Item
1. Financial
Statements
CONDENSED
CONSOLIDATED BALANCE
SHEETS
(unaudited)
(dollars
in thousands, except share
data)
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
|
|
|
(restated)
|
|
|
|
|
|
|
|
(See
Note
1)
|
|
|
Assets
|
|
|
|
|
|
|
|
Current
assets
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
1,323
|
|
|
$
|
7,887
|
|
|
Accounts
receivable, net of allowances of $804 at September 30, 2007 and
$793 at
December 31, 2006
|
|
|
34,676
|
|
|
|
27,072
|
|
|
Unbilled
expenditures and fees on contracts in process
|
|
|
31,496
|
|
|
|
36,174
|
|
|
Prepaid
expenses and other current assets
|
|
|
3,543
|
|
|
|
2,933
|
|
|
Total
current assets
|
|
|
71,038
|
|
|
|
74,066
|
|
|
Noncurrent
assets
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
10,400
|
|
|
|
11,509
|
|
|
Goodwill
|
|
|
63,055
|
|
|
|
63,055
|
|
|
Intangible
assets, net
|
|
|
3,720
|
|
|
|
5,671
|
|
|
Deferred
tax asset
|
|
|
1,680
|
|
|
|
1,507
|
|
|
Other
noncurrent assets
|
|
|
3,963
|
|
|
|
4,044
|
|
|
Total
noncurrent assets
|
|
|
82,818
|
|
|
|
85,786
|
|
|
Total
assets
|
|
$
|
153,856
|
|
|
$
|
159,852
|
|
|
Liabilities
and stockholders' equity
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
13,060
|
|
|
$
|
18,195
|
|
|
Accrued
compensation and employee benefits
|
|
|
14,727
|
|
|
|
14,473
|
|
|
Deferred
taxes
|
|
|
6,748
|
|
|
|
9,864
|
|
|
Other
accrued expenses
|
|
|
4,959
|
|
|
|
5,201
|
|
|
Total
current liabilities
|
|
|
39,494
|
|
|
|
47,733
|
|
|
Long-term
liabilities
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
|
11,748
|
|
|
|
15,000
|
|
|
Other
long-term liabilities
|
|
|
11,634
|
|
|
|
12,805
|
|
|
Total
long-term liabilities
|
|
|
23,382
|
|
|
|
27,805
|
|
|
Total
liabilities
|
|
|
62,876
|
|
|
|
75,538
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity
|
|
|
|
|
|
|
|
|
|
Preferred
stock, $0.10 par value; 5,000,000 shares authorized; no shares
issued and
outstanding
|
|
|
-
|
|
|
|
-
|
|
|
Common
stock, $0.10 par value; 30,000,000 shares authorized; 9,487,758
and
9,314,962 shares issued and outstanding at September 30, 2007
and December
31, 2006, respectively
|
|
|
949
|
|
|
|
931
|
|
|
Capital
in excess of par value
|
|
|
49,736
|
|
|
|
47,644
|
|
|
Accumulated
other comprehensive loss
|
|
|
(9,206
|
)
|
|
|
(9,206
|
)
|
|
Retained
earnings
|
|
|
49,501
|
|
|
|
44,945
|
|
|
Total
stockholders' equity
|
|
|
90,980
|
|
|
|
84,314
|
|
|
Total
liabilities and stockholders' equity
|
|
$
|
153,856
|
|
|
$
|
159,852
|
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
CONDENSED
CONSOLIDATED STATEMENTS OF
OPERATIONS
(unaudited)
(dollars
in thousands, except per
share data)
|
|
|
Three
Months
Ended
|
|
|
Nine
Months
Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Contract
revenue
|
|
$
|
57,180
|
|
|
$
|
61,547
|
|
|
$
|
170,122
|
|
|
$
|
194,026
|
|
|
Product
sales
|
|
|
1,148
|
|
|
|
1,614
|
|
|
|
2,996
|
|
|
|
4,626
|
|
|
Total
revenue
|
|
|
58,328
|
|
|
|
63,161
|
|
|
|
173,118
|
|
|
|
198,652
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of contract revenue
|
|
|
47,808
|
|
|
|
53,756
|
|
|
|
142,201
|
|
|
|
169,054
|
|
|
Cost
of product sales
|
|
|
1,212
|
|
|
|
1,217
|
|
|
|
3,560
|
|
|
|
3,771
|
|
|
Selling,
general and administrative expenses
|
|
|
5,262
|
|
|
|
5,559
|
|
|
|
16,623
|
|
|
|
18,228
|
|
|
Amortization
of intangible assets
|
|
|
650
|
|
|
|
702
|
|
|
|
1,951
|
|
|
|
2,107
|
|
|
Total
operating costs and expenses
|
|
|
54,932
|
|
|
|
61,234
|
|
|
|
164,335
|
|
|
|
193,160
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
3,396
|
|
|
|
1,927
|
|
|
|
8,783
|
|
|
|
5,492
|
|
|
Interest
expense, net
|
|
|
(373
|
)
|
|
|
(558
|
)
|
|
|
(1,302
|
)
|
|
|
(1,693
|
)
|
|
Other
income
|
|
|
323
|
|
|
|
78
|
|
|
|
397
|
|
|
|
429
|
|
|
Income
before provision for income taxes
|
|
|
3,346
|
|
|
|
1,447
|
|
|
|
7,878
|
|
|
|
4,228
|
|
|
Provision
for income taxes
|
|
|
1,427
|
|
|
|
526
|
|
|
|
3,322
|
|
|
|
1,741
|
|
|
Income
before cumulative effect of accounting change
|
|
|
1,919
|
|
|
|
921
|
|
|
|
4,556
|
|
|
|
2,487
|
|
|
Cumulative
benefit of accounting change, net of tax of $62
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
84
|
|
|
Net
income
|
|
$
|
1,919
|
|
|
$
|
921
|
|
|
$
|
4,556
|
|
|
$
|
2,571
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per common share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before cumulative effect of accounting change
|
|
$
|
0.21
|
|
|
$
|
0.10
|
|
|
$
|
0.49
|
|
|
$
|
0.27
|
|
|
Cumulative
effect of accounting change
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.01
|
|
|
Net
income
|
|
$
|
0.21
|
|
|
$
|
0.10
|
|
|
$
|
0.49
|
|
|
$
|
0.28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before cumulative effect of accounting change
|
|
$
|
0.20
|
|
|
$
|
0.10
|
|
|
$
|
0.47
|
|
|
$
|
0.26
|
|
|
Cumulative
effect of accounting change
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
0.01
|
|
|
Net
income
|
|
$
|
0.20
|
|
|
$
|
0.10
|
|
|
$
|
0.47
|
|
|
$
|
0.27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
9,354,332
|
|
|
|
9,133,552
|
|
|
|
9,326,367
|
|
|
|
9,079,601
|
|
|
Diluted
|
|
|
9,702,910
|
|
|
|
9,395,360
|
|
|
|
9,644,760
|
|
|
|
9,424,170
|
|
The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
CONDENSED
CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
FOR
THE THREE MONTHS ENDED SEPTEMBER
30, 2007 AND 2006
(unaudited)
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
in
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
Excess
of
|
|
|
Comprehensive
|
|
|
Retained
|
|
|
|
|
|
|
|
Shares
|
|
|
Par
Value
|
|
|
Par
Value
|
|
|
Loss
|
|
|
Earnings
|
|
|
Total
|
|
|
Balance
June 30, 2007 (unaudited)
|
|
|
9,464
|
|
|
$
|
946
|
|
|
$
|
49,066
|
|
|
$
|
(9,206
|
)
|
|
$
|
47,582
|
|
|
$
|
88,388
|
|
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,919
|
|
|
|
1,919
|
|
|
Comprehensive
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,919
|
|
|
Issuance
of common stock through stock options exercised and employee
stock
purchase plan transactions
|
|
|
22
|
|
|
|
2
|
|
|
|
228
|
|
|
|
-
|
|
|
|
-
|
|
|
|
230
|
|
|
Issuance
of restricted stock
|
|
|
6
|
|
|
|
1
|
|
|
|
(1
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Forfeiture
of restricted stock
|
|
|
(4
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Release
of restricted stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Share-based
compensation expense
|
|
|
-
|
|
|
|
-
|
|
|
|
434
|
|
|
|
-
|
|
|
|
-
|
|
|
|
434
|
|
|
Tax
benefit from stock options exercised and employee stock purchase
plan
transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
9
|
|
|
|
-
|
|
|
|
-
|
|
|
|
9
|
|
|
Balance
September 30, 2007 (unaudited)
|
|
|
9,488
|
|
|
$
|
949
|
|
|
$
|
49,736
|
|
|
$
|
(9,206
|
)
|
|
$
|
49,501
|
|
|
$
|
90,980
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
in
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
Excess
of
|
|
|
Comprehensive
|
|
|
Retained
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Par
Value
|
|
|
Par
Value
|
|
|
Loss
|
|
|
Earnings
|
|
|
Total
|
|
|
Balance
June 30, 2006 (unaudited)
|
|
|
9,252
|
|
|
$
|
925
|
|
|
$
|
45,855
|
|
|
$
|
(10,768
|
)
|
|
$
|
41,974
|
|
|
$
|
77,986
|
|
|
Impact
of restatement - Note 1
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
549
|
|
|
|
549
|
|
|
Balance
June 30, 2006 (unaudited)
|
|
|
9,252
|
|
|
|
925
|
|
|
|
45,855
|
|
|
|
(10,768
|
)
|
|
|
42,523
|
|
|
|
78,535
|
|
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
921
|
|
|
|
921
|
|
|
Comprehensive
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
921
|
|
|
Issuance
of common stock through stock options exercised and employee
stock
purchase plan transactions
|
|
|
40
|
|
|
|
4
|
|
|
|
431
|
|
|
|
-
|
|
|
|
-
|
|
|
|
435
|
|
|
Issuance
of restricted stock
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Forfeiture
of restricted stock
|
|
|
(5
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Release
of restricted stock
|
|
|
(1
|
)
|
|
|
-
|
|
|
|
(6
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(6
|
)
|
|
Share-based
compensation expense
|
|
|
-
|
|
|
|
-
|
|
|
|
600
|
|
|
|
-
|
|
|
|
-
|
|
|
|
600
|
|
|
Tax
benefit from stock options exercised and employee stock purchase
plan
transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
2
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2
|
|
|
Balance
September 30, 2006 (unaudited)
|
|
|
9,286
|
|
|
$
|
929
|
|
|
$
|
46,882
|
|
|
$
|
(10,768
|
)
|
|
$
|
43,444
|
|
|
$
|
80,487
|
|
The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
CONDENSED
CONSOLIDATED STATEMENTS OF
CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
FOR
THE NINE MONTHS ENDED SEPTEMBER
30, 2007 AND 2006
(unaudited)
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
in
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
Excess
of
|
|
|
Unearned
|
|
|
Comprehensive
|
|
|
Retained
|
|
|
|
|
|
|
|
Shares
|
|
|
Par
Value
|
|
|
Par
Value
|
|
|
Compensation
|
|
|
Loss
|
|
|
Earnings
|
|
|
Total
|
|
|
Balance
December 31, 2006 (audited)
|
|
|
9,315
|
|
|
$
|
931
|
|
|
$
|
47,644
|
|
|
$
|
-
|
|
|
$
|
(9,206
|
)
|
|
$
|
44,396
|
|
|
$
|
83,765
|
|
|
Impact
of restatement - Note 1
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
549
|
|
|
|
549
|
|
|
Balance
December 31, 2006 (unaudited)
|
|
|
9,315
|
|
|
|
931
|
|
|
|
47,644
|
|
|
|
-
|
|
|
|
(9,206
|
)
|
|
|
44,945
|
|
|
|
84,314
|
|
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
4,556
|
|
|
|
4,556
|
|
|
Comprehensive
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
4,556
|
|
|
Issuance
of common stock through stock options exercised and employee
stock
purchase plan transactions
|
|
|
116
|
|
|
|
12
|
|
|
|
982
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
994
|
|
|
Issuance
of restricted stock
|
|
|
90
|
|
|
|
9
|
|
|
|
(9
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Forfeiture
of restricted stock
|
|
|
(14
|
)
|
|
|
(1
|
)
|
|
|
1
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Release
of restricted stock
|
|
|
(19
|
)
|
|
|
(2
|
)
|
|
|
(191
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(193
|
)
|
|
Share-based
compensation expense
|
|
|
-
|
|
|
|
-
|
|
|
|
1,237
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,237
|
|
|
Tax
benefit from stock options exercised and employee stock purchase
plan
transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
72
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
72
|
|
|
Balance
September 30, 2007 (unaudited)
|
|
|
9,488
|
|
|
$
|
949
|
|
|
$
|
49,736
|
|
|
$
|
-
|
|
|
$
|
(9,206
|
)
|
|
$
|
49,501
|
|
|
$
|
90,980
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
in
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
Excess
of
|
|
|
Unearned
|
|
|
Comprehensive
|
|
|
Retained
|
|
|
|
|
|
|
|
|
Shares
|
|
|
Par
Value
|
|
|
Par
Value
|
|
|
Compensation
|
|
|
Loss
|
|
|
Earnings
|
|
|
Total
|
|
|
Balance
December 31, 2005 (audited)
|
|
|
9,097
|
|
|
$
|
910
|
|
|
$
|
45,571
|
|
|
$
|
(1,850
|
)
|
|
$
|
(10,768
|
)
|
|
$
|
40,324
|
|
|
$
|
74,187
|
|
|
Impact
of restatement - Note 1
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
549
|
|
|
|
549
|
|
|
Balance
December 31, 2005 (unaudited)
|
|
|
9,097
|
|
|
|
910
|
|
|
|
45,571
|
|
|
|
(1,850
|
)
|
|
|
(10,768
|
)
|
|
|
40,873
|
|
|
|
74,736
|
|
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,571
|
|
|
|
2,571
|
|
|
Comprehensive
income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,571
|
|
|
Issuance
of common stock through stock options exercised and employee
stock
purchase plan transactions
|
|
|
154
|
|
|
|
15
|
|
|
|
1,559
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,574
|
|
|
Issuance
of restricted stock
|
|
|
70
|
|
|
|
7
|
|
|
|
(7
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Forfeiture
of restricted stock
|
|
|
(21
|
)
|
|
|
(2
|
)
|
|
|
2
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Release
of restricted stock
|
|
|
(14
|
)
|
|
|
(1
|
)
|
|
|
(183
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(184
|
)
|
|
Share-based
compensation expense
|
|
|
-
|
|
|
|
-
|
|
|
|
1,632
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,632
|
|
|
Tax
benefit from stock options exercised and employee stock purchase
plan
transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
158
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
158
|
|
|
Reversal
of unearned compensation upon adoption of SFAS No. 123(R)
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,850
|
)
|
|
|
1,850
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Balance
September 30, 2006 (unaudited)
|
|
|
9,286
|
|
|
$
|
929
|
|
|
$
|
46,882
|
|
|
$
|
-
|
|
|
$
|
(10,768
|
)
|
|
$
|
43,444
|
|
|
$
|
80,487
|
|
The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
CONDENSED
CONSOLIDATED STATEMENTS OF
CASH FLOWS
(unaudited)
(dollars
in
thousands)
|
|
|
Nine
Months
Ended
|
|
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
4,556
|
|
|
$
|
2,571
|
|
|
Adjustments
to reconcile net cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
2,294
|
|
|
|
2,425
|
|
|
Amortization
of intangible assets
|
|
|
1,951
|
|
|
|
2,107
|
|
|
Share-based
compensation, including cumulative effect of accounting
change
|
|
|
1,237
|
|
|
|
1,632
|
|
|
Non-cash
interest expense
|
|
|
110
|
|
|
|
166
|
|
|
Amortization
of deferred gain on sale of building
|
|
|
(507
|
)
|
|
|
(507
|
)
|
|
Investment
income from equity interest
|
|
|
(380
|
)
|
|
|
(169
|
)
|
|
Tax
benefit from stock options exercised and employee stock purchase
plan
transactions
|
|
|
(72
|
)
|
|
|
(158
|
)
|
|
Deferred
income taxes
|
|
|
(3,289
|
)
|
|
|
(6,866
|
)
|
|
Gain
on sale of investments and long-lived assets, net
|
|
|
-
|
|
|
|
(193
|
)
|
|
Change
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts
receivable, net
|
|
|
(7,604
|
)
|
|
|
(2,478
|
)
|
|
Unbilled
expenditures and fees on contracts in process
|
|
|
4,995
|
|
|
|
19,888
|
|
|
Prepaid
expenses and other current assets
|
|
|
(610
|
)
|
|
|
(825
|
)
|
|
Accounts
payable
|
|
|
(5,135
|
)
|
|
|
(5,400
|
)
|
|
Accrued
compensation and employee benefits
|
|
|
254
|
|
|
|
(3,667
|
)
|
|
Other
accrued expenses
|
|
|
(363
|
)
|
|
|
(2,677
|
)
|
|
Other
long-term liabilities
|
|
|
(664
|
)
|
|
|
(2,477
|
)
|
|
Net
cash provided by (used in) operating activities
|
|
|
(3,227
|
)
|
|
|
3,372
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
Additions
to property, plant and equipment
|
|
|
(1,185
|
)
|
|
|
(2,063
|
)
|
|
Proceeds
from sale of investments and long-lived assets
|
|
|
4
|
|
|
|
214
|
|
|
Dividends
from equity investment
|
|
|
174
|
|
|
|
155
|
|
|
Increase
in other assets
|
|
|
(144
|
)
|
|
|
(44
|
)
|
|
Net
cash used in investing activities
|
|
|
(1,151
|
)
|
|
|
(1,738
|
)
|
|
Cash
flow from financing activities:
|
|
|
|
|
|
|
|
|
|
Borrowings
under revolving credit agreement
|
|
|
158,825
|
|
|
|
129,142
|
|
|
Repayments
under revolving credit agreement
|
|
|
(162,077
|
)
|
|
|
(107,450
|
)
|
|
Principal
payments under loan agreements
|
|
|
-
|
|
|
|
(25,412
|
)
|
|
Proceeds
from the exercise of stock options and employee stock purchase
plan
transactions
|
|
|
994
|
|
|
|
1,574
|
|
|
Tax
benefit from stock options exercised and employee stock purchase
plan
transactions
|
|
|
72
|
|
|
|
158
|
|
|
Payments
of deferred financing costs
|
|
|
-
|
|
|
|
(82
|
)
|
|
Net
cash used in financing activities
|
|
|
(2,186
|
)
|
|
|
(2,070
|
)
|
|
Net
decrease in cash and cash equivalents
|
|
|
(6,564
|
)
|
|
|
(436
|
)
|
|
Cash
and cash equivalents, beginning of period
|
|
|
7,887
|
|
|
|
1,020
|
|
|
Cash
and cash equivalents, end of period
|
|
$
|
1,323
|
|
|
$
|
584
|
|
The
accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.
DYNAMICS
RESEARCH
CORPORATION
NOTES
TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per
share amounts)
The
unaudited condensed consolidated financial statements of Dynamics Research
Corporation (the “Company”) and its subsidiaries included herein have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The year-end condensed balance sheet data
was derived from audited financial statements, but does not include all
disclosures required by accounting principles generally accepted in the United
States of America.
On
January 1, 2007, the Company adopted
Financial Accounting
Standards Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes” (“FIN 48”). There was no transition adjustment required due to the
adoption of FIN 48 (See Note 7 for additional information).
The
Company has restated its consolidated financial statements as of December 31,
2006 and 2005 to correct certain tax liabilities, which resulted in an increase
in stockholders’ equity of $549. The restatement reflects corrections
in the measurement of deferred income tax liabilities relating to property
and
equipment. The principal corrections pre-date all periods reported in
the Company’s financial statements, and, as a result, the related financial
statement effects are immaterial to the statements of operations for each of
the
three years in the period ended December 31, 2006. A summary of the
aggregate effect of the restatement on the Company’s consolidated balance sheet
as of December 31, 2006 is shown below.
|
|
|
As
of December 31,
2006
|
|
|
|
|
Previously
Reported
|
|
|
As Restated
|
|
|
Changes
to Consolidated Balance Sheet:
|
|
|
|
|
|
|
|
Deferred
income taxes
|
|
$
|
11,698
|
|
|
$
|
9,864
|
|
|
Other
accrued expenses
|
|
$
|
3,916
|
|
|
$
|
5,201
|
|
|
Total
current liabilities
|
|
$
|
48,282
|
|
|
$
|
47,733
|
|
|
Total
liabilities
|
|
$
|
76,087
|
|
|
$
|
75,538
|
|
|
Retained
earnings
|
|
$
|
44,396
|
|
|
$
|
44,945
|
|
|
Total
stockholders' equity
|
|
$
|
83,765
|
|
|
$
|
84,314
|
|
In
the
opinion of management, all material adjustments that are of a normal and
recurring nature necessary for a fair presentation of the results for the
periods presented have been reflected. All material intercompany transactions
and balances have been eliminated in consolidation. The results for the three
and nine months ended September 30, 2007 may not be indicative of the results
that may be expected for the year ending December 31, 2007. The accompanying
financial information should be read in conjunction with the consolidated
financial statements and notes contained in the Company’s Form 10-K, filed with
the United States Securities and Exchange Commission (“SEC”) for the year ended
December 31, 2006. The Company has reclassified certain prior period
amounts to conform with the current period presentation.
NOTE
2. RECENT ACCOUNTING
PRONOUNCEMENTS
In
February 2007, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair
Value Option for Financial Assets and Financial Liabilities - Including an
amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits
entities to choose to measure many financial instruments and certain other
items
at fair value. The objective is to improve financial reporting by providing
entities with the opportunity to mitigate volatility in reported earnings caused
by measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions. SFAS 159 is effective for the
Company’s fiscal year beginning January 1, 2008. The Company is currently
evaluating whether it will elect the option provided for in SFAS 159, and
whether the adoption will have an impact on its financial
statements.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”
(“SFAS 157”). SFAS 157 clarifies the principle that fair value should be based
on the assumptions market participants would use when pricing
DYNAMICS
RESEARCH
CORPORATION
NOTES
TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except share
amounts)
an
asset
or liability and establishes a fair value hierarchy that prioritizes the
information used to develop those assumptions. Under SFAS 157, fair value
measurements would be separately disclosed by level within the fair value
hierarchy. SFAS 157 is effective for the Company’s fiscal year beginning January
1, 2008, with early adoption permitted. The Company is currently evaluating
whether the adoption of SFAS 157 will have a material impact on its financial
statements.
NOTE
3. STOCKHOLDERS’
EQUITY
Earnings
Per
Share
Basic
earnings per share are computed by dividing net income by the weighted average
number of shares of common stock outstanding during the period. Unvested
restricted shares are excluded from the basic earnings per share calculation
but
are included in the diluted earnings per share calculation using the treasury
stock method. Diluted earnings per share are determined by using the
weighted average number of common and dilutive common equivalent shares
outstanding during the period.
Due
to
their anti-dilutive effect, approximately 76,500 and 95,000 options to purchase
common stock were excluded from the calculation of diluted earnings per share
for the three months ended September 30, 2007 and 2006,
respectively. Approximately 81,500 and 83,500 options to purchase
common stock were excluded from the calculation of diluted earnings per share
for the nine months ended September 30, 2007 and 2006, respectively. These
options could become dilutive in future periods.
The
following table illustrates the reconciliation of the weighted average shares
outstanding:
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Weighted
average shares outstanding - Basic
|
|
|
9,354,332
|
|
|
|
9,133,552
|
|
|
|
9,326,367
|
|
|
|
9,079,601
|
|
|
Diluted
effect of stock options and restricted stock grants
|
|
|
348,578
|
|
|
|
261,808
|
|
|
|
318,393
|
|
|
|
344,569
|
|
|
Weighted
average shares outstanding - Diluted
|
|
|
9,702,910
|
|
|
|
9,395,360
|
|
|
|
9,644,760
|
|
|
|
9,424,170
|
|
Comprehensive
Income
Comprehensive
income for the three and nine months ended September 30, 2007 of $1,919 and
$4,556, respectively, and for the three months ended September 30, 2006 of
$921,
consisted solely of net income. Comprehensive income for the nine
months ended September 30, 2006 consisted of net income of $2,571 and an
unrealized holding gain with an offsetting reclassification adjustment for
the
sale of an investment. During the first quarter of 2006, the Company
recorded an unrealized holding gain of $122, net of tax benefit of $89, for
the
release of Lucent Technologies, Inc. (“Lucent”) shares to the
Company. The Company subsequently sold all of the Lucent shares and
realized a gain of $122, net of tax expense of $89.
DYNAMICS
RESEARCH
CORPORATION
NOTES
TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except share
amounts)
NOTE
4. SHARE-BASED
COMPENSATION
Total
share-based compensation recorded in the Condensed Consolidated Statements
of
Operations was as follows:
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Cost
of products and services
|
|
$
|
166
|
|
|
$
|
297
|
|
|
$
|
446
|
|
|
$
|
897
|
|
|
Selling,
general and administrative
|
|
|
268
|
|
|
|
303
|
|
|
|
791
|
|
|
|
881
|
|
|
Cumulative
effect of accounting change
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(146
|
)
|
|
Total
share-based compensation expense
|
|
$
|
434
|
|
|
$
|
600
|
|
|
$
|
1,237
|
|
|
$
|
1,632
|
|
A
summary
of share-based payment award activity was as follows:
|
|
|
Stock
Options
|
|
|
Restricted
Stock
|
|
|
|
|
Number
of
Shares
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Number
of
Shares
|
|
|
Weighted
Average
Fair
Value
|
|
|
Outstanding
at June 30, 2007
|
|
|
1,031,082
|
|
|
$
|
8.37
|
|
|
|
223,297
|
|
|
$
|
11.61
|
|
|
Granted
|
|
|
-
|
|
|
$
|
-
|
|
|
|
5,900
|
|
|
$
|
12.12
|
|
|
Exercised/Vested
|
|
|
(9,470
|
)
|
|
$
|
8.80
|
|
|
|
(3,333
|
)
|
|
$
|
15.89
|
|
|
Cancelled
|
|
|
(1,967
|
)
|
|
$
|
15.08
|
|
|
|
(3,934
|
)
|
|
$
|
13.51
|
|
|
Outstanding
at September 30, 2007
|
|
|
1,019,645
|
|
|
$
|
8.35
|
|
|
|
221,930
|
|
|
$
|
11.53
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2006
|
|
|
1,140,679
|
|
|
$
|
8.37
|
|
|
|
212,264
|
|
|
$
|
12.86
|
|
|
Granted
|
|
|
-
|
|
|
$
|
-
|
|
|
|
90,000
|
|
|
$
|
11.46
|
|
|
Exercised/Vested
|
|
|
(68,350
|
)
|
|
$
|
7.37
|
|
|
|
(66,010
|
)
|
|
$
|
15.43
|
|
|
Cancelled
|
|
|
(52,684
|
)
|
|
$
|
10.11
|
|
|
|
(14,324
|
)
|
|
$
|
12.91
|
|
|
Outstanding
at September 30, 2007
|
|
|
1,019,645
|
|
|
$
|
8.35
|
|
|
|
221,930
|
|
|
$
|
11.53
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at June 30, 2006
|
|
|
1,159,775
|
|
|
$
|
8.47
|
|
|
|
232,971
|
|
|
$
|
13.14
|
|
|
Granted
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
|
Exercised/Vested
|
|
|
(6,729
|
)
|
|
$
|
8.45
|
|
|
|
(4,526
|
)
|
|
$
|
15.88
|
|
|
Cancelled
|
|
|
(3,851
|
)
|
|
$
|
18.09
|
|
|
|
(4,997
|
)
|
|
$
|
15.18
|
|
|
Outstanding
at September 30, 2006
|
|
|
1,149,195
|
|
|
$
|
8.44
|
|
|
|
223,448
|
|
|
$
|
13.04
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2005
|
|
|
1,239,393
|
|
|
$
|
8.49
|
|
|
|
221,816
|
|
|
$
|
13.60
|
|
|
Granted
|
|
|
-
|
|
|
$
|
-
|
|
|
|
69,900
|
|
|
$
|
14.30
|
|
|
Exercised/Vested
|
|
|
(50,297
|
)
|
|
$
|
6.97
|
|
|
|
(46,933
|
)
|
|
$
|
16.89
|
|
|
Cancelled
|
|
|
(39,901
|
)
|
|
$
|
12.46
|
|
|
|
(21,335
|
)
|
|
$
|
14.07
|
|
|
Outstanding
at September 30, 2006
|
|
|
1,149,195
|
|
|
$
|
8.44
|
|
|
|
223,448
|
|
|
$
|
13.04
|
|
During
2005, the Company realigned its approach to share-based compensation by
increasing the issuance of restricted stock awards and reducing the issuance
of
stock options. As a result, no stock options were awarded during the
three or nine months ended September 30, 2007 and 2006. Also, during
the fourth quarter of 2006, the Company’s Board of Directors approved an
amendment to eliminate the “look-back” option and to reduce the stock purchase
discount from 15% to 5% under the Employee Stock Purchase Plan (“ESPP”)
effective November 1, 2006. Under SFAS 123R, this amendment results
in the Company accounting for shares purchased in connection with the ESPP
after
the effective date as non-compensatory. The fair value of purchases
made under the ESPP during the three and nine months ended September 30, 2006
were estimated using the Black-Scholes option pricing model as of the date
of
purchase. The following weighted average assumptions were used for
the three and nine months ended September 30, 2006: risk-free rate of
4.99% and 4.77%, respectively; dividend yield of zero for both periods;
volatility of 21.37% and 27.14%, respectively; and expected life of three months
for both periods.
DYNAMICS
RESEARCH
CORPORATION
NOTES
TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except share
amounts)
NOTE
5. SUPPLEMENTAL BALANCE SHEET
INFORMATION
The
composition of selected balance sheet accounts is as follows:
|
|
|
September
30,
|
|
|
December 31,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Property
and equipment, net:
|
|
|
|
|
|
|
|
Production
equipment
|
|
$
|
11,972
|
|
|
$
|
11,942
|
|
|
Software
|
|
|
11,741
|
|
|
|
11,283
|
|
|
Furniture
and other equipment
|
|
|
9,074
|
|
|
|
8,792
|
|
|
Leasehold
improvements
|
|
|
2,495
|
|
|
|
2,137
|
|
|
Property
and equipment
|
|
|
35,282
|
|
|
|
34,154
|
|
|
Less
accumulated depreciation
|
|
|
(24,882
|
)
|
|
|
(22,645
|
)
|
|
Property
and equipment, net
|
|
$
|
10,400
|
|
|
$
|
11,509
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
noncurrent assets:
|
|
|
|
|
|
|
|
|
|
Deferred
compensation plan investments
|
|
$
|
1,760
|
|
|
$
|
1,627
|
|
|
Equity
investments
|
|
|
989
|
|
|
|
787
|
|
|
Unbilled
expenditures and fees on contracts in process
|
|
|
721
|
|
|
|
1,038
|
|
|
Other
|
|
|
493
|
|
|
|
592
|
|
|
Other
noncurrent assets
|
|
$
|
3,963
|
|
|
$
|
4,044
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued
compensation and employee benefits:
|
|
|
|
|
|
|
|
|
|
Accrued
payroll and payroll taxes
|
|
$
|
6,432
|
|
|
$
|
5,956
|
|
|
Accrued
vacation
|
|
|
4,812
|
|
|
|
4,343
|
|
|
Accrued
pension liability
|
|
|
-
|
|
|
|
2,000
|
|
|
Other
|
|
|
3,483
|
|
|
|
2,174
|
|
|
Accrued
compensation and employee benefits
|
|
$
|
14,727
|
|
|
$
|
14,473
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
accrued expenses:
|
|
|
|
|
|
|
|
|
|
Accrued
income taxes
|
|
$
|
1,337
|
|
|
$
|
946
|
|
|
Amount
outstanding under letter of credit
|
|
|
976
|
|
|
|
1,016
|
|
|
Deferred
gain on sale of building
|
|
|
676
|
|
|
|
676
|
|
|
Other
|
|
|
1,970
|
|
|
|
2,563
|
|
|
Other
accrued expenses
|
|
$
|
4,959
|
|
|
$
|
5,201
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
long-term liabilities:
|
|
|
|
|
|
|
|
|
|
Deferred
gain on sale of building
|
|
$
|
4,902
|
|
|
$
|
5,407
|
|
|
Accrued
pension liability
|
|
|
3,370
|
|
|
|
1,933
|
|
|
Deferred
compensation plan liability
|
|
|
1,760
|
|
|
|
1,627
|
|
|
Long-term
contract obligations
|
|
|
-
|
|
|
|
2,700
|
|
|
Other
|
|
|
1,602
|
|
|
|
1,138
|
|
|
Other
long-term liabilities
|
|
$
|
11,634
|
|
|
$
|
12,805
|
|
NOTE
6. GOODWILL AND INTANGIBLE
ASSETS
The
Company’s identifiable intangible assets consisted of only customer
relationships as of September 30, 2007 and December 31, 2006. The
carrying cost of customer relationships for both periods was $12,800, offset
by
accumulated amortization of $9,080 and $7,129 as of September 30, 2007 and
December 31, 2006, respectively. The Company recorded amortization
expense for its identifiable intangible assets of $650 and $702 for the three
months ended September 30, 2007 and 2006, respectively, and $1,951 and $2,107
for the nine months ended September 30, 2007 and 2006,
respectively.
DYNAMICS
RESEARCH
CORPORATION
NOTES
TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except share
amounts)
Amortization
expense on the Company’s identifiable intangible assets for their remaining
useful lives is as follows:
|
Remainder
of 2007
|
|
$
|
651
|
|
|
2008
|
|
$
|
2,038
|
|
|
2009
|
|
$
|
1,031
|
|
There
were no changes in the carrying amount of goodwill for the nine months ended
September 30, 2007. The carrying amount of goodwill of $63,055 at September
30,
2007 and December 31, 2006 was included in the Systems and Services
segment.
NOTE
7. INCOME
TAXES
For
the
nine months ended September 30, 2007 and 2006, the effective income tax rate
was
42.2% and 41.2%, respectively, compared to 40.6% for the year ended December
31,
2006. The 2006 tax rates reflect favorable state income tax audits and tax
credits and adjustments of tax accruals and reserves.
On
January 1, 2007, the Company adopted the provisions of FIN 48. The
implementation of FIN 48 did not have a material impact on the amount of the
Company’s tax liability for unrecognized tax benefits. As of the date of
adoption, the Company had approximately $300 of unrecognized tax benefits,
of
which $100 would affect its effective tax rate if recognized. Interest costs
and
penalties related to uncertain tax positions continue to be classified as net
interest expense and selling, general and administrative costs, respectively,
in
the Company’s financial statements. As of the date of adoption, the
Company had approximately $89 of accrued interest and penalties related to
unrecognized tax benefits.
The
Internal Revenue Service (“IRS”) has initiated an audit of the Company’s 2004
income tax return. The IRS continues to challenge the deferral of
income for tax purposes related to unbilled receivables including the
applicability of a Letter Ruling issued by the IRS to the Company in January
1976 which granted to the Company deferred tax treatment of the unbilled
receivables. This issue has been elevated to the IRS National Office
for determination. While the outcome of the audit is not expected to
be known for several months and remains uncertain, the Company may incur
interest expense, its deferred tax liabilities may be reduced and income tax
payments may be increased substantially in future periods.
The
Company files income tax returns in the U.S. federal jurisdiction and numerous
state jurisdictions. Federal tax returns for all years after 2003 are
subject to future examination while tax returns for all years after 2002 are
subject to future examination by state and local tax authorities.
NOTE
8. DEFINED BENEFIT PENSION
PLAN
The
components of net periodic benefit cost for the Company’s defined benefit
pension plan are as follows:
|
|
|
Three
Months
Ended
|
|
|
Nine Months Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Interest
cost on projected benefit obligation
|
|
$
|
1,006
|
|
|
$
|
1,002
|
|
|
$
|
3,018
|
|
|
$
|
3,006
|
|
|
Expected
return on plan assets
|
|
|
(1,464
|
)
|
|
|
(1,262
|
)
|
|
|
(4,391
|
)
|
|
|
(3,786
|
)
|
|
Recognized
actuarial loss
|
|
|
270
|
|
|
|
440
|
|
|
|
810
|
|
|
|
1,320
|
|
|
Net
periodic pension cost
|
|
$
|
(188
|
)
|
|
$
|
180
|
|
|
$
|
(563
|
)
|
|
$
|
540
|
|
On
October 25, 2006, the Company’s Board of Directors approved amendments to the
Company’s Defined Benefit Pension Plan (the “Pension Plan”) which removed
the 3% annual benefit inflator for active participants in the Pension
Plan and froze each participant's calculated pension benefit as of December
31, 2006.
DYNAMICS
RESEARCH
CORPORATION
NOTES
TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except share
amounts)
The
Company does not expect to make any additional pension payments during 2007
based on the current and projected funded status of the Pension
Plan.
NOTE
9. FINANCING
ARRANGEMENTS
The
Company’s outstanding debt at September 30, 2007 and December 31, 2006 was
$11,748 and $15,000, respectively, which consisted of net borrowings against
the
Company’s $50 million revolving credit facility (the “Revolver”). The
weighted average interest rate on $7,000 of the outstanding balance at September
30, 2007 was 6.90% based on LIBOR options elected during the third quarter
of
2007. The interest rate on the remaining $4,748 outstanding balance
at September 30, 2007 was 7.75% based on a base rate option that was in effect
on September 30, 2007. The interest rate on the outstanding balance at December
31, 2006 was 6.87% based on the 90-day LIBOR option elected on October 5,
2006. Borrowings under the Revolver have been classified as a
long-term liability. The repayment of borrowings under the Revolver
is contractually due on September 29, 2009; however, the Company may repay
at
any time prior to that date. The Company was in compliance with its
debt covenants at September 30, 2007.
NOTE
10. BUSINESS SEGMENT, MAJOR
CUSTOMERS AND RELATED PARTY INFORMATION
Business
Segment
Results
of operations information for the Company’s two reportable business segments are
as follows:
|
|
|
Three
Months
Ended
|
|
|
Nine
Months
Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Revenues
from external customers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Systems
and Services
|
|
$
|
57,180
|
|
|
$
|
61,547
|
|
|
$
|
170,122
|
|
|
$
|
194,026
|
|
|
Metrigraphics
|
|
|
1,148
|
|
|
|
1,614
|
|
|
|
2,996
|
|
|
|
4,626
|
|
|
|
|
$
|
58,328
|
|
|
$
|
63,161
|
|
|
$
|
173,118
|
|
|
$
|
198,652
|
|
|
Gross
profit (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Systems
and Services
|
|
$
|
9,372
|
|
|
$
|
7,791
|
|
|
$
|
27,921
|
|
|
$
|
24,972
|
|
|
Metrigraphics
|
|
|
(64
|
)
|
|
|
397
|
|
|
|
(564
|
)
|
|
|
855
|
|
|
|
|
$
|
9,308
|
|
|
$
|
8,188
|
|
|
$
|
27,357
|
|
|
$
|
25,827
|
|
|
Operating
income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Systems
and Services
|
|
$
|
3,722
|
|
|
$
|
1,806
|
|
|
$
|
10,060
|
|
|
$
|
5,465
|
|
|
Metrigraphics
|
|
|
(326
|
)
|
|
|
121
|
|
|
|
(1,277
|
)
|
|
|
27
|
|
|
|
|
$
|
3,396
|
|
|
$
|
1,927
|
|
|
$
|
8,783
|
|
|
$
|
5,492
|
|
Sales
between segments represent less than 1% of total revenue and are accounted
for
at cost.
Major
Customers
Revenues
from Department of Defense (“DoD”) customers accounted for approximately 78% and
80% of total revenues in both the three and nine months ended September 30,
2007
and 2006, respectively. Revenues earned from the U.S. Air Force
Aeronautical Systems Center (“ASC”), a significant DoD customer, which includes
revenue recognized by the Company as a subcontractor to
HMR
Tech/HJ
Ford SBA
JV, LLC, were as follows:
|
|
|
Three
Months Ended September
30,
|
|
Nine
Months Ended September
30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
Revenue
|
|
|
%
|
|
|
Revenue
|
|
|
%
|
|
|
Revenue
|
|
|
%
|
|
|
Revenue
|
|
|
%
|
|
|
U.S.
Air Force ASC
|
|
$
|
5,840
|
|
|
|
10
|
%
|
|
$
|
12,754
|
|
|
|
20
|
%
|
|
$
|
19,546
|
|
|
|
11
|
%
|
|
$
|
39,467
|
|
|
|
20
|
%
|
DYNAMICS
RESEARCH
CORPORATION
NOTES
TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except share
amounts)
The
outstanding accounts receivable balances of this customer were as
follows:
|
|
|
September
30,
|
|
|
December 31,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
U.S.
Air Force ASC
|
|
$
|
4,050
|
|
|
$
|
2,159
|
|
The
Company had no other customer in the three or nine months ended September 30,
2007 and 2006 that accounted for more than 10% of revenues.
Related
Party
Through
its wholly owned subsidiary, H.J. Ford Associates, Inc. (“HJ Ford”), the Company
has a 40% interest in
HMR
Tech,
LLC (“
HMR
Tech”)
which is
accounted for using the equity method. Revenues from
HMR
Tech
included in
contract revenues for the three months ended September 30, 2007 and 2006 were
$97 and $90, respectively, and $287 and $311, respectively, for the nine months
then ended. The amounts due from
HMR
Tech
included in
accounts receivable at September 30, 2007 and December 31, 2006, were $60 and
$50, respectively. The Company’s portion of earnings in
HMR
Tech
recorded in
other income for the nine months ended September 30, 2007 and 2006 was $380
and
$226, respectively.
On
September 28, 2007, the Company sold its 40% interest in
HMR
Tech/HJ
Ford SBA
JV, LLC, (the “Joint Venture”) to the Joint Venture. Management’s
decision to sell its interest in the Joint Venture was based on the U.S Air
Force’s determination that the Joint Venture would no longer be qualified to bid
on further contract task orders, as
HMR
Tech
had
graduated from the Small Business Administration (“SBA”) 8(a) program in April
2007. The Joint Venture unsuccessfully protested this determination
with the SBA and with the Government Accountability Office. As a result of
the
transaction,
HMR
Tech
is now the
sole member of the Joint Venture. The Joint Venture, which was formed
by
HMR
Tech
and HJ Ford
under the Small Business Administration Mentor-Protégé program, was accounted
for using the equity method of accounting. The Company received $4 in
proceeds from the transaction, representing the Company’s original investment in
the Joint Venture.
Revenues
recognized by the Company as a subcontractor to the Joint Venture for the three
and nine months ended September 30, 2007 were $5,767 and $16,431,
respectively. Revenues recognized by the Company for both the three
and nine months ended September 30, 2006 were $242. Charges by the
Company for administrative services to the Joint Venture under the terms of
the
Services Agreement for the three and nine months ended September 30, 2007 were
$408 and $1,155, respectively. A new Services Agreement was entered
into effective October 1, 2007 under which the Company will charge
HMR
Tech
for
administrative services at 2.8% of revenues derived from the Consolidated
Acquisition of Professional Services (“CAPS”) contract.
The
table
below presents the various amounts included in the Company’s Consolidated
Balance Sheet related to the above mentioned transactions with the Joint
Venture:
|
|
|
September
30,
|
|
|
December 31,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
Accounts
receivable
|
|
$
|
3,452
|
|
|
$
|
870
|
|
|
Unbilled
expenditures and fees on contracts in process
|
|
$
|
1,849
|
|
|
$
|
967
|
|
|
Prepaid
expenses and other current assets
|
|
$
|
1,369
|
|
|
$
|
110
|
|
NOTE
11. COMMITMENTS AND
CONTINGENCIES
During
the third quarter of 2007, the Company implemented a plan to relocate its
Washington, D.C. area headquarters from Vienna, Virginia to Reston,
Virginia. The transition to the Reston facility is expected to occur
by the end of 2007. The minimum rental payments under the Reston
facility operating lease will be approximately $630 for the initial twelve
month
period and will increase by 5% annually until it ends in March
2011. The Company entered into a subleasing agreement for its Vienna
facility for the period beginning November 1, 2007
DYNAMICS
RESEARCH
CORPORATION
NOTES
TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except share
amounts)
until
the
end of the current lease obligation in May 2011. The rental income to
be received will be essentially the same as payments due under the lease
obligation for the Vienna facility, which is approximately $1,300 per
year. These transactions had an immaterial effect on the Condensed
Consolidated Statements of Operations for the three and nine months ended
September 30, 2007.
As
a
defense contractor, the Company is subject to many levels of audit and review
from various government agencies, including the Defense Contract Audit Agency,
various inspectors general, the Defense Criminal Investigation Service, the
Government Accountability Office, the Department of Justice and Congressional
Committees. Both related to and unrelated to its defense industry involvement,
the Company is, from time to time, involved in audits, lawsuits, claims,
administrative proceedings and investigations. The Company accrues for
liabilities associated with these activities when it becomes probable that
future expenditures will be made and such expenditures can be reasonably
estimated. Except as noted below, the Company does not presently believe it
is
reasonably likely that any of these matters would have a material adverse effect
on the Company’s business, financial position, results of operations or cash
flows. The Company’s evaluation of the likelihood of expenditures related to
these matters is subject to change in future periods, depending on then current
events and circumstances, which could have material adverse effects on the
Company’s business, financial position, results of operations and cash
flows.
On
October 26, 2000, two former Company employees were indicted and charged with
conspiracy to defraud the U.S. Air Force and wire fraud, among other charges,
arising out of a scheme to defraud the U.S. out of approximately $10 million.
Both men subsequently pled guilty to the principal charges against them. On
October 9, 2003, the U.S. Attorney filed a civil complaint in the U.S. District
Court for the District of Massachusetts against the Company based in substantial
part upon the actions and omissions of the former employees that gave rise
to
the criminal cases against them. In the civil action, the U.S. Attorney is
asserting claims against the Company, which are not additive, based on the
False
Claims Act, the Anti-Kickback Act, or breach of contract for which the
government estimates damages at approximately $24 million, $20 million and
$10
million, respectively. The U.S. Attorney is also seeking recovery on
certain common law claims, costs, equitable claims, and interest on breach
of
contract damages. On February 14, 2007, the U.S. Attorney filed a
motion for summary judgment as to liability and as to damages in this matter.
The Company has filed an opposition to the government’s motion which includes
substantive defenses. The court, in the ordinary course, is expected
to rule by the end of 2007. The Company filed a motion, which
was granted in part, to compel further discovery. While there can be
no assurance as to the ultimate disposition of this case, the Company considers
it to be probable that the court may grant summary judgment as to the breach
of
contract liability claim and more likely than not, but not probable, that the
court may grant summary judgment as to the False Claims Act liability
claim. For the claim in which management believes an unfavorable outcome is
probable, the Company has recognized its estimated liability. The
Company believes, however, that it is unlikely the court would grant summary
judgment as to the government’s claim of damages, in which circumstance the case
would proceed to trial as to damages. If, upon conclusion of summary
judgment, liability claims are entered against the Company, the Company
estimates that it would become liable for repayment of certain contract billings
and penalties that together are expected to range from approximately $181 to
$1,750, excluding the outcome as to damages. Regarding the alleged
actual damages, the Company believes that it has substantive defenses and
intends to vigorously defend itself. The Company presently has
insufficient information to quantify potential actual damages, if
any. As a result, the ultimate outcome of the litigation
as to damages remains indeterminate. If an unfavorable determination
is rendered, the outcome would have a material adverse effect on the Company’s
business, financial position, results of operations and cash flows.
The
Company has provided documents in response to a previously disclosed grand
jury
subpoena issued on October 15, 2002 by the U.S. District Court for the District
of Massachusetts, directing the Company to produce specified documents dating
back to 1996. The subpoena relates to an investigation, which focused on the
period from 1996 to 1999, by the Antitrust Division of the Department of Justice
in New York into the 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. On February 7, 2007, the Company
learned that the Antitrust Division has communicated to the Department of
Justice in Washington, D.C. the results of its investigation which have not
been
made available to the Company. The Company has cooperated in the investigation;
however, it does not have a sufficient basis to predict the outcome of the
investigation. Should the
DYNAMICS
RESEARCH
CORPORATION
NOTES
TO CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except share
amounts)
Company
be found to have violated the antitrust laws, the matter could have a material
adverse effect on the Company’s business, financial position, results of
operations and cash flows.
On
June
28, 2005, a suit, characterized as a class action employee suit, was filed
in
the U.S. District Court for the District of Massachusetts alleging violations
of
the Fair Labor Standards Act and certain provisions of Massachusetts General
Laws. The Company believes that its practices complied with the Fair Labor
Standards Act and Massachusetts General Laws. The Company intends to vigorously
defend itself and has sought to have the complaint dismissed from District
Court
and addressed in accordance with the Company’s mandatory dispute resolution
program for the arbitration of workplace complaints. On April 10, 2006, the
U.S.
District Court for the District of Massachusetts entered an order granting
in
part the Company’s motion to dismiss the civil action filed against the Company,
and to compel compliance with its mandatory dispute resolution program,
directing that the parties arbitrate the aforementioned claims, and striking
the
class action waiver which was part of the dispute resolution program. Following
the District Court’s decision, the plaintiffs commenced an arbitration before
the American Arbitration Association, asserting the same claims as they asserted
in the District Court. An arbitrator has been selected, but no
substantive action has occurred in the arbitration. On January 26, 2007 the
Company filed an appeal with the United States Court of Appeals for the Second
Circuit appealing the portion of the District Court’s decision that the class
action waiver is not enforceable. The outcome of the arbitration, if
unfavorable, could have a material adverse effect on the Company’s business,
financial position, results of operations and cash flows.
Item
2. Management’s Discussion and
Analysis of Financial Condition and Results
of Operations
The
following discussion should be read in conjunction with our condensed
consolidated financial statements and the related notes. Unless the
context otherwise requires, references in this Form 10-Q to “DRC”, “we”, “us” or
“our” refer to Dynamics Research Corporation and its
subsidiaries.
OVERVIEW
DRC,
founded in 1955 and headquartered in Andover, Massachusetts, provides
Information Technology (“IT”), engineering and other services focused on
national defense and intelligence, public safety and citizen services for
government customers. The government market is composed of three sectors:
national defense and intelligence, federal civilian agencies, and state and
local governments. Our core capabilities are focused on IT, engineering and
technical subject matter expertise that pertain to the knowledge domains of
our
core customers.
Recent
industry reports, such as the Federal IT Market Forecast published by INPUT,
Inc., are projecting long-term growth rates of approximately 5% for the federal
government professional services industry. We are cognizant of funding
challenges facing the federal government and the resulting increase in
competitiveness in our industry. Significant contract awards have
been and will continue to be delayed and new initiatives have been slow to
start. Customers are moving away from General Services Administration and
time and materials contracts toward agency sponsored Indefinite
Delivery-Indefinite Quantity contract vehicles and fixed price contracts and
task orders. The DoD seeks to reduce spending on contracted program
support services, often referred to as advisory and assistance services, and
frequently is setting this work aside for small businesses. However, there
is increasing demand from federal customers for engineering, training, business
transformation, lean six sigma and business intelligence solutions and services.
In addition, many federal customers are seeking to streamline their
procurement activities by consolidating work under large contract vehicles.
Our competitive strategy is intended to align with these
trends.
Operating
income for the three months ended September 30, 2007 and 2006 was $3.4 million
and $1.9 million, respectively, and $8.8 million and $5.5 million, respectively,
for the nine months then ended. The operating margin for the three
months ended September 30, 2007 and 2006 was 5.8% and 3.1% of total revenue,
respectively, and 5.1% and 2.8% of total revenue, respectively, for the nine
months then ended. The increase in operating margin was primarily due
to a favorable increase in total gross margin reflecting a shift in our business
into the new CAPS contract with the ASC and lower indirect costs which resulted
from a variety of cost savings initiatives undertaken in 2006.
We
have
two reportable business segments: Systems and Services and Metrigraphics. The
Systems and Services segment accounted for 98.3% of total revenue and the
Metrigraphics segment accounted for 1.7% of total revenue for the nine months
ended September 30, 2007.
CRITICAL
ACCOUNTING
POLICIES
There
are
business risks specific to the industries in which we operate. 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.
The
use
of alternative estimates and assumptions and changes in business strategy
or
market conditions may significantly impact our assets or liabilities, and
potentially result in a different impact to our results of
operations. Consistent with the prior year, we believe the following
critical accounting policies affect the more significant judgments made and
estimates used in the preparation of our consolidated financial
statements:
|
|
•
|
Revenue
recognition
|
|
|
|
|
|
|
•
|
Goodwill
and other intangible assets
|
|
|
|
|
|
|
•
|
Income
taxes and deferred taxes
|
|
|
|
|
|
|
•
|
Pension
obligations
|
Except
for income taxes and deferred taxes, there have been no material changes from
the methodology applied by management for critical accounting policies
previously disclosed in our most recent Form 10-K. The methodology applied
to
management’s estimate for income taxes and deferred taxes has changed due to the
implementation of a new accounting pronouncement as described
below.
Income
Taxes and Deferred
Taxes
On
January 1, 2007, we adopted FIN 48 which addresses the determination of how
tax
benefits claimed or expected to be claimed on a tax return should be recorded
in
the financial statements. Under FIN 48, we must recognize the tax benefit from
an uncertain tax position only if it is more likely than not that the tax
position will be sustained on examination by the taxing authorities, based
on
the technical merits of the position. The tax benefits recognized in the
financial statements from such a position are measured based on the largest
benefit that has a greater than fifty percent likelihood of being realized
upon
ultimate resolution.
The
impact from our adoption of FIN 48 is more fully described in Note 7 in our
“Notes to Condensed Consolidated Financial Statements” in Part I,
Item 1 on this Form 10-Q. For further discussion of our critical
accounting policy related to income taxes and deferred taxes, refer to the
section titled “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” in Part II, Item 7 of our 2006 Form 10-K.
RESULTS
OF
OPERATIONS
Operating
results (in millions) expressed as a percentage of segment and total revenue
are
as follows:
|
|
|
Three
Months Ended September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
$
(1)
|
|
|
%
(1)
|
|
|
$
(1)
|
|
|
%
(1)
|
|
|
Contract
revenue
|
|
$
|
57.2
|
|
|
|
98.0
|
%
|
|
$
|
61.5
|
|
|
|
97.4
|
%
|
|
Product
sales
|
|
|
1.1
|
|
|
|
2.0
|
|
|
|
1.6
|
|
|
|
2.6
|
|
|
Total
revenue
|
|
$
|
58.3
|
|
|
|
100.0
|
%
|
|
$
|
63.2
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit on contract revenue
(2)
|
|
$
|
9.4
|
|
|
|
16.4
|
%
|
|
$
|
7.8
|
|
|
|
12.7
|
%
|
|
Gross
profit (loss) on product sales
(2)
|
|
|
(0.1
|
)
|
|
|
(5.6
|
)%
|
|
|
0.4
|
|
|
|
24.6
|
%
|
|
Total
gross profit
(2)
|
|
|
9.3
|
|
|
|
16.0
|
%
|
|
|
8.2
|
|
|
|
13.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
5.3
|
|
|
|
9.0
|
%
|
|
|
5.6
|
|
|
|
8.8
|
%
|
|
Amortization
of intangible assets
|
|
|
0.7
|
|
|
|
1.1
|
%
|
|
|
0.7
|
|
|
|
1.1
|
%
|
|
Operating
income
|
|
|
3.4
|
|
|
|
5.8
|
%
|
|
|
1.9
|
|
|
|
3.1
|
%
|
|
Interest
expense, net
|
|
|
(0.4
|
)
|
|
|
(0.6
|
)%
|
|
|
(0.6
|
)
|
|
|
(0.9
|
)%
|
|
Other
income, net
|
|
|
0.3
|
|
|
|
0.6
|
%
|
|
|
0.1
|
|
|
|
0.1
|
%
|
|
Provision
for income taxes
(3)
|
|
|
1.4
|
|
|
|
42.6
|
%
|
|
|
0.5
|
|
|
|
36.4
|
%
|
|
Net
income
|
|
$
|
1.9
|
|
|
|
3.3
|
%
|
|
$
|
0.9
|
|
|
|
1.5
|
%
|
|
|
|
Nine
Months Ended September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
$
(1)
|
|
|
%
(1)
|
|
|
$
(1)
|
|
|
%
(1)
|
|
|
Contract
revenue
|
|
$
|
170.1
|
|
|
|
98.3
|
%
|
|
$
|
194.0
|
|
|
|
97.7
|
%
|
|
Product
sales
|
|
|
3.0
|
|
|
|
1.7
|
|
|
|
4.6
|
|
|
|
2.3
|
|
|
Total
revenue
|
|
$
|
173.1
|
|
|
|
100.0
|
%
|
|
$
|
198.7
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit on contract revenue
(2)
|
|
$
|
27.9
|
|
|
|
16.4
|
%
|
|
$
|
25.0
|
|
|
|
12.9
|
%
|
|
Gross
profit (loss) on product sales
(2)
|
|
|
(0.6
|
)
|
|
|
(18.8
|
)%
|
|
|
0.9
|
|
|
|
18.5
|
%
|
|
Total
gross profit
(2)
|
|
|
27.4
|
|
|
|
15.8
|
%
|
|
|
25.8
|
|
|
|
13.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
16.6
|
|
|
|
9.6
|
%
|
|
|
18.2
|
|
|
|
9.2
|
%
|
|
Amortization
of intangible assets
|
|
|
2.0
|
|
|
|
1.1
|
%
|
|
|
2.1
|
|
|
|
1.1
|
%
|
|
Operating
income
|
|
|
8.8
|
|
|
|
5.1
|
%
|
|
|
5.5
|
|
|
|
2.8
|
%
|
|
Interest
expense, net
|
|
|
(1.3
|
)
|
|
|
(0.8
|
)%
|
|
|
(1.7
|
)
|
|
|
(0.9
|
)%
|
|
Other
income, net
|
|
|
0.4
|
|
|
|
0.2
|
%
|
|
|
0.4
|
|
|
|
0.2
|
%
|
|
Provision
for income taxes
(3)
|
|
|
3.3
|
|
|
|
42.2
|
%
|
|
|
1.7
|
|
|
|
41.2
|
%
|
|
Cumulative
benefit of accounting change
|
|
|
-
|
|
|
|
0.0
|
%
|
|
|
0.1
|
|
|
|
0.0
|
%
|
|
Net
income
|
|
$
|
4.6
|
|
|
|
2.6
|
%
|
|
$
|
2.6
|
|
|
|
1.3
|
%
|
|
|
|
|
(1)
|
Totals
may not add due to rounding.
|
|
(2)
|
These
amounts represent a percentage of contract revenues, product
sales and
total revenues, respectively.
|
|
(3)
|
These
amounts represent a percentage of income before provision for
income
taxes.
|
Revenues
We
reported total revenues of $58.3 million and $63.2 million in the third quarters
of 2007 and 2006, respectively. The revenues for the third quarter of 2007
represent a decrease of $4.9 million, or 7.7%, from the same period in
2006. Our revenues for the nine months ended September 30, 2007 and
2006 were $173.1 million and $198.7 million, respectively, representing a
decrease of $25.6 million, or 12.9%, compared to the same nine month period
in
2006.
Contract
Revenues
Contract
revenues in our Systems and Services segment were earned from the following
sectors (in millions):
|
|
|
Three
Months Ended September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
$
(1)
|
|
|
%
(1)
|
|
|
$
(1)
|
|
|
%
(1)
|
|
|
National
defense and intelligence agencies
|
|
$
|
45.5
|
|
|
|
79.6
|
%
|
|
$
|
50.6
|
|
|
|
82.2
|
%
|
|
Federal
civilian agencies
|
|
|
7.9
|
|
|
|
13.9
|
|
|
|
6.6
|
|
|
|
10.8
|
|
|
State
and local government agencies
|
|
|
3.5
|
|
|
|
6.2
|
|
|
|
4.0
|
|
|
|
6.4
|
|
|
Other
|
|
|
0.2
|
|
|
|
0.4
|
|
|
|
0.4
|
|
|
|
0.6
|
|
|
Total
contract revenue
|
|
$
|
57.2
|
|
|
|
100.0
|
%
|
|
$
|
61.5
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine
Months Ended September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
|
|
$
(1)
|
|
|
%
(1)
|
|
|
$
(1)
|
|
|
%
(1)
|
|
|
National
defense and intelligence agencies
|
|
$
|
135.4
|
|
|
|
79.6
|
%
|
|
$
|
159.0
|
|
|
|
81.9
|
%
|
|
Federal
civilian agencies
|
|
|
23.4
|
|
|
|
13.8
|
|
|
|
23.0
|
|
|
|
11.8
|
|
|
State
and local government agencies
|
|
|
10.8
|
|
|
|
6.4
|
|
|
|
11.2
|
|
|
|
5.8
|
|
|
Other
|
|
|
0.5
|
|
|
|
0.3
|
|
|
|
0.8
|
|
|
|
0.4
|
|
|
Total
contract revenue
|
|
$
|
170.1
|
|
|
|
100.0
|
%
|
|
$
|
194.0
|
|
|
|
100.0
|
%
|
|
|
|
|
(1)
|
Totals
may not add due to
rounding.
|
National
defense and intelligence agency revenues for the three and nine months ended
September 30, 2007 were lower than the comparable periods in 2006 primarily
due
to the transition into the new CAPS contract in August 2006 and the loss of
the
Air National Guard (“Guard”) contract in May 2006, partially offset by increased
revenues from the Naval Air System Command AIRSpeed sub-contract awarded in
March 2006. Approximately $7.1 million of the three month change and
$27.6 million of the nine month change resulted from the transition into the
new
CAPS contract and the loss of the Guard contract. Under the new CAPS contract
structure, work performed by other contractor team members on these programs,
which under the predecessor contract was passed through our revenue and cost
of
sales at a very low profit margin, is contracted directly between the Joint
Venture and the subcontractor and no longer is included in our financial
results.
On
July
2, 2007, the Joint Venture was notified that the U.S. Air Force contracting
officer for the CAPS contract had made a determination that it would no longer
be eligible to bid on further contract task orders, as
HMR
Tech
had graduated from the SBA 8(a) program in April 2007. The Joint
Venture unsuccessfully protested this determination with the SBA and with
the
Government Accountability Office. We are actively developing and
implementing alternate plans to retain our work. We believe through
the implementation of these plans we have successfully avoided any material
adverse effect on 2007 financial results. Current contract task orders, which
are subject to re-competition in 2008 and affected by this eligibility
determination, have an annual revenue value of approximately $17
million. Of this total we currently anticipate that we will not
re-compete for approximately $3 million of this work. Through our
alternative plans we are seeking to avoid further risk of revenue
reduction. However, the outcome is uncertain at this
time.
On
September 28, 2007, we sold our 40% interest in the Joint Venture back to the
Joint Venture. We continue to be a subcontractor to the Joint Venture
on existing contract task orders.
Revenues
from federal civilian agencies increased primarily due to added revenues from
the Federal Deposit Insurance Company contract awarded in November 2006,
partially offset by the loss of the IRS contract for which task orders ended
in
May 2006.
Revenues
from state and local government agencies decreased primarily due to lower
revenues from our contract with the State of Ohio, under which a significant
portion of the work has been completed, partially offset by higher revenues
from
our State of Colorado contract awarded in April 2006.
Revenues
by contract type as a percentage of Systems and Services revenues were as
follows:
|
|
|
Three
Months
Ended
|
|
|
Nine
Months
Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Time
and materials
|
|
|
59
|
%
|
|
|
64
|
%
|
|
|
57
|
%
|
|
|
62
|
%
|
|
Cost
reimbursable
|
|
|
21
|
|
|
|
17
|
|
|
|
22
|
|
|
|
19
|
|
|
Fixed
price, including service type contracts
|
|
|
20
|
|
|
|
19
|
|
|
|
21
|
|
|
|
19
|
|
|
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime
contract
|
|
|
54
|
%
|
|
|
67
|
%
|
|
|
55
|
%
|
|
|
68
|
%
|
|
Sub-contract
|
|
|
46
|
|
|
|
33
|
|
|
|
45
|
|
|
|
32
|
|
|
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
Product
Sales
Product
sales for our Metrigraphics segment were $1.1 million and $1.6 million in the
three months ended September 30, 2007 and 2006, respectively, and $3.0 million
and $4.6 million, respectively, in the nine months then ended. The
decrease from the prior year periods was primarily due to a decrease in medical
device sales. In October 2007, Metrigraphics was approved to begin production
shipments to a new medical device customer. We anticipate shipments
in the fourth quarter of 2007 will contribute to sequentially higher
revenues.
Funded
Backlog
Our
funded backlog was $98.6 million at September 30, 2007, $92.9 million at
December 31, 2006 and $97.9 million at September 30, 2006. We expect that
substantially all of our backlog will generate revenue during
the
subsequent
twelve month period. The funded backlog generally is subject to
possible termination at the convenience of the contracting party. Contracts
are
generally funded on an annual basis or incrementally for shorter time
periods. Due to current U.S. Government budgetary pressures, we have
seen an increase in the application of incremental funding, reducing backlog
in
proportion to revenue. A portion of our funded backlog is based on annual
purchase contracts and is subject to annual governmental approval or
appropriations legislation. The amount of funded backlog as of any
date can be affected by the timing of order receipts and
deliveries.
Gross
Profit
Total
gross profit was $9.3 million for the three months ended September 30, 2007,
compared to $8.2 million in the same period in 2006, resulting in a gross margin
of 16.0% and 13.0% for the third quarters of 2007 and 2006,
respectively. For the nine months ended September 30, 2007 and 2006,
the total gross profit was $27.4 million and $25.8 million, respectively,
resulting in a gross margin of 15.8% and 13.0%, respectively.
Our
gross
profit on contract revenue was $9.4 million and $7.8 million for the three
months ended September 30, 2007 and 2006, respectively, and $27.9 million and
$25.0 million for the respective nine months then ended. The increase in gross
profit resulted in a gross margin of 16.4% and 12.7% in the three months ended
September 30, 2007 and 2006, respectively, and 16.4% and 12.9% for the
respective nine months then ended. The increase in gross margin was primarily
attributable to the reduction in low margin subcontractor revenues resulting
from the transition to the new CAPS contract noted above. For both
the three and nine months ended September 30, 2007, a reduction of costs related
to administrative services funded by the Joint Venture and lower severance
cost
and stock-based compensation also contributed to the increase in gross profit,
compared to the same periods last year.
Our
gross
profit (loss) on product sales was $(0.1) million and $0.4 million for the
three
months ended September 30, 2007 and 2006, respectively, and $(0.6) million
and
$0.9 million for the respective nine months then ended. The decline
in gross profit was primarily attributable to the decline in medical device
sales.
Selling,
general and administrative
expenses
Selling,
general and administrative expenses were $5.3 million and $5.6 million in the
three months ended September 30, 2007 and 2006, respectively, and $16.6 million
and $18.2 million for the respective nine months then ended. Selling, general
and administrative expenses as a percent of total revenue in the three months
ended September 30, 2007 and 2006 was 9.0% and 8.8%, respectively, and 9.6%
and
9.2% for the respective nine months then ended. Selling, general and
administrative expenses were lower than the same periods in 2006 as a result
of
cost savings initiatives undertaken in the first half of 2006, which also
included higher severance costs. For both the three and nine months ended
September 30, 2007, a reduction of costs related to administrative services
funded by the Joint Venture also contributed to the decrease in selling, general
and administrative expenses, compared to the same periods last
year.
Amortization
of intangible
assets
Amortization
expense was $0.7 million in both the three months ended September 30, 2007
and
2006, and $2.0 million and $2.1 million for the respective nine months then
ended. Amortization expense primarily relates to intangible assets
acquired in our 2004 acquisition of Impact Innovations Group LLC and is included
in the Systems and Services segment. The remaining amortization expense for
the
current fiscal year will be approximately $0.7 million.
Interest
expense,
net
We
incurred interest expense of $0.4 million and $0.6 million in the three months
ended September 30, 2007 and 2006, respectively, and $1.3 million and $1.7
million for the respective nine months then ended. The decrease in interest
expense compared to the same periods in 2006 was primarily due to a lower
outstanding debt balance during
the
first
nine months of 2007, partially offset by a higher average interest rate during
the first nine months of 2007 compared to the same period in 2006.
Other
income (expense),
net
We
recorded net other income of $0.4 million in both the nine months ended
September 30, 2007 and 2006. The amount in 2006 included $0.2 million of
realized gains resulting from the sale of Lucent Technologies, Inc. (“Lucent”)
shares during that period. Other income includes recognition of
our portion of earnings in
HMR
Tech,
and in the
Joint Venture through September 28, 2007. Our earnings related to
these equity investments were $0.4 million and $0.2 million in the first nine
months of 2007 and 2006, respectively.
Income
tax
provision
We
recorded income tax provisions of $1.4 million, or 42.6% of pre-tax income,
and
$0.5 million, or 36.4% of pre-tax income, in the three months ended September
30, 2007 and 2006, respectively. The income tax provision for the
nine months ended September 30, 2007 and 2006 was $3.3 million, or 42.2% of
pre-tax income, and $1.7 million, or 41.2% of pre-tax income, respectively,
compared to 40.6% for the year ended December 31, 2006. The 2006 third quarter
and year-end tax rate reflects favorable state income tax audits and tax credits
and adjustments of tax accruals and reserves.
LIQUIDITY
AND CAPITAL
RESOURCES
The
following discussion analyzes liquidity and capital resources by operating,
investing and financing activities as presented in our Condensed Consolidated
Statements of Cash Flows. Our principal sources of liquidity are cash flows
from
operations and borrowings from our Revolver. At September 30, 2007, the
borrowing capacity available under our Revolver was $37.2
million.
Our
results of operations, cash flows and financial condition are subject to
certain
trends, events and uncertainties, including demands for capital to support
growth, economic conditions, government payment practices and contractual
matters. Our need for access to funds is dependent on future operating results,
our growth and acquisition activity and external conditions.
Based
upon our present business plan and operating performance, we believe that
cash
provided by operating activities, combined with amounts available for borrowing
under our revolving credit facility, will be adequate to fund the capital
requirements of our existing operations during 2007 and for the foreseeable
future. In the event that our current capital resources are not sufficient
to
fund requirements, we believe our access to additional capital resources
would
be sufficient to meet our needs. However, the development of adverse economic
or
business conditions could significantly affect the need for and availability
of
capital resources.
At
September 30, 2007 and December 31, 2006, we had cash and cash equivalents
aggregating $1.3 million and $7.9 million, respectively. The decrease in cash
and cash equivalents is the result of $3.2 million, $1.2 million and $2.2
million of net cash used in operating, financing and investing activities,
respectively.
Operating
activities
Net
cash
used in operating activities totaled $3.2 million in the first nine months
of
2007, compared to cash provided of $3.4 million in the first nine months of
2006. The cash used in 2007 was primarily attributable to an increase in
accounts receivable and a decrease in accounts payable, offset by a decrease
in
unbilled expenditures. The cash provided in 2006 was primarily
attributable to the collection of total receivables (including unbilled
expenditures); partially offset by a reduction in accounts payable and accrued
expenses and a contribution of $5.2 million during the third quarter to fund
the
pension plan.
Total
accounts receivable and unbilled expenditures combined were $66.9 million and
$64.3 million at September 30, 2007 and December 31, 2006, respectively. In
the
first nine months of 2007 accounts receivable increased $7.6 million while
unbilled expenditures decreased $5.0 million. Total accounts receivable
(including
unbilled
expenditures) days sales outstanding, or DSO, was 103 days at September 30,
2007, 105 days at June 30, 2007 and 96 days at December 31, 2006.
At
September 30, 2007, our receivables and unbilled expenditure balance for our
contract with the State of Ohio totaled $9.5 million, or 11 days, relatively
unchanged from December 31, 2006. Under the current terms of the contract,
this
amount is anticipated to be invoiced and collected in accordance with completion
of contract milestones.
The
increase in accounts receivable during the first nine months of 2007 was
primarily due to a $3.2 million receivable from the State of Ohio contract
and a
slowdown in cash collections on U.S. government receivables. We
consider the increase to be temporary with no increased risk of
collection.
Our
net
deferred tax liability was $5.1 million at September 30, 2007 compared to $8.4
million at December 31, 2006. The decrease in deferred taxes was
principally due to deferred taxes on unbilled receivables which declined to
$7.5
million at September 30, 2007 from $9.2 million at December 31,
2006. We paid $4.6 million in income taxes in the first nine months
of 2007 and currently anticipate additional income tax payments of $1.9 million
in the last quarter of 2007. The IRS continues to challenge the
deferral of income for tax purposes related to our unbilled receivables
including the applicability of a Letter Ruling issued by the IRS to us in
January 1976 which granted to us deferred tax treatment of our unbilled
receivables. This issue has been elevated to the IRS National Office
for determination. While the outcome of the audit of the 2004 income
tax return is not expected to be known for several months and remains uncertain,
we may incur interest expense, our deferred tax liabilities may be reduced
and
income tax payments may be increased substantially in future
periods.
Share-based
compensation expense was $1.2 million in the first nine months of 2007, compared
to $1.6 million in the same period in 2006. During the first quarter of 2006,
we
recorded a pre-tax cumulative benefit of accounting change of $0.1 million
related to the adoption of SFAS 123R for estimating forfeitures for restricted
stock awards that were unvested as of January 1, 2006. We anticipate
share-based compensation expense will remain at a comparable level through
the
remainder of 2007.
Non-cash
amortization expense of our acquired intangible assets was $2.0 million in
the
first nine months of 2007, compared to $2.1 million in the same period in 2006.
We anticipate that non-cash expense for the amortization of intangible assets
will remain at a comparable level through the remaining half of
2007.
Investing
activities
Net
cash
used in investing activities was $1.2 million and $1.7 million in the first
nine
months of 2007 and 2006, respectively. The net cash used in 2007 was primarily
comprised of capital expenditures aggregating $1.2 million. The net cash
used in
2006 was primarily comprised of capital expenditures aggregating $2.1 million,
partially offset by $0.2 million of proceeds from the sale of Lucent shares.
We
expect capital expenditures to be approximately $2 million in
2007.
We
believe that selective acquisitions of businesses are an important component
of
our growth strategy. We may acquire, from time to time, businesses that are
aligned with our core capabilities and which complement our customer base.
We
will continue to consider acquisition opportunities that align with our
strategic objectives, along with the possibility of utilizing our credit
facility as a source of financing.
Financing
activities
Net
cash
used in financing activities was $2.2 million and $2.1 million in the first
nine
months of 2007 and 2006, respectively. The amount of cash used in 2007
represents net repayments under our revolving credit agreement of $3.3 million,
partially offset by $1.0 million of proceeds from the issuance of common stock
through the exercises of stock options and employee stock purchase plan
transactions. The amount of cash used in 2006 represents principal
payments under the then existing acquisition loan of $25.4 million, partially
offset by $21.7 million of net borrowings under our then existing revolving
credit agreement and $1.6 million of proceeds from the issuance of common stock
through the exercises of stock options and employee stock purchase plan
transactions.
The
average daily borrowing on our Revolver for the first nine months of 2007 was
$19.1 million at a weighted average interest rate of 7.45%, compared to an
average daily borrowing of $7.3 million at a weighted average interest rate
of
7.86% under our then existing revolver in the first nine months of
2006. Also, at September 30, 2006 our average daily outstanding
balance under our then existing acquisition term loan was $19.7 million at
a
weighted average interest rate of 6.87%. At September 30, 2007, the
outstanding balance of the Revolver was $11.7 million with a weighted average
interest rate of 7.24%.
RECENT
ACCOUNTING
PRONOUNCEMENTS
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities - Including an amendment of FASB
Statement No. 115”, (“SFAS 159”). SFAS 159 permits entities to choose
to measure many financial instruments and certain other items at fair value.
The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently without having to apply complex
hedge
accounting provisions. SFAS 159 is effective for our fiscal year beginning
January 1, 2008. We are currently evaluating whether we will elect the option
provided for in SFAS 159, and whether the adoption will have an impact of on
our
financial statements.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”
(“SFAS 157”). SFAS 157 clarifies the principle that fair value should be based
on the assumptions market participants would use when pricing an asset or
liability and establishes a fair value hierarchy that prioritizes the
information used to develop those assumptions. Under SFAS 157, fair value
measurements would be separately disclosed by level within the fair value
hierarchy. SFAS 157 is effective for our fiscal year beginning January 1, 2008,
with early adoption permitted. We are currently evaluating whether the adoption
of SFAS 157 will have a material impact on our financial
statements.