set forth in Section II of this Amendment, the execution, delivery, and effectiveness of this Amendment shall not (a) limit, impair, constitute a waiver of, or otherwise affect any right, power, or remedy by the Lenders, the Swing Line Lender, or the Agent under the Credit Agreement, as amended by and through this Amendment, (b) constitute a waiver of any provision in the Credit Agreement, as amended by and through this Amendment, or (c) alter, modify, amend, or in any way affect any of the terms, conditions, obligations, covenants, or agreements contained in the Credit Agreement, as amended by and through this Amendment, all of which are ratified and affirmed in all respects and shall continue in full force and effect. This Amendment may be executed in any number of counterparts, all of which together shall constitute one and the same instrument. This Amendment shall be governed by the laws of the Commonwealth of Massachusetts and shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. IN WITNESS WHEREOF, the parties hereto have executed this Amendment as a sealed instrument as of the date first set forth above. DYNAMICS RESEARCH CORPORATION By:_____/s/ Douglas R. Potter______ Name: Douglas R. Potter Title: Vice President President of Finance DRC ENCODER, INC. By:____/s/ Douglas R. Potter___ Name: Douglas R. Potter Title: Treasurer DRC METRIGRAPHICS, INC. By:_____/s/ Douglas R. Potter____ Name: Douglas R. Potter Title: Treasurer DRC SOFTWARE, INC. By:_____/s/ Douglas R. Potter___ Name: Douglas R. Potter Title: Treasurer DRC TELECOM, INC. By:_____/s/ Douglas R. Potter____ Name: Douglas R. Potter Title: Treasurer per pro BROWN BROTHERS HARRIMAN & CO. By:_____/s/ Timothy T. Telman_____ Name: Timothy T. Telman Title: Deputy Manager BANKBOSTON, N.A. By:_____/s/ Jeff R. Westling____ Name: Jeff R. Westling Title: Vice President THE CHASE MANHATTAN BANK By:_____/s/ A. Neil Sweeny____ Name: A. Neil Sweeny Title: Vice President STATE STREET BANK AND TRUST COMPANY By:_____/s/ Mark Trachy___ Name: Mark Trachy Title: Vice President CITIZENS BANK OF MASSACHUSETTS By:_____/s/ R.E. James Hunter__ Name: R. E. James Hunter Title: Vice President EX-10 8 CERTIFICATE OF VOTE OF DIRECTORS ESTABLISHING A CLASS OR SERIES OF STOCK (General Laws, Chapter 156B, Section 26) We, Albert Rand, President, and John Wilkinson, Clerk, of Dynamics Research Corporation located at 60 Frontage Road, Andover, MA 01810-5498 do hereby certify that at a meeting of the directors of the corporation held on September 10, 1998, the following vote establishing and designating a class or series of stock and determining the relative rights and preferences thereof was duly adopted. The directors wish to amend the Series B Preferred Stock pursuant to Section 26, as no shares of the Series B Preferred Stock have been issued at this time. VOTED: That pursuant to the authority vested in the Board of Directors of this Corporation in accordance with the provisions of its Restated Articles of Organization, as amended, the voting powers of the Series B Preferred Stock of the Corporation be and they hereby are amended as follows: Section 3(a) shall be amended to read in its entirety as follows: "Each share of Series B Stock shall entitle the holder thereof to ten votes on all matters submitted to a vote of the stockholders of the Corporation." Section 8 shall be amended to read in its entirety as follows: "Certain Adjustments. In the event the Corporation shall at any time declare or pay any dividend on Common Stock payable in shares of Common Stock, or effect a subdivision or combination or consolidation of the outstanding shares of Common Stock (by reclassification or otherwise than by payment of a dividend in shares of Common Stock) into a greater or lesser number of shares of Common Stock, then, in each such case, the amounts set forth in Sections 2(a) and (b), 6(a) and 7 hereof with respect to the multiple of cash and non-cash dividends, the Series B Liquidation Preference and an aggregate amount of stock, securities, cash and/or other property referred to in Section 7 hereof, shall be adjusted by multiplying such amount by a fraction the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event." Signed under the penalties of perjury, this 10th day of September, 1998. /s/ Albert Rand Albert Rand, President /s/ John Wilkinson John Wilkinson, Clerk -----END PRIVACY-ENHANCED MESSAGE-----