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Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[x] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 2002
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 No.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
Incorporation or Organization) Identification No.)
60 Frontage Road, Andover, Massachusetts 01810-5498
----------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (978) 475-9090
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____ .
-----
The number of shares outstanding of the Registrant's Common stock, par value
$.10 per share, at October 31, 2002 was 8,160,684 shares.
DYNAMICS RESEARCH CORPORATION
INDEX
Page
Part I. Financial Information Number
------
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 2002 and December 31, 2001 3
Consolidated Statements of Operations -
Three Months Ended September 30, 2002 and
September 30, 2001 4
Consolidated Statements of Operations -
Nine Months Ended September 30, 2002 and
September 30, 2001 5
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2002 and
September 30, 2001 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk 23
Item 4. Controls and Proceedings 23
Part II. Other Information
Item 1. Legal Proceedings 24
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
2
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars except share and per share data)
(unaudited)
Assets September 30, 2002 December 31, 2001
- ------ ------------------ -----------------
Current assets
Cash and cash equivalents $ 14,749 $ 16,657
Receivables, net of allowances of $1,063 in 2002 and $1,355 in 2001 23,804 22,946
Unbilled expenditures and fees on contracts in process 19,475 22,876
Inventories 2,481 2,960
Prepaid expenses and other current assets 3,076 1,789
---------- ----------
Total current assets 63,585 67,228
Noncurrent assets
Net property, plant and equipment 14,901 14,597
Goodwill 5,595 -
Intangible assets, net of amortization 1,597 -
Other noncurrent assets 250 -
---------- ----------
Total noncurrent assets 22,343 14,597
---------- ----------
Total assets $ 85,928 $ 81,825
========== ==========
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities
Current portion of long-term debt $ 500 $ 500
Accounts payable 11,003 13,588
Accrued payroll and employee benefits 11,500 11,911
Other accrued expenses 3,890 2,913
Current deferred income taxes 3,495 4,275
---------- ----------
Total current liabilities 30,388 33,187
---------- ----------
Long-term debt 8,375 8,750
Deferred income taxes 2,750 2,750
Commitments and contingencies (Note 6)
Stockholders' Equity
Preferred stock, par value, $.10 per share 5,000,000 shares
authorized, none issued - -
Common stock, par value, $.10 per share:
Authorized - 30,000,000 shares
Issued - 9,492,334 shares in 2002 and 9,320,036 in 2001 949 932
Treasury stock - 1,379,426 shares in 2002 and 2001, at par value (138) (138)
Capital in excess of par value 33,365 31,331
Unearned compensation (849) (992)
Accumulated other comprehensive income (608) (608)
Retained earnings 11,696 6,613
---------- ----------
Total stockholders' equity 44,415 37,138
---------- ----------
Total liabilities and stockholders' equity $ 85,928 $ 81,825
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
3
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands of dollars except share and per share data)
(unaudited)
Three Three
Months Ended Months Ended
September 30, 2002 September 30, 2001
------------------ ------------------
Revenue
Contract revenue $ 45,633 $ 45,091
Product sales 3,547 5,154
----------- -----------
Total revenue 49,180 50,245
Costs and expenses
Cost of contract revenue 38,459 38,655
Cost of product sales 3,203 3,906
Selling, engineering and administrative expenses 4,429 4,188
Amortization of intangible assets 136 -
----------- -----------
Total operating costs and expenses 46,227 46,749
----------- -----------
Operating income 2,953 3,496
Other income 57 -
Interest expense, net (103) (144)
----------- -----------
Income before provision for income taxes 2,907 3,352
Provision for income taxes 1,114 1,374
----------- -----------
Net income $ 1,793 $ 1,978
=========== ===========
Earnings per share
- ------------------
Net income per common share - basic $ 0.22 $ 0.26
Net income per common share - diluted $ 0.20 $ 0.24
Weighted average shares outstanding
- -----------------------------------
Weighted average shares outstanding - basic 7,986,550 7,693,060
Dilutive effect of options and restricted common stock 952,967 499,300
----------- -----------
Weighted average shares outstanding - diluted 8,939,517 8,192,360
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
4
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands of dollars except share and per share data)
(unaudited)
Nine Nine
Months Ended Months Ended
September 30, 2002 September 30, 2001
------------------ ------------------
Revenue
Contract revenue $ 136,057 $ 132,631
Product sales 12,405 16,837
----------- -----------
Total revenue 148,462 149,468
Costs and expenses
Cost of contract revenue 116,004 115,367
Cost of product sales 10,493 12,710
Selling, engineering and administrative expenses 13,182 12,665
Amortization of intangible assets 203 -
----------- -----------
Total operating costs and expenses 139,882 140,742
----------- -----------
Operating income 8,580 8,726
Other income (expense) 60 (193)
Interest expense, net (186) (636)
----------- -----------
Income from continuing operations before provision
for income taxes 8,454 7,897
Provision for income taxes 3,371 3,238
----------- -----------
Income from continuing operations 5,083 4,659
Gain from discontinued operations, net of tax
expense of $43 in 2001 - 62
----------- -----------
Net income $ 5,083 $ 4,721
=========== ===========
Earnings per share
- ------------------
Per common share - basic
Income from continuing operations $ 0.64 $ 0.61
Gain from discontinued operations, net of tax - 0.01
----------- -----------
Net income $ 0.64 $ 0.62
=========== ===========
Per common share - diluted
Income from continuing operations $ 0.57 $ 0.59
Gain from discontinued operations, net of tax - 0.01
----------- -----------
Net income $ 0.57 $ 0.60
=========== ===========
Weighted average shares outstanding
- -----------------------------------
Weighted average shares outstanding - basic 7,928,678 7,640,135
Dilutive effect of options and restricted common stock 991,685 257,949
----------- -----------
Weighted average shares outstanding - diluted 8,920,363 7,898,084
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
5
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
(unaudited)
Nine Nine
Months Ended Months Ended
September 30, 2002 September 30, 2001
------------------ ------------------
Cash provided by operations
Net income $ 5,083 $ 4,721
Adjustments to reconcile net income to cash
provided by (used for) operating activities:
Gain from discontinued operations - (62)
Loss on disposal of assets - 193
Interest income (157) (81)
Equity in income of unconsolidated affiliate (57) -
Tax benefit from stock options exercised 177 -
Stock compensation expense 117 45
Depreciation and amortization of fixed assets 2,433 2,497
Amortization of intangible assets 203 -
Deferred income taxes (780) 1,917
------------------ ------------------
7,019 9,230
------------------ ------------------
Cash provided by (used for) working capital,
net of effects of acquisition
Receivables 5,225 6,240
Unbilled expenditures and fees on contracts in process 8,746 (610)
Inventories 479 (212)
Prepaid expenses and other current assets (1,274) 2,760
Accounts payable (10,360) (804)
Accrued payroll and employee benefits (1,342) 664
Other accrued expenses 784 (498)
------------------ ------------------
2,258 7,540
------------------ ------------------
Net cash provided by continuing operations 9,277 16,770
Net cash provided by discontinued operations - 62
------------------ ------------------
Cash provided by operating activities 9,277 16,832
------------------ ------------------
Cash provided by (used for) investing activities
Proceeds from sale of assets 3 100
Additions to property, plant and equipment (2,442) (2,716)
Purchase of business, net of cash acquired (9,554) -
------------------ ------------------
Net cash used for investing activities (11,993) (2,616)
------------------ ------------------
Cash provided by (used for) financing activities
Net repayments under revolving credit agreement - (5,784)
Net repayments of loan agreement with Bank of America (700) -
Principal payment under 10-year mortgage (375) (375)
Proceeds from the exercise of stock options 1,883 733
------------------ ------------------
Net cash provided by (used for) financing activities 808 (5,426)
------------------ ------------------
Net increase (decrease) in cash and cash equivalents (1,908) 8,790
Cash and cash equivalents at the beginning of the period 16,657 527
------------------ ------------------
Cash and cash equivalents at the end of the period $ 14,749 $ 9,317
================== ==================
Supplemental information
Cash paid for interest $ 315 $ 707
Cash paid for taxes $ 2,264 $ 1,065
The accompanying notes are an integral part of these consolidated financial
statements.
6
DYNAMICS RESEARCH CORPORATION
Notes to Consolidated Financial Statements
Note 1. Significant Accounting Policies
Basis of Presentation
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 period presentation.
Certain information in footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States has been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. The company believes that
the disclosures are adequate to make the information presented not misleading.
The interim financial information is unaudited, but reflects all normal
adjustments which are, in the opinion of the management, necessary to fairly
present the results of operations and financial position. The interim financial
statements should be read in conjunction with the financial statements in the
company's Annual Report on Form 10-K for the year ended December 31, 2001. The
results of the three and nine month periods ended September 30, 2002 may not be
indicative of the results that may be expected for the fiscal year ended
December 31, 2002.
Risks, Uncertainties and Use of Estimates
There are business risks specific to the industries in which the company
operates. These risks include, but are not limited to, estimates of costs to
complete contract obligations, changes in government policies and procedures,
government contracting issues and risks associated with technological
development. The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements. Estimates and assumptions also affect the amount of
revenue and expenses during the reported period. Actual results could differ
from those estimates.
Revenue Recognition
The company's systems and services business provides its services under time and
materials, cost reimbursable and fixed-price contracts. Accordingly, the company
adheres to generally accepted contract accounting principles. For time and
materials contracts, revenue reflects the number of direct labor hours expended
in the performance of a contract multiplied by the contract billing rate, as
well as reimbursement of other billable direct costs. The risk inherent in time
and materials contracts is that actual costs differ materially from negotiated
billing rates in the contract, which directly affects operating income. Under
fixed-price contracts, revenue is recognized under the percentage of completion
method, on the basis of costs incurred in relation to estimated total costs to
complete the contract. The risk on fixed-price contracts is that if actual costs
exceed the estimated costs to complete the contract, then profit is eroded or
losses are incurred. For cost reimbursable contracts, revenue is recognized as
costs are incurred and include a proportionate amount of the fee earned. Cost
reimbursable contracts specify the contract fee in dollars or as a percentage of
estimated costs. The primary risk on cost reimbursable contracts is that a
government audit of direct and indirect costs could
7
result in the disallowance of certain costs, which would directly impact revenue
and operating income. Historically, such audits have had no material impact on
the company's revenue and operating income.
The company does not recognize revenue associated with amounts claimed under a
contract that are not agreed to by the customer. For all types of contracts, the
company recognizes anticipated contract losses as soon as they become known and
estimable. Out-of-pocket expenses that are reimbursable by the customer are
included in contract revenue and cost of contract revenue.
Unbilled expenditures and fees on contracts in process are the amounts of
recoverable contract revenue that have not been billed at the balance sheet
date. Most of the company's unbilled expenditures and fees relate to revenue
that is billed in the month after services are performed. In certain instances,
billing is deferred in compliance with contract terms, such as milestone billing
arrangements and withholdings. Costs related to United States Government
contracts, including applicable indirect costs, are subject to audit by the
government. Revenue from such contracts has been recorded at amounts expected to
be realized upon final settlement.
Revenue from product sales, less returns, is generally recognized at the time of
shipment. Warranty costs are estimated based on historical activity and are
recognized as a component of cost of sales.
Inventories
Inventories stated at the lower of cost or market (in thousands of dollars):
- --------------------------------------------------------------------------------
September 30, 2002 December 31, 2001
------------------ -----------------
Work in process $ 240 $ 296
Raw materials and subassemblies 2,241 2,664
---------------- ----------------
Total inventories $ 2,481 $ 2,960
================ ================
Property, Plant and Equipment
Property, plant and equipment stated at cost (in thousands of dollars):
- --------------------------------------------------------------------------------
September 30, 2002 December 31, 2001
------------------ -----------------
Land $ 1,126 $ 1,126
Building 9,103 8,587
Machinery and equipment 37,387 47,546
Leasehold improvements 2,409 2,723
---------------- ----------------
Total property, plant and equipment 50,025 59,982
Less accumulated depreciation and
amortization 35,124 45,385
---------------- ----------------
Net property, plant and equipment $ 14,901 $ 14,597
================ ================
During the second quarter of 2002, the company recorded disposals of $12.3
million of fully depreciated machinery, equipment and leasehold improvements,
and the associated accumulated depreciation.
8
Earnings Per Common Share
Basic earnings per share is computed by dividing net income by the weighted
average number of shares of common stock outstanding during the period. Diluted
earnings per share is determined by giving effect to the exercise of stock
options and restricted common stock using the treasury stock method. Due to
their antidilutive effect, 24,600 and 23,600 stock options were excluded from
the calculation of earnings per share in the third quarter and first nine months
of 2002, respectively. In the first nine months of 2001, 41,800 stock options
were excluded from the calculation of earnings per share.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 141, Business
Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No.
141 requires business combinations initiated after June 30, 2001 to be accounted
for using the purchase method. It also specifies the types of acquired
intangible assets required to be recognized and reported separately from
goodwill. SFAS No. 142 requires that goodwill and certain intangibles no longer
be amortized, but instead be tested for impairment at least annually. SFAS No.
142 was effective for the company beginning January 1, 2002. The adoption of
SFAS Nos. 141 and 142 did not have an impact on the company's financial position
or results of operations, because the company did not have any goodwill or other
intangible assets recorded at that time. On May 31, 2002 the company acquired HJ
Ford Associates, Inc. and recorded $7.4 million of goodwill and other intangible
assets (see Note 10). The company accounted for the acquisition in accordance
with the provisions of SFAS No. 141. In addition, goodwill is not being
amortized pursuant to provisions of SFAS No. 142. Intangible assets with finite
lives are being amortized over their expected useful lives.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144 modifies the rules for accounting
for the impairment of long-lived assets. The new rules were effective for the
company beginning January 1, 2002. The adoption of SFAS No. 144 did not have a
material impact on the company's financial position or results of operations.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements Nos.
4, 44 and 64, Amendment of FASB Statement No. 13 and Technical Corrections. It
rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt,
SFAS No. 44, Accounting for Intangible Assets of Motor Carriers and SFAS No. 64,
Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements. SFAS No. 145
also amends SFAS No. 13, Accounting for Leases, to eliminate the inconsistency
in the required accounting for sale-leaseback transactions. SFAS No. 145 also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings or describe their applicability under changed
conditions. The new rule is effective for the company beginning January 1, 2003.
The company does not believe that the adoption of SFAS No.145 will have a
material impact on the company's financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. SFAS No. 146 requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to the exit or disposal plan. The new rule is
effective for the company beginning January 1, 2003. The company does not
believe that the adoption of SFAS No. 146 will have a material impact on the
company's financial position or results of operations.
9
Note 2. Loss Provision
In 1997, the company entered into a fixed-price software development contract
with the Colorado Department of Human Services. During the period of
performance, this contract incurred cost overruns, and management anticipated
additional overruns that were provided for in the company's results of
operations. Implementation of the final phase of this project was commenced in
the first quarter of 2002 and was completed on April 12, 2002. With the
exception of remediation requirements, which could arise during the system
warranty period due to expire in the second quarter of 2003, the contract will
be completed with the expiration of the maintenance period in the fourth quarter
of 2002. The company believes that it has reasonably estimated and provided for
all remaining costs to complete the Colorado contract at September 30, 2002.
Note 3. Restructuring
During the second and third quarters of 2002, the company incurred involuntary
separation costs for 93 employees, 60 in the second quarter and 33 in the third
quarter. Costs associated with these terminations totaled $0.4 million for the
second quarter of 2002 and $0.2 million for the third quarter of 2002 and are
included in operating results. At September 30, 2002, $0.3 million of the
expense was accrued and the majority is expected to be paid in the fourth
quarter of 2002.
During the second and third quarters of 2001, the company provided $0.3 million
for involuntary severance costs for 45 employees in the Encoder Division. These
costs were paid in the second half of 2001.
Note 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 for a
period ending in the third quarter of 2002. No royalty income was realized in
the first nine months of 2002. Royalty income of $62,000 was recognized in the
second quarter of 2001.
Note 5. Debt
Effective June 30, 2002, the company obtained a $50 million revolving credit
agreement (the "Revolver"), replacing the previous revolver. The Revolver has a
three-year term and is available to the company for general corporate purposes,
including strategic acquisitions. The fee on the unused portion of the Revolver
is 0.25% and is payable quarterly in arrears. The company has the option to
elect on a fixed 30, 60 or 90-day term, an interest rate of LIBOR plus 2.0% or
the prime rate on any outstanding balance. Interest on the outstanding balance
of the Revolver is payable monthly under the prime rate option or at the end of
the elected term for the LIBOR rate option. At September 30, 2002, there was no
outstanding balance under the Revolver. If there had been an outstanding balance
under the Revolver, the interest rate would have been 3.8% based on the 90-day
LIBOR rate at September 30, 2002. At December 31, 2001, there was no outstanding
balance under the previous revolver.
The company has a 10-year mortgage loan (the "Mortgage"), dated June 12, 2000,
on the company's real estate. The outstanding balance of the Mortgage was $8.9
million and $9.3 million at September 30, 2002 and December 31, 2001,
respectively. The agreement requires quarterly principal payments of $125,000
that began on August 1, 2000, with a final payment of $5 million in June 2010.
Interest on the Mortgage accrued at the rate of LIBOR plus 2.5% at September 30,
2001. Effective November 6, 2001, the interest rate on the Mortgage was reduced
to LIBOR plus 2.0%. On September 30, 2002, the
10
interest rate on the Mortgage under the 90-day LIBOR option elected at July 15,
2002, was 4.0%. 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 September 30, 2002.
Note 6. Commitments and Contingencies
As a defense contractor, the company is subject to many levels of audit and
review from various government agencies, including the Defense Contract Audit
Agency, the Inspector General, the Defense Criminal Investigative Service, the
General Accounting Office, the Department of Justice and Congressional
Committees. Both related to and unrelated to its defense industry involvement,
the company is, from time to time, involved in audits, lawsuits, claims,
administrative proceedings and investigations. The company accrues for
liabilities associated with these activities when it becomes probable that
future expenditures will be made and such expenditures can be reasonably
estimated.
As previously disclosed, on October 26, 2000, two former company employees were
indicted for conspiracy to defraud the United States Air Force and pled guilty.
The United States Attorney's office continues to consider the possibility of
civil liability on the part of the company arising from the former employees'
conspiracy. The company does not have a sufficient basis to determine whether
this matter will have a material adverse effect on the company's financial
position or results of operations.
On September 5, 2002, Genesis Tactical Group LLC ("Genesis") asserted a
cross-claim against Lockheed Martin Corporation ("Lockheed") seeking $50 million
in damages and against the company seeking $35 million in damages. These
cross-claims arise out of a suit filed on July 30, 2002 by Lockheed against
Tactical Communications Group LLC, Genesis and the company in the State of New
York Supreme Court, County of Onondaga. The Lockheed suit relates to a contract
for services which was sold to Genesis by the company pursuant to an asset
purchase agreement in 2001. By the terms of the asset purchase agreement the
company's liability is limited to $300,000, other than for intentional
misrepresentation, willful breach and fraud. Lockheed has asserted breach of
contract and is seeking damages from and performance of the contract by Genesis
and unspecified compensatory damages from the company. Genesis' cross-claims
relate to alleged breaches of the contract by Lockheed and for alleged breaches
of the asset purchase agreement by the company. The company has asserted claims
against Lockheed and Genesis and believes that the Lockheed and Genesis claims
against the company are without merit. While the company believes that the
possibility of a material adverse effect on the company's financial position or
results of operations is remote, there can be no assurance as to the outcome.
The company is preparing a response to a grand jury subpoena issued on October
15, 2002 by the United States District Court for the District of Massachusetts
directing the company to produce specified documents dating back to 1996. The
subpoena relates to an investigation, currently focused on the period 1996-1999,
by the Antitrust Division of the Department of Justice into bidding and
procurement activities involving the company and several other defense
contractors who have received similar subpoenas and may also be subjects of the
investigation. Although the company is cooperating in the investigation, it does
not have a sufficient basis to predict the outcome of the investigation. Should
the company be found to have violated the antitrust laws, the matter could have
a material adverse effect on the company's financial position and results of
operations.
11
Note 7. Segment Information
Results from operations and identifiable assets of HJ Ford Associates, Inc., a
wholly-owned subsidiary that was acquired on May 31, 2002 (see Note 10), have
been included in the company's Systems and Services Segment from the date of
acquisition.
Identifiable assets by business segment include both assets directly identified
with those operations and an allocable share of jointly used assets.
Summarized financial information by business segment for the three months ended
September 30, 2002 and September 30, 2001 are as follows (in thousands of
dollars):
Identifiable
Systems Continuing
and Metri- Operations
Services Encoder graphics Corporate Total
-----------------------------------------------------------------------
September 30, 2002
Net sales $ 45,633 $ 2,025 $ 1,522 $ - $ 49,180
Operating income (loss) 3,300 (410) 63 - 2,953
Identifiable assets at
September 30, 2002 58,576 3,965 2,977 20,410 85,928
September 30, 2001
Net sales $ 45,091 $ 2,242 $ 2,912 $ - $ 50,245
Operating income (loss) 3,039 (645) 1,102 - 3,496
Identifiable assets at
September 30, 2001 52,953 5,292 3,568 16,327 78,140
Summarized financial information by business segment for the nine months ended
September 30, 2002 and September 30, 2001 are as follows (in thousands of
dollars):
Identifiable
Systems Continuing
and Metri- Operations
Services Encoder graphics Corporate Total
-----------------------------------------------------------------------
September 30, 2002
Net sales $ 136,057 $ 6,443 $ 5,962 $ - $ 148,462
Operating income (loss) 8,864 (1,343) 1,059 - 8,580
Identifiable assets at
September 30, 2002 58,576 3,965 2,977 20,410 85,928
September 30, 2001
Net sales $ 132,631 $ 8,459 $ 8,378 $ - $ 149,468
Operating income (loss) 7,242 (1,492) 2,976 - 8,726
Identifiable assets at
September 30, 2001 52,953 5,292 3,568 16,327 78,140
12
Net sales and operating income (loss) are presented after the elimination of
intersegment transactions, which are not material.
During the third quarter of 2002 and 2001, revenue from Department of Defense
(the "DoD") customers represented approximately 77% and 73% of revenue,
respectively, and approximately 76% and 72% of revenue for the first nine months
of 2002 and 2001, respectively. Revenue earned from one significant DoD contract
represented approximately 8% and 20% of revenue in the third quarter of 2002 and
2001, respectively, and approximately 11% and 20% of revenue in the first nine
months of 2002 and 2001, respectively.
Note 8. Sale of Tactical Communications Group
On June 1, 2001, the company completed the sale of its Tactical Communications
Group ("TCG") and the transfer of related employees and assets. TCG developed
and sold communications software for defense applications. For the first six
months of 2001, TCG recorded revenue of approximately $0.8 million and a loss of
$0.5 million. The sale resulted in a net loss of $0.2 million, included in Other
expense on the Consolidated Statements of Operations in the second quarter of
2001. Proceeds from the transaction were $0.1 million in cash.
Note 9. Stock Plans
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 each three-month offering period, whichever is lower. All employees of the
company or designated subsidiaries who customarily work at least 20 hours per
week and do not own five percent or more of the company's common stock are
eligible to participate in the purchase plan. A total of 800,000 shares have
been reserved for issuance under the ESPP of which 661,759 shares remain
unissued at September 30, 2002. The program commenced in May 2001. In the third
quarter and first nine months of 2002, 28,450 and 79,854 shares, respectively,
were issued through the plan. For the first nine months of 2001, 30,282 shares
were issued under the plan.
During the second quarter of 2001, the Board of Directors approved the Executive
Long Term Incentive Program (the "ELTIP"), implemented under the provisions of
the shareholder approved 2000 Incentive Plan. The ELTIP provides incentives to
program participants through a combination of stock options and restricted stock
grants which vest fully in seven years. The ELTIP allows for accelerated vesting
based on the company's achievement of specified financial performance goals.
During the second quarter of 2001, the company granted under this plan stock
options totaling 750,000 shares of common stock at fair market value and granted
121,000 shares of restricted common stock with approximately $1.1 million of
compensatory value which is being amortized over the vesting period of the
grant. In the third quarter and first nine months of 2002, the company
recognized approximately $39,000 and $117,000, respectively, of compensation
expense under this plan. In the third quarter of 2002, the company recognized a
forfeiture of $26,000 under the plan, which is recorded as a reduction to
unearned compensation.
Note 10. Acquisition and Goodwill
On May 31, 2002, the company completed the acquisition of HJ Ford Associates,
Inc. ("HJ Ford") for $10.1 million in net cash in exchange for all of the voting
common stock. Pursuant to certain provisions of the purchase agreement, the
price was adjusted downward in the third quarter of 2002 by $0.5 million. The
purchase agreement also calls for the payment by the company to the sellers of
an
13
additional $1.0 million in 2005, subject to the occurrence of certain events
related to contract renewals. Should these events occur, the additional payment
would be recorded as additional purchase price. HJ Ford, headquartered in
Washington, D.C., had approximately 150 employees in Washington, D.C., Dayton,
Ohio, Mechanicsburg, PA and Patuxent River, MD at the time of acquisition. HJ
Ford helps their clients manage operational processes and acquisition programs
by drawing on their core competencies of systems and information engineering,
acquisition logistics and logistics engineering, information technology,
enterprise engineering, and acquisition program support.
The Consolidated Statements of Operations include the results of HJ Ford
beginning May 31, 2002. The company obtained an independent appraisal of the
fair value of assets acquired, and allocated $1.8 million of the purchase price
to intangible assets with estimated useful lives of 2 to 4 years.
The preliminary purchase price of the HJ Ford acquisition at May 31, 2002 has
been allocated as follows (in thousands of dollars):
- -------------------------------------------------------------------------------
Working capital, net of cash acquired of $1,000 $ 2,470
Property and equipment 209
Other noncurrent asset 180
Long-term debt (700)
Intangible assets
Customer contracts $ 1,400
Employment/non-competition agreements 400
Total intangible assets 1,800
Goodwill 5,595
---------
Purchase price, net of cash acquired $ 9,554
=========
The company paid the long-term debt of $0.7 million in the second quarter of
2002 and canceled the related loan agreement.
The following table represents the company's unaudited pro forma results of
operations for the nine months ended September 30, 2002 and 2001, as if the HJ
Ford acquisition had occurred on January 1, 2001. These pro forma results
include adjustments for the amortization of other intangible assets with finite
useful lives (see Note 1), the elimination of intercompany transactions and
adjustments for income taxes. The table has been prepared for comparative
purposes only and does not purport to be indicative of what would have occurred
had the acquisition been made at the beginning of the period noted or of results
that may occur in the future.
Nine months ended Nine months ended
(in thousands of dollars, except per share data) September 30, 2002 September 30, 2001
- ---------------------------------------------------------------------------- ------------------
Net revenue $ 160,961 $ 172,627
Net income 5,220 4,812
Net income per share - basic .66 .63
Net income per share - diluted .58 .61
Effective January 1, 2002, the company adopted SFAS No. 142, which addresses
financial accounting and reporting for acquired goodwill and other intangible
assets (see Note 1). Goodwill is no longer amortized. Instead, the company will
perform an annual test for impairment of goodwill.
14
The accumulated amortization expense for the acquired intangible assets was
$203,000 at September 30, 2002.
The estimated amortization expense for the remainder of 2002 and for each of the
four succeeding fiscal years is as follows (in thousands of dollars):
Remainder of 2002 ........ $ 136
2003 ..................... 545
2004 ..................... 428
2005 ..................... 344
2006 ..................... 144
15
Note 11. Subsequent Event
On October 18, 2002, the company announced that it is actively pursuing the
divestiture of the Encoder Division. Effective in the fourth quarter of 2002,
the company will report the Encoder Division as a discontinued operation.
The following table represents the company's unaudited pro forma results of
operations for the three months and nine months ended September 30, 2002 and
2001, as if the Encoder Division divestiture had occurred on January 1, 2001.
The table has been prepared for comparative purposes only and does not purport
to be indicative of future results.
Three months ended Nine months ended
(in thousands of dollars, except per share data) September 30, September 30,
- ------------------------------------------------ ------------------------- ---------------------------
2002 2001 2002 2001
----------- ---------- ---------- ------------
Revenue
Continuing Operations $ 47,154 $ 48,003 $ 142,018 $ 141,009
Discontinued Operations 2,026 2,242 6,444 8,459
----------- ---------- ---------- ------------
Total Revenue $ 49,180 $ 50,245 $ 148,462 $ 149,468
Operating Income (Loss)
Continuing Operations $ 3,200 $ 3,942 $ 9,499 $ 9,551
Discontinued Operations (247) (446) (919) (825)
----------- ---------- ---------- ------------
Total Operating Income $ 2,953 $ 3,496 $ 8,580 $ 8,726
Net Income (Loss)
Continuing Operations $ 1,939 $ 2,241 $ 5,628 $ 5,146
Discontinued Operations (1) (146) (263) (545) (425)
----------- ---------- ---------- ------------
Total Net Income $ 1,793 $ 1,978 $ 5,083 $ 4,721
=========== ========== ========== ============
Earnings (Loss) per Share - Basic
Continuing Operations $ 0.24 $ 0.29 $ 0.71 $ 0.67
Discontinued Operations (1) (0.02) (0.03) (0.07) (0.05)
----------- ---------- ---------- ------------
Net Income per Share - Basic $ 0.22 $ 0.26 $ 0.64 $ 0.62
=========== ========== ========== ============
Earnings (Loss) per Share - Diluted
Continuing Operations $ 0.22 $ 0.27 $ 0.63 $ 0.65
Discontinued Operations (1) (0.02) (0.03) (0.06) (0.05)
----------- ---------- ---------- ------------
Net Income per Share - Diluted $ 0.20 $ 0.24 $ 0.57 $ 0.60
=========== ========== ========== ============
(1) Includes income from discontinued operations from a prior disposition of
$62,000 in the second quarter of 2001.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
Total revenue decreased 2.1% to $49.2 million in the third quarter of 2002
compared with $50.2 million in the third quarter of 2001. For the first nine
months of 2002, total revenue decreased slightly to $148.5 million compared with
$149.5 million in the first nine months of 2001.
Contract revenue increased slightly to $45.6 million in the third quarter of
2002 compared with $45.1 million in the same period last year. For the first
nine months of 2002 and 2001, contract revenue was $136.1 million and $132.6
million, respectively.
Defense revenue for the third quarter of 2002 and 2001 was $37.9 million and
$36.9 million, respectively. Results for the third quarter of 2002 reflect four
events. First, the third quarter of 2002 included $7.3 million in revenue
derived from HJ Ford. Second, subcontract revenue derived from the Electronic
Systems Center Combat Air Force program was down nearly $4 million in the third
quarter of 2002 compared with the same quarter last year due to a change from a
prime to subcontract position on this program. Third, revenue from the test
equipment portion of the company's Trident program work was down $1.9 million in
the third quarter of 2002 compared with the third quarter of 2001. There have
been significant changes in the Trident program direction, which have impacted
the company's level of effort in the third quarter of 2002. Fourth, delays in
various contract starts, which were expected to begin during the quarter,
negatively affected results by about $1.6 million. For the first nine months of
2002 and 2001, defense revenue was $112.9 million and $109.7 million,
respectively.
After nine months of competitions at the Air Force Electronic Systems Center for
Information Technology Services Program tasking, known as the ITSP, the
competitions are essentially concluded for the company. While there potentially
will be one more bidding opportunity in the fourth quarter of 2002 on which the
company currently has a small subcontract position, all significant re-compete
and new business opportunity decisions affecting the company have been made. The
company was selected as the lead integrator for two large programs on which the
company previously held subcontract positions. Also, the company moved from a
prime contract position to a subcontract position for two programs on which the
company had previously been the lead integrator. The company estimates the
annualized change in its revenues resulting from ITSP competition awards made to
date, when comparing the company's position immediately preceding the
competitions with the company's current position, to be a reduction in
subcontract pass-through revenue of $14 million and an increase in revenue
derived from company employees of $1 million, for an estimated net reduction in
revenue of $13 million.
Revenue from federal civilian agencies, primarily related to additional work
with the Internal Revenue Service and new work with the Department of
Transportation, increased 42.2% to $4.5 million for the quarter ended September
30, 2002, compared with the same quarter a year ago. For the first nine months
of 2002 and 2001, federal civilian agencies revenue was $12.8 million and $8.1
million, respectively.
State and local government revenue was $3.2 million and $4.9 million for the
third quarter of 2002 and 2001, respectively, and $10.4 million and $14.8
million for the first nine months of 2002 and 2001, respectively. The decrease
resulted primarily from the expected transition of work in Colorado, as
discussed below, and a curtailment of work for the State of Ohio. While there is
the potential for project
17
delays and cutbacks in other states due to state budget deficits, the State of
Ohio is presently the company's only account that has taken such steps.
Product sales for the Precision Manufacturing Group, which is comprised of the
Metrigraphics and Encoder reportable segments, decreased 31.2% to $3.5 million
in the third quarter of 2002 compared with $5.2 million in the same period of
2001. For the first nine months of 2002 and 2001, product revenue was $12.4
million and $16.8 million, respectively. Metrigraphics Division sales decreased
47.7% to $1.5 million in the third quarter of 2002 compared with $2.9 million in
the third quarter of 2001, and 28.8% to $6.0 million in the first nine months of
2002 compared with $8.4 million in the first nine months of 2001. The decrease
was due to delayed orders from a major medical products customer who, the
company believes, was working down inventories, and due to lower sales of inkjet
printer cartridge nozzle plates. Encoder Division sales decreased to $2.0
million in the third quarter of 2002 from $2.2 million for the same period in
2001. For the first nine months of 2002 and 2001, Encoder Division revenue was
$6.4 million and $8.5 million, respectively. These decreases are reflective of
the current state of the capital equipment manufacturing market. Effective in
the fourth quarter of 2002, the company will report the Encoder Division as a
discontinued operation (see Note 11).
Total gross margin was $7.5 million and $7.7 million in the third quarter of
2002 and 2001, respectively, representing 15.3% of total revenue in both the
third quarter of 2002 and 2001. For the first nine months of 2002, total gross
margin was $22.0 million, or 14.8% of total revenue, compared with $21.4
million, or 14.3% of total revenue for the first nine months of 2001.
Gross margin on contract revenue was $7.2 million and $6.4 million for the third
quarter of 2002 and 2001, respectively, representing 15.7% and 14.3% of contract
revenue in the third quarter of 2002 and 2001, respectively. For the first nine
months of 2002, contract revenue gross margin was $20.1 million, or 14.7% of
total contract revenue, compared with $17.3 million, or 13.0% of contract
revenue for the first nine months of 2001. A favorable shift in the mix of prime
and subcontract work and improved pricing were the principal factors
contributing to the margin improvement. The improvement in gross margin on
contract revenue was somewhat dampened by increasing medical costs. For the
first nine months of 2002, cost of contract revenue included $0.5 million of
involuntary severance costs described below. Also during the second quarter of
2002, events related to a specific loss reserve resulted in a $0.3 million
reduction in the reserve, which was credited to the cost of contract revenue.
In 1997, the company entered into a fixed-price software development contract
with the Colorado Department of Human Services. During the period of
performance, this contract incurred cost overruns, and management anticipated
additional overruns that were provided for in the company's results of
operations. Implementation of the final phase of this project was commenced in
the first quarter of 2002 and was completed on April 12, 2002. With the
exception of remediation requirements, which could arise during the system
warranty period due to expire in the second quarter of 2003, the contract will
be completed with the expiration of the maintenance period in the fourth quarter
of 2002. The company believes that it has reasonably estimated and provided for
all remaining costs to complete the Colorado contract at September 30, 2002.
In the third quarter of 2002 and 2001, gross margin on product sales was $0.3
million and $1.2 million, respectively, representing 9.7% and 24.2% of product
sales for the third quarter of 2002 and 2001, respectively. Gross margin on
product sales was $1.9 million and $4.1 million for the first nine months of
2002 and 2001, respectively, representing 15.4% and 24.5% of product sales for
the first nine months of 2002 and 2001, respectively. The decline in gross
margin on product sales resulted from lower sales.
18
Operating expenses increased slightly to $4.4 million in the third quarter of
2002 compared with $4.2 million for the same period in 2001, reflecting an
increase in sales and marketing activities. Amortization expense of $0.1 million
for the third quarter of 2002 reflects three months of amortization of
intangible assets associated with the HJ Ford acquisition (see Note 10). For the
first nine months of 2002 and 2001, operating expenses were $13.2 million and
$12.7 million, respectively. Operating expenses for the first nine months of
2002 includes $0.1 million of employee severance costs recorded in the second
quarter of 2002 and further described below. Amortization expense of $0.2
million for the first nine months of 2002 reflects four months of amortization
of intangible assets associated with the HJ Ford acquisition (see Note 10) and
is based on the final appraisal of the intangible assets.
Total operating income was $3.0 million, or 6.0% of revenue, and $3.5 million,
or 7.0% of revenue, for the third quarter of 2002 and 2001, respectively. For
the first nine months of 2002 and 2001, total operating income was $8.6 million
and $8.7 million, respectively. Operating income was 5.8% of revenue for both
the first nine months of 2002 and 2001.
Operating income for the Systems and Services Segment increased to $3.3 million,
or 7.2% of contract revenue for the third quarter of 2002, compared with $3.0
million, or 6.7% of contract revenue for the third quarter of 2001. For the
first nine months of 2002, operating income for the Systems and Services Segment
increased to $8.9 million, or 6.5% of contract revenue, compared with $7.2
million, or 5.5% of contract revenue for the same period last year.
Operating loss for the Precision Manufacturing Group was $0.3 million, or (9.8)%
of product revenue, for the third quarter of 2002, compared with operating
income of $0.5 million, or 8.9% of product revenue for the same period last
year. For the first nine months of 2002, operating loss for the Precision
Manufacturing Group was $0.3 million, or (2.3)% of product revenue, compared
with operating income of $1.5 million, or 8.8% of product revenue for the first
nine months of 2001.
On June 1, 2001, the company completed the sale of its Tactical Communications
Group ("TCG") and the transfer of related employees and assets. TCG developed
and sold communications software for defense applications. For the first six
months of 2001, TCG recorded revenue of approximately $0.8 million and a loss of
$0.5 million. The sale resulted in a net loss of $0.2 million, included in Other
expense on the Consolidated Statements of Operations in the second quarter of
2001. Proceeds from the transaction were $0.1 million in cash.
In June 1999, the company completed the sale of its previously discontinued
Telecommunications Fraud Control business for $1.7 million plus royalties for a
period ending in the third quarter of 2002. No royalty income was realized in
the first nine months of 2002. Royalty income of $62,000 was recognized in the
second quarter of 2001.
Net interest expense was $0.1 million for both the third quarter of 2002 and
2001. For the first nine months of 2002 and 2001, net interest expense was $0.2
million and $0.6 million, respectively. The decrease in interest expense
reflects lower average interest rates and debt levels, and the net benefit of
investment income on cash and cash equivalents.
Income tax expense for the third quarter of 2002 and 2001 was $1.1 million and
$1.4 million, respectively, representing 38.3% and 41.0% of pre-tax income in
2002 and 2001, respectively. For the
19
first nine months of 2002 and 2001, income tax was $3.4 million, or 39.9% of
pre-tax income and $3.2 million, or 41.0% of pre-tax income, respectively. The
company provides for income taxes on a year-to-date basis at an effective rate
based upon its estimate of full year earnings. Accordingly, the company has
reduced its estimated income tax rate for 2002 from 40.7% to 40.0%.
In response to lower than expected demand in certain sectors of the company's
business, as well as the need to maintain a competitive cost structure, during
the second and third quarters of 2002, the company incurred involuntary
separation costs for 93 employees, 60 in the second quarter of 2002 and 33 in
the third quarter of 2002. All operating groups and functions of the company
were affected. Costs associated with these terminations totaled $0.4 million for
the second quarter of 2002 and $0.2 million for the third quarter of 2002 and
are included in operating results. Of the second quarter of 2002 total, $0.3
million was charged to cost of contract revenue and $0.1 million was charged to
selling, engineering and administrative expenses. Most of the $0.2 million third
quarter of 2002 amount was charged to cost of contract revenue. At September 30,
2002, $0.3 million of the expense was accrued and the majority is expected to be
paid in the fourth quarter of 2002.
During the second and third quarters of 2001, the company provided $0.3 million
for involuntary severance costs for 45 employees in the Encoder Division. These
costs were paid in the second half of 2001.
On a diluted per share basis, earnings of $0.20 for the third quarter of 2002
were down from $0.24 for the same period a year ago. Presented below is an
assessment of the change in consolidated earnings per share, on a pro forma
basis, after giving effect to the impact of income taxes. Comparing segments on
a year over year basis, earnings from the Metrigraphics Division were lower for
the third quarter of 2002 by $0.07 on a per share basis, while earnings from the
Systems and Services Segment were up by $0.02 and the loss from the Encoder
Division was $0.02 less in the third quarter of this year compared with the
third quarter of 2001. Other income and lower interest expense improved diluted
earnings per share by $0.01 for the third quarter of 2002 compared with the same
quarter last year. An increase in common and common equivalent shares
outstanding also accounted for $0.02 of lower per share earnings in the third
quarter of 2002 when compared with the third quarter of 2001. Outstanding common
and common equivalent shares increased from 8.2 million for the quarter ended
September 30, 2001 to 8.9 million for the quarter ended September 30, 2002.
Changes in the company's stock price and an increased level of options granted
have resulted in a greater number of employee stock options counted as
outstanding common equivalent shares and included in the dilutive effect of
options for the purpose of computing diluted earnings per share.
On a diluted per share basis, earnings of $0.57 for the first nine months of
2002 were down from $0.60 for the same period a year ago. Presented below is an
assessment of the change in consolidated earnings per share, on a pro forma
basis, after giving effect to the impact of income taxes. For the nine months
ended September 30, 2002 and 2001 earnings per diluted share derived from the
Systems and Services Segment increased $0.12, earnings per diluted share derived
from the Metrigraphics Division decreased $0.14 and earnings per diluted share
derived from the Encoder Division improved by $0.01. Also, for the nine months
ended September 30, 2002 and 2001 outstanding common and common equivalent
shares increased to 8.9 million from 7.9 million, decreasing diluted earnings
per share by $0.07 on a nine month comparative basis. In addition, 173,000
shares were issued through the company's employee stock purchase plan and option
exercises during the first nine months of 2002. Lower interest and other expense
improved earnings per diluted share by $0.05 for the nine months ended September
30, 2002 compared with the same period in 2001.
The company's total employment at September 30, 2002 was 1,548, up from 1,517 at
December 31, 2001. The company increased its employee count by approximately 150
with the purchase of HJ Ford in the second quarter of 2002 (see Note 10).
20
The company's funded backlog was $91.6 million at September 30, 2002, up from
$91.4 million at December 31, 2001. The addition of HJ Ford fully accounts for
the increase in backlog. A portion of the company's backlog is based on annual
purchase contracts. The amount of backlog as of any date can be affected by the
timing of order receipts and associated deliveries. Backlog does not necessarily
equate to future revenue.
Critical Accounting Policies
The company considered the disclosure requirements regarding critical accounting
policies and liquidity and capital resources, certain trading activities and
related party transactions. Appropriate disclosure was made in the Annual Report
on Form 10-K for the year ended December 31, 2001, and the company concluded
that nothing material changed during the quarter that would warrant further
disclosure.
Liquidity and Capital Resources
Cash provided by continuing operations in the first nine months of 2002 was $9.3
million primarily due to a decrease in unbilled expenditures and fees on
contracts in process and accounts receivable, and positive cash earnings,
partially offset by a decrease in accounts payable, accrued payroll and employee
benefits, and an increase in prepaid expenses and other current assets. Cash
provided by continuing operations in the first nine months of 2001 was $16.8
million primarily resulting from decreased accounts receivable, positive cash
earnings, an income tax refund of $2.2 million and increased deferred income
taxes, partially offset by decreased accounts payable and other accrued
expenses, and increased unbilled expenditures and fees on contracts in process.
Cash used for investing activities was $12.0 million and $2.6 million in the
first nine months of 2002 and 2001, respectively. In 2002, cash used for
investing activities was principally for the purchase of HJ Ford (see Note 10).
The company intends to acquire, from time to time, firms that are aligned with
the company's core capabilities and which complement the company's customer
base.
Effective June 30, 2002, the company obtained a $50 million revolving credit
agreement (the "Revolver"), replacing the previous revolver. The Revolver has a
three-year term and is available to the company for general corporate purposes,
including strategic acquisitions. The fee on the unused portion of the Revolver
is 0.25% payable quarterly in arrears. The company has the option to elect on a
fixed 30, 60 or 90-day term, an interest rate of LIBOR plus 2.0% or the prime
rate on any outstanding balance. Interest on the outstanding balance of the
Revolver is payable monthly under the prime rate option or at the end of the
elected term for the LIBOR rate option. At September 30, 2002, there was no
outstanding balance under the Revolver. If there had been an outstanding balance
under the Revolver, the interest rate would have been 3.8% based on the 90-day
LIBOR rate at September 30, 2002. At December 31, 2001, there was no outstanding
balance under the previous revolver.
The company has a 10-year mortgage loan (the "Mortgage"), dated June 12, 2000,
on the company's real estate. The outstanding balance of the Mortgage was $8.9
million and $9.3 million at September 30, 2002 and December 31, 2001,
respectively. The agreement requires quarterly principal payments of
$125,000 that began on August 1, 2000, with a final payment of $5 million in
June 2010. Interest on the Mortgage accrued at the rate of LIBOR plus 2.5% at
June 30, 2001. Effective November 6, 2001, the interest rate on the Mortgage was
reduced to LIBOR plus 2.0%. The interest rate on the Mortgage
21
under the 90-day LIBOR option elected at July 15, 2002, was 4.0% on September
30, 2002. 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 September 30, 2002.
For the first nine months of 2002, the company realized $1.4 million in proceeds
from the exercise of stock options and $0.5 million in proceeds from the
issuance of shares under the employee stock purchase plan. In the first nine
months of 2001, $0.5 million was realized from the exercise of stock options and
$0.2 million in proceeds from the issuance of shares under the employee stock
purchase plan.
As a defense contractor, the company is subject to many levels of audit and
review from various government agencies, including the Defense Contract Audit
Agency, the Inspector General, the Defense Criminal Investigative Service, the
General Accounting Office, the Department of Justice and Congressional
Committees. Both related to and unrelated to its defense industry involvement,
the company is, from time to time, involved in audits, lawsuits, claims,
administrative proceedings and investigations. The company accrues for
liabilities associated with these activities when it becomes probable that
future expenditures will be made and such expenditures can be reasonably
estimated.
As previously disclosed, on October 26, 2000, two former company employees were
indicted for conspiracy to defraud the United States Air Force and pled guilty.
The United States Attorney's office continues to consider the possibility of
civil liability on the part of the company arising from the former employees'
conspiracy. The company does not have a sufficient basis to determine whether
this matter will have a material adverse effect on the company's financial
position or results of operations.
On September 5, 2002, Genesis Tactical Group LLC ("Genesis") asserted a
cross-claim against Lockheed Martin Corporation ("Lockheed") seeking $50 million
in damages and against the company seeking $35 million in damages. These
cross-claims arise out of a suit filed on July 30, 2002 by Lockheed against
Tactical Communications Group LLC, Genesis and the company in the State of New
York Supreme Court, County of Onondaga. The Lockheed suit relates to a contract
for services which was sold to Genesis by the company pursuant to an asset
purchase agreement in 2001. By the terms of the asset purchase agreement the
company's liability is limited to $300,000, other than for intentional
misrepresentation, willful breach and fraud. Lockheed has asserted breach of
contract and is seeking damages from and performance of the contract by Genesis
and unspecified compensatory damages from the company. Genesis' cross-claims
relate to alleged breaches of the contract by Lockheed and for alleged breaches
of the asset purchase agreement by the company. The company has asserted claims
against Lockheed and Genesis and believes that the Lockheed and Genesis claims
against the company are without merit. While the company believes that the
possibility of a material adverse effect on the company's financial position or
results of operations is remote, there can be no assurance as to the outcome.
The company is preparing a response to a grand jury subpoena issued on October
15, 2002 by the United States District Court for the District of Massachusetts
directing the company to produce specified documents dating back to 1996. The
subpoena relates to an investigation, currently focused on the period 1996-1999,
by the Antitrust Division of the Department of Justice into bidding and
procurement activities involving the company and several other defense
contractors who have received similar subpoenas and may also be subjects of the
investigation. Although the company is cooperating in the investigation, it does
not have a sufficient basis to predict the outcome of the investigation. Should
the company be found to have violated the antitrust laws, the matter could have
a material adverse effect on the company's financial position and results of
operations.
22
The company's prospective cash flows are subject to certain trends, events and
uncertainties, including demands for capital to support growth, acquisitions,
economic conditions, government payment practices and contractual matters. The
company's capital expenditures are expected to be in the range of $3 million to
$4 million in 2002, primarily for technology advancements, facilities and
infrastructure improvements and capacity expansion in support of growth and
operational performance enhancement. 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, capital requirements, and its acquisition program for the
near term.
Forward-Looking Information
Safe harbor statements under the Private Securities Litigation Reform Act of
1995: Some statements contained or implied in this quarterly report that are not
historical fact such as financial forecasts, contain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
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 from those expected, including
uncertainties regarding contractual requirements, actions by customers and
actual costs to complete contractual obligations; 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 the company's Annual Report on Form 10-K for the year ended
December 31, 2001. The company assumes no obligation to update any
forward-looking information.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The company is subject to interest rate risk associated with our Mortgage and
Revolver where interest payments are tied to either the LIBOR or prime rate. At
any time a sharp rise in interest rates could have an adverse effect on net
interest expense as reported in the Consolidated Statements of Operations. The
company does not currently hedge these interest rate exposures.
Item 4. Controls and Procedures
Based on their evaluation as of a date within 90 days of the filing of this Form
10-Q, the company's Chief Executive Officer and Chief Financial Officer have
concluded that the company's disclosure controls and procedures are effective to
ensure that information required to be disclosed in the reports that the company
files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms. There have been no
significant changes in the company's internal controls or in other factors that
could significantly affect those controls subsequent to the date of their
evaluation.
23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
As a defense contractor, the company is subject to many levels of audit and
review from various government agencies, including the Defense Contract Audit
Agency, the Inspector General, the Defense Criminal Investigative Service, the
General Accounting Office, the Department of Justice and Congressional
Committees. Both related to and unrelated to its defense industry involvement,
the company is, from time to time, involved in audits, lawsuits, claims,
administrative proceedings and investigations. The company accrues for
liabilities associated with these activities when it becomes probable that
future expenditures will be made and such expenditures can be reasonably
estimated.
As previously disclosed, on October 26, 2000, two former company employees were
indicted for conspiracy to defraud the United States Air Force and pled guilty.
The United States Attorney's office continues to consider the possibility of
civil liability on the part of the company arising from the former employees'
conspiracy. The company does not have a sufficient basis to determine whether
this matter will have a material adverse effect on the company's financial
position or results of operations.
On September 5, 2002, Genesis Tactical Group LLC ("Genesis") asserted a
cross-claim against Lockheed Martin Corporation ("Lockheed") seeking $50 million
in damages and against the company seeking $35 million in damages. These
cross-claims arise out of a suit filed on July 30, 2002 by Lockheed against
Tactical Communications Group LLC, Genesis and the company in the State of New
York Supreme Court, County of Onondaga. The Lockheed suit relates to a contract
for services which was sold to Genesis by the company pursuant to an asset
purchase agreement in 2001. By the terms of the asset purchase agreement the
company's liability is limited to $300,000, other than for intentional
misrepresentation, willful breach and fraud. Lockheed has asserted breach of
contract and is seeking damages from and performance of the contract by Genesis
and unspecified compensatory damages from the company. Genesis' cross-claims
relate to alleged breaches of the contract by Lockheed and for alleged breaches
of the asset purchase agreement by the company. The company has asserted claims
against Lockheed and Genesis and believes that the Lockheed and Genesis claims
against the company are without merit. While the company believes that the
possibility of a material adverse effect on the company's financial position or
results of operations is remote, there can be no assurance as to the outcome.
The company is preparing a response to a grand jury subpoena issued on October
15, 2002 by the United States District Court for the District of Massachusetts
directing the company to produce specified documents dating back to 1996. The
subpoena relates to an investigation, currently focused on the period 1996-1999,
by the Antitrust Division of the Department of Justice into bidding and
procurement activities involving the company and several other defense
contractors who have received similar subpoenas and may also be subjects of the
investigation. Although the company is cooperating in the investigation, it does
not have a sufficient basis to predict the outcome of the investigation. Should
the company be found to have violated the antitrust laws, the matter could have
a material adverse effect on the company's financial position and results of
operations.
24
Item 6. Exhibits and Reports on Form 8-K
(a) The following Exhibits are filed herewith:
Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Exhibit 99.2 Certification Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) The following reports were filed on Form 8-K:
(1) On July 3, 2002, the company filed a Form 8-K under Item 4, Changes
in Registrant's Certifying Accountant, reporting a change in the
company's certifying accountants.
(2) On July 12, 2002, the company filed an amendment on Form 8-K/A to
the June 28, 2002 Form 8-K to include an exhibit under Item 7,
Financial Statement, Pro Forma Financial Information and Exhibits,
a letter from the company's former accountants stating its
agreement with the company's statement in the June 28, 2002 Form
8-K.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNAMICS RESEARCH CORPORATION
(Registrant)
Date: November 12, 2002 By: /s/ David Keleher
-------------------------
David Keleher
Vice President and Chief Financial Officer
(Principal Financial Officer)
By: /s/ Donald B. Levis
-------------------------
Donald B. Levis
Corporate Controller and Chief Accounting
Officer
(Principal Accounting Officer)
26
Certifications
I, James P. Regan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Dynamics Research
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
By: /s/ James P. Regan
-----------------------
James P. Regan
Chairman, President and
Chief Executive Officer
27
I, David Keleher, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Dynamics Research
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
By: /s/ David Keleher
----------------------
David Keleher
Vice President and
Chief Financial Officer
28