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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, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-7348
DYNAMICS RESEARCH CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Massachusetts 04-2211809
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
60 FRONTAGE ROAD
ANDOVER, MASSACHUSETTS 01810-5498
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (978) 475-9090
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange on
Title of Each Class Which Registered
------------------- ----------------
NONE NOT APPLICABLE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.10 Par Value
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
(Continued)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of February 13, 2001, the aggregate market value of Common Stock held by
nonaffiliates of the Registrant was $62,712,531.75 and the number of shares of
Common Stock, $.10 par value, of the Registrant outstanding was 7,601,519.
Documents Incorporated By Reference
Portions of the Registrant's Proxy Statement for the 2001 Annual Meeting of
Shareholders are incorporated by reference in Part III.
The Exhibit Index is on pages 50 and 51.
2
DYNAMICS RESEARCH CORPORATION
Form 10-K
For the Fiscal Year Ended December 31, 2000
Page
Part I
Item 1. Business 4
2. Properties 9
3. Legal Proceedings 10
4. Submission of Matters to a Vote of Security Holders 10
4A. Executive Officers of the Registrant 11
Part II
5. Market for Registrant's Common Equity and
Related Stockholder Matters 12
6. Selected Financial Data 13
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
8. Financial Statements and Supplementary Data 21
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 46
Part III
10. Directors and Executive Officers of the Registrant 46
11. Executive Compensation 46
12. Security Ownership of Certain Beneficial Owners
and Management 46
13. Certain Relationships and Related Transactions 46
Part IV
14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K 47
3
PART I
Item 1. Business
- ----------------
Dynamics Research Corporation ("DRC" or the "company") was incorporated in 1955
under the laws of the Commonwealth of Massachusetts. The company is an
innovative solutions provider, partnering with customers to apply proven
processes and technologies. 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. The company's Systems and Services segment represented 86% of revenue
from continuing operations for the year ended December 31, 2000. Precision
manufactured products, which includes the Encoder and Metrigraphics business
segments, represented 14% of 2000 revenue from continuing operations.
Systems and Services Segment
The company provides systems analysis, integration and software design and
development services. The Systems and Services segment's information technology
offerings also include installation, systems operation, and maintenance.
Systems built by the company are used for aircraft maintenance and parts
tracking, supply chain management, training requirements, and for managing state
government health and human services commitments.
The company's major Department of Defense (the "DoD") information systems
programs are often referred to as logistics information systems. These systems
manage data related to inventory requirements and control, maintenance and
repair, warranty analysis, supply, and distribution of numerous products and
parts.
For more than forty years, the company has provided services to the United
States Navy Strategic Systems Program office in three areas. First, the company
develops and maintains performance, reliability, and logistics databases for the
inertial guidance instruments housed in missile guidance systems and submarine
inertial guidance systems. These databases track detailed information on
thousands of component parts comprising the systems. In connection with these
databases, the company has successfully integrated customer workflow and
database activity information with Internet technology. Second, the company
provides independent analysis and monitoring of submarine-based, inertial
guidance systems and electronic modules. The company designs, constructs,
installs and supports test equipment used in the United States Navy Trident
program. Third, the company is involved in the design of a closed-loop system
used in the field of parameter control in semiconductor manufacture. This
process is being developed together with other companies under the auspices of
the United States Navy in the San Diego, California, Space and Naval Warfare
Systems Center. The company performs computer-aided, semiconductor circuit
analysis for its Navy customer as well as commercial companies.
The DRC-developed Weapon Systems Management Information System (the "WSMIS")
assesses the "health" and capability of the United States Air Force weapon
systems to meet wartime objectives. The company had served as the overall
functional integrator of WSMIS and
4
the developer of most WSMIS modules. The company currently provides WSMIS
operational and software development support under a subcontract to the current
WSMIS prime integrator. As a decision-support tool for assessing the impacts of
logistics status on potential wartime capabilities, WSMIS computes inventory
requirements, purchasing needs and logistics capability assessments for complex,
high-priced aircraft spare parts necessary to meet aircraft availability
requirements.
A major component of the company's DoD business consists of a wide variety of
engineering, technical assistance and management support services performed
under various indefinite order, indefinite quantity contracts. Work performed
under these contracts is generally done on a time and materials basis utilizing
a wide range of the company's technical and management skills to plan, analyze,
design, test, support, train, maintain and dispose of a variety of complex
systems. Systems include radar, missile, aircraft, information, logistics and
munitions.
The company provides support at all stages of a system's life cycle. In response
to emerging requirements, the company helps its federal government customers
define, develop and initiate new programs. The company also helps customers
obtain program approval, conduct strategic planning and evaluate proposals from
private contractors. After prime contract awards, the company helps monitor
contractor activities, evaluate progress and measure performance against program
requirements. Products and services include computer-based training, systems
integration and business process improvement/reengineering. Under a variety of
contracts, the company supports the United States Air Force at bases such as
Hanscom Air Force Base, Scott Air Force Base, Langley Air Force Base, Maxwell
Air Force Base, Gunter Annex, Peterson Air Force Base, and Eglin Air Force Base.
The company provides engineering services to the Electronics Systems Center (the
"ESC"). Under the Information Technology Support Program, the company provides
acquisition management, systems engineering, systems integration, test and
evaluation and computer based training to ESC's System Program Offices and
Product Acquisition Directorates.
The company provides engineering, logistics, and software support on programs
such as the B-1B, the B-2, the B-52, the KC-135 and the E-3A aircraft repair,
maintenance, and upgrade programs. From its origin at the Oklahoma City Air
Logistics Center (the "ALC"), DRC has expanded its task orders to include work
at other ALC's located at Warner Robins, Georgia and Ogden, Utah. Additional
tasking has centered on providing support to Air Force reengineering and
business process improvement initiatives at these ALC's. The company was awarded
a prime contract for the Design Engineering Support Program at the Ogden ALC.
The company has installed, integrated and is providing operational support for a
suite of software satisfying the unique requirements of the United States Air
Force's landing gear maintenance, repair and overhaul operations at Hill Air
Force Base in Ogden, Utah.
DRC provides programmatic consulting, engineering and logistics management to
the Army Materiel Command and Army executive officers for acquisition of major
weapon systems. DRC engineers analyze and review airframe, avionics,
aeromechanics and propulsion issues associated
5
with preparing electronic technical manuals for Fixed Wing Aircraft and the
Army's Special Operations Aviation Regiment. Additionally, the company supports
other United States Army activities with acquisition logistics, systems
engineering and other related program management services at the Tank-Automotive
Command and Communications-Electronics Command from its office in Huntsville,
Alabama.
Combining its expertise in weapon system acquisition processes with its
expertise in systems analysis, design, training and simulation and human
factors, the company performs human-systems integration and force analysis. DRC
is the developer of the training system requirements analysis (the "TSRA")
tools, a suite of software which helps instructional designers perform the
initial phases of the instructional systems development process. The TSRA tools
have been developed with the Naval Air Warfare Center Training Systems Division
and are widely used throughout the DoD by government and contractor
organizations.
As a subcontractor to Lockheed Martin, the company is supporting the United
States Army's Warfighter Simulation 2000, a simulation system supporting the
training of commanders and staff under a wide variety of battlefield scenarios.
The company's services include providing knowledge acquisition, software and
human factors engineering, database development and manpower staffing reduction
analysis.
DRC provides analytical support and develops automated tools for the Defense
Modeling and Simulation Office. DRC is developing Extensive Markup Language
based applications as part of a research and development effort for the Defense
Advanced Research Projects Agency.
The company is a subcontractor to Raytheon Company on the United States Air
Force National Air and Space Model. The company develops conceptual models and
collects data on mission space objects and processes.
In October 2000, the company was awarded a United States Army contract to
develop air crew training programs. The crew coordination training to be
developed under this contract will provide Army aircrews with the knowledge,
skills and attitudes to increase mission effectiveness, while decreasing the
errors that lead to accidents. The company has also developed a teamwork
training program, called MedTeams, that is designed to improve teamwork and
reduce errors in emergency medicine. This program has been instituted in
military and civilian hospitals in the United States.
Also in October 2000, the company was awarded a five-year multimillion dollar
subcontract to provide engineering and information services to the United States
Naval Aviation Systems Command Logistics Competency (the "NAVAIR"). DRC is the
primary subcontractor to Lockheed Martin Systems Integration-Owego in assisting
NAVAIR in the modernization of naval aviation logistics information management
systems.
The company provides systems design, development, implementation and support
services to state health and human services departments. These services
primarily are in support of child welfare requirements, but can also include
child enforcement, temporary assistance, medicaid
6
and financial benefits management, among many programs. The company has
implemented a distributed computer-based statewide automated child welfare
information system (the "SACWIS") for the states of New Hampshire and Colorado.
Under support contracts, DRC provides additional functional and technical
services for the SACWIS systems as well as other information technology
services. The company also installed and maintains the Ohio state-wide computer
network infrastructure for the Support Enforcement, Tracking Systems and Ohio
Works First Programs.
The company continues to provide the United States Department of Treasury with
information technology services for the Internal Revenue Service (the "IRS") and
other Treasury departments. During 1998 and 1999 the company's work for the IRS
focused on year 2000 procedures. In 2000, the company focused on full life
cycle development of the Compliance Research Information Service. In July 2000,
the company 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.
Precision Manufactured Products
The company's precision manufacturing group consists of two business divisions,
Encoder and Metrigraphics.
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 equipment and
factory automation equipment. Optical encoders are essential elements of
today's electronically-controlled systems and equipment.
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 microflex 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.
Sales and Marketing
Contracts with defense, state and other government agency customers are obtained
by marketing and technical personnel employed by the company. The company's
other products are sold by sales personnel employed by the company and outside
sales representatives.
7
Government Contracts
During 2000, the company's revenue from contracts with the DoD, either as prime
contractor or subcontractor, accounted for approximately 74% of the company's
total revenue. The company's contracts with the United States Government 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 revenue from contracts with four different states accounted for
approximately 8% of 2000 revenue. Revenue under various contracts with the
State of Ohio accounted for approximately 5% of 2000 revenue. The company's
state contracts are generally either fixed-price or time and material. In
certain instances, funding for these contracts is subject to annual state
legislative approval.
The company's government contracts fall into one of three categories: (1)
fixed-price, (2) time and materials, and (3) cost plus fixed-fee. Under a
fixed-price contract, the government pays an agreed upon price for the company's
services or products, and the company bears the risk that increased or
unexpected costs may reduce its profits or cause it to incur a loss.
Conversely, to the extent the company incurs actual costs below anticipated
costs on these contracts, the company could realize greater profits. Under a
time and materials contract, the government pays the company a fixed hourly rate
intended to cover salary costs and related indirect expenses plus a profit
margin. Under a cost plus fixed-fee contract, the government reimburses the
company for its allowable direct expenses and allowable and allocable indirect
costs and pays a negotiated fee.
Backlog
At December 31, 2000, the company's funded backlog was approximately $89.8
million compared with $83.5 million at December 31, 1999. The company expects
that substantially all of its backlog at December 31, 2000 will be filled during
the year ending December 31, 2001. 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
thereunder.
Competition
The company competes with both domestic and foreign firms, including larger
diversified companies and smaller specialized firms. The United States
Government's own in-house capabilities are also, in effect, competitors because
various agencies perform certain types of
8
services which might otherwise be performed by the company. The principal
competitive factors for systems and services are price, performance, technical
competence and reliability. In the commercial businesses, the company competes
with other manufacturers of encoders, electroform vendors and suppliers of
precision measurement scales. The principal competitive factors affecting the
precision components manufacturing businesses are price, product quality and
custom engineering to meet customers' system requirements.
Research and Development
The company expended approximately $0.2 million, inclusive of overhead and other
indirect costs, on new product and service development during the year ended
December 31, 2000, as compared to expenditures of $1.5 million during 1999 and
$2.7 million during 1998.
Raw Materials
Raw materials and components are purchased from a large number of independent
sources and are generally available in sufficient quantities to meet current
requirements.
Environmental Matters
Compliance with federal, state and local provisions relating to the protection
of the environment has not had and is not expected to have a material effect
upon the capital expenditures, earnings or competitive position of the company.
Employees
At December 31, 2000, the company had 1,504 employees.
Proprietary Information
Patents, trademarks and copyrights are not materially important to the business
of the company. The United States Government has certain proprietary rights in
processes and data developed by the company in its performance of government
contracts.
Item 2. Properties
- -------------------
The company leases offices and other facilities, totaling approximately 481,000
square feet, which are utilized for its federal and state government services,
manufacturing and warehousing operations as well as its marketing and
engineering offices. The company has manufacturing and office space in
Wilmington, Massachusetts under three leases totaling 113,000 square feet,
expiring in 2005, with options 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.
9
The company's total rental cost for 2000 was $3.8 million.
The company believes its properties are adequate for its present needs.
Item 3. Legal Proceedings
- --------------------------
The company is not a party to any material litigation.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
10
Item 4A. Executive Officers of the Registrant
- ----------------------------------------------
The following is a list of the names and ages of the executive officers of the
company indicating all positions and offices held by each person and each
person's principal occupations or employment during the past five years. The
executive officers were elected by the Board of Directors and will hold office
until the next annual election of officers and their successors are elected and
qualified, or until their earlier resignation or removal by the Board of
Directors. There are no family relationships between any executive officers and
directors.
Name Position Age
- ---- -------- ---
John S. Anderegg, Jr. Chairman, Director 77
James P. Regan President, Chief Executive Officer, 60
Director
Richard A. Covel Vice President and General Counsel 54
David Keleher Vice President and 51
Chief Financial Officer
John L. Wilkinson Vice President and 61
General Manager, Human Resources
Messrs. Anderegg 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. Prior to that, 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.
11
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 2000 and 1999 are listed below.
2000 1999
High Low High Low
- --------------------------------------------------------------------------------
First quarter $8.38 $6.94 $7.19 $2.88
Second quarter 8.63 7.00 6.63 4.25
Third quarter 8.53 6.75 6.25 3.50
Fourth quarter 9.25 7.13 9.50 3.94
As of December 31, 2000 there were 787 holders of record of the company's common
stock.
In September 1984, the Board of Directors indicated its intention not to declare
cash dividends to preserve cash for the future growth and development of the
company. The company did not declare any cash dividends between 1984 and 2000
and does not anticipate doing so for the foreseeable future.
The Annual Meeting of the stockholders of Dynamics Research Corporation will be
held at 1:30 p.m. on Tuesday, April 24, 2001 on the 33rd Floor of the State
Street Bank and Trust Building, 225 Franklin Street, Boston, Massachusetts.
12
Item 6. Selected Financial Data
- --------------------------------
Five Year Summary of Selected Financial Information
- ---------------------------------------------------
2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
(in thousands of dollars, except share, per share and employee data)
Revenue $ 200,175 $ 191,621 $ 182,344 $ 156,733 $ 129,997
Operating income (loss) 9,203 (11,378) 2,459 7,807 4,283
Income (loss) from continuing operations 4,353 (8,888) 491 5,177 2,311
Net income (loss) 4,559 (7,526) (5,971) 4,129 1,729
Income (loss) from continuing operations
per common share - basic .57 (1.21) .07 .69 .31
Income (loss) from continuing operations
per common share - diluted .56 (1.21) .06 .66 .30
Net income (loss) per common share - basic .60 (1.02) (.80) .55 .23
Net income (loss) per common share - diluted .59 (1.02) (.77) .53 .22
Total assets 78,702 75,188 88,067 77,629 70,950
Total debt 15,534 19,700 26,800 10,000 12,101
Stockholders' equity 29,289 23,805 31,246 39,147 35,239
Return on invested capital 12.0% (13.8)% 2.4% 10.6% 6.2%
Stockholders' equity per share 3.85 3.23 4.24 5.19 4.69
Return on stockholders' equity 15.6% (31.6)% (19.1)% 10.6% 4.9%
Backlog 89,843 83,549 105,427 110,001 73,200
Cash flow from operations 4,735 10,985 (11,406) 7,980 1,035
Research and development expense 150 1,478 2,739 1,249 2,189
Capital expenditures 3,120 2,702 3,171 5,104 9,266
Depreciation and amortization 3,746 6,060 6,219 5,240 4,910
Number of shares outstanding at end of year 7,601,519 7,363,324 7,369,190 7,546,646 7,515,630
Number of employees 1,504 1,613 1,557 1,455 1,349
See Management's Discussion and Analysis of Financial Condition and Results of
Operations for discussion of unusual items.
13
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations
- -------------
Results of Operations
- ---------------------
For the years ended December 31, 2000 1999 1998
- -------------------------------------------------------------------------------------------------
(expressed as a percentage of total revenue)
Contract revenue 86.3% 86.0% 84.6%
Product sales 13.7% 14.0% 15.4%
Total revenue 100.0% 100.0% 100.0%
Gross margin on contract revenue* 9.5% 0.3% 8.9%
Gross margin on product sales* 30.3% 20.8% 21.3%
Total gross margin 12.4% 3.2% 10.8%
Selling, engineering and administrative expenses 7.8% 9.1% 9.4%
Operating income (loss) 4.6% (5.9)% 1.4%
Interest expense, net 0.9% 1.2% 0.9%
Income (loss) from continuing operations before provision
(benefit) for income taxes 3.7% (7.1)% 0.5%
- -------------------------------------------------------------------------------------------------
* These amounts represent a percentage of contract revenue and product sales,
respectively.
Overview
Dynamics Research Corporation (the "company") has an outstanding 46-year legacy
of customer satisfaction, strong information technology and logistics management
skills--expertise that is in high demand in defense, civil and commercial
markets. But, most of all, the company's potential derives from its highly
skilled and dedicated employees.
The 2000 results are the result of the teamwork, focus and hard work of the
company's employees. Returning to profitability, while instituting a stable
capital structure, was the primary objective for 2000. The company achieved
this goal, recording record revenue and earnings in 2000.
Highlights for the year included:
o Developing and beginning implementation of a five-year strategic plan
o Organizationally aligning the company to achieve its strategic objectives
o Launching employee-centered initiatives, including an enterprise-wide human
resources planning system and an employee stock purchase plan
o Reaching the highest levels of revenue and net income in the company's
46-year history
14
o Achieving profitability across all business segments
o Generating $4.7 million in cash flow from operations
o Strengthening the balance sheet, reducing debt by 21%
o Winning $206 million in new and repeat orders
o Receiving ISO 9001 certification for the Encoder Division
o Successfully completing pilot implementation of the State of Colorado child
welfare system, followed by the commencement of statewide rollout shortly
after the end of the year
Revenue
Total revenue from continuing operations was $200.2 million, $191.6 million and
$182.3 million for 2000, 1999 and 1998, respectively, representing increases of
4.5% and 5.1% in 2000 and 1999, respectively.
Contract revenue in the Systems and Services segment was $172.8 million in 2000
compared with $164.8 million in 1999 and $154.3 million in 1998, representing an
increase of 4.9% and 6.8% in 2000 and 1999, respectively. An increase in revenue
for 2000 of nearly $13 million from systems engineering, logistics and systems
support work, primarily for the United States Air Force, offset an expected
decline in revenue from state and local projects. State and local revenue was
$16 million in 2000. Revenue growth in 2000 was aided by an unusual $4.1 million
purchase and resale of equipment to a major customer in the second quarter of
the year. The increase in Systems and Services segment revenue in 1999 compared
with the prior year was primarily due to growth in the company's field offices,
logistics and material acquisition services to the United States Air Force and
Army, partially offset by a decrease in the company's state health and human
services contracts.
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. As expected, 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. The decline resulted
from the planned phase out of ink jet printer cartridge products which use the
nozzle plates supplied by the company. With this eventuality in mind, the
company has focused on generating Metrigraphics revenue from other customers. In
2000, Metrigraphics sales to other customers represented more than 50% of its
sales.
Recent softening in the manufacturing sector of the United States economy
presents a risk and uncertainty to the continuation of favorable Encoder
Division results in 2001 and, to a lesser extent, to the Metrigraphics Division.
Product sales decreased 4.1% in 1999 compared with 1998, principally due to a
$3.6 million, or 21.5%, decline in Encoder Division sales related to a reduction
in sales of a custom encoder to an automotive customer. The decrease in Encoder
Division sales was partially offset by a $2.5 million, or 22.2% increase, in
Metrigraphics Division revenue related to increased sales of electroformed
components.
15
Gross Margin
Total gross margin was $24.8 million, $6.1 million and $19.7 million for 2000,
1999 and 1998, respectively, representing 12.4%, 3.2% and 10.8% of total revenue
for 2000, 1999 and 1998, respectively.
Gross margin on contract revenue was $16.4 million, $0.5 million and $13.7
million for 2000, 1999 and 1998, respectively, representing 9.5%, 0.3% and 8.9%
of contract revenue for 2000, 1999 and 1998, respectively. The increase in the
2000 gross margin resulted primarily from the absence in the 2000 results of 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 and $1.7 million in the fourth quarter of 1999 and
1998, respectively, for other unrecoverable contract costs. In the fourth
quarter of 1998, the company recorded a $2.6 million loss provision related to
the Colorado contract in the results of the Systems and Services segment.
While, during 2000, completion of the project was extended about six months, the
company passed a major milestone on the Colorado project in January 2001 when
the Colorado Department of Human Services approved the completion of pilot
testing and commencement of rollout of the first release of a new child welfare
information and management system. This milestone will be followed by the
completion of the rest of the project in the first half of 2001, including an
additional three releases of increased functionality. While the company believes
it has reasonably estimated and provided for the costs to complete the Colorado
contract, there can be no assurances that actual costs on the project will not
differ materially from current estimates.
Subsequent to the end of the year, the company agreed to sell the assets of its
Tactical Communications Group for $0.3 million and transfer related employees.
The group develops and sells communications software for defense applications.
In 2000, the group recorded revenues of $2.3 million and an after tax loss of
$0.9 million. In anticipation of the sale, the company recorded in the fourth
quarter of 2000, in cost of contract revenue, a $0.4 million impairment
provision on the assets of the group. The gain or loss upon closing of the
transaction, planned for early in the second quarter of 2001, is expected to be
immaterial.
In 2000, 1999 and 1998, gross margin on product sales was $8.3 million, $5.6
million and $6.0 million, respectively, representing 30.3%, 20.8% and 21.3% of
product sales in 2000, 1999 and 1998, respectively. 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. The
decrease in 1999 compared with the prior year was principally due to lower
Encoder Division
16
revenue allocated over constant fixed costs, partially offset by higher revenue
and margin in the Metrigraphics Division.
Other Operating Items
Selling, engineering, and administrative expenses (S,E&A) of $15.6 million in
2000 were down $1.9 million from 1999. Absent from the 2000 S,E&A expenses were
the write-off of the company's $1.4 million investment in Empresa, Inc. (see
Note 12) in the second quarter of 1999 and $0.2 million of restructuring charges
described below. Research and development expense declined from $2.7 million in
1998, to $1.5 million in 1999 and $0.2 million in 2000 primarily as a result of
discontinuing new software product development projects and focusing the company
on existing core businesses.
S,E&A expenses were flat in 1999 compared with 1998, as the write-off of
Empresa, Inc. and the restructuring provision were offset by the research and
development expense decline noted above.
Net interest expense was $1.8 million, $2.3 million and $1.6 million in 2000,
1999 and 1998, respectively. The decrease in 2000 compared with 1999 and the
increase in 1999 compared with 1998 were due to higher average debt levels in
1999, compared with 2000 and 1998 (see Note 7).
Income tax expense or benefit has been recorded at rates of 41%, 35% and 42% of
income or loss from continuing operations before taxes in 2000, 1999 and 1998,
respectively. The 2000 rate reflects the statutory federal rate of 34% combined
with an average state income tax rate, net of federal income tax benefit, of 7%.
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 5).
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,
recorded in the fourth quarter of 1998. The company recognized $0.2 million of
royalty income in 2000 and may benefit modestly from future royalty payments
over a three-year period, up to a cap of $0.9 million, net of taxes. These
receipts will be recorded as income from discontinued operations, after
deducting taxes, when received.
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
17
lines that the company does not intend to pursue in the future. As of December
31, 1999, no costs had been charged against the 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 $0.1 million of reserves related to
a specific business were no longer necessary, and these reserves were reversed
against the cost of contract revenue. The remaining restructuring reserve of
$0.2 million at December 31, 2000 will be expended during the first half of
2001, primarily on continuation pay for employees who had left the company prior
to December 31, 2000.
The company's funded backlog was $89.8 million, $83.5 million and $105.4 million
at December 31, 2000, 1999 and 1998, 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.
Liquidity and Capital Resources
On February 10, 2000, the company finalized a three-year $20 million secured
revolving credit agreement (the "Revolver") and a six-month $7.5 million interim
mortgage loan (the "Interim Mortgage") on the company's real estate. Proceeds
were used to pay off existing debt. The Revolver expires on February 10, 2003.
The Revolver provides for borrowings of up to the lesser of $20 million or 80%
of eligible accounts receivable, as defined. At December 31, 2000, $5.8 million
was outstanding under the Revolver and the company had $11.7 million of unused
credit line available. Interest on the outstanding balance of the Revolver and
the Interim Mortgage is the prime rate and is payable monthly. The interest rate
on the Revolver was 9.5% on December 31, 2000. The agreement includes a fee of
0.375% on the unused portion of the Revolver. Commencing in February 2001, the
company has the option to elect an interest rate of LIBOR plus 2% or the prime
rate, and the fee on the unused Revolver is reduced to 0.25%.
On June 12, 2000, the company entered into a $10 million mortgage loan (the
"Mortgage") on the company's real estate with a 10-year term. Proceeds from the
loan were used to repay the Interim Mortgage, with the balance used to repay
outstanding debt on the Revolver. Interest on the Mortgage accrues at the rate
of LIBOR plus 2.5%. The agreement requires quarterly principal payments of
$125,000 beginning on August 1, 2000, with a final payment of $5 million in
June, 2010. The interest rate on the Mortgage was 9.2% on December 31, 2000.
The Revolver is secured by all assets. The Mortgage is secured by the corporate
office facility in Andover, Massachusetts. The 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, 2000.
18
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 was primarily due to $2.6 million of refundable federal income taxes,
most of which was received in the first quarter of 2001. Refundable federal
income taxes were $0.9 million at December 31, 1999. 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. Cash used
by operating activities of $11.4 million in 1998 was primarily the result of a
$16.0 million increase in accounts receivables.
Days sales outstanding ("DSO") on total receivables, both billed and unbilled,
were 110 days at the end of 2000, compared with 105 days at the end of 1999.
Increased unbilled costs and fees associated with fixed price contracts
accounted for the increase in total DSO. Delays in customer invoice approval in
December 2000, related to holidays and vacations, caused a $3.1 million increase
in the unbilled balance which, otherwise, would have been classified as accounts
receivable.
Inventories of $3.2 million at December 31, 2000 were up from $2.7 million at
the end of 1999. Most of the inventory is related to the Encoder business. With
a 34% increase in Encoder revenue over the course of the year, inventories have
increased at a somewhat slower rate of 17%.
Capital spending for property, plant and equipment was $3.1 million, $2.7
million and $2.9 million in 2000, 1999, and 1998, respectively. 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.
In 2000, the company realized $0.8 million in proceeds from the exercise of
stock options. In 1999 and 1998, $28,000 and $0.3 million, 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 in the range of $7 million to $8 million
in 2001, primarily for technology advancements, infrastructure improvements and
capacity expansion in support of growth and operational performance enhancement.
As a defense contractor, the company is subject to many levels of audit and
review, including the Defense Contract Audit Agency (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, $0.8 million of which was paid in
early 2001. Both related to and unrelated to its defense industry involvement,
the company is,
19
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. Although the alleged events are historical, occurring between
1997 and January 2000, the government's investigation is ongoing. 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. The company
believes that its current assets, cash flows from operations and available lines
of credit are sufficient to support its normal 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
74% of revenue in 2000, are generally one year and 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, competitive market
conditions; customer requirements, schedules and related funding; technological
change; uncertainty of future financing; overall economic factors; 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.
20
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
The following consolidated financial statements of the company and its
subsidiaries are included herein as indicated below:
Page
Consolidated Balance Sheets at
December 31, 2000 and 1999.............................................. 22
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 and 1998........................................ 23
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2000, 1999 and 1998........................................ 24
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998........................................ 25
Schedule II - Valuation and Qualifying Accounts for the years ended
December 31, 2000, 1999 and 1998........................................ 49
21
Consolidated Balance Sheets
December 31, 2000 1999
- ---------------------------------------------------------------------------------------------------------------------------
(in thousands of dollars, except share and per share data)
Assets
Current assets
Cash and cash equivalents $ 527 $ 2,267
Receivables, net of allowances of $1,096 in 2000 and $790 in 1999 31,967 34,917
Unbilled expenditures and fees on contracts in process 24,633 18,609
Inventories 3,208 2,735
Prepaid expenses and other current assets 3,926 1,593
---------- ---------
Total current assets 64,261 60,121
Net property, plant and equipment 14,441 15,067
---------- ----------
Total assets $ 78,702 $ 75,188
========== ==========
Liabilities and Stockholders' Equity
Current liabilities
Notes payable $ 5,784 $ 19,700
Current portion of long term debt 500 -
Accounts payable 12,843 11,641
Accrued payroll and employee benefits 9,901 9,435
Other accrued expenses 5,711 7,840
Current deferred income taxes 4,575 1,575
Net liabilities of discontinued operations - 273
---------- ----------
Total current liabilities 39,314 50,464
Long term debt 9,250 -
Deferred income taxes 849 919
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 - 8,980,945 shares in 2000 and
8,742,750 in 1999 898 874
Treasury stock - 1,379,426 shares in 2000 and 1999 (138) (138)
Capital in excess of par value 28,461 27,560
Retained earnings (accumulated deficit) 68 (4,491)
---------- ----------
Total stockholders' equity 29,289 23,805
---------- ----------
Total liabilities and stockholders' equity $ 78,702 $ 75,188
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
22
Consolidated Statements of Operations
For the years ended December 31, 2000 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------
(in thousands of dollars, except share and per share data)
Revenue
Contract revenue $ 172,774 $ 164,766 $ 154,336
Product sales 27,401 26,855 28,008
----------- ----------- -----------
Total revenue 200,175 191,621 182,344
Costs and expenses
Cost of contract revenue 156,327 164,278 140,653
Cost of product sales 19,087 21,257 22,029
Selling, engineering and administrative expenses 15,558 17,464 17,203
----------- ----------- -----------
Total operating costs and expenses 190,972 202,999 179,885
Operating income (loss) 9,203 (11,378) 2,459
Interest expense, net 1,842 2,255 1,612
----------- ----------- -----------
Income (loss) from continuing operations before provision
(benefit) for income taxes 7,361 (13,633) 847
Provision (benefit) for income taxes 3,008 (4,745) 356
----------- ----------- -----------
Income (loss) from continuing operations 4,353 (8,888) 491
Gain (loss) from discontinued operations, net of
tax benefit of $1,989 in 1998 - - (3,890)
Gain (loss) on disposal of discontinued operations, net of tax expense
of $143 in 2000, $835 in 1999 and tax benefit of $1,576 in 1998 206 1,362 (2,572)
----------- ----------- -----------
Gain (loss) from discontinued operations 206 1,362 (6,462)
----------- ----------- -----------
Net income (loss) $ 4,559 $ (7,526) $ (5,971)
=========== =========== ===========
Earnings (loss) per share
Per common share - basic
Income (loss) from continuing operations $ .57 $ (1.21) $ .07
Gain (loss) from discontinued operations .03 .19 (.87)
----------- ----------- -----------
Net income (loss) $ .60 $ (1.02) $ (.80)
=========== =========== ===========
Per common share - diluted
Income (loss) from continuing operations $ .56 $ (1.21) $ .06
Gain (loss) from discontinued operations .03 .19 (.83)
----------- ----------- -----------
Net income (loss) $ .59 $ (1.02) $ (.77)
=========== =========== ===========
Weighted average shares outstanding
Weighted average shares outstanding - basic 7,541,376 7,360,548 7,501,604
Dilutive effect of options 151,780 - 269,711
----------- ----------- -----------
Weighted average shares outstanding - diluted 7,693,156 7,360,548 7,771,315
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
23
Consolidated Statements of Stockholders' Equity
Common Stock Retained
------------------------------------------- Capital in Earnings
Issued Treasury Stock Excess of (Accumulated
For the three years ended December 31, 2000 Shares Par Value Shares Par Value Par Value Deficit) Total
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands)
Balance at December 31, 1997 7,366 $ 737 (1,078) $ (108) $ 14,506 $ 24,012 $ 39,147
Year 1998
Stock options exercised 103 10 - - 581 - 591
Treasury stock purchased - - (286) (28) (2,489) - (2,517)
20% Stock dividend 1,264 126 - - 14,876 (15,006) (4)
Net loss - - - - - (5,971) (5,971)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 8,733 873 (1,364) (136) 27,474 3,035 31,246
Year 1999
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
Year 2000
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
====================================================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
24
Consolidated Statements of Cash Flows
For the years ended December 31, 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------------------
(in thousands of dollars)
Cash Provided By (Used For) Operations
Net income (loss) $ 4,559 $ (7,526) $ (5,971)
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
(Gain) loss from discontinued operations (206) (1,362) 6,462
Non-cash stock compensation expense 114 116 -
Provision for impairment of investment in Empresa, Inc. - 1,424 -
Depreciation and amortization 3,746 6,060 6,219
Deferred income tax provision 2,930 (5,043) (1,347)
--------- ---------- ---------
11,143 (6,331) 5,363
Cash Provided By (Used For) Working Capital
Receivables 2,950 (1,901) (15,916)
Unbilled expenditures and fees on contracts in process (6,024) 13,560 128
Inventories (473) (88) 730
Prepaid expenses and other current assets (2,333) (626) 1,568
Accounts payable 1,202 1,341 1,945
Accrued payroll and employee benefits 466 1,653 (199)
Other accrued expenses (2,129) 5,210 (1,810)
--------- ---------- ---------
(6,341) 19,149 (13,554)
Net cash provided by (used for) continuing operations 4,802 12,818 (8,191)
Net cash used for discontinued operations (67) (1,833) (3,215)
--------- ---------- ---------
Net cash provided by (used for) operating activities 4,735 10,985 (11,406)
Cash Used For Investing Activities
Additions to property, plant and equipment related to
continuing operations (3,120) (2,702) (2,874)
Additions to property, plant and equipment related to
discontinued operations - - (297)
Investments and acquisitions - (682) (742)
Proceeds from the sale of discontinued operations - 1,700 -
--------- ---------- ---------
Net cash used for investing activities (3,120) (1,684) (3,913)
Cash Provided By (Used For) Financing Activities
Net borrowings (repayments) under revolving credit agreement 5,784 (7,100) 16,800
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 (250) - -
Proceeds from the exercise of stock options 811 28 346
Purchase of treasury stock - (59) (2,272)
--------- ---------- ---------
Net cash provided by (used for) financing activities (3,355) (7,131) 14,874
Net increase (decrease) in cash and cash equivalents (1,740) 2,170 (445)
Cash and cash equivalents at the beginning of the year 2,267 97 542
--------- ---------- ---------
Cash and cash equivalents at the end of the year $ 527 $ 2,267 $ 97
========= ========== =========
Supplemental Information
Cash paid for interest $ 2,055 $ 2,451 $ 1,640
Cash paid for taxes $ 2,893 $ 199 $ 150
Cashless options exercised $ - $ - $ 245
The accompanying notes are an integral part of these consolidated financial
statements.
25
Notes to Consolidated Financial Statements
1. Significant Accounting Policies
Nature of Business
Dynamics Research Corporation (the "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
The company is subject to certain business risks specific to the industries in
which it 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 and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
Revenue Recognition
The company provides services under fixed-price, cost-reimbursement, time and
material, and level of effort contracts. The company follows generally accepted
contract accounting principles in accordance with AICPA Statement of Position
81-1. Revenue under cost-reimbursement and fixed-price contracts is recognized
as costs are incurred and include applicable fees in the proportion that costs
incurred bear to total estimated costs. When a loss is indicated on any contract
in process, provision for the total estimated loss is made at that time. For
time and material and level of effort types of contracts, revenue is recorded as
the costs are incurred.
Unbilled expenditures and fees on contracts in process represent the recoverable
amounts of contract revenue under contracts in process which were not billable
at the balance sheet date. Such amounts generally become billable upon
completion of a specific phase of the contract, negotiation of contract
modifications, completion of government audit or upon acceptance by the
government. Costs related to certain contracts, including applicable indirect
costs, are subject to audit by the United States Government. Revenue from such
contracts has been recorded at amounts expected to be realized upon final
settlement.
Revenue from sales of precision products and associated warranty costs are
generally recognized at the time of shipment.
26
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.
Cash and Cash Equivalents
The company considers all cash investments with original maturities of three
months or less to be 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, 2000 1999
- --------------------------------------------------------------
(in thousands of dollars)
Work in process $ 726 $ 630
Raw materials and subassemblies 2,482 2,105
- --------------------------------------------------------------
$3,208 $2,735
- --------------------------------------------------------------
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation and amortization
are provided in amounts sufficient to amortize the cost of such assets over
their estimated useful lives, 3 to 8 years for equipment and 31 years for the
building, using principally the straight-line method. Leasehold improvements are
amortized over the remaining term of the lease or the life of the related asset,
whichever is shorter.
December 31, 2000 1999
- --------------------------------------------------------------
(in thousands of dollars)
Land $ 1,126 $ 1,126
Building 7,774 7,774
Machinery and equipment 45,133 42,016
Leasehold improvements 2,551 2,548
- --------------------------------------------------------------
Total property, plant and
equipment, at cost 56,584 53,464
Less accumulated depreciation
and amortization 42,143 38,397
- --------------------------------------------------------------
Net property, plant and equipment $14,441 $15,067
- --------------------------------------------------------------
27
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 as 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,
which 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 embedded 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) will be effective January 1,
2001. Management believes that the adoption of SFAS No. 133 will not have a
material impact on the company's financial position or results of operations,
because it currently has no derivative instruments or hedging activities.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements.
SAB No. 101 provides interpretative guidance on the recognition, presentation
and disclosure of revenue. The company completed its review of the guidance
provided in SAB No. 101 in the fourth quarter of 2000 and concluded that there
was no material impact on the company's revenue recognition policies and
practices.
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 earnings from continuing operations are positive, diluted
earnings per share is determined by giving effect to the exercise of stock
options using the treasury stock method.
Due to their antidilutive effect, 437,500 and 58,800 stock options were excluded
from the calculation of earnings per share in 2000 and 1998, 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
28
the results of operations of the Systems and Services segment as a charge to
cost of contract revenue. The company has continued to update its estimate of
project cost and recorded, as necessary, changes in estimates during each
reporting period in 2000. While, during 2000, completion of the project was
extended about six months, a major milestone was passed in January 2001 when the
Colorado Department of Human Services approved the completion of pilot testing
and commencement of rollout of the first release of a new child welfare
information and management system. This milestone will be followed by the
completion of the rest of the project in the first half of 2001, including an
additional three releases of increased functionality. While the company believes
it has reasonably estimated and provided for the costs to complete the Colorado
contract, there can be no assurances that 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 13. 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 in 1999 and $1.7 million in 1998
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 $16.6 million and $16.4 million at December 31, 2000 and 1999,
respectively. Receivables under United States Government contracts were $17.7
million and $19.7 million at December 31, 2000 and 1999, 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 is related
to Massachusetts operations. The remainder of the charge relates 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 does 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 $0.1 million of reserves related to
a specific business were no longer necessary, and these reserves were reversed
against cost of contract revenue. The remaining restructuring reserve of $0.2
million at December 31, 2000 will be expended during the first half of 2001,
primarily on continuation pay for employees who had left the company prior to
December 31, 2000.
29
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,
recorded in the fourth quarter of 1998. The company recognized $0.2 million of
royalty income in 2000 and may benefit modestly from future royalty payments
over a three-year period, up to a cap of $0.9 million, net of taxes. These
receipts will be recorded as income from discontinued operations, after
deducting taxes, when received.
The consolidated financial statements of the company have been restated to
reflect the discontinuation of the Telecommunications Fraud Control business.
Accordingly, the revenue, costs, expenses, assets, liabilities and cash flows of
the business have been excluded from the respective captions in the Consolidated
Statements of Operations, Consolidated Balance Sheets and Consolidated
Statements of Cash Flows and have been reported as Gain (loss) from discontinued
operations, net of income taxes, as Net liabilities of discontinued operations,
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 2000 other
than royalty income discussed above. Revenue for the Telecommunications Fraud
Control business for the years ended December 31, 1999 and 1998 was $0.7 million
and $2.8 million, respectively. Pre-tax net operating losses of the business
were $2.4 million and $5.9 million for the years ended December 31, 1999 and
1998, 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, 2000 1999 1998
- --------------------------------------------------------------------------------
(in thousands of dollars)
Currently payable
Federal $ 68 $ 75 $ 1,301
State 10 223 402
- --------------------------------------------------------------------------------
78 298 1,703
Deferred
Federal 2,296 (3,584) (1,073)
State 634 (1,459) (274)
- --------------------------------------------------------------------------------
2,930 (5,043) (1,347)
- --------------------------------------------------------------------------------
Total provision (benefit) $3,008 $(4,745) $ 356
- --------------------------------------------------------------------------------
30
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, 2000 1999 1998
- -------------------------------------------------------------------------------
(in thousands of dollars)
Provision (benefit) on income (loss)
from continuing operations at
statutory rate $2,503 $(4,635) $288
State income taxes, net of federal
tax benefit 425 (810) 50
Increase in valuation allowance - 449 -
Other, net 80 251 18
- -------------------------------------------------------------------------------
Provision (benefit) for income taxes $3,008 $(4,745) $356
- -------------------------------------------------------------------------------
During 1999, the company recorded a tax valuation allowance related to a capital
loss from the sale of its investment in Empresa, Inc., discussed further in Note
12. The company currently has no expectation that it will meet the 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.
At December 31, 2000, the company had federal net operating loss carryforwards
of approximately $0.4 million available to offset future taxable income. These
carryforwards expire through 2020 and are subject to review and possible
adjustment by the Internal Revenue Service. The United States Tax Reform Act of
1986 contains provisions that may limit the net operating loss carryforwards
available to be used in any given year under certain circumstances, including
significant changes in ownership interests.
In 1999, the company utilized $4.2 million of federal net operating loss
carryforwards to reduce 1999 federal taxable income. Also in 1999, the company
filed returns to carry back $3.2 million of prior year federal net operating
losses for federal income tax purposes, resulting in refundable income taxes of
$0.9 million which were included in prepaid expenses and other current assets on
the Consolidated Balance Sheet.
31
The tax effects of significant temporary differences that comprise deferred tax
assets and liabilities are as follows:
December 31, 2000 1999
- -----------------------------------------------------------------------
(in thousands of dollars)
Unbilled costs and fees and deferred
contract revenue, net $(10,510) $ (7,148)
Accrued expenses 4,112 4,240
Receivables reserves 439 317
Inventory reserves 649 518
Federal net operating loss carryforwards 148 429
Other 587 69
- -----------------------------------------------------------------------
Current deferred tax liabilities, net (4,575) (1,575)
- -----------------------------------------------------------------------
Accelerated tax depreciation 93 (500)
State net operating loss and credit
carryforwards 383 464
Capital loss carryforward 449 449
Valuation allowance (449) (449)
Alternative minimum tax credit carryforward 153 -
DISC deferral (966) (742)
Other (512) (141)
- -----------------------------------------------------------------------
Non-current deferred tax liabilities, net (849) (919)
- -----------------------------------------------------------------------
Total deferred tax liabilities, net $ (5,424) $ (2,494)
- -----------------------------------------------------------------------
Total deferred tax assets and total deferred tax liabilities were $7.4 million
and $12.8 million, respectively, at December 31, 2000, compared with $10.4
million and $12.9 million, respectively, at December 31, 1999.
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
years of service and compensation during final years of employment. The
company's funding policy is to contribute at least the minimum amount required
by the Employee Retirement Income Security Act of 1974 or additional amounts to
assure that plan assets will be adequate to provide retirement benefits.
Contributions are intended to provide not only for benefits attributed to
service to date, but also for those expected to be earned in the future.
32
Periodic Pension Cost
- ---------------------
For the years ended December 31, 2000 1999 1998
- ---------------------------------------------------------------------------------
(in thousands of dollars)
Service cost - benefits earned during
the period $ 2,322 $ 2,502 $ 1,933
Interest cost on projected
benefit obligation 3,240 2,735 2,499
Expected return on plan assets (3,450) (3,114) (2,723)
Amortization of prior service cost 220 220 220
Amortization of transition
obligation 35 35 35
- ---------------------------------------------------------------------------------
Net periodic pension cost $ 2,367 $ 2,378 $ 1,964
- ---------------------------------------------------------------------------------
Changes in Benefit Obligations
- ------------------------------
December 31, 2000 1999
- ----------------------------------------------------------------------
(in thousands of dollars)
Projected benefit obligation at
beginning of year $43,653 $42,072
Service cost - benefits earned during
the period 2,322 2,502
Interest cost on projected
benefit obligation 3,240 2,735
Benefits and expenses paid (1,789) (1,123)
Actuarial (gain) loss 2,059 (2,533)
- ----------------------------------------------------------------------
Projected benefit obligation at
end of year $49,485 $43,653
- ----------------------------------------------------------------------
Change in Plan Assets
- ---------------------
December 31, 2000 1999
- ----------------------------------------------------------------------
(in thousands of dollars)
Fair value of plan assets at
beginning of year $37,699 $34,596
Actual return on plan assets 1,737 2,005
Employer contributions 2,774 2,288
Benefits and expenses paid (1,789) (1,190)
- ----------------------------------------------------------------------
Fair value of plan assets at end of year $40,421 $37,699
- ----------------------------------------------------------------------
33
Funded Status
- ---------------------------------
December 31, 2000 1999
- ----------------------------------------------------------------------
(in thousands of dollars)
Plan assets less than projected
benefit obligation $ 9,064 $ 5,954
Unrecognized net transition obligation (35) (70)
Unrecognized prior service costs (1,040) (1,259)
Unrecognized net actuarial loss (6,398) (2,626)
- ----------------------------------------------------------------------
Accrued pension liability $ 1,591 $ 1,999
- ----------------------------------------------------------------------
Weighted Average Assumptions
- ----------------------------
December 31, 2000 1999
- ----------------------------------------------------------------------
Discount rate 7.25% 7.5%
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.
The company has established a Supplemental Executive Retirement Plan ("SERP")
for a certain former key employee providing for annual benefits commencing on
the sixth anniversary of the executive's retirement. The cost of these benefits
is being charged to expense and accrued using a projected unit credit method.
Expense related to this plan was $12,000, $13,000 and $12,000 for the years
ended December 31, 2000, 1999 and 1998, respectively.
The company also maintains a cash or deferred savings plan (401(k) plan), under
which employees may reduce their compensation and have such "elective deferrals"
contributed to the plan on their behalf. The company contributes to the plan an
amount equal to 25% of the first 6% of an employee's elective deferrals. The
company contributed $0.9 million to the plan for each of 2000, 1999 and 1998.
The elective deferrals 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 allows 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. At December 31, 2000, no
amounts had been deferred.
34
7. Debt
On February 10, 2000, the company finalized a three-year $20 million secured
revolving credit agreement (the "Revolver") and a six-month $7.5 million interim
mortgage loan (the "Interim Mortgage") on the company's real estate. Proceeds
were used to pay off existing debt. The Revolver expires on February 10, 2003.
The Revolver provides for borrowings of up to the lesser of $20 million or 80%
of eligible accounts receivable, as defined. At December 31, 2000, $5.8 million
was outstanding under the Revolver and the company had $11.7 million of unused
credit line available. Interest on the outstanding balance of the Revolver and
the Interim Mortgage is the prime rate and is payable monthly. The interest rate
on the Revolver was 9.5% on December 31, 2000. The agreement includes a fee of
0.375% on the unused portion of the Revolver. Commencing in February 2001, the
company has the option to elect an interest rate of LIBOR plus 2% or the prime
rate, and the fee on the unused Revolver is reduced to 0.25%.
On June 12, 2000, the company entered into a $10 million mortgage loan (the
"Mortgage") on the company's real estate with a 10-year term. Proceeds from the
loan were used to repay the Interim Mortgage, with the balance used to repay
outstanding debt on the Revolver. Interest on the Mortgage accrues at the rate
of LIBOR plus 2.5%. The agreement requires quarterly principal payments of
$125,000 beginning on August 1, 2000, with a final payment of $5 million in June
2010. The interest rate on the Mortgage was 9.2% on December 31, 2000.
The Revolver is secured by all assets. The Mortgage is secured by the corporate
office facility in Andover, Massachusetts. The 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, 2000.
The company previously had a secured working capital line of credit of up to $35
million with a syndicate of banks, based on assets consisting of inventory,
receivables and real estate. Interest on the outstanding balance was the prime
rate plus 2%. The agreement included a fee of 0.375% on the unused portion of
the credit line. At December 31, 1999, the company was not in compliance with a
covenant included in the agreement regarding minimum earnings before income
taxes. The amended agreement expired January 31, 2000. At December 31, 1999,
$19.7 million was outstanding under the agreement.
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 and the number and option price of shares covered by each such
option.
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
35
of restricted common stock and deferred grants of common stock. The option price
of incentive stock options shall not be less than the fair market value at the
time the option is granted, and the option period may not be greater than 10
years from the date the option is granted. Options under the plans have normally
been exercisable in three equal installments commencing one year from the date
of the grant. Under the 1993 plan, 580,800 shares have been reserved through
shareholder approval, none of which were available for future grants at December
31, 2000.
The company's 1995 Stock Option Plan for Non-Employee Directors provides for
each outside director to receive options to purchase 5,000 shares of common
stock at the first annual meeting at which such director is elected, and options
to purchase 1,000 shares of common stock at each annual meeting thereafter so
long as he or she remains an eligible director. Such directors cannot be an
employee of the company or one of its subsidiaries or a holder of five percent
or more of the company's common stock. The exercise price of such options will
be the fair market value of the common stock on the date of grant. Each option
is not transferable except upon death, expires 10 years after the date of grant
and becomes exercisable in three equal installments on the first, second and
third anniversary of the date of grant. A total of 132,000 shares has been
reserved for issuance of which 81,040 shares remained available at December 31,
2000.
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 at $4.44, which was the fair market value of the common stock at the date
of grant. Twenty percent of the options vested immediately, with an additional
20% vesting 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 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 up to a total of 1.5 million shares. The option price
may not be less than the fair market value at the date of grant in the case of
incentive stock options and the option period may not exceed 10 years from the
date of grant. The terms of the 2000 Plan are substantially similar to those of
the 1993 Plan. A total of 1.5 million shares has been reserved for issuance of
which 1,050,300 shares remained available at December 31, 2000.
The company has computed the pro forma disclosures required under SFAS No. 123
using the Black-Scholes option pricing model prescribed by SFAS No. 123.
Black-Scholes Assumptions
- -------------------------
December 31, 2000 1999 1998
- -------------------------------------------------------------------------------
Risk free interest rate 5% 7% 6%
Expected option life (years) 9.6 8.9 8.8
Stock volatility 72.64% 73.49% 71.01%
- -------------------------------------------------------------------------------
36
Options to purchase 469,200 shares, 310,500 shares and 99,800 shares were
granted in 2000, 1999, and 1998, respectively, with a weighted average fair
value of $6.40, $3.59 and $6.75, respectively.
The company accounts for its plans under APB Opinion No. 25 under which no
compensation cost has been recognized. Had compensation costs for these plans
been recognized consistent with SFAS No. 123, 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, 2000 1999 1998
- --------------------------------------------------------------------------------
(in thousands of dollars)
Income (loss) from continuing operations $3,724 $(9,416) $ (222)
Income (loss) from continuing operations
per share - basic $ .49 $ (1.28) $ (.03)
Income (loss) from continuing operations
per share - diluted $ .48 $ (1.28) $ (.03)
Net income (loss) $3,930 $(8,054) $(6,684)
Net income (loss) per share - basic $ .52 $ (1.09) $ (.89)
Net income (loss) per share - diluted $ .51 $ (1.09) $ (.89)
- --------------------------------------------------------------------------------
37
Stock Option Activity
- ------------------------------
For the years ended December 31, 2000 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Number Average Number Average Number Average
of Shares Price of Shares Price of Shares Price
- -----------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 911,185 $ 5.07 627,630 $ 5.32 687,163 $4.93
Granted 469,200 $ 8.12 310,500 $ 4.53 99,800 $8.66
Exercised (223,381) $ 3.64 (9,785) $ 2.92 (118,413) $3.69
Canceled (80,344) $ 6.07 (17,160) $ 5.59 (40,920) $7.78
Outstanding at end of year 1,076,660 $ 6.62 911,185 $ 5.07 627,630 $5.32
- -----------------------------------------------------------------------------------------------------------------------------
Exercisable at end of year 426,498 $ 5.69 562,393 $ 4.79 441,190 $4.34
- -----------------------------------------------------------------------------------------------------------------------------
Stock Options Outstanding
- -------------------------
Options Outstanding Options Exercisable
--------------------------------------------------- -------------------
Weighted-Average Weighted- Weighted-
Number Remaining Average Number Average
Outstanding as of Contractual Exercise Exercisable as of Exercise
Range of Exercise Prices December 31, 2000 Life (Years) Price December 31, 2000 Price
- --------------------------------------------------------------------------------------------------------------------------------
$3.12 - $ 4.41 34,320 4.1 $ 3.20 34,320 $ 3.20
$4.42 - $ 5.52 439,000 7.3 $ 4.76 272,333 $ 4.92
$5.53 - $ 6.63 8,140 7.3 $ 6.12 4,472 $ 5.98
$6.64 - $ 7.73 137,700 7.7 $ 7.37 70,033 $ 7.26
$7.74 - $ 9.94 410,700 9.7 $ 8.25 14,140 $ 9.14
$9.95 - $11.04 46,800 7.1 $10.11 31,200 $10.11
$3.12 - $11.04 1,076,660 8.1 $ 6.62 426,498 $ 5.69
- --------------------------------------------------------------------------------------------------------------------------------
On January 30, 2001, company's shareholders approved the adoption of the 2000
Employee Stock Purchase Plan (the "ESPP"). The ESPP is designed to give eligible
employees an opportunity 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 the 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 has been
reserved for issuance under the ESPP.
38
9. Commitments and Contingencies
The company conducts certain of its operations in facilities which are under
long-term operating leases expiring 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 (exclusive of real estate taxes and insurance) was approximately
$3.8 million in 2000, $3.7 million in 1999, and $3.6 million in 1998. The
aggregate minimum lease commitment for the company's facilities on December 31,
2000 was $11.5 million, payable as follows: $3.5 million in 2001, $2.7 million
in 2002, $2.1 million in 2003, $2.0 million in 2004, and $1.2 million in 2005.
As a defense contractor, the company is subject to many levels of audit and
review, including the Defense Contract Audit Agency (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, $0.8 million 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, 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. Although the alleged events are historical, occurring between
1997 and January 2000, the government's investigation is ongoing. 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 2000, approximately 78% 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 2000, approximately 8% of the
company's sales were to agencies of state governments. The cost-reimbursable and
fixed-price contracts the company has won are generally multi-year efforts. In
accordance with state laws, funding must be approved annually by the state's
legislatures.
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
39
certificates will be issued. The Rights will become exercisable upon the tenth
business day following the earlier of (i) the date of a public announcement that
a person or group of affiliated or associated persons has acquired or obtained
the right to acquire, beneficial ownership of 15% or more of the outstanding
shares of common stock of the company or (ii) the commencement or announcement
of an intention to make a tender offer or exchange offer that would result in a
person or group owning 15% or more of the outstanding common stock of the
company.
When exercisable, each Right entitles the registered holder to purchase from the
company one-twelfth of a share of its Series B Participating Preferred Stock,
$.10 par value, at a price of $54.17 per each one-twelfth share of preferred
stock. Until a Right is exercised, the holder thereof, as such, will have no
rights as a shareholder of the company, including, without limitation, the right
to vote or to receive dividends. Under certain circumstances, each share of the
Series B Participating Preferred Stock would be convertible into a number of
shares of the company's common stock having a value equal to twice the exercise
price of the preferred stock purchase right. The Rights may be redeemed by the
company at the discretion of the Board of Directors at a price of $.0083 per
Right. The Rights expire on July 27, 2008.
11. Business Segments
In 2000, the company had three reportable business segments: Systems and
Services, Metrigraphics and Encoder. In 1999 and 1998, the company also had
VisualMagic (see Note 12) 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 two divisions
that provide similar services to the Department of Defense and operate in the
same regulatory environment.
The segments follow the same accounting polices described in Note 1, Significant
Accounting Policies. The company evaluates performance based upon profit or loss
before interest and taxes. Intersegment sales 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 97% of revenue from continuing operations in 2000, and 99% in both
1999 and 1998.
During 2000, 1999 and 1998, revenue from Department of Defense customers
represented approximately 74%, 66% and 59% of total revenue from continuing
operations, respectively. Revenue earned from one significant DoD contract
represented 17%, 12% and 14% of revenue from continuing operations in 2000, 1999
and 1998, respectively. One state customer accounted for 14% of total revenue
from continuing operations in 1998.
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 86% of total
40
company revenue in 2000. 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 12, 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.
41
Financial Information by Business Segment
- -----------------------------------------
(in thousands of dollars)
Identifiable Telecom-
Systems Continuing munications
and Visual Operations Fraud Identifiable
Services Encoder Metrigraphics Magic Total Control (1) Total
- ------------------------------------------------------------------------------------------------------------------------------------
2000
- ----------
Net sales (2) $172,774 $17,648 $ 9,753 $ - $200,175 $ - $200,175
Operating income (2) 4,466 1,619 3,118 - 9,203 - 9,203
Identifiable assets at year end 58,504 5,973 2,537 - 67,014 - 67,014
Depreciation and
Amortization expense 1,955 593 663 - 3,211 - 3,211
Capital expenditures 996 170 983 - 2,149 - 2,149
- ------------------------------------------------------------------------------------------------------------------------------------
1999
- ---------
Net sales (2) $164,766 $13,214 $13,641 $ - $191,621 $ - $191,621
Operating income (loss) (2), (3) (12,988) (785) 4,100 (1,424) (11,097) - (11,097)
Identifiable assets at year end 55,191 5,818 2,527 - 63,536 - 63,536
Depreciation and
amortization expense 1,967 618 2,841 - 5,426 - 5,426
Capital expenditures 1,442 262 786 - 2,490 - 2,490
- ------------------------------------------------------------------------------------------------------------------------------------
1998
- ---------
Net sales (2) $154,336 $16,842 $11,166 $ - $182,344 $ 2,775 $185,119
Operating income (loss) (2) 1,077 254 3,160 (1,859) 2,632 (5,879) (3,247)
Identifiable assets at year end 67,030 5,892 4,680 - 77,602 1,425 79,027
Depreciation and
Amortization expense 2,411 681 2,323 103 5,518 272 5,790
Capital expenditures 2,172 261 277 54 2,764 297 3,061
- ------------------------------------------------------------------------------------------------------------------------------------
(1) As discussed in Note 4, Discontinued Operations, during 1998, the
company adopted a plan to exit the Telecommunications Fraud Control
business and subsequently sold the business during 1999. Accordingly,
the results of the units are presented as discontinued operations in
the Consolidated Statements of Operations. Total 1998
Telecommunications Fraud Control business results exclude the estimated
loss on disposal of the business.
(2) Net sales and operating income (loss) are presented after the
elimination of intersegment transactions.
(3) Systems and Services Segment includes a $1.2 million restructuring
charge.
42
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, 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------
(in thousands of dollars)
Identifiable operating income (loss) $ 9,203 $(11,097) $ 2,632
Other corporate expense - (281) (173)
- -------------------------------------------------------------------------------------------------------------
Operating income (loss) $ 9,203 $(11,378) $ 2,459
- -------------------------------------------------------------------------------------------------------------
Identifiable assets (4) $67,014 $ 63,536 $77,602
Corporate assets (5) 11,688 11,652 10,465
- -------------------------------------------------------------------------------------------------------------
Total assets $78,702 $ 75,188 $88,067
- -------------------------------------------------------------------------------------------------------------
Identifiable depreciation and amortization $ 3,211 $ 5,426 $ 5,518
Corporate depreciation and amortization 535 634 701
- -------------------------------------------------------------------------------------------------------------
Total depreciation and amortization $ 3,746 $ 6,060 $ 6,219
- -------------------------------------------------------------------------------------------------------------
Identifiable capital expenditures $ 2,149 $ 2,490 $ 2,764
Corporate capital expenditures 971 212 110
- -------------------------------------------------------------------------------------------------------------
Total capital expenditures $ 3,120 $ 2,702 $ 2,874
- -------------------------------------------------------------------------------------------------------------
(4) Identifiable assets by business segment include both assets directly
identified with those operations and an allocable share of jointly used
assets.
(5) Corporate assets consist primarily of cash and the company's Andover,
Massachusetts corporate headquarters.
12. Investment in Empresa, Inc.
In 1998 and 1999, the company made investments in Empresa, Inc. (the "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 Statement of Operations.
Subsequently, Empresa ceased operations.
13. Subsequent Event
Subsequent to the end of the year, the company agreed to sell the assets of its
Tactical Communications Group for $0.3 million and transfer related employees.
The group develops and sells communications software for defense applications.
In 2000, the group recorded revenues of
43
$2.3 million and an after tax loss of $0.9 million. In anticipation of the sale,
the company recorded in the fourth quarter of 2000, in cost of contract revenue,
a $0.4 million impairment provision on the assets of the group. The gain or loss
upon closing of the transaction, planned for early in the second quarter of
2001, is expected to be immaterial.
14. Quarterly Results (unaudited)
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
- -----------------------------------------------------------------------------------------------------------------------
(in thousands of dollars, except per share data)
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
1999
Revenue $46,549 $48,810 $48,241 $ 48,021
Gross margin 6,659 (5,367) 4,041 753
Operating income (loss) 2,563 (9,545) (200) (4,196)
Income (loss) from continuing operations 1,182 (6,075) (602) (3,393)
Gain on discontinued operations - 1,362 - -
Net income (loss) 1,182 (4,713) (602) (3,393)
Income (loss) from continuing operations
per common share - diluted (1) .16 (.83) (.08) (.46)
Gain on discontinued operations
per common share - diluted (1) - .19 - -
Net income (loss) per common share - diluted (1) .16 (.64) (.08) (.46)
(1) Quarterly per share amounts may not equal annual amounts due to rounding.
44
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, 2000 and 1999, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 2000. 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, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2000, 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 5, 2001
45
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 2001 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, 2000, is incorporated herein by reference.
Information relating to the Executive Officers of the company is included in
Item 4A of Part I of this Form 10K.
Item 11. Executive Compensation
Information called for by this item is incorporated by reference from the
section entitled "Compensation and Related Matters" in the company's definitive
Proxy Statement for the 2001 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, 2000.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information called for by this item is incorporated by reference from the
sections entitled "Common Stock Ownership of Certain Beneficial Owners and
Management" in the company's definitive Proxy Statement for the 2001 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,
2000.
Item 13. Certain Relationships and Related Transactions
Not applicable.
46
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 pages 50
and 51.
(c) Reports on Form 8-K
The company filed a report on Form 8-K on March 24, 2000 to report
the signing of the Loan and Security Agreement dated February 10,
2000 and the Mortgage Security Agreement and Assignment dated
February 10, 2000.
The company filed a report on Form 8-K on June 27, 2000 to report
the signing of the Second Amendment to the Loan and Security
Agreement dated June 12, 2000 and the Amendment to Mortgage
Security Agreement and Assignment dated June 12, 2000.
47
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 19, 2001
DYNAMICS RESEARCH CORPORATION
By: /s/ James P. Regan
-----------------------------
James P. Regan, President,
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 19th of March, 2001.
/s/ James P. Regan
------------------
James P. Regan President, Chief Executive Officer and Director
/s/ David Keleher
-----------------
David Keleher Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ John S. Anderegg, Jr.
-------------------------
John S. Anderegg, Jr. Chairman and 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
48
SCHEDULE II
DYNAMICS RESEARCH CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR THE THREE YEARS ENDED DECEMBER 31, 2000
(in thousands of dollars)
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURNS
Balance, December 31, 1997 $ 217
Additions charged to expense 149
Write-off of uncollectible accounts, net (50)
----
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
======
ACCRUAL OF LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS
Balance, December 31, 1997 $ -
Additions charged to discontinued operations expense 4,148
-----
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
Balance, December 31, 1998 -
Additions charged to restructuring expense $1,157
------
Balance, December 31, 1999 1,157
Reversal of reserves (117)
Expenditures charged against restructuring reserve (888)
------
Balance, December 31, 2000 $ 152
======
49
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)
50
EXHIBIT INDEX
(CONTINUED)
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.
23.0 Consents of experts and counsel
23.1 Consent of Independent Accountants (Arthur Andersen LLP) dated
March 22, 2001 filed herewith.
99.0 Important Factors Regarding Forward-Looking Statements.
* Previously Filed
All documents incorporated by reference may be found at Commission file number
1-7348.
51