10-K 1 d10k.txt FORM 10-K 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, 2001 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 (State or Other Jurisdiction of Incorporation or Organization) 04-2211809 (I.R.S. Employer Identification No.) 60 FRONTAGE ROAD ANDOVER, MASSACHUSETTS 01810-5498 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (978) 475-9090 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class NONE Name of Each Exchange on Which Registered 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 . Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] As of February 22, 2002, the aggregate market value of Common Stock held by nonaffiliates of the Registrant was $147,832,002 and the number of shares of Common Stock, $.10 par value, of the Registrant outstanding was 7,990,919. Documents Incorporated By Reference Portions of the Registrant's Proxy Statement for the 2002 Annual Meeting of Shareholders are incorporated by reference in Part III. The Exhibit Index is on page 46. Form 10-K for the Fiscal Year Ended December 31, 2001
Part I Page Item 1. Business 4 2. Properties 11 3. Legal Proceedings 11 4. Submission of Matters to a Vote of Security Holders 11 4A. Executive Officers of the Registrant 12 Part II 5. Market for Registrant's Common Equity and Related Stockholder Matters 12 6. Selected Financial Data 12 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 7A. Quantitative and Qualitative Disclosures about Material Risk 19 8. Financial Statements and Supplementary Data 19 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 38 Part III 10. Directors and Executive Officers of the Registrant 38 11. Executive Compensation 38 12. Security Ownership of Certain Beneficial Owners and Management 38 13. Certain Relationships and Related Transactions 38 Part IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 38
Part I Item 1. Business Overview Dynamics Research Corporation ("DRC" or the "company") provides information technology, engineering, logistics and other consulting services to federal defense, civil and state agency customers. Founded in 1955 and headquartered in Andover, Massachusetts, DRC has 1,517 employees in 36 offices in 19 states in the United States. DRC's core capabilities are focused on information technology, engineering and technical subject matter expertise, which pertain to the knowledge domains relevant to the company's core customers. More specifically, these capabilities include design, development, operation and maintenance of information technology systems, engineering services, complex logistics planning systems and services, defense program administrative support services, simulation, modeling, training systems and services and custom built electronic test equipment and services. DRC applies proven processes and technologies to enhance the performance and cost effectiveness of a variety of mission-critical customer systems. DRC believes that one of its unique competitive advantages is its ability to provide subject matter experts who work closely with specialists in disciplines such as information technology, logistics, engineering, modeling, simulation and training systems to develop innovative solutions to customer challenges. In the company's precision manufacturing business DRC develops and produces components for original equipment manufacturers in the computer, medical electronics, telecommunications and factory automation industries. Manufacturing core capabilities are focused on the custom design and manufacture of miniature electronic parts meeting ultra-high precision requirements using electroforming, thin film deposition and photolithography technologies, as well as on optical encoders that convert analog motion and position information into digital signals. Markets DRC's systems and services business, which accounted for 89 percent of revenues in 2001, is focused on providing information technology and technical services to government customers. The government market is composed of three sectors - defense, federal civilian agencies, and state and local governments. The United States Department of Defense spends, according to industry reports, approximately $20 billion annually on information technology. Several factors are driving growth in this market. First, increased spending on national defense, the war on terrorism, sustaining military readiness, homeland security and efforts to transform the United States military forces will focus on technology-based solutions. Second, there is an increased reliance on contractors to supply mission critical services due to government workforce ceilings. In the federal civilian agency sector annual information technology spending is estimated by industry reports at more than $20 billion. Factors driving growth in this sector include an on-going need for systems modernization and, as in the defense sector, government workforce ceilings. These factors have and are expected to continue to cause federal civilian agencies to turn to contractors on an increasing basis to fill their needs for information technology services. Customers in the third sector of the government market, states and local jurisdictions, are estimated by industry reports to spend $39 billion annually on information technology. Health and human services, an area in which DRC has considerable experience, constitute the second largest area of state spending with annual budgets totaling $8 billion. Factors driving growth in this sector are infrastructure modernization and expansion, the migration of information and training to the Web, and cost-sharing incentives to facilitate data exchange with federal agencies. State government health and human services agencies are among the organizations that most need information technology services to upgrade and maintain their computer-based information systems. They have large and burdensome caseloads and must maintain extensive records, reporting of program data, elimination of errors, and more responsive management. Yet the information systems of many such agencies are antiquated and have limited data interfacing and reporting capabilities. While this market has excellent long-term growth prospects, in the short-term state spending constraints are limiting investments and growth in contracted services. 4 DRC's Precision Manufacturing Group, which represented 11 percent of total company revenues in 2001, serves the commercial high-tech original equipment manufacturers' ("OEM") market. This market, which was in a downturn in 2001, includes computing, electronic test, telecommunications, medical technology, optical and industrial equipment. The Precision Manufacturing Group sells exclusively to commercial customers. Major Customers The company's 2001 revenues, broken down by market sector, were 73 percent defense, 6 percent federal civilian agencies, 10 percent state and local governments, and 11 percent commercial OEMs. Federal civilian agencies and state and local government were the fastest growing sectors for DRC in 2001. Defense Sector United States Air Force customers constituted the largest component of DRC's defense revenues in 2001, representing 44 percent of total revenues, while Navy revenues were 18 percent of the total, Army revenues represented 7 percent and other agencies were 4 percent. DRC's defense sector revenues have grown at an average annual rate of 11 percent since 1996. Key capabilities DRC offers defense customers include program management services; modeling and simulation; training products and systems; and software development and maintenance. In addition, DRC's test equipment business develops, maintains and validates hardware and software for complex weapons systems and operates a supercomputing facility for semiconductor modeling for defense applications. Descriptions of the work DRC performs for the company's major customers in this sector follow. Air Force Electronic Systems Center The mission of the Electronic Systems Center ("ESC"), headquartered at Hanscom Air Force Base, Bedford, MA, is to serve as the Center of Excellence for command and control and information systems to support the Air Force warfighter in war and peace. ESC provides full spectrum architectures, weapon systems management and technical cognizance throughout the life cycle of communications, intelligence, surveillance, reconnaissance, and information systems. DRC evaluates system requirements, provides software development and test services, integrates products into airborne and ground weapons systems, and provides management services supporting ESC systems program offices, including the Combat Air Forces Command and Control, Military Satellite Communications, Joint Surveillance Target Attack Radar, Airborne Warning and Control Systems, and Defense Information Infrastructure offices. DRC is the prime support contractor to the Combat Air Forces Command and Control Systems Program Office, which manages the development and acquisition of command and control systems. These systems gather and analyze information on hostile forces, enabling commanders to rapidly make and communicate decisions to their forces. This office is the Electronic System Center's largest and most advanced information technology program. In addition to the services noted above, DRC also is helping this program office with controlling costs. The company's proprietary expense tracking and planning system has enabled the program to cut operating and overhead costs by 20 percent. Navy Trident Missile Program For more than forty years, the company has provided services to the United States Navy Strategic Systems Program office. DRC builds specialized equipment that tests and validates the accuracy and operability of gyroscopes and other navigational equipment for Trident II submarines and missiles. DRC develops and maintains performance, reliability, and logistics databases for the inertial guidance instruments housed in missile guidance systems and submarine inertial guidance systems. It also provides independent analysis and monitoring of submarine-based inertial guidance systems and electronic modules. Air Force Depot Operations DRC performs logistics analyses and operations for the United States Air Force's three domestic Air Logistics Centers at Tinker, Warner Robins and Hill Air Force Bases. The company provides logistics support, information technology management and analysis, system engineering and technical services on programs such as the B-1B, the B-2, the B-52, the KC-135, and the E-3A aircraft repair, maintenance, and upgrade programs. Additional tasking has centered on providing support to Air Force reengineering and business process improvement initiatives at these Air Logistics Centers. 5 DRC is also developing an analytical simulation model that will enable Tinker Air Force Base to determine how to more efficiently conduct depot repairs on aircraft engines, especially for the F-16. A key program objective is minimizing the lifecycle costs of maintaining major weapons systems. DRC has installed, integrated and is providing operational support for a customized suite of commercial software products to improve productivity at the United States Air Force's landing gear maintenance, repair and overhaul operations at Hill Air Force Base in Ogden, Utah. Aeronautical Systems Center, Air Force Materiel Command The Aeronautical Systems Center, headquartered at Wright-Patterson Air Force Base, Ohio is responsible for research, development, test, evaluation and initial acquisition of aeronautical systems and related equipment for the Air Force. Its major active programs are the B-2 and B-1B bombers, C-17 airlifter, F-22 fighter and continuing work on the F-117A fighter, F-15 Eagle and F-16 Fighting Falcon. DRC provides technical and subject matter expertise supporting a number of the offices responsible for these programs in carrying out their mission-essential tasks and objectives such as product support, information services, supply management, depot maintenance, science and technology, test and evaluation, information management, installations and support, and combat support. Army Aviation/Missile Command DRC provides programmatic consulting, engineering and logistics management to the Army Materiel Command and Army program executive officers for acquisition of major weapon systems. DRC engineers analyze and review airframe, avionics, aeromechanics and propulsion issues for Army project managers, provide logistics and fielding support, and prepare electronic technical manuals for rotary and fixed-wing aircraft systems. DRC supports other United States Army activities with acquisition logistics, systems engineering and other related program management services at the United States Army Aviation Center, Tank-automotive and Armaments Command and Communications-Electronics Command. In 2001, DRC received a contract from the United States Army Aviation & Missile Command located at Redstone Arsenal, Alabama to provide helicopter vibration analysis, a program designed to improve the operational effectiveness of the Army's helicopters through use of advanced identification, monitoring, and analysis techniques to control adverse vibrations in dynamic components. Army Research In 2001 DRC received a five-year contract from the United States Army Medical Research Acquisition Activity to expand its MedTeams(R) program for improving teamwork and reducing medical error among emergency care hospital staff into other medical specialties. The contract provides for research to expand MedTeams into other specialties such as labor and delivery. It also includes provisions for establishing MedTeams Centers of Excellence and a cadre of trainers to deliver MedTeams training throughout the Department of Defense. Recognizing the need for better communication and teamwork among Army air crews, the United States Army Research Institute for the Behavioral and Social Sciences, the Army's main research laboratory for personnel performance and training, turned to DRC behavioral scientists. Based on the success of a program originally created for the Army in 1993, DRC is developing a Web-based, interactive training system that offers air crews anywhere in the world the knowledge, teamwork skills and attitudes that will result in improved mission effectiveness and lower accident rates. The first part of this three-phase program is an 18-month contract valued at $1.8 million. DRC's team training and evaluation system is one of the Army Aviation Safety Investment Strategy Team's top 10 solutions for reducing aviation accidents. Air Force Air Mobility Command The Air Mobility Command, headquartered at Scott Air Force Base, Illinois has as its primary mission rapid, global mobility and sustainment for America's armed forces. The command also plays a crucial role in providing humanitarian support at home and around the world. DRC provides technical and subject matter expertise in support of this mission, providing program planning, decision support, logistics analysis and financial analysis services. Modeling, Simulation and Decision Support Programs DRC applies its capabilities in the area of modeling and simulation on many engagements, including projects for the United States Joint Forces Command, the Defense Modeling and Simulation Office, the Naval Aviation Warfare Center, the Chief of Naval Education and Training, Air National Guard, and the Air Force Installations and Logistics Director of Supply. 6 The United States Joint Forces Command Joint Warfighting Center orchestrates military training exercises in various world theaters. These wargames entail major geographic and functional commands, and thousands of troops, as well as supplies, vehicles and equipment to support them. Such exercises require top-level coordination to maximize effectiveness and avoid schedule and resource conflicts. DRC developed and is now enhancing the Joint Training Information Management System ("JTIMS"), a Web-based application that lets authorized personnel collaboratively plan and execute wargames. The system enables combatant commands, joint organizations and defense agencies to align training with assigned missions, and helps ensure missions are consistent with organizational priorities. The United States Naval Aviation Warfare Center's Training Systems Division develops instructional programs for Navy pilots and maintenance personnel. After identifying aviation readiness as an area of concern, the Navy established a program to improve aviator training. DRC's first task under an initial 10-month, $2.75 million contract is to exhaustively analyze course content and determine which material is best taught in the classroom, through self-study programs, at simulators or in flight. DRC engineers and training specialists are also working under an aggressive schedule to deconstruct and categorize flight mission tasks. This information will be used to design flight simulators that provide the most relevant, cost-effective training and accurate performance measures. DRC is developing an analytical tool for the Chief of Naval Education & Training to simulate the training pipeline and help the Navy predict demand for various training programs. The system is being designed to help the Navy ascertain the costs and risks of potential changes to training programs before they are made. DRC has developed and maintains a system, called the Guard Information Analysis Network, which is used daily to provide updates and performance reports on aircraft capability, engine status, spare parts availability, and to provide decision support to mission planning for the United States Air National Guard. This real-time information system is currently playing a critical role in homeland defense. DRC developed a similar system and provides similar services for the Air Force Installations and Logistics Director of Supply under a program known as Multi-Echelon Resources and Logistics Information, providing insight on availability and capacity of Air Force assets, fleet-wide. Air Force Materiel Support Group One system, for which the Materiel Support Group ("MSG") is responsible, is the Weapon Systems Management Information System, a key decision-support tool for assessing the impacts of maintenance, parts and repair status on weapons systems availability. DRC provides operations, maintenance and development support services to MSG for this system. Naval Aviation Systems Command In 2000 DRC was awarded a five-year, multi-million dollar subcontract to provide engineering and information services to the United States Naval Aviation Systems Command Logistics Competency ("NAVAIR"). DRC is a primary subcontractor to Lockheed Martin Systems Integration-Owego in assisting NAVAIR in the modernization of naval aviation logistics information management systems. Federal Civilian Agency Sector United States Government federal civilian agencies present an important growth market for DRC. While DRC currently has limited penetration in this market, several of the company's core capabilities have direct applicability to the needs of customers in this sector. A description of DRC's major customer engagements in this sector follows. Internal Revenue Service The Internal Revenue Service is DRC's primary customer in this sector. DRC is a key contractor on this program, having been awarded potentially more than $65 million in contracts to date. In July 2000, DRC signed a five-year contract with the IRS to provide technical and management services in four task areas: telecommunications, information services, organizational management and operational support. In 2001 DRC was the recipient of a five-year information system contract worth $20-36 million to support the Internal Revenue Services' Dallas-based Mid-America Development Center. Currently, DRC's efforts focus on two major projects: the Compliance Research Information System ("CRIS"), a tool that helps IRS statisticians identify deviations that indicate potential tax fraud; and the Integrated Collection System ("ICS"), a tool for more timely, accurate and productive tax collection. DRC is helping convert CRIS to a Web-based platform, giving hundreds of IRS statisticians access to the latest version regardless of location or computer configuration. DRC is also assisting with data warehousing, data mining and expanding the system for more 7 users. On the ICS project, DRC is helping the IRS migrate from a legacy system to a Windows NT environment, which will allow agents responsible for apprehending tax evaders to access ICS, Microsoft Office and e-mail from laptops while they're out in the field. United States Customs Service Air and Marine Interdiction Division The United States Customs Service National Aviation Center in Oklahoma City trains pilots and other flight personnel for aerial border surveillance. DRC has assisted agency flight experts to plan standardized training systems and develop courseware. Manuals and other paper curriculum materials were converted to a computer-based system and integrated into an overall instructional framework. DRC now creates electronic training materials for use in classrooms, on standalone computers, over the agency's local area network, and via a secure Web site for distance learning. State and Local Government Sector DRC designs, develops, implements, maintains and supports software, networks and systems for state health and human services agencies and local users of these statewide systems. While DRC currently has limited penetration, the company has several avenues for growth in this market. In addition to an expected increase in state spending in these areas over the next several years, the company has the ability to expand the scope of services provided to current customers and to attract new customers in other agencies and in other states. A description of DRC's major customer engagements in this sector follows. Colorado Department of Human Services Since 1997, DRC has worked with the state of Colorado to develop, deploy and maintain an integrated statewide system, known as Colorado Trails ("Trails"), that streamlines the workload for social workers, youth corrections officers and administrators. DRC has developed and maintains the software and has installed a network of 3,000 computers at 130 sites, providing users with new computers, networking equipment, e-mail and the Trails application. Trails includes tools for determining and managing such functions as client eligibility, court appearances, residential facilities, finance, automatic payment generation through the state's financial processing system and administration. DRC also developed an award-winning online support tool with a computer-based training program for social workers that incorporates links to electronic policy and procedure manuals. To facilitate intra-agency coordination, Trails also interfaces with systems supporting criminal justice and childcare tracking functions. The network supported by DRC has been expanded to support the state's benefits management system, which also is under the responsibility of the Department of Human Services. State of Ohio, Department of Job and Family Services Since 1997, DRC has provided information technology expertise and implementation to the state of Ohio's Support Enforcement Tracking System, a program that tracks down "deadbeat parents." DRC has a dedicated network maintenance team responsible for rapid-response repair of the agency's 19,000 computers, 600 printers, 240 file servers, and 520 routers and switches--across 88 counties. DRC's team of engineers and network administrators must respond to trouble calls within four hours and resolve the problem within eight hours. Since the program began four years ago, DRC has achieved a perfect record for responding to and repairing all reported problems. DRC's Capabilities Systems and Services The core capabilities of DRC's systems and services business are focused on information technology, engineering and technical subject matter expertise, which pertain to the knowledge domains relevant to the company's core customers. These include design, development, operation and maintenance of information technology systems, acquisition and program support, engineering services, complex logistics planning systems and services, defense program administrative support services, modeling, simulation, training systems and services and custom built electronic test equipment and services. More specific descriptions of these capabilities follow. Information Technology Capabilities DRC offers include systems integration; applications development; engineering of multi-level information system security; legacy system data migration; development of decision support systems; integration of commercial off-the-shelf software; network infrastructure design and maintenance; technical management services and consulting; and independent verification and validation services. 8 Defense Program Management Services Capabilities in this category include technology, planning and acquisition, systems engineering, logistics systems planning, decision support, financial and administrative services. Engineering Services Capabilities in this category include engineering analysis applied to electronic, communication, aeronautical, naval and navigation systems; reverse engineering of electronic components; precision component design; test, maintenance and support of navigation and guidance systems; human factors integration; and business process reengineering. Logistics Capabilities DRC offers include logistics analysis and support; supply chain analysis and management; development of decision support systems; and configuration of maintenance, repair and overhaul systems. Modeling and Simulation DRC's capabilities in this category include simulation of discrete and ongoing events; simulation-based reengineering; logistics and supply chain modeling; object-oriented modeling techniques; and simulation support services. Training Analysis and Delivery Capabilities in this category include training task analysis; development of computer-based training programs and training delivery systems; and electronic performance support systems. Precision Manufacturing The core capabilities of DRC's Precision Manufacturing Group are process focused for the Metrigraphics Division and product focused for the Encoder Division. Metrigraphics Division The Metrigraphics Division's expertise centers on photolithography, thin film deposition of metals and dielectrics, and electroforming. Metrigraphics' superior ability to design and manufacture components and maintain critical tolerances is an important driver for a wide range of high-technology applications. The company currently applies these technologies in four distinct applications: 1) inkjet printer cartridge nozzle plates and hard drive test devices; 2) medical applications for micro-flex circuits used in angioplasty and for blood testing; 3) electrical test devices for application in flexible interposers and 3-D microstructures; and 4) devices used in the manufacture of fiber optic system components requiring precision alignment and 3-D microstructures. Encoder Division The Encoder Division designs, manufactures and markets a line of optical encoders that convert analog motion and position information into digital signals used in a wide variety of industrial products and systems, including machine tools, robotics, engine fuel-control systems, packaging and factory automation equipment, and semiconductor processing. The ability to custom design products is a core capability for the Encoder Division. Business Development The company has a well-established capability of winning contract renewals and re-competes, based on the company's line management knowledge of customer needs and DRC's incumbent expertise. The company's business development group is charged with identifying and winning significant new business opportunities and supporting major competitions related to existing customers and business. The group is centrally managed, with resources aligned to operating line organizations. The group also maintains a proposal development and publication capability. The group operates with formal processes, which monitor the pipeline of opportunities, align resources to significant opportunities and engage line and executive management. Government Contracts The federal procurement process has changed significantly in recent years. Whereas the traditional method of federal government procurement has been to conduct a lengthy competitive bidding process for each award, today base purchase agreements, indefinite delivery, indefinite quantity contracts and the General Services 9 Administration contract form and related schedules are the predominant forms of contracting for IT and technical services. These vehicles have enabled contracting officers to accelerate the pace of awards. DRC's contracts with United States Government customers are generally subject to termination at the convenience of the United States Government. However, the company would be reimbursed for its allowable costs to the time of termination and would be paid a proportionate amount of the stipulated profit attributable to the work actually performed. Although United States 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 United States Government requirements or budgetary concerns. If the United States Government curtails expenditures for research, development and consulting activities, such curtailment might have an adverse impact on the company's revenue and earnings. The company's state contracts are generally either fixed-price or time and materials. In certain instances, funding for these contracts is subject to annual state legislative approval. The company's government contracts fall into one of three categories: (1) fixed-price, (2) time and materials, and (3) cost reimbursable. Under a fixed-price contract, the government pays an agreed upon price for the company's services or products, and the company bears the risk that increased or unexpected costs may reduce its profits or cause it to incur a loss. Conversely, to the extent the company incurs actual costs below anticipated costs on these contracts, the company could realize greater profits. Under a time and materials contract, the government pays the company a fixed hourly rate intended to cover salary costs and related indirect expenses plus a profit margin. Under a cost reimbursable contract, the government reimburses the company for its allowable direct expenses and allowable and allocable indirect costs and pays a negotiated fee. Backlog At December 31, 2001, the company's funded backlog was approximately $91.4 million compared with $89.8 million at December 31, 2000. The company expects that substantially all of its backlog at December 31, 2001 will be filled during the year ending December 31, 2002. The company has a number of multi-year contracts with agencies of the United States and state governments on which actual funding generally occurs on an annual basis. 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. Competition The company's systems and services business competes with public and privately held firms, which specialize in providing government information technology services. These firms may be large or small. The company also competes with the government services divisions of large commercial IT service firms and with government IT service divisions of large defense weapons systems producers. The United States Government's own in-house capabilities are also, in effect, competitors because various agencies perform certain types of services, which might otherwise be performed by the company. The principal competitive factors for systems and services are past performance, technical capabilities and price. In the precision manufacturing business, the company competes with other manufacturers of encoders, electroform vendors and suppliers of precision measurement discs, scales, and reticles. The principal competitive factors affecting the precision components manufacturing businesses are price, product quality and custom engineering to meet customers' system requirements. Research and Development The company expended approximately $0.5 million, inclusive of overhead and other indirect costs, on new product and service development during the year ended December 31, 2001, compared with expenditures of $0.2 million in 2000 and $1.5 million in 1999. The expenditures in 2001 were attributable mainly to the development of MedTeams training products. 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. 10 Employees At December 31, 2001, the company had 1,517 employees. The company considers its relationship with its employees to be satisfactory. Proprietary Information Patents, trademarks and copyrights are not materially important to the company's business. The United States Government has certain proprietary rights in processes and data developed by the company in its performance of government contracts. Item 2. Properties The company leases approximately 323,000 square feet of office and manufacturing space. This space is used for its federal and state government services, manufacturing and warehousing operations as well as its marketing and engineering offices. The company has 113,000 square feet of manufacturing and office space in three Wilmington, Massachusetts facilities. The Wilmington leases expire in 2005, with options to renew the leases to the year 2010. The remaining leased facilities consist of offices in 32 locations across the United States. The company owns a 135,000 square foot facility in Andover, Massachusetts which serves as its corporate headquarters. The company's total rental cost for 2001 was $4.1 million. The company believes its properties are adequate for its present needs. Item 3. Legal Proceedings The company is not a party to any material litigation. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of 2001. 11 Item 4A. Executive Officers of the Registrant The following is a list of the names and ages of the executive officers of the company, all positions and offices held by each person and each person's principal occupations or employment during the past five years. The 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.
Name and Position Age James P. Regan Chairman, President and Chief Executive Officer, Director 61 Richard A. Covel Vice President and General Counsel 55 Chester Ju Vice President and General Manager, Precision Manufacturing Group 52 David Keleher Vice President and Chief Financial Officer 52 John L. Wilkinson Vice President and General Manager, Human Resources 62
Messrs. Ju and Wilkinson have served in their respective positions for more than five years. Mr. Regan joined the company in 1999 as President, Chief Executive Officer and Director. In April 2001, Mr. Regan was elected Chairman of the Board of Directors. Prior to joining DRC, he was President and Chief Executive Officer of CVSI, Inc. from 1997 to October 1999 and served as Senior Vice President of Litton PRC from 1992 to 1996. Mr. Covel joined the company as Vice President and General Counsel in December 2000. Prior to that, he was General Counsel, Patent Counsel and Clerk at Foster-Miller, Inc. from 1985-2000. Mr. Keleher joined the company as Vice President and Chief Financial Officer in January 2000. Prior to that, he was employed by Raytheon Company as Group Controller for the Commercial Electronics Division in 1999 and Assistant Corporate Controller in 1998. Prior to that, he served in several senior management positions in corporate finance and operations at Digital Equipment Corporation from 1981 to 1997. Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The common stock of the company is traded on the NASDAQ National Market under the symbol DRCO. The high and low prices for the quarters in 2001 and 2000 as reported on the NASDAQ National Market are listed below. These market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. 2001 2000 High Low High Low ---------------------------------------------------------------------------- First quarter $ 11.00 $ 7.75 $ 8.38 $ 6.94 Second quarter 10.38 8.16 8.63 7.00 Third quarter 14.69 8.86 8.53 6.75 Fourth quarter 19.50 12.79 9.25 7.13 ---------------------------------------------------------------------------- As of December 31, 2001 there were 767 holders of record of the company's common stock. In September 1984, the Board of Directors voted not to declare cash dividends to preserve cash for the future growth and development of the company. The company did not declare any cash dividends between 1984 and 2001 and does not intend to in the near future. The Annual Meeting of the stockholders of Dynamics Research Corporation will be held at 2:00 p.m. on Thursday, April 25, 2002 on the 2nd floor of the Hampshire House, 84 Beacon Street, Boston, Massachusetts. Item 6. Selected Financial Data Five Year Summary of Selected Financial Information
2001 2000 1999 1998 1997 ---------------------------------------------------------------------------------------------------------- (in thousands of dollars, except share, per share and employee data) Revenue $ 201,112 $ 200,175 $ 191,621 $ 182,344 $ 156,733 Operating income (loss) 11,869 9,203 (11,378) 2,459 7,807 Income (loss) from continuing operations 6,483 4,353 (8,888) 491 5,177 Net income (loss) 6,545 4,559 (7,526) (5,971) 4,129 Income (loss) from continuing operations per common share - basic .84 .57 (1.21) .07 .69 Income (loss) from continuing operations per common share - diluted .80 .56 (1.21) .06 .66 Net income (loss) per common share - basic .85 .60 (1.02) (.80) .55 Net income (loss) per common share - diluted .81 .59 (1.02) (.77) .53 Total assets 81,825 78,702 75,188 88,067 77,629 Total debt 9,250 15,534 19,700 26,800 10,000 Stockholders' equity 37,138 29,289 23,805 31,246 39,147 Stockholders' equity per share 4.68 3.85 3.23 4.24 5.19 Return on stockholders' equity(1) 19.9% 17.1% (26.5)% (16.0)% 11.2% Return on invested capital(1) 16.1% 12.0% (13.8)% 2.4% 10.6% Backlog 91,404 89,843 83,549 105,427 110,001 Cash flow from operations 24,717 4,735 10,985 (11,406) 7,980 Research and development expense 488 150 1,478 2,739 1,249 Capital expenditures 3,752 3,120 2,702 3,171 5,104 Depreciation and amortization 3,457 3,746 6,060 6,219 5,240 Number of shares outstanding at end of year 7,940,610 7,601,519 7,363,324 7,369,190 7,546,646 Number of employees 1,517 1,504 1,613 1,557 1,455 -----------------------------------------------------------------------------------------------------------
(1) Percentages are calculated using a 5-point average of equity and invested capital. See Management's Discussion and Analysis of Financial Condition and Results of Operations for discussion of unusual items. 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations For the years ended December 31, 2001 2000 1999 -------------------------------------------------------------------------------------------------------------- (expressed as a percentage of total revenue) Contract revenue 89.2% 86.3% 86.0% Product sales 10.8% 13.7% 14.0% Total revenue 100.0% 100.0% 100.0% Gross margin on contract revenue(1) 13.4% 9.5% 0.3% Gross margin on product sales(1) 24.0% 30.3% 20.8% Total gross margin 14.5% 12.4% 3.2% Selling, engineering and administrative expenses 8.6% 7.8% 9.1% Operating income (loss) 5.9% 4.6% (5.9)% Interest expense, net 0.4% 0.9% 1.2% Income (loss) from continuing operations before provision (benefit) for income taxes 5.4% 3.7% (7.1)% ------------------------------------------------------------------------------------------------------------
(1) These amounts represent a percentage of contract revenue and product sales, respectively. 13 Overview Overall, Dynamics Research Corporation (the "company") became a stronger, more balanced company in 2001. It bolstered its traditional competitive advantages, including strong and relevant core competencies, a 47-year legacy of satisfied customers, a reputation for thought leadership and innovation, and an intense customer focus. The company also made further improvements in execution, business development, and employee satisfaction. Financial results for the year reflected improvements in every aspect of the company's operations, as well as the growing strength of the markets it serves and customers' positive reaction to a renewed focus on their successes. These advances served the company well in 2001 and should pave the way for more progress in 2002. Revenue Total revenue from continuing operations was $201.1 million, $200.2 million and $191.6 million for 2001, 2000 and 1999, respectively, representing increases of 0.5% and 4.5% in 2001 and 2000, respectively. During 2001, the company changed its contractual relationship with two major customers, moving from a prime contractor position to one as a subcontractor. Further, work that was previously subcontracted through the company is now directed to other companies, which were awarded the prime contracts. As a result of these changes, $9.4 million of low margin work performed by subcontractors to the company in 2000 no longer flows through the company's operating results as revenue and cost of sales in 2001. The comparison of revenue on a year-over-year basis is also affected by a one-time $4.1 million purchase and resale of equipment to a major customer in the second quarter of 2000. Analytically excluding the effect of these non-recurring items revenue increased 7.7% in 2001, compared with 2000. This increase reflects sales growth in government information technology sectors. In 2000, revenue increased $4.5 million, or 2.3%, when compared with 1999, excluding the one-time $4.1 million resale of equipment in 2000 previously discussed. Contract Revenue Contract revenue in the Systems and Services business was $179.4 million in 2001 compared with $172.8 million in 2000 and $164.8 million in 1999, representing increases of 3.8% and 4.9% in 2001 and 2000, respectively. Excluding the non-recurring items discussed above, Systems and Services revenue increased 12.7% in 2001, compared with 2000 and defense related revenue grew 8.5% in 2001 compared with 2000. Defense revenue grew primarily due to increased business with the Navy and other Department of Defense agencies. Revenue from federal civilian agencies primarily the Internal Revenue Service, increased $4.0 million, or 53.3%, in 2001 when compared with 2000. State and local revenue was $20.0 million in 2001 and $16.0 million in 2000. The increase in state and local revenue was primarily due to additional work related to the company's contracts with the State of Colorado. Heightened interest and focus on defense and homeland security did not significantly affect 2001 revenue. Government expenditures in these areas are expected to increase significantly in the coming years. The company expects that over time, these increases will favorably impact the company's ability to increase revenue. Contract revenue from systems engineering, logistics and systems support work, primarily for the United States Air Force, increased nearly $13 million in 2000 when compared to 1999, offset by an expected decline in revenue from state and local projects. As discussed above, revenue growth in 2000 when compared with 1999, was aided by a one-time $4.1 million purchase and resale of equipment to a major customer in 2000. The company provides services under time and materials, cost reimbursable and fixed-price contracts. The following table expresses revenue by contract type as a percentage of Systems and Services revenue:
For years ended December 31, 2001 2000 1999 -------------------------------------------------------------------------------- Cost reimbursable 31% 31% 28% Fixed-price 17% 14% 20% Time and materials 52% 55% 52% -------------------------------------------------------------------------------- Total contracts 100% 100% 100% ================================================================================
The company follows generally accepted contract accounting principles for its systems and services business. For time and materials contracts, revenue reflects the number of direct labor hours expended in the performance of a contract multiplied by the contract billing rate, as well as reimbursement of other billable direct costs. Profits on time and materials contracts vary depending on the extent to which actual per hour costs differ from negotiated billing rates in the contract, which directly affects operating income. Under fixed-price contracts, revenue is recognized under the percentage of completion method, on the basis of costs incurred in relation to estimated total costs to complete the contract. On a fixed-price contract, if actual costs exceed the estimated costs to complete the contract, then profit is eroded or losses are incurred. For cost reimbursable contracts, revenue is recognized as costs are incurred and include a proportionate amount of the 14 fee earned. Cost reimbursable contracts specify the contract fee in dollars or as a percentage of estimated costs. The primary risk on a cost reimbursable contract is that a government audit of direct and indirect costs could result in the disallowance of certain costs, which would directly impact revenue and margin on the contract. Historically, such audits have had no material impact on the company's revenue and margin. For all types of contracts, the company recognizes anticipated contract losses as soon as they become known and estimable. Out-of-pocket expenses that are reimbursable by the customer are included in contract revenue and cost of contract revenue. Unbilled expenditures and fees on contracts in process are the amounts of recoverable contract revenue, which had not been billed at the balance sheet date. Costs related to United States Government contracts, including applicable indirect costs, are subject to audit by the government. Revenue from such contracts has been recorded at amounts expected to be realized upon final settlement. Product Sales Product sales for the Precision Manufacturing Group, which consists of the Encoder and Metrigraphics Divisions, decreased $5.6 million to $21.8 million in 2001 compared with 2000. Encoder Division sales decreased to $10.8 million for 2001 compared with $17.6 million in 2000. The Encoder Division has been significantly affected by the current economic downturn in capital equipment manufacturing. Currently, there is no indication of improvement. Metrigraphics Division sales increased 11.9% to $10.9 million in 2001 compared with $9.8 million in 2000. Medical electronics customers contributed to the growth in 2001. The company remains cautious about the potential for further economic weakness adversely affecting the Encoder and Metrigraphics Divisions. Product sales increased 2.0% in 2000 compared with 1999. Encoder Division sales of $17.6 million in 2000 were up 34% over 1999. Increased demand from automotive and other customers was supported by strong economic conditions throughout 2000. Metrigraphics Division sales decreased in 2000 by $3.5 million primarily due to lower sales of inkjet printer cartridge nozzle plates to the Metrigraphics Division's largest customer. Revenue from product sales, less associated warranty costs, is generally recognized at the time of shipment. Gross Margin Total gross margin was $29.2 million, $24.8 million and $6.1 million for 2001, 2000 and 1999, respectively, representing 14.5%, 12.4% and 3.2% of total revenue for 2001, 2000 and 1999, respectively. Gross margin on contract revenue was $24.0 million, $16.4 million and $0.5 million for 2001, 2000 and 1999, respectively, representing 13.4%, 9.5% and 0.3% of contract revenue for 2001, 2000 and 1999, respectively. In 2001, the increase in gross margin when compared with last year, was due to improved contract pricing, a mix shift toward higher gross margin fixed-price work, control of overhead costs and $1.2 million of contract close out credits, partially offset by the pension plan curtailment discussed below. The increase in the 2000 gross margin compared favorably to 1999 primarily due to two unusual charges to cost of sales which were included in the Systems and Services segment results for 1999: an $11.9 million loss provision on the company's contract with the State of Colorado and a restructuring severance provision of $1.0 million. Other factors contributing to improvement in gross margin included: improved bidding and pricing practices, higher direct labor utilization and curtailment in the level of discretionary overhead expenses. Also in 1999, the company recorded charges of $2.2 million to provide for estimated contract losses on two other fixed-price software development contracts, and $1.8 million for other unrecoverable contract costs. Regarding the Colorado contract mentioned above and described in Note 2 of the Notes to the Consolidated Financial Statements, entering 2001, the project was scheduled for completion in the first half of the year, including rollout of the first release of the new child welfare information and management system, plus three releases of increased functionality. During 2001, the final releases of the child welfare system functionality, although delayed, were deployed. Rollout of the youth correction functionality, the final phase of the system, has been delayed to the first half of 2002. The cost impact of these delays was reflected in the results of operations, as necessary, when identified. While the company believes it has reasonably estimated and provided for the costs to complete the Colorado contract, estimates of project costs will continue to be updated and changes in estimates provided for, as necessary, in each reporting period until completion. 15 Accordingly, there can be no assurances that the actual costs on the project will not differ materially from current estimates. In 2001, 2000 and 1999, gross margin on Precision Manufacturing Group sales was $5.2 million, $8.3 million and $5.6 million, respectively, representing 24.0%, 30.3% and 20.8% of product sales in 2001, 2000 and 1999, respectively. The decrease in product sales gross margin in 2001, was due primarily to the decline in Encoder revenue. During the second and third quarters of 2001, the company provided $0.3 million for involuntary severance costs for 45 employees in the Encoder Division. These costs were expended in the second half of 2001, primarily for continuation pay. In 2000, the gross margin benefits of volume and price increases in Encoder Division sales and a favorable shift in the Metrigraphics product mix toward higher gross margin products more than offset the somewhat negative impact of lower Metrigraphics revenue. In December 2001, the Board of Directors approved to proceed with amendments limiting future increases in benefits under the company's Defined Benefit Pension Plan, freezing membership in the Plan, and providing for improvements to the company's 401(k) Plan. Accordingly, the approval to amend the Defined Benefit Pension Plan resulted in a curtailment charge of $0.8 million in the fourth quarter of 2001. Other Operating Items Operating expense, which includes selling, engineering, and administrative costs, increased to $17.3 million in 2001 compared with $15.6 million in 2000. The increase reflects three factors, a planned increase in sales and marketing activities, normal cost inflation of approximately 4%, and planned expenses associated with employee-centered initiatives. In 2000, operating expenses were down $1.9 million compared with 1999. In 1999, operating expense included the write-off of the company's $1.4 million investment in Empresa, Inc. (see Note 13 of Notes to the Consolidated Financial Statements) in 1999 and $0.2 million of restructuring charges described below. Research and development expense (R&D) was $0.5 million, $0.2 million and $1.5 million in 2001, 2000 and 1999, respectively. The increase in R&D in 2001 when compared with 2000, resulted from the development of MedTeams training products. The decline in R&D in 2000, compared with 1999 was primarily the result of discontinuing new software product development projects and focusing the company on existing core businesses. On June 1, 2001, the company completed the sale of its Tactical Communications Group ("TCG") and the transfer of related employees and assets. TCG developed and sold communications software for defense applications. For the first six months of 2001, TCG recorded revenue of approximately $0.8 million and a loss of $0.5 million. The sale resulted in a net loss of $0.2 million, shown as Other expense on the Consolidated Statements of Operations. Proceeds from the transaction were $0.1 million in cash, with a $50,000 note receivable due one year from the date of the sale. In 2000, TCG recorded revenue of $2.3 million and an after tax-loss of $0.9 million, including a $0.4 million pre-tax impairment charge. Net interest expense was $0.7 million, $1.8 million and $2.3 million in 2001, 2000 and 1999, respectively. The decrease in net interest expense reflects lower average debt levels over the last two years, and in 2001, lower interest rates and the net benefit of investment income on cash balances. Income tax expense has been recorded at a rate of 40.7% and 40.9% of income from continuing operations before taxes in 2001 and 2000, respectively, and an income tax benefit of 34.8% of the loss from continuing operations before taxes in 1999. The 2001 and 2000 rate reflects the statutory federal rate of 34% combined with an average state income tax rate, net of federal income tax benefit, of 6.7% and 6.9% in 2001 and 2000, respectively. The 1999 tax benefit is net of a $0.4 million provision for an unrecoverable capital loss carryforward related to the write-off of the Empresa investment (see Note 13 of Notes to the Consolidated Financial Statements). In June 1999, the company completed the sale of its previously discontinued Telecommunications Fraud Control business for $1.7 million plus royalties. The sale resulted in a 1999 favorable pre-tax adjustment of $2.2 million to the estimated pre-tax loss on disposal of discontinued operations of $4.1 million in 1998. Royalty income of $62,000 and $0.2 million, after taxes, was recognized in 2001 and 2000, respectively. The company may benefit modestly from future royalty payments through July 31, 2002, up to a cap of $0.9 million, net of taxes. These receipts will be recorded as gain from discontinued operations, after deducting taxes, when received. 16 In the fourth quarter of 1999, the company adopted a restructuring plan intended to reduce overhead costs and increase efficiencies. The company recorded a restructuring charge of $1.2 million. The remaining reserve balance from this action was $0.2 million at December 31, 2000. During the first six months of 2001, the company expended the remaining restructuring reserve, primarily for continuation pay for employees who had left the company prior to December 31, 2000. Recent increases in the company's stock price have resulted in an increase in the number of employee stock options counted as outstanding common equivalent shares and included in the dilutive effect of options for the purpose of computing diluted earnings per share. Outstanding common and common equivalent shares increased from 7.7 million at December 31, 2000 to 8.1 million at December 31, 2001. The company's funded backlog was $91.4 million, $89.8 million and $83.5 million at December 31, 2001, 2000 and 1999, respectively. A portion of the company's backlog is based on annual purchase contracts. The amount of backlog as of any date may be affected by the timing of order receipts and associated deliveries and is subject to reduction or cancellation. Refer to Note 1 of Notes to the Consolidated Financial Statements for significant accounting policies, and a discussion of new accounting pronouncements and their impact on the company's financial statements. Liquidity and Capital Resources In 2001, cash provided by operating activities was $24.7 million. This primarily resulted from net income, refundable income taxes, and improved working capital management resulting in decreased accounts receivable and unbilled expenditures and fees on contracts in process. Cash provided by operating activities of $4.7 million in 2000 primarily resulted from net income, a decrease in accounts receivable and an increase in the deferred tax provision partially offset by an increase in unbilled expenditures and fees on contracts in process and prepaid expenses. The increase in prepaid expenses in 2000 was primarily due to $2.6 million of refundable federal income taxes, most of which was received in the first quarter of 2001. Cash provided by operating activities of $11.0 million in 1999 primarily resulted from a significant reduction in unbilled expenditures and fees on contracts in process. Days sales outstanding ("DSO") on total receivables, both billed and unbilled, were 84 days at the end of 2001, compared with 110 days at the end of 2000. In 2000, increased unbilled costs and fees associated with fixed-price contracts affected DSO. Inventories, which support the Encoder business, decreased slightly to $3.0 million in 2001 from $3.2 million at the end of 2000. The company has been working to reduce inventory levels required to support a significantly lower level of sales. Capital spending for property, plant and equipment was $3.8 million, $3.1 million and $2.7 million in 2001, 2000 and 1999, respectively. In 2001, capital investments were made primarily for enterprise information systems and equipment and building improvements to the Andover corporate headquarters. The major capital project for the company in 2000 was the development of an enterprise human resource management system, which was put into service in January 2001. The company's revolving credit agreement (the "Revolver") dated February 10, 2000, allows the company to borrow up to the lesser of $20.0 million or 80% of eligible accounts receivable, as defined by the agreement. The Revolver expires on February 10, 2003. Interest on the outstanding balance of the Revolver is payable monthly. Prior to February 2001, interest accrued at the prime rate and the agreement included a fee of 0.375% on the unused portion of the Revolver. Beginning in February 2001, the company received the option to elect, on a fixed 30, 60 or 90-day term, an interest rate of LIBOR plus 2% or the prime rate. In addition, the fee on the unused Revolver was reduced to 0.25%. Effective June 30, 2001, the Revolver was amended (the "Amended Revolver") to release the banks' security interests in the company's assets and to continue the Amended Revolver on an unsecured basis. At December 31, 2001, there was no outstanding balance under the Amended Revolver, and the company had $15.2 million of unused credit line available. At December 31, 2000, $5.8 million was outstanding under the Revolver. Available interest rates on the Amended Revolver at December 31, 2001, were 4.75% under the prime rate option and 3.88% under the 30-day LIBOR rate option. 17 The company has a 10-year mortgage loan (the "Mortgage"), dated June 12, 2000, on the company's real estate. The outstanding balance of the Mortgage was $9.3 million and $9.8 million at December 31, 2001 and 2000, respectively. The agreement requires quarterly principal payments of $125,000 beginning on August 1, 2000, with a final payment of $5.0 million in June 2010. Interest on the Mortgage accrued at the rate of LIBOR plus 2.5% at December 31, 2000. Effective November 6, 2001, the interest rate on the Mortgage was reduced to LIBOR plus 2.0%. The interest rate on the Mortgage under the 90-day LIBOR option elected at October 15, 2001, was 4.51% on December 31, 2001. The Mortgage is secured by the corporate office facility in Andover, Massachusetts. The Amended Revolver and Mortgage require the company to meet certain financial covenants including maintaining a minimum tangible net worth, cash flow and debt coverage ratios, as well as limit the company's ability to incur additional debt, to pay dividends, to purchase capital assets, to sell or dispose of assets, to make additional acquisitions or investments, or to enter into new leases, among other restrictions. The company was in compliance with all covenants on December 31, 2001. In 2001, the company realized $1.3 million in proceeds from the exercise of stock options and the issuance of shares under the employee stock purchase plan. In 2000 and 1999, $0.8 million and $28,000, respectively, were realized from the exercise of stock options. The company's prospective cash flows are subject to certain trends, events and uncertainties, including demands for capital to support growth, economic conditions, government payment practices and contractual matters. The company's capital expenditures are expected to be approximately $6 million in 2002, primarily for technology advancements, infrastructure improvements and capacity expansion in support of growth and operational performance enhancement. Contractual financing obligations at December 31, 2001 were as follows:
Payments due by period ----------------------------------------------------- Less than 1-3 4-5 After 1 year years years 5 years Total ------------------------------------------------------------------------------------------------ (in thousands of dollars) Long-term debt $ 500 $ 1,500 $ 1,000 $ 6,250 $ 9,250 Operating leases 3,500 6,300 100 -- 9,900 ------------------------------------------------------------------------------------------------ Total contractual obligations $ 4,000 $ 7,800 $ 1,100 $ 6,250 $ 19,150 ================================================================================================
As a defense contractor, the company is subject to many levels of audit and review, including the Defense Contract Audit Agency, the Inspector General, the Defense Criminal Investigative Service, the General Accounting Office, the Department of Justice and Congressional Committees. Both related to and unrelated to its defense industry involvement, the company is, from time to time, involved in audits, lawsuits, claims, administrative proceedings and investigations, and accrues for liabilities associated with these activities, if any, for which the company considers it probable that future expenditures will be made and for which such expenditures can be reasonably estimated. In management's opinion, the outcome from such audits and other matters discussed above is not expected to have a material adverse effect on the company's financial position or results of operations. On October 26, 2000, the United States Attorney's Office announced the indictment of two former company employees for conspiracy to defraud the United States Air Force. Both former employees pled guilty. The United States Attorney's Office has informed the company that it is not a target of the investigation. Separately, the United States Attorney's Office is investigating certain company activity and billing transactions from prior years. The company does not know, at this time, what financial effects, if any, may result to the company from these matters. The company's need for, cost of, and access to funds are dependent on future operating results, as well as conditions external to the company. Based on its current business plan, the company believes that its current assets, cash flows from operations and available lines of credit are sufficient to support its existing operations and capital requirements for the foreseeable future. Impact of Inflation and Changing Prices Overall, inflation has not had a material impact on the company's operations. Additionally, the terms of Defense contracts, which accounted for approximately 73% of revenue in 2001, are generally one year and 18 include salary increase factors for future years, thus reducing the potential impact of inflation on the company. Forward-Looking Information Safe harbor statements under the Private Securities Litigation Reform Act of 1995: Some statements contained or implied in this annual report, which are not historical fact such as financial forecasts, contain forward-looking information. These statements may be identified by forward-looking words such as "expect," "look," "believe," "anticipate," "may," "will" and other forward-looking terminology. Such statements are subject to risks and uncertainties that could cause actual results to differ materially, including uncertainties regarding contractual requirements, actions by customers and actual costs to complete; federal budget matters; government contracting risks and competitive market conditions; customer requirements, schedules and related funding; technological change; uncertainty of future financing; overall economic factors; and the ability to successfully complete and integrate acquisitions and other matters. These factors are discussed in more detail in Exhibit 99 of this report. The company assumes no obligation to update any forward-looking information. Item 7A. Quantitative and Qualitative Disclosures about Market Risk The company is subject to interest rate risk associated with our Mortgage and Amended Revolver where interest payments are tied to either the LIBOR or prime rate. At any time a sharp rise in interest rates could have an adverse effect on net interest expense as reported in the Statements of Operations. The company does not currently hedge these interest rate exposures. Item 8. Financial Statements and Supplementary Data The following consolidated financial statements of the company and its subsidiaries are on the pages listed below:
Page Consolidated Balance Sheets at December 31, 2001 and 2000 20 Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999 21 Consolidated Statements of Stockholders' Equity for the three years ended December 31, 2001, 2000 and 1999 22 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999 23 Schedule II - Valuation and Qualifying Accounts for the years ended December 31, 2001, 2000 and 1999 45
19
Consolidated Balance Sheets December 31, 2001 2000 ---------------------------------------------------------------------------------------------------------- (in thousands of dollars, except share and per share data) Assets Current assets Cash and cash equivalents $ 16,657 $ 527 Receivables, net of allowances of $1,355 in 2001 and $1,096 in 2000 22,946 31,967 Unbilled expenditures and fees on contracts in process 22,876 24,633 Inventories 2,960 3,208 Prepaid expenses and other current assets 1,789 3,926 --------------------------------------------------------------------------------------------------------- Total current assets 67,228 64,261 Net property, plant and equipment 14,597 14,441 ----------------------------------------------------------------------------------------------------------- Total assets $ 81,825 $ 78,702 ------------------------------------------------------------------------------------------------------ Liabilities and Stockholders' Equity Current liabilities Current portion of long term debt $ 500 $ 500 Notes payable -- 5,784 Accounts payable 13,588 12,843 Accrued payroll and employee benefits 11,911 9,901 Other accrued expenses 2,913 5,711 Current deferred income taxes 4,275 4,575 --------------------------------------------------------------------------------------------------------- Total current liabilities 33,187 39,314 Long term debt 8,750 9,250 Deferred income taxes 2,750 849 Commitments and contingencies Stockholders' equity Preferred stock, par value, $.10 per share 5,000,000 shares authorized, none issued -- -- Common stock, par value, $.10 per share: Authorized - 30,000,000 shares Issued - 9,320,036 shares in 2001 and 8,980,945 in 2000 932 898 Treasury stock - 1,379,426 shares in 2001 and 2000 (138) (138) Capital in excess of par value 31,331 28,461 Unearned compensation (992) -- Accumulated other comprehensive income (608) -- Retained earnings 6,613 68 -------------------------------------------------------------------------------------------------------- Total stockholders' equity 37,138 29,289 ----------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 81,825 $ 78,702 ===================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. 20
Consolidated Statements of Operations For the years ended December 31, 2001 2000 1999 ---------------------------------------------------------------------------------------------------------- (in thousands of dollars, except share and per share data) Revenue Contract revenue $ 179,350 $ 172,774 $ 164,766 Product sales 21,762 27,401 26,855 -------------------------------------------------------------------------------------------------------- Total revenue 201,112 200,175 191,621 Costs and expenses Cost of contract revenue 155,394 156,327 164,278 Cost of product sales 16,548 19,087 21,257 Selling, engineering and administrative expenses 17,301 15,558 17,464 -------------------------------------------------------------------------------------------------------- Total operating costs and expenses 189,243 190,972 202,999 Operating income (loss) 11,869 9,203 (11,378) Other expense 193 -- -- Interest expense, net 744 1,842 2,255 ---------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations before provision (benefit) for income taxes 10,932 7,361 (13,633) Provision (benefit) for income taxes 4,449 3,008 (4,745) ---------------------------------------------------------------------------------------------------------- Income (loss) from continuing operations 6,483 4,353 (8,888) Gain on disposal of discontinued operations, net of tax expense of $43 in 2001, $143 in 2000 and $835 in 1999 62 206 1,362 -------------------------------------------------------------------------------------------------------- Net income (loss) $ 6,545 $ 4,559 $ (7,526) ========================================================================================================== Earnings (loss) per share Per common share - basic Income (loss) from continuing operations $ .84 $ .57 $ (1.21) Gain from discontinued operations .01 .03 .19 ----------------------------------------------------------------------------------------------------- Net income (loss) $ .85 $ .60 $ (1.02) =================================================================================================== Per common share - diluted Income (loss) from continuing operations $ .80 $ .56 $ (1.21) Gain from discontinued operations .01 .03 .19 ----------------------------------------------------------------------------------------------------- Net income (loss) $ .81 $ .59 $ (1.02) =================================================================================================== Weighted average shares outstanding Weighted average shares outstanding - basic 7,674,608 7,541,376 7,360,548 Dilutive effect of options 414,477 151,780 -- -------------------------------------------------------------------------------------------------------- Weighted average shares outstanding - diluted 8,089,085 7,693,156 7,360,548 ========================================================================================================
The accompanying notes are an integral part of these consolidated financial statements. 21 Consolidated Statements of Stockholders' Equity
Common Stock ------------------------------- Accumulated Retained Issued Treasury Stock Other Earnings ------------------------------- Capital in Unearned Comp- (Accum For the three years Par Par Excess of Compen- rehensive -ulated ended December 31, 2001 Shares Value Shares Value Par Value sation Income Deficit) Total ----------------------------------------------------------------------------------------------------------------------------- (in thousands) Balance at December 31, 1998 8,733 $ 873 (1,364) $(136) $ 27,474 $ -- $ -- $ 3,035 $ 31,246 1999 Activity Stock options exercised 10 1 -- -- 27 -- -- -- 28 Treasury stock purchased -- -- (15) (2) (57) -- -- -- (59) Stock option compensation expense -- -- -- -- 116 -- -- -- 116 Net loss -- -- -- -- -- -- -- (7,526) (7,526) ----------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1999 8,743 874 (1,379) (138) 27,560 -- -- (4,491) 23,805 2000 Activity Stock options exercised 223 22 -- -- 789 -- -- -- 811 Stock compensation expense 15 2 -- -- 112 -- -- -- 114 Net income -- -- -- -- -- -- -- 4,559 4,559 ----------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 2000 8,981 898 (1,379) (138) 28,461 -- -- 68 29,289 2001 Activity Stock options exercised 194 20 -- -- 1,329 -- -- -- 1,349 Restricted stock and related compensation expense 145 14 -- -- 1,330 (992) -- -- 352 Accumulated other comprehensive income(1) -- -- -- -- -- -- (608) -- (608) Tax benefit from stock options exercised -- -- -- -- 211 -- -- -- 211 Net income -- -- -- -- -- -- -- 6,545 6,545 ----------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 2001 9,320 $ 932 (1,379) $(138) $ 31,331 $ (992) $ (608) $ 6,613 $ 37,138 =============================================================================================================================
(1)Comprehensive income is as follows: Year ended December 31, 2001 ----------------------------------------------- Net income $ 6,545 Minimum pension liability adjustment, net of tax effect of $405 (608) --------------------------------------------- Comprehensive income $ 5,937 =============================================== The accompanying notes are an integral part of these consolidated financial statements. 22 Consolidated Statements of Cash Flows
For the years ended December 31, 2001 2000 1999 --------------------------------------------------------------------------------------------------- (in thousands of dollars) Cash provided by (used for) operations Net income (loss) $ 6,545 $ 4,559 $ (7,526) Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: Gain from discontinued operations (62) (206) (1,362) Loss on disposal of assets 193 -- -- Non-cash stock compensation expense 90 114 116 Tax benefit from stock options exercised 211 -- -- Provision for impairment of investment in Empresa, Inc. -- -- 1,424 Depreciation and amortization 3,457 3,746 6,060 Deferred income tax provision 1,601 2,930 (5,043) --------------------------------------------------------------------------------------------------- 12,035 11,143 (6,331) Cash provided by (used for) working capital Receivables 8,293 2,950 (1,901) Unbilled expenditures and fees on contracts in process 1,074 (6,024) 13,560 Inventories 248 (473) (88) Prepaid expenses and other current assets 2,137 (2,333) (626) Accounts payable 745 1,202 1,341 Accrued payroll and employee benefits 1,402 466 1,653 Other accrued expenses (1,279) (2,129) 5,210 --------------------------------------------------------------------------------------------------- 12,620 (6,341) 19,149 Net cash provided by continuing operations 24,655 4,802 12,818 Net cash provided by (used for) discontinued operations 62 (67) (1,833) --------------------------------------------------------------------------------------------------- Net cash provided by operating activities 24,717 4,735 10,985 Cash provided by (used for) investing activities Additions to property, plant and equipment related to continuing operations (3,752) (3,120) (2,702) Proceeds from the sale of assets 100 -- -- Investments and acquisitions -- -- (682) Proceeds from the sale of discontinued operations -- -- 1,700 --------------------------------------------------------------------------------------------------- Net cash used for investing activities (3,652) (3,120) (1,684) Cash provided by (used for) financing activities Net borrowings (repayments) under revolving credit agreement (5,784) 5,784 (7,100) Repayment of working capital agreement -- (19,700) -- Proceeds from mortgage agreements -- 17,500 -- Repayment of interim mortgage -- (7,500) -- Principal payment under 10-year mortgage (500) (250) -- Proceeds from the exercise of stock options 1,349 811 28 Purchase of treasury stock -- -- (59) --------------------------------------------------------------------------------------------------- Net cash used for financing activities (4,935) (3,355) (7,131) Net increase (decrease) in cash and cash equivalents 16,130 (1,740) 2,170 Cash and cash equivalents at the beginning of the year 527 2,267 97 --------------------------------------------------------------------------------------------------- Cash and cash equivalents at the end of the year $ 16,657 $ 527 $ 2,267 =================================================================================================== Supplemental information Cash paid for interest $ 858 $ 2,055 $ 2,451 Cash paid for taxes 2,185 2,893 199 Restricted stock issued 1,344 -- -- Minimum pension liability 1,013 -- --
The accompanying notes are an integral part of these consolidated financial statements. 23 Notes to Consolidated Financial Statements 1. Significant Accounting Policies Nature of Business Dynamics Research Corporation ("company") is an innovative solutions provider, partnering with customers to apply proven processes and technology. The company delivers engineering, logistics and information technology services and precision manufactured products that enhance the performance and cost effectiveness of its customers' mission critical systems. Principles of Consolidation The accompanying consolidated financial statements include the accounts of the company and its wholly-owned subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to current year presentation. Risks, Uncertainties and Use of Estimates There are certain business risks specific to the industries in which the company operates, including estimates of costs to complete contract obligations, changes in government policies and procedures, government contracting issues and risks associated with technological development. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates and assumptions also affect the amount of revenue and expenses reported during the year. Actual results could differ from those estimates. Revenue Recognition The company's systems and services business provides its services under time and materials, cost reimbursable and fixed-price contracts. Accordingly, the company adheres to generally accepted contract accounting principles. For time and materials contracts, revenue reflects the number of direct labor hours expended in the performance of a contract multiplied by the contract billing rate, as well as reimbursement of other billable direct costs. The risk inherent in time and materials contracts is that actual costs differ materially from negotiated billing rates in the contract, which directly affects operating income. Under fixed-price contracts, revenue is recognized under the percentage of completion method, on the basis of costs incurred in relation to estimated total costs to complete the contract. The risk to the company on a fixed-price contract is that if actual costs exceed the estimated costs to complete the contract, then profit is eroded or losses are incurred. For cost reimbursable contracts, revenue is recognized as costs are incurred and include a proportionate amount of the fee earned. Cost reimbursable contracts specify the contract fee in dollars or as a percentage of estimated costs. The primary risk on a cost reimbursable contract is that a government audit of direct and indirect costs could result in the disallowance of certain costs, which would directly impact revenue and margin on the contract. Historically, such audits have had no material impact on the company's revenue and margin. For all types of contracts, the company recognizes anticipated contract losses as soon as they become known and estimable. Out-of-pocket expenses that are reimbursable by the customer are included in contract revenue and cost of contract revenue. Unbilled expenditures and fees on contracts in process are the amounts of recoverable contract revenue, which had not been billed at the balance sheet date. Costs related to United States Government contracts, including applicable indirect costs, are subject to audit by the government. Revenue from such contracts has been recorded at amounts expected to be realized upon final settlement. Revenue from product sales, less associated warranty costs, is generally recognized at the time of shipment. Income Taxes The company accounts for income taxes using the liability method. 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. The deferred tax provision represents the change in the deferred tax asset or liability balance. 24 Cash and Cash Equivalents All cash investments, which consist primarily of money market accounts, have original maturities of three months or less and are classified as cash equivalents. 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. December 31, 2001 2000 ------------------------------------------------------------------------------- (in thousands of dollars) Work in process $ 296 $ 726 Raw materials and subassemblies 2,664 2,482 ------------------------------------------------------------------------------- Total inventories $ 2,960 $ 3,208 =============================================================================== Property, Plant and Equipment Property, plant and equipment are stated at cost. Plant and equipment are depreciated principally on a straight-line basis over their estimated useful lives. Useful lives range from 3 to 8 years for equipment and 31 years for the building. Leasehold improvements are amortized over the shorter of the remaining term of the lease or the life of the related asset.
December 31, 2001 2000 ----------------------------------------------------------------------------------------- (in thousands of dollars) Land $ 1,126 $ 1,126 Building 8,587 7,774 Machinery and equipment 47,546 45,133 Leasehold improvements 2,723 2,551 ----------------------------------------------------------------------------------------- Total property, plant and equipment, at cost 59,982 56,584 Less accumulated depreciation and amortization 45,385 42,143 ----------------------------------------------------------------------------------------- Net property, plant and equipment $ 14,597 $ 14,441 =========================================================================================
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the asset carrying value may not be recoverable. Impairment losses are measured based on the fair market value of the assets. In 2001, the company did not incur any impairment losses. See Notes 12 and 13 for a discussion of prior year impairment losses. Fair Value of Financial Instruments The carrying values of cash and cash equivalents, accounts receivable, unbilled expenditures and fees on contracts in process, and accounts payable approximate fair value because of the short-term nature of these instruments. The fair value of debt approximates carrying value because the debt bears interest at a variable market rate. Stock-Based Compensation The company adopted the disclosure alternative under Statement of Financial Accounting Standard ("SFAS") No. 123, Accounting for Stock-Based Compensation. The disclosure alternative requires the presentation of the pro forma effects on earnings (loss) and earnings (loss) per share as if stock-based compensation had been recognized, as well as the disclosure of certain other information. New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments included in other contracts (collectively referred to as derivatives), and for hedging activities. SFAS No. 133 (as amended by SFAS No. 137 and SFAS No. 138) was effective January 1, 2001. The adoption of SFAS No. 133 did not have a material impact on the company's financial position or results of operations, because it has no derivative instruments or hedging activities. In June 2001, the FASB issued SFAS No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method. It also specifies the types of acquired intangible assets required to be recognized and reported separately from goodwill. SFAS No. 142 will require that goodwill and certain 25 intangibles no longer be amortized, but instead be tested for impairment at least annually. SFAS No. 142 is required to be applied starting with fiscal years beginning after December 15, 2001. The company believes that the adoption of SFAS Nos. 141 and 142 will not have a material impact on the company's financial position or results of operations, because it currently has no goodwill or other intangible assets recorded. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 modifies the rules for accounting for the impairment of long-lived assets. The new rules are effective for the company beginning January 1, 2002. The company does not believe that the adoption of SFAS No. 144 will have a material impact on the company's financial position or results of operations. Earnings (Loss) Per Common Share Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the year. For years in which there is net income, diluted earnings per share is determined by giving effect to the exercise of stock options and restricted stock using the treasury stock method. Due to their antidilutive effect, 7,500 and 437,500 stock options were excluded from the calculation of earnings per share in 2001 and 2000, respectively. In 1999, because the company reported a net loss from continuing operations, 911,185 outstanding stock options were excluded from the weighted average number of shares outstanding. 2. Contracts in Process and Contract Loss Provisions In 1997, the company entered into a fixed-price software development contract with the Colorado Department of Human Services. This contract encountered difficulties, and as a result, the company recorded losses, including an $11.9 million charge in 1999. The losses are included in the results of operations of the Systems and Services segment as a charge to cost of contract revenue. The company continued to update its estimate of project cost and recorded, as necessary, changes in estimates during each reporting period through 2001. The company currently anticipates that the contract, except for the system warranty period, will be completed during the first half of 2002. Although the company believes it has reasonably estimated and provided for the costs to complete the Colorado contract at December 31, 2001, estimates of project costs will continue to be updated and changes in estimates provided for, as necessary, in each reporting period until completion. Accordingly, there can be no assurances that the actual costs on the project will not differ materially from current estimates. In 2000, the company incurred losses on communications software development projects described in Note 12. In 1999, the company recorded charges of $2.2 million to provide for estimated contract losses on two other fixed-price software development contracts and $1.8 million for other unrecoverable contract costs. These charges are reflected in the results of the Systems and Services segment as a charge to cost of contract revenue. Unbilled expenditures and fees on contracts in process with the United States Government were $16.5 million and $16.6 million at December 31, 2001 and 2000, respectively. Receivables under United States Government contracts were $11.1 million and $17.7 million at December 31, 2001 and 2000, respectively. 3. Restructuring In the fourth quarter of 1999, the company adopted a restructuring plan intended to reduce overhead costs and increase efficiencies. The company recorded a restructuring charge of $1.2 million to provide for severance and other exit costs for approximately 100 involuntarily terminated employees, of which $1.0 million was recorded as cost of contract revenue and the remainder as selling, engineering and administrative expense. Approximately half the charge was related to Massachusetts operations. The remainder of the charge related to a number of other locations. The plan involved reducing personnel in certain operating units, the consolidation and realignment of certain functions, and the evaluation of strategic alternatives for certain operations. The affected employees were primarily employed in an indirect capacity or in service lines that the company did not intend to pursue in the future. As of December 31, 1999, no costs had been charged against accrued liability. During 2000, the company expended approximately $0.9 million related to severance costs and outplacement services for 58 employees. During the fourth quarter of 2000, the company determined that 26 $0.1 million of reserves related to a specific business were no longer necessary, and those reserves were reversed against cost of contract revenue. The remaining restructuring reserve of $0.2 million at December 31, 2000 was expended during the first half of 2001, primarily for continuation pay for employees who had left the company prior to December 31, 2000. During the second and third quarters of 2001, the company provided $0.3 million for involuntary severance costs for 45 employees in the Encoder Division. These costs were expended in the second half of 2001, primarily for continuation pay. 4. Discontinued Operations In June 1999, the company completed the sale of its previously discontinued Telecommunications Fraud Control business for $1.7 million plus royalties. The sale resulted in a 1999 favorable pre-tax adjustment of $2.2 million to the estimated pre-tax loss on disposal of discontinued operations of $4.1 million, which was recorded in 1998. Royalty income of $62,000 and $0.2 million, after taxes, was recognized in 2001 and 2000, respectively. The company may benefit modestly from future royalty payments through July 31, 2002, up to a cap of $0.9 million, net of taxes. These receipts will be recorded as gain from discontinued operations, after deducting taxes, when received. The 1999 consolidated financial statements of the company were restated to reflect the discontinuation of the Telecommunications Fraud Control business. Accordingly, the revenue, costs, expenses and cash flows of the business were excluded from the respective captions in the Consolidated Statements of Operations and Consolidated Statements of Cash Flows and were reported as Gain (loss) from discontinued operations, net of income taxes, and as Net cash used for discontinued operations for all periods presented. The results of discontinued operations do not reflect any interest expense or any allocation of corporate general and administrative expense. There was no revenue from discontinued operations or operating loss of the business during 2001 and 2000 other than royalty income discussed above. Revenue and pre-tax net operating losses for the Telecommunications Fraud Control business for the year ended December 31, 1999 were $0.7 million and $2.4 million, respectively. The results for 1999 were charged to the accrual established at the date the plan of disposal was adopted. 5. Income Taxes The components of the provision (benefit) for federal and state income taxes from continuing operations are as follows:
For the years ended December 31, 2001 2000 1999 ----------------------------------------------------------------------------------------------------------- (in thousands of dollars) Currently payable Federal $ 2,328 $ 68 $ 75 State 520 10 223 ----------------------------------------------------------------------------------------------------------- 2,848 78 298 Deferred Federal 1,546 2,296 (3,584) State 55 634 (1,459) ----------------------------------------------------------------------------------------------------------- 1,601 2,930 (5,043) ----------------------------------------------------------------------------------------------------------- Total provision (benefit) $ 4,449 $ 3,008 $ (4,745) ===========================================================================================================
The major items contributing to the difference between the statutory United States federal income tax rate of 34% and the company's effective tax rate are as follows:
For the years ended December 31, 2001 2000 1999 ---------------------------------------------------------------------------------------------------------- (in thousands of dollars) Provision (benefit) on income (loss) from continuing operations at statutory rate $ 3,717 $ 2,503 $ (4,635) State income taxes, net of federal tax benefit 380 425 (810) Increase in valuation allowance -- -- 449 Other, net 352 80 251 ----------------------------------------------------------------------------------------------------------- Provision (benefit) for income taxes $ 4,449 $ 3,008 $ (4,745) ===========================================================================================================
During 1999, the company recorded a tax valuation allowance related to a capital loss from the sale of its investment in Empresa, Inc. (see Note 13). Currently, the company does not expect that it will meet the 27 requirements necessary to deduct this loss for federal income tax purposes. Accordingly, the company has recorded a valuation allowance for the full amount of the potential tax benefit associated with the loss. In 2000, the company generated a federal net operating loss carryforward of $1.8 million that the company will fully utilize to reduce 2001 federal taxable income. In 1999, the company utilized $4.2 million of federal net operating loss carryforwards to reduce 1999 federal taxable income. The tax effects of significant temporary differences that comprise deferred tax assets and liabilities are as follows:
December 31, 2001 2000 ---------------------------------------------------------------------------------------------- (in thousands of dollars) Unbilled costs and fees and deferred contract revenue, net $ (9,143) $ (10,510) Accrued expenses 2,892 3,648 Receivables reserves 541 439 Inventory reserves 597 649 Pension liability 405 -- Federal net operating loss carryforwards -- 612 Other 433 587 ---------------------------------------------------------------------------------------------- Current deferred tax liabilities, net (4,275) (4,575) ----------------------------------------------------------------------------------------------- Accelerated tax depreciation (899) 93 State net operating loss and credit carryforwards 163 383 Capital loss carryforward 449 449 Valuation allowance (449) (449) Alternative minimum tax credit carryforward 153 153 DISC deferral (1,886) (966) Other (281) (512) ----------------------------------------------------------------------------------------------- Non-current deferred tax liabilities, net (2,750) (849) ----------------------------------------------------------------------------------------------- Total deferred tax liabilities, net $ (7,025) $ (5,424) ===============================================================================================
Total deferred tax assets and total deferred tax liabilities were $6.5 million and $13.5 million, respectively, at December 31, 2001, compared with $7.4 million and $12.8 million, respectively, at December 31, 2000. 6. 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 the number of years an employee has worked 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. Additional amounts are contributed to assure that plan assets will be adequate to provide retirement benefits. Contributions are intended to provide for benefits earned to date and also for those expected to be earned in the future. In December 2001, the Board of Directors approved to proceed with amendments limiting future increases in benefits under the company's Defined Benefit Pension Plan, freezing membership in the Plan, and providing for improvements to the company's 401(k) Plan. Accordingly, the approval to amend the Defined Benefit Pension Plan resulted in a curtailment charge of $0.8 million in the fourth quarter of 2001. Periodic Pension Cost
For the years ended December 31, 2001 2000 1999 --------------------------------------------------------------------------------------------------- (in thousands of dollars) Service cost - benefits earned during the period $ 2,470 $ 2,322 $ 2,502 Interest cost on projected benefit obligation 3,476 3,240 2,735 Expected return on plan assets (3,684) (3,450) (3,114) Amortization of prior service cost 220 220 220 Amortization of transition obligation 35 35 35 Recognized actuarial loss 72 -- -- --------------------------------------------------------------------------------------------------- Net periodic pension cost 2,589 2,367 2,378 Recognized curtailment loss 819 -- -- --------------------------------------------------------------------------------------------------- Net periodic pension cost after curtailment loss $ 3,408 $ 2,367 $ 2,378 ===================================================================================================
28 Changes in Benefit Obligations
December 31, 2001 2000 -------------------------------------------------------------------------------------------- (in thousands of dollars) Projected benefit obligation at beginning of year $ 49,485 $ 43,653 Service cost - benefits earned during the period 2,403 2,322 Interest cost on projected benefit obligation 3,475 3,240 Benefits paid (1,502) (1,789) Actuarial loss 1,437 2,059 Plan amendments - curtailment gain (9,732) -- -------------------------------------------------------------------------------------------- Projected benefit obligation at end of year $ 45,566 $ 49,485 ============================================================================================ Change in Plan Assets December 31, 2001 2000 -------------------------------------------------------------------------------------------- (in thousands of dollars) Fair value of plan assets at beginning of year $ 40,421 $ 37,699 Actual return on plan assets 708 1,737 Employer contributions 2,480 2,774 Benefits and expenses paid (1,575) (1,789) --------------------------------------------------------------------------------------------- Fair value of plan assets at end of year $ 42,034 $ 40,421 ============================================================================================ Funded Status December 31, 2001 2000 -------------------------------------------------------------------------------------------- (in thousands of dollars) Plan assets less than projected benefit obligation $ 3,532 $ 9,064 Unrecognized net transition obligation -- (35) Unrecognized prior service costs -- (1,040) Unrecognized net actuarial loss (1,013) (6,398) --------------------------------------------------------------------------------------------- Accrued pension liability $ 2,519 $ 1,591 ============================================================================================ Weighted Average Assumptions December 31, 2001 2000 -------------------------------------------------------------------------------------------- Discount rate 7.0% 7.3% Rate of compensation increase 4.0% 4.0% Expected rate of return on assets 9.0% 9.0% --------------------------------------------------------------------------------------------
Plan assets consist primarily of equity and fixed income securities. Fluctuations in the fair market value of plan assets will affect pension expense in future years. At December 31, 2001, the defined benefit pension plan was underfunded relative to its accumulated benefit obligation. This resulted in the company recording an additional liability of $1.0 million in 2001 to reflect the required minimum pension liability amount. The amount is recorded, net of the related tax effect, as a component of accumulated other comprehensive income. Additional Liability at December 31, 2001 ------------------------------------------------------------------------------- (in thousands of dollars) Accumulated benefit obligation at end of year $ 45,566 ------------------------------------------------------------------------------- Unfunded accumulated benefit obligation $ 3,532 Accrued pension liability (2,519) ------------------------------------------------------------------------------- Additional minimum liability $ 1,013 =============================================================================== The company also maintains a cash or deferred savings plan (the "401(k) plan"). Employees may elect to defer a portion of their salary and contribute the deferred portion to the 401(k) plan. The company contributes an amount equal to 25% of the first 6% of an employee's contribution to the plan. The company contributed $0.9 million to the plan for each of 2001, 2000 and 1999. Employee contributions and the company's matching contributions are invested in one or more collective investment funds at the participant's direction. The company's matching contributions are subject to forfeiture of any non-vested portion if termination occurs within the first five years of employment. On October 31, 2000, the Board of Directors approved a deferred compensation plan. The plan provides certain employees of the company the ability to annually elect to defer up to 100% of any cash incentive payments from the company and any salary in excess of the FICA earnings ceiling. Employee contributions are invested in selected mutual funds within a Rabbi Trust. These investments, which the company has classified as trading securities, are recorded at fair value with corresponding amounts recorded as deferred 29 compensation liabilities for certain employees. At December 31, 2001 $0.4 million had been deferred under the plan. At December 31, 2000, no amounts had been deferred. The company also has a deferred compensation plan under which non-employee directors may elect to defer their directors' fees. Amounts deferred for each participant are credited to a separate account, and interest at the lowest rate at which the company borrowed money during each quarter or, if there was no such borrowing, at the prime rate, is credited to such account quarterly. The balance in a participant's account is payable in a lump sum or in installments when the participant ceases to be a director. In 2001, deferred compensation having an aggregate value of approximately $262,000 was converted into 23,577 shares of restricted company stock, based upon the fair market value of the stock at the date of conversion. 7. Debt The company's revolving credit agreement (the "Revolver"), dated February 10, 2000, allows the company to borrow up to the lesser of $20.0 million or 80% of eligible accounts receivable, as defined by the agreement. The Revolver expires on February 10, 2003. Interest on the outstanding balance of the Revolver is payable monthly. Prior to February 2001, interest accrued at the prime rate and the agreement included a fee of 0.375% on the unused portion of the Revolver. Beginning in February 2001, the company received the option to elect, on a fixed 30, 60 or 90-day term, an interest rate of LIBOR plus 2% or the prime rate. In addition, the fee on the unused Revolver was reduced to 0.25%. Effective June 30, 2001, the Revolver was amended (the "Amended Revolver") to release the banks' security interests in the company's assets and to continue the Amended Revolver on an unsecured basis. At December 31, 2001, there was no outstanding balance under the Amended Revolver, and the company had $15.2 million of unused credit line available. At December 31, 2000, $5.8 million was outstanding under the Revolver. Available interest rates on the Amended Revolver at December 31, 2001, were 4.75% under the prime rate option and 3.88% under the 30-day LIBOR rate option. The company has a 10-year mortgage loan (the "Mortgage"), dated June 12, 2000, on the company's real estate. The outstanding balance of the Mortgage was $9.3 million and $9.8 million at December 31, 2001 and 2000, respectively. The agreement requires quarterly principal payments of $125,000 beginning on August 1, 2000, with a final payment of $5.0 million in June 2010. Interest on the Mortgage accrued at the rate of LIBOR plus 2.5% at December 31, 2000. Effective November 6, 2001, the interest rate on the Mortgage was reduced to LIBOR plus 2.0%. The interest rate on the Mortgage under the 90-day LIBOR option elected at October 15, 2001 was 4.51% on December 31, 2001. The Mortgage is secured by the corporate office facility in Andover, Massachusetts. The Amended Revolver and Mortgage require the company to meet certain financial covenants including maintaining a minimum tangible net worth, cash flow and debt coverage ratios, as well as limit the company's ability to incur additional debt, to pay dividends, to purchase capital assets, to sell or dispose of assets, to make additional acquisitions or investments, or to enter into new leases, among other restrictions. The company was in compliance with all covenants on December 31, 2001. 8. Stock Plans The company has stock option plans, which are administered by the Compensation Committee of the Board of Directors. The committee determines which employees receive options, the number of options granted and the option prices of the shares covered by each stock option grant. The 1993 Equity Incentive Plan (the "1993 Plan") permits the company to grant incentive stock options, non-qualified stock options, stock appreciation rights, awards of nontransferable shares of restricted common stock and deferred grants of common stock. The option price of incentive stock options will not be less than the fair market value at the time the option is granted. The option period will not be greater than 10 years from the date the option is granted. Normally the stock options have been exercisable in three equal installments beginning one year from the date of the grant. Through shareholder approval, 580,800 shares were reserved for the 1993 Plan. At December 31, 2001, 46,809 shares were available for future grants. The company's 1995 Stock Option Plan for Non-Employee Directors provides for each outside director to receive options to purchase 5,000 shares of common stock at the first annual meeting at which the director is elected. As long as he or she remains an eligible director, the director receives options to purchase 1,000 shares of common stock at each annual meeting. These directors cannot be an employee of the company or one of its subsidiaries or a holder of five percent or more of the company's common stock. The exercise price 30 of these options is the fair market value of the common stock on the date of grant. Each option is not transferable except upon death and expires 10 years after the date of grant. The options become exercisable in three equal installments on the first, second and third anniversary of the date of grant. A total of 132,000 shares were reserved for issuance. At December 31, 2001, 81,040 shares remained available for future grants. There were no grants under this plan during 2001. Under the 2000 Plan, discussed below, options to purchase 60,000 shares of the company's common stock were issued to directors in 2001. In 1999, unrelated to the 1993 and 1995 plans, the company granted an officer 250,000 non-qualified stock options to purchase shares of the company's common stock. The option price is $4.44, which was the fair market value of the common stock at the date of grant. Twenty percent of the options vested immediately. An additional 20% vest in each successive year from the date of grant. The options expire 10 years from the date of grant. On January 18, 2000, the company's shareholders approved the adoption of the 2000 Incentive Plan (the "2000 Plan"). The 2000 Plan allows the company to grant incentive stock options, non-qualified stock options, stock appreciation rights, awards of nontransferable shares of restricted common stock and deferred grants of common stock up to a total of 1.5 million shares. In the case of incentive stock options, the option price will not be less than the fair market value of the stock at the date of grant. The option period will not exceed 10 years from the date of grant. The terms of the 2000 Plan are substantially similar to those of the 1993 Plan. A total of 1.5 million shares were reserved for issuance of which 116,200 shares remained available at December 31, 2001. On January 30, 2001, the company's shareholders approved the 2000 Employee Stock Purchase Plan (the "ESPP"). The ESPP is designed to give eligible employees an option to purchase common stock of the company through accumulated payroll deductions. The purchase price of the stock is equal to 85% of the fair market value of a share of common stock on the first day or last day of each three-month offering period, whichever is lower. All employees of the company or designated subsidiaries who customarily work at least 20 hours per week and do not own five percent or more of the company's common stock are eligible to participate in the purchase plan. A total of 800,000 shares have been reserved for issuance under the ESPP. The program commenced in May 2001 and as of December 31, 2001, 58,387 shares have been issued through the plan. During the second quarter of 2001, the Board of Directors approved the Executive Long Term Incentive Program (the "ELTIP"), implemented under the provisions of the shareholder approved 2000 Incentive Plan. The ELTIP provides incentives to program participants through a combination of stock options and restricted stock grants which vest fully in seven years. The ELTIP allows for accelerated vesting based on the company's achievement of specified financial performance goals. During the second quarter of 2001, the company granted under this plan stock options totaling 750,000 shares of common stock at fair market value and granted 121,000 shares of restricted common stock with approximately $1.1 million of compensatory value to be amortized over the vesting period of the grant. In 2001, the company recognized approximately $90,000 of compensation expense under this plan. The company has computed pro forma disclosures using the Black-Scholes option pricing model. The Black-Scholes model computes the estimated fair market value of the options granted each year.
Black-Scholes Assumptions December 31, 2001 2000 1999 ------------------------------------------------------------------------------- Risk free interest rate 5.4% 5.0% 7.0% Expected option life (years) 8.6 9.6 8.9 Stock volatility 73.19% 72.64% 73.49% -------------------------------------------------------------------------------
Options Granted For the years ended December 31, 2001 2000 1999 ------------------------------------------------------------------------------- Number of shares 829,500 469,200 310,500 Weighted average fair market value $ 7.02 $ 6.40 $ 3.59 -------------------------------------------------------------------------------
31 The company accounts for its stock option plans under APB Opinion No. 25 under which no compensation cost has been recognized. If compensation costs for the fair value of options granted under these plans had been recognized in the financial results, the company's net income (loss) and earnings (loss) per share would have approximated the following pro forma amounts:
For the years ended December 31, 2001 2000 1999 -------------------------------------------------------------------------------------------- (in thousands of dollars) Income (loss) from continuing operations $ 4,189 $ 3,724 $ (9,416) Income (loss) from continuing operations per share - basic .55 .49 (1.28) Income (loss) from continuing operations per share - diluted .52 .48 (1.28) Net income (loss) 4,251 3,930 (8,054) Net income (loss) per share - basic .55 .52 (1.09) Net income (loss) per share - diluted .53 .51 (1.09) ============================================================================================
Stock option information for 2001, 2000 and 1999 is as follows: Number Weighted- of Shares Average Price ------------------------------------------------------------------------------ Outstanding at December 31, 1998 627,630 $ 5.32 Granted 310,500 4.53 Exercised (9,785) 2.92 Canceled (17,160) 5.59 ------------------------------------------------------------------------------ Outstanding at December 31, 1999 911,185 5.07 Granted 469,200 8.12 Exercised (223,381) 3.64 Canceled (80,344) 6.07 ------------------------------------------------------------------------------ Outstanding at December 31, 2000 1,076,660 6.62 Granted 829,500 9.01 Exercised (136,127) 6.28 Canceled (18,880) 7.52 ------------------------------------------------------------------------------ Outstanding at December 31, 2001 1,751,153 7.76 ================================================================================ The following tables summarize information about stock options outstanding and exercisable at December 31, 2001: Options Outstanding
Weighted- Average Weighted- Number of Shares Contractual Average Exercise Outstanding at Remaining Exercise Price Range December 31, 2001 Life in Years Price ----------------------------------------------------------------------------------------- $3.12-$4.41 34,320 3.2 $ 3.20 4.42-5.52 353,200 6.8 4.65 5.53-6.63 8,140 6.3 6.12 6.64-7.73 105,560 6.9 7.39 7.74-9.94 1,200,633 9.1 8.72 9.95-11.04 49,300 7.1 10.80 ----------------------------------------------------------------------------------------- 3.12-11.04 1,751,153 8.3 7.76 =========================================================================================
Options Exercisable
Number of Shares Weighted- Exercise Exercisable at Average Price Range December 31, 2001 Exercise Price ----------------------------------------------------------------------------------------- $3.12-$4.41 34,320 $ 3.20 4.42-5.52 244,867 4.72 5.53-6.63 6,308 6.07 6.64-7.73 68,893 7.33 7.74-9.94 132,198 8.32 9.95-11.04 34,800 10.14 ----------------------------------------------------------------------------------------- 3.12-11.04 521,386 6.26 =========================================================================================
32 Stock options exercisable at December 31, 2000 and December 31, 1999 were 426,498 and 562,393, respectively. 9. Commitments and Contingencies The company conducts some of its operations in facilities, which are under long-term operating leases. These leases expire at various dates through 2005, with various options to renew through 2010. It is expected that in the normal course of business, leases that expire will be renewed or replaced. Rent expense under these leases (inclusive of real estate taxes and insurance) was approximately $4.1 million in 2001, $3.8 million in 2000 and $3.7 million in 1999. The aggregate minimum lease commitment for the company's facilities on December 31, 2001 was $9.9 million, payable as follows: $3.5 million in 2002, $2.7 million in 2003, $2.2 million in 2004, $1.4 million in 2005 and $0.1 million in 2006. As a defense contractor, the company is subject to many levels of audit and review, including the Defense Contract Audit Agency (the "DCAA"), the Inspector General, the Defense Criminal Investigative Service, the General Accounting Office, the Department of Justice and Congressional Committees. As a result of certain DCAA audit findings in January 2000, the United States Government temporarily deferred a portion of its payments to the company. At December 31, 2000, $1.0 million in payments were deferred, all of which was paid in early 2001. Both related to and unrelated to its defense industry involvement, the company is, from time to time, involved in audits, lawsuits, claims, administrative proceedings and investigations. The company accrues for liabilities associated with these activities when it becomes probable that future expenditures will be made and when the expenditures can be reasonably estimated. In management's opinion, the outcome from such audits and other matters discussed above is not expected to have a material adverse effect on the company's financial position or results of operations. On October 26, 2000, the United States Attorney's Office announced the indictment of two former company employees for conspiracy to defraud the United States Air Force. Both former employees pled guilty. The United States Attorney's Office has informed the company that it is not a target of the investigation. Separately, the United States Attorney's Office is investigating certain company activity and billing transactions from prior years. The company does not know, at this time, what financial effects, if any, may result to the company from these matters. In 2001, approximately 79% of the company's sales were to United States Government agencies, primarily the Department of Defense. All of the company's United States Government contracts are subject to termination for convenience in accordance with government regulations. In 2001, approximately 10% of the company's sales were to agencies of state governments. Many of the contracts the company has won are multi-year efforts. In accordance with state laws, funding must be approved annually by the states' legislatures. The company has change of control agreements with certain employees of the company providing them with benefits if their employment with the company is terminated, other than for cause or their disability or death, or if they resign for good reason within a certain period of time from the date of any change of control of the company. 10. Preferred Stock Purchase Rights On February 17, 1998, the company declared a dividend distribution of one preferred stock purchase right (the "Right") for every outstanding share of common stock, effective July 27, 1998. The Rights attach to all outstanding shares of common stock, and no separate right certificates will be issued. The Rights will become exercisable upon the tenth business day following the earlier of (i) the date of a public announcement that a person or group of affiliated or associated persons has acquired or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of common stock of the company or (ii) the commencement or announcement of an intention to make a tender offer or exchange offer that would result in a person or group owning 15% or more of the outstanding common stock of the company. When exercisable, each Right entitles the registered holder to purchase from the company one-twelfth of a share of its Series B Participating Preferred Stock, $.10 par value, at a price of $54.17 per each one-twelfth share of preferred stock. Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the company, including, without limitation, the right to vote or to receive dividends. Under certain circumstances, each share of the Series B Participating Preferred Stock would be convertible into a number of shares of the company's common stock having a value equal to twice the exercise price of the 33 preferred stock purchase right. The Rights may be redeemed by the company at the discretion of the Board of Directors at a price of $.0083 per Right. The Rights expire on July 27, 2008. 11. Business Segments In 2001 and 2000, the company had three reportable business segments: Systems and Services, Metrigraphics and Encoder. In 1999, the company also had VisualMagic (see Note 13) and the Telecommunications Fraud Control business (see Note 4). Each of the segments represents a separate product line, has different customer requirements and production processes and operate in different industries. The Systems and Services segment is the aggregation of five operating groups that provide similar services to government customers and are subject to similar regulations. The segments follow the same accounting policies described in Note 1. Sales between segments represent less than 1% of total revenue and are accounted for at cost. Revenue is attributed to geographic areas based upon the customer's location. The company does not have locations outside the United States, but does contract with sales representatives located in foreign countries and the company's employees and subcontractors provide services at customer locations outside the United States. Domestic revenue represented 98%, 97% and 99% of revenue from continuing operations in 2001, 2000 and 1999, respectively. During 2001, 2000 and 1999, revenue from Department of Defense customers represented approximately 73%, 74% and 66% of total revenue from continuing operations, respectively. Revenue earned from one significant DoD contract represented 19%, 17% and 12% of revenue from continuing operations in 2001, 2000 and 1999, respectively. Systems and Services The Systems and Services segment provides specialized technical services to the DoD, federal agencies, state governments and other customers and produced approximately 89% of total company revenue in 2001. These services include engineering services, development and operation of computer-based management systems and other management services. The Systems and Services segment provides network infrastructure for state human services as well as software system implementation services. Metrigraphics The Metrigraphics Division uses photolithographic and material deposition processes to manufacture optical discs, scales and reticles that are used for precision measurement. Metrigraphics produces a variety of precision components including inkjet printer cartridge nozzle plates and fine line circuits used in certain medical instruments. Encoder The Encoder Division designs, manufactures and markets a line of digital encoders that convert analog motion and position information into digital signals used in a wide variety of industrial products and systems which include machine tools, robotics, engine fuel-control systems, packaging equipment and other capital equipment. Encoder's digital encoding devices are essential elements of today's electronically controlled systems and equipment. Telecommunications Fraud Control Between 1996 and the second quarter of 1999, the company operated under an exclusive license to enhance, develop and market a telephone fraud-detection control system. Telecommunication customers included five regional bell operating companies. As discussed further in Note 4, Discontinued Operations, during 1998, the company adopted a plan to exit the business. In 1999 the company sold the business. VisualMagic Over a number of years, the company invested in the research and development of VisualMagic, an object-oriented development environment. As discussed further in Note 13, during 1998, the company acquired an interest in Empresa, Inc., formerly Electronic Press Services Group, Inc., in exchange for a license to VisualMagic, cash and the assets of the business. Empresa, Inc. also hired most of the segment's employees. 34 Financial Information by Business Segment
Depreciation Operating Identifiable and Net Income Assets at Amortization Capital Sales(1) (Loss)(1)(2) Year End Expense Expenditures ----------------------------------------------------------------------------------------------------------------- (in thousands of dollars) 2001 Systems and Services $ 179,350 $ 9,971 $ 49,156 $ 1,889 $ 2,162 Encoder 10,848 (1,671) 4,386 468 157 Metrigraphics 10,914 3,569 3,126 574 692 ----------------------------------------------------------------------------------------------------------------- Total identifiable continuing operations $ 201,112 $ 11,869 $ 56,668 $ 2,931 $ 3,011 =============================================================================================================== 2000 Systems and Services $ 172,774 $ 4,466 $ 58,504 $ 1,955 $ 996 Encoder 17,648 1,619 5,973 593 170 Metrigraphics 9,753 3,118 2,537 663 983 ----------------------------------------------------------------------------------------------------------------- Total identifiable continuing operations $ 200,175 $ 9,203 $ 67,014 $ 3,211 $ 2,149 =============================================================================================================== 1999 Systems and Services $ 164,766 $ (12,988) $ 55,191 $ 1,967 $ 1,442 Encoder 13,214 (785) 5,818 618 262 Metrigraphics 13,641 4,100 2,527 2,841 786 VisualMagic -- (1,424) -- -- -- ----------------------------------------------------------------------------------------------------------------- Total identifiable continuing operations $ 191,621 $ (11,097) $ 63,536 $ 5,426 $ 2,490 ===============================================================================================================
(1)Net sales and operating income (loss) are presented after the elimination of intersegment transactions. (2)In 1999, Systems and Services segment includes a $1.2 million restructuring charge. Reconciliations of amounts related to identifiable continuing operations to amounts included in the Consolidated Balance Sheets, Consolidated Statements of Operations and Consolidated Statements of Cash Flows are as follows:
As of and for the years ended December 31, 2001 2000 1999 ---------------------------------------------------------------------------------------------------------- (in thousands of dollars) Identifiable operating income (loss) $ 11,869 $ 9,203 $ (11,097) Other corporate expense -- -- (281) ----------------------------------------------------------------------------------------------------------- Operating income (loss) $ 11,869 $ 9,203 $ (11,378) ========================================================================================================== Identifiable assets(3) $ 56,668 $ 67,014 $ 63,536 Corporate assets(4) 25,157 11,688 11,652 ----------------------------------------------------------------------------------------------------------- Total assets $ 81,825 $ 78,702 $ 75,188 ========================================================================================================= Identifiable depreciation and amortization $ 2,931 $ 3,211 $ 5,426 Corporate depreciation and amortization 526 535 634 ----------------------------------------------------------------------------------------------------------- Total depreciation and amortization $ 3,457 $ 3,746 $ 6,060 ========================================================================================================= Identifiable capital expenditures $ 3,011 $ 2,149 $ 2,490 Corporate capital expenditures 741 971 212 ----------------------------------------------------------------------------------------------------------- Total capital expenditures $ 3,752 $ 3,120 $ 2,702 =========================================================================================================
(3) Identifiable assets by business segment include both assets directly identified with those operations and an allocable share of jointly used assets. (4) Corporate assets consist primarily of cash, short-term investments and the company's Andover, Massachusetts corporate headquarters. 12. Sale of Tactical Communications Group On June 1, 2001, the company completed the sale of its Tactical Communications Group ("TCG") and the transfer of related employees and assets. TCG developed and sold communications software for defense applications. In 2000, TCG recorded revenue of $2.3 million and an after-tax loss of $0.9 million, including a 35 $0.4 million impairment charge recorded in the fourth quarter of 2000. For the first six months of 2001, TCG recorded revenue of approximately $0.8 million and a loss of $0.5 million. The sale resulted in a net loss of $0.2 million, shown as Other expense on the Consolidated Statements of Operations. Proceeds from the transaction were $0.1 million in cash, with a $50,000 note receivable due one year from the date of sale. 13. Investment in Empresa, Inc. In 1998 and 1999, the company made investments in Empresa, Inc. ("Empresa"), a privately held company. The company contributed a perpetual license to the VisualMagic development environment, the assets of the VisualMagic segment and cash. In the second quarter of 1999, the company wrote off its investment in Empresa due to the uncertainties of the early stage business resulting in an impairment charge of $1.4 million which is included in selling, engineering and administrative expenses in the Consolidated Statements of Operations. Subsequently, Empresa ceased operations. Item 14. Quarterly Information (unaudited)
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr -------------------------------------------------------------------------------------------------------- (in thousands of dollars, except per share data) 2001 Revenue $ 48,640 $ 50,584 $ 50,245 $ 51,643 Gross margin 6,810 6,898 7,684 7,778 Operating income 2,480 2,750 3,496 3,143 Income from continuing operations 1,320 1,361 1,978 1,824 Gain on discontinued operations - 62 - - Net income 1,320 1,423 1,978 1,824 Income from continuing operations per common share - diluted(1) .17 .17 .24 .21 Gain on discontinued operations per common share - diluted(1) - .01 - - Net income per common share - diluted(1) .17 .18 .24 .21 2000 Revenue $ 47,790 $ 54,440 $ 48,376 $ 49,569 Gross margin 5,556 7,215 6,257 5,733 Operating income 1,512 2,981 2,701 2,009 Income from continuing operations 556 1,436 1,350 1,011 Gain on discontinued operations 171 35 - - Net income 727 1,471 1,350 1,011 Income from continuing operations per common share - diluted(1) .07 .19 .17 .13 Gain on discontinued operations per common share - diluted(1) .02 - - - Net income per common share - diluted(1) .09 .19 .17 .13
(1) Quarterly per share amounts may not equal annual amounts due to rounding. 36 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, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2001. 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 auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Dynamics Research Corporation and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of financial statements 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. /s/ Arthur Andersen LLP Arthur Andersen LLP Boston, Massachusetts, February 1, 2002 37 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 2002 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, 2001, 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 10-K. 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 2002 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, 2001. Item 12. Security Ownership of Certain Beneficial Owners and Management Information called for by this item is incorporated by reference from the section entitled "Common Stock Ownership of Certain Beneficial Owners and Management" in the company's definitive Proxy Statement for the 2002 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, 2001. 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. (b) (3) Exhibits. The exhibits that are filed with this Form 10-K, or that are incorporated herein by reference, are set forth in the Exhibit Index, which appears in Part IV of this report on page 46. (c) Reports on Form 8-K - None 38 Exhibit 99 Important Factors Regarding Forward-Looking Statements The following factors, among others, could cause our actual results and performance to differ materially from those contained or implied in forward-looking statements made in this report and presented elsewhere by or on behalf of the company from time to time. Our Revenue is Highly Dependent on Federal, State and Local Agencies and any Decreases in Their Budgets Could Affect our Results In 2001, approximately 89% of our revenue was derived from government agencies, primarily the Department of Defense. Presently, many states are curtailing expenditures in response to budget deficits. While DRC provides critical services to state and local governments, it is possible the programs supported by DRC, and DRC's revenue, could be affected. In the past, our defense business has been adversely affected by significant changes in defense spending during periods of declining United States defense budgets. Among the effects of this general decline has been increased competition within a consolidating defense industry. It is not possible for us to predict whether defense budgets will increase or decline in the future. Further, changing missions and priorities in the defense budget may have adverse effects on our business. Funding limitations could result in a reduction, delay or cancellation of existing or emerging programs. We anticipate there will continue to be significant competition when our defense contracts are rebid, as well as significant competitive pressure to lower prices, which may reduce profitability in this area of our business. Any reduction in the level or profitability of our defense business, if not offset by new commercial business or other business, will adversely affect our business, financial condition and results of operations. We Must Bear the Risk of Various Pricing Structures Associated with Government Contracts We have historically derived a substantial portion of our revenue from contracts and subcontracts with the United States Government. A significant portion of our federal and state government contracts are undertaken on a time and materials nature, with fixed hourly rates that are intended to cover salaries, benefits, other indirect costs of operating the business and profit. The pricing of such contracts is based upon estimates of future costs and assumptions as to the aggregate volume of business that we will perform in a given business division or other relevant unit. For long-term contracts, we must estimate the costs necessary to complete the defined statement of work and recognize revenue or losses in accordance with such estimates. Actual costs may vary materially from the estimates made from time to time, necessitating adjustments to reported revenue and net income. Underestimates of the costs associated with a project could adversely affect our overall profitability and could have a material adverse effect on our business, financial condition and results of operations. Alternatively, we undertake various government projects on a fixed-price basis, as distinguished from billing on a time and materials basis. Under a fixed-price contract, the government pays an agreed upon price for our services or products, and we bear the risk that increased or unexpected costs may reduce our profits or cause us to incur a loss. Significant cost overruns can occur if we fail to: - adequately estimate the resources required to complete a project; - properly determine the scope of an engagement; or - complete our contractual obligation in a manner consistent with the project plan. The potential for cost overruns may be heightened if we act as a subcontractor on a fixed-price project, because we have a limited ability to control project variables and to negotiate directly with the ultimate client. We cannot be certain that any of our existing or future time and materials or fixed-price projects will be profitable. A substantial portion of our United States Government business is as a subcontractor. In such circumstances, we generally bear the risk that the prime contractor will meet its performance obligations to the United States Government under the prime contract and that the prime contractor will have the financial capability to pay us amounts due under the subcontract. The inability of a prime contractor to perform or make required payments to us could have a material adverse effect on the company's business, financial condition and results of operations. 39 Our Contracts and Subcontracts with Government Agencies are Subject to a Competitive Bidding Process and to Termination Without Cause by the Government A significant portion of our federal and state government contracts are renewable on an annual basis, or are subject to the exercise of contractual options. Multi-year contracts often require funding actions by the United States Government, state legislature or others on an annual or more frequent basis. As a result, our business could experience material adverse consequences should such funding actions or other approvals not be taken. Governmental awards of contracts are subject to regulations and procedures that permit formal bidding procedures and protests by losing bidders. Such protests may result in significant delays in the commencement of expected contractual effort, the reversal of a previous award decision or the reopening of the competitive bidding process, which could have a material adverse effect on our business, financial condition and results of operations. Because of the complexity and scheduling of contracting with government agencies, from time to time we may incur costs before receiving contractual funding by the United States Government. In some circumstances, we may not be able to recover such costs in whole or in part under subsequent contractual actions. Failure to collect such amounts may have material adverse consequences on our business, financial condition and results of operations. In addition, the United States Government has the right to terminate contracts for convenience. If the government terminated contracts with us, we would generally recover costs incurred up to termination, costs required to be incurred in connection with the termination and a portion of the fee earned commensurate with the work we have performed to termination. However, significant adverse effects on our indirect cost pools may not be recoverable in connection with a termination for convenience. Contracts with state and other governmental entities are subject to the same or similar risks. We are Subject to a High Level of Government Regulations and Audits Under our Government Contracts and Subcontracts As a defense contractor, we are subject to many levels of audit and review, including by the Defense Contract Audit Agency, the Inspector General, the Defense Criminal Investigative Service, the General Accounting Office, the Department of Justice and Congressional Committees. These audits and reviews could result in the termination of contracts, the imposition of fines or penalties, the withholding of payments due to us or the prohibition from participating in certain United States Government contracts for a specified period of time. Although we have thus far not been required to make any material audit adjustments, the United States government, in the past, has temporarily deferred a portion of its payments to us. We cannot assure you that any such adjustments will not be required in the future. Loss of Key Personnel or Increased Government Regulation of Immigration Could Limit our Growth We are dependent on our ability to attract and retain highly skilled technical personnel. Many of our technical personnel may have specific knowledge and experience related to various government customer operations and these individuals would be difficult to replace in a timely fashion. In addition, qualified technical personnel are in high demand worldwide and are likely to remain a limited resource. The loss of services of key personnel could impair our ability to perform required services under some of our contracts, to retain such business after the expiration of the existing contract, or to win new business in the event that we lose the services of individuals who have been identified in a given proposal as key personnel in the proposal. Any of these situations could have a material adverse effect on our business, financial condition and results of operations. In addition, we recruit technical professionals globally and, as a result, we must comply with the immigration laws in the countries in which we operate, particularly the United States. As of December 31, 2001, less than 1% of our workforce was working under H-1B temporary work permits in the United States. Government regulation limits the number of new H-1B permits that may be approved in a fiscal year. If the limit is reached in any year, we may not be able to recruit enough technical professionals to meet our personnel requirements. This could materially affect our business. Congress and administrative agencies with jurisdiction over immigration matters have periodically expressed concern over the level of legal and illegal immigration into the United States, which may reduce the number of work permits that may be issued. Any change making it more difficult for us to hire foreign nationals, or limiting our ability to retain foreign employees, could require us to incur additional unexpected labor costs and other expenses. 40 We Operate in Highly Competitive Markets and May have Difficulties Entering New Markets The markets for our services are highly competitive. The government contracting business is subject to intense competition from numerous companies, many of which have significantly greater financial, technical and marketing resources than we do. The principal competitive factors are price performance, technical competence and reliability. Competition in the market for our commercial products is also intense. There is a significant lead-time for developing such business, and it involves substantial capital investment including development of prototypes and investment in manufacturing equipment. Principal competitive factors are price, product quality and the ability to specialize our engineering in order to meet our customers' specific system requirements. Our precision products business has a number of competitors, many of which have significantly greater financial, technical and marketing resources than we do. Competitive pressures in our government and commercial businesses could have a material adverse effect on our business, financial condition and results of operations. In our efforts to enter new markets, including commercial markets and United States Government agencies other than the Department of Defense, we generally face significant competition from other companies that have prior experience with such potential customers, as well as significantly greater financial, technical and marketing resources than we have. As a result, we may not achieve the level of success that we expect in our efforts to enter such new markets. Our Business is Highly Concentrated and a Significant Portion of our Revenue is Derived from a Few Customers Our revenue from contracts with the Department of Defense, either as prime contractor or subcontractor, accounted for approximately 73% of our total revenue during 2001. Within the Department of Defense, individual services and program offices account for a significant portion of our United States Government business. We cannot assure you that any of these customers will continue as such or will continue at current levels. A decrease in orders from any of these customers would have an adverse effect on our profitability, and the loss of any large customer could have a material adverse effect on our business, financial condition and results of operations. We May be Subject to Product Liability Claims Our precision manufactured products are generally designed to operate as important components of complex systems or products. Defects in our products could cause our customer's product or systems to fail or perform below expectations. Although we attempt to contractually limit our liability for such defects or failures, we cannot assure you that our attempts to limit our liability will be successful. Like other manufacturing companies, we may be subject to claims for alleged performance issues related to our products. Such claims, if made, could damage our reputation and could have a material adverse effect on our business, financial conditions or results of operations. Economic Events May Affect our Business Segments Many of our precision products are components of commercial products. Factors that affect the production and demand for such products, including economic events both domestically and in other regions of the world, competition, technological change and production disruption, could adversely affect demand for our products. Many of our products are incorporated into capital equipment, such as machine tools and other automated production equipment, used in the manufacture of other products. As a result, this portion of our business may be subject to fluctuations in the manufacturing sector of the overall economy. An economic recession, either in the United States or elsewhere in the world, could have a material adverse effect on the rate of orders received by the commercial divisions. Significantly lower production volumes resulting in under-utilization of our manufacturing would adversely affect our business, financial condition and results of operations. Our Products and Services Could Become Obsolete Due to Rapid Technological Changes in the Industry We offer sophisticated products and services in areas in which there have been and are expected to continue to be significant technological changes. Many of our products are incorporated into sophisticated machinery, equipment or electronic systems. Technological changes may be incorporated into competitors' products that may adversely affect the market for our products. If our competitors introduce superior technologies or products, we cannot assure you that we will be able to respond quickly enough to such changes or to offer services that satisfy our customers' requirements at a competitive price. Further, we cannot assure you that our research and product development efforts will be successful or result in new or improved products that may be required to sustain our market position. 41 Our Financing Requirements May Increase and We Could have Limited Access to Capital Markets While we believe that our current resources and access to capital markets is adequate to support operations over the near term and foreseeable future, we cannot assure you that these circumstances will remain unchanged. Our need for capital is dependent on operating results and may be greater than expected. Our ability to maintain our current sources of debt financing depends on our ability to remain in compliance with certain covenants contained in our financing agreements, including, among other requirements, maintaining a minimum tangible net worth and minimum cash flow and debt coverage ratios. As of February 28, 2002, we were in compliance with all covenants. If changes in capital markets restrict the availability of funds or increase the cost of funds, we may be required to modify, delay or abandon some of our planned expenditures, which could have a material adverse effect on our business, financial condition and results of operations. Our Quarterly Operating Results may Vary Significantly from Quarter to Quarter Our revenues and earnings may fluctuate from quarter to quarter depending on a number of factors, including: - the number, size, and timing of client projects commenced and completed during a quarter; - bid and proposal efforts undertaken; - progress on fixed-price projects during a given quarter; - employee productivity and hiring, attrition and utilization rates; - accuracy of estimates of resources required to complete ongoing projects; and - general economic conditions. Demand for our products and services in each of the markets we serve can vary significantly from quarter to quarter due to revisions in customer budgets or schedules and other factors beyond our control. In addition, because a high percentage of our expenses are fixed and do not vary relative to revenue, a decrease in revenue may cause a significant variation in our operating results. We May not have the Ability to Develop or Manage Mergers, Acquisitions or Strategic Alliances or Investments We may seek to expand our operations through mergers, acquisitions or strategic alliances with businesses that will complement our existing business. However, we may not be able to find attractive candidates or we may find that the acquisition terms are not favorable to us. In addition, we may compete with other companies for these acquisition candidates, which could make an acquisition more expensive for us. If we were able to successfully identify and complete an acquisition or similar transaction, it could involve a number of risks, including, among others: - the difficulty of assimilating the acquired operations and personnel; - the potential disruption of our ongoing business and diversion of resources and management time; - the potential failure to retain key personnel of the acquired business; - the possible inability of management to maintain uniform standards, controls, procedures and policies; - the difficulty of integrating systems, operations and cultures; and - the potential impairment of relationships with customers as a result of changes in management or otherwise arising out of such transactions. We cannot assure you that any acquisition will be made, that we will be able to obtain financing needed to fund such acquisitions and, if any acquisitions are so made, that the acquired business will be successfully integrated into our operations or that the acquired business will perform as expected. In addition, if we were to proceed with one or more significant strategic alliances, acquisitions or investments in which the consideration consists of cash, a substantial portion of our available cash could be used to consummate the strategic alliances, acquisitions or investments. The financial impact of acquisitions, investments and strategic alliances could have a material adverse effect on our business, financial condition and results of operations and could cause substantial fluctuations in our quarterly and yearly operating results. The Market Price of our Common Stock may be Volatile The market price of securities of technology companies has historically faced significant volatility. The stock market in recent years has also experienced significant price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of particular companies. Many factors that have influenced trading prices will vary from period to period, including: - decreases in our earnings and revenues or quarterly operating results; 42 - changes in estimates by analysts; - market conditions in the industry; - announcements and new developments by competitors; and - regulatory reviews. Any of these events would likely result in a material adverse effect on the market price of our common stock. 43 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 22, 2002 DYNAMICS RESEARCH CORPORATION by: /s/ James P. Regan ------------------ James P. Regan, Chairman, President and Chief Executive Officer (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 22nd of March, 2002. /s/ James P. Regan --------------------------- James P. Regan Chairman, President, Chief Executive Officer and Director /s/ David Keleher --------------------------- David Keleher Vice President and Chief Financial Officer (Principal Financial Officer) /s/ Donald B. Levis --------------------------- Donald B. Levis Corporate Controller and Chief Accounting Officer (Principal Accounting Officer) /s/ John S. Anderegg, Jr. --------------------------- John S. Anderegg, Jr. Director /s/ Francis J. Aguilar --------------------------- Dr. Francis J. Aguilar Director /s/ Martin V. Joyce, Jr. --------------------------- Martin V. Joyce, Jr. Director /s/ Kenneth F. Kames --------------------------- Kenneth F. Kames Director /s/ James P. Mullins --------------------------- Gen. James P. Mullins Director 44 Schedule II Dynamics Research Corporation and Subsidiaries Valuation and Qualifying Accounts
Allowance for Doubtful Accounts and Sales Returns\ For the three years ended December 31, 2001 ------------------------------------------------------------------------------------ (in thousands of dollars) Balance, December 31, 1998 $ 316 Additions charged to expense 491 Write-off of uncollectible accounts, net (17) ----------------------------------------------------------------------------------- Balance, December 31, 1999 790 Additions charged to expense 384 Write-off of uncollectible accounts, net (78) ----------------------------------------------------------------------------------- Balance, December 31, 2000 1,096 Additions charged to expense 492 Write-off of uncollectible accounts, net (233) ----------------------------------------------------------------------------------- Balance, December 31, 2001 $ 1,355 ------------------------------------------------------------------------------- Accrual of Loss on Disposal of Discontinued Operations For the three years ended December 31, 2001 ------------------------------------------------------------------------------------ (in thousands of dollars) Balance, December 31, 1998 $ 4,148 Results from discontinued operations charged against accrual (1,510) Gain on disposal of discontinued operations (2,197) ----------------------------------------------------------------------------------- Balance, December 31, 1999 441 Results from discontinued operations charged against accrual (441) ----------------------------------------------------------------------------------- Balance, December 31, 2000 $ 0 ------------------------------------------------------------------------------- Provision for Restructuring Costs For the three years ended December 31, 2001 ------------------------------------------------------------------------------------ (in thousands of dollars) Balance, December 31, 1998 $ -- Additions charged to restructuring reserves 1,157 ---------------------------------------------------------------------------------- Balance, December 31, 1999 1,157 Reversal of reserves (117) Expenditures charged against restructuring reserves (888) ----------------------------------------------------------------------------------- Balance, December 31, 2000 152 Additions charged to restructuring reserves 275 Expenditures charged against restructuring reserves (427) ----------------------------------------------------------------------------------- Balance, December 31, 2001 $ 0 -------------------------------------------------------------------------------
45 Exhibit Index 3.0 Certificate of Incorporation and By-Laws. 3.1 Restated Articles of Organization dated May 22, 1987. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/13/87) 3.2 By-Laws dated May 22, 1987. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/13/87) 4.0 Instruments defining the rights of security holders, including indentures. *4.1 Common stock certificate. 4.2 Certificate of Vote of Directors Establishing Series B Preferred Stock (Incorporated by reference to the Registrant's Form 8-K on June 25, 1998). *4.3 Amendment to Certificate of Vote Establishing Series B Preferred Stock. 4.4 Rights Agreement dated as of February 17, 1998 between the company and American Stock Transfer & Trust Company, as Rights Agent. (Incorporated by reference to the Registrant's Form 8-K on June 25, 1998) 10.0 Material Contracts 10.1 Amended 1983 Stock Option Plan. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/27/87) 10.2 Form of Dynamics Research Corporation Indemnification Agreement for Directors. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91) 10.3 Form of Dynamics Research Corporation Severance Agreement for Mr. Anderegg. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91) 10.4 Dynamics Research Corporation Deferred Compensation Plan for Non-Employee Directors. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91) 10.5 Form of Consulting Agreement between Dynamics Research Corporation and Albert Rand. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 3/31/97) 10.6 Form of Supplemental Retirement Pension Agreement between Dynamics Research Corporation and Albert Rand. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 3/31/97) *10.7 Amended 1993 Equity Incentive Plan *10.8 Amended 1995 Stock Option Plan for Non-Employee Directors 10.9 Loan and Security Agreement dated as of February 10, 2000 by and among Dynamics Research Corporation, and its subsidiaries and Brown Brothers Harriman & Co. and Family Bank FSB. (Incorporated by reference to the Registrant's Form 8-K dated March 24, 2000.) 10.10 Mortgage Security Agreement and Assignment dated as of February 10, 2000 by and among Dynamics Research Corporation and Brown Brothers Harriman & Co. and Family Bank FSB. (Incorporated by reference to the Registrant's Form 8-K dated March 24, 2000.) *10.11 Form of Employment Agreement between Dynamics Research Corporation and James P. Regan. *10.12 Form of Change of Control Agreement between Dynamics Research Corporation and James P. Regan. *10.13 Dynamics Research Corporation 2000 Incentive Plan. *10.14 2000 Employee Stock Purchase Plan. *10.15 Third Amendment to Loan and Security Agreement dated as of June 30, 2001 by and between Dynamics Research Corporation and Brown Brothers Harriman & Co. and First Massachusetts Bank, N.A., f/k/a Family Bank, FSB. 10.16 Form of Change of Control Agreement between Dynamics Research Corporation and David Keleher, Richard A. Covel and John L. Wilkinson 23.0 Consents of experts and counsel 23.1 Consent of Independent Accountants (Arthur Andersen LLP) dated March 25, 2002 filed herewith 99.0 Important Factors Regarding Forward-Looking Statements. 99.1 Letter to Commission Pursuant to Temporary Note 3T. * Previously Filed All documents incorporated by reference may be found at Commission file number 1-7348. 46