10-K 1 27 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [ X ]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1994 OR [ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-7348 DYNAMICS RESEARCH CORPORATION (Exact Name of Registrant as Specified in Its Charter) Massachusetts 04-2211809 (State or Other Jurisdiction of(I.R.S. Employer Identification No.) Incorporation or Organization) 60 FRONTAGE ROAD ANDOVER, MASSACHUSETTS 01810-5498 (Address of Principal Executive Offices)(Zip Code) Registrant's telephone number, including area code: (508) 475-9090 Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange on Title of Each Class Which Registered NONE NOT APPLICABLE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.10 Par Value (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . (Continued) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 10, 1995, the aggregate market value of Common Stock held by nonaffiliates of the Registrant was $23,908,154 and the number of shares of Common Stock, $.10 par value, of the Registrant outstanding was 5,625,448. Documents Incorporated By Reference Portions of the 1994 Annual Report to Shareholders are incorporated by reference in Parts I and II. Portions of the Registrant's Proxy Statement for the 1995 Annual Meeting of Shareholders are incorporated by reference in Part III. The Exhibit Index is on pages 20 and 21. DYNAMICS RESEARCH CORPORATION Form 10-K For the Fiscal Year Ended December 31, 1994 Part I Page Item 1. Business 4 2. Properties 11 3. Legal Proceedings 12 4. Submission of Matters to a Vote of Security Holders 12 4A. Executive Officers of the Registrant 12 Part II 5. Market for Registrant's Common Equity and Related Stockholder Matters 13 6. Selected Financial Data 13 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 8. Financial Statements and Supplementary Data 13 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 14 Part III 10. Directors and Executive Officers of the Registrant 15 11. Executive Compensation 15 12. Security Ownership of Certain Beneficial Owners and Management 15 13. Certain Relationships and Related Transactions 15 Part IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 16 PART I Item 1. Business Dynamics Research Corporation (referred to herein as "DRC" or the "Company") was organized in 1955 under the laws of the Commonwealth of Massachusetts. The Company is principally engaged in providing a broad range of computer-based systems development, engineering, and management support services to organizations of the United States Department of Defense (DoD), other agencies of the U.S. Government and commercial companies. The Company also designs and manufactures precision products and measurement devices, often used as components in computer controlled systems. The Company's products and services fall within the following broad categories: Information systems development and operation Engineering and management support services Digital instruments and components The following sections describe each of these business areas and related major programs and products. Information Systems Development and Operation DRC maintains a multi-vendor data processing environment with professionals who provide systems analysis and programming support primarily to government customers. The Company designs, develops, installs, operates, and maintains custom-engineered data systems. Systems developed by DRC gather information electronically from various sources, organize the data and store it in large databases. The Company's systems enable customers to track product location and configuration, and perform detailed reliability, maintainability, quality assurance, vendor qualification and cost analyses. The Company has developed systems for transit vehicles, missiles, submarines, surface ships, land warfare weapons, and aircraft. The Company's major DoD information systems programs are sometimes referred to as logistics information systems. These systems are essentially product management information systems and involve inventory requirements and control, maintenance and repair, warranty analysis, supply, distribution and other functions critical to effective and economical support of system hardware and software throughout the system's life. Under contract with the U.S. Air Force, the Company designed, developed, implemented and operates TICARRS (Tactical Interim CAMS and REMIS Reporting System) for the F-16 aircraft. The TICARRS databases accept data entries and requests from numerous Air Force user organizations worldwide. The TICARRS databases are continuously expanded and provide upon request by the Air Force user organizations worldwide, a variety of operational reports. Data include results from worldwide F-16 flight operations and maintenance activities. While remote computer terminals and communications interfaces are an integral part of the system, the host computer facility and its associated F-16 databases are located at a Company facility where system operations are supported around the clock. Based on TICARRS, DRC developed Smart Data System (SDS) for the F-117A Stealth Fighter Program by special request of the U.S. Air Force. It was used in the Persian Gulf to support Operation Desert Storm. The SDS is an on-line interactive aircraft maintenance data reporting and analysis system supporting operational, staff, depot and contractor organizations. For nearly thirty years, the Company has assisted the U.S. Navy's Fleet Ballistic Missile program office in the design, development, and operation of inertial systems. The Company has extensive experience with the Polaris, Poseidon, and Trident missile guidance systems and submarine inertial navigation systems. The Company develops and maintains performance, reliability, and logistics databases for the inertial guidance instruments housed in those systems. These databases track detailed information on thousands of component parts comprising the systems. This information is used by the customer for a wide range of operating management tasks and decision making. Also for the U.S. Navy, the Company provides independent analysis and monitoring of submarine-based inertial guidance systems and electronic modules. The Company's support capabilities include its Inertial Instrument Test Laboratory, which is equipped for full-scale performance testing of navigational quality inertial instruments. Weapon Systems Management Information System (WSMIS) is a primary Air Force decision support tool for assessing the impacts of logistics status on potential wartime capabilities. WSMIS computes inventory requirements and purchasing needs for high-tech, high-cost aircraft spare parts to meet aircraft availability requirements. WSMIS also controls repair, manufacturing and distribution schedules to meet customer demands. WSMIS assesses the "health" and capability of the Air Force's weapon systems to meet wartime objectives. DRC served as the overall functional integrator of WSMIS and the developer of certain WSMIS modules. Currently, the Company continues to provide operational support for the system as well as software development modifications and other changes. During 1994, DRC completed work as subcontractor under the U.S. Air Force Aircraft Mishap Prevention (AMP) Program. The Company developed a new system to facilitate aircraft accident analysis. The system helps analysts systematically identify safeguards, corrective actions, and countermeasures to reduce the number and impact of human factors that contribute to aircraft mishaps. Critical to the development of information systems is the Company's software development process and related tools. The Company's approach to mission-critical software stresses principles of continuous software quality evaluation and increased visibility throughout the software development life cycle. The Company uses commercially available software development tools and internally developed tools to meet the needs of software acquisition managers and developers. The Company has also developed computer-based tools which evaluate the quality of software programs and determine how well they adhere to predetermined standards. One of these tools, AdaMAT, is licensed to commercial customers as a tool for an Ada software engineering environment. The Company designed this static code analyzer for use with the Ada programming language. AdaMAT helps Ada users and managers of Ada development efforts adhere to specific programming practices and program development goals during coding, testing, and maintenance of the software. AdaMAT allows visibility into the quality of the code at any given point in time. AdaMAT incorporates a hierarchy of software metrics including management-related concerns such as reliability, portability, maintainability; and software-related concerns such as code simplicity, modularity, and self-descriptiveness. Engineering and Management Support Services Under various DoD contracts, the Company has performed a variety of services for its U.S. Government customers to assist them in the planning and managing of their large system development programs. This business area utilizes a wide range of technical and management skills of Company personnel to plan, analyze, design, test, support, train, maintain and dispose of a variety of complex physical systems. Systems include radar, C3I, missile, aircraft, information, software, munitions, and soldier protective gear. The Company provides support at all stages of a system's life. In response to emerging requirements, the Company helps clients define, develop, and initiate new programs. The Company helps clients receive program approval, conduct strategic planning, and evaluate proposals from industry. After prime contract awards, the Company helps clients monitor contractor activities, evaluate progress, and measure performance against program requirements. Under the umbrella of the U.S. Air Force Technical and Engineering Management Support (TEMS) and System Design and Analysis Support (SDAS) contracts, the Company has supported, among others, the following programs out of the Air Force Electronic Systems Center at Hanscom Air Force Base in Massachusetts: o Milstar o Airborne Warning and Control System (AWACS) o Joint Surveillance Target Attack Radar System (JSTARS) o Mission Planning Systems o Cheyenne Mountain Upgrade o U.S. Transportation Command/Air Mobility Command Support o PEACE SHIELD Air Defense System o Airborne Battlefield Command and Control Center o Over-the-Horizon Radar DRC served as a prime contractor under the TEMS program from 1984 to 1993. During 1993, the Air Force recompeted the TEMS program and awarded contracts to eight contractors, including several small and "disadvantaged" businesses. DRC was a subcontractor on one of the winning teams, and has been subsequently added as a subcontractor to several of the other winning bidders. As a result, DRC has retained substantially all the tasks it had previously performed as a prime contractor. As discussed in the Company's third and fourth quarter reports during 1993, financial results have been adversely affected by the reduced hourly rates available as a subcontractor. In November 1993, the Defense Information Systems Agency (DISA) awarded its Defense Enterprise Integration Services (DEIS) contract, an estimated $900 million, five- year program, to six competitors. DRC is a member of the winning Computer Sciences Corporation team. DEIS is an indefinite order, indefinite quantity program that may be a vehicle for a wide variety of tasks which DRC will perform for DISA and related agencies. In particular, DRC brings its experience in Business Process Re-Engineering (BPR), as well as systems development, integration and migration, to the DEIS program. The Company is also supporting the DoD in the area of acquisition logistics. DRC technical staff assist the customers to plan and manage the implementation of program requirements throughout all phases of the acquisition process. From 1987 to present the Company has provided services to the Ballistic Missile Defense Organization (BMDO) that include operating and support considerations during the early conceptual phases of the BMDO program. In February 1995, the Company received a $0.7 million contract to provide logistics modeling support for the Joint Advanced Strike Technology program. Also in February 1995, an indefinite quantity contract was awarded to the Company to provide logistics support to the Air Staff. The Company combines its expertise in the weapon system acquisition process with expertise in systems analysis, design, training and simulation, and human factors to perform human-systems integration and force analysis. DRC has been providing force analysis support to the Army Research Laboratory since 1987. Force Analysis activities are focused on developing tools that support analysis of soldier and system effectiveness, identify and assess force improvement options (doctrine, training, leader development, organization, and material), and ensure that soldier considerations are addressed in force improvements. Under the Company's current contract, begun in 1991, DRC developed a set of automated manpower and personnel integration analysis tools that are used to analyze system cost versus performance to help maintain optimal system performance at an affordable price. DRC also developed methods for analyzing training requirements to promote standardized training across the military services. In addition, DRC developed advanced crew coordination training methods for the Army aviation community designed to help reduce aviation mishaps. A follow-on to the current contract is presently under evaluation with award expected during the first half of 1995. Through its human-systems integration efforts, the Company helps the military benefit through improved performance and effectiveness, by matching soldiers to the tasks they must perform; cost and resource savings, by making soldiers more effective and by automating tasks; and more effective system design, by documenting relationships of design options to eventual performance. HARDMAN III, a suite of microcomputer-based tools developed by DRC, estimates a weapon system's manpower and training requirements, calculating manpower requirements by military specialty, skill level, pay grade, and maintenance level for every unit within a specified force structure. This suite of tools also allows analysts to locate and distribute system-level requirements to lower-level tasks with consistency; estimate and set required parameters for personnel quality constraints that affect job performance; and evaluate contractor designs on the basis of performance requirements, available maintenance support, and operator crew sizes. The training model estimates a weapon system's total course costs, costs per graduate, instructor requirements, and training man-day requirements. The HARDMAN software has been used on over fifteen Army weapon systems, including the APACHE helicopter, and can produce manpower requirements for the Active Army, Reserves, and National Guard components. DRC is a subcontractor to Loral Federal Systems for the Close Combat Tactical Trainer program (CCTT). CCTT will simulate Army tank and mechanized infantry units from vehicle crews to the battalion level. CCTT will use distributed, interactive simulation technology to provide a "virtual" training environment. DRC will conduct all manpower and personnel integration activities such as training, human factors engineering, system safety, health hazards, and survivability, and will develop modules of software for CCTT that generate tactical exercises and that assess unit performance. DRC has been supporting the B-1B Program Office since 1990. We provide independent, third party test and evaluation services to ensure the proper installation and implementation of avionics and software modifications. In 1994, the Company received an award to continue these services through the Government's 1995 fiscal year. DRC staff in offices in Oklahoma City, Oklahoma and Andover, Massachusetts support this program. The Company's Test Equipment Division provides a variety of research, engineering, and manufacturing services in support of the U.S. Navy, including test equipment services for the Trident submarine's inertial gyroscopes, accelerometers, and other components. Also for the Navy, the Company has developed an automated system used for the design, simulation, synthesis, analysis, and verification of integrated circuits, printed circuit boards, and entire electronic systems. During 1994, the Company's Systems and Test Divisions competitively bid and won an Air Force contract to produce a test system for secure tactical communications devices. Company systems engineers are responsible for the integration of commercially available components with sophisticated software supplied by a subcontractor. The system operates with a DEC Alpha workstation. Future system sales depend on system performance capabilities as well as cost and customer budget factors. Digital Instruments and Components The Company operates two units that produce precision manufactured products for commercial markets, the Encoder Division and the Metrigraphics Division. Encoder Division designs, manufactures and markets a line of digital encoders used to sense position in a wide range of equipment. These products use optical techniques to convert motion to digital signals that can then be used to control the speed and position of devices such as machine tools, computer peripherals, robotics arms and medical equipment. Beginning in late 1992 and continuing through 1993, the Company invested in a specialized production line and produced a line of encoders for an automotive industry manufacturing customer. This line of encoders is designed into a fuel pump and is used to control fuel flow and reduce emissions. Manufacturing on the line commenced in 1993 and was fully operational for 1994. The continuation of this business throughout 1995 and beyond depends on follow-on orders on mutually satisfactory terms and conditions, end user demand for the vehicles equipped with the system and other factors. Metrigraphics Division uses photolithographic processes to manufacture optical discs, scales and reticles which are used for precision measurement. Metrigraphics also uses various metals deposition processes, including electroplating and electroforming, to produce a variety of precision components. Products include printheads and oriface plates used in electronic printers. The customers for these products are primarily OEM companies which integrate the Company's components into their equipment. Encoder and Metrigraphics engineers work closely with customer engineers to design and develop prototypes to meet customer product requirements. Repeat orders for these customer-designed components are a significant factor. High quality standards and competitive unit costs are critical aspects of this business. United States Government Contracts Contracts for the Company's defense services are obtained by marketing and technical personnel employed by the Company. The Company's other products are sold by sales personnel employed by the Company and sales representatives. During 1994, the Company's revenues from contracts with the Department of Defense, either as prime contractor or subcontractor, accounted for approximately 82% of the Company's total revenues. The Company's government contracts can fall into one of three categories: (1) fixed price, (2) time and materials or (3) cost plus fixed fee. Under a fixed price contract, the customer pays an agreed upon price for the Company's services or products and the Company bears the risk that increased or unexpected costs may reduce its profits or cause it to incur a loss. Conversely, to the extent the Company incurs actual costs below anticipated costs on these contracts, the Company could realize greater profits. Under a time and materials contract, the government pays the Company a fixed hourly rate intended to cover salary costs and related indirect expenses plus a certain profit margin. Under a cost plus fixed fee contract, the government reimburses the Company for its allowable expenses and allowable costs and pays a negotiated fee. In 1994, approximately 60% of the Company's government contracts revenue was under fixed price or time and material contracts, while approximately 40% of revenue was under costs plus fixed fee contracts. During 1994 the Company's U.S. Government business consisted of approximately 125 separate contracts on 50 different programs. The Company's contracts with the government are generally subject to termination at the convenience of the government; however, the Company would be reimbursed for its allowable costs to the time of termination and would be paid a proportionate amount of the stipulated profit attributable to work actually performed. Although government contracts may extend for several years, they are generally funded on an annual basis and are subject to reduction or cancellation in the event of changes in government requirements or budgetary concerns. If the U.S. Government significantly curtails expenditures for research, development and consulting activities, such curtailment might have an adverse impact on the Company's sales and earnings. Backlog At December 31, 1994, the Company's backlog of unfilled orders was approximately $43,679,000 compared with $51,257,000 at December 25, 1993. The Company expects that substantially all of its backlog on December 31, 1994 will be filled during the fiscal year ending December 30, 1995. Backlog at December 31, 1994 consisted of funded amounts under contracts. Backlog at December 25, 1993 included $21,534,000 of unfunded amounts under ongoing programs which were contractually committed by the procuring Government agency. The Company has a number of multi-year contracts with agencies of the U.S. Government on which actual funding generally occurs on an annual basis. The Company's business does not have seasonal characteristics but a portion of its funded backlog is based on annual purchase contracts, and the amount of funded backlog as of any date can be affected by the timing of order receipts and deliveries thereunder. Competition The Company competes with both domestic and foreign firms, including larger diversified companies and smaller specialized firms. The U.S. Government's own in-house capabilities are also, in effect, competitors of the Company since various agencies perform certain types of services which might otherwise be performed by the Company. The principal competitive factors for Defense Services are price, performance, technical competence and reliability. In addition, in our commercial business, the Company also competes with other manufacturers of encoders, electroform vendors and photolithographic suppliers. Research and Development The Company expended approximately $224,000 (inclusive of overhead and other indirect costs) on new product and service development during the year ended December 31, 1994, as compared to expenditures of $2,007,000 during 1993 and $1,463,000 during 1992. Raw Materials Raw materials and components are purchased from a large number of independent sources and are generally available in sufficient quantities to meet current requirements. Environmental Matters Compliance with federal, state and local provisions relating to the protection of the environment has not had and is not expected to have a material effect upon the capital expenditures, earnings or competitive position of the Company. Employees At December 31, 1994, the Company had approximately 1,130 employees. Proprietary Information Patents, trademarks and copyrights are not materially important to the business of the Company. The United States Government has certain proprietary rights in processes and data developed by the Company in its performance of government contracts. Item 2. Properties The Company leases offices and other facilities, totaling approximately 170,000 square feet, which are utilized for its defense services, manufacturing and warehousing operations as well as its marketing and engineering offices. The Company has manufacturing and office space in Wilmington, Massachusetts under two leases totaling 85,000 square feet, expiring in 1995, with options to the year 2000. The remaining leased facilities consist of offices in 22 locations across the United States. The Company owns its 135,000 square foot facility in Andover, Massachusetts. This building was purchased in 1993 and is utilized for defense service operations and corporate administrative offices. The Company's total rental cost for 1994 was $1,800,000. The Company believes its properties are adequate for its present needs. See Note 7 to the Consolidated Financial Statements included in the Company's 1994 Annual Report to Shareholders for a description of the Company's lease obligations. Item 3. Legal Proceedings The information set forth in the last paragraph of Note 7 to the Consolidated Financial Statements included in the Company's Annual Report to Shareholders for 1994 is incorporated herein by reference. The complaint described therein, filed in the United States District Court for Massachusetts by the United States Government, was dismissed in connection with a settlement agreement entered into by the Company in April 1994. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. Item 4A. Executive Officers of the Registrant The following is a list of the names and ages of the executive officers of the Company indicating all positions and offices held by each person and each person's principal occupations or employment during the past five years. The executive officers were elected by the Board of Directors and will hold office until the next annual election of officers and their successors are elected and qualified, or until their earlier resignation or removal by the Board of Directors. There are no family relationships between any executive officers and directors. Years of Age Service Position John S. Anderegg, Jr. 71 40 Chairman Albert Rand 68 35President and Chief Executive Officer John L. Wilkinson 55 13 Vice President, Human Resources Douglas R. Potter 44 1 Vice President of Finance, Chief Financial Officer Each of the persons named above has served in the position indicated for more than five years, with the exception of Douglas R. Potter. Mr. Potter was appointed Vice President of Finance and Chief Financial Officer in November 1993. Previously he was Vice President, Treasurer, and Chief Financial Officer of SofTech, Inc. of Waltham, Massachusetts since 1990 and Corporate Controller from 1985 to 1990. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The common stock of Dynamics Research Corporation is traded on the National Market System of the National Association of Securities Dealers, Inc., Automated Quotation System (NASDAQ - NMS) under the symbol DRCO. The high and low bid prices for the quarters in 1993 and 1994 and number of holders of record the Company's common stock are described in the Company's Annual Report to Shareholders for 1994 under the caption "Stock Prices" and "Number of Shareholders," and such information is incorporated herein by reference. In September 1984, the Board of Directors indicated its intention not to declare cash dividends to preserve cash for the future growth and development of the Company. The Company did not declare any cash dividends between 1984 and 1994 and does not anticipate doing so for the forseeable future. Item 6. Selected Financial Data The section entitled, "Five Year Summary of Selected Financial Data" in the Company's Annual Report to Shareholders for 1994 is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The section entitled, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report to Shareholders for 1994 is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data The following financial statements are filed as part of this Annual Report: Report of Independent Public Accountants Consolidated Balance Sheets at December 31, 1994, December 25, 1993 and December 26, 1992 Consolidated Statements of Operations for the three years ended December 31, 1994 Consolidated Statements of Shareholders' Investment for the three years ended December 31, 1994 Consolidated Statements of Cash Flows for the three years ended December 31, 1994 Notes to Consolidated Financial Statements (The consolidated financial statements and related notes listed above are incorporated by reference to the Company's Annual Report to Shareholders for the year 1994.) Report of Independent Public Accountants on Schedules to Consolidated Financial Statements Schedule VIII - Valuation and Qualifying Accounts for the three years ended December 31, 1994 The foregoing schedule is included as part of Item 14 of this Annual Report on Form 10-K All other financial statements and schedules have been omitted because the information required to be submitted has been included in the financial statements and related notes or they are either not applicable or not required under the rules of Regulation S-X. Quarterly financial data presented on page 13, and Management's Discussion and Analysis of Financial Condition and Results of Operations presented on pages 26-28 of the Company's Annual Report to Shareholders for the year 1994, are also incorporated herein by reference. With the exception of the portions listed in the above index, the Annual Report referred to above is not to be deemed filed as part of the financial statements. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant Information with respect to Directors of the Registrant in the section entitled "Election of Directors" in the Company's definitive proxy Statement for the 1995 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 31, 1994, is incorporated herein by reference. Information relating to the Executive Officers of the Company is included in Item 4A of Part I of this Form 10K. Item 11. Executive Compensation Information called for by this item is incorporated by reference from the section entitled "Compensation and Related Matters" in the Company's definitive Proxy Statement for the 1995 Annual Meeting of Stockholders which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 31, 1994. Item 12. Security Ownership of Certain Beneficial Owners and Management Information called for by this item is incorporated by reference from the sections entitled "Common Stock Ownership of Certain Beneficial Owners and Management" in the Company's definitive Proxy Statement for the 1995 Annual Meeting of Stockholders which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 31, 1994. Item 13. Certain Relationships and Related Transactions Not applicable. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) (1) and (2) Financial Statements and Schedules -See Item 8. (a) (3) Exhibits. The exhibits which are filed with this Form 10-K or which are incorporated herein by reference are set forth in the Exhibit Index which appears in Part IV of this report on pages 20 and 21. (b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during the last quarter of fiscal 1994. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES TO CONSOLIDATED FINANCIAL STATEMENTS To Dynamics Research Corporation: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Dynamics Research Corporation's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 10, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the accompanying index is the responsibility of the company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Boston, Massachusetts, February 10, 1995 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 27, 1995 DYNAMICS RESEARCH CORPORATION by: /s/ Albert Rand Albert Rand, President (Principal Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 27th of March, 1995. /s/ Albert Rand Albert Rand Director, President, Chief Executive Officer /s/ Douglas R. Potter Douglas R. Potter Vice President of Finance, Chief Financial Officer (Principal Financial and Accounting Officer) /s/ John S. Anderegg, Jr. John S. Anderegg, Jr. Director, Chairman /s/ Francis J. Aguilar Dr. Francis J. Aguilar Director /s/ Thomas J. Troup Thomas J. Troup Director /s/ James P. Mullins Gen. James P.Mullins Director SCHEDULE VIII DYNAMICS RESEARCH CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED DECEMBER 31, 1994 (in thousands of dollars) ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURNS Balance, December 28, 1991 $320 Additions charged to expense 65 Write-off of uncollectible accounts, net (29) Balance, December 26, 1992 $356 Additions charged to expense 63 Write-off of uncollectible accounts, net (1) Balance, December 25, 1993 $418 Additions charged to expense 222 Write-off of uncollectible accounts, net (54) Balance, December 31, 1994 $586 EXHIBIT INDEX 3.0 Certificate of Incorporation and By-Laws. 3.1 Restated Articles of Organization dated May 22, 1987. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/13/87) 3.2 By-Laws dated May 22, 1987. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/13/87) 4.0 Instruments defining the rights of security holders, including indentures. 4.1 Common stock included in Exhibit 3.1 through 3.2. 4.2 Preferred stock included in Exhibit 3.1 through 3.2. 4.3 Rights Agreement dated as of July 14, 1988 ("Rights Agreement") between the Company and American Stock Transfer & Trust Company, as Rights Agent.* (Incorporated by reference to the Registrant's Form 8-K on July 14, 1988) 4.4 Rights Agreement Amendment No. 1 dated as of September 6, 1989.* (Incorporated by reference to the Registrant's Form 8-K on September 12, 1989) 10.0 Material Contracts 10.1 Amended 1983 Stock Option Plan dated January 14, 1987 (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/27/87) Plan terminated during 1993.* 10.2 Form of Dynamics Research Corporation Indemnification Agreement for Directors as of July, 1988. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91)* 10.3 Form of Dynamics Research Corporation Severance Agreement for Messrs. Anderegg and Rand as of July, 1988. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91)* 10.4 Dynamics Research Corporation Deferred Compensation Plan for Non- Employee Directors as of October 22, 1991. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91)* 10.5 Mortgage agreement dated February 5, 1993 on the Andover office building as referred above between Dynamics Research Corporation and ABN AMRO Bank, N.V., Boston branch of a Connecticut corporation. (Incorporated by reference to the Registrants Form 8-K on May 5, 1993) 10.6 1993 Equity Incentive Plan dated April 27, 1993. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/12/93)* 10.7 1995 Stock Option Plan for non-employee directors filed herewith.* 13.0 Annual Report to security holders, Form 10-Q or quarterly reports to security holders. The Company's Annual Report to Shareholders for the year ended December 31, 1994 filed herewith with the exception of the information incorporated by reference in parts I, II and IV of this Form 10-K is not deemed to be filed as part of this report. 23.0 Consents of experts and councel 23.1 Consent of Independent Accountants (Arthur Andersen LLP) dated March 24, 1995 filed herewith. * Management contract or compensatory plan or arrangement. CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in and incorporated by reference in this Form 10-K into the Company's previously filed Registration Statement on Form S-8 File No. 33-68548. ARTHUR ANDERSEN LLP Boston, Massachusetts March 23, 1995 EXHIBIT A DYNAMICS RESEARCH CORPORATION 1995 STOCK OPTION PLAN FOR NON-EMPLOYEE DIRECTORS 1. PURPOSE The purpose of this 1995 Stock Option Plan for Non-Employee Directors (the "Plan") is to advance the interests of Dynamics Research Corporation (the "Company") by enhancing the ability of the Company to attract and retain non-employee directors who are in a position to make significant contributions to the success of the Company and to align the interest of those directors more closely with the stockholders. 2. ADMINISTRATION The Plan shall be administered by a committee (the "Committee") of the Board of Directors (the "Board") of the Company designated by the Board for that purpose. Unless and until a Committee is appointed the Plan shall be administered by the entire Board, the references in the Plan to the "Committee " shall be deemed references to the Board. The Committee shall have authority, not inconsistent with the express provisions of the Plan, (a) to grant options in accordance with the Plan to such directors as are eligible to receive options; (b) to prescribe the form or forms of instruments evidencing options and any other instruments required under the Plan and to change such forms from time to time; (c) to adopt, amend and rescind rules and regulations for the administration of the Plan; and (d) to interpret the Plan and to decide any questions and settle all controversies and disputes that may arise in connection with the Plan. Such determinations of the Committee shall be conclusive and shall bind all parties. 3. EFFECTIVE DATE AND TERM OF PLAN Plan shall become effective on the date on which the Plan is approved by the Board of Directors of the Company, subject to approval by the shareholders of the Company. No option shall be granted under the Plan after the completion of ten years from the date on which the Plan was adopted by the Board, but options previously granted may extend beyond that date. 4. SHARES SUBJECT TO THE PLAN (a) Number of Shares. Subject to adjustment as provided in Section 4(c), the aggregate number of shares of the Company's common stock (the "Stock") that may be delivered upon the exercise of options granted under the Plan shall be 100,000. If any option granted under the Plan terminates without having been exercised in full, the number of shares of Stock as to which such option was not exercised shall be available for future grants within the limits set forth in this Section 4(a). (b) Shares to be Delivered. Shares delivered under the Plan shall be authorized but unissued Stock or, if the Board so decides in its sole discretion, previously issued Stock acquired by the Company and held in treasury. No fractional shares of Stock shall be delivered under the Plan. (c) Changes in Stock. In the event of a stock dividend, stock split or combination of shares, recapitalization or other change in the Company's capital stock, after the effective date of the Plan, the number and kind of shares of stock or securities of the Company subject to options then outstanding or subsequently granted under the Plan, the maximum number of shares or securities that may be delivered under the Plan, the exercise price, and other relevant provisions shall be appropriately adjusted by the Committee, whose determination shall be binding on all persons. 5. ELIGIBILITY FOR OPTIONS Directors eligible to receive options under the Plan ("Eligible Directors") shall be those directors who are not employees of the Company or of any subsidiary of the Company. 6. TERMS AND CONDITIONS OF OPTIONS (a) Number of Options. On the date of the first annual meeting of stockholders following the adoption of this Plan each Eligible Director who is elected, re-elected or continuing as a director on such date shall be awarded on such date an option covering 5,000 shares of Stock; thereafter, at each annual meeting or meeting of the board of directors at which a new Eligible Director is elected to the Board or following the election by the Board of a new Eligible Director to the Board, he or she shall be awarded an option covering 5,000 shares of Stock; and at each annual meeting subsequent to the annual meeting at which the initial grant was made to an Eligible Director and at which he or she is reelected or is continuing as a director, he or she shall be awarded an additional option covering 1,000 shares of Stock. (b) Exercise Price. The exercise price of each option shall be 100% of the fair market value per share of the Stock on the date the option is granted. In no event, however, shall the option price be less, in the case of an original issue of authorized stock, than par value per share. For purposes of this paragraph, (A) the fair market value of a share of Stock on any date shall be the Closing Price on such day or, if there was no Closing Price on such day, the latest day prior thereto on which there was a Closing Price; and (B) the "Closing Price" of the Stock on any business day will be the last sale price as reported on the principal market on which the Stock is traded or, if no last sale is reported, then the mean between the highest bid and lowest asked prices on that day. (c) Duration of Options. The latest date on which an option may be exercised (the "Final Exercise Date") shall be the date which is ten years from the date the option was granted. (d) Exercise of Options. (1) Each option shall become exercisable to the extent of one-third of the shares covered thereby on each of the first, second and third anniversaries of the date of grant. (2) Any exercise of an option shall be in writing, signed by the proper person and delivered or mailed to the Company, accompanied by (i) any documentation required by the Committee and (ii) payment in full for the number of shares for which the option is exercised. (3) The Committee shall have the right to require that the individual exercising the option remit to the Company an amount sufficient to satisfy any federal, state, or local withholding tax requirements (or make other arrangements satisfactory to the employer with regard to such taxes) prior to the delivery or any Stock pursuant to the exercise of the option. If permitted by the committee the individual exercising the option may elect, at such time and in such manner as the Committee may prescribe, to have the Company hold back from the transfer Stock having a value calculated to satisfy such withholding obligation. In the case of an individual subject to Section 16(b) of the Exchange Act, no such election shall be effective unless made in compliance with the applicable requirements of Rule 16b-3 or any successor Rule under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). (4) If an option is exercised by the executor or administrator of a deceased director, or by the person or persons to whom the option has been transferred by the director's will or the applicable laws of descent and distribution, the Company shall be under no obligation to deliver Stock pursuant to such exercise until the Company is satisfied as to the authority of the person or persons exercising the option. (e) Payment for and Delivery of Stock. Stock purchased under the Plan shall be paid for as follows: (i) in cash or by check (acceptable to the Company in accordance with guidelines established for this purpose), bank draft or money order payable to the order of the Company; (ii) through the delivery of shares of Stock (which, in the case of shares of Stock acquired from the Company, have been outstanding for at least six months) having a fair market value on the last business day preceding the date of exercise equal to the purchase price; (iii) by having the Company hold back from the shares transferred upon exercise Stock having a fair market value on the last business day preceding the date of exercise equal to the exercise price; (iv) by delivery of an unconditional and irrevocable undertaking by a broker to deliver promptly to the Company sufficient funds to pay the purchase price; or (v) by any combination of the permissible forms of payment; provided, that if the Stock delivered upon exercise of the option is an original issue of authorized Stock, at least so much of the exercise price as represents the par value of such Stock shall be paid other than with a personal check or promissory note of the option holder. An option holder shall not have the rights of a shareholder with regard to awards under the Plan except as to Stock actually received by him or her under the Plan. The Company shall not be obligated to deliver any shares of Stock (a) until, in the opinion of the Company's counsel, all applicable federal and state laws and regulations have been complied with, and (b) if the outstanding Stock is at the time listed on any stock exchange, until the shares to be delivered have been listed or authorized to be listed on such exchange upon official notice of issuance, and (c) until all other legal matters in connection with the issuance and delivery of such shares have been approved by the Company's counsel. If the sale of Stock has not been registered under the Securities Act of 1933, as amended, the Company may require, as a condition to exercise of the option, such representations or agreements as counsel for the Company may consider appropriate to avoid violation of such Act and may require that the certificates evidencing such Stock bear an appropriate legend restricting transfer. (f) Nontransferability of Options. No option may be transferred other than by will or by the laws of descent and distribution, and during a director's lifetime an option may be exercised only by him or her. (g) Death. Upon the death of any Eligible Director granted options under this Plan, all options not then exercisable shall terminate. All options held by the director that are exercisable immediately prior to death may be exercised by his or her executor or administrator, or by the person or persons to whom the option is transferred by will or the applicable laws of descent and distribution, at any time within one year after the director's death (subject, however, to the limitations of Section 6(c) regarding the maximum exercise period for such option). After completion of that one-year period, such options shall terminate to the extent not previously exercised. (h) Other Termination of Status of Director. If a director's service with the Company terminates for any reason other than death, all options held by the director that are not then exercisable shall terminate. Options that are exercisable on the date or termination shall continue to be exercisable for a period of three months (subject to Section 6(c)). After completion of that three-month period such options shall terminate to the extent not previously exercised, expired or terminated. (i) Mergers, etc. In the event of a consolidation or merger in which the Company is not the surviving corporation or which results in the acquisition of substantially all the Company's outstanding Stock by a single person or entity or by a group of persons and/or entities acting in concert, or in the event of a sale or transfer of substantially all of the Company's assets or a dissolution or liquidation of the Company, all options hereunder will terminate; provided, that 20 days prior to the scheduled date of the stockholders meeting to vote upon any such merger, consolidation sale, dissolution, or liquidation as set forth in the related proxy statement, or if there shall be no such meeting, 20 days prior to the effective date of any such transaction, all options outstanding hereunder that are not otherwise exercisable shall become immediately exercisable, and provided, further that in the event such a transaction is to be accounted for as a pooling of interests, the Company shall provide for the surviving or acquiring corporation or an affiliate thereof to grant each holder of an option hereunder outstanding at the time of the transaction replacement options on substantially equivalent terms. 7. EFFECT, DISCONTINUANCE, CANCELLATION, AMENDMENT, TERMINATION AND EFFECTIVENESS Neither adoption of the Plan nor the grant of options to a director shall affect the Company's right to grant to such director options that are not subject to the Plan, to issue to such directors Stock as a bonus or otherwise, or to adopt other plans or arrangements under which Stock may be issued to directors. The Committee may at any time terminate the Plan as to any further grants of options. The Committee may at any time or times, but in no event (except to comply with the provisions of the Internal Revenue Code, the Employee Retirement Income Security Act or the rules thereunder) more than once in any six-month period, amend the Plan for any purpose which may at the time by permitted by law; provided, that except to the extent expressly required or permitted by the Plan, no such amendment will, without the approval of the stockholders of the Company, effectuate a change for which stockholder approval is required in order for the Plan to continue to qualify under Rule 16b-3 promulgated under Section 16 of the Exchange Act. EX-27 2
5 1,000 YEAR DEC-31-1994 DEC-31-1994 206 0 14,939 586 2,353 37,907 39,134 23,064 53,977 17,682 0 657 0 0 32,056 53,977 18,073 102,964 14,571 102,332 0 0 431 201 (23) 224 0 0 0 224 .04 .04
EX-13 3 03/29/95 11:36 AM 51 DYNAMICS RESEARCH CORPORATION Solutions Through Information Technology ANNUAL REPORT 1994 FINANCIAL HIGHLIGHTS ( In thousands of dollars, except share data) 1994 1993 Revenue $102,964 $101,102 Net Income $ 224 $1,834 Net income per share*$ .04 $ .33 Backlog $43,679 $51,257 Number of employees 1,130 1,188 Number of shares outstanding* 5,631,448 5,610,878 * Retroactively adjusted for the May 1994 stock dividend. CORPORATE PROFILE Dynamics Research Corporation applies information system and manufacturing technologies to create innovative solutions for its customers. Our solutions enhance the performance, reliability, and cost-effectiveness of complex systems. Our mission is to help our customers compete and win in their markets through the continuous improvement of their products and processes. We believe that our innovative people, equipped with the best technology the market has to offer, can create new ways to help our customers deliver better products more cost effectively. The majority of our work is for various branches of the U.S. military and other federal agencies. We develop and operate complex computer and communications-intensive information systems, as well as provide a broad array of engineering and management support services. Our growing commercial divisions, Encoder and Metrigraphics, produce high-precision manufactured components, often used for digital measurement and computer- based control systems. DRC has been committed to the delivery of quality and value for our customers since its incorporation in 1955. Color photograph of Al Rand, President and Chief Executive Officer, and Jack Anderegg, Chairman. TO OUR SHAREHOLDERS For the year ended December 31, 1994, Dynamics Research Corporation achieved record revenue of $103.0 million, up 2% from $101.1 million in 1993. Net income for the year was $224,000, or $.04 per share, compared with $1.8 million, or $.33 per share a year ago. In the third quarter, we incurred non-recurring, pre-tax charges totaling $2.25 million. These charges are related to staff reductions in the Company's Systems Division and adjustments to revenue and fees on certain Air Force contracts. In 1994, DRC's defense services business received continuing significant contract awards for two of the Company's largest programs: The Air Force's TICARRS maintenance data system and the Navy's Trident inertial guidance and navigation systems. Both of these projects are considered to be high-priority efforts that position DRC for follow-on work in the future. In addition, we are pleased that DRC has been successful in sustaining its significant business base providing program management services to the Air Force at its Electronic Systems Center at Hanscom Air Force Base in Massachusetts through subcontracts. We are encouraged by the recent news that Hanscom has been excluded from the Secretary of Defense's recommended base closings. However, our St. Louis operation will be affected if the recommendation to close the U.S. Army Aviation-Troop Command is carried out. DRC was awarded an important new Air Force program in 1994, the Test Device for the Joint Tactical Information Distribution System, competitively won through the outstanding teamwork of our Systems and Test Divisions. This device tests the performance and security of tactical communications radios. Under this program, initially valued at $4.1 million, DRC system engineers are integrating sophisticated software and commercially-available components to produce a test device with dramatic improvements in capability and performance at a much lower cost than the earlier system. Also of importance are February 1995 awards for DRC to provide logistics modeling support for the Joint Advanced Strike Technology program and the Air Staff. These contracts build on DRC's historical expertise in logistics and sophisticated modeling techniques. While the U.S. Defense budget has been under constant pressure for several years, and DRC has certainly felt the consequences, the information technology sector in which we participate has a more favorable outlook. As many realize, the information systems industry is in a dynamic state of change. To remain competitive, DRC must continue to improve its technology and knowledge base. We have been fortunate that many of our contracts are at the leading edge of technology; and in executing these contracts, we continue to expand our employees' skills and capabilities. In addition to our technology development under contract, we fund internal development programs such as image storage, software simulation development, object- oriented tool development and open system architecture design. Highly skilled and knowledgeable employees, company proprietary software tools, and almost forty years of technical experience place us in a favorable competitive position to participate in major new programs. Our commercial business, manufacturing motion and position sensors and precision electroformed products grew 39% in 1994. Over the last two years, we invested in product and customer development programs that began to pay off with growing sales and improving profitability in 1994. The Encoder Division's sales were up sharply as its high-speed automated production line completed its first full year of producing automotive components. The Metrigraphics Division also grew, driven in part by rising sales of nozzle plates used in ink cartridges for home and business computer printers. As we look ahead, we will endeavor to be even more responsive to the needs and demands of our customers - both commercial and government. As always, we are grateful to the employees of DRC. Their loyalty, creativity, and dedication to customer needs are the greatest assets in our continuing efforts to build a growing company with appreciating value for our shareholders. Albert Rand President and Chief Executive Officer John S. Anderegg, Jr. Chairman MANAGING COMPLEXITY FOR THE U.S. NAVY Since its founding in 1955, DRC has provided a wide range of sophisticated analytical and systems services in connection with the U.S. Navy's strategic programs. The Company's early work involved engineering analysis of inertial guidance and navigational systems, including methods for improving systems effectiveness. DRC developed a computer-based database for managing information about inertial guidance systems. Our role expanded over the years as we built, operated, and enhanced the database system to respond to evolving needs with emerging technology. DRC continues to provide services for this important on-going project in 1995. Today, the automated database tracks more than 800 guidance systems containing nearly 12,000 parts from hundreds of suppliers across the country. The DRC system maintains a complete record of every part - who made it, where it is, and its performance history. DRC re-engineered the system two years ago using commercial off-the-shelf components to accomplish an open-system architecture. More recently, we have added technology that increases efficiency by allowing users to access the 15 gigabyte system through Windows-based PCs, workstations, the Internet, and object-oriented languages. We have also implemented a paperless system in which on-line documentation in the form of text, drawings, video, and audio, replaces paper manuals. We are adding CD ROM capabilities to lower costs of off-line data storage. We are currently defining a knowledge-based system that will provide on- line information for decision support. Much system expertise resides in the experience of people who have worked with the system for many years. The knowledge-based system will help ensure that this complex database will continue to fulfill its mission even as the Navy reduces its personnel requirements. The success of the project has become a strategic model for DRC's growth. We start with a detailed understanding of customer needs, creatively apply the best available technology to meet the needs, and build long-term relationships based on performance, integrity, and service. This model continues to serve us well as we look to the future. Color photograph of U.S. Navy submarine, missile, and guidance system. Caption: SOPHISTICATED INERTIAL DEVICES (LEFT) ARE AT THE CORE OF COMPLEX GUIDANCE AND NAVIGATIONAL SYSTEMS. UNDERSTANDING THE SYSTEM ENVIRONMENT ENABLES DRC TO DESIGN, INSTALL, AND OPERATE INFORMATION SYSTEMS THAT PROVIDE SUPERIOR PERFORMANCE FOR SYSTEM MANAGERS AND ENGINEERS. INERTIAL GUIDANCE AND NAVIGATIONAL SYSTEMS DRC services are crucial to the management of the Navy's Trident inertial guidance and navigation systems. Our engineering and management services help to achieve: * Extremely high levels of reliability * Continuous system improvements * Re-engineering to use state-of-the-art technology, including: Commercial off-the-shelf components Open architecture On-line documentation CD ROM storage Knowledge-based systems CUTTING-EDGE TECHNOLOGY FOR TEST AND EVALUATION DRC's Test Equipment Division provides specialized skills in hardware, software, and product engineering. This division provides a strong capability for developing and custom-producing a variety of high- performance devices as well as integrating cutting edge technology into customer hardware and software based systems. Under a Navy contract, DRC has developed an Integrated Engineering Environment that uses software to simulate the characteristics of electronic components. Software simulation allows users to design and evaluate system improvements without the expense and time-consuming process of building physical mockups of the device. Also for the Navy, we are creating new technology that allows electronic chips to be built in layers, thus reducing the space between components. These "multi-chip modules" are expected to provide a higher system speed and performance. Teamed with a U.K. partner, we are building a system for the Air Force to test secure communications devices known as Joint Tactical Information Distribution System (JTIDS). These devices provide highly secure and reliable digital communications over a radio network of airborne, shipborne and land-based nodes. The test device being built is basically a simulator designed to stress JTIDS performance in simulated combat conditions. We believe that the simulation capabilities of the device will allow it to be used for training as well as testing. DRC is providing systems integration expertise for JTIDS as well as hardware and manufacturing experience. Software is provided by our team partner, Wellic Ltd. DRC won this contract in an open, competitive procurement bid, based in part on our ability to assemble an integrated team that crosses organizational and functional boundaries. Color photograph of Universal Interface Board and geographic display of tactical environment. Caption: DRC IS DEVELOPING A "UNIVERSAL INTERFACE BOARD" (LEFT) TO PERMIT INCREASED INTEROPERABILITY OF SYSTEMS. THE JTIDS TEST DEVICE (ABOVE) PROVIDES A GEOGRAPHIC DISPLAY AND SIMULATION OF THE TACTICAL ENVIRONMENT. HARDWARE, SOFTWARE, AND SYSTEMS CAPABILITIES Drawing upon engineering and technical talents that span the Company's divisions, DRC provides coordinated services to meet customer needs over a wide range of advanced and high-performance systems: * Integrated hardware capabilities Re-engineering Simulation Prototyping Electronic design Automation * Integrated software capabilities Re-use Code conversion Migration * Proprietary products and tools AdaMAT:software code metrics, process improvement, and code quality improvement Harness: Distributed heterogenous processing * Business process re-engineering Architectural analysis Requirements analysis Data standards and modeling Functional economic analysis Training A WORLDWIDE INFORMATION SYSTEM FOR THE AIR FORCE Under contract with the Air Force, DRC developed and operates a maintenance information system called TICARRS which has contributed substantially to the success of the F-16 program over the last 15 years. TICARRS is an integrated worldwide information system. It provides around- the-clock, real-time maintenance information for all U.S. Air Force F-16 aircraft. The success of this system has resulted in its expansion over the years to handle additional information demands for a growing user community. Today, TICARRS serves more than 14,000 terminals at 72 user sites worldwide, linked by satellite and land-based communications to a central computer at DRC headquarters. During 1995, we will provide additional enhancements to the system. Also during 1995, we are closely following customer planning for a new generation Air Force program expected to consolidate air-craft maintenance information. The mission of this high- priority effort is to improve efficiency by integrating all maintenance- related information and decision support systems into a unified system that will be operational by the year 2005. DRC is strategically positioned to participate in the Air Force's procurement of this integrated maintenance data system for the 21st century. We created a base of expert knowledge in the domain of aircraft maintenance; then we applied our capabilities in existing and emerging technologies to capture and manage the data required to most effectively and cost-efficiently support the Air Force mission. TICARRS is another example of a strategy that has been highly successful for DRC over the years. Color photograph of TICARRS Communication Network and F-16 aircraft. Caption: DRC's F-16 AIRCRAFT MAINTENANCE INFORMATION SYSTEM SUPPORTS OPERATIONS WORLDWIDE. DRC HAS THE FULL RANGE OF CREATIVE TECHNICAL SKILLS AND EXPERIENCE NEEDED TO PROVIDE INNOVATIVE, COST-EFFECTIVE SOLUTIONS TO CHANGING CUSTOMER REQUIREMENTS. INFORMATION FOR MANAGING AIRCRAFT MAINTENANCE DATA Building upon years of experience in logistics, data systems, and aircraft maintenance information, DRC offers a unique capability in the development and management of complex, large scale systems that meet demanding requirements for decision making: * Comprehensive skills Management Engineering Maintenance * Integrated development team Systems designers Hardware designers Users/customers * Domain expertise * Use of commercially available software and tools * Integrated testing * Independent verification and validation * Configuration management and control Identification and tracking Information for problem solving Failure analysis and diagnosis HIGH-PRECISION PRODUCTS FOR DEMANDING COMMERCIAL MARKETS DRC designs, custom-engineers, and produces high-precision products for demanding applications in commercial markets. We target niche markets where our creative engineering capabilities and our commitment to service and our quality combine to meet extremely demanding requirements. The Encoder Division manufactures products used in automotive applications. An expanding market for these products is met through our high-speed, automated production facility, which successfully completed its first full year of operation in 1994. Other encoder products are used in a wide range of applications, including medical equipment, semiconductor processing, and factory automation equipment. The Metrigraphics Division uses advanced electroforming capabilities in the production and prototyping of precision components. Advantages of electroforming include superior edge definition and the ability to hold critical tolerances on parts with as many as two million holes per square inch. Sales of electroformed products improved in 1994, partly due to strong sales of printers that use our electroformed nozzle plates. Metrigraphics also produces code discs, linear scales, high density circuit and optical targets. A number of different market forces are creating opportunities for our commercial products. The trend toward higher levels of automation, the demand for speed and precision, and the spread of computer technology to many manufactured products provide future opportunities for our Commercial Divisions. Encoders covert analog information to digital form and thus become integral to the computer control feedback system. Electroforming is a superior manufacturing process for a growing array of micro-miniature parts. By providing exceptional service and customer satisfaction, DRC seeks to build long-term relationships that result in new product opportunities - for DRC and for our customers. Color photograph of quality control device and electronic circuit boards. Caption: MINIATURE COMPONENT PARTS MANUFACTURED BY AN ELECTROFORMING PROCESS ARE SUBJECT TO RIGOROUS QUALITY CONTROL AND TESTING (LEFT). ELECTRONIC CIRCUITRY IN ENCODERS IS MANUFACTURED IN HIGH VOLUMES WITH HIGH- SPEED AUTOMATED PRODUCTION EQUIPMENT. PRECISE MOTION AND POSITION SENSORS. ELECTROFORMED COMPONENTS. DRC applies it's experience and technical expertise to the development of specialized products and capabilities, including: * High-precision measurement devices and components Optical encoders Linear and rotary measurement devices Scales and reticles * Electroformed parts Nozzle plates Printheads * Custom-engineering * Manufacturing skills and techniques Materials deposition Chemical processes Photo lithography * Specialized production lines Automation High speed High accuracy DIVERSITY AND STRENGTH As the examples in this report illustrate, our ability to understand and meet customer requirements is critical to success in our traditional markets. In addition, our emphasis on quality assurance, customer service, and total customer satisfaction has positioned DRC to continue to compete successfully. In recent years, we have augmented our traditional strengths with new areas of expertise: the use of commercial, off-the-shelf technology, open system architectures, standards-based systems, and object-oriented technology. These and other initiatives align DRC with the Department of Defense emphasis on greater efficiency, better use of resources, and maintaining mission readiness with fewer personnel. As a result, we continue to be successful in attracting contract support in forward-looking, high-priority projects. Space does not permit a full presentation of all our engineering and management support services for Air Force, Navy and Army customers, but other work includes: * Technical and engineering management support for a wide range of high-profile Air Force electronics systems programs. Our people support all stages of an acquisition from program definition and initiation, strategic planning, proposal evaluation, contract or monitoring, progress evaluation and measurement. * Logistics analysis and support, throughout all phases of the acquisition process and system life. * Human-systems integration for improved performance and effectiveness of personnel and systems: training methods, task automation, performance analysis and personnel requirements. In non-DoD markets, we continue to develop opportunities where our proven capabilities can produce significant and measurable results for our customers. In addition, we are growing the commercial segment of our business through innovative product engineering and aggressive, focused marketing. Information technology is the core of DRC's strength. With customer service and satisfaction as a driving force, we provide solutions that result in engineering, manufacturing, and business opportunities - for us and for our customers. FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA
(in thousands of dollars, except per share data)1994 1993 1992 1991 1990 Revenue $102,964$101,102$102,581$97,701$90,548 Operating income 632 3,242 6,377 5,684 5,557 Net income 224 1,834 4,014 3,630 3,260 Net income per common share* .04 .33 .70 .61 .51 Total assets 53,977 59,494 48,877 45,397 43,137 Long-term debt (excl. curr. port.) 2,717 3,900 - - - Shareholders' investment 32,713 32,437 30,805 27,550 24,718 Shareholders' investment per share* 5.81 5.78 5.47 4.74 4.08 Return on shareholders' investment (%) .7 5.7 13.0 13.2 13.2 Backlog 43,679 51,257 54,547 52,609 50,605 Cash flow from operations 5,721 1,397 9,468 3,416 4,462 Research and development expense224 2,007 1,463 698 667 Capital expenditures 2,444 12,144 4,732 3,710 2,151 Number of shares outstanding at end of year* 5,631,4485,610,8785,632,2645,815,5986,061,072 Number of employees 1,130 1,188 1,189 1,195 1,174
QUARTERLY DATA** (in thousands of dollars, except per share data) unaudited 1994 1st Qtr2nd Qtr 3rd Qtr4th Qtr Revenue $22,692$23,656 $21,573$35,043 Operating income 696 580 (2,699) 2,055 Net income 390 302 (1,734) 1,266 Net income per common share .07 .05 (.31).22 1993 Revenue $23,026$24,382 $21,892$31,802 Operating income 1,118 1,034 368 722 Net income 651 594 189 400 Net income per common share* .12 .11 .03 .07 1992 Revenue $21,194$24,222 $23,731$33,434 Operating income 810 1,174 1,481 2,912 Net income 518 761 950 1,785 Net income per common share* .09 .13 .16 .32 * Retroactively adjusted for the May 1994, February 1993, and February 1992 stock dividends. ** The Company uses a 13-period accounting year, each with four weeks. The first three quarters contain 12 weeks, and the fourth fiscal quarter contains 16 weeks. The 1994 fiscal year covered a 53-week period with 17 weeks in the fourth fiscal quarter. CONSOLIDATED BALANCE SHEETS At December 31, l994, December 25, 1993 and December 26, 1992 (in thousands of dollars, except per share data) 1994 1993 1992 Assets Current assets: Cash and cash equivalents $ 206 $ 140 $2,908 Receivables, less allowances of $586, $418 and $356 14,939 20,016 15,810 Unbilled expenditures and fees on contracts in process 18,194 17,053 16,214 Inventories 2,353 2,630 2,007 Refundable income taxes 885 553 1,550 Prepaid expenses and other current assets 1,330 1,315 873 Total current assets 37,907 41,707 39,362 Property, plant and equipment, at cost: Land 1,126 1,126 - Building 7,774 7,774 - Machinery and equipment 28,857 27,637 25,258 Leasehold improvements 1,377 1,835 1,826 Total property, plant and equipment, at cost 39,134 38,372 27,084 Less-accumulated depreciation and amortization 23,064 20,585 17,569 Net property, plant and equipment 16,070 17,787 9,515 Total assets $53,977 $59,494 $48,877 Liabilities and Shareholders' Investment Current liabilities: Notes payable $1,200 $3,301 $220 Accounts and drafts payable 3,442 4,327 4,877 Accrued payroll and employee benefits 4,649 4,736 4,678 Deferred contract and other revenue 894 3,073 2,880 Other accrued expenses 1,535 944 579 Current deferred income taxes 4,741 4,531 3,761 Current portion of long-term debt 1,221 1,200 - Total current liabilities 17,682 22,11216,995 Long-term debt, less current portion 2,717 3,900 - Deferred income taxes 865 1,045 1,077 Commitments and contingencies Shareholders' Investment Preferred stock, par value, $.10 per share, 5,000,000 shares authorized, none issued Common stock, par value, $.10 per share Authorized - 15,000,000 shares Issued - 6,571,495 shares in 1994, 6,028,155 shares in 1993 and 5,960,940 shares in 1992 657 603 596 Less: Treasury stock - 940,047 shares in 1994, 927,357 shares in 1993 and 840,700 shares in 1992, at par value (94) (93) (84) Capital in excess of par value 9,284 6,977 7,199 Retained earnings 22,866 24,950 23,094 Total shareholders' investment 32,713 32,437 30,805 Total liabilities and shareholders' investment$53,977 $59,494 $ 48,877 The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF OPERATIONS For the three years ended December 31, 1994 (in thousands of dollars, except per share data) 1994 1993 1992 Revenue: Contract revenue $84,891 $88,085 $92,015 Product sales 18,073 13,017 10,566 Total revenue 102,964 101,102 102,581 Costs and expenses: Cost of contract revenue 77,398 74,523 76,241 Cost of goods 14,571 10,768 8,170 Selling, engineering and administrative expenses 10,363 12,569 11,793 Total operating costs and expenses 102,332 97,860 96,204 Operating income 632 3,242 6,377 Interest expense (income), net 431 250 (167) Income before provision for income taxes 201 2,992 6,544 Provision (benefit) for income taxes (23) 1,158 2,530 Net income $ 224 $1,834 $4,014 Net income per common share* $ .04 $ .33 $ .70 Weighted average number of common shares outstanding* 5,638,700 5,633,354 5,745,302 * Retroactively adjusted for the May 1994 and February 1993 stock dividends. The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' INVESTMENT For the three years ended December 31, 1994 (in thousands) Common Stock Capital in Issued Treasury StockExcess ofRetained SharesPar ValueSharesPar ValuePar ValueEarnings Balance at December 28, 1991 5,480 $548(674) $ (67) $5,958 $21,111 Year 1992 10% stock dividend 470 47 - - 1,981(2,031) Stock options exercised 11 1 - - 35 - Treasury stock purchased - - (167) (17) (775) - Net income - - - - - 4,014 Balance at December 26, 1992 5,961 $596(841) $ (84) $7,199 $23,094 Year 1993 Stock dividend adjustment(5) - - - (22) 22 Stock options exercised 72 7 - - 206 - Treasury stock purchased - - (86) (9) (406) - Net income - - - - - 1,834 Balance at December 25, 1993 6,028 $603(927) $ (93) $6,977 $24,950 Year 1994 10% stock dividend 509 51 - - 2,255(2,308) Stock options exercised 34 3 - - 94 - Treasury stock purchased - - (13) (1) (42) - Net income - - - - - 224 Balance at December 31, 1994 6,571 $657(940) $ (94) $9,284 $22,866 The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS For the three years ended December 31, 1994 (in thousands of dollars) 1994 1993 1992 Cash provided by operations: Net income $ 224 $1,834 $4,014 Depreciation and amortization 4,161 3,872 2,834 Increase (decrease) in deferred income taxes(180) (32) 115 Provision for receivable reserves 222 63 65 4,427 5,737 7,028 Cash provided by (used for) working capital: Receivables 4,855 (4,269) 7,046 Unbilled expenditures and fees on contracts in process(1,141) (839) (5,727) Inventories 277 (623) (274) Refundable income taxes (332) 997(1,508) Prepaid expenses and other current assets(15) (442) (321) Accounts and drafts payable (885) (550) 1,325 Accrued payroll and employee benefits (87) 58 461 Deferred contract and other revenue (2,179) 193 110 Other accrued expenses 591 365 153 Accrued and current deferred income taxes 210 770 1,175 1,294 (4,340) 2,440 Net cash generated in operations 5,721 1,397 9,468 Cash used for investing activities: Additions to property and equipment, net(2,444)(12,144)(4,732) Cash provided by (used for) financing activities: Net borrowings (repayments) under line-of-credit agreements(2,065) 3,081 (3,117) Proceeds from issuance of the mortgage loan - 6,000 - Principal payment under mortgage agreement(1,200)(900) - Proceeds from exercise of stock options 97 213 36 Purchase of treasury shares (43) (415) (792) Net cash generated (used) in financing activities(3,211)7,979 (3,873) Net increase (decrease) in cash and cash equivalents 66(2,768) 863 Cash and cash equivalents at the beginning of the year140 2,908 2,045 Cash and cash equivalents at the end of the year $ 206 $ 140 $ 2,908 Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 583 $ 276 $ 32 Income taxes $ 265 $ 905 $2,761 The accompanying notes are an integral part of these consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation. The accompanying consolidated financial statements include the accounts of Dynamics Research Corporation and its wholly-owned subsidiaries (the Company). All material intercompany transactions and balances have been eliminated in consolidation. Revenue recognition. Revenues under cost-reimbursement and fixed-price contracts are recognized as costs are incurred and include applicable fees in the proportion that costs incurred bear to total estimated costs. When a loss is indicated on any contract in process, provision for the total estimated loss is made at that time. Unbilled expenditures and fees on contracts in process represent the revenue recognized on certain contracts in excess of the billings to date. Deferred contract revenue represents the amounts billed on certain contracts in excess of costs and fees incurred to date. Overhead and general and administrative costs charged to U.S. government contracts are subject to audit for years after 1992. Income taxes. Effective December 27, 1992, the Company adopted the liability method of accounting for income taxes as set forth in Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes." Under the liability method, deferred taxes are determined based upon the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax expense represents the change in the deferred tax asset/liability balance. The adoption of SFAS 109 in 1993 did not have a material effect on the Company's consolidated financial statements. Prior to fiscal 1993, the Company recorded income taxes on timing differences between financial statement and tax treatment of income and expenses under Accounting Principle Board Opinion No. 11. Inventories. Inventories are stated at the lower of cost (first-in, first- out) or market, and consist of materials, labor and overhead. There are no amounts in inventories relating to contracts having production cycles longer than one year. (in thousands of dollars) 1994 1993 1992 Work in process $ 603 $ 632 $ 418 Raw materials and subassemblies 1,750 1,998 1,589 Total $2,353 $2,630 $2,007 Property, plant & equipment. Property, plant and equipment are recorded at cost. Depreciation and amortization are provided in amounts sufficient to amortize the cost of such assets over their estimated useful lives using principally the straight-line method for plant and equipment. Leasehold improvements are amortized over the remaining term of the lease or the life of the related asset, whichever is shorter. Cash and cash equivalents. The Company considers all cash investments with original maturities of three months or less to be cash equivalents. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 2. INCOME TAXES The components of the provisions (benefit) for federal and state income taxes are as follows: (in thousands of dollars) 1994 1993 1992 Currently payable (refundable) Federal $(354) $517 $ 320 State (24) 172 85 Total $(378) $689 $ 405 Deferred Federal $ 297 $366 $1,641 State 58 103 484 Total $ 355 $469 $2,125 Total provision (benefit) $(23) $1,158 $2,530 The differences between the statutory U.S. federal income tax rate and the Company's effective tax rates are as follows: (in thousands of dollars) 1994 1993 1992 Provision at statutory rate $ 68 $1,017 $2,225 State income tax, net of federal tax benefit 23 182 375 R&D tax credit (100) - - Other, net (14) (41) (70) Provision (benefit) for income taxes $(23) $1,158 $2,530 Significant items comprising deferred tax assets and liabilities are as follows: (in thousands of dollars) 1994 1993 Unbilled costs and fees and deferred contract revenue, net $ (6,768) $(5,634) Accrued expenses 1,338 733 Receivable reserves 230 170 Inventory reserves 155 168 Other 304 32 Current deferred tax liabilities, net $(4,741)$(4,531) Accelerated tax depreciation $(581) $(820) Other (284) (225) Non-current deferred tax liabilities $(865) $(1,045) Total deferred tax liabilities, net $(5,606)$(5,576) During 1992, deferred income taxes were provided primarily for timing differences in the recognition of contract revenue. Total deferred tax assets and total deferred tax liabilities were $7,633,000 and $2,027,000, respectively at December 31, 1994 compared with $6,679,000 and $1,103,000, respectively at December 25, 1993. 3. EMPLOYEE BENEFIT PROGRAMS The Company has a noncontributory defined benefit pension plan covering substantially all of its employees. Pension plan benefits are generally based on years of service and compensation during final years of employment. The Company's funding policy is to contribute at least the minimum amount required by the Employee Retirement Income Security Act of 1974 or additional amounts to assure that plan assets will be adequate to provide retirement benefits. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. Net pension cost for 1994, 1993 and 1992 included the following components: (in thousands of dollars) 1994 1993 1992 Service cost - benefits earned during the period $1,309 $1,108 $ 1,081 Interest cost on projected benefit obligation 1,666 1,544 1,343 Actual return on plan assets 685 (1,662) (979) Net amortization and deferred items (2,198) (116) (676) Net periodic pension cost $1,462 $ 874 $ 769 The following table sets forth the plan's funded status and amounts recognized in the Company's consolidated financial statements at December 31, 1994, December 25, 1993 and December 26, 1992: (in thousands of dollars) 1994 1993 1992 Actuarial present value of benefit obligations: Vested $18,327 $19,814$13,324 Nonvested 466 569 510 Accumulated benefit obligation 18,793 20,383 13,834 Effect of projected future salary increases 2,644 2,595 3,324 Projected benefit obligation for service rendered to date 21,437 22,978 17,158 Plan assets at fair market value 19,600 19,639 17,565 Projected benefit obligation less than (in excess of) plan assets (1,837) (3,339) 407 Unrecognized net gain from past experience different from that assumed and effects of changes in assumptions (2,097) (430) (4,299) Prior service cost not yet recognized in net periodic pension cost 2,359 2,579 2,799 Unrecognized net obligation at January 1, 1987 being recognized over 15 years 246 281 316 Net pension liability recognized in the Consolidated Balance Sheet at December 31, 1994, December 25, 1993 and December 26, 1992 $ (1,329) $(909) $(777) The weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 8.5% and 3.5% in 1994, 7.25% and 3% in 1993 and 9% and 5% in 1992. The expected long-term rate of return on assets was 9% in 1994 and 1993 and 10% in 1992. A substantial portion of the projected benefit obligation decrease from 1993 to 1994 was attributable to the increase in the discount rate to match current market conditions, while the substantial increase from 1992 to 1993 was due to the lowering of the discount rate. The Company also maintains a cash or deferred savings plan (401(k) plan), under which employees may reduce their compensation and have such "elective deferrals" contributed to the plan on their behalf. The Company contributes to the plan an amount equal to 25% of the first 6% of employee's elective deferrals. The Company contributed $581,305 to the plan for 1994, $534,321 for 1993 and $477,789 for 1992. The elective deferrals are invested in one or more collective investment funds at the participant's direction. The Company's contributions are invested in guaranteed investment contracts and are paid to the employee upon termination, subject to forfeiture of any non-vested portion if termination occurs within the first five years of employment. 4. NOTES PAYABLE AND LINES OF CREDIT At December 31, l994, the Company had unsecured lines of credit with various banks that provide for maximum borrowings of $21,000,000, of which $1,200,000 was utilized. Borrowings under these lines of credit are payable on demand and bear interest at the prevailing prime interest rate (8.5% at December 31, 1994) or at a lower rate quoted by the respective banks. The Company's average interest rate on outstanding borrowings at December 31, 1994, December 25, 1993 and December 26, 1992 were 7.0%, 3.8% and 6.0% respectively. While the arrangements do not have termination dates, the terms are reviewed and revised periodically. 5. LONG-TERM DEBT (in thousands of dollars) Long-term debt consists of the following: 1994 1993 Mortgage note payable to a bank, bearing interest at LIBOR plus 1% (6.7% through February 2, 1995, at which time the interest rate is to be adjusted) due in quarterly payments of $300,000 plus interest through February 1998,secured by certain land and buildings. $ 3,900 $ 5,100 Other 38 - Less - current portion (1,221) (1,200) $2,717 $3,900 Future maturities of long-term debt are as follows:1995 $ 1,221 1996 1,217 1997 1,200 1998 300 $3,938 The Mortgage Agreement contains covenants concerning certain operating ratios, minimum balances of net worth and specified fixed charge coverage ratios. The Company, during the third and fourth quarters of 1994 was not in compliance with the covenants which require specified fixed charge coverage ratios. The bank has waived these defaults. The Mortgage Agreement has been amended and the Company is in compliance with the amended covenants. Based on current operating plans, management believes the amended covenants can be met on a continuing basis. 6. STOCK OPTION PLANS The Company has stock option plans which are administered by the Compensation Committee of the Board of Directors who determine the employees to receive options and the number and option price of shares covered by each such option. On April 27, 1993, the Company's shareholders approved the 1993 Equity Incentive Plan (1993 Plan) to replace the Company's 1983 Stock Option Plan (1983 Plan), which terminated in 1993. The 1993 Plan permits the Company to grant incentive stock options, stock appreciation rights (SAR), awards of nontransferable shares of restricted common stock and deferred grants of common stock. Options granted under the 1983 Plan on or before December 31, 1986 are not exercisable, while previously granted options are outstanding. Options granted under both plans may be either incentive stock options or non-qualified stock options. The option price shall not be less than the fair market value at the time the option is granted, and the option period may not be greater than ten years from the date the option is granted. Options under the plans have normally been exercisable in three equal installments commencing one year from the date of the grant. Transactions involving the plans are summarized as follows:* 1994 1993 1992 Shares under option: Outstanding at beginning of year 429,129 481,704 434,775 Granted - 38,500 89,843 Exercised (34,120) (79,986) (12,966) Canceled (34,117) (11,089) (29,948) Outstanding at end of year 360,892 429,129 481,704 Price range of options outstanding$3.46-$7.42$2.60-$7.42$2.60-$7.42 Exercisable at end of year 315,602 315,205 340,293 * Retroactively adjusted for the May 1994 stock dividend. At December 31, l994, under the 1993 Plan, 440,000 shares have been reserved, of which 418,000 shares are available for future grants. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 7. COMMITMENTS AND CONTINGENCIES The Company conducts certain of its operations in facilities which are under long-term operating leases expiring at various dates through 1999, with various options to renew through 2004. Rent expense under these leases (exclusive of real estate taxes, insurance and other expenses payable under the terms of the leases) was approximately $1,800,000 in 1994 and $1,887,000 in 1993 and $3,300,000 in 1992. The aggregate minimum lease commitment for the Company's facilities on December 31, 1994 was $2,344,000, payable as follows: $1,332,000 in 1995, $436,000 in 1996, $359,000 in 1997, $188,000 in 1998 and $29,000 in 1999. The Company also leases certain equipment. Rent expense under these leases was approximately $46,000 in 1994, $429,000 in 1993 and $1,390,000 in 1992. The Company entered into a settlement agreement in April, 1994 with the Department of Justice whereby the Company paid $1,790,000, to the U.S. Government and a civil suit against the Company, filed by the Department of Justice in 1991, was dismissed. The amount of the settlement had been fully reserved and had no impact on reported results during 1994. 8. PREFERRED STOCK PURCHASE RIGHTS On July 14, 1988, and as amended on September 6, 1989, the Company declared a dividend distribution of one preferred stock purchase right (Right) for every outstanding share of common stock. The Rights have attached to all outstanding shares of common stock, and no separate Rights certificates will be issued. The Rights will become exercisable upon the earlier to occur of (i) the date which is the tenth business day following a public announcement that a person or group of affiliated or associated persons has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of common stock or (ii) the tenth business day following the commencement or announcement of an intention to make a tender offer or exchange offer that would result in a person or group owning 30% or more of the outstanding common stock. When exercisable, each Right entitles the registered holder to purchase from the Company one tenth of a share of its Series A Participating Preferred Stock, $.10 par value, at a price of $40.00 per each one tenth share of preferred stock. Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the Company including, without limitation, the right to vote or to receive dividends. The Rights may be redeemed by the Company at the discretion of the Board of Directors, at a price of $.01 per Right, and they expire on July 27, 1998. 9. BUSINESS SEGMENTS The Company provides computer systems services, other engineering and management support services and manufactures position and motion sensors and other precision components. The Systems segment provides specialized technical services to the Department of Defense and produced approximately 82% of total Company revenues in 1994. These services include the development and operation of computer-based management information systems where sophisticated software programs are applied to collect, analyze, store and retrieve information regarding the location, design, configuration, maintenance status and performance test history of the individual component parts of major weapons systems. The Commercial products segment produces encoders, which are used to measure rotary or linear movement, and precision-patterned glass and electroformed metal products. Identifiable assets by business segment include both assets directly identified with those operations and an allocable share of jointly used assets. General corporate assets consist primarily of cash and the Company's corporate headquarters. Summarized financial information by business segment for 1994, 1993 and 1992 are as follows: (in thousands of dollars) 1994 1993 1992 Revenue: Defense systems and services $84,891 $88,085$92,015 Commercial products 18,073 13,017 10,566 Total Revenue $102,964$101,102 $102,581 Operating income: Defense systems and services $(290) $3,457 $6,225 Commercial products 922 (215) 152 Total operating income $ 632 $3,242 $6,377 Total assets: Defense systems and services $36,573 $41,744$37,767 Commercial products 6,878 7,432 6,060 Corporate 10,526 10,318 5,050 Total Assets $53,977 $59,494$48,877 Depreciation and amortization: Defense systems and services $2,932 $2,726 $2,114 Commercial products 772 674 545 Corporate 457 472 175 Total depreciation and amortization $4,161 $3,872 $2,834 Capital expenditures: Defense systems and services $1,971 $2,207 $3,455 Commercial products 347 779 1,191 Corporate 126 9,158 86 Total capital expenditures $2,444 $12,144$4,732 9. BUSINESS SEGMENTS - CONTINUED Unbilled expenditures and fees on contracts in process consist of costs and estimated earnings in excess of billings on uncompleted government contracts and are comprised principally of amounts, including retainage, for which billings could not be presented under the terms of the contracts at the balance sheet dates. Unbilled expenditures and fees on contracts in process with the U.S. Government at December 31, 1994 were $18,194,000 compared to $17,053,000 at December 25, 1993, and $16,214,000 at December 26, 1992. The approximate number of U.S. Government contracts has varied between 100 and 150 during the past five years, with 125 contracts open at December 31, 1994. Receivables under U.S. Government contracts at December 31, 1994 were $12,505,000 compared to $17,580,000 at December 25, 1993, and $14,059,000 at December 26, 1992. MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS The management of Dynamics Research Corporation is responsible for the accuracy and internal consistency of all information contained in this annual report, including the consolidated financial statements. Management has followed those generally accepted accounting principles which it believes to be most appropriate to the circumstances of the Company, and has made what it believes to be reasonable and prudent judgments and estimates where necessary. Dynamics Research Corporation operates under a system of internal accounting controls designed to provide reasonable assurance that its financial records are accurate, that the assets of the Company are protected, and that the financial statements present fairly the financial position and results of operations of the Company. The internal accounting control system is tested, monitored and revised as necessary. Three directors of the Company, not members of management, serve as the Audit Committee of the Board of Directors and are the principal means through which the Board supervises the performance of the financial reporting duties of management. The Audit Committee meets with management and the Company's independent auditors several times a year to review the results of external audits of the Company and to discuss plans for future audits. At these meetings the Audit Committee also meets privately with the independent auditors to assure its free access to them. The Company's independent auditors, Arthur Andersen LLP, audited the financial statements prepared by the management of Dynamics Research Corporation. Their report on these statements is presented below. Albert Rand Douglas R. Potter President, Chief Executive OfficerVice President of Finance, Chief Financial Officer REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Dynamics Research Corporation: We have audited the accompanying consolidated balance sheets of DYNAMICS RESEARCH CORPORATION (a Massachusetts corporation) and subsidiaries as of December 31, 1994, December 25, 1993 and December 26, 1992, and the related consolidated statements of operations, shareholders' investment and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of DYNAMICS RESEARCH CORPORATION and subsidiaries as of December 31, 1994, December 25, 1993 and December 26, 1992, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Boston, Massachusetts, February 10, 1995 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND OPERATING RESULTS RESULTS OF OPERATIONS This discussion and analysis should be read in conjunction with and is intended to supplement the information set forth in the Company's consolidated financial statements and related notes. The following table sets forth, for the periods indicated, the percentage which certain items in the Consolidated Statements of Operations bear to revenue: 1994 1993 1992 Revenue Contract revenue 82.4% 87.1% 89.7% Product sales 17.6 12.9 10.3 Total revenue 100.0 100.0 100.0 Cost of contract revenue* 91.2 84.6 82.9 Cost of product sales* 80.6 82.7 77.3 Total cost of sales 89.3 84.4 82.3 Selling, engineering and administrative expenses 10.1 12.411.5 Total operating costs 99.4 96.8 93.8 Operating income 0.6 3.2 6.2 Interest expense (income), net 0.4 0.2 (0.2) Income before income taxes 0.2 3.0 6.4 Provision for income taxes 0.0 1.2 2.5 Net income 0.2% 1.8% 3.9% *These amounts represent a percentage of contract revenue and product sales, respectively. The following comments should be read in conjunction with the foregoing table: Contract revenue decreased 3.6% or $3,194,000 in 1994 over 1993 as compared to a 4.3% or $3,930,000 decrease in 1993 over 1992. During 1994, the Company experienced reductions in several areas including the Air Force Technical, Engineering and Management Support (TEMS) program at Hanscom Air Force Base. Also, reflected in 1994 revenue was a $1.0 million third quarter adjustment in connection with a contract with the United States Air Force to reflect the uncertainty of recovery of certain costs incurred to date. Defense budget pressures and priorities may alter the future scope of defense programs, and the potential impact of these changes on the Company's future contract revenue is difficult to predict. However, much of the Company's revenue relates to the development and operation of computer based management information and logistics support systems which continue to receive budgetary suppport. The Company is continuing to pursue additional programs both within the Department of Defense (DoD) and with other government agencies. The 1993 decrease in revenue primarily resulted from the Company continuing TEMS work as a subcontractor, rather than as prime contractor. Product sales in 1994 increased 38.8% or $5,056,000 as compared with 1993. This was principally the result of full production of a new line of custom encoder devices for a customer in the automotive industry and of electroformed components for commercial printers and increased business across a wide customer base. Product sales in 1993 increased 23.2% or $2,451,000 as compared with 1992. This principally resulted from commencement of sales of the new product lines. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND OPERATING RESULTS - CONTINUED Cost of contract revenue as a percentage of contract revenue increased from 84.6% in 1993 to 91.2% in 1994. This increase was due principally to $500,000 in charges for reserves related to certain Air Force programs and to the continuing adverse effect on profit margins resulting from the Company's shift from a prime contractor role to a subcontractor role for the engineering services program performed for the Air Force at Hanscom Air Force Base. A nonrecurring charge of $750,000 was taken in the third quarter of 1994 relating to staff reductions, consisting primarily of seperation costs. Cost reduction actions were taken in the fourth quarter of 1993, consisting primarily of indirect labor staff reductions and consolidation of office space. Facility costs were significantly reduced in 1994 and 1993 compared to 1992 due to the January 1993 purchase of the Andover, Massachusetts building occupied by its Corporate offices and Systems Division. The cost of contract revenue, measured as a percentage of contract revenue, increased from 82.9% in 1992 to 84.6% in 1993. This was attributable to lower profit margins on specific contracts in 1993. Cost of goods as a percentage of product sales decreased from 82.7% in 1993 to 80.6% in 1994. This decrease was primarily the result of full production levels of the new custom encoder product line and increased production of electroformed components for commercial printers. Start-up costs for these product lines were incurred in 1993 and targeted unit production levels for these products were achieved in 1994. Cost of goods as a percentage of product sales increased from 77.3% in 1992 to 82.7% in 1993. This increase was the result of start-up costs for the new custom encoder product line. Selling, engineering and administrative expenses decreased $2,206,000 or 17.6% in 1994 from 1993. The decrease was principally due to the completion of research and development efforts by the Company related to the Company's maintenance data system for the Air Force. These internal research and development efforts were completed late in 1993. There was also a decrease in general and administrative expenses due to staff reductions in late 1993. Selling, engineering and administrative expenses increased $776,000 or 6.6% in 1993 over 1992. The increase was principally due to an increase of $544,000 in research and development expense as discussed above. Interest expense (income), net increased to $431,000 in 1994 from $250,000 in 1993 due to an increase in the average level of the Company's borrowings in 1994 combined with higher average interest rates in 1994. The sum of receivables and unbilled expenditures and fees on contracts in process increased from the end of 1992 to 1993 and then decreased at the end of 1994. Early in 1993, the Company acquired its headquarters building with a combination of cash and mortgage financing. Provision (benefit) for income taxes was (11.4%) for 1994, and 38.7% for 1993 and 1992. Effective December 27, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." This statement requires the use of the liability method for computing the current and deferred provisions for income taxes. The adoption of this method did not have a material impact on the Company's tax provision. The 1994 tax rate was favorably affected by research and development expenditure credits as well as somewhat lower net state income taxes. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND OPERATING RESULTS - CONTINUED The Company's backlog of unfilled orders at the end of 1994 was $43,679,000, a decrease of 14.8% from $51,257,000 in 1993. A portion of the Company's backlog is based on annual purchase contracts, and the amount of the backlog as of any date can be affected by the timing of such order receipts and deliveries thereunder. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of liquidity have been cash flow from operations and bank credit lines. The ratio of current assets to current liabilities was 2.1 to 1 at December 31, 1994 compared to 1.9 to 1 at the end of 1993. The change in this ratio is attributable to the paydown of notes payable from $3.3 million at year-end 1993 to $1.2 million at year- end 1994 as well as other reductions in payables. During 1994, noncash expenses for depreciation and amortization and favorable receivables collections enabled the Company to generate $5.7 million from operations despite net income of only $.2 million. Further receivable reductions are expected in 1995. The Company had no large capital spending commitments as of December 31, 1994. At December 31, 1994, $19,800,000 was available under the Company's current lines of credit. The Company believes that its liquid assets, cash flows from operations and available bank lines of credit will support its operating and capital requirements for 1995. IMPACT OF INFLACTION AND CHANGING PRICES Overall, inflation has not had a material impact on the Company's operations. Increased costs and expenses have been offset by price increases, cost reduction programs and improved productivity. In addition, the terms of Defense contracts, which account for approximately 82% of the Company's revenues in 1994 are generally for one year, thus reducing the potential impact of inflation on the Company. CORPORATE HEADQUARTERS 60 Frontage Road Andover, Massachusetts 01810-5498 Telephone: (508) 475-9090 Fax: (508) 475-8205 AUDITORS Arthur Andersen LLP One International Place, Boston, Massachusetts 02110 LEGAL COUNSEL Ropes & Gray One International Place, Boston, Massachusetts 02110 TRANSFER AGENT American Stock Transfer & Trust Company 99 Wall Street, New York, New York 10005 Telephone: (800) 937-5449 STOCK PRICES Bid price by quarter 1994 1993* High LowHigh Low First quarter $4.77 $3.86$5.80 $3.62 Second quarter 4.55 3.645.45 4.21 Third quarter 4.00 3.385.00 4.32 Fourth quarter 3.75 2.754.66 3.41 * Retroactively adjusted for the May 1994 stock dividend. The bid and asked prices of the Company's common stock on February 16, 1995 were $4.00 and $4.75, respectively. Prices shown reflect inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions. Source: Monthly Statistical Report of the National Association of Securities Dealers, Inc. - NASDAQ. COMMON STOCK The Company's stock is traded on the NASDAQ National Market System, Symbol: DRCO; and listed in newspapers as DynamR., DynRsh. or DynRsearch. NUMBER OF SHAREHOLDERS The approximate number of shareholders of record at February 16, 1995 was 1,085. As of February 16, 1995 there were 5,630,448 common shares outstanding. FORM 10-K A copy of DRC's Form 10-K, which is filed annually with the Securities and Exchange Commission, will be sent without charge to any shareholder requesting it in writing to the Treasurer's office, Dynamics Research Corporation, 60 Frontage Road, Andover, Massachusetts 01810-5498. ANNUAL MEETING The 1995 Annual Meeting of Shareholders will be held on Tuesday, April 25, 1995 at the State Street Bank and Trust Building, 33rd floor, 225 Franklin Street, Boston, Massachusetts 02110. DIRECTORS Dr. Francis J. Aguilar** Professor of Business Administration, Harvard University, Graduate School of Business Administration John S. Anderegg, Jr. Chairman, Dynamics Research Corporation General James P. Mullins** USAF retired Albert Rand President and Chief Executive Officer, Dynamics Research Corporation Thomas J. Troup* Vice Chairman, Burr-Brown Corporation * Member of the Audit Committee. ** Member of the Audit and Compensation Committees OFFICERS John S. Anderegg, Jr. Chairman Albert Rand President, Chief Executive Officer Arthur Brown Vice President, Contracts, Systems Division Dr. Joseph W. Griffin, Jr. Vice President, Systems Development, Systems Division Chester Ju Vice President, Encoder Division and Metrigraphics Division Douglas R. Potter Vice President of Finance and Chief Financial Officer Richard P. Rappaport Vice President, Test Equipment Division Vernon F. Vutech Vice President, Systems Programs, Systems Division John L. Wilkinson Vice President, Human Resources David C. Proctor Treasurer and Assistant Clerk Frederick Eromin Controller, Systems Division John R.D. McClintock Clerk