form10-k.htm

In 2010 and 2009, we derived 27% and 29% of our revenues, respectively, from contracts in which we acted as a subcontractor to other contractors or to joint ventures that we and other contractors formed to bid on and execute particular contracts or programs. We expect to continue to depend on relationships with other contractors for a portion of our revenues for the foreseeable future. Our business, prospects, financial condition or operating results could be harmed if other contractors eliminate or reduce their subcontracts or joint venture relationships with us because they choose to establish relationships with our competitors; they choose to directly offer services that compete with our business; the government terminates or reduces these other contractors’ programs; or the government does not award them new contracts.

Many of Our Federal Government Customers Execute Their Procurement Budgets Through Multiple Award Contracts Under Which We Are Required to Compete for Post-Award Orders, Potentially Limiting Our Ability to Win New Contracts and Increase Revenue.

Changes in the federal procurement process have caused many U.S. Government customers to increasingly purchase goods and services through multiple award ID/IQ contracts and other multiple award and/or government-wide acquisition contract vehicles.

These contract vehicles require that we make sustained post-award efforts to obtain task orders under the relevant contract. There can be no assurance that we will obtain revenues or otherwise sell successfully under these contract vehicles. Our failure to compete effectively in this procurement environment could harm our operating results.

Our inability to win re-competitions of the multiple award contracts we currently hold could have a material adverse effect on future revenues, operating results and cash flows. Also our inability to win newly competed multiple award schedule contracts, which we do not currently hold, may impede our ability to grow.

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We May Lose Revenue and Our Cash Flow and Profitability Could Be Negatively Affected if Expenditures Are Incurred Prior to Final Receipt of a Contract or Contract Funding Modification.

We provide professional services and sometimes procure materials on behalf of our government clients under various contract arrangements. From time to time, in order to ensure that we satisfy our clients’ delivery requirements and schedules, we may elect to initiate procurements or provide services in advance of receiving formal contractual authorization from the government client or a prime contractor. If our government client or prime contractor requirements should change or the government directs the anticipated procurement to a contractor other than us, or if the materials become obsolete or require modification before we are under contract for the procurement, our investment might be at risk. If we do not receive the required funding, our cost of services incurred in excess of contractual funding may not be recoverable. This c ould reduce anticipated revenue or result in a loss, negatively affecting our cash flow and profitability.

We May Be Liable for Systems and Service Failures.

We create, implement and maintain IT and technical services solutions that are often critical to our customers’ operations, including those of federal, state and local governments. We may in the future experience some systems and service failures, schedule or delivery delays and other problems in connection with our work. If our solutions, services, products or other applications have significant defects or errors, are subject to delivery delays or fail to meet our customers’ expectations, we may:

	•	lose revenues due to adverse customer reaction;
	•	be required to provide additional services to a customer at no charge or a discount;
	•	receive negative publicity that could damage our reputation and adversely affect our ability to attract or retain customers; and
	•	suffer claims for substantial damages against us.

In addition to any costs resulting from product warranties, contract performance or required corrective action, these failures may result in increased costs or loss of revenues if they result in customers postponing subsequently scheduled work, canceling contracts or failing to renew contracts.

While many of our contracts with the federal government limit our liability for damages that may arise from negligence in rendering services to our customers, we cannot be sure that these contractual provisions will protect us from liability for damages if we are sued. Even if unsuccessful, these claims could result in significant legal and other costs that may be a distraction to our management and/or may harm our reputation.

If We Fail to Comply with Complex Procurement Laws and Regulations, We Could Lose Business and Be Subject to Various Penalties or Sanctions.

We must comply with laws and regulations relating to the formation, administration and performance of federal government contracts. These laws and regulations affect how we conduct business with our federal government contracts. In complying with these laws and regulations, we may incur additional costs. Non-compliance may also allow for the assignment of additional fines and penalties, including contractual damages. Among the more significant laws and regulations affecting our business are the following:

	•	the Federal Acquisition Regulation, which comprehensively regulates the formation, administration and performance of federal government contracts;
	•	the Truth in Negotiations Act, which requires certification and disclosure of all cost and pricing data in connection with contract negotiations;
	•	the Cost Accounting Standards and Cost Principles, which impose accounting requirements that govern our right to reimbursement under certain cost-based federal government contracts;
	•	laws, regulations and executive orders restricting the use and dissemination of information classified for national security purposes and the export of certain products, services and technical data; and
	•	U.S export controls, which apply when we engage in international work.

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Failure to comply with these control regimes can lead to severe penalties, both civil and criminal, and can include debarment from contracting with the U.S. Government.

Our contracting agency customers periodically review our performance under and compliance with the terms of our federal government contracts. If a government review or investigation uncovers improper or illegal activities, we may be subject to civil or criminal penalties or administrative sanctions, including:

	•	termination of contracts;
	•	forfeiture of profits;
	•	cost associated with triggering of price reduction clauses;
	•	suspension of payments;
	•	fines; and
	•	suspension or debarment from doing business with federal government agencies.

Additionally, the civil False Claims Act provides for potentially substantial civil penalties where, for example, a contractor presents a false or fraudulent claim to the government for payment or approval. Actions under the civil False Claims Act may be brought by the government or by other persons on behalf of the government, who may then share a portion of any recovery.

If we fail to comply with these laws and regulations, we may also suffer harm to our reputation, which could impair our ability to win awards of contracts in the future or receive renewals of existing contracts. If we are subject to civil and criminal penalties and administrative sanctions or suffer harm to our reputation, our current business, future prospects, financial condition or operating results could be materially harmed.

The government may also revise its procurement practices or adopt new contracting rules and regulations, including cost accounting standards, at any time. Any new contracting methods could be costly to satisfy, be administratively difficult for us to implement and could impair our ability to obtain new contracts.

Our Contracts and Administrative Processes and Systems Are Subject to Government Regulations, Audits and Cost Adjustments By the Federal Government, Which Could Reduce Our Revenue, Disrupt Our Business or Otherwise Adversely Affect Our Results of Operations.

Federal government agencies, including the Defense Contract Audit Agency (“DCAA”), the Defense Contract Management Agency, various inspectors general, the Defense Criminal Investigative Service, the Government Accountability Office and the Department of Justice, routinely audit and investigate government contracts and government contractors’ administrative processes and systems. These agencies review our performance on contracts, pricing practices, cost structure and compliance with applicable laws, regulations and standards. They also review our compliance with government regulations and policies and the adequacy of our internal control systems and policies, including our purchasing, accounting, estimating, compensation and management information processes and systems. Any costs found to be improperly allocated to a sp ecific contract will not be reimbursed, and any such costs already reimbursed must be refunded and certain penalties may be imposed.

DCAA audits for costs incurred on work performed after December 31, 2004 have not yet been completed. In addition, DCAA audits for costs incurred by our recent acquisitions for certain periods prior to acquisition have not yet been finalized.

An unfavorable outcome of an audit by the DCAA or another government agency may adversely affect our financial results. Moreover, if any of the administrative processes and systems are found not to comply with requirements, we may be subjected to increased government scrutiny and approval that could delay or otherwise adversely affect our ability to compete for or perform contracts or collect our revenue in a timely manner. Such possibilities include that:

	•	we would be required to reimburse the government for amounts previously received;
	•	our pricing on contracts may be prospectively reduced;
	•	payments to us may be significant delayed or withheld; and
	•	our ability to compete may be impaired by negative audit reports or by the failure to receive audit reports.

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If a government investigation uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeitures of profits, suspension of payments, fines and suspension or debarment from doing business with the federal government. In addition, we could suffer serious reputational harm if allegations of impropriety were made against us.

Each of these results could cause actual results to differ materially and adversely from those anticipated. We do not know the outcome of pending or future audits.

Our Markets are Highly Competitive, and Many of the Companies We Compete Against Have Substantially Greater Resources.

The markets in which we operate include a large number of participants and are highly competitive. Many of our competitors may compete more effectively than we can because they are larger, better financed and better known companies than we are. In order to stay competitive in our industry, we must also keep pace with changing technologies and client preferences. If we are unable to differentiate our services from those of our competitors, our revenue may decline. In addition, our competitors have established relationships among themselves or with third parties to increase their ability to address client needs. As a result, new competitors or alliances among competitors may emerge and compete more effectively than we can. There is also a significant industry trend towards consolidation, which may result in the emergence of companies who a re better able to compete against us. The results of these competitive pressures could cause our actual results to differ materially and adversely from those anticipated.

Our Failure to Adequately Protect Our Confidential Information and Proprietary Rights May Harm Our Competitive Position.

Our success depends, in part, upon our ability to protect our proprietary information and other intellectual property. Although our employees are subject to confidentiality obligations, this protection may be inadequate to deter misappropriation of our confidential information. In addition, we may be unable to detect unauthorized use of our intellectual property in order to take appropriate steps to enforce our rights. If we are unable to prevent third parties from infringing or misappropriating our copyrights, trademarks or other proprietary information, our competitive position could be harmed and our actual results could differ materially and adversely from those anticipated.

Loss of Our Position as a Qualified Contractor Under One or More General Services Administration Schedules, Would Impair Our Operating Results and Our Ability to Keep Our Existing Business or Win New Business.

If we were to lose any of our GSA schedules or our prime contractor position on any of our contracts, we could lose revenues, and our ability to win new business and our operating results could decline as a result.

A Preference for Minority-Owned, Small and Small Disadvantaged Businesses Could Impact Our Ability to be a Prime Contractor on Certain Governmental Procurements.

As a result of the Small Business Administration, (“SBA”), set-aside program, the federal government may decide to restrict certain procurements only to bidders that qualify as minority-owned, small or small disadvantaged businesses. As a result, we would not be eligible to perform as a prime contractor on those programs and in general would be restricted to no more than 49% of the work as a subcontractor on those programs. An increase in the amount of procurements under the SBA set-aside program may impact our ability to bid on new procurements as a prime contractor or restrict our ability to recompete on incumbent work that is placed in the set-aside program.

If Our Employees Engage in Misconduct or Other Improper Activities, Our Business Could Be Harmed.

We are exposed to the risk that employee fraud or other misconduct could occur. Misconduct by employees could include intentional failures to comply with federal government procurement regulations, engaging in unauthorized activities or falsifying time records. Employee misconduct could also involve the improper use of our

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clients’ sensitive or classified information, which could result in regulatory sanctions against us and serious harm to our reputation. It is not always possible to deter employee misconduct, and the precautions we take to prevent and detect this activity may not be effective in controlling unknown or unmanaged risks or losses, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We Are Involved in Litigation and Other Regulatory Matters Which, If Not Resolved in Our Favor, Could Harm Our Business.

We are involved in litigation matters which could have a material adverse effect on our business, financial position, results of operations and cash flow.

As a defense contractor, DRC is subject to many levels of audit and review from various government agencies, including the Defense Contract Audit Agency, various inspectors general, the Defense Criminal Investigation Service, the Government Accountability Office, the Department of Justice and Congressional committees. Both related to and unrelated to its defense industry involvement, DRC is, from time to time, involved in audits, lawsuits, claims, administrative proceedings and investigations. We accrue for liabilities associated with these activities when it becomes probable that future expenditures will be made and such expenditures can be reasonably estimated. Except as noted below, we do not presently believe it is reasonably likely that any of these matters would have a material adverse effect on our business, financial position, re sults of operations or cash flows. Our evaluation of the likelihood of expenditures related to these matters is subject to change in future periods, depending on then current events and circumstances, which could have material adverse effects on our business, financial position, results of operations and cash flows.

On June 28, 2005, a class action employee suit was filed in the U.S. District Court for the District of Massachusetts alleging violations of the Fair Labor Standards Act and certain provisions of Massachusetts General Laws. In July 2010, DRC and the plaintiff agreed upon principle terms of settlement, the cost of which was accrued on the balance sheet as of June 30, 2010. In October 2010, we received an executed settlement agreement by the plaintiff. The Federal District Court for the First Circuit has reviewed the settlement and the parties are expecting the court’s approval in the first quarter of 2011. Failure to obtain such approval may materially adversely affect our financial position and results of operations.

In September 2009, the IRS completed its examination of our tax returns for 2004 through 2007 and issued a Revenue Agent Report, which reduced the deferral of income for tax reporting purposes. As a result DRC reclassified approximately $1.0 million from deferred to current taxes payable. The IRS report also included an assessment of interest of $0.5 million. DRC has filed a protest with the IRS to appeal the assessment and has made no provision for the interest associated with the assessment. If the appeal is not successful, DRC will be required to record a reserve for the interest payable, which could adversely affect our cash flows and financial position.

We Operate in Highly Competitive Markets and May Have Difficulties Entering New Markets.

The government contracting business is subject to intense competition from numerous companies. The principal competitive factors are prior performance, previous experience, technical competence and price. In our efforts to enter new markets and attract new customers, we generally face significant competition from other companies that have prior experience with such potential customers. As a result, we may not achieve the level of success that we expect in our efforts to enter such new markets.

We May Be Subject to Product Liability Claims.

Certain components sold by DRC are generally designed to operate as important elements of complex systems or products. Defects in our products could cause our customer’s product or systems to fail or perform below expectations. Although we attempt to contractually limit our liability for such defects or failures, we cannot assure you that our attempts to limit our liability will be successful. As such, we may be subject to claims for alleged performance issues related to our products. Such claims, if made, could damage our reputation and could have a material adverse effect on our business, financial condition, results of operations and cash flows.

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Our Financing Requirements May Increase and We Could Have Limited Access to Capital Markets.

Over the last several years, United States and worldwide capital and credit markets have experienced significant price volatility, dislocations and liquidity disruptions, which have caused market prices of many stocks to fluctuate substantially and the spreads on prospective debt financings to widen considerably. While we believe that our current resources and access to capital markets are adequate to support operations over the near term and foreseeable future, we cannot assure you that these circumstances will remain unchanged. Our need for capital is dependent on operating results and may be greater than expected. Our ability to maintain our current sources of debt financing depends on our ability to remain in compliance with covenants contained in our financing agreements, including, among other requirements, maintaining a minimum to tal net worth and minimum cash flow and debt coverage ratios. If changes in capital markets restrict the availability of funds or increase the cost of funds, we may be required to modify, delay or abandon some of our planned expenditures, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Our Operating Results May Vary Significantly From Quarter to Quarter and Such Fluctuations May Affect the Price of Our Common Stock.

Our revenue and earnings may fluctuate from quarter to quarter depending on a number of factors, including:

	•	the number, size and timing of client projects commenced and completed during a quarter;
	•	contract wins and losses;
	•	changes to existing contracts made by our customers;
	•	bid and proposal efforts undertaken;
	•	progress on fixed-price projects during a given quarter;
	•	employee productivity and hiring, attrition and utilization rates;
	•	rapid changes in demand from our precision manufacturing customers;
	•	accuracy of estimates of resources required to complete ongoing projects;
	•	the trend in interest rates; and
	•	general economic conditions.

We May Not Make or Complete Future Mergers, Acquisitions or Strategic Alliances or Investments Which May Adversely Affect Our Growth. Additionally, Acquired Operations May Perform at Levels Below Our Financial Projections or We May Be Unable to Successfully Integrate the Acquired Operations.

We intend to continue to expand our operations through mergers, acquisitions or strategic alliances with businesses that will complement our existing business. However, we may not be able to find attractive candidates, or enter into acquisitions on terms that are favorable to us, or successfully integrate the operations of companies that we acquire. In addition, we may compete with other companies for these acquisition candidates, which could make an acquisition more expensive for us.

If we are able to successfully identify and complete an acquisition or similar transaction, it could involve a number of risks, including, among others:

	•	the difficulty of assimilating the acquired operations and personnel;
	•	the potential disruption of our ongoing business and diversion of resources and management time;
	•	the potential failure to retain key personnel of the acquired business;
	•	the difficulty of integrating systems, operations and cultures; and
	•	the potential impairment of relationships with customers as a result of changes in management or otherwise arising out of such transactions.

We cannot assure that any acquisition will be made, that we will be able to obtain financing needed to fund any acquisitions and, if any acquisitions are so made, that the acquired business will be successfully integrated into our operations or that the acquired business will perform as expected. In addition, if we were to proceed with one or more significant strategic alliances, acquisitions or investments in which the consideration consists of cash, a substantial portion of our available cash could be used to consummate the strategic alliances, acquisitions or

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investments. The financial impact of acquisitions, investments and strategic alliances could have a material adverse effect on our business, financial condition, results of operations and cash flows and could cause substantial fluctuations in our quarterly and annual operating results.

The Company Has Substantial Investments in Recorded Goodwill as a Result of Prior Acquisitions, and Changes in Future Business Conditions Could Cause These Investments to Become Impaired, Requiring Substantial Write-Downs That Would Reduce the Company’s Operating Income.

As of December 31, 2010, goodwill accounted for $97.6 million, or approximately 49%, of the Company’s recorded total assets. Under generally accepted accounting principles, the Company reviews its goodwill for impairment annually or when events or changes in circumstances indicate the carrying value may not be recoverable. A significant and sustained decrease in expected reporting unit cash flows or changes in market conditions would increase the risk of impairment of recorded goodwill. If goodwill becomes impaired, the Company would record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill is determined, which may significantly reduce or eliminate our profits.

The Market Price of Our Common Stock May Be Volatile.

The stock market in recent years has experienced significant price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of particular companies. Many factors that have influenced trading prices will vary from period to period, including:

	•	decreases in our earnings and revenue or quarterly operating results;
	•	changes in estimates by analysts;
	•	repurchases of our common stock under our share repurchase program, pursuant to which we are authorized to purchase up to 700,000 shares of our common stock through June 6, 2011, under which 40,400 shares have been repurchased to date;
	•	market conditions in the industry;
	•	announcements and new developments by competitors; and
	•	regulatory reviews.

Any of these events could have a material adverse effect on the market price of our common stock. In addition, low trading volume in our common stock may cause volatility in stock price.

We are Subject to Changes in United States and Global Market Conditions That Are Beyond Our Control and May Have a Material Effect on Our Business and Results of Operations.

The United States and global economies are currently experiencing a period of substantial economic uncertainty with wide-ranging effects. The Company is unable to predict the impact, severity, and duration of these economic events, which could have a material effect on the Company’s consolidated financial position, results of operations, or cash flows. If there is a downturn in the market, DRC may be required to make a larger than expected contribution to its legacy pension plan fund to enable the pension plan fund to meet its obligations to plan participants , which in turn could have an adverse impact on the Company’s cash flow and liquidity.

ITEM 1B. UNRESOLVED STAFF COMMENTS

We have not received any written comments from the staff of the Securities and Exchange Commission regarding our periodic or current reports that (1) were issued not less than 180 days before the end of our 2010 fiscal year, (2) remain unresolved and (3) we believe are material.

ITEM 2. PROPERTIES

As of December 31, 2010 we leased all of the facilities used in our operations totaling approximately 454,000 square feet, of which we subleased approximately 178,000 square feet. We have principal offices in Andover, Massachusetts and in the Washington, D.C. area. We believe that our facilities are adequate for our current needs.

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ITEM 3. LEGAL PROCEEDINGS

As a defense contractor, we are subject to many levels of audit and review from various government agencies, including the Defense Contract Audit Agency, Defense Contract Management Agency, various inspectors general, the Defense Criminal Investigation Service, the Government Accountability Office, the Department of Justice and Congressional committees. Both related to and unrelated to our defense industry involvement, we are, from time to time, involved in audits, lawsuits, claims, administrative proceedings and investigations. We accrue for liabilities associated with these activities when it becomes probable that future expenditures will be made and such expenditures can be reasonably estimated.

We are a party to or are subject to litigation and other proceedings referenced in Note 15 of our “Notes to Consolidated Financial Statements” in Part II, Item 8 of this Form 10-K. Except as noted therein we do not presently believe it is reasonably likely that any of these matters would have a material adverse effect on our business, financial position, results of operations or cash flows.

Our evaluation of the likelihood of expenditures related to these matters is subject to change in future periods, depending on then-current events and circumstances, which could have material adverse effects on our business, financial position, results of operations and cash flows.

ITEM 4. [REMOVED AND RESERVED]

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PART II

ITEM 5. MARKET FOR RESISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the NASDAQ Global Market under the symbol “DRCO”. The following table sets forth, for the periods indicated, the high and low sale prices per share of our common stock, as reported by the NASDAQ Global Market. These market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

	High		Low
Fiscal year ended December 31, 2010
First quarter	$	11.88	$	9.92
Second quarter	$	14.31	$	9.79
Third quarter	$	10.69	$	8.58
Fourth quarter	$	14.10	$	10.10

Fiscal year ended December 31, 2009
First quarter	$	9.00	$	5.86
Second quarter	$	10.61	$	6.80
Third quarter	$	14.32	$	10.01
Fourth quarter	$	13.80	$	9.36

As of February 25, 2011, there were 508 shareholders of record of our common stock.

Dividend Policy

We did not declare any cash dividends in the two years ended December 31, 2010 and do not intend to in the near future. Our present policy is to retain earnings and preserve cash for our future growth and development of our business. In addition, our financing arrangements, as described in Note 8 of our “Notes to Consolidated Financial Statements” in Part II, Item 8 of this Form 10-K, restrict our ability to pay dividends.

Recent Sales of Unregistered Securities

We did not issue or sell any securities in 2010 that were not registered under the Securities Act of 1933.

Issuer Purchases of Equity Securities

The following table sets forth all purchases made by us or on our behalf by any "affiliated purchaser," as defined in Rule 10b-18(a)(3) under the Exchange Act, of shares of our common stock during each month in the fourth quarter of 2010.

							Approximate
							Dollar
					Total		Value
					Number of Shares		of Shares that May
			Average		Purchased		Yet Be
	Total		Price		as Part of		Purchased
	Number		Paid		Publicly		Under the
	of Shares		Per		Announced		Programs
Period	Purchased(1)		Share		Programs		(in millions)
October 1, 2010 to October 31, 2010		8,293	$	11.14		-	$	-
November 1, 2010 to November 30, 2010		1,016	$	11.49		-		-
December 1, 2010 to December 31, 2010		40,400	$	13.60		40,400		8.8
Total		49,709	$	13.15		40,400	$	8.8

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(1)

During the month of December, we repurchased 40,400 shares under a repurchase program approved by our Board of Directors that was publically announced on December 6, 2010. Overall, the Board of Directors authorized the repurchase of 700,000 shares. At December 31, 2010, there were 659,600 shares remaining under the repurchase program which shares may be repurchased through June 6, 2011. The approximate dollar value of shares available to be repurchased was calculated using DRC’s stock price of $13.40 at December 31, 2010. The remaining shares repurchased in the months of October and November represented shares repurchased to cover option costs in connection with the exercise of stock options and payroll withholding taxes in connection with the vesting of restricted stock awards.

Stock Performance Graph

The following graph compares the cumulative total stockholder return on our common stock from December 30, 2005 to December 31, 2010 with the cumulative total return of (i) the NASDAQ Composite U.S. Index and (ii) our industry peers. This graph assumes the investment of $100.00 at the closing price on December 30, 2005 in our common stock, the NASDAQ Composite U.S. Index and our industry peers, and assumes any dividends are reinvested.

	December 31,
	2005		2006		2007		2008		2009		2010
Dynamics Research Corporation	$	100.00	$	63.11	$	70.03	$	51.78	$	68.67	$	86.73
NASDAQ Stock Market (US Companies)	$	100.00	$	109.52	$	120.27	$	71.51	$	102.89	$	120.29
Peer Group	$	100.00	$	101.95	$	105.79	$	102.53	$	103.28	$	102.38

The performance in the above graph is not necessarily indicative of future stock price performance. Our peer group consists of industry peers with which we compete, including, CACI International, Inc., Global Defense Technology and Systems, Inc., ICF International, Inc., ManTech International Corp., NCI, Inc., SAIC, Inc., SRA International, Inc. and VSE Corp.

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ITEM 6. SELECTED FINANCIAL DATA

The selected condensed consolidated financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as Part II, Item 7 of this Form 10-K, and our consolidated financial statements and notes thereto included in Part II, Item 8 of this Form 10-K. The historical results provided below are not necessarily indicative of future results.

	Year Ended December 31,
(dollars in thousands, except per share data)	2010		2009			2008(1)			2007			2006
Revenue	$	272,065	$	268,661		$	236,796		$	224,676		$	252,890
Gross profit	$	43,890	$	44,967		$	38,994		$	37,160		$	33,914
Operating income (loss)	$	20,815	$	17,908		$	(150	)	$	13,104		$	7,507
Income (loss) from continuing operations	$	12,313	$	10,313		$	(1,084	)	$	7,413		$	3,578
Income (loss) from discontinued operations		392		(141	)		(171	)		(311	)		410
Cumulative benefit of accounting change		-		-			-			-			84
Net income (loss)	$	12,705	$	10,172		$	(1,255	)	$	7,102		$	4,072

Earnings (loss) per share - Basic
Income (loss) from continuing operations before cumulative effect of accounting change	$	1.24	$	1.08		$	(0.11	)	$	0.79		$	0.39
Income (loss) from discontinued operations		0.04		(0.02	)		(0.02	)		(0.03	)		0.05
Cumulative benefit of accounting change		-		-			-			-			0.01
Net earnings (loss) per share - Basic	$	1.28	$	1.06		$	(0.13	)	$	0.76		$	0.45

Earnings (loss) per share - Diluted
Income (loss) from continuing operations before cumulative effect of accounting change	$	1.22	$	1.06		$	(0.11	)	$	0.77		$	0.38
Income (loss) from discontinued operations		0.04		(0.02	)		(0.02	)		(0.03	)		0.04
Cumulative benefit of accounting change		-		-			-			-			0.01
Net earnings (loss) per share - Diluted	$	1.26	$	1.04		$	(0.13	)	$	0.74		$	0.43

Net cash provided by operating activities from continuing operations	$	41,331	$	8,208		$	18,582		$	3,487		$	18,301
Capital expenditures	$	4,449	$	5,185		$	1,973		$	1,676		$	1,887
Depreciation	$	3,564	$	2,987		$	2,961		$	2,869		$	2,837
EBITDA(2)	$	26,373	$	24,891		$	5,466		$	19,404		$	13,742

	As of December 31,
(dollars in thousands, except per share data)	2010			2009			2008(1)			2007			2006
Total assets	$	198,216		$	203,601		$	208,930		$	149,953		$	159,852
Total debt	$	22,000		$	31,973		$	38,000		$	7,737		$	15,000
Other long-term liabilities	$	27,067		$	31,936		$	30,286		$	8,576		$	12,805
Stockholders’ equity	$	107,185		$	94,096		$	81,475		$	96,504		$	84,314
Return on invested capital(3)		12.8	%		8.8	%		(0.1	)%		7.7	%		4.9	%
Stockholders’ equity per share(4)	$	10.68		$	9.48		$	8.42		$	10.15		$	9.05
Return on stockholders’ equity(5)		11.9	%		10.8	%		(1.5	)%		7.4	%		4.8	%
Funded backlog	$	133,516		$	158,518		$	146,619		$	115,155		$	91,884
Number of shares outstanding		10,040,029			9,923,357			9,674,512			9,509,849			9,314,962

(1)	Amounts include results of operations of Kadix (acquired August 1, 2008) for the period subsequent to our acquisition.

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(2)

Earnings before interest, taxes, depreciation and amortization, or EBITDA, is defined as GAAP income from continuing operations plus net interest expense, income taxes, depreciation expense and amortization expense. EBITDA as calculated by us may be calculated differently than EBITDA for other companies. We have provided EBITDA because it is a component of our debt covenants calculations and we believe it is a commonly used measure of financial performance in comparable companies and is provided to help investors evaluate performance and to enhance investors’ understanding of our operating results. EBITDA should not be construed as an alternative measure of net income, income from continuing operations or cash flows. Reconciliation of net income to EBITDA is as follows:

	Year Ended December 31,
(in thousands)	2010			2009		2008			2007		2006
Net income (loss)	$	12,705		$	10,172	$	(1,255	)	$	7,102	$	4,072
Loss (income) from discontinued operations		(392	)		141		171			311		(410	)
Cumulative benefit of accounting change		-			-		-			-		(84	)
Income (loss) from continuing operations		12,313			10,313		(1,084	)		7,413		3,578
Interest expense, net		1,084			2,024		1,423			1,541		2,042
Provision (benefit) for income taxes		7,871			6,262		(454	)		4,979		2,476
Depreciation expense		3,564			2,987		2,961			2,869		2,837
Amortization expense		1,541			3,305		2,620			2,602		2,809
EBITDA	$	26,373		$	24,891	$	5,466		$	19,404	$	13,742

(3)	Return on invested capital is calculated by dividing operating income, net of related income taxes, by the ending invested capital. Invested capital is the sum of outstanding debt and stockholders’ equity, minus cash, normalized for the investment made for acquisitions during the year.

(4)	Stockholders’ equity per share is calculated by dividing ending stockholders’ equity by the number of shares outstanding at the end of the period.

(5)	Return on stockholders’ equity is calculated by dividing net income by ending stockholders equity.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with the consolidated financial statements and the notes to those statements that appear elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions, such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those anticipated in the forward-looking statements. Factors that could cause or contribute to our actual results differing materially from those anticipated include, but are not limited to, those discussed in “Risk Factors” in Part 1, Item 1A and elsewhere in this Form 10-K.

OVERVIEW

Dynamics Research Corporation, headquartered in Andover, Massachusetts, is a leading provider of innovative management consulting, engineering, and information technology services and solutions to federal and state governments.

Our go-to-market strategy is sharply focused within each of four dimensions:

Solutions. We deliver high-value differentiated solutions to our clients. Our five areas of differentiated expertise are business transformation, information technology, training and performance support, management services and engineering services. We believe our solutions align well with the needs of our government customers today through improved efficiencies and effectiveness, procurement reform, transformational and technology based changes, and ongoing, changing security threats.

Markets and Customers. We target markets, which based on long-term market force drivers, have sustained government projected demand for services. We select customers from the spectrum of federal government departments and agencies in our target growth markets with needs that well match the solutions we provide. Currently our target growth markets include homeland security, healthcare, cyber security, intelligence and financial/regulatory reform. In 2010 approximately 60% of our revenue was derived from clients in these markets and selected high growth areas of defense such as unmanned aerial systems and force readiness and training. Our 2010 revenue derived from these markets grew 12% over 2009.

Prime Government and Agency-Wide Contracts. We hold an enviable portfolio of government and agency-wide multiple award schedule ID/IQ task order contracts. Today, these types of contracts are the federal government’s preferred means of procurement for services.

Acquisitions. We use acquisitions, funded through both operationally generated cash and leverage, to strengthen our position in our target growth markets.

During the second quarter of 2010, we sold our Metrigraphics business division which was classified as held for sale at December 31, 2009 and accounted for as a discontinued operation. Our financial results were restated to reflect the discontinuation of Metrigraphics for all periods presented prior to the sale.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

There are specific business risks to the industries in which we operate. These risks include: estimates of costs to complete contract obligations, changes in government policies and procedures, government contracting issues and risks associated with technological development. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates and assumptions also affect the amount of revenue and expenses during the reported period. Actual results could differ from those estimates.

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Management bases its estimates on historical experience and various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities. The use of alternative estimates and assumptions and changes in business strategy or market conditions may significantly impact our assets or liabilities, and potentially result in a different impact to our results of operations. We believe the following critical accounting policies affect the more significant accounting areas particularly those that involve judgments, estimates and assumptions used in the preparation of our consolidated financial statements.

Revenue Recognition

We provide services pursuant to time and materials, cost reimbursable and fixed-price contracts, including service-type contracts.

For time and materials contracts, revenue reflects the number of direct labor hours expended in the performance of a contract multiplied by the contract billing rate, as well as reimbursement of other billable direct costs. The risk inherent in time and materials contracts is that actual costs may differ materially from negotiated billing rates in the contract, which would directly affect operating income.

For cost reimbursable contracts, revenue is recognized as costs are incurred and includes a proportionate amount of the fee earned. Cost reimbursable contracts specify the contract fee in dollars or as a percentage of estimated costs. The primary risk on a cost reimbursable contract is that a government audit of direct and indirect costs could result in the disallowance of some costs, which would directly impact revenue and margin on the contract. Historically, such audits have not had a material impact on our revenue and operating income.

Revenue from service-type fixed-price contracts is recognized ratably over the contract period or by other appropriate output methods to measure service provided, and contract costs are expensed as incurred. Under fixed-price contracts, other than service-type contracts, revenue is recognized primarily under the percentage of completion method. The risk on a fixed-price contract is estimates of costs to complete the contract may exceed revenues on the contract.

From time to time, we may proceed with work based on client direction prior to the completion and signing of formal contract documents. We have a formal review process for approving any such work. Revenue associated with such work is recognized only when it can reliably be estimated and realization is probable. We base our estimates on a variety of factors, including previous experiences with the client, communications with the client regarding funding status, and our knowledge of available funding for the contract.

For all types of contracts, we recognize anticipated contract losses as soon as they become known and estimable. Out-of-pocket expenses that are reimbursable by the customer are included in revenue and cost of revenue.

Unbilled receivables are the amounts of recoverable revenue that have not been billed at the balance sheet date. Unbilled receivables relate principally to revenue that is billed in the month after services are performed. In certain instances, billing is deferred in compliance with the contract terms, such as milestone billing arrangements and withholdings, indirect rate approvals or other reasons. Costs related to certain U.S. Government contracts, including applicable indirect costs, are subject to audit by the government. Revenue from such contracts has been recorded at amounts we expect to realize upon final settlement.

Goodwill and Other Intangible Assets

With the acquisition of Kadix and other businesses, we acquired goodwill and other intangible assets. The identification and valuation of these intangible assets and the determination of the estimated useful lives at the time of acquisition, as well as the completion of annual impairment tests, require significant management judgments and estimates. These estimates are based on, among other things, consultations with an accredited independent valuation consultant and reviews of projected cash flows.

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We estimate fair value for our annual goodwill impairment test by employing different methodologies, including a comparison to comparable industry companies, discounted cash flows and market value, which are then weighted to arrive at an estimated fair value. The determination of relevant comparable industry companies impacts our assessment of fair value. Should the operating performance of our reporting unit change in comparison to these companies or should the valuation of these companies change, this could impact our assessment of the fair value of the reporting unit. Our discounted cash flow analysis factors in assumptions on revenue and expense growth rates. These estimates are based upon our historical experience and projections of future activity, factoring in customer demand, changes in technology and a cost structure necessary t o achieve the related revenues. Additionally, the discounted cash flow analysis factors in expected amounts of working capital and weighted average cost of capital. The market value factor is primarily driven by the underlying value of our common stock, which can vary significantly depending upon a number of factors, such as overall market conditions and our estimated future profitability. Changes in judgments on any of these factors could materially impact the value of the reporting unit.

Our annual impairment test is based on several qualitative and quantitative factors. Principally, a significant and sustained decrease in expected reporting unit cash flows or changes in market conditions would increase the risk of impairment of recorded goodwill.

We operate in the government IT consulting marketplace which has historically been characterized by high visibility of future revenue streams, profitability and generally consistent positive cash flows. Our federal government customer base mitigates against near term volatility in financial performance experienced by companies operating in other parts of the economy. Long-term industry trends and other business considerations, such as those outlined in the Risk Factors section of our Form 10-K can have a favorable or unfavorable effect on future cash flows. These trends and business considerations include our concentration of business with the Federal Government, competitive bidding for contracts, and the mix of contract types in which we enter. We considered our low short-term volatility, favorable long-term industry trends, high visibility for future revenue and cash flow and stock price as context for the determination that disclosure of heightened risk relative to goodwill impairment was not necessary at the time of our filing.

As a result of the annual impairment test performed as of November 30, 2010, we determined that the carrying amount of the reporting unit did not exceed its fair value and, accordingly, did not record a charge for impairment. However, we are unable to assure that goodwill will not be impaired in subsequent periods. As of December 31, 2010, we had recorded goodwill and other intangible assets of $100.2 million in the Consolidated Balance Sheets.

Income Taxes and Deferred Taxes

Tax provisions are completed based on the asset and liability method. As part of our process of preparing consolidated financial statements, management is required to estimate the provision for income taxes, deferred tax assets and liabilities and future taxable income for purposes of assessing our ability to realize any future benefits from deferred taxes. This process involves estimating the current tax liability and assessing temporary and permanent differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Consolidated Balance Sheets. We had a net deferred liability of $1.8 million at December 31, 2010 compared to a $2.8 million at December 31, 2009.

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from these positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. We review our tax positions on a quarterly basis and more frequently as facts surrounding tax positions change. Based on these future events, we may recognize uncertain tax positions or reverse current uncertain tax positions which would affect the statement of operations and/or the balance sheet.

We must also assess the likelihood that our deferred tax asset will be recovered from future taxable income and, to the extent a recovery is not likely, a valuation allowance must be established. At December 31, 2010, we determined that a valuation allowance was not required.

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Pension Obligations

Accounting and reporting for our pension plan requires the use of assumptions, including the discount rate and expected rate of return on assets. These assumptions are used by independent actuaries to determine the value of our pension obligations and allocate this cost to the service periods. The actuarial assumptions used to calculate pension costs are determined and reviewed annually by management after consulting with outside investment advisors and actuaries.

The assumed discount rate, which is intended to be the actual rate at which benefits could effectively be settled, is determined by a spot-rate yield curve method. The spot-rate yield curve is employed to match the plan assets cash outflows with the timing and amount of the expected benefit payments. As of December 31, 2010, the pension plan’s measurement date, the weighted average discount rate used to determine the benefit obligations and the net periodic benefit costs was 5.25% and 5.75%, respectively. A decrease of 50 basis points in the discount rate would have resulted in an increase in annual pension expense by approximately $0.1 million.

The assumed expected rate of return on plan assets, which is the average return expected on the funds invested or to be invested to provide future benefits to pension plan participants, is determined by an annual review of historical long-term asset returns and consultation with outside investment advisors. The weighted average expected rate of return for 2010 was 8.50%. A decrease of 50 basis points in the expected rate of return would have resulted in an increase in annual pension expense by approximately $0.3 million.

If assumptions differ materially from actual results in the future, our obligations under the pension plan could also differ materially, potentially requiring us to record an additional pension liability and record additional pension costs. An actuarial valuation of the pension plan is performed each year. The results of this actuarial valuation are reflected in the accounting for the pension plan upon determination. At December 31, 2010 and 2009, we recorded a pension liability of $20.7 million and $21.5 million, respectively, in the Consolidated Balance Sheet that represented the underfunded benefit obligation.

Litigation, Commitments and Contingencies

We are subject to a range of claims, lawsuits and administrative proceedings that arise in the ordinary course of business. Estimating liabilities and costs associated with these matters requires judgment and assessment based upon professional knowledge and experience of management and its internal and external legal counsel. Amounts are recorded as charges to earnings when management, after taking into consideration the facts and circumstances of each matter, including any settlement offers, has determined that it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The ultimate resolution of any such exposure to us may vary from earlier estimates as further facts and circumstances become known.

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RESULTS OF OPERATIONS

Operating results and results expressed as a percentage of total revenues are as follows:

	Year Ended December 31,
(in millions)	2010					2009					2008
Revenue	$	272.1				$	268.7				$	236.8
Gross profit	$	43.9		16.1	%	$	45.0		16.7	%	$	39.0		16.5	%

Selling, general and administrative		21.5		7.9	%		23.8		8.8	%		36.5		15.4	%
Amortization of intangible assets		1.5		0.6	%		3.3		1.2	%		2.6		1.1	%
Operating Income (loss) (1)		20.8		7.7	%		17.9		6.7	%		(0.1	)	(0.1	)%
Interest expense, net		(1.1	)	(0.4	)%		(2.0	)	(0.8	)%		(1.4	)	(0.6	)%
Other income, net		0.5		0.2	%		0.7		0.3	%		0.0		0.0	%
Provision (benefit) for income taxes (2)		7.9		39.0	%		6.3		37.8	%		(0.5	)	29.5	%
Gain (loss) on discontinued operations		0.4		0.1	%		(0.1	)	(0.1	)%		(0.2	)	(0.1	)%
Net income (loss) (1)	$	12.7		4.7	%	$	10.2		3.8	%	$	(1.3	)	(0.5	)%

(1)	Totals may not add due to rounding.
(2)	The percentage for provision (benefit) for income taxes relate to a percentage of income before provision for income taxes.

Revenue

Total revenue increased by $3.4 million, or 1.3% in 2010 compared to 2009, and $31.9 million, or 13.5% in 2009 compared to 2008. Revenues were earned from the following sectors:

	Year Ended December 31,
(in millions)	2010				2009				2008
National defense and intelligence agencies	$	179.7	66.1	%	$	163.2	60.8	%	$	162.0	68.4	%
Homeland security		50.5	18.5			54.6	20.3			19.4	8.2
Federal civilian agencies (1)		23.9	8.8			26.5	9.9			29.4	12.4
Total revenue from federal agencies		254.1	93.4			244.3	90.9			210.8	89.0
State and local government agencies		17.9	6.6			24.0	8.9			25.6	10.8
Other		0.1	0.0			0.3	0.1			0.5	0.2
Total revenue (1)	$	272.1	100.0	%	$	268.7	100.0	%	$	236.8	100.0	%

(1)	Totals may not add due to rounding.

Federal agency revenue increased $9.8 million, or 4.0% in 2010 compared to 2009, and $33.5 million, or 15.9% in 2009 compared to 2008. Federal agency revenues derived from our target growth markets were the primary reason for the increase in total revenues in 2010. Currently our target growth markets include homeland security, healthcare, cyber security, intelligence and financial/regulatory reform. In 2010 approximately 60% of our revenue was derived from clients in these markets and selected high growth areas of defense such as unmanned aerial systems and force readiness and training. Our 2010 revenue derived from these markets grew 12% over 2009.

During 2010, the increase in federal agency revenues from our target growth markets were partially offset by a loss of billable positions to the government’s in-sourcing and related cost reduction initiatives. During 2010, we lost 81 billable positions to the government’s in-sourcing and related cost reduction initiatives. While the Department of Defense has announced a discontinuation of in-sourcing, we anticipate the in-sourcing initiatives will continue, and these may result in additional in-sourcing of an estimated 20 positions in the first quarter of 2011. In total, we continue to project the total affect of the government’s in-sourcing initiative to exceed 100 positions, equating to annualized reven ue of approximately $15 million, of which approximately half was realized in 2010 results and the remainder is to be reflected in 2011 results.

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The increase in 2009 federal agency revenue compared to 2008 was due a full year of Kadix revenue, supplemented by new contracts and task orders received in the second half of 2008 and in 2009. Revenue from federal agencies grew 3.7% excluding the effect of acquisitions in 2009 compared with 2008, which is calculated by adding the first seven months of Kadix 2008 revenue of $24.7 million to our reported 2008 federal agency revenue. Growth in our target markets in 2009 was partially offset by the roll-off of 8(a) set aside contracts, lower Air Force small business set aside revenue under the Consolidated Acquisition of Professional Services contract and lower revenue related to the U.S. Navy Trident Missile Program.

The decrease in revenues from state and local government agencies in 2010 compared to 2009 was due to the deployment of the State of Tennessee child welfare system contract in September 2010. The decrease in 2009 compared to 2008 was due to the completion of the State of Ohio contract in 2009, partially offset by increased revenues from the State of Tennessee contract which began in the second quarter of 2008. Revenues from the State of Tennessee contract were $5.2 million in 2010 compared to $14.3 million in 2009 and $7.0 million in 2008.

Revenues by contract type as a percentage of revenues were as follows:

	Year Ended December 31,
	2010			2009			2008
Fixed price, including service type contracts		47	%		40	%		33	%
Time and materials		32			42			49
Cost reimbursable		21			18			18
		100	%		100	%		100	%

Prime contract		73	%		71	%		63	%
Sub-contract		27			29			37
		100	%		100	%		100	%

Prime contract revenues increased in 2010 compared to prior periods as a result of an increasing portion of contracts awarded under DRC’s agency-wide multiple award schedule ID/IQ contracts.

Indefinite Contract Awards

The preferred means by which the government procures services today is through indefinite contract awards, commonly referred as agency-wide ID/IQ contracts. Occasionally, these contracts are issued to a single provider but most often they are issued for multiple years to multiple vendors. The majority of our revenue is derived from these contracts. We hold a broad portfolio of these prime contracts, including the following:

Market	Sponsoring Agency	M/S(1)	Contract Name
Government Wide	General Services Administration	M	Alliant
Government Wide	Office of Personnel Management	M	Training and Management Assistance (TMA)
Homeland Security	Department of Homeland Security	M	Enterprise Acquisition Gateway to Leading Edge (EAGLE)
Homeland Security	Department of Homeland Security	M	Professional Program Management Services/Solutions (PPMSS)
Financial/Regulatory	Department of Treasury	M	Treasury Information Processing Support Services (TIPSS IV)
Financial/Regulatory	Federal Deposit Insurance Corporation	S	Business Analysis Management Support Services(BAMSS)
Healthcare	TRICARE (Department of Defense)	M	Evaluation, Analysis, Management & Support (TEAMS)
Intelligence	Maryland Procurement Office	S	BajaSands
Readiness	Army Training and Doctrine Command	M	Simulation & Training Omnibus Contract (STOC II)
Readiness	Army Research Institute	M	Research, Development & Analysis in Army Training (TRAIN II)
Readiness	Department of Defense	M	Logistics Management Support Services (LMSS)
Readiness	U.S. Air Force	M	Enterprise Integration Services Management (NETCENTS EISM)
Readiness	U.S. Air Force	M	Design Engineering Support Program (DESP II)

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The EAGLE, PPMSS, BAMSS and DESP II contracts are currently under re-competition for successor contract vehicles. Individual contracts and contract task orders, which are subject to re-competition in 2011 total $68 million in annual revenue. We believe we are well positioned to win successor contracts in each circumstance. However, the outcomes from the competitions remain uncertain, and there can be no assurance of award of successor contracts to DRC.

Backlog and Bookings

Our backlog position was as follows:

	Year Ended December 31,
(in millions)	2010		2009		2008
Backlog:
Funded	$	133.5	$	158.5	$	146.6
Unfunded		267.4		276.0		211.0
Total	$	400.9	$	434.5	$	357.6
Funded Bookings	$	272.1	$	282.3	$	262.8

Funded bookings generated a book-to-bill ratio of approximately 1.0 to 1 in 2010 and 1.1 to 1 in both 2009 and 2008. The ending funded backlog as of December 31, 2010, 2009 and 2008 covered approximately 5.7, 7.2 and 6.7 months of revenue, respectively. We expect that substantially all of our funded backlog at December 31, 2010 will generate revenue during the year ending December 31, 2011. The funded backlog generally is subject to possible termination at the convenience of the contracting party. Contracts are generally funded on an annual basis or incrementally for shorter time periods.

Gross Profit

Our gross profit on revenue was $43.9 million, $45.0 million and $39.0 million in 2010, 2009 and 2008, respectively, resulting in a gross margin of 16.1% in 2010, 16.7% in 2009 and 16.5% in 2008. The decrease in gross profit in 2010 compared to 2009 was primarily due to lower direct labor content of revenue which resulted primarily from the government’s in-sourcing initiative partially offset by indirect cost efficiencies including labor related and facilities efficiencies. The increase in gross profit in 2009 compared to 2008 was primarily due to a full year of business activity associated with Kadix revenue. The improvement in gross margin was due to the addition of higher margin services provided by the acquired Kadix operations, improved labor utilization and a shift from subcontract work to prime contract work, partially offset by an increase in pension expense due to the decline in plan asset performance in 2008. We recorded severance costs of $0.8 million, $1.0 million and $1.7 million in cost of revenue in 2010, 2009 and 2008, respectively.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $21.5 million in 2010, $23.8 million in 2009 and $36.5 million in 2008. Selling, general and administrative expenses as a percent of total revenue was 7.9%, 8.8% and 15.4% for 2010, 2009 and 2008, respectively. During 2008, selling, general and administrative expenses included a litigation provision of $14.8 million. Excluding the litigation provision, selling, general and administrative expenses as a percent of total revenue would have been 9.2%. The decrease in selling, general and administrative expenses in 2010 compared to 2009 was primarily due to lower legal fees, business development costs, facility costs and administrative staffing costs. The decrease in 2009 compared to 2008 was due to the litigation provision recorded i n 2008, partially offset by a full year of Kadix selling, general and administrative costs and an increase in deferred compensation costs in 2009.

Amortization of Intangible Assets

Amortization expense, which relates to the amortization of acquired intangible assets, was $1.5 million in 2010, $3.3 million in 2009 and $2.6 million in 2008. The decrease in amortization expense in 2010 compared to 2009

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primarily relates to the intangible assets acquired from our 2004 acquisition of Impact Innovations Group which was fully amortized in the third quarter of 2009. The increase in 2009 compared to 2008 primarily relates to a full year of amortization expense recorded for the 2008 acquisition of Kadix. We anticipate 2011 amortization expense of $1.2 million.

Interest Expense, net

We incurred net interest expense of $1.1 million in 2010, $2.0 million in 2009 and $1.5 million in 2008. The decrease in interest expense in 2010 compared to 2009 was due to lower debt levels and interest rates during 2010. The increase in interest expense in 2009 compared to 2008 was due to a full year of interest expense associated with our term loan used to finance the Kadix acquisition in 2008. We recorded approximately $0.1 million of interest income in each of the three years ended in 2010.

Other Income, net

Other income (expense) consists of our portion of earnings and losses in HMRTech, LLC, a small disadvantaged business in which we own a 40% interest, gains and losses realized from our deferred compensation plan and results from other non-operating transactions, all of which were immaterial to our results.

Provision for Income Taxes

We recorded income tax provisions of $7.9 million in 2010 and $6.3 million in 2009, and recorded an income tax benefit of $0.5 million in 2008. The effective income tax rate was 39.0% in 2010 compared to 37.8% in 2009 and 39.9% in 2008, excluding the tax effect of $5.8 million in 2008 related to the litigation provision. On April 5, 2010, we received a tax refund of $0.3 million related to 2003 tax deductions, which we recorded in the first quarter of 2010. The 2009 effective rate was favorably affected by an adjustment to our unrecognized tax benefits and a reduction in state tax expense associated with the filing of prior year tax returns.

Loss on Discontinued Operations

As of December 31, 2009, Metrigraphics was classified as held for sale and accounted for as a discontinued operation. Effective July 19, 2010, we sold Metrigraphics for consideration of $2.5 million. We recorded a gain from discontinued operation, net of taxes, of $0.4 million in 2010 and a loss, net of taxes, of $0.1 million and $0.2 million in 2009 and 2008, respectively.

Shares Used in Computing Earnings (Loss) Per Share

Weighted average common shares outstanding and common equivalent shares totaled 10.1 million, 9.8 million and 9.5 million for the years ended December 31, 2010, 2009 and 2008, respectively. The increase in shares in 2010 compared to 2009 was due to the issuance of common stock, primarily through stock plan transactions. The increase in shares in 2009 compared to 2008 was due to the net loss recorded in 2008, which did not include the dilutive effect of stock options or unvested restricted stock.

LIQUIDITY AND CAPITAL RESOURCES

The following discussion analyzes liquidity and capital resources by operating, investing and financing activities as presented in our Consolidated Statements of Cash Flows. Our principal sources of liquidity are cash flows from operations and borrowings from our revolving credit facility.

Our results of operations, cash flows and financial condition are subject to trends, events and uncertainties, including demands for capital to support growth, economic conditions, government payment practices and contractual matters. Our need for access to funds is dependent on future operating results, our growth and acquisition activity and external conditions.

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We have evaluated our future liquidity needs, both from a short-term and long-term basis. We believe we have sufficient funds to meet our working capital and capital expenditure needs for the short term. Cash on hand plus cash generated from operations along with cash available under credit lines are expected to be sufficient in 2011 to service debt, finance capital expenditures, pay federal and state income taxes and fund the pension plan, if necessary. To provide for long-term liquidity, we believe we can generate substantial positive cash flow, as well as obtain additional capital, if necessary, from the use of subordinated debt or equity. In the event that our current capital resources are not sufficient to fund requirements, we believe our access to additional capital resources would be sufficient to meet our needs.

We believe that selective acquisitions are an important component of our growth strategy. We may acquire, from time to time, firms or properties that are aligned with our core capabilities and which complement our customer base. We will continue to consider acquisition opportunities that align with our strategic objectives, along with the possibility of utilizing the credit facility as a source of financing.

At December 31, 2010 and 2009, we had cash and cash equivalents aggregating $30.2 million and $0.1 million, respectively.

Operating Activities

Net cash provided by operating activities from continuing operations of $41.3 million during 2010 was primarily attributable to net earnings realized and collections on our contract receivables. Net cash provided by operating activities from continuing operations totaled $8.2 million and $18.6 million in 2009 and 2008, respectively.

Net contract receivables were $48.4 million and $72.6 million at December 31, 2010 and December 31, 2009, respectively. Billed receivables decreased $11.1 million and $6.4 million in 2010 and 2009, respectively. Unbilled receivables decreased $13.2 million in 2010 and increased $8.0 million in 2009. Contract receivables days sales outstanding (“DSO”), was 62 days at December 31, 2010 and 99 days at December 31, 2009. Federal business DSO, which excludes the effect of state contracts, was 55 days at December 31, 2010 and 73 days at December 31, 2009. The states of Ohio and Tennessee had a combined contract receivable balance outstanding of $1.9 million and $19.9 million at December 31, 2010 and December 31, 2009, respectively.

Our net deferred tax liability was $1.8 million at December 31, 2010 compared to $2.8 million at December 31, 2009. The decrease was primarily due to changes in unbilled receivables, partially offset by changes in property and equipment, the timing of pension contributions and the usage of the state net operating loss. During 2010, we paid $6.2 million in income taxes, net of $3.3 million in refunds, compared to $0.5 million in 2009. In July 2010, we received $3.0 million from a federal net operating loss carryback tax claim.

The IRS has challenged the deferral of income for tax reporting purposes related to unbilled receivables including the applicability of a Letter Ruling issued by the IRS to DRC in January 1976 which granted us deferred tax treatment of the unbilled receivables. This issue was elevated to the IRS National Office for determination. On October 23, 2008, we received a notification of ruling from the IRS National Office. This ruling provided clarification regarding the IRS position relating to revenue recognition for tax purposes regarding our unbilled receivables. During September 2009, the IRS completed its examination of our tax returns for 2004 through 2007 and issued a Revenue Agent Report, which reduced the deferral of income for tax reporting purposes. As a result we reclassified a pproximately $1 million from deferred to current taxes payable. The IRS report also included an assessment of interest of $0.5 million. We have filed a protest with the IRS to appeal the assessment. We believe the appeal will be successful and have therefore made no provision for the interest associated with the assessment.

Share-based compensation was $0.7 million in both 2010 and 2009, and $1.1 million in 2008. The decrease in 2009 compared to 2008 was primarily due to the vesting of Executive Long Term Incentive Program shares in the second quarter of 2008. As of December 31, 2010 the total unrecognized compensation expense related to restricted stock awards was $0.6 million which is expected to be amortized over approximately 1.8 years, and the unrecognized compensation expense related to stock option awards was $0.2 million which is expected to be amortized over approximately 2.5 years.

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Non-cash amortization expense of our acquired intangible assets was $1.5 million in 2010, $3.3 million in 2009 and $2.6 million in 2008. We anticipate that non-cash expense for the amortization of intangible assets will decrease to approximately $1.2 million in 2011, excluding the addition of any acquisitions.

Our defined benefit pension plan was underfunded by $20.7 million and $21.5 million at December 31, 2010 and 2009, respectively. The decrease in the plan’s underfunded status in 2010 was primarily attributable to favorable asset performance during the year and an increase in cash contributions to the plan during 2010. We recorded pension expense of $0.8 million and $1.6 million in 2010 and 2009, respectively, compared to pension income of $1.3 million in 2008. The decrease in pension expense was primarily due to favorable asset performance in 2009 and an increase in cash contributions to the plan during 2010. We contributed $3.5 million to fund the pension plan in January 2011 and anticipate pension expense to be approximately $0.2 million in 2011.

Investing Activities

Net cash used in investing activities from continuing operations of $2.1 million during 2010 was primarily attributable to capital expenditures, partially offset by proceeds from the sale of Metrigraphics. Net cash used in investing activities from continuing operations was $9.0 million in 2009 and $44.3 million in 2008.

Capital expenditures for the purchase of property and equipment were $4.4 million, $5.2 million and $2.0 million in 2010, 2009 and 2008, respectively. The increase in capital expenditures in 2010 and 2009 compared to 2008 was primarily related to the move to our corporate headquarters in 2009. We expect discretionary capital expenditures in 2011 to be in the range of $2 million to $4 million.

During July 2010, we sold Metrigraphics for consideration of $2.5 million, which consisted of $1.75 million in cash and $0.75 million in the form of a subordinated note. Interest on the subordinated note is payable quarterly and the repayment of principal is due in full in July 2012, the maturity date of the subordinated note.

In August 2008, we completed the acquisition of Kadix. The total purchase price of $47.3 million included additional contingent consideration related to achievement of earnout objectives of $4.3 million that was accrued at December 31, 2008 and paid in 2009.

Financing Activities

In December 2010, DRC’s board of directors authorized a share repurchase program, which allows us to buy back up to 700,000 shares of our common stock through June 6, 2011. During 2010, we repurchased 40,400 shares at a weighted average price of $13.60. The timing, price and amount of any repurchase will be determined by management based on its evaluation of market conditions and other factors. These repurchases may be made through the open market, including block purchases, or in private negotiated transactions, or otherwise. The buyback will be funded through available cash balances and or borrowings, and may be suspended or discontinued at any time. At December 31, 2010, there were 659,600 shares available to be repurchased under the program.

Our term loan requires quarterly repayments of $2.0 million and we expect operating cash flows to be sufficient to fund these repayments. Our swap agreement effectively fixes our interest rate on an initial notional amount of $20.0 million of the term loan principal at 5.10% (3.60% swap fixed rate plus the current margin of 1.50%) throughout the term of the credit facility. At December 31, 2010, the borrowing capacity available under our revolver was $24.6 million. The facility and swap agreements are more fully described in Note 8 and Note 10, respectively, of our “Notes to Consolidated Financial Statements” in Part II, Item 8 on this Form 10-K.

The Company believes it has access to additional capital resources, from the use of subordinated debt or equity, as alternate sources of funding. We are confident that our current resources are sufficient and we believe the possibility of needing additional financing resources for the continuation of current operations is remote.

At December 31, 2010, the Company was in compliance with its loan covenants. The Company’s most stringent financial covenant is the fixed charge coverage ratio. This covenant requires the Company to maintain a ratio of

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adjusted consolidated EBITDA to adjusted consolidated interest expense of not less than 1.25 to 1.00. This fixed charge coverage ratio is tested on a quarterly basis and is measured on a trailing four fiscal quarter basis.

The average daily borrowing on our revolver for 2010 was $1.0 million at a weighted average interest rate of 3.25%, compared to $3.2 million at a weighted average interest rate of 3.25% in 2009 and $3.2 million at a weighted average interest rate of 5.41% in 2008. During 2010, the average outstanding balance of our term loan was $26 million at a weighted average interest rate of 3.76% compared to $34.0 million at a weighted average interest rate of 4.27% in 2009 and $40.0 million outstanding for the last five months of 2008 at a weighted average interest rate of 5.14%.

During 2010, net cash used in financing activities of $8.9 million represented repayments under the term loan of $8.0 million, net payments of $2.0 million under our revolver and payments of $0.6 million for the repurchase of shares, partially offset by proceeds of $1.5 million from the issuance of common stock through stock plan transactions.

During 2009, net cash used in financing activities of $5.9 million represented repayments under the term loan of $8.0 million, partially offset by net borrowings of $2.0 million under our revolver and proceeds of $0.3 million from the issuance of common stock through the exercises of stock options and employee stock purchase plan transactions.

During 2008, net cash provided by financing activities of $30.7 million represented net borrowings under the term loan of $38.0 million and proceeds of $0.9 million from the issuance of common stock through the exercises of stock options and employee stock purchase plan transactions, partially offset by net repayments of $7.7 million under our revolver.

Off-Balance Sheet Arrangements

We did not utilize or employ any off-balance sheet arrangements during the three years ended December 31, 2010, defined as (i) an obligation under a guarantee contract with certain characteristics, (ii) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement, (iii) an obligation, including a contingent obligation, under a contract that would be accounted for as a derivative instrument but for the fact that it is indexed to the issuer’s stock and classified as shareholder’ equity or (iv) an obligation, including a contingent obligation, arising out of a variable interest in an unconsolidated entity.

Contractual Obligations

Our contractual obligations as of December 31, 2010 consist of the following:

	Payments Due By Period
			Less
			than		Two to		Four to
			one		three		five
(in millions)	Total(1)		year		years		years		Thereafter
Long-term debt payments	$	22.0	$	8.0	$	14.0	$	-	$	-
Interest payments		0.8		0.5		0.4		-		-
Operating lease payments		38.1		6.6		12.7		11.7		7.0
Total contractual obligation payments	$	60.9	$	15.1	$	27.1	$	11.7	$	7.0
Contractually obligated operating lease receipts	$	9.2	$	2.3	$	3.5	$	3.5	$	-

(1)	Totals may not add due to rounding.

The contractual amounts above related to interest payments does not include the portion of interest contractually due on our term loan principal balance that is not tied to the interest rate swap because those interest rates are not fixed. The interest rate swap agreement effectively fixes half of the term loan’s principal balance at an interest rate of 5.10%, which includes the applicable margin of 1.50% at December 31, 2010.

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We may be required to make cash outlays related to our unrecognized tax benefits. However, due to the uncertainty of the timing of future cash flows associated with our unrecognized tax benefits, we are unable to make reasonably reliable estimates of the period of cash settlement, if any, with the respective taxing authorities. Accordingly, unrecognized tax benefits, including interest and penalties of $0.6 million as of December 31, 2010, have been excluded from the contractual obligations table above. For further information on unrecognized tax benefits, see Note 7 of our “Notes to Consolidated Financial Statements” in Part II, Item 8 of this Form 10-K.

Contingencies

We are a party to litigation and other proceedings as referenced in Note 15 of our “Notes to Consolidated Financial Statements” in Part II, Item 8 on this Form 10-K. Except as noted therein we do not presently believe it is likely that any of these matters would have a material adverse effect on our business, financial position, results of operations or cash flows.

Our evaluation of the likelihood of expenditures related to these matters is subject to change in future periods, depending on then current events and circumstances, which could have material adverse effect on our business, financial position, results of operations and cash flows.

RECENT ACCOUNTING PRONOUNCEMENTS

A description of recent accounting pronouncements are referenced in Note 2 of our “Notes to Consolidated Financial Statements” in Part II, Item 8 on this Form 10-K.

IMPACT OF INFLATION AND CHANGING PRICES

Overall, inflation has not had a material impact on our operations. Additionally, the terms of DoD contracts, which accounted for approximately 66% of total revenue in 2010, are generally one year contracts and include salary increase factors for future years, reducing the potential impact of inflation.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are subject to interest rate risk associated with our revolver and term loan, where interest payments are tied to either the LIBOR or prime rate. At December 31, 2010, the interest rate on our term loan was 1.79%. We entered into an interest rate swap agreement to mitigate the floating interest rate risk on half of our outstanding term loan. The swap agreement effectively fixes the interest rate on half of our outstanding term loan at 5.10%, which includes the applicable margin of 1.50% at December 31, 2010. The blended interest rate of our term loan and swap agreement was 3.44% at December 31, 2010. At any time, a sharp rise in interest rates could have an adverse effect on net interest expense as reported in our Consolidated Statements of Operations. Our potential loss over one year that w ould result in a hypothetical and instantaneous increase of one full percentage point in the interest rate on half of our term loan would increase annual interest expense by approximately $0.2 million.

In addition, historically our investment positions have been relatively small and short-term in nature. We typically invest excess cash in money market accounts with original maturities of three months or less with no exposure to market interest rates. We have no significant exposure to foreign currency fluctuations. Foreign sales, which are nominal, are primarily denominated in U.S. dollars.

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PART II

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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	Page
Report of Independent Registered Public Accounting Firm	44
Consolidated Balance Sheets as of December 31, 2010 and 2009	45
Consolidated Statements of Operations for the years ended December 31, 2010, 2009 and 2008	46
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2010, 2009 and 2008	47
Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 and 2008	48
Notes to Consolidated Financial Statements	49
Schedule II — Valuation and Qualifying Accounts and Reserves	75

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and

Shareholders of Dynamics Research Corporation:

We have audited the accompanying consolidated balance sheets of Dynamics Research Corporation (a Massachusetts corporation) and subsidiaries (collectively the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2010. Our audits of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15 (a)(2). These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 28, 2011 expressed an unqualified opinion thereon.

/s/ Grant Thornton LLP

Boston, Massachusetts

February 28, 2011

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DYNAMICS RESEARCH CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

	December 31,
	2010			2009
Assets
Current assets
Cash and cash equivalents	$	30,163		$	55
Contract receivables, net		48,394			72,569
Prepaid expenses and other current assets		2,924			5,702
Discontinued operations		-			2,058
Total current assets		81,481			80,384
Noncurrent assets
Property and equipment, net		12,219			13,915
Goodwill		97,641			97,641
Intangible assets, net		2,533			4,074
Deferred tax asset		585			4,252
Other noncurrent assets		3,757			3,335
Total noncurrent assets		116,735			123,217
Total assets	$	198,216		$	203,601

Liabilities and stockholders' equity
Current liabilities
Current portion of long-term debt	$	8,000		$	8,000
Accounts payable		16,883			18,299
Accrued compensation and employee benefits		18,046			16,357
Deferred tax liability		2,418			7,046
Other accrued expenses		4,617			3,708
Discontinued operations		-			186
Total current liabilities		49,964			53,596
Long-term liabilities
Long-term debt		14,000			23,973
Other long-term liabilities		27,067			31,936
Total long-term liabilities		41,067			55,909
Total liabilities		91,031			109,505
Commitments and contingencies (Note 15)
Stockholders' equity
Preferred stock, $0.10 par value; 5,000,000 shares authorized; no shares issued		-			-
Common stock, $0.10 par value; 30,000,000 shares authorized; 10,040,029 and 9,923,357 shares issued and outstanding at December 31, 2010 and 2009, respectively		1,004			992
Capital in excess of par value		54,138			52,580
Accumulated other comprehensive loss, net of tax		(21,691	)		(20,505	)
Retained earnings		73,734			61,029
Total stockholders' equity		107,185			94,096
Total liabilities and stockholders' equity	$	198,216		$	203,601

The accompanying notes are an integral part of these consolidated financial statements.

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DYNAMICS RESEARCH CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share data)

	Year Ended December 31,
	2010			2009			2008
Revenue	$	272,065		$	268,661		$	236,796
Cost of revenue		228,175			223,694			197,802
Gross profit		43,890			44,967			38,994

Selling, general and administrative expenses		21,534			23,754			36,524
Amortization of intangible assets		1,541			3,305			2,620
Operating income (loss)		20,815			17,908			(150	)
Interest expense, net		(1,084	)		(2,024	)		(1,423	)
Other income, net		453			691			35
Income (loss) from continuing operations before provision for income taxes		20,184			16,575			(1,538	)
Provision (benefit) for income taxes		7,871			6,262			(454	)
Income (loss) from continuing operations		12,313			10,313			(1,084	)
Gain (loss) from discontinued operations (Note 3)		392			(141	)		(171	)
Net income (loss)	$	12,705		$	10,172		$	(1,255	)

Earnings (loss) per common share
Basic
Income (loss) from continuing operations	$	1.24		$	1.08		$	(0.11	)
Gain (loss) from discontinued operations		0.04			(0.02	)		(0.02	)
Net income (loss)	$	1.28		$	1.06		$	(0.13	)

Diluted
Income (loss) from continuing operations	$	1.22		$	1.06		$	(0.11	)
Gain (loss) from discontinued operations		0.04			(0.02	)		(0.02	)
Net income (loss)	$	1.26		$	1.04		$	(0.13	)

Weighted average shares outstanding
Basic		9,893,322			9,551,614			9,493,495
Diluted		10,078,937			9,772,722			9,493,495

The accompanying notes are an integral part of these consolidated financial statements.

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DYNAMICS RESEARCH CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)

(in thousands)

							Capital			Accumulated
	Common			Common			In Excess			Other
	Stock			Stock			of Par			Comprehensive			Retained
	Shares			Par Value			Value			Loss			Earnings			Total
Balance at December 31, 2007		9,510		$	951		$	50,251		$	(6,745	)	$	52,112		$	96,569
Comprehensive loss:
Net loss		-			-			-			-			(1,255	)		(1,255	)
Other comprehensive loss, net of tax:
Pension liability adjustment, net of reclassification adjustment		-			-			-			(14,896	)		-			(14,896	)
Reclassification adjustment for gains realized in net loss		-			-			-			(108	)		-			(108	)
Unrealized loss on derivative instruments		-			-			-			(519	)		-			(519	)
Other comprehensive loss																	(15,523	)
Comprehensive loss																	(16,778	)
Issuance of common stock through stock plan transactions		128			12			843			-			-			855
Issuance of restricted stock		92			9			(9	)		-			-			-
Forfeiture of restricted stock		(13	)		(1	)		1			-			-			-
Release of restricted stock		(42	)		(4	)		(418	)		-			-			(422	)
Share-based compensation		-			-			1,148			-			-			1,148
Tax benefit from stock plan transactions		-			-			103			-			-			103
Balance at December 31, 2008		9,675			967			51,919			(22,268	)		50,857			81,475
Comprehensive income:
Net income		-			-			-			-			10,172			10,172
Other comprehensive income, net of tax:
Pension liability adjustment, net of reclassification adjustment		-			-			-			1,587			-			1,587
Changes in unrealized loss on derivative instruments, net of reclassification adjustment		-			-			-			176			-			176
Other comprehensive income																	1,763
Comprehensive income																	11,935
Issuance of common stock through stock plan transactions, net		190			19			231			-			-			250
Issuance of restricted stock		101			10			(10	)		-			-			-
Forfeiture of restricted stock		(24	)		(2	)		2			-			-			-
Release of restricted stock		(19	)		(2	)		(171	)		-			-			(173	)
Share-based compensation		-			-			736			-			-			736
Tax deficiency from stock plan transactions		-			-			(127	)		-			-			(127	)
Balance at December 31, 2009		9,923			992			52,580			(20,505	)		61,029			94,096
Comprehensive income:
Net income		-			-			-			-			12,705			12,705
Other comprehensive loss, net of tax:
Pension liability adjustment, net of reclassification adjustment		-			-			-			(1,247	)		-			(1,247	)
Changes in unrealized loss on derivative instruments, net of reclassification adjustment		-			-			-			61			-			61
Other comprehensive loss																	(1,186	)
Comprehensive income																	11,519
Issuance of common stock through stock plan transactions, net		171			17			1,463			-			-			1,480
Issuance of restricted stock		30			3			(3	)		-			-			-
Repurchased shares		(40	)		(4	)		(546	)		-			-			(550	)
Forfeiture of restricted stock		(24	)		(2	)		2			-			-			-
Release of restricted stock		(20	)		(2	)		(219	)		-			-			(221	)
Share-based compensation		-			-			718			-			-			718
Tax benefit from stock plan transactions		-			-			143			-			-			143
Balance at December 31, 2010		10,040		$	1,004		$	54,138		$	(21,691	)	$	73,734		$	107,185

The accompanying notes are an integral part of these consolidated financial statements.

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DYNAMICS RESEARCH CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Year Ended December 31,
	2010			2009			2008
Cash flows from operating activities:
Net income (loss)	$	12,705		$	10,172		$	(1,255	)
Gain (loss) from discontinued operations		392			(141	)		(171	)
Income (loss) from continuing operations		12,313			10,313			(1,084	)
Adjustments to reconcile net cash provided by operating activities:
Depreciation		3,564			2,987			2,961
Amortization of intangible assets		1,541			3,305			2,620
Share-based compensation		718			736			1,148
Investment income from equity interest		(228	)		(355	)		(483	)
Tax benefit from stock plan transactions, net of tax deficiencies from equity awards		(143	)		127			(103	)
Litigation settlement (payment)		-			(15,000	)		14,819
Deferred income taxes		(183	)		9,362			(4,572	)
Other		(507	)		(637	)		(620	)
Change in operating assets and liabilities:
Contract receivables, net		24,175			(1,937	)		1,310
Prepaid expenses and other current assets		2,778			(3,996	)		4
Accounts payable		1,151			(2,342	)		3,558
Accrued compensation and employee benefits		1,689			2,713			(1,519	)
Other accrued expenses		831			(2,043	)		2,239
Other long-term liabilities		(6,368	)		4,975			(1,696	)
Net cash provided by continuing operations		41,331			8,208			18,582
Net cash provided by (used in) discontinued operations		(161	)		(280	)		173
Net cash provided by operating activities		41,170			7,928			18,755
Cash flows from investing activities:
Purchase of business, net of cash acquired		-			(4,250	)		(43,016	)
Additions to property and equipment		(4,449	)		(5,185	)		(1,973	)
Proceeds from the sale of business		1,750			-			-
Proceeds from sale of investments and long-lived assets		20			215			291
Dividends from equity investment		207			556			423
Payments related to sale of building		-			-			(35	)
Change in other assets		385			(345	)		21
Net cash used in continuing operations		(2,087	)		(9,009	)		(44,289	)
Net cash used in discontinued operations		(75	)		(71	)		(37	)
Net cash used in investing activities		(2,162	)		(9,080	)		(44,326	)
Cash flow from financing activities:
Borrowings under term loan agreement		-			-			40,000
Repayments under term loan agreement		(8,000	)		(8,000	)		(2,000	)
Borrowings under revolving credit agreement		34,156			79,497			69,225
Repayments under revolving credit agreement		(36,129	)		(77,524	)		(76,962	)
Proceeds from the exercise of stock plan transactions		1,480			250			855
Payments of repurchased shares		(550	)		-			-
Tax benefit from stock plan transactions, net of tax deficiencies from equity awards		143			(127	)		103
Payments of deferred financing costs		-			-			(545	)
Net cash provided by (used in) financing activities		(8,900	)		(5,904	)		30,676
Net increase (decrease) in cash and cash equivalents		30,108			(7,056	)		5,105
Cash and cash equivalents, beginning of period		55			7,111			2,006
Cash and cash equivalents, end of period	$	30,163		$	55		$	7,111

Supplemental disclosure of cash flow information:
Cash paid during the year for interest	$	936		$	2,350		$	973
Cash paid during the year for income taxes, net of refunds	$	6,207		$	522		$	2,399
Supplemental disclosure of noncash financing and investing activities:
Issuance of restricted stock	$	333		$	903		$	869
Increase (decrease) in pension liability	$	2,066		$	(2,630	)	$	24,682
Increase (decrease) in fair value of derivative liability	$	(102	)	$	(291	)	$	860
Note receivable from sale of business	$	750		$	-		$	-
Accrual of additions to property and equipment	$	-		$	2,767		$	-
Accrual of earnout on purchase of business	$	-		$	-		$	4,250

The accompanying notes are an integral part of these consolidated financial statements.

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)

NOTE 1. NATURE OF OPERATIONS

Dynamics Research Corporation (the “Company”) is a leading provider of innovative management consulting, engineering, technical, information technology services and solutions to federal and state governments. Founded in 1955 and headquartered in Andover, Massachusetts, the Company has approximately 1,300 employees located throughout the United States. The Company operates as a parent corporation as well as through its wholly owned subsidiaries, Kadix Systems, LLC, H.J. Ford Associates, Inc. and DRC International Corporation.

The Company provides support to its customers in the primary mission areas of information technology, logistics and readiness, cyber security and information assurance, homeland security, healthcare and intelligence and space. Customers include the Department of Defense, the Department of Homeland Security, federal civilian agencies and state governments.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation and Basis of Presentation

The consolidated financial statements include the accounts of the Company and all wholly owned subsidiaries. All significant intercompany accounts and transactions are eliminated in consolidation. Unless otherwise indicated, all dollars presented herein are in thousands and financial information refers to continuing operations. The Company has reclassified certain prior period amounts to conform with the current period presentation.

During the second quarter of 2010, the Company sold Metrigraphics which was classified as held for sale at December 31, 2009 and accounted for as a discontinued operation. The Company’s consolidated financial statements and notes thereto were restated to reflect the discontinuation of Metrigraphics for all periods presented. Refer to Note 3 for additional information regarding the sale and results of Metrigraphics.

The Company has a 40% ownership interest in HMRTech, LLC (“HMRTech”), a small disadvantaged business as defined by the Small Business Administration of the U.S. Government. This investment is accounted for using the equity method and reported as a component of other noncurrent assets in the Company’s Consolidated Balance Sheets. Refer to Note 14 for additional information regarding the Company’s ownership in HMRTech.

Risks, Uncertainties and Use of Estimates

There are risks specific to the industries in which the Company operates. These risks include, but are not limited to, estimates of costs to complete contract obligations, changes in government priorities, policies and procedures and government contracting issues. The U.S. Government has the right to terminate contracts for convenience in accordance with government regulations. If the government terminated contracts, the Company would generally recover costs incurred up to termination, costs required to be incurred in connection with the termination and a portion of the fee earned commensurate with the work performed to termination. However, significant adverse effects on the Company’s indirect cost pools may not be recoverable in connection with a termination for convenience. Contracts with state and other governmental entities ar e subject to the same or similar risks.

A majority of the Company’s revenue is derived from U.S. Government contracts. Cancellations, modifications, failure to win a re-competition of the Company’s contracts or subcontracts, or failure by the government to exercise option periods relating to those contracts or subcontracts, could adversely affect the Company’s business, financial condition, results of operations and cash flows. The Company could experience material adverse consequences should such actions not be taken.

The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and, accordingly, include amounts based on informed estimates and judgments of management with consideration given to materiality. Estimates and judgments also affect the amount of revenue and expenses during the reported period. Actual results could differ from those estimates. The Company believes the following accounting policies affect the more significant judgments made and estimates used in the preparation of its consolidated financial statements.

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

The Company estimates and provides for potential losses that may arise out of litigation and regulatory proceedings to the extent that such losses are probable and can be estimated. Significant judgment is required in making these estimates and the Company’s final liabilities may ultimately be materially different. The Company’s total liability in respect of litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses after considering, among other factors, the progress of each case or proceeding, the Company’s experience and the experience of others in similar cases or proceedings, and the opinions and views of legal counsel. Given the inherent difficulty of predicting the outcome of the Company’s litigation and regulatory matters, particularly in cases or proceedings in which substantial or indeterminate damages or fines are sought, the Company cannot always estimate losses or ranges of losses. Refer to Note 15 for information on the Company’s litigation and other proceedings.

Revenue Recognition

The Company provides its services pursuant to time and materials, cost reimbursable and fixed-price contracts, including service-type contracts.

For time and materials contracts, revenue reflects the number of direct labor hours expended in the performance of a contract multiplied by the contract billing rate, as well as reimbursement of other billable direct costs. The risk inherent in time and materials contracts is that actual salaries and other costs may differ materially from negotiated billing rates in the contract, which would directly affect operating income.

For cost reimbursable contracts, revenue is recognized as costs are incurred and includes a proportionate amount of the fee earned. Cost reimbursable contracts specify the contract fee in dollars or as a percentage of estimated costs. The primary risk on a cost reimbursable contract is that a government audit of direct and indirect costs could result in the disallowance of certain costs, which would directly impact revenue and margin on the contract. Historically, such audits have not had a material impact on the Company’s revenue and operating income.

From time to time, the Company may proceed with work based on client direction prior to the completion and signing of formal contract documents. The Company has a formal review process for approving any such work. Revenue associated with such work is recognized only when it can reliably be estimated and realization is probable. The Company bases its estimates on a variety of factors, including previous experiences with the client, communications with the client regarding funding status, and our knowledge of available funding for the contract.

For each type of contract, the Company recognizes anticipated contract losses as soon as they become known and estimable. Out-of-pocket expenses that are reimbursable by the customer are included in revenue and cost of revenue.

Unbilled receivables are the amounts of recoverable revenue that have not been billed at the balance sheet date. Generally, the Company’s unbilled receivables relate to revenue that is billed in the month after services are performed. In certain instances, billing is deferred in compliance with the contract terms, such as milestone billing arrangements and withholdings, indirect rate approvals or other reasons. Costs related to certain U.S. Government contracts, including applicable indirect costs, are subject to audit by the government. Revenue from such contracts has been recorded at amounts the Company expects to realize upon final settlement.

Cash and Cash Equivalents

The Company considers cash on deposit and all highly liquid investments with original maturities of three months or less to be cash and cash equivalents.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

Contract Receivables

Contract receivables, net of the allowance for doubtful accounts, are stated at amounts expected to be realized in future periods. Unbilled receivables are amounts that are expected to be billed in accordance with contract terms and delivery schedules, as well as amounts expected to become billable upon final execution of contracts, contract completion, milestones or completion of rate negotiations. Generally, the Company’s unbilled receivables relate to revenue that is billed in the month after services are performed. Costs related to certain U.S. Government contracts, including applicable indirect costs, are subject to audit by the government. Revenue from such contracts has been recorded at amounts the Company expects to realize upon final settlement. Contract receivables are classified as curren t assets in accordance with industry practice.

The allowance for doubtful accounts is determined based upon the Company's best estimate of a customer's ability to pay. The factors that influence management’s estimate include historical experience, specific identification and an aging criteria of potential uncollectible accounts. The Company writes off contract receivables when such amounts are determined to be uncollectible. Losses have historically been within management’s expectations.

Property and Equipment

Property and equipment, including improvements that significantly add to productive capacity or extend the asset’s useful life are capitalized and recorded at cost. When items are sold, or otherwise retired or disposed of, operating income is charged or credited for the difference between the net book value and proceeds realized thereon. Repair and maintenance costs are expensed as incurred. Property and equipment is depreciated on the straight-line basis over their estimated useful lives. Estimated useful lives of production equipment typically range from three to five years, while software and furniture and other equipment typically range from three to fifteen years. Leasehold improvements are amortized over the shorter of the remaining expected term of the lease, considering renewal options if reasonably as sured, or the life of the related asset. The Company recorded depreciation expense of $3.6 million in 2010 and $3.0 million in both 2009 and 2008. The Company recorded disposals of $3.5 million, $0.9 million and $0.8 million during 2010, 2009 and 2008, respectively, of substantially fully-depreciated property and equipment no longer in use.

Internal Software Development Costs

In accounting for development costs of software to be used internally both internal and external costs incurred during the application development stage are capitalized and subsequently amortized over the estimated economic useful life of the software. These costs are included with machinery and equipment, a separate component of property and equipment.

Investments

The Company holds investments related to its deferred compensation plan. These investments, which are classified as trading securities and held in a Rabbi Trust, are carried at fair value and reported as a component of other noncurrent assets. Unrealized holding gains and losses are included in earnings as a component of other income or expense. The Company recorded net unrealized holding gains of $0.2 million and $0.3 million in 2010 and 2009, respectively, and recorded a net unrealized holding loss of $0.6 million in 2008.

Business Acquisitions

The Company accounts for business acquisitions using the purchase method of accounting. The Company determines and records the fair value of assets acquired and liabilities assumed as of the dates of acquisition. The Company utilizes an independent valuation specialist to determine the fair value of identifiable intangible assets acquired in order to assist in the determination of the portion of the purchase price allocable to these assets.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

Goodwill and Indefinite-lived Intangible Assets

Goodwill is recorded when the consideration paid for a business acquisition exceeds the fair value of net tangible and identifiable intangible assets acquired. Goodwill and other intangible assets with indefinite useful lives are not amortized, but rather, tested annually for impairment.

The Company assesses goodwill for impairment annually and when events or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value by applying a direct value-based fair value test. Goodwill could be impaired due to market declines, reduced expected future cash flows, or other factors or events. Should the fair value of goodwill at the measurement date fall below its carrying value, a charge for impairment of goodwill could occur in that period. Impairment is tested using a two-step approach. Companies must first determine whether goodwill is impaired and if so, they must value that impairment based on the amount by which the book value exceeds the estimated fair value.

The Company changed the date as of which its annual goodwill impairment analysis is performed from December 31st to November 30th. This change in timing is considered a change in accounting principle. The Company believes the new date is preferable because the timing coincides with the Company’s long-range planning process and it allows the Company more time to complete the analysis prior to the date the Company reports its results for the fourth quarter. As a result of the annual impairment test performed as of November 30, 2010 and December 31, 2009, the Company determined that the carrying amount of its reporting unit did not exceed its estimated fair value and, accordingly, did not record a charge for impairment. There can be no assurance that goodwill will not become impaired in future periods.

Intangible and Other Long-lived Assets

The Company uses assumptions in establishing the carrying value, fair value and estimated lives of identifiable intangible and other long-lived assets. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the asset carrying value may not be recoverable. Recoverability is measured by a comparison of the asset’s continuing ability to generate positive income from operations and positive cash flow in future periods compared to the carrying value of the asset. If assets are considered to be impaired, the impairment is recognized in the period of identification and is measured as the amount by which the carrying value of the asset exceeds the fair value of the asset. The useful lives and related amortization of identifiable intangible assets are based on their estimated residual value i n proportion to the economic benefit consumed. The useful lives and related depreciation of other long-lived assets are based on the Company’s estimate of the period over which the asset will generate revenue or otherwise be used by the Company. During 2010, there were no events or changes in circumstances that required the Company to test for impairment.

Asset Retirement Obligations

The Company records the fair value of obligations to retire and/or remove long-lived assets in the period in which the obligation is incurred, typically when the asset is placed in service. When the liability is initially recorded, the Company capitalizes this cost by increasing the carrying amount of the related asset. Over time the liability is increased for the change in its present value, and the capitalized cost is depreciated over the useful life of the related asset. At December 31, 2010 and 2009, the Company recorded a long-term liability of $0.2 million and $0.1 million, respectively, offset by a similar increase in leasehold improvements due to a legal obligation to remove certain leasehold improvements at the Company’s corporate headquarters.

Income Taxes

The Company accounts for income taxes using the asset and liability method pursuant to which deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the financial statements in the period that includes the enactment date. Valuation allowances are provided if based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. The Company has considered future taxable income and ongoing prudent

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

and feasible tax planning strategies in assessing the need for the valuation allowance. In the event the Company determined it would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. The Company determined that no valuation allowance was required at December 31, 2010 and 2009.

The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from these positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. Interest costs and penalties related to uncertain tax positions are classified as net interest expense and selling, general and administrative costs, respectively, in the Company’s financial statements. The Company reviews its tax positions on a quarterly basis and more frequently as facts surrounding tax positions change. Based on these future events, the Company may recognize uncertain tax positions or reverse current uncertain tax positions the impact of which would affect the consolidated financial statements.

Pension Obligations

The Company measures plan assets and benefit obligations as of the date of its fiscal year end. Accounting and reporting for the Company’s pension plan requires the use of assumptions, including but not limited to, a discount rate and an expected return on assets. These assumptions are reviewed at least annually based on reviews of current plan information and consultation with the Company’s independent actuary and the plan’s investment advisor. If these assumptions differ materially from actual results, the Company’s obligations under the pension plan could also differ materially, potentially requiring the Company to record an additional pension liability. An independent actuarial valuation of the pension plan is performed each year.

Deferred Financing Costs

Costs associated with obtaining the Company’s financing arrangements are deferred and amortized over the term of the financing arrangements using the effective interest method.

Derivative Financial Instruments

The Company recognizes derivatives as either an asset or liability measured at its fair value. For derivatives that have been formally designated as a cash flow hedge, the effective portion of changes in the fair value of the derivatives are recorded in accumulated other comprehensive income (loss). Amounts in accumulated other comprehensive income (loss) are reclassified into earnings when interest expense on the underlying borrowings is recognized.

The Company entered into an interest rate swap agreement to manage its exposure to interest rate changes. The swap effectively converts a portion of the Company’s variable rate debt under the term loan to a fixed rate, without exchanging the notional principal amounts. If, at any time, the swap is determined to be ineffective, in whole or in part, due to changes in the interest rate swap or underlying debt agreements, the fair value of the portion of the swap determined to be ineffective will be recognized as a gain or loss in the statement of operations for the applicable period.

Fair Value Measurements

The Company’s financial assets and liabilities are measured at fair value which is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants. Valuation techniques are based on observable or unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs have created the following fair value hierarchy:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

	•	Level 1 — Quoted prices for identical instruments in active markets.

	•	Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which significant value drivers are observable.

	•	Level 3 — Valuations derived from valuation techniques in which significant value drivers are unobservable.

The carrying values of cash and cash equivalents, contract receivables and accounts payable approximate fair value because of the short-term nature of these instruments. The carrying value of debt also approximates fair value because the interest rate is variable.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to credit risk include accounts receivable and cash equivalents. Management believes that credit risk related to the Company’s accounts receivable is limited due to a large number of customers in differing segments and agencies of the U.S. government. Accounts receivable credit risk is also limited due to the credit worthiness of the U.S. government. Management believes the credit risk associated with the Company’s cash equivalents is limited due to the credit worthiness of the obligors of the investments underlying the cash equivalents. In addition, although the Company maintains cash balances at financial institutions that exceed federally insured limits, these balances are placed with high quality financial institutions.

Operating Leases

The Company’s minimum operating lease payments are recognized on a straight-line basis, beginning on the date that the Company takes possession or control of the property. When the terms of an operating lease provide for periods of free rent, rent concessions or rent escalations, the Company establishes a deferred rent liability for the difference between the scheduled rent payment and the straight-line rent expense recognized. The deferred rent liability is amortized over the underlying lease term on a straight-line basis as a reduction of rent expense.

The Company had a deferred rent liability of $4.8 million and $5.2 million recorded as of December 31, 2010 and 2009, respectively. The long-term portions of the deferred rent liability of $4.2 million and $5.0 million were recorded in other long-term liabilities as of December 31, 2010 and 2009, respectively, and the remaining current portions were recorded in other accrued expenses in the accompanying balance sheets.

Restructuring Costs

Obligations associated with restructuring activities generally requires a liability for costs associated with an exit or disposal activity be recognized and measured initially at its fair value in the period in which the liability is incurred. The overall purpose of the Company’s restructuring actions is to lower overall operating costs and improve profitability by reducing excess capacities. Restructuring charges are reported in the period in which the plan is approved by the Company’s senior management and, where material, the Company’s Board of Directors, and when the liability is incurred.

During 2008, the Company recorded a restructuring cost of $0.7 million consisting principally of employee termination costs related to the Navy’s Trident Missile program which was included in cost of revenue and paid out in full during 2009.

Comprehensive Income (Loss)

As it relates to the Company, comprehensive income (loss) is defined as net income (loss) plus other comprehensive income (loss), which is the sum of changes in the pension liability adjustments and unrealized gains and losses on investments available for sale and derivative instruments. These amounts are presented net of tax in the accompanying statements of changes in stockholders’ equity and comprehensive income (loss).

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

Earnings Per Share

Basic earnings (loss) per share are computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is determined by using the weighted average number of common and dilutive common equivalent shares outstanding during the period. In years in which a net loss is reported, the dilutive effect of stock options and restricted stock grants are not included in the computation as their effect would be anti-dilutive.

Restricted shares of common stock that vest based on the satisfaction of certain conditions are treated as contingently issuable shares until the conditions are satisfied. These shares are excluded from the basic earnings per share calculation and included in the diluted earnings per share calculation as the shares do not qualify as a participating security.

Share-Based Compensation

The measurement and recognition of share-based compensation expense is based on estimated fair value for all share-based payment awards including stock options, employee stock purchases under employee stock purchase plans, non-vested share awards (restricted stock) and stock appreciation rights. The Company recognizes compensation expense based on the estimated grant date fair value method using a straight-line amortization method over the vesting period of the award reduced for actual forfeitures.

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2010-06, Improving Disclosures about Fair Value Measurements. The standard amends Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements and Disclosures, to require additional disclosures related to transfers between levels in the hierarchy of fair value measurement. The Company adopted this standard on January 1, 2010. The standard does not change how fair values are measured; accordingly, the standard will not have an impact on the Company’s consolidated financial statements. See Note 9 for fair value measurement disclosures.

In February 2010, the FASB issued ASU No. 2010-09, Amendments to Certain Recognition and Disclosure Requirements. The standard amends ASC Topic 855 to address certain implementation issues related to an entities requirement to perform and disclose subsequent-event procedures. The standard requires SEC filers to “evaluate subsequent events through the date the financial statements are issued” and exempts SEC filers from disclosing the date through which subsequent events have been evaluated. The Company evaluates subsequent events through the date and time of the filing of the applicable periodic report with the SEC.

In July 2010, the FASB issued ASU No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The purpose of the additional disclosures is to enable users of financial statements to better understand the nature of credit risk inherent in an entity’s portfolio of financing receivables and how that risk is analyzed. For end of period balances, the new disclosures are required to be made in all interim and annual periods ending on or after December 15, 2010. For activity during a reporting period, the disclosures are required to be made in all interim and annual periods after January 1, 2011. These changes did not have an impact on the consolidated financial statements.

NOTE 3. DISCONTINUED OPERATIONS

During 2009, the Company engaged an investment banker, and in the fourth quarter entered into a plan to sell Metrigraphics as management determined that Metrigraphics was not core to the Company’s mission and strategy. As of December 31, 2009, Metrigraphics was classified as held for sale as a discontinued operation and the Company’s consolidated financial statements and notes thereto were restated to reflect the discontinuation of Metrigraphics for all periods presented.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

Effective July 19, 2010, the Company sold Metrigraphics for consideration of $2.5 million, which consisted of $1.75 million in cash and $0.75 million in the form of a subordinated note. Interest on the subordinated note is payable quarterly and the repayment of principal is due in full on July 20, 2012, the maturity date of the subordinated note.

The operating results of Metrigraphics classified as discontinued operations are summarized below:

	Year ended December 31,
	2010			2009			2008
Product revenue	$	4,790		$	6,611		$	6,028

Gain (loss) before benefit for income taxes	$	806		$	(314	)	$	(421	)
(Provision) benefit for income taxes		(322	)		173			250
Income (loss) from operations of discontinued operations, net of income taxes		484			(141	)		(171	)
Loss on sale of discontinued operations, net of income taxes		(92	)		-			-
Effect of discontinued operations, net of income taxes	$	392		$	(141	)	$	(171	)

Details of balance sheet items for Metrigraphics are summarized below:

	December 31,
	2009
Accounts receivables	$	946
Inventory		864
Prepaid expenses and other current assets		22
Property and equipment, net		226
Total current assets	$	2,058

Accounts payable	$	186
Total current liabilities	$	186

NOTE 4. BUSINESS ACQUISITION

On August 1, 2008, the Company completed the acquisition of Kadix for $42.3 million in cash including acquisition costs of $0.4 million, plus additional consideration of $5.0 million based on migration to the Company of services provided by Kadix under 8(a) contracts, which were stipulated for performance by minority/women owned contracts having an unrestricted status, and the achievement of anticipated 2009 gross margin targets. During 2008, additional consideration of $5.0 million was earned and accrued as additional purchase price. Of the additional purchase price $0.8 million was paid in 2008 and the remaining $4.2 million was paid in the first quarter of 2009. The Company recorded $41.5 million to goodwill and other intangible assets and believes it will be tax deductible.

The following unaudited pro forma results of operations have been prepared as though the acquisition of Kadix had occurred on January 1, 2007. These pro forma results include adjustments for interest expense and amortization of deferred financing costs on the acquisition term loan used to finance the transaction, amortization expense for the identifiable intangible asset determined in the preliminary independent appraisal and the effect of income taxes. These unaudited pro forma results do not include certain nonrecurring costs Kadix paid at the closing of the sale, including the payout for Kadix’ Phantom Unit Plan and Ownership Appreciations Rights participants, professional fees related to the acquisition and discretionary bonuses. This unaudited pro forma information does not purport to be indicative of the resul ts of operations that would have been attained had the acquisition been made as of January 1, 2007, or of results of operations that may occur in the future.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

	Year Ended
	December 31,
	2008
	(unaudited)
Revenue	$	261,540
Gross profit	$	48,118
Operating income	$	4,228
Net income	$	692

Earnings per share:
Basic	$	0.07
Diluted	$	0.07

NOTE 5. SUPPLEMENTAL BALANCE SHEET INFORMATION

The composition of selected balance sheet accounts is as follows:

	December 31,
	2010			2009
Contract receivables, net:
Billed receivables	$	17,123		$	28,203
Unbilled receivables(1):
Revenues recorded in excess of milestone billings on fixed price contracts with the State of Tennessee		499			18,004
Retainages and fee withholdings		394			689
Other unbilled receivables		30,899			26,256
Total unbilled receivables		31,792			44,949
Allowance for doubtful accounts		(521	)		(583	)
Contract receivables, net	$	48,394		$	72,569

Prepaid expenses and other current assets:
Refundable income taxes	$	-		$	1,604
Restricted cash		350			262
Other		2,574			3,836
Prepaid expenses and other current assets	$	2,924		$	5,702

Property and equipment, net:
Software	$	10,834		$	12,107
Furniture and other equipment		8,657			9,679
Leasehold improvements		7,104			6,445
Production equipment		341			440
Property and equipment		26,936			28,671
Less accumulated depreciation		(14,717	)		(14,756	)
Property and equipment, net	$	12,219		$	13,915

Other noncurrent assets:
Deferred compensation plan investments	$	1,589		$	1,378
Equity investments		999			978
Other		1,169			979
Other noncurrent assets	$	3,757		$	3,335

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

	December 31,
	2010		2009
Accrued compensation and employee benefits:
Accrued compensation and related taxes	$	8,487	$	9,029
Accrued vacation		4,008		4,724
Accrued pension liability		4,000		840
Other		1,551		1,764
Accrued compensation and employee benefits	$	18,046	$	16,357

Other accrued expenses:
Deferred gain on sale of building	$	676	$	676
Deferred rent liability		591		206
Accrued income taxes		390		-
Other		2,960		2,826
Other accrued expenses	$	4,617	$	3,708

Other long-term liabilities:
Accrued pension liability	$	16,694	$	20,666
Deferred rent liability		4,185		4,951
Deferred gain on sale of building		2,705		3,381
Deferred compensation plan liability		1,589		1,378
Other		1,894		1,560
Other long-term liabilities	$	27,067	$	31,936

(1)	At December 31, 2010 and 2009, $0.3 million and $0.5 million, respectively, of unbilled retainages and fee withholdings are not anticipated to be billed within twelve months.

NOTE 6. INTANGIBLE ASSETS

Components of the Company’s identifiable intangible assets are as follows:

	December 31, 2010							December 31, 2009
			Accumulated							Accumulated
	Cost		Amortization			Net		Cost		Amortization			Net
Customer relationships	$	1,900	$	(440	)	$	1,460	$	13,400	$	(11,643	)	$	1,757
Customer contracts		3,500		(2,857	)		643		3,500		(2,234	)		1,266
Non-competition agreements		1,400		(970	)		430		1,400		(349	)		1,051
8(a) contract transition		130		(130	)		-		130		(130	)		-
Total	$	6,930	$	(4,397	)	$	2,533	$	18,430	$	(14,356	)	$	4,074

During 2010 and 2009, the Company wrote off $11.5 million and $1.3 million, respectively, of fully amortized intangible assets. The Company recorded amortization expense for its identifiable intangible assets of $1.5 million, $3.3 million and $2.6 million in the years ended December 31, 2010, 2009 and 2008, respectively. At December 31, 2010, estimated future amortization expense for the identifiable intangible assets to be recorded by the Company in subsequent fiscal years is as follows:

Year ending December 31:
2011	$	1,188
2012	$	492
2013	$	349
2014	$	299
2015	$	205

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

NOTE 7. INCOME TAXES

Total income tax expense was allocated as follows:

	Year Ended December 31,
	2010			2009			2008
Income (loss) from operations	$	7,871		$	6,262		$	(454	)
Gain (loss) from discontinued operations		261			(173	)		(250	)
Deficiency (benefit) from stock plan transactions		(143	)		127			(103	)
Other comprehensive income (loss)		(778	)		1,158			(10,198	)
	$	7,211		$	7,374		$	(11,005	)

The components of the provision (benefit) for federal and state income taxes from operations were as follows:

	Year Ended December 31,
	2010			2009			2008
Currently payable (receivable)
Federal	$	7,368		$	(2,997	)	$	3,429
State		686			(103	)		689
Total currently payable (receivable)		8,054			(3,100	)		4,118
Deferred payable (prepaid)
Federal		(984	)		8,367			(3,692	)
State		801			995			(880	)
Total deferred payable (prepaid)		(183	)		9,362			(4,572	)
Provision (benefit) for income taxes	$	7,871		$	6,262		$	(454	)

The major items contributing to the difference between the statutory U.S. federal income tax rate and the Company’s effective tax rate on income from continuing operations were as follows:

	Year Ended December 31,
	2010					2009					2008
Provision (benefit) at statutory rate	$	7,065		35.0	%	$	5,801		35.0	%	$	(538	)	35.0	%
State income taxes, net of federal tax benefit		989		4.9			752		4.5			(127	)	8.3
Permanent differences, net		(2	)	(0.0	)		(35	)	(0.2	)		126		(8.2	)
Stock based compensation		16		0.1			-		-			71		(4.7	)
Other, net		(197	)	(1.0	)		(256	)	(1.5	)		14		(0.9	)
Provision (benefit) for income taxes	$	7,871		39.0	%	$	6,262		37.8	%	$	(454	)	29.5	%

The tax effects of significant temporary differences that comprise deferred tax assets and liabilities are as follows:

	December 31,
	2010		2009
Pension liability	$	14,027	$	13,208
Deferred gain on sale of building		1,545		1,854
Accrued expenses		3,596		3,684
Accrued vacation		1,174		1,386
Employee share-based compensation		521		630
Net operating loss carry forward, net of federal tax benefit		-		621
Receivables reserves		207		244
Other		330		257
Deferred tax assets		21,400		21,884

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

	December 31,
	2010			2009
Unbilled receivables	$	(4,106	)	$	(9,863	)
Fixed assets and intangibles		(8,957	)		(7,083	)
Pension funding		(7,408	)		(4,882	)
Domestic International Sales Corporation		(2,198	)		(2,183	)
Other		(564	)		(667	)
Deferred tax liability		(23,233	)		(24,678	)
Deferred tax liability, net	$	(1,833	)	$	(2,794	)

Management believes that it is more likely than not that these deferred tax assets will be realized.

The Internal Revenue Service (“IRS”) had challenged the deferral of income for tax reporting purposes related to unbilled receivables including the applicability of a Letter Ruling issued by the IRS to the Company in January 1976 which granted to the Company deferred tax treatment of the unbilled receivables. This issue was elevated to the IRS National Office for determination. On October 23, 2008, the Company received a notification of ruling from the IRS National Office. This ruling provided clarification regarding the IRS position relating to revenue recognition for tax purposes regarding its unbilled receivables. During September 2009, the IRS completed its examination of the Company’s tax returns for 2004 through 2007 and issued a Revenue Agent Report (“RARR 21;), which reduced the deferral of income for tax reporting purposes. As a result the Company reclassified approximately $1 million from deferred to current taxes payable. The RAR also included an assessment of interest of $0.5 million. The Company has filed a protest letter with the IRS to appeal the assessment. The Company believes the appeal will be successful and has made no provision for the interest associated with the assessment.

As of December 31, 2009 the Company had a state net operating loss carry-forward of approximately $11 million which was carried forward and fully utilized during 2010.

The change in the unrecognized tax benefits was as follows:

Balance at December 31, 2007	$	517
Reductions for current year tax positions		(87	)
Balance at December 31, 2008		430
Additions for current year tax positions		132
Lapses of applicable statute of limitations		(153	)
Balance at December 31, 2009		409
Reductions for current year tax positions		(31	)
Balance at December 31, 2010	$	378

At December 31, 2010, the Company’s unrecognized tax benefits, which if recognized in future periods, could favorably impact the effective tax rate by approximately $0.2 million. The total amount of accrued interest and penalties resulting from such unrecognized tax benefits was $0.2 million at both December 31, 2010 and 2009.

The Company files income tax returns in the U.S. federal jurisdiction and numerous state jurisdictions. State tax returns for all years after 2006 are subject to future examination. Although the IRS has completed its examination of tax years 2004 through 2007 the statutes are still open for those years until the appeals process is finalized.

NOTE 8. FINANCING ARRANGEMENTS

The Company’s credit facility provides for a $40.0 million, five-year term loan (the “term loan”) and a $25.0 million, five-year revolving credit agreement for working capital (the “revolver”). The bank group, led by Brown Brothers Harriman & Co. as a lender and as administrative agent, also includes TD Bank, N.A. and Bank of America, N.A.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

On an ongoing basis, the credit facility requires the Company to meet certain financial covenants, including maintaining a minimum net worth and certain cash flow and debt coverage ratios. The covenants also limit the Company’s ability to incur additional debt, pay dividends, purchase capital assets, sell or dispose of assets, make additional acquisitions or investments, or enter into new leases, among other restrictions. In addition, the credit facility provides that the bank group may accelerate payment of all unpaid principal and all accrued and unpaid interest upon the occurrence and continuance of certain events of default, including, among others, the following:

	•	Any failure by the Company and its subsidiaries to make any payment of principal, interest and other sums due within three calendar days of the date when such payment is due;
	•	Any breach by the Company or any of its subsidiaries of certain covenants, representations and warranties;
	•	Any default and acceleration of any indebtedness owed by the Company or any of its subsidiaries to any person (other than the bank group) which is in excess of $1.0 million;
	•	Any final judgment against the Company or any of its subsidiaries in excess of $1.0 million which has not been insured to the reasonable satisfaction of Brown Brothers as administrative agent;
	•	Any bankruptcy (voluntary or involuntary) of the Company or any of its subsidiaries;
	•	Any material adverse change in the business or financial condition of the Company and its subsidiaries; or
	•	Any change in control of the Company.

At December 31, 2010, the Company was in compliance with its loan covenants.

The Company used the $40.0 million term loan proceeds to fund the acquisition of Kadix. The credit facility requires quarterly principal payments on the term loan of $2.0 million, which commenced December 31, 2008. The Company has the option of selecting an interest rate for the term loan equal to either: (a) the then applicable LIBOR rate plus 1.50% per annum to 2.50% per annum, depending on the Company’s most recently reported leverage ratio (currently 1.50%); or (b) the base rate as announced from time to time by the administrative agent plus 0.00% per annum to 0.25% per annum, depending on the Company’s most recently reported leverage ratio (currently 0.00%). For those portions of the term loan accruing at the LIBOR rate, the Company has the option of selecting interest periods of 30, 60, 90 or 180 days.&# 160; The credit facility also required the Company, within thirty days of the closing date, to secure interest rate protection in an amount not less than fifty percent of the outstanding principal balance of the term loan, as more fully described in Note 10.

The revolver has a five-year term and is available to the Company for general corporate purposes, including strategic acquisitions. The interest rate terms on the revolver are similar to those of the term loan.

Outstanding Debt

The Company’s outstanding debt at December 31, 2010 was $22.0 million which consisted of an outstanding balance under the term loan. The interest rate on the term loan at December 31, 2010 was 1.79% based on the 90-day LIBOR rate option that was in effect on December 31, 2010. The Company’s outstanding debt at December 31, 2009 was $32.0 million which consisted of an outstanding balance of $30.0 million under the term loan and $2.0 million of net borrowings under the revolver. The interest rate on the term loan at December 31, 2009 was 2.28% based on the 90-day LIBOR rate option that was in effect on December 31, 2009. The interest rate on the revolver at December 31, 2009 was 3.25% based on the base rate that was in effect on December 31, 2009.

The repayment of borrowings under the revolver is contractually due on August 1, 2013 and therefore the amounts outstanding are classified as long-term, however, the Company may repay at any time prior to that date. At December 31, 2010, the remaining available balance to borrow against the revolver was $24.6 million.

As noted above, the credit facility requires quarterly principal payments on the term loan of $2.0 million, which commenced December 31, 2008. The Company’s contractual obligations for principal payments on the term loan is $8.0 million in each year ending December 31, 2011 through 2012 and $6.0 million for the year ended December 31, 2013. However, the Company has the option to prepay principal at anytime during the term of the credit facility without penalty.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

NOTE 9. FAIR VALUE MEASUREMENTS

The following tables present our assets and liabilities that are measured at fair value on a recurring basis:

		Fair Value Measurements
		At December 31, 2010 Using
	Balance Sheet Classification	Level 1		Level 2		Level 3		Total
Assets:
Investments held in Rabbi Trusts	Other noncurrent assets	$	1,589	$	-	$	-	$	1,589

Liabilities:
Interest rate swap	Other long-term liabilities	$	-	$	467	$	-	$	467

		Fair Value Measurements
		At December 31, 2009 Using
	Balance Sheet Classification	Level 1		Level 2		Level 3		Total
Assets:
Investments held in Rabbi Trusts	Other noncurrent assets	$	1,378	$	-	$	-	$	1,378

Liabilities:
Interest rate swap	Other long-term liabilities	$	-	$	569	$	-	$	569

The following is a description of the valuation methodologies used for these items, as well as the general classification of such items:

Investments held in Rabbi Trusts - The investments include exchange-traded equity securities and mutual funds. Fair values for these investments were based on quoted prices in active markets and were therefore classified within Level 1 of the fair value hierarchy.

Interest rate swap - The derivative is a receive-variable, pay-fixed interest rate swap based on the LIBOR rate and is designated as a fair value hedge. Fair value was based on a model-driven valuation using the LIBOR rate, which was observable at commonly quoted intervals for the full term of the swap. Therefore, our interest rate swap was classified within Level 2 of the fair value hierarchy.

NOTE 10. DERIVATIVE FINANCIAL INSTRUMENTS

The Company has an interest rate swap agreement with an initial notional amount of $20.0 million of the term loan principal which matures on August 1, 2013. Under this agreement, the Company receives a floating rate based on the 90-day LIBOR rate and pays a fixed rate of 3.60% (both excluding the applicable margin) on the outstanding notional amount. The swap fixed rate was based on a 90-day LIBOR rate and is structured to mirror the payment terms of the term loan. The fair value of the swap at inception was zero. It is not expected that any gains or losses will be reported in the statement of operations during the term of the agreement as the swap is assumed to be highly effective through its maturity based on the matching terms of the swap and term loan.

As of December 31, 2010 and 2009, the total notional amount committed to the swap agreement was $11.0 million and $15.0 million, respectively. The Company recorded a liability to recognize the fair value of the swap which has been accounted for as a component of the accumulated other comprehensive loss.

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

The fair value effect on the financial statements from the interest rate swap designated as a cash flow hedge is as follows:

	December 31,				Year Ended December 31,
	2010		2009		2010		2009
Other long-term liabilities	$	467	$	569
Loss recognized in other comprehensive income, net of tax					$	282	$	343

NOTE 11. EMPLOYEE BENEFIT PROGRAMS

Defined Benefit Pension Plan

The Company’s Defined Benefit Pension Plan (the “Pension Plan”) is non-contributory, covering substantially all employees of the Company who had completed a year of service prior to July 1, 2002. Membership in the Pension Plan was frozen effective July 1, 2002 and participants’ calculated pension benefit was frozen effective December 31, 2006.

The Company’s funding policy is to contribute at least the minimum amount required by the Employee Retirement Income Security Act of 1974. Additional amounts are contributed to assure that plan assets will be adequate to provide retirement benefits. The Company expects required payments of $4.0 million will be needed to fund the Pension Plan in 2011.

The Company’s Pension Plan measurement date was changed to December 31 from November 30 in 2008.

Net Periodic Pension Cost

	Year Ended December 31,
	2010			2009			2008
Interest cost	$	4,217		$	4,269		$	4,103
Expected return on plan assets		(4,516	)		(3,857	)		(5,975	)
Recognized actuarial loss		1,098			1,209			586
Net periodic pension cost (income)	$	799		$	1,621		$	(1,286	)

Obligations and Funded Status

	December 31,
	2010			2009
Change in benefit obligation
Benefit obligation at beginning of year	$	75,233		$	69,691
Interest cost		4,217			4,269
Benefits paid		(3,683	)		(3,450	)
Actuarial loss		4,655			4,723
Benefit obligation at end of year		80,422			75,233
Change in plan assets
Fair value of plan assets at beginning of year		53,727			47,121
Actual return on plan assets		6,006			10,001
Employer contributions		3,678			55
Benefits paid		(3,683	)		(3,450	)
Fair value of plan assets at end of year		59,728			53,727
Funded status	$	(20,694	)	$	(21,506	)

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

Amounts recognized in the consolidated balance sheets consist of:

	December 31,
	2010		2009
Accrued compensation and employee benefits	$	4,000	$	840
Other long-term liabilities		16,694		20,666
Net amount recognized	$	20,694	$	21,506

At December, 31, 2010, the Company increased its pension liability adjustment by $2.1 million to reflect the required liability of $35.4 million. In 2009, the Company decreased its pension liability adjustment by $2.6 million to reflect the required liability of $33.3 million. These amounts are reflected, net of related tax effects, as a component of accumulated other comprehensive loss as part of stockholders’ equity in the accompanying balance sheets.

The reconciliation of the pension liability adjustment was as follows:

						Experience
	Beginning					Loss/			Ending
	Balance		Amortization			(Gain)			Balance
2010	$	33,312	$	(1,098	)	$	3,165		$	35,379
2009	$	35,942	$	(1,209	)	$	(1,421	)	$	33,312
2008	$	11,260	$	(635	)	$	25,317		$	35,942

The Company expects to recognize amortization expense related to the net actuarial loss of approximately $1.2 million in 2011.

Assumptions

The assumed long-term rate of return on plan assets, which is the average return expected on the funds invested or to be invested to provide future benefits to pension plan participants, is determined by an annual review of historical plan assets returns and consultation with outside investment advisors. In selecting the expected long-term rate of return on assets, the Company considered its investment return goals stated in the Pension Plan’s investment policy. The Company, with input from the Pension Plan’s professional investment managers, also considered the average rate of earnings expected on the funds invested or to be invested to provide Pension Plan benefits. This process included determining expected returns for the various asset classes that comprise the Pension Plan’s target asset allocation.

The following assumptions were used to determine the benefit obligations and net periodic benefit costs:

	December 31,
	2010			2009
Used to determine benefit obligations
Discount rate		5.25	%		5.75	%
Rate of compensation increase		N/A			N/A

	2010			2009			2008
Used to determine net periodic benefit costs
Discount rate		5.75	%		6.25	%		6.25	%
Expected rate of return on assets		8.50	%		8.50	%		9.00	%
Rate of compensation increase		N/A			N/A			N/A

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

Plan Assets

The Company’s overall investment strategy for plan assets is to achieve a long-term rate of return of 8.5%, with a wide diversification of asset types, fund strategies and fund managers. The target allocation for the plan assets are 55% in equity securities, 38% in fixed income securities, 5% in other types of investments and 2% in cash and cash equivalents. The risk management practices include regular evaluations of fund managers to ensure the risk assumed is commensurate with the given investment style and objectives. Prohibited investments include, but are not limited to private placements, limited partnerships, venture-capital investments, real estate properties and collateralized mortgage obligation.

The Company’s investment policy includes a periodic review of the Pension Plan’s investment in the various asset classes. The Company’s asset allocations by asset category are as follows:

			Fair Value Measurement at December 31, 2010
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Asset Category	Total		(Level 1)		(Level 2)		(Level 3)
Cash	$	414	$	414	$	-	$	-
Money market funds		4,227		-		4,227		-
Equity securities:
Common equity securities		11,183		7,505		3,678		-
Preferred equity securities		142		142		-		-
Equity mutual funds		21,593		21,593		-		-
Fixed income securities:
U.S. Treasury obligations		7,046		-		7,046		-
U.S. Government agencies		1,278		-		1,278		-
Corporate and foreign bonds		9,626		-		9,626		-
Other type of investments:
Managed futures		2,024		-		-		2,024
Hedge fund		2,195		-		-		2,195
Total	$	59,728	$	29,654	$	25,855	$	4,219

The Pension Plan’s assets did not include any of the Company’s common stock at December 31, 2010 and 2009.

A reconciliation of the beginning and ending balances of Level 3 assets is as follows:

	Fair Value Measurement Using Significant Unobservable Inputs (Level 3)
	Managed Futures		Hedge Fund		Total
Beginning balance at December 31, 2009	$	2,000	$	1,000	$	3,000
Unrealized gains on plan assets:
Relating to assets still held at the reporting date		24		195		219
Relating to assets sold during the period		-		-		-
Purchases		-		1,000		1,000
Transfers in and/or out of Level 3		-		-		-
Ending balance at December 31, 2010	$	2,024	$	2,195	$	4,219

The managed futures consist of units of limited partnership interests through the allocation of assets of multiple commodity trading advisors. These commodity trading advisors engage in speculative trading in U.S. and international markets for currencies, interest rates, stock indices, agricultural and energy products, and precious base

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

metals. The fair value of managed futures is estimated based on the investments net asset value at the reporting period. Redemptions can only be made monthly and require ten days prior notice to the general partner of the fund.

The hedge fund is a fund of funds that combines diversified multi-strategy methods to achieve investment objectives during a three to five year investment cycle. Strategy methods may consist of conventional long-term equity and fixed income investments or derivative investments, including, total return swaps, options and forwards. The fair value of the hedge fund is estimated based on the investments net asset value at the reporting period. Redemptions can be made quarterly based on the discretion of the investment company's board of directors.

Estimated Future Benefit Payments

The following table sets forth the expected timing of benefit payments:

Year ending December 31:
2011	$	3,915
2012	$	4,188
2013	$	4,458
2014	$	4,605
2015	$	4,821
Five subsequent fiscal years ending December 31, 2020	$	26,314

401(k) Plan

The Company maintains a cash or deferred savings plan, the 401(k) Plan. All employees are eligible to elect to defer a portion of their salary and contribute the deferred portion to the 401(k) Plan.

The 401(k) Plan is structured with two components: (i) a Company matching contribution for 100% of the first 2% of the employee contribution and an additional 50% of the next 4% of the employee contribution; and (ii) a discretionary profit sharing contribution by the Company for all eligible employees.

Employee contributions and the Company’s contributions are invested in one or more collective investment funds at the participant’s direction. The Company’s contributions are subject to forfeitures of any non-vested portion if termination occurs. The vesting of the Company’s matching contribution is 25% after one year and 100% after the second year. The vesting of profit sharing contributions is 100% cliff vesting after three years. The Company’s contributions, net of forfeitures, charged to expense aggregated $3.3 million, $3.5 million and $3.1 million in 2010, 2009 and 2008, respectively.

Supplemental Executive Retirement Plan

The Company has a Supplemental Executive Retirement Plan, or SERP, for certain former key employees providing for annual benefits commencing on the sixth anniversary of the executive’s retirement. The cost of these benefits is being charged to expense and accrued using a projected unit credit method. Expenses related to this plan were approximately $0.1 million in each of the years ended December 31, 2010. The liability related to the SERP, which is unfunded, was $0.4 million at both December 31, 2010 and 2009. These amounts represent the amounts the Company estimates to be the present value of the obligation at each respective date.

Deferred Compensation Plans

The Company has a deferred compensation plan approved by the Board of Directors that allows certain employees to defer up to 100% of cash incentive payments and salary in excess of the FICA earnings ceiling. Employee contributions are invested in selected mutual funds held within a Rabbi Trust. These investments, which the Company has classified as trading securities, are recorded at fair value and reported as a component of other noncurrent assets in the accompanying balance sheets. Amounts recorded as deferred compensation liabilities are adjusted to reflect the fair value of investments held by the Rabbi Trust. Changes in obligations to participants as a

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

result of gains or losses on the fair value of the investments are reflected as a component of compensation expense. At December 31, 2010 and 2009, $1.6 million and $1.4 million, respectively, had been deferred under the plan.

The Company also has a deferred compensation plan under which non-employee directors may elect to defer their directors’ fees. Amounts deferred for each participant are credited to a separate account, and interest at the lowest rate at which the Company borrowed money during each quarter is credited quarterly. The balance in a participant’s account is payable in a lump sum or in installments when the participant ceases to be a director.

NOTE 12. SHARE–BASED COMPENSATION

Share-Based Compensation Plans

The Company has four shareholder approved equity incentive plans, which are administered by the Compensation Committee of the Board of Directors (the “Committee”). The Committee determines which employees receive grants, the number of shares or options granted and the exercise prices of the shares covered by each grant.

The Company’s 1993 Equity Incentive Plan (the “1993 Plan”) expired in April 2003. The 1993 Plan permitted the Company to grant incentive stock options, nonqualified stock options, stock appreciation rights, awards of nontransferable shares of restricted common stock and deferred grants of common stock. The option price of incentive stock options was not less than the fair market value at the time the option was granted. The option period was not greater than 10 years from the date the option was granted. Normally the stock options were exercisable in three equal installments beginning one year from the date of the grant. Through shareholder approval, 580,800 shares were reserved for the 1993 Plan. A total of 9,500, 10,000 and 12,000 stock options were outstanding and exercisable under the 1993 Plan at December 31, 2010, 2009 and 2008, respectively.

The Company’s 1995 Stock Option Plan for Non-employee Directors (the “1995 Plan”) expired in April 2006. The 1995 Plan provided for each outside director to receive options to purchase 5,000 shares of common stock at the first annual meeting at which the director was elected. As long as he or she remained an eligible director, the director received options to purchase 1,000 shares of common stock at each annual meeting. Eligible directors could not be an employee of the Company or one of its subsidiaries or a holder of five percent or more of the Company’s common stock. The exercise price of these options was the fair market value of the common stock on the date of grant. Each option was non-transferable except upon death and expires 10 years after the date of grant. The options became ex ercisable in three equal installments on the first, second and third anniversaries of the date of grant. A total of 132,000 shares were reserved for issuance. A total of 10,000, 11,000 and 12,214 stock options were outstanding and exercisable under the 1995 Plan at December 31, 2010, 2009 and 2008, respectively.

The Company’s 2000 Incentive Plan (the “2000 Plan”) expired in November 2009. The 2000 Plan allowed the Company to grant incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock awards and deferred grants of common stock. In the case of incentive stock options, the option price was not less than the fair market value of the stock at the date of grant. The option period did not exceed 10 years from the date of grant. The terms of the 2000 Plan were substantially similar to those of the 1993 Plan. A total of 412,990, 585,843 and 664,894 stock options were outstanding and exercisable under the 2000 Plan at December 31, 2010, 2009 and 2008, respectively.

The Company’s 2003 Incentive Plan (the “2003 Plan”) allows the Company to grant incentive stock options, non-qualified stock options, stock appreciation rights, awards of nontransferable shares of restricted common stock and deferred grants of common stock up to directors or key employees of the Company. The terms of the 2003 Plan are substantially similar to those of the 2000 Plan. A total of 400,000 shares were reserved for issuance of which 309,124 shares remained available at December 31, 2010. A total of 40,000 stock options were outstanding and non-exercisable under the 2003 Plan at December 31, 2010. The 2003 Plan expires in December 2012.

Restricted stock awards granted by the Company were issued under the 2000 Plan and 2003 Plan. Shares of restricted stock of the Company may be granted at no cost to employees. Restrictions limit the sale or transfer of these shares until they vest, which is typically over three years. The Company granted a total of 30,300 restricted stock awards from the 2003 Plan during the year ended December 31, 2010. During 2009, the Company granted a total of 100,748 restricted

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

stock awards of which 66,750 and 33,998 restricted stock awards were granted from the 2000 Plan and the 2003 Plan, respectively. During 2008, the Company granted 92,000 restricted stock awards from the 2000 Plan. Restricted stock awards of 56,404, 137,725 and 158,476 were unvested and outstanding under the 2000 Plan as of December 31, 2010, 2009 and 2008, respectively, and 42,351 and 27,976 awards were unvested and outstanding under the 2003 Plan as of December 31, 2010 and 2009, respectively.

The Company’s Executive Long Term Incentive Program (the “ELTIP”) provides incentives to program participants through a combination of cash incentives, stock options and restricted stock grants. Included in the 2000 Plan amounts stated above, the Board of Director approved 2001 ELTIP, which fully vested in May 2008, had a total of 375,000, 425,000 and 475,000 stock options that were outstanding and exercisable at December 31, 2010, 2009 and 2008, respectively.

During 2010, the Company’s shareholders approved the 2010 ELTIP which is administered by the Compensation Committee of the Company. The Company recorded compensation costs for all share-based compensation that is expected to be issued based on the achievement of certain goals. Additional information regarding the 2010 ELTIP is included in the Company proxy statement under the heading Approval of Executive Long-Term Incentive Plan, filed with the Securities Exchange Commission on Form DEF14 A on April 15, 2010.

Employee Stock Purchase Plan

The Company’s shareholders approved the 2000 Employee Stock Purchase Plan (the “ESPP”) which is designed to give eligible employees an opportunity to purchase common stock of the Company through accumulated payroll deductions. All employees of the Company who customarily work at least 20 hours per week and do not own five percent or more of the Company’s common stock are eligible to participate in the ESPP. The ESPP allows stock to be purchased at a discount of 5% and does not include a “look-back” option, therefore the accounting for shares purchased is not considered compensatory. A total of 1,300,000 shares are available for issuance under the ESPP, of which 364,336 shares were remaining at December 31, 2010. Shares issued under the ESPP were 34,266 in 2010, 38,953 in 2009 and 46,880 in 2008.

Share-Based Compensation Costs

Total share-based compensation cost reported in the consolidated statements of operations was as follows:

	Year ended December 31,
	2010		2009		2008
Cost of products and services	$	324	$	319	$	483
Selling, general and administrative		394		417		665
Total share-based compensation expense	$	718	$	736	$	1,148

Stock Option Award Activity

The following table summarizes stock option activity under all plans:

						Weighted
						Average
				Weighted		Remaining
				Average		Contractual	Aggregate
	Number of			Exercise		Term	Intrinsic
	Shares			Price		(in years)	Value
Outstanding and exercisable at December 31, 2009		606,843		$	9.62	1.5	$	981
Granted		40,000		$	13.36
Exercised		(161,484	)	$	8.52
Cancelled		(12,869	)	$	12.76
Outstanding at December 31, 2010		472,490		$	10.23	1.5	$	1,688
Exercisable at December 31, 2010		432,490		$	9.94	0.7	$	1,684

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

As of December 31, 2010 the total unrecognized compensation cost related to stock option awards was $0.2 million which is expected to be amortized over approximately 2.5 years.

The fair value of share-based awards for employee stock option awards was estimated using the Black-Scholes pricing model. The following weighted average assumptions were used to calculate the weighted per share fair value of $6.43 for stock options issued during 2010: risk-free rate of 2.4%; dividend yield of zero; volatility of 47.7%; and expected life of 6 years.

The Company selected the assumptions used in the Black-Scholes pricing model using the following criteria:

Risk-free interest rate. The Company bases the risk-free interest rate on implied yields available on a U.S. Treasury note with a maturity term equal to or approximating the expected term of the underlying award.

Dividend yield. The Company does not intend to pay dividends on its common stock for the foreseeable future and, accordingly, uses a dividend yield of zero.

Volatility. The expected volatility of the Company’s shares was estimated based upon the historical volatility of the Company’s share price with consideration given to the expected life of the award.

Expected life. The expected term was estimated based upon exercise experience made in the past to employees.

Cash proceeds received, the intrinsic value and the total tax benefits realized resulting from stock option exercises were as follows:

	Year Ended December 31,
	2010		2009		2008
Amounts realized or received from stock option exercises:
Cash proceeds received	$	1,108	$	631	$	449
Intrinsic value realized	$	598	$	1,972	$	267
Income tax benefit realized	$	166	$	84	$	101

Restricted Stock Award Activity

The following table summarizes restricted stock activity:

				Weighted
				Average
	Number			Grant-
	of			Date
	Shares			Fair Value
Nonvested at December 31, 2009		165,701		$	9.39
Granted		30,300		$	10.99
Vested		(73,711	)	$	9.77
Cancelled		(23,535	)	$	9.48
Nonvested at December 31, 2010		98,755		$	9.57

The total fair value of restricted shares vested during 2010, 2009 and 2008 was $0.7 million, $0.8 million and $1.6 million, respectively. As of December 31, 2010, the total unrecognized compensation cost related to restricted stock awards was $0.6 million which is expected to be amortized over a weighted-average period of approximately 1.8 years.

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

NOTE 13. SHAREHOLDERS’ EQUITY

Preferred Stock Purchase Rights

On June 5, 2008, the Board of Directors of the Company approved a shareholder Rights Agreement, subject to finalization of price, which was approved by the Board on July 23, 2008 at $59.09 per one one-hundredth of a Preferred Share.

On July 23, 2008, the Board of Directors of the Company authorized and declared a dividend distribution of one right (a “Right”) for each outstanding share of the Company’s common stock, par value $0.10 per share to stockholders of record at the close of business on such date. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series B Preferred Stock, par value $0.10 per share, of the Company (the “Preferred Stock”), at a price of $59.09 per one one-hundredth of a Preferred Share, subject to adjustment. The definitive terms of the Rights are set forth in a Rights Agreement, dated as of July 23, 2008, between the Company and American Stock Transfer & Trust Company, LLC, as Rights Agent.

The Rights become exercisable upon the earlier of the following events: (i) 10 days following a public announcement that a person or group of affiliated or associated persons have acquired beneficial ownership of 15% or more of the outstanding Common Stock or (ii) 10 business days (or such later date as may be determined by action of the Board of Directors prior to such time as any person or group of affiliated or associated persons becomes an acquiring person) following the commencement of, or announcement of an intention to make, a tender offer or exchange offer the consummation of which would result in the beneficial ownership by a person or group of 15% or more of the outstanding Common Stock (the earlier of such dates being the distribution date). The Rights will expire on July 27, 2018.

Share Repurchase Program

In December 2010, The Company’s board of directors authorized a share repurchase program, which allows the Company to buy back up to 700,000 shares of its common stock through June 6, 2011. During 2010, the Company repurchased 40,400 shares at a weighted average price of $13.60. The timing, price and amount of any repurchase will be determined by management based on its evaluation of market conditions and other factors. These repurchases may be made through the open market, including block purchases, or in private negotiated transactions, or otherwise. The buyback will be funded through available cash balances and or borrowings, and may be suspended or discontinued at any time. At December 31, 2010, there were 659,600 shares available to be repurchased under the program.

Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss as of December 31, 2010 of $21.7 million consisted of aggregate additional pension liability adjustments of $21.4 million, net of a $14.0 million tax benefit and an unrealized holding loss on a derivative instrument of $0.3 million, net of a tax benefit of $0.2 million. Accumulated other comprehensive loss as of December 31, 2009 of $20.5 million consisted of aggregate additional pension liability adjustments of $20.2 million, net of a $13.2 million tax benefit and an unrealized holding loss on a derivative instrument of $0.3 million, net of a tax benefit of $0.2 million.

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

The related tax effects allocated to each component of other comprehensive income (loss) was as follows:

	Before			Tax			Net of
	Tax			(Expense)			Tax
	Amount			Benefit			Amount
Year ended December 31, 2008
Pension liability adjustment	$	(25,268	)	$	10,018		$	(15,250	)
Less: reclassification adjustment for costs realized in net loss		586			(232	)		354
Net pension liability adjustment		(24,682	)		9,786			(14,896	)
Unrealized holding losses on derivative instruments		(860	)		341			(519	)
Reclassification adjustment for gains on investments realized in net loss		(179	)		71			(108	)
Other comprehensive loss	$	(25,721	)	$	10,198		$	(15,523	)

Year ended December 31, 2009
Pension liability adjustment	$	1,421		$	(564	)	$	857
Less: reclassification adjustment for costs realized in net income		1,209			(479	)		730
Net pension liability adjustment		2,630			(1,043	)		1,587
Unrealized holding losses on derivative instruments		(175	)		69			(106	)
Less: reclassification adjustment for costs realized in net income		466			(184	)		282
Net unrealized holding gain on derivative instruments		291			(115	)		176
Other comprehensive income	$	2,921		$	(1,158	)	$	1,763

Year ended December 31, 2010
Pension liability adjustment	$	(3,164	)	$	1,254		$	(1,910	)
Less: reclassification adjustment for costs realized in net income		1,098			(435	)		663
Net pension liability adjustment		(2,066	)		819			(1,247	)
Unrealized holding losses on derivative instruments		(344	)		136			(208	)
Less: reclassification adjustment for costs realized in net income		446			(177	)		269
Net unrealized holding gain on derivative instruments		102			(41	)		61
Other comprehensive loss	$	(1,964	)	$	778		$	(1,186	)

Earnings Per Share

Due to their antidilutive effect, approximately 98,500, 63,000 and 279,200 options to purchase common stock were excluded from the calculation of diluted earnings per share for the years ended December 31, 2010, 2009 and 2008, respectively. However, these options could become dilutive in future periods. The following table sets forth the reconciliation of the weighted average shares outstanding:

	Year Ended December 31,
	2010		2009		2008
Weighted average shares outstanding - Basic		9,893,322		9,551,614		9,493,495
Dilutive effect of stock options and restricted stock grants		185,615		221,108		-
Weighted average shares outstanding - Diluted		10,078,937		9,772,722		9,493,495

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

NOTE 14. BUSINESS SEGMENT, GEOGRAPHIC, MAJOR CUSTOMER AND RELATED PARTY INFORMATION

Business Segment

The Company operates in one business segment providing support to its customers in the primary mission areas of information technology, logistics and readiness, information assurance and cyber security, homeland security, healthcare and intelligence and space. The Company offers several business solutions to its customers, often combining two or more solutions to achieve customer goals, including business transformation, information technology infrastructure, training and performance support, business intelligence, automated case management, program management, engineering, human capital management, information assurance and cyber security and healthcare.

Geographic

Revenue is attributed to geographic areas based on the customer’s location. The Company does not have locations outside the U.S. and substantially all revenue was earned in the U.S during each of the three years ended December 31, 2010. The Company’s long-lived assets of $116.2 million and $119.0 million at December 31, 2010 and 2009, respectively, were located in the U.S. Long-lived assets included property and equipment, goodwill, intangible assets and other noncurrent assets.

Major Customers

No customers accounted for more than 10% of revenue in each of the three years ended December 31, 2010 and no customers accounted for more than 10% of the contract receivable balance at December 31, 2010 and 2009.

Related Party

The Company has a 40% interest in HMRTech which is accounted for using the equity method. Revenues from HMRTech for 2010 and 2009 and amounts due from HMRTech included in contract receivables at December 31, 2010 and 2009 were immaterial. Revenues recorded from HMRTech in 2008 were $4.8 million. In addition, HMRTech charged the Company $1.9 million, $1.3 million and $1.4 million in 2010, 2009 and 2008, respectively, r elating to contract work. At December 31, 2010 and 2009, the Company had a related payable of $0.3 million and $0.2 million, respectively.

NOTE 15. COMMITMENTS AND CONTINGENCIES

Commitments

The Company conducts its operations in facilities that are under long-term operating leases. These leases expire at various dates through 2018, with options to renew as negotiated between the Company and its landlords. With the exception of the Company’s current corporate headquarters facility, the Company does not believe that exercise of any of its lease renewal options are reasonably assured and, accordingly, the exercise of such options has not been assumed in the accounting for leasehold improvements and the deferred gain on the sale of the former corporate headquarters facility. Rent expense under these leases, inclusive of real estate taxes and insurance, was $5.3 million in 2010, $5.9 million in 2009 and $5.8 million in 2008.

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

Minimum lease commitments, primarily for facilities under non-cancelable operating leases and related sublease receipts in effect at December 31, 2010 were as follows:

	Lease		Sublease
	Commitment		Receipts
Year ending December 31:
2011	$	6,645	$	2,313
2012		6,463		1,732
2013		6,215		1,732
2014		6,094		1,732
2015		5,615		1,732
2016 and thereafter		7,046		-
	$	38,078	$	9,241

The Company entered into letter of credit agreements with its bank group for a total of $0.6 million to satisfy required lease security deposits.

During 2009, the Company entered into an assignment and assumption agreement to assign all of the Company’s right, title, and interest in, to and under its former corporate headquarters facility. The effective date of the agreement was December 1, 2009, the date the Company vacated the building. The terms of the agreement assign the sublessee all of the rights and obligations of the original lease signed by the Company in 2005. The original lease includes two consecutive five year renewal options. If these options are exercised by the sublessee, the Company will be released for the option periods by the landlord. The Company is continuing to amortize the deferred gain over the original ten year lease period. The agreement also provides the sublessee the use of certain Company owned furnit ure in connection with their occupancy of the building.

Contingencies

As a defense contractor, the Company is subject to many levels of audit and review from various government agencies, including the Defense Contract Audit Agency, various inspectors general, the Defense Criminal Investigation Service, the Government Accountability Office, the Department of Justice and Congressional committees. Both related to and unrelated to its defense industry involvement, the Company is, from time to time, involved in audits, lawsuits, claims, administrative proceedings and investigations. The Company accrues for liabilities associated with these activities when it becomes probable that future expenditures will be made and such expenditures can be reasonably estimated. Except as noted below, the Company does not presently believe it is reasonably likely that any of these matters would have a material adverse effect on the Company’s business, financial position, results of operations or cash flows. The Company’s evaluation of the likelihood of expenditures related to these matters is subject to change in future periods, depending on then current events and circumstances, which could have material adverse effects on the Company’s business, financial position, results of operations and cash flows.

On June 28, 2005, a class action employee suit was filed in the U.S. District Court for the District of Massachusetts alleging violations of the Fair Labor Standards Act and certain provisions of Massachusetts General Laws. In July 2010, the Company and the plaintiff agreed upon principle terms of settlement, the cost of which was accrued on the balance sheet as of June 30, 2010. In October 2010, the Company received an executed settlement agreement by the plaintiff. The Federal District Court for the First Circuit has reviewed the settlement and the parties are expecting the court’s approval in the first quarter of 2011.

In August 2009, the Company, the Department of Justice and the United States Attorney Office, Boston, MA, executed a settlement agreement involving the Company's admission of liability solely for breach of contract, payment of $15.0 million to the government, of which $14.8 million was included in selling, general and administrative expenses in 2008, and dismissal with prejudice of all other claims against the Company.

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DYNAMICS RESEARCH CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(dollars in thousands, except per share amounts)

NOTE 16. QUARTERLY RESULTS (UNAUDITED)

During the fourth quarter of 2009, the Company entered into a plan to sell the Metrigraphics business segment. The results listed below were restated to reflect Metrigraphics as a discontinued operation for all periods presented. Refer to Note 3 for additional information regarding Metrigraphics.

	First			Second			Third		Fourth		Fiscal
	Quarter			Quarter			Quarter		Quarter		Year
2010
Revenue	$	68,584		$	65,308		$	68,420	$	69,753	$	272,065
Gross profit	$	10,757		$	10,197		$	10,790	$	12,146	$	43,890
Operating income	$	4,416		$	4,731		$	5,208	$	6,460	$	20,815
Income from continuing operations	$	2,737		$	2,579		$	3,006	$	3,991	$	12,313
Income from discontinued operations		132			173			87		-		392
Net income	$	2,869		$	2,752		$	3,093	$	3,991	$	12,705
Earnings per share:(1)
Basic
Income from continuing operations	$	0.28		$	0.26		$	0.30	$	0.40	$	1.24
Income from discontinued operations		0.01			0.02			0.01		-		0.04
Net income	$	0.29		$	0.28		$	0.31	$	0.40	$	1.28
Diluted
Income from continuing operations	$	0.27		$	0.26		$	0.30	$	0.39	$	1.22
Income from discontinued operations		0.01			0.02			0.01		-		0.04
Net income	$	0.29		$	0.27		$	0.31	$	0.39	$	1.26

2009
Revenue	$	67,203		$	68,128		$	67,504	$	65,826	$	268,661
Gross profit	$	11,260		$	11,113		$	10,622	$	11,972	$	44,967
Operating income	$	3,976		$	3,930		$	4,058	$	5,944	$	17,908
Income from continuing operations	$	1,957		$	2,174		$	2,896	$	3,286	$	10,313
Income (loss) from discontinued operations		(186	)		(124	)		59		110		(141	)
Net income	$	1,771		$	2,050		$	2,955	$	3,396	$	10,172
Earnings per share:(1)
Basic
Income from continuing operations	$	0.20		$	0.23		$	0.30	$	0.34	$	1.08
Income (loss) from discontinued operations		(0.02	)		(0.02	)		0.01		0.01		(0.02	)
Net income	$	0.18		$	0.21		$	0.31	$	0.35	$	1.06
Diluted
Income from continuing operations	$	0.20		$	0.22		$	0.29	$	0.33	$	1.06
Income (loss) from discontinued operations		(0.02	)		(0.01	)		0.01		0.01		(0.02	)
Net income	$	0.18		$	0.21		$	0.30	$	0.34	$	1.04

(1)

Basic and diluted earnings per share is computed independently for each of the quarters presented; accordingly, the sum of the quarterly earnings per share may not equal the total computed for the year. The components of basic and diluted earnings per share are also computed independently for each quarter presented; accordingly amounts may not add due to rounding.

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DYNAMICS RESEARCH CORPORATION

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

			Additions
	Balance at		Charged to		Charged to		Deductions			Balance at
	Beginning		Costs and		Other		and			End of
	of Period		Expenses		Accounts		Write-Offs			Period
Allowance for doubtful accounts
Year ended December 31,
2010	$	583	$	388	$	-	$	(450	)	$	521
2009	$	910	$	124	$	-	$	(451	)	$	583
2008	$	873	$	249	$	-	$	(212	)	$	910

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The Company’s principal executive officer (“CEO”) and principal financial officer (“CFO”) evaluated, together with other members of senior management, the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of December 31, 2010; and, based on this review, the Company’s CEO and CFO concluded that, as of December 31, 2010, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) is accumulated and communicated to the Company’s management, including the Compan y’s CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.

Management Annual Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our management conducted an assessment of the effectiveness of our internal control over financial reporting. This assessment was based upon the criteria for effective internal control over financial reporting established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission.

The Company’s internal control over financial reporting involves a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes the controls themselves, as well as monitoring of the controls and internal auditing practices and actions to correct deficiencies identified. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.

A material weakness is a deficiency (within the meaning of Public Company Accounting Oversight Board Auditing Standard No. 5), or combination of deficiencies in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. Based on this assessment, management concluded that, as of December 31, 2010, the Company’s internal control over financial reporting was effective.

Attestation Report of Registered Public Accounting Firm

The Company’s internal control over financial reporting as of December 31, 2010 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report, which is included herein.

Changes in Internal Control over Financial Reporting

There has been no change in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the quarterly period ended December 31, 2010 that has materially affected, or is reasonably likely to materially effect, the Company’s internal control over financial reporting.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and

Shareholders of Dynamics Research Corporation:

We have audited Dynamics Research Corporation’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Dynamics Research Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on Dynamics Research Corporation’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Dynamics Research Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Dynamics Research Corporation as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2010 and our report dated February 28, 2011 expressed an unqualified opinion.

/s/ Grant Thornton LLP

Boston, Massachusetts

February 28, 2011

ITEM 9B. OTHER INFORMATION

None.

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PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information required by this item is hereby incorporated by reference to the Company’s definitive proxy statement under the captions “Election of Directors,” “Report of the Audit Committee of the Board of Directors,” “Other Directors and Officer Information” and “Executive Compensation” to be filed by the Company within 120 days after the close of its fiscal year.

Executive Officers of the Registrant

The following is a list of the names and ages of our executive officers, all positions and offices held by each person and each person’s principal occupations or employment during the past five years. The officers were elected by the Board of Directors and will hold office until the next annual election of officers and their successors are elected and qualified, or until their earlier resignation or removal by the Board of Directors. There are no family relationships between any executive officers and directors.

Name	Executive Office Held	Age
James P. Regan	President, Chairman and Chief Executive Officer	70

Richard A. Covel	Vice President, General Counsel and Secretary	64

David Keleher	Senior Vice President and Chief Financial Officer	61

Steven P. Wentzell	Senior Vice President and General Manager, Human Resources	64

Lawrence H. O’Brien, Jr.	Senior Vice President and General Manager, Business Solutions and Business Development	59

Mr. Regan joined us in 1999 as President, Chief Executive Officer and Director and was elected Chairman in April 2001. Prior to joining us, he was President and Chief Executive Officer of CVSI, Inc. from 1997 to October 1999. Prior to that, he served as Senior Vice President of Litton PRC from 1992 to 1996.

Mr. Covel joined us as Vice President and General Counsel in December 2000. Prior to joining us, he was General Counsel, Patent Counsel and Secretary at Foster-Miller, Inc. from 1985 to 2000.

Mr. Keleher joined us as Vice President and Chief Financial Officer in January 2000. Prior to joining us, he was employed by Raytheon Company as Group Controller for the Commercial Electronics Division in 1999 and Assistant Corporate Controller in 1998. Prior to that, he served in several senior management positions in corporate finance and operations at Digital Equipment Corporation from 1981 to 1997.

Mr. Wentzell joined us as Senior Vice President and General Manager, Human Resources, in October 2004. Prior to joining us, Mr. Wentzell was Senior Vice President of Human Resources for Brooks Automation, Inc. from 2002 to 2004, following its acquisition of PRI Automation, Inc., where Mr. Wentzell served as Corporate Vice President for Human Resources from 1997 through the acquisition. Prior to that, Mr. Wentzell served as the Corporate Vice President of Human Resources for Dialogic Corporation from 1993 to 1997.

Mr. O’Brien joined us in 1978 and has held various senior management positions during this time. In 2007, Mr. O’Brien became Senior Vice President and General Manager, Business Solutions and Business Development. From 2004 to 2007, Mr. O’Brien was Vice President for Business Solutions. Prior to that, Mr. O’Brien was Vice President of Systems Engineering Group from 2001 to 2004.

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The Company has adopted a code of ethics applicable to all of its directors, officers and employees including its CEO, CFO and principle accounting officer. A copy of the Company’s Standards of Ethics and Conduct may be obtained free of charge through the Company’s internet website at http://www.drc.com by choosing the “Corporate Governance” link under the “Investors” link.

If any substantive amendments are made to the Company’s code of ethics or any waiver is granted, the Company intends to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding such amendment to, or waiver from, a provision of the Company’s code of ethics by posting such information on its website, at the address and location specified above.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item 11 is hereby incorporated by reference to the Company’s definitive proxy statement under the caption “Executive Compensation” to be filed by the Company within 120 days after the close of its fiscal year.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this Item 12 is hereby incorporated by reference to the Company’s definitive proxy statement under the caption “Stock Ownership of Certain Persons” to be filed by the Company within 120 days after the close of its fiscal year.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this Item 13 is hereby incorporated by reference to the Company’s definitive proxy statement under the caption “Other Director and Executive Officer Information” to be filed by the Company within 120 days after the close of its fiscal year.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The information required by this Item 14 is hereby incorporated by reference to the Company’s definitive proxy statement under the caption “Independent Public Accountants” to be filed by the Company within 120 days after the close of its fiscal year.

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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE

(a)		Documents filed as part of the report:

	(1)	Financial Statements

		The consolidated financial statements of the Company are listed in the index under Part II, Item 8 of this Annual Report on Form 10-K.

	(2)	Financial Statement Schedules

		The Schedule II Valuation and Qualifying Accounts and Reserves of the Company are listed in the index under Part II, Item 8 of this Annual Report on Form 10-K. Other financial statements schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the supplementary consolidated financial statements or notes thereto.

	(3)	Exhibits

		The exhibits that are filed with this Annual Report on Form 10-K, or that are incorporated herein by reference, are set forth in the Exhibit Index hereto.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


	DYNAMICS RESEARCH CORPORATION

Date: February 28, 2011	/s/ James P. Regan

	James P. Regan
	President, Chairman and Chief 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 and on the dates indicated.

/s/ James P. Regan	President, Chairman and Chief Executive Officer (Principal Executive Officer)	February 28, 2011
James P. Regan		February 28, 2011

/s/ David Keleher	Senior Vice President and Chief Financial Officer (Principal Financial Officer)	February 28, 2011
David Keleher		February 28, 2011

/s/ Shaun McCarthy	Vice President, Corporate Controller and Chief Accounting Officer (Principal Accounting Officer)	February 28, 2011
Shaun McCarthy		February 28, 2011

/s/ John S. Anderegg, Jr.	Director	February 28, 2011
John S. Anderegg, Jr.	Director	February 28, 2011

/s/ Francis J. Aguilar	Director	February 28, 2011
Francis J. Aguilar	Director	February 28, 2011

/s/ Gen. George T. Babbitt, Jr.	Director	February 28, 2011
Gen. George T. Babbitt, Jr.	Director	February 28, 2011

/s/ Lt. Gen. Charles P. McCausland	Director	February 28, 2011
Lt. Gen. Charles P. McCausland	Director	February 28, 2011

/s/ Nickolas Stavropoulos	Director	February 28, 2011
Nickolas Stavropoulos	Director	February 28, 2011

/s/ Richard G. Tennant	Director	February 28, 2011
Richard G. Tennant	Director	February 28, 2011

/s/ W. Scott Thompson	Director	February 28, 2011
W. Scott Thompson	Director	February 28, 2011

Table of Contents

EXHIBIT INDEX

		Filed	Incorporated by Reference**
Exhibit No.	Description	Herewith	Form	Date
2.1	Equity Purchase Agreement among Dynamics Research Corporation and Impact Innovations Group LLC and J3 Technology Services Corp., dated August 2, 2004.		8-K	September 8, 2004

2.2	Membership Interest Purchase Agreement among Dynamics Research Corporation and Kadix Systems, LLC and Daisy D. Layman, The Sole Member of Kadix Systems, LLC, dated July 30, 2008.		8-K	August 5, 2008

3.1	Restated Articles of Organization of the Company, dated May 22, 1987.		10-Q	June 17, 1987

3.2	By-Laws of the Company, dated May 22, 1987.		10-Q	June 17, 1987

3.3	Certificate of Vote of Directors Establishing Series B Preferred Stock, dated February 17, 1998.		8-A12G	June 25, 1998

3.4	Amendment, dated September 10, 1998, to the Certificate of Vote of Directors Establishing Series B Preferred Stock.		8-A12G/A	September 30, 1998

3.5	Certificate of Vote of Directors Establishing Series A Preferred Stock, dated July 14, 1988.		10-K	December 31, 2002

3.6	Amendment, dated April 28, 1998, to the restated Articles of Organization of the Company.		10-K	December 31, 2002

3.7	Amendment, dated April 25, 2000, to the restated Articles of Organization of the Company.		10-K	December 31, 2002

3.8	Certificate of Designation with respect to the Series B Preferred Stock, par value $.10 per share, of the Company (attached as Exhibit A to the Rights Agreement).		8-K	July 25, 2008

4.1	Specimen certificate for shares of the Company’s common stock.		S-8	April 27, 2001

4.2	Rights Agreement dated as of July 23, 2008 ("Rights Agreement") between the Company and American Stock Transfer & Trust Company, as Rights Agent.		8-K	July 25, 2008

10.1	Form of indemnification agreement for directors of the Company.		10-K	December 31, 1991

Table of Contents

		Filed	Incorporated by Reference**
Exhibit No.	Description	Herewith	Form	Date
10.2 *	Severance Agreement between John S. Anderegg, Jr. and the Company.		10-K	December 31, 1991

10.3 *	Deferred Compensation Plan for Non-Employee Directors of the Company.		10-K	December 31, 1991

10.4 *	Form of Supplemental Retirement Pension Agreement by and between the Company and Albert Rand.		10-Q	March 31, 1997

10.5 *	Amended 1995 Stock Option Plan for Non-Employee Directors.		10-Q	March 31, 1997

10.6 *	Amended 1993 Equity Incentive Plan.		10-K	December 31, 1998

10.7 *	2000 Incentive Plan.		DEFS14A	December 6, 1999

10.8 *	Employment Agreement between the Company and James P. Regan.		10-K	December 31, 1999

10.9 *	Change of Control Agreement between the Company and James P. Regan.		10-K	December 31, 1999

10.10 *	Non-qualified Stock Option Agreement between the Company and James P. Regan.		S-8	October 12, 2000

10.11 *	2000 Employee Stock Purchase Plan.		S-8	April 27, 2001

10.12 *	Special Severance Plan.		10-K	December 31, 2001

10.13 *	Senior Management Deferred Compensation Plan.		10-Q	March 31, 2002

10.14 *	Dynamics Research Corporation Special Severance Plan, as amended on May 14, 2003.		10-K	December 31, 2003

10.15 *	2003 Incentive Plan.		10-K	December 31, 2003

10.16 *	Form of grant of stock options under the 2003 Incentive Plan.		10-Q	September 30, 2004

10.17 *	Form of grant of restricted stock under the 2003 Incentive Plan.		10-Q	September 30, 2004

10.18 *	Form of grant of stock options under the 2000 Incentive Plan.		10-Q	September 30, 2004

10.19 *	Deferred Stock Compensation Plan for Non-Employee Directors, as amended for deferrals on or after January 1, 2005.		10-K	December 31, 2004

Table of Contents

		Filed	Incorporated by Reference**
Exhibit No.	Description	Herewith	Form	Date
10.20 *	Amendment to Deferred Stock Compensation Plan for Non-Employee Directors.		10-K	December 31, 2004

10.21 *	Beneficiary Designation Form for the Deferred Compensation Plan for Non-Employee Directors.		10-K	December 31, 2004

10.22 *	Forms of grant of restricted stock under the 2000 Incentive Plan.		10-K	December 31, 2005

10.23	Purchase and Sale Agreement, dated November 18, 2005, by and between Dynamics Research Corporation and Direct Invest Property Acquisition, LLC.		8-K	January 4, 2006

10.24	Amendment to Purchase and Sale Agreement, dated December 28, 2005, by and between Dynamics Research Corporation and Direct Invest Property Acquisition, LLC.		8-K	January 4, 2006

10.25	Lease, dated December 28, 2005, by and between Dynamics Research Corporation and Direct Invest-60 Frontage, LLC.		8-K	January 4, 2006

10.26	Consent, Waiver and Amendment Agreement, dated December 28, 2005, by and among Dynamics Research Corporation, Brown Brothers Harriman & Co., KeyBank National Association, TD Banknorth, N.A., and Bank of America, N.A.		8-K	January 4, 2006

10.27	Third Amended and Restated Loan Agreement, as of September 29, 2006, by and among Dynamics Research Corporation, DRC International Corporation and H.J. Ford Associates, Inc. and Brown Brothers Harriman & Co., TD Banknorth, N.A., Bank of America, N.A.		8-K	October 4, 2006

10.28	Master Unlimited Guaranty, dated as of September 29, 2006, by each of Dynamics Research Corporation, DRC International Corporation, and H.J. Ford Associates Inc., in favor of Brown Brothers Harriman & Co., for itself and as Administrative Agent for each of the Lenders which are and which may become parties to the Loan Agreement.		8-K	October 4, 2006

Table of Contents

		Filed	Incorporated by Reference**
Exhibit No.	Description	Herewith	Form	Date
10.29	First Amendment to Third Amended and Restated Loan Agreement by and among Dynamics Research Corporation, DRC International Corporation, and H.J. Ford Associates, Inc. and Brown Brothers Harriman & Co., TD Banknorth, N.A. and Bank of America, N.A.		8-K	May 14, 2008

10.30	Fourth Amended and Restated Loan Agreement by and among Dynamics Research Corporation, DRC International Corporation, H.J. Ford Associates, Inc., Kadix Systems, LLC as the Borrowers, and The Lenders Party hereto and Brown Brothers Harriman & Co., as Administrative Agent and TD Bank, N.A. as Documentation Agent and Bank of America, N.A. as Syndication Agent, as of August 1, 2008.		8-K	August 5, 2008

10.31	Pledge Agreement by and between Dynamics Research Corporation and Brown Brothers Harriman & Co., for itself and as Administrative Agent for each of the Lenders which are and which may become parties to the Loan Agreement, as of August 1, 2008.		8-K	August 5, 2008

10.32	First Amendment to Fourth Amended and Restated Loan Agreement by and among Dynamics Research Corporation, DRC International Corporation, H.J. Ford Associates, Inc., Kadix Systems, LLC as the Borrowers, and The Lenders Party hereto and Brown Brothers Harriman & Co., as Administrative Agent and TD Bank, N.A. as Documentation Agent and Bank of America, N.A. as Syndication Agent, as of December 31, 2008.		10-K	December 31, 2008

21.1	Subsidiaries of the registrant.	X

23.1	Consent of Independent Registered Public Accounting Firm (Grant Thornton LLP).	X

31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	X

Table of Contents

		Filed	Incorporated by Reference**
Exhibit No.	Description	Herewith	Form	Date
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	X

32.1	Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	X

32.2	Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	X

*	Management contract or compensatory plan or arrangement.

**	In accordance with Rule 12b-32 under the Securities Exchange Act of 1934, as amended, reference is made to the documents previously filed with the Securities and Exchange Commission, which documents are hereby incorporated by reference. The dates listed for Forms 8-A12G, Forms 8-K, Forms DEFS14A and Forms S-8 are dates the respective forms were filed on, and dates listed for Forms 10-Q and Forms 10-K are for the quarterly or annual period ended dates.

EX-21.1 2 ex21-1.htm SUBSIDIARIES OF DRC ex21-1.htm

Exhibit 21.1

DYNAMICS RESEARCH CORPORATION

Subsidiaries of the Registrant

Name		Jurisdiction

DRC International Corporation		Massachusetts
H.J. Ford Associates, Inc.		Delaware
Kadix Systems, LLC		Virginia

EX-23.1 3 ex23-1.htm CONSENT OF GRANT THORNTON LLP ex23-1.htm

Exhibit 23.1

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have issued our reports dated February 28, 2011, with respect to the consolidated financial statements and schedule and internal control over financial reporting included in the Annual Report of Dynamics Research Corporation on Form 10-K for the year ended December 31, 2010. We hereby consent to the incorporation by reference of said reports in the Registration Statement of Dynamics Research Corporation on Form S-8 (File No. 333-109973, effective October 24, 2003).

/s/ Grant Thornton LLP

Boston, Massachusetts

February 28, 2011

EX-31.1 4 ex31-1.htm SECTION 302 CEO CERTIFICATION ex31-1.htm

Exhibit 31.1

CERTIFICATION

I, James P. Regan, certify that:

1. I have reviewed this Annual Report on Form 10-K of Dynamics Research Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 28, 2011	/s/ James P. Regan
	President, Chairman and Chief Executive Officer

EX-31.2 5 ex31-2.htm SECTION 302 CFO CERTIFICATION ex31-2.htm

Exhibit 31.2

CERTIFICATION

I, David Keleher, certify that:

1. I have reviewed this Annual Report on Form 10-K of Dynamics Research Corporation;

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 28, 2011	/s/ David Keleher
	Senior Vice President, Chief Financial Officer and Treasurer

EX-32.1 6 ex32-1.htm SECTION 906 CEO CERTIFICATION ex32-1.htm

Exhibit 32.1

The following certification accompanies Dynamics Research Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010 and is not filed as provided in Item 601(b)(32)(ii) of Regulation S-K of the Securities and Exchange Commission.

Certification Pursuant to 18 U.S.C. Section 1350,

As Adopted Pursuant to Section 906 of the

Sarbanes—Oxley Act of 2002

In connection with the Annual Report on Form 10-K of Dynamics Research Corporation, a Massachusetts corporation (the “Company”), for the year ended December 31, 2010 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, the Chief Executive Officer, hereby certifies pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that, to his knowledge:

(1) the Report of the Company filed today pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), fully complies with the requirements of Section 13(a) of the Exchange Act; and

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: February 28, 2011	/s/ James P. Regan
	President, Chairman and Chief Executive Officer

EX-32.2 7 ex32-2.htm SECTION 906 CFO CERTIFICATION ex32-2.htm

Exhibit 32.2

Certification Pursuant to 18 U.S.C. Section 1350,

As Adopted Pursuant to Section 906 of the

Sarbanes—Oxley Act of 2002

In connection with the Annual Report on Form 10-K of Dynamics Research Corporation, a Massachusetts corporation (the “Company”), for the year ended December 31, 2010 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, the Chief Financial Officer of the Company, hereby certifies pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 that, to his knowledge:

(2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: February 28, 2011	/s/ David Keleher
	Senior Vice President, Chief Financial Officer and Treasurer

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þ	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2010
	OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from to

Massachusetts		04-2211809
(State or other Jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

Two Tech Drive, Andover, Massachusetts (Address of Principal Executive Offices)		01810-2434 (Zip Code)

Title of each class	Name of exchange on which registered
Common Stock, $0.10 par value	The NASDAQ Global Market

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.	Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.	Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.	Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). * The registrant has not yet been phased into the interactive data requirements.	Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.	o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer þ Non-accelerated filer o Smaller reporting company o
Indicate by check mark whether the registrant is a shell Company (as defined in Rule 12b-2 of the Exchange Act).	Yes o No þ
The aggregate market value of the registrant’s common stock, $0.10 par value, held by nonaffiliates of the registrant as of June 30, 2010, was $85.4 million based on the reported last sale price per share of $10.11 on that date on the NASDAQ Global Market. As of February 25, 2011, 10,078,718 shares of the registrant’s common stock, $0.10 par value, were outstanding.

			Page
PART I
	ITEM
	1.	Business	2
	1A.	Risk Factors	16
	1B.	Unresolved Staff Comments	26
	2.	Properties	26
	3.	Legal Proceedings	26
	4.	[Removed and Reserved]	26
PART II
	ITEM
	5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	27
	6.	Selected Financial Data	29
	7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
	7A.	Quantitative and Qualitative Disclosures About Market Risk	42
	8.	Financial Statements and Supplementary Data	43
	9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	76
	9A.	Controls and Procedures	76
	9B.	Other Information	77
PART III
	ITEM
	10.	Directors, Executive Officers and Corporate Governance	78
	11.	Executive Compensation	79
	12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	79
	13.	Certain Relationships and Related Transactions, and Director Independence	79
	14.	Principal Accounting Fees and Services	79
PART IV
	ITEM
	15.	Exhibits and Financial Statement Schedules	80

	•	decreases in spending by agencies or programs we support;
	•	changes in funding priorities within the U.S. Government;
	•	replacement of professional services contractors with federal employees (i.e., in-sourcing);
	•	federal government shutdowns due to weather, security threats, lack of budget funding or other reasons;
	•	delays in payment of our invoices due to policy changes or problems with government information systems;
	•	failure of Congress to timely pass sufficient appropriations to fund our programs;
	•	increased allocation of federal contracts to small minority-owned or disadvantaged businesses;
	•	failure of Congress to continue funding of programs that extend over multiple fiscal years;
	•	diversion of funds to pay for international conflicts or reconstruction; or
	•	DoD Base realignment and closures.

	•	adequately estimate the resources required to complete a project;
	•	properly determine the scope of an engagement; or
	•	complete our contractual obligation in a manner consistent with the project plan.

	•	terminate existing contracts for convenience, as well as for default;
	•	reduce orders under, or otherwise modify contracts or subcontracts;
	•	cancel multi-year contracts and related orders if funds for contract performance for any subsequent year become unavailable;
	•	decline to exercise an option to renew a multi-year contract;
	•	suspend or debar us from doing business with the federal government or with a governmental agency;
	•	prohibit future procurement awards with a particular agency as a result of a finding of an organizational conflict of interest based upon prior related work performed for the agency that would give a contractor an unfair advantage over competing contractors;
	•	subject the award of contracts to protest by competitors, which may require the contracting federal agency or department to suspend our performance pending the outcome of the protest; and
	•	claim rights in products and systems produced by us.