UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
(Mark
One)
R
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF
1934
|
FOR THE QUARTERLY PERIOD ENDED
SEPTEMBER 30, 2008
OR
£
|
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF
1934
|
FOR THE TRANSITION PERIOD
FROM _______
TO ________
Commission
file number 000-02479
DYNAMICS
RESEARCH CORPORATION
(Exact
name of registrant as specified in its charter)
MASSACHUSETTS
|
04-2211809
|
(State
or other jurisdiction of Incorporation or organization)
|
(I.R.S.
Employer Identification No.)
|
60
FRONTAGE ROAD, ANDOVER, MASSACHUSETTS 01810-5498
(Address
of principal executive offices) (Zip Code)
978-289-1500
(Registrant’s
telephone number, including area code)
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
R
No
£
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.
Large
accelerated filer
£
|
Accelerated
filer
R
|
Non-accelerated
filer
£
(Do not
check if a smaller reporting company)
|
Smaller
reporting company
£
|
Indicate
by check mark whether the registrant is a shell Company (as defined in Rule
12b-2 of the Exchange Act). Yes
£
No
R
As of
October 31, 2008, there were 9,662,930 shares of the registrant’s common stock
outstanding.
FORM
10-Q
For
the Quarterly Period Ended September 30, 2008
Table
of Contents
|
|
Page
|
Part I.
Financial Information
|
Item
1.
|
|
|
|
|
3
|
|
|
4
|
|
|
5
|
|
|
6
|
|
|
7
|
|
|
8
|
Item
2.
|
|
21
|
Item
3.
|
|
29
|
Item
4.
|
|
30
|
Part
II. Other Information
|
|
Item
1.
|
|
30
|
Item
1A.
|
|
30
|
Item
2.
|
|
31
|
Item
6.
|
|
31
|
FORWARD-LOOKING
STATEMENTS
Some of
the statements under “Management’s Discussion and Analysis of Financial
Condition and Results of Operations”, and elsewhere in this Quarterly Report on
Form 10-Q (“Form 10-Q”), contain “forward-looking statements” within the meaning
of the Private Securities Litigation Reform Act of 1995, regarding future events
and the future results of Dynamics Research Corporation (“DRC”) that are based
on current expectations, estimates, forecasts, and projections about the
industries in which DRC operates and the beliefs and assumptions of the
management of DRC. Words such as “anticipates”, “believes”,
“estimates”, “expects”, “intends”, “plans”, “projects”, “may”, “will”, “should”,
and other similar expressions are intended to identify these forward-looking
statements. These forward-looking statements are predictions of
future events or trends and are not statements of historical
matters. These statements are based on current expectations and
beliefs of DRC and involve a number of risks, uncertainties, and assumptions
that are difficult to predict. Therefore, actual results may differ
materially and adversely from those expressed in any forward-looking
statements. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date of this
document or in the case of the statements incorporated by reference, the date of
those statements. Factors that might cause or contribute to any
differences include, but are not limited to, those discussed in DRC’s Annual
Report on Form 10-K for the year ended December 31, 2007 under the section
entitled “Risk Factors”. Except to the extent required by applicable
law or regulation, DRC undertakes no obligation to revise or update publicly any
forward-looking statements for any reason.
PART
I. FINANCIAL
INFORMATION
Item
1. FINANCIAL STATEMENTS
DYNAMICS
RESEARCH CORPORATION
CONDENSED
CONSOLIDATED BALANCE SHEETS (unaudited)
(dollars
in thousands, except share data)
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
Assets
|
|
|
|
|
|
|
Current
assets
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
10,818
|
|
|
$
|
2,006
|
|
Contract
receivables, net
|
|
|
67,649
|
|
|
|
63,570
|
|
Prepaid
expenses and other current assets
|
|
|
6,332
|
|
|
|
2,508
|
|
Total
current assets
|
|
|
84,799
|
|
|
|
68,084
|
|
Noncurrent
assets
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
9,818
|
|
|
|
10,182
|
|
Goodwill
|
|
|
94,826
|
|
|
|
63,055
|
|
Intangible
assets, net
|
|
|
6,232
|
|
|
|
3,069
|
|
Deferred
tax asset
|
|
|
1,182
|
|
|
|
1,484
|
|
Other
noncurrent assets
|
|
|
4,915
|
|
|
|
4,079
|
|
Total
noncurrent assets
|
|
|
116,973
|
|
|
|
81,869
|
|
Total
assets
|
|
$
|
201,772
|
|
|
$
|
149,953
|
|
Liabilities
and stockholders' equity
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
|
|
|
|
Current
portion of long-term debt
|
|
$
|
8,000
|
|
|
$
|
-
|
|
Accounts
payable
|
|
|
18,472
|
|
|
|
12,163
|
|
Accrued
compensation and employee benefits
|
|
|
15,932
|
|
|
|
13,409
|
|
Deferred
taxes
|
|
|
7,605
|
|
|
|
8,486
|
|
Other
accrued expenses
|
|
|
18,408
|
|
|
|
3,078
|
|
Total
current liabilities
|
|
|
68,417
|
|
|
|
37,136
|
|
Long-term
liabilities
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
|
32,000
|
|
|
|
7,737
|
|
Other
long-term liabilities
|
|
|
7,615
|
|
|
|
8,576
|
|
Total
long-term liabilities
|
|
|
39,615
|
|
|
|
16,313
|
|
Total
liabilities
|
|
|
108,032
|
|
|
|
53,449
|
|
Commitments
and contingencies (Note 14)
|
|
|
|
|
|
|
|
|
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; 9,636,130 and
9,509,849 shares issued and outstanding at September 30, 2008 and December
31, 2007, respectively
|
|
|
964
|
|
|
|
951
|
|
Capital
in excess of par value
|
|
|
51,495
|
|
|
|
50,251
|
|
Accumulated
other comprehensive loss
|
|
|
(6,907
|
)
|
|
|
(6,745
|
)
|
Retained
earnings
|
|
|
48,188
|
|
|
|
52,047
|
|
Total
stockholders' equity
|
|
|
93,740
|
|
|
|
96,504
|
|
Total
liabilities and stockholders' equity
|
|
$
|
201,772
|
|
|
$
|
149,953
|
|
The
accompanying notes are an integral part of these condensed consolidated
finanical statements.
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(dollars
in thousands, except share and per share data)
|
|
Three
Months Ended
|
|
|
Nine
months Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Contract
revenue
|
|
$
|
62,300
|
|
|
$
|
57,180
|
|
|
$
|
170,781
|
|
|
$
|
170,122
|
|
Product
sales
|
|
|
1,191
|
|
|
|
1,148
|
|
|
|
4,481
|
|
|
|
2,996
|
|
Total
revenue
|
|
|
63,491
|
|
|
|
58,328
|
|
|
|
175,262
|
|
|
|
173,118
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of contract revenue
|
|
|
52,256
|
|
|
|
47,808
|
|
|
|
144,067
|
|
|
|
142,201
|
|
Cost
of product sales
|
|
|
1,271
|
|
|
|
1,212
|
|
|
|
4,269
|
|
|
|
3,560
|
|
Total
cost of revenue
|
|
|
53,527
|
|
|
|
49,020
|
|
|
|
148,336
|
|
|
|
145,761
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit on contract revenue
|
|
|
10,044
|
|
|
|
9,372
|
|
|
|
26,714
|
|
|
|
27,921
|
|
Gross
profit (loss) on product sales
|
|
|
(80
|
)
|
|
|
(64
|
)
|
|
|
212
|
|
|
|
(564
|
)
|
Total
gross profit
|
|
|
9,964
|
|
|
|
9,308
|
|
|
|
26,926
|
|
|
|
27,357
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative expenses
|
|
|
5,529
|
|
|
|
5,262
|
|
|
|
16,077
|
|
|
|
16,623
|
|
Provision
for litigation
|
|
|
6,000
|
|
|
|
-
|
|
|
|
14,819
|
|
|
|
181
|
|
Amortization
of intangible assets
|
|
|
718
|
|
|
|
650
|
|
|
|
1,737
|
|
|
|
1,951
|
|
Operating
income (loss)
|
|
|
(2,283
|
)
|
|
|
3,396
|
|
|
|
(5,707
|
)
|
|
|
8,602
|
|
Interest
expense, net
|
|
|
(424
|
)
|
|
|
(373
|
)
|
|
|
(705
|
)
|
|
|
(1,302
|
)
|
Other
income, net
|
|
|
39
|
|
|
|
323
|
|
|
|
207
|
|
|
|
578
|
|
Income
(loss) before provision for income taxes
|
|
|
(2,668
|
)
|
|
|
3,346
|
|
|
|
(6,205
|
)
|
|
|
7,878
|
|
Provision
(benefit) for income taxes
|
|
|
(2,436
|
)
|
|
|
1,427
|
|
|
|
(2,346
|
)
|
|
|
3,322
|
|
Net
income (loss)
|
|
$
|
(232
|
)
|
|
$
|
1,919
|
|
|
$
|
(3,859
|
)
|
|
$
|
4,556
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
(loss) per common share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.02
|
)
|
|
$
|
0.21
|
|
|
$
|
(0.41
|
)
|
|
$
|
0.49
|
|
Diluted
|
|
$
|
(0.02
|
)
|
|
$
|
0.20
|
|
|
$
|
(0.41
|
)
|
|
$
|
0.47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
9,487,155
|
|
|
|
9,354,332
|
|
|
|
9,471,420
|
|
|
|
9,326,367
|
|
Diluted
|
|
|
9,487,155
|
|
|
|
9,702,910
|
|
|
|
9,471,420
|
|
|
|
9,644,760
|
|
The
accompanying notes are an integral part of these condensed consolidated
finanical statements.
CONDENSED
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE
INCOME (LOSS)
FOR
THE THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007 (unaudited)
(in
thousands)
|
|
|
|
|
|
|
|
Capital
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in
Excess
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
of
Par
|
|
|
Comprehensive
|
|
|
Retained
|
|
|
|
|
|
|
Shares
|
|
|
Par value
|
|
|
Value
|
|
|
Loss
|
|
|
Earnings
|
|
|
Total
|
|
Balance
at June 30, 2008
|
|
|
9,562
|
|
|
$
|
956
|
|
|
$
|
50,995
|
|
|
$
|
(6,853
|
)
|
|
$
|
48,420
|
|
|
$
|
93,518
|
|
Comprehensive
loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(232
|
)
|
|
|
(232
|
)
|
Other
comprehensive loss, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
loss on derivative instruments
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(54
|
)
|
|
|
-
|
|
|
|
(54
|
)
|
Comprehensive
loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(286
|
)
|
Issuance
of common stock through stock option exercises and employee stock purchase
plan transactions
|
|
|
41
|
|
|
|
4
|
|
|
|
243
|
|
|
|
-
|
|
|
|
-
|
|
|
|
247
|
|
Issuance
of restricted stock
|
|
|
38
|
|
|
|
4
|
|
|
|
(4
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeiture
of restricted stock
|
|
|
(5
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Release
of restricted stock
|
|
|
-
|
|
|
|
-
|
|
|
|
(2
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(2
|
)
|
Share-based
compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
219
|
|
|
|
-
|
|
|
|
-
|
|
|
|
219
|
|
Tax
benefit from stock options exercised and employee stock purchase plan
transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
44
|
|
|
|
-
|
|
|
|
-
|
|
|
|
44
|
|
Balance
at September 30, 2008
|
|
|
9,636
|
|
|
$
|
964
|
|
|
$
|
51,495
|
|
|
$
|
(6,907
|
)
|
|
$
|
48,188
|
|
|
$
|
93,740
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in
Excess
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
of
Par
|
|
|
Comprehensive
|
|
|
Retained
|
|
|
|
|
|
|
|
Shares
|
|
|
Par value
|
|
|
Value
|
|
|
Loss
|
|
|
Earnings
|
|
|
Total
|
|
Balance
at June 30, 2007
|
|
|
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 option exercises 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
|
|
|
-
|
|
|
|
-
|
|
|
|
434
|
|
|
|
-
|
|
|
|
-
|
|
|
|
434
|
|
Tax
benefit from stock options exercised and employee stock purchase plan
transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
9
|
|
|
|
-
|
|
|
|
-
|
|
|
|
9
|
|
Balance
at September 30, 2007
|
|
|
9,488
|
|
|
$
|
949
|
|
|
$
|
49,736
|
|
|
$
|
(9,206
|
)
|
|
$
|
49,501
|
|
|
$
|
90,980
|
|
The
accompanying notes are an integral part of these condensed consolidated
finanical statements.
CONDENSED
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE
INCOME (LOSS)
FOR
THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007 (unaudited)
(in
thousands)
|
|
|
|
|
|
|
|
Capital
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in
Excess
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
of
Par
|
|
|
Comprehensive
|
|
|
Retained
|
|
|
|
|
|
|
Shares
|
|
|
Par value
|
|
|
Value
|
|
|
Loss
|
|
|
Earnings
|
|
|
Total
|
|
Balance
at December 31, 2007
|
|
|
9,510
|
|
|
$
|
951
|
|
|
$
|
50,251
|
|
|
$
|
(6,745
|
)
|
|
$
|
52,047
|
|
|
$
|
96,504
|
|
Comprehensive
loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(3,859
|
)
|
|
|
(3,859
|
)
|
Other
comprehensive loss, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reclassification
adjustment for gain on sale of investment included in net loss, net of
taxes
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(108
|
)
|
|
|
-
|
|
|
|
(108
|
)
|
Unrealized
loss on derivative instruments
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(54
|
)
|
|
|
-
|
|
|
|
(54
|
)
|
Comprehensive
loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(4,021
|
)
|
Issuance
of common stock through stock option exercises and employee stock purchase
plan transactions
|
|
|
91
|
|
|
|
9
|
|
|
|
652
|
|
|
|
-
|
|
|
|
-
|
|
|
|
661
|
|
Issuance
of restricted stock
|
|
|
86
|
|
|
|
9
|
|
|
|
(9
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeiture
of restricted stock
|
|
|
(10
|
)
|
|
|
(1
|
)
|
|
|
1
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Release
of restricted stock
|
|
|
(41
|
)
|
|
|
(4
|
)
|
|
|
(412
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(416
|
)
|
Share-based
compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
943
|
|
|
|
-
|
|
|
|
-
|
|
|
|
943
|
|
Tax
benefit from stock options exercised and employee stock purchase plan
transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
69
|
|
|
|
-
|
|
|
|
-
|
|
|
|
69
|
|
Balance
at September 30, 2008
|
|
|
9,636
|
|
|
$
|
964
|
|
|
$
|
51,495
|
|
|
$
|
(6,907
|
)
|
|
$
|
48,188
|
|
|
$
|
93,740
|
|
|
|
|
|
|
|
|
|
|
|
Capital
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in
Excess
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
of
Par
|
|
|
Comprehensive
|
|
|
Retained
|
|
|
|
|
|
|
|
Shares
|
|
|
Par value
|
|
|
Value
|
|
|
Loss
|
|
|
Earnings
|
|
|
Total
|
|
Balance
at December 31, 2006
|
|
|
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 option exercises 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
|
|
|
-
|
|
|
|
-
|
|
|
|
1,237
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,237
|
|
Tax
benefit from stock options exercised and employee stock purchase plan
transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
72
|
|
|
|
-
|
|
|
|
-
|
|
|
|
72
|
|
Balance
at September 30, 2007
|
|
|
9,488
|
|
|
$
|
949
|
|
|
$
|
49,736
|
|
|
$
|
(9,206
|
)
|
|
$
|
49,501
|
|
|
$
|
90,980
|
|
The
accompanying notes are an integral part of these condensed consolidated
finanical statements.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(dollars
in thousands)
|
|
Nine
months Ended
|
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(3,859
|
)
|
|
$
|
4,556
|
|
Adjustments
to reconcile net cash provided by (used in) operating
activities:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
2,187
|
|
|
|
2,294
|
|
Amortization
of intangible assets
|
|
|
1,737
|
|
|
|
1,951
|
|
Share-based
compensation
|
|
|
943
|
|
|
|
1,237
|
|
Investment
income from equity interest
|
|
|
(411
|
)
|
|
|
(380
|
)
|
Tax
benefit from stock options exercised and employee stock purchase plan
transactions
|
|
|
(69
|
)
|
|
|
(72
|
)
|
Provision
for litigation
|
|
|
14,819
|
|
|
|
181
|
|
Deferred
income taxes
|
|
|
(473
|
)
|
|
|
(3,289
|
)
|
Other
|
|
|
(516
|
)
|
|
|
(397
|
)
|
Change
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Contract
receivables, net
|
|
|
4,950
|
|
|
|
(2,609
|
)
|
Prepaid
expenses and other current assets
|
|
|
(3,867
|
)
|
|
|
(610
|
)
|
Accounts
payable
|
|
|
4,189
|
|
|
|
(5,135
|
)
|
Accrued
compensation and employee benefits
|
|
|
783
|
|
|
|
254
|
|
Other
accrued expenses
|
|
|
192
|
|
|
|
(544
|
)
|
Other
long-term liabilities
|
|
|
(544
|
)
|
|
|
(664
|
)
|
Net
cash provided by (used in) operating activities
|
|
|
20,061
|
|
|
|
(3,227
|
)
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Purchase
of business, net of cash acquired
|
|
|
(42,436
|
)
|
|
|
-
|
|
Additions
to property and equipment
|
|
|
(1,509
|
)
|
|
|
(1,185
|
)
|
Proceeds
from sale of investments and long-lived assets
|
|
|
280
|
|
|
|
4
|
|
Dividends
from equity investment
|
|
|
411
|
|
|
|
174
|
|
Payments
related to the sale of building
|
|
|
(35
|
)
|
|
|
-
|
|
Increase
in other assets
|
|
|
(489
|
)
|
|
|
(144
|
)
|
Net
cash used in investing activities
|
|
|
(43,778
|
)
|
|
|
(1,151
|
)
|
Cash
flow from financing activities:
|
|
|
|
|
|
|
|
|
Borrowings
under term loan and revolving credit agreement
|
|
|
109,225
|
|
|
|
158,825
|
|
Repayments
under revolving credit agreement
|
|
|
(76,962
|
)
|
|
|
(162,077
|
)
|
Proceeds
from the exercise of stock options and employee stock purchase plan
transactions
|
|
|
661
|
|
|
|
994
|
|
Tax
benefit from stock options exercised and employee stock purchase plan
transactions
|
|
|
69
|
|
|
|
72
|
|
Payments
of deferred financing costs
|
|
|
(464
|
)
|
|
|
-
|
|
Net
cash provided by (used in) financing activities
|
|
|
32,529
|
|
|
|
(2,186
|
)
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
8,812
|
|
|
|
(6,564
|
)
|
Cash
and cash equivalents, beginning of period
|
|
|
2,006
|
|
|
|
7,887
|
|
Cash
and cash equivalents, end of period
|
|
$
|
10,818
|
|
|
$
|
1,323
|
|
The
accompanying notes are an integral part of these condensed consolidated
finanical statements.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
NOTE
1. BASIS OF PRESENTATION
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 August
1, 2008, the Company completed the acquisition of all membership interest of
Kadix Systems, LLC (“Kadix”) as more fully described in Note 3. The
transaction was recorded using the purchase method of accounting in accordance
with Financial Accounting Standards Board (“FASB”) Statement of Financial
Accounting Standards (“SFAS”) No. 141,
Business
Combinations
. Accordingly, the results of Kadix are included
in the Company’s Condensed Consolidated Statements of Operations and Cash Flows
for the period subsequent to its acquisition.
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, 2008 may not be indicative of the results
that may be expected for the year ending December 31, 2008. 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, 2007. The Company has reclassified certain prior period
amounts to conform with the current period presentation.
NOTE 2. RECENT ACCOUNTING
PRONOUNCEMENTS
In March
2008, the FASB issued SFAS No. 161,
Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133
(“SFAS 161”). SFAS 161 expands the disclosure requirements in Statement
133 about an entity's derivative instruments and hedging activities. SFAS 161 is
effective for financial statements issued for fiscal years and interim periods
beginning after November 15, 2008. The Company is currently evaluating the
impact of adopting FAS 161.
In April
2008, the FASB issued FASB Staff Position 142-3,
Determination of the Useful Life of
Intangible Assets
(“FSP FAS 142-3”), which amends the factors to be
considered in renewal or extension assumptions used to determine the useful life
of a recognized intangible asset. FSP FAS 142-3 is effective for
interim periods and fiscal years beginning after December 15,
2008. The Company will adopt FSP FAS 142-3 effective January 1,
2009. The Company is currently assessing the impact of FSP FAS 142-3
on its financial statements.
In
December 2007, the FASB issued SFAS No. 141(R),
Business Combinations
(“SFAS
141(R)”), which amends SFAS No. 141, and provides revised guidance for
recognizing and measuring identifiable assets and goodwill acquired, liabilities
assumed, and any non-controlling interest in an acquired entity. It also
provides disclosure requirements to enable users of the financial statements to
evaluate the nature and financial effects of the business combination. SFAS
141(R) is effective for fiscal years beginning after December 15, 2008 and
is to be applied prospectively. SFAS 141(R) will have an impact on
accounting for business combinations once adopted but the effect is dependent
upon acquisitions at that time.
In
December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in
Consolidated Financial Statements—An Amendment of ARB No. 51
(“SFAS
160”). SFAS 160 establishes new accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. SFAS 160 is effective for fiscal years beginning on or after
December 15, 2008 and early adoption is prohibited. The Company does not
currently expect the adoption of SFAS 160 to have a material impact on its
consolidated financial statements.
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
NOTE
3. BUSINESS ACQUISITION
On August
1, 2008, the Company completed the acquisition of Kadix for
$42.4 million in cash, subject to certain adjustments typical for a
transaction of this type, with the potential for additional consideration of up
to $5 million, based on achievement of certain conditions, as more fully
described in the Member Interest Purchase Agreement, dated July 30, 2008 filed
in our Current Report on Form 8-K on August 5, 2008. For tax
purposes, the transaction will be treated as an asset purchase resulting in tax
benefits to the Company, which has an estimated value of $14.5
million. Kadix maintains practice specialties in organizational
change, human capital, information technology and public and environmental
health. As a part of the Company’s System and Services segment, Kadix
is focused on the U.S. Department of Homeland Security (“DHS”), Marine Corps
information technology, military medical health, and federal civilian
markets. On August 1, 2008, Kadix had approximately 270 employees and
is headquartered in Arlington, VA with additional offices in greater Washington,
DC and Aberdeen, MD. The acquisition strengthens and
expands the Company’s growth as a provider of high-end services and solutions in
the DHS and other federal civilian markets.
The
purchase price associated with the Kadix acquisition is as follows:
Cash
consideration
|
|
$
|
45,130
|
|
Transaction
costs
|
|
|
408
|
|
Purchase
price
|
|
|
45,538
|
|
Cash
acquired
|
|
|
(3,102
|
)
|
Purchase
price, net of cash acquired
|
|
$
|
42,436
|
|
The
preliminary purchase price allocation associated with the Kadix acquisition is
as follows:
Current
assets, net of cash acquired
|
|
$
|
9,320
|
|
Property
and equipment
|
|
|
316
|
|
Current
liabilities
|
|
|
(3,867
|
)
|
Long-term
liabilities
|
|
|
(4
|
)
|
Goodwill
and other intangible assets
|
|
|
36,671
|
|
Total
purchase price allocation
|
|
$
|
42,436
|
|
|
|
|
|
|
amortization
|
|
|
|
|
|
|
life
(years)
|
|
Customer
contracts
|
|
$
|
3,500
|
|
|
|
5
|
|
Non-compete
agreement
|
|
|
1,400
|
|
|
|
3
|
|
Goodwill
|
|
|
31,771
|
|
|
|
-
|
|
Total
goodwill and other intangible assets
|
|
$
|
36,671
|
|
|
|
|
|
The
Company's purchase price has been preliminarily allocated based upon an
independent appraisal. The Company believes it has sufficient information to
finalize the purchase price allocation but requires additional time to complete
the analysis. As a result, the allocation of purchase price to
customer contracts and relationships could be higher than the preliminary
estimate.
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
The
following pro forma results of operations for the three and nine month periods
ended September 30, 2008 and 2007 have been prepared as though the
acquisition of Kadix had occurred on January 1, 2007. These pro forma
results include adjustments for interest expense and amortization of deferred
financing costs on the acquisition term loan used to finance the transaction,
amortization expense for the identifiable intangible asset determined in the
preliminary independent appraisal and the effect of income taxes. These pro
forma results do not include certain nonrecurring costs Kadix paid at the
closing of the sale, including the payout for Kadix’ Phantom Unit Plan and
Ownership Appreciations Rights participants, professional fees related to the
acquisition and discretionary bonuses. This pro forma information
does not purport to be indicative of the results of operations that would have
been attained had the acquisition been made as of January 1, 2007, or of
results of operations that may occur in the future.
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Revenue
|
|
$
|
67,626
|
|
|
$
|
64,451
|
|
|
$
|
200,006
|
|
|
$
|
189,247
|
|
Gross
profit
|
|
$
|
11,377
|
|
|
$
|
11,336
|
|
|
$
|
36,050
|
|
|
$
|
32,967
|
|
Operating
income (loss)
|
|
$
|
(1,761
|
)
|
|
$
|
3,580
|
|
|
$
|
(1,329
|
)
|
|
$
|
9,044
|
|
Net
income (loss)
|
|
$
|
(117
|
)
|
|
$
|
1,271
|
|
|
$
|
(2,800
|
)
|
|
$
|
2,615
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
(loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.01
|
)
|
|
$
|
0.14
|
|
|
$
|
(0.30
|
)
|
|
$
|
0.28
|
|
Diluted
|
|
$
|
(0.01
|
)
|
|
$
|
0.13
|
|
|
$
|
(0.30
|
)
|
|
$
|
0.27
|
|
NOTE 4. SUPPLEMENTAL BALANCE SHEET
INFORMATION
The
composition of selected balance sheet accounts is as follows:
|
|
September
30,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
Contract
receivables, net
|
|
|
|
|
|
|
Billed
receivables
|
|
$
|
34,837
|
|
|
$
|
31,884
|
|
Unbilled
receivables
(1)
:
|
|
|
|
|
|
|
|
|
Revenues
recorded in excess of milestone billings on fixed price contracts with the
State of Ohio and State of Tennessee
|
|
|
8,797
|
|
|
|
7,572
|
|
Retainages
and fee withholdings
|
|
|
1,272
|
|
|
|
1,529
|
|
Other
unbilled receivables
|
|
|
23,736
|
|
|
|
23,488
|
|
Total
unbilled receivables
|
|
|
33,805
|
|
|
|
32,589
|
|
Allowance
for doubtful accounts
|
|
|
(993
|
)
|
|
|
(903
|
)
|
Contract
receivables, net
|
|
$
|
67,649
|
|
|
$
|
63,570
|
|
|
|
|
|
|
|
|
|
|
Prepaid
expenses and other current assets:
|
|
|
|
|
|
|
|
|
Refundable
income taxes
|
|
$
|
3,794
|
|
|
$
|
-
|
|
Inventory
|
|
|
736
|
|
|
|
584
|
|
Restricted
cash
|
|
|
152
|
|
|
|
-
|
|
Investments
available for sale
|
|
|
-
|
|
|
|
334
|
|
Other
|
|
|
1,650
|
|
|
|
1,590
|
|
Prepaid
expenses and other current assets
|
|
$
|
6,332
|
|
|
$
|
2,508
|
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net:
|
|
|
|
|
|
|
|
|
Production
equipment
|
|
$
|
11,942
|
|
|
$
|
11,917
|
|
Software
|
|
|
11,512
|
|
|
|
11,052
|
|
Furniture
and other equipment
|
|
|
7,730
|
|
|
|
6,862
|
|
Leasehold
improvements
|
|
|
2,845
|
|
|
|
2,375
|
|
Property
and equipment
|
|
|
34,029
|
|
|
|
32,206
|
|
Less
accumulated depreciation
|
|
|
(24,211
|
)
|
|
|
(22,024
|
)
|
Property
and equipment, net
|
|
$
|
9,818
|
|
|
$
|
10,182
|
|
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
|
|
September
30,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
Other
noncurrent assets:
|
|
|
|
|
|
|
Prepaid
pension asset
|
|
$
|
1,618
|
|
|
$
|
718
|
|
Deferred
compensation plan investments
|
|
|
1,352
|
|
|
|
1,747
|
|
Equity
investment
|
|
|
1,119
|
|
|
|
1,119
|
|
Other
|
|
|
826
|
|
|
|
495
|
|
Other
noncurrent assets
|
|
$
|
4,915
|
|
|
$
|
4,079
|
|
|
|
|
|
|
|
|
|
|
Accrued
compensation and employee benefits:
|
|
|
|
|
|
|
|
|
Accrued
payroll and payroll taxes
|
|
$
|
7,490
|
|
|
$
|
6,967
|
|
Accrued
vacation
|
|
|
4,907
|
|
|
|
4,273
|
|
Accrued
employee exit costs
(2)
|
|
|
330
|
|
|
|
-
|
|
Other
|
|
|
3,205
|
|
|
|
2,169
|
|
Accrued
compensation and employee benefits
|
|
$
|
15,932
|
|
|
$
|
13,409
|
|
|
|
|
|
|
|
|
|
|
Other
accrued expenses:
|
|
|
|
|
|
|
|
|
Accrued
litigation reserve
|
|
$
|
15,000
|
|
|
$
|
181
|
|
Deferred
gain on sale of building
|
|
|
676
|
|
|
|
676
|
|
Accrued
income taxes
|
|
|
-
|
|
|
|
585
|
|
Other
|
|
|
2,732
|
|
|
|
1,636
|
|
Other
accrued expenses
|
|
$
|
18,408
|
|
|
$
|
3,078
|
|
|
|
|
|
|
|
|
|
|
Other
long-term liabilities:
|
|
|
|
|
|
|
|
|
Deferred
gain on sale of building, net
|
|
$
|
4,226
|
|
|
$
|
4,733
|
|
Deferred
compensation plan liability
|
|
|
1,352
|
|
|
|
1,747
|
|
Other
|
|
|
2,037
|
|
|
|
2,096
|
|
Other
long-term liabilities
|
|
$
|
7,615
|
|
|
$
|
8,576
|
|
(1)
|
Contract
receivables are classified as current assets in accordance with industry
practice. At September 30, 2008 and December 31, 2007, $657 and
$553, respectively, of unbilled retainages and fee withholdings are not
anticipated to be billed within twelve months. Additionally, at
September 30, 2008, $1,930 of the unbilled balance under the Company’s
contract with the State of Tennessee is not scheduled to be invoiced
within one year.
|
(2)
|
During
the first half of 2008, the Company learned that its work on the Navy’s
Trident Missile program would be curtailed significantly in the second
half of 2008. During the second quarter of 2008, the Company
recorded an initial provision of $736 which was included in cost of
contract revenue. During the third quarter of 2008, the Company
recorded an additional provision of $17. The Company has paid out $423 of
benefits resulting in a balance of $330 at September 30,
2008.
|
NOTE 5. GOODWILL AND INTANGIBLE
ASSETS
Components
of the Company’s identifiable intangible assets are as follows:
|
|
September
30, 2008
|
|
|
December 31,
2007
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
Cost
|
|
|
Amortization
|
|
|
Net
|
|
|
Cost
|
|
|
Amortization
|
|
|
Net
|
|
Customer
relationships
|
|
$
|
12,800
|
|
|
$
|
(11,259
|
)
|
|
$
|
1,541
|
|
|
$
|
12,800
|
|
|
$
|
(9,731
|
)
|
|
$
|
3,069
|
|
Customer
contracts
|
|
|
3,500
|
|
|
|
(209
|
)
|
|
|
3,291
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Non-competition
agreements
|
|
|
1,400
|
|
|
|
-
|
|
|
|
1,400
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
17,700
|
|
|
$
|
(11,468
|
)
|
|
$
|
6,232
|
|
|
$
|
12,800
|
|
|
$
|
(9,731
|
)
|
|
$
|
3,069
|
|
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
The
Company recorded amortization expense for its identifiable intangible assets of
$718 and $650 for the three months ended September 30, 2008 and 2007,
respectively, and $1,737 and $1,951 for the nine month period then ended,
respectively. Estimated amortization expense, excluding the impact of
a potential change in intangible assets resulting from completion of the
purchase price allocation in connection with the Kadix acquisition (see Note 3),
on the Company’s identifiable intangible assets for the remainder of the current
year and each of the five subsequent years is as follows:
Remainder
of 2008
|
|
$
|
823
|
|
2009
|
|
$
|
3,093
|
|
2010
|
|
$
|
1,245
|
|
2011
|
|
$
|
879
|
|
2012
|
|
$
|
186
|
|
2013
|
|
$
|
6
|
|
The
change of $31,771 in the carrying amount of goodwill for the nine months ended
September 30, 2008 related to the acquisition of Kadix and is included in
the Company’s System and Services business segment.
NOTE
6. INCOME TAXES
For the
nine months ended September 30, 2008, the effective income tax rate excluding
the $14,819 litigation provision was 39.6%. The Company has estimated
the tax benefit associated with the litigation provision at $5,757 or 38.8% of
such provision. The effective income tax rate for the comparable
prior year period excluding the $181 litigation provision recorded in the nine
months ended September 30, 2007 was 42.1%. The pool of excess tax
benefits has been depleted and as a result any future SFAS 123(R) tax
deficiencies will be recorded directly to earnings.
As of
September 30, 2008 the Company had $557 of unrecognized tax benefits, of which
$194 would affect its effective tax rate if recognized. Accrued penalties and
interest were $154 at September 30, 2008.
The
Internal Revenue Service (“IRS”) is currently examining 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 was elevated to the IRS National Office for
determination. On October 23, 2008, the Company received a
notification of ruling from the IRS National Office. This
correspondence provided clarification regarding the IRS position relating to
revenue recognition for unbilled receivables. The Company is in the
process of evaluating the impact of this recent notification. As a
result, the Company may incur interest expense, penalties and its deferred tax
liabilities may be adjusted and income tax payments may be increased in future
periods.
The
Company files income tax returns in the U.S. federal jurisdiction and numerous
state jurisdictions. Tax returns for all years after 2004 are subject
to future examination by state and local tax authorities. Currently
the 2004 federal return is still under audit.
NOTE 7. FINANCING
ARRANGEMENTS
Credit
Facility
On August
1, 2008, the Company entered into a new unsecured credit facility (the
“facility”) with its bank group to restructure and increase the Company’s credit
facility to $65.0 million, which matures on August 1, 2013. The facility
provides for a $40.0 million, five-year term loan (the “term loan”) and a
$25.0 million, five-year revolving credit agreement for working capital
(the “revolver”). The bank group, led by Brown Brothers Harriman & Co. as a
lender and as administrative agent, also includes TD Bank, N.A. and Bank of
America, N.A. The term loan and the revolver replace the Company’s previous
$50.0 million revolving credit agreement, which was entered into on
September 29, 2006.
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
On an
ongoing basis, the facility requires the Company to meet certain financial
covenants, including maintaining a minimum net worth and certain cash flow and
debt coverage ratios. The covenants also limit the Company’s ability to incur
additional debt, pay dividends, purchase capital assets, sell or dispose of
assets, make additional acquisitions or investments, or enter into new leases,
among other restrictions. In addition, the facility provides that the bank group
may accelerate payment of all unpaid principal and all accrued and unpaid
interest under the facility, upon the occurrence and continuance of certain
events of default, including, among others, the following:
|
•
|
Any
failure by the Company and its subsidiaries to make any payment of
principal, interest and other sums due under the facility within three
calendar days of the date when such payment is
due;
|
|
•
|
Any
breach by the Company or any of its subsidiaries of certain covenants,
representations and warranties;
|
|
•
|
Any
default and acceleration of any indebtedness owed by the Company or any of
its subsidiaries to any person (other than the bank group) which is in
excess of $1.0 million;
|
|
•
|
Any
final judgment against the Company or any of its subsidiaries in excess of
$1.0 million which has not been insured to the reasonable satisfaction of
Brown Brothers as administrative
agent;
|
|
•
|
Any
bankruptcy (voluntary or involuntary) of the Company or any of its
subsidiaries;
|
|
•
|
Any
material adverse change in the business or financial condition of the
Company and its subsidiaries; or
|
|
•
|
Any
change in control of the Company.
|
At
September 30, 2008 the Company was not in compliance with its net profit
covenant. On November 10, 2008, the Company received a waiver for
non-compliance with the net profit covenant test due to the net loss recorded
during the third quarter. The Company is also in the process of
amending the credit facility to exclude the provision for litigation recorded in
the third quarter of 2008 from the net profit covenant test.
The
Company used the $40 million term loan proceeds to fund the acquisition
of Kadix. The facility requires quarterly principal payments on the term
loan of $2 million, commencing December 31, 2008. The Company has the
option of selecting an interest rate for the term loan equal to either: (a) the
then applicable LIBOR rate plus 1.50% per annum to 2.50% per annum, depending on
the Company’s most recently reported leverage ratio (currently 2.00%); or (b)
the base rate as announced from time to time by the administrative agent plus
0.00% per annum to 0.25% per annum, depending on the Company’s most recently
reported leverage ratio (currently 0.00%). For those portions of the term loan
accruing at the LIBOR rate, the Company has the option of selecting interest
periods of 30, 60, 90 or 180 days. The facility also required the Company,
within thirty days of the closing date, to secure interest rate protection in an
amount not less than fifty percent of the outstanding principal balance of the
term loan, as more fully described in Note 8.
The
revolver has a five-year term and is available to the Company for general
corporate purposes, including strategic acquisitions. The Company used $4.8
million of the revolver to complete the acquisition of Kadix. The interest rate
terms on the revolver are similar to those of the term
loan.
The terms
of the facility are more fully described in the Fourth Amended and Restated Loan
Agreement, dated August 1, 2008, by and among the Company, all of the
subsidiaries of the Company, Brown Brothers, TD Bank and Bank of America as
filed in our Current Report on Form 8-K on August 5, 2008.
Outstanding
Debt
The
Company’s outstanding debt at September 30, 2008 was $40.0 million which
consisted of borrowings under the term loan. The interest rate on the
outstanding balance at September 30, 2008 was 4.81% based on the 90-day LIBOR
rate option that was in effect on September 5, 2008. The outstanding
debt at December 31, 2007 was $7,737 which consisted of net borrowings under the
Company’s previous $50 million revolving credit facility. The interest rate on
$5,000 of the outstanding balance at December 31, 2007 was 6.34% based on the
60-day LIBOR rate option elected on December 31, 2007. The interest
rate on the remaining $2,737 outstanding balance at December 31, 2007 was 7.25%
based on a base rate option that was in effect on December 31,
2007. Borrowings under the revolver at December 31, 2007 have
been classified as a long-term liability. The repayment of borrowings
under the revolver is contractually due on August 1, 2013; however, the Company
may repay at any time prior to that date. At September 30, 2008, the
remaining available balance to borrow against the revolver was $25.0
million.
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
As noted
above, the facility requires quarterly principal payments on the term loan of $2
million, commencing December 31, 2008. The Company’s contractual
obligations for principal payments on the term loan is $2 million at December
31, 2008, $8 million in each year ending December 31, 2009 through 2012 and $6
million in the year ending December 31, 2013. However, the Company
has the option to prepay principal at anytime during the term of the
facility.
NOTE
8. DERIVATIVE FINANCIAL INSTRUMENTS
The
Company accounts for its derivative financial instruments in accordance with
SFAS No. 133,
Accounting for
Derivative Instruments and Hedging Activities
. The Company
recognizes derivatives as either an asset or liability measured at its fair
value. For derivatives that have been formally designated as a cash
flow hedge, the effective portion of changes in the fair value of the
derivatives are recorded in accumulated other comprehensive income
(loss). Amounts in accumulated other comprehensive income (loss) are
reclassified into earnings when interest expense on the underlying borrowings is
recognized.
The
Company has entered into an interest rate swap agreement to manage its exposure
to interest rate changes. The swap effectively converts a portion of
the Company’s variable rate debt under the term loan to a fixed rate, without
exchanging the notional principal amounts. The Company does not enter into
financial instruments for trading or speculative purposes.
If, at
any time, the swap is determined to be ineffective, in whole or in part, due to
changes in the interest rate swap or underlying debt agreements, the fair value
of the portion of the swap determined to be ineffective will be recognized as a
gain or loss in the statement of operations for the applicable
period.
In
September 2008, the Company entered into an interest rate swap agreement with an
initial notional amount of $20.0 million of the term loan principal
and matures on August 1, 2013. Under this agreement, the
Company receives a floating rate based on the 90-day LIBOR rate and pays a fixed
rate of 3.60% (both excluding the applicable margin of 2.00%) on the outstanding
notional amount. The swap fixed rate was based on a 90-day LIBOR rate and is
structured to mirror the payment terms of the term loan. The fair
value of the swap at inception was zero. It is not expected that any
gains or losses will be reported in the statement of operations during the term
of the agreement as the swap is assumed to be highly effective through its
maturity based on the matching terms of the swap and facility
agreements.
As of
September 30, 2008, the total notional amount committed to the swap agreement
was $20.0 million. On that date, the floating rate of a loan based on a 90-day
LIBOR rate was 4.05%. The Company recorded a liability of $89 to recognize the
fair value of swap and recorded a respective tax asset of $35. The
net offset is recorded in accumulated other comprehensive income
(loss).
NOTE
9. FAIR VALUE MEASUREMENTS
Effective
January 1, 2008, the Company adopted SFAS No. 157,
Fair Value Measurements
, for
its financial assets and liabilities. SFAS No. 157 establishes a new
framework for measuring fair value and expands disclosure requirements. SFAS
No. 157 defines fair value as the price that would be received to sell an
asset, or paid to transfer a liability, in an orderly transaction between market
participants.
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
SFAS
No. 157’s valuation techniques are based on observable or unobservable
inputs. Observable inputs reflect market data obtained from independent sources,
while unobservable inputs reflect the Company’s market assumptions. These two
types of inputs have created the following fair value hierarchy:
|
•
|
Level
1 — Quoted prices for identical instruments in active
markets.
|
|
•
|
Level
2 — Quoted prices for similar instruments in active markets; quoted prices
for identical or similar instruments in markets that are not active; and
model-derived valuations in which significant value drivers are
observable.
|
|
•
|
Level
3 — Valuations derived from valuation techniques in which significant
value drivers are unobservable.
|
The
Company’s swap is valued using Level 2 inputs. As of September 30,
2008, the decrease in the fair value of the Company’s swap was $89.
NOTE 10. DEFINED BENEFIT PENSION
PLAN
The
components of net periodic benefit income for the Company’s defined benefit
pension plan are as follows:
|
|
Three
Months Ended
|
|
|
Nine
months Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Interest
cost on projected benefit obligation
|
|
$
|
959
|
|
|
$
|
1,006
|
|
|
$
|
2,877
|
|
|
$
|
3,018
|
|
Expected
return on plan assets
|
|
|
(1,396
|
)
|
|
|
(1,464
|
)
|
|
|
(4,188
|
)
|
|
|
(4,391
|
)
|
Recognized
actuarial loss
|
|
|
137
|
|
|
|
270
|
|
|
|
411
|
|
|
|
810
|
|
Net
periodic pension income
|
|
$
|
(300
|
)
|
|
$
|
(188
|
)
|
|
$
|
(900
|
)
|
|
$
|
(563
|
)
|
The
Company will adopt the measurement date provisions of SFAS 158,
Employers’
Accounting for Defined Benefit
Pension and Other Postretirement Plans – an amendment of FASB Statements
No. 87, 88, 106, and 132(R),
on December 31, 2008, using the
alternative transition method. In lieu of re-measuring plan assets at the
beginning of 2008, the alternative transition method allows the use of the
November 30, 2007 measurement date with net periodic benefit income for the
period from December 1, 2007 to December 31, 2008 allocated
proportionately between an adjustment of retained earnings (for the period from
December 1, 2007 to December 31, 2007) and net periodic benefit income
for 2008 (for the period from January 1, 2008 to December 31, 2008).
The impact of using the alternative transition method is expected to result in a
positive adjustment of approximately $100 to retained earnings and net periodic
benefit income is anticipated to be approximately $1,200 for fiscal year
2008.
At
September 30, 2008, the market value of the plan assets was $55.3 million, a
decline of $12.8 million since December 31, 2007. In accordance with
SFAS No. 87 and SFAS No. 158, at December 31, 2008, the Company will likely be
required to record an increase in unfunded plan liabilities and charge
accumulated other comprehensive income, a component of shareholders’ equity, to
reflect an increase in the plan
’
s unfunded
status.
NOTE 11. SHARE-BASED
COMPENSATION
Share-Based
Compensation Costs
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,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Cost
of products and services
|
|
$
|
102
|
|
|
$
|
166
|
|
|
$
|
398
|
|
|
$
|
446
|
|
Selling,
general and administrative
|
|
|
117
|
|
|
|
268
|
|
|
|
545
|
|
|
|
791
|
|
Total
share-based compensation expense
|
|
$
|
219
|
|
|
$
|
434
|
|
|
$
|
943
|
|
|
$
|
1,237
|
|
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
Stock
Option Award Activity
The
following table summarizes stock option activity under all
plans:
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Contractual
|
|
|
Aggregate
|
|
|
|
Number
of
|
|
|
Exercise
|
|
|
Term
|
|
|
Intrinsic
|
|
|
|
Shares
|
|
|
Price
|
|
|
(in years)
|
|
|
Value
|
|
Outstanding
at December 31, 2007
|
|
|
1,012,078
|
|
|
$
|
8.34
|
|
|
|
3.0
|
|
|
$
|
3,030
|
|
Granted
|
|
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(56,117
|
)
|
|
$
|
6.02
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
(35,753
|
)
|
|
$
|
10.78
|
|
|
|
|
|
|
|
|
|
Outstanding
and exercisable at September 30, 2008
|
|
|
920,208
|
|
|
$
|
8.39
|
|
|
|
2.3
|
|
|
$
|
711
|
|
Cash
proceeds received, the intrinsic value and the total tax benefits realized
resulting from stock option exercises were as follows:
|
|
Three
Months Ended
|
|
|
Nine
months Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Amounts
realized or received from stock option exercises:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
proceeds received
|
|
$
|
152
|
|
|
$
|
83
|
|
|
$
|
338
|
|
|
$
|
504
|
|
Intrinsic
value realized
|
|
$
|
112
|
|
|
$
|
38
|
|
|
$
|
182
|
|
|
$
|
257
|
|
Income
tax benefit realized
|
|
$
|
44
|
|
|
$
|
7
|
|
|
$
|
68
|
|
|
$
|
65
|
|
The total
income tax benefit realized from exercised stock options and Employee Stock
Purchase Plan transactions for the nine months ended September 30, 2008 and 2007
was $69 and $72, respectively. These amounts were reported as a
financing cash inflow with a corresponding operating cash outflow in the
accompanying Condensed Consolidated Statement of Cash Flows. At
December 31, 2007, the remaining pool of excess tax benefits was depleted and as
a result any future SFAS 123(R) tax deficiencies will be recorded directly to
earnings. All stock options granted fully vested prior to or during the second
quarter of 2008, and therefore there was no unrecognized compensation cost
related to stock options as of September 30, 2008.
Restricted
Stock Award Activity
The
following table summarizes restricted stock activity under the Company’s 2000
Incentive Plan:
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
Number
of
|
|
|
Grant-Date
|
|
|
|
Shares
|
|
|
Fair Value
|
|
Nonvested
at December 31, 2007
|
|
|
223,330
|
|
|
$
|
11.43
|
|
Granted
|
|
|
85,500
|
|
|
$
|
9.67
|
|
Vested
|
|
|
(140,303
|
)
|
|
$
|
11.04
|
|
Cancelled
|
|
|
(9,850
|
)
|
|
$
|
12.10
|
|
Nonvested
at September 30, 2008
|
|
|
158,677
|
|
|
$
|
10.79
|
|
The total
fair value of restricted shares vested during the three months ended September
30, 2008 and 2007 was $65 and $53, respectively, and $1,549 and $1,018,
respectively, during the nine months then ended. During the second quarter of
2008, 77,000 shares vested that were issued in May 2001 under the Company’s 2001
Executive Long-term Incentive Plan. As of September 30, 2008, the
total unrecognized compensation cost related to restricted stock awards was
$1,319, which is expected to be amortized over a weighted-average period of
approximately 2.1 years.
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
NOTE 12. STOCKHOLDERS’
EQUITY
Earnings
(Loss) Per Share
For the
three and nine months ended September 30, 2008 and 2007, basic earnings (loss)
per share are computed by dividing net income (loss) by the weighted average
number of shares of common stock outstanding during the period. Unexercised
stock options and unvested restricted shares are excluded from this calculation
but are included in the diluted earnings per share calculation using the
treasury stock method so long as their effect is not anti-dilutive.
For the
three and nine months ended September 30, 2007, diluted earnings per share are
determined by using the weighted average number of common and dilutive common
equivalent shares outstanding during the period. For the three and
nine months ended September 30, 2008, the dilutive effect of stock options and
restricted stock grants of approximately 269,400 and 330,800 shares,
respectively, were not included in the computation of diluted loss per share as
the net loss would have made their effect anti-dilutive.
Due to
the anti-dilutive effect, approximately 76,500 and 81,500 options to purchase
common stock were excluded from the calculation of diluted earnings per share
for the three and nine months ended September 30, 2007,
respectively. Approximately 73,500 options to purchase common stock
were excluded from the calculation of diluted earnings per share for the three
and nine months ended September 30, 2008.
The
following table illustrates the reconciliation of the weighted average shares
outstanding:
|
|
Three
Months Ended
|
|
|
Nine
months Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Weighted
average shares outstanding - Basic
|
|
|
9,487,155
|
|
|
|
9,354,332
|
|
|
|
9,471,420
|
|
|
|
9,326,367
|
|
Dilutive
effect of stock options and restricted stock grants
|
|
|
-
|
|
|
|
348,578
|
|
|
|
-
|
|
|
|
318,393
|
|
Weighted
average shares outstanding - Diluted
|
|
|
9,487,155
|
|
|
|
9,702,910
|
|
|
|
9,471,420
|
|
|
|
9,644,760
|
|
Comprehensive
Income (Loss)
Comprehensive
income (loss) for the three and nine months ended September 30, 2008 consisted
of a net loss of $232 and $3,859, respectively, and an unrealized loss of $54,
net of tax of $35, related to the change in fair value on the swap
agreement. Comprehensive income (loss) for the nine months ended
September 30, 2008 also included a reclassification adjustment for gains
realized in net income of $108, net of tax expense of
$71. Comprehensive income for the three and nine months ended
September 30, 2007 of $1,919 and $4,556, respectively, consisted solely of net
income.
Preferred
Stock Rights Agreement
On June
5, 2008, the Board of Directors of the Company approved a shareholder Rights
Agreement, subject to finalization of price, which was approved by the Board on
July 23, 2008 at $59.09 per one one-hundredth of a Preferred
Share. The Rights replaced preferred share purchase rights which were
attached to common shares (the “Old Rights”), that expired on July 27,
2008. The Old Rights were issued pursuant to a Rights Agreement,
dated as of February 17, 1998, as amended, between the Company and the Rights
Agent. Subsequent to July 27, 2008, the Old Rights were no further in
force or effect.
On July
23, 2008, the Board of Directors of the Company authorized and declared a
dividend distribution of one right (a “Right”) for each outstanding share of the
Company’s common stock, par value $0.10 per share to stockholders of record at
the close of business on such date. Each Right entitles the registered holder to
purchase from the Company one-hundredth of a share of Series B Preferred Stock,
par value $.10 per share, of the Company (the “Preferred Stock”), at a price of
$59.09 per one one-hundredth of a Preferred Share, subject to
adjustment. The definitive terms of the Rights are set forth in a
Rights Agreement, dated as of July 23, 2008, between the Company and American
Stock Transfer & Trust Company, LLC, as Rights Agent.
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
The
Rights become exercisable upon the earlier of the following events: (i) 10 days
following a public announcement that a person or group of affiliated or
associated persons have acquired beneficial ownership of 15% or more of the
outstanding Common Stock or (ii) 10 business days (or such later date as may be
determined by action of the Board of Directors of the Company prior to such time
as any person or group of affiliated or associated persons becomes an acquiring
person) following the commencement of, or announcement of an intention to make,
a tender offer or exchange offer the consummation of which would result in the
beneficial ownership by a person or group of 15% or more of the outstanding
Common Stock (the earlier of such dates being the distribution date). The
Rights will expire on July 27, 2018.
The terms
of the Rights Agreement are more fully described in the Current Report on Form
8-K filed on July 25, 2008.
NOTE 13. 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,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Revenues
from external customers
|
|
|
|
|
|
|
|
|
|
|
|
|
Systems
and Services
|
|
$
|
62,300
|
|
|
$
|
57,180
|
|
|
$
|
170,781
|
|
|
$
|
170,122
|
|
Metrigraphics
|
|
|
1,191
|
|
|
|
1,148
|
|
|
|
4,481
|
|
|
|
2,996
|
|
|
|
$
|
63,491
|
|
|
$
|
58,328
|
|
|
$
|
175,262
|
|
|
$
|
173,118
|
|
Gross
margin (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Systems
and Services
|
|
$
|
10,044
|
|
|
$
|
9,372
|
|
|
$
|
26,714
|
|
|
$
|
27,921
|
|
Metrigraphics
|
|
|
(80
|
)
|
|
|
(64
|
)
|
|
|
212
|
|
|
|
(564
|
)
|
|
|
$
|
9,964
|
|
|
$
|
9,308
|
|
|
$
|
26,926
|
|
|
$
|
27,357
|
|
Operating
income (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Systems
and Services
|
|
$
|
(1,963
|
)
|
|
$
|
3,722
|
|
|
$
|
(5,049
|
)
|
|
$
|
9,879
|
|
Metrigraphics
|
|
|
(320
|
)
|
|
|
(326
|
)
|
|
|
(658
|
)
|
|
|
(1,277
|
)
|
|
|
$
|
(2,283
|
)
|
|
$
|
3,396
|
|
|
$
|
(5,707
|
)
|
|
$
|
8,602
|
|
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 ranged between 63% and 67% of total
revenues in the three and nine months ended September 30, 2008, and were 78% of
total revenue for the three and nine months ended September 30,
2007. Revenues earned from the U.S. Air Force Aeronautical Systems
Center (“ASC”) during the three and nine months ended September 30, 2007 were
$5,840, or 10% of total revenue, and $19,546, or 11% of total revenue,
respectively. No other customers in the three or nine months ended
September 30, 2007 accounted for more than 10% of revenue. The
Company had no customer in the three or nine months ended September 30, 2008
that accounted for more than 10% of revenues. The outstanding
contract receivable balance of the State of Ohio as of December 31, 2007 was
$7,572. No other customers accounted for more than 10% of the
outstanding contract receivable balance.
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. The Company,
through HJ Ford, also had a 40% ownership interest in
HMR
Tech/HJ
Ford SBA JV, LLC (the “Joint Venture”) formed with
HMR
Tech. Revenues from
HMR
Tech
included in contract revenues for the three months ended September 30, 2008 and
2007 were $0, and $97, respectively, and $31 and $287, respectively, for the
nine months then ended. The amounts due from
HMR
Tech
included in contract receivables at September 30, 2008 and December 31, 2007
were $1 and $52, respectively.
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
In
September 2007, the Company sold its 40% interest in the Joint Venture back to
the Joint Venture. The Company received $4 in proceeds from the
transaction, representing the Company’s original investment in the Joint
Venture. The Joint Venture, which had been formed under the SBA
Mentor-Protégé program, was accounted for using the equity method of
accounting. The Company continues to be a subcontractor to the Joint
Venture on existing Consolidated Acquisition and Professional Services (“CAPS”)
contract task orders until such task orders are completed. Revenues recognized
by the Company as a subcontractor to the Joint Venture for the three months
ended September 30, 2008 and 2007 were $199 and $5,767, respectively, and $4,455
and $16,431, respectively, for the nine months then ended.
Through
September 2007, the Company provided the Joint Venture with various
administrative services under the terms of a Services
Agreement. Charges by the Company for these administrative services
to the Joint Venture 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 charges
HMR
Tech
for administrative services at 2.8% of revenues derived from the CAPS
contract. Revenues under this arrangement were $11 and $225 in the
three and nine months ended September 30, 2008, respectively.
The table
below presents the various amounts included in the accompanying balance sheets
related to the above mentioned transactions with the Joint Venture:
|
|
September
30,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
Contract
receivables, net
|
|
$
|
1,216
|
|
|
$
|
4,486
|
|
Other
receivables, net
|
|
$
|
-
|
|
|
$
|
314
|
|
NOTE 14. 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,
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 those 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 federal government 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 has asserted three claims against the Company. On March 31,
2008, the Court issued a Memorandum on Summary Judgment Motion granting summary
judgment in favor of the Government on the breach of contract, False Claims Act
and Anti-Kickback Act claims but, due to substantial disputed facts, denied
summary judgment on damages. Regarding the alleged actual damages,
the Company believes that it has substantive defenses. On March 31,
2008, the Company recognized an estimated liability for all claims related to
this matter in the amount of $9 million. Prior to a scheduled
September 3, 2008 status conference on the amount of damages alleged by the
Government, the Government and the Company agreed to attempt to mediate their
differing positions on such alleged damages. The Company and the Government
have reached an agreement on principal settlement terms, including a settlement
amount of $15 million and, accordingly. The Company increased it's accrued
litigation reserve from $9 million to $15 million during the quarter ended
September 30, 2008. The Company and the Government are working to
complete the settlement agreement which is expected to be finalized in
2008.
DYNAMICS
RESEARCH CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars
in thousands, except per share amounts)
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 arbitration before the
American Arbitration Association, asserting the same claims as they asserted in
the District Court. 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 U.S. Court of Appeals on November 19, 2007 concurred with the District
Court’s opinion that the matter should proceed in arbitration and remanded the
matter to the District Court. The parties have informed the District
Court that they will proceed in arbitration as a class action. In the
arbitration, the Company has filed a Motion to Dismiss and/or for Summary
Disposition, asserting that the Company is entitled to use the “window of
correction” provided by the Fair Labor Standards Act’s regulations and that the
arbitration should be dismissed without further action in the
arbitration. The motion is under consideration and the arbitrator has
requested oral argument by the parties.
|
MANGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
|
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.
The
following discussion also contains non-GAAP financial measures. In evaluating
our operating performance, management uses certain non-GAAP financial measures
to supplement the consolidated financial statements prepared under generally
accepted accounting principles in the United States (“GAAP”).
More
specifically, we use the following non-GAAP financial measures: non-GAAP
operating profit, non-GAAP income before income taxes, non-GAAP provision for
income taxes, non-GAAP net income and non-GAAP earnings per
share.
Management
believes these non-GAAP measures help indicate our operating performance before
charges that are considered by management to be outside our ongoing operating
results. Accordingly, management uses these non-GAAP measures to gain a better
understanding of our comparative operating performance from period-to-period and
as a basis for planning and forecasting future periods. Management believes
these non-GAAP measures, when read in conjunction with our GAAP financials,
provide useful information to investors by offering:
|
•
|
the ability to make more
meaningful period-to-period comparisons of our ongoing operating
results;
|
|
•
|
the ability to better identify
trends in our underlying business and perform related trend
analysis;
|
|
•
|
a higher degree of transparency
for certain expenses (particularly when a specific charge impacts multiple
line items);
|
|
•
|
a better understanding of how
management plans and measures our underlying business;
and
|
|
•
|
an easier way to compare our most
recent results of operations against investor and analyst financial
models.
|
The
non-GAAP measures we use exclude the provision for litigation charge and its
related tax effect that management believes is unusual and outside of our
ongoing operations for the periods presented.
These
non-GAAP measures have limitations, however, because they do not include all
items of expense that impact our operations. Management compensates for these
limitations by also considering our GAAP results. The non-GAAP financial
measures we use are not prepared in accordance with, and should not be
considered an alternative to, measurements required by GAAP, such as operating
loss, net loss and loss per share, and should not be considered measures of our
liquidity. The presentation of this additional information is not meant to be
considered in isolation or as a substitute for the most directly comparable GAAP
measures. In addition, these non-GAAP financial measures may not be comparable
to similar measures reported by other companies.
OVERVIEW
Dynamics
Research Corporation, headquartered in Andover, Massachusetts, is a leading,
innovative provider of solutions and services to federal, state and local
governments. We provide support to our customers in the primary
mission areas of IT, Logistics and Readiness, Systems Integration and Technical
Services, C4ISR (Command, Control, Computers, Communication, Intelligence,
Surveillance and Reconnaissance), Homeland Security, Health and Human Services
and Intelligence/Space.
On August
1, 2008, DRC completed the acquisition of Kadix as more fully described in
Note 3 of our Notes to Condensed Consolidated Financial
Statements. The acquisition strengthens and expands our growth as a
provider of high-end services and solutions in the homeland security and other
federal civilian markets. The operating results of Kadix are included
in DRC’s results of operations within the Systems and Services segment for the
period subsequent to the acquisition date.
We are
cognizant of funding challenges facing the federal government and the resulting
increase in competitiveness in our industry. 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 advisory and assistance services and often
is setting this work aside for small businesses. Concurrently, there is
increasing demand from federal customers for engineering, training, business
transformation, lean six sigma, information technology and business intelligence
solutions and services. 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 (loss) for the three months ended September 30, 2008 and 2007 was $(2.3)
million and $3.4 million, respectively. Excluding the provision for
litigation, operating income for the three months ended September 30, 2008 was
$3.7 million and the operating margin was 5.9% of total revenue, compared to
5.8% of total revenue for the three months ended September 30,
2007.
Operating
income (loss) for the nine months ended September 30, 2008 and 2007 was $(5.7)
million and $8.6 million, respectively. Excluding the provision for
litigation, operating income for the nine month periods ended September 30, 2008
and 2007 was $9.1 million and $8.8 million, respectively, and the operating
margin was 5.2% and 5.1% of total revenue, respectively.
RECONCILIATION
OF NON-GAAP MEASURES
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
(in
millions)
|
|
$
(1)
|
|
|
%
(2)
|
|
|
$
(1)
|
|
|
%
(2)
|
|
GAAP
operating income (loss)
|
|
$
|
(2.3
|
)
|
|
|
(3.6
|
)%
|
|
$
|
3.4
|
|
|
|
5.8
|
%
|
Provision
for litigation
|
|
|
6.0
|
|
|
|
9.5
|
%
|
|
|
-
|
|
|
|
-
|
|
Non-GAAP
operating income
|
|
$
|
3.7
|
|
|
|
5.9
|
%
|
|
$
|
3.4
|
|
|
|
5.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP
income (loss) before provision for income taxes
|
|
$
|
(2.7
|
)
|
|
|
(4.2
|
)%
|
|
$
|
3.3
|
|
|
|
5.7
|
%
|
Provision
for litigation
|
|
|
6.0
|
|
|
|
9.5
|
%
|
|
|
-
|
|
|
|
-
|
|
Non-GAAP
income before provision for income taxes
|
|
$
|
3.3
|
|
|
|
5.2
|
%
|
|
$
|
3.3
|
|
|
|
5.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP
provision (benefit) for income taxes
(3)
|
|
$
|
(2.4
|
)
|
|
|
91.3
|
%
|
|
$
|
1.4
|
|
|
|
42.6
|
%
|
Tax
benefit for provision for litigation
(3)
|
|
|
3.6
|
|
|
|
60.6
|
%
|
|
|
-
|
|
|
|
-
|
|
Non-GAAP
provision for income taxes
(3)
|
|
$
|
1.2
|
|
|
|
35.9
|
%
|
|
$
|
1.4
|
|
|
|
42.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP
net income (loss)
|
|
$
|
(0.2
|
)
|
|
|
(0.4
|
)%
|
|
$
|
1.9
|
|
|
|
3.3
|
%
|
Provision
for litigation, net of tax benefit
|
|
|
2.4
|
|
|
|
3.7
|
%
|
|
|
-
|
|
|
|
-
|
|
Non-GAAP
net income
|
|
$
|
2.1
|
|
|
|
3.4
|
%
|
|
$
|
1.9
|
|
|
|
3.3
|
%
|
|
|
Nine
Months Ended
|
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
(in
millions)
|
|
$
(1)
|
|
|
%
(2)
|
|
|
$
(1)
|
|
|
%
(2)
|
|
GAAP
operating income (loss)
|
|
$
|
(5.7
|
)
|
|
|
(3.3
|
)%
|
|
$
|
8.6
|
|
|
|
5.0
|
%
|
Provision
for litigation
|
|
|
14.8
|
|
|
|
8.5
|
%
|
|
|
0.2
|
|
|
|
0.1
|
%
|
Non-GAAP
operating income
|
|
$
|
9.1
|
|
|
|
5.2
|
%
|
|
$
|
8.8
|
|
|
|
5.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP
income (loss) before provision for income taxes
|
|
$
|
(6.2
|
)
|
|
|
(3.5
|
)%
|
|
$
|
7.9
|
|
|
|
4.6
|
%
|
Provision
for litigation
|
|
|
14.8
|
|
|
|
8.5
|
%
|
|
|
0.2
|
|
|
|
0.1
|
%
|
Non-GAAP
income before provision for income taxes
|
|
$
|
8.6
|
|
|
|
4.9
|
%
|
|
$
|
8.1
|
|
|
|
4.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP
provision (benefit) for income taxes
(3)
|
|
$
|
(2.3
|
)
|
|
|
37.8
|
%
|
|
$
|
3.3
|
|
|
|
42.2
|
%
|
Tax
benefit for provision for litigation
(3)
|
|
|
5.8
|
|
|
|
38.8
|
%
|
|
|
0.1
|
|
|
|
39.8
|
%
|
Non-GAAP
provision for income taxes
(3)
|
|
$
|
3.4
|
|
|
|
39.6
|
%
|
|
$
|
3.4
|
|
|
|
42.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GAAP
net income (loss)
|
|
$
|
(3.9
|
)
|
|
|
(2.2
|
)%
|
|
$
|
4.6
|
|
|
|
2.6
|
%
|
Provision
for litigation, net of tax benefit
|
|
|
9.1
|
|
|
|
5.2
|
%
|
|
|
0.1
|
|
|
|
0.1
|
%
|
Non-GAAP
net income
|
|
$
|
5.2
|
|
|
|
3.0
|
%
|
|
$
|
4.7
|
|
|
|
2.7
|
%
|
(1)
|
Totals
may not add due to rounding.
|
(2)
|
Represents
a percentage of total revenue of $175.3 million and $173.1 million in the
nine months ended September 30, 2008 and 2007, excluding the percentages
for provision for income taxes and the tax benefit for provision for
litigation.
|
(3)
|
The
percent amounts represent a percentage of GAAP income (loss) before
provision for income taxes, provision for litigation and non-GAAP income
before provision for income taxes,
respectively.
|
We have
two reportable business segments: Systems and Services and Metrigraphics. The
Systems and Services segment accounted for approximately 97% of total revenue
and the Metrigraphics segment accounted for approximately 3% of total revenue
for the nine months ended September 30, 2008.
RESULTS
OF OPERATIONS
Operating
results expressed as a percentage of segment and total revenue are as
follows:
|
|
Three
Months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
(in
millions)
|
|
$
(1)
|
|
|
%
|
|
|
$
(1)
|
|
|
%
|
|
Contract
revenue
|
|
$
|
62.3
|
|
|
|
98.1
|
%
|
|
$
|
57.2
|
|
|
|
98.0
|
%
|
Product
sales
|
|
|
1.2
|
|
|
|
1.9
|
|
|
|
1.1
|
|
|
|
2.0
|
|
Total
revenue
|
|
$
|
63.5
|
|
|
|
100.0
|
%
|
|
$
|
58.3
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit on contract revenue
(2)
|
|
$
|
10.0
|
|
|
|
16.1
|
%
|
|
$
|
9.4
|
|
|
|
16.4
|
%
|
Gross
profit (loss) on product sales
(2)
|
|
|
(0.1
|
)
|
|
|
(6.7
|
)%
|
|
|
(0.1
|
)
|
|
|
(5.6
|
)%
|
Total
gross profit
(2)
|
|
|
10.0
|
|
|
|
15.7
|
%
|
|
|
9.3
|
|
|
|
16.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
5.5
|
|
|
|
8.7
|
%
|
|
|
5.3
|
|
|
|
9.0
|
%
|
Provision
for litigation
|
|
|
6.0
|
|
|
|
9.5
|
%
|
|
|
-
|
|
|
|
-
|
|
Amortization
of intangible assets
|
|
|
0.7
|
|
|
|
1.1
|
%
|
|
|
0.7
|
|
|
|
1.1
|
%
|
Operating
income
|
|
|
(2.3
|
)
|
|
|
(3.6
|
)%
|
|
|
3.4
|
|
|
|
5.8
|
%
|
Interest
expense, net
|
|
|
(0.4
|
)
|
|
|
(0.7
|
)%
|
|
|
(0.4
|
)
|
|
|
(0.6
|
)%
|
Other
income, net
|
|
|
0.0
|
|
|
|
0.1
|
%
|
|
|
0.3
|
|
|
|
0.6
|
%
|
Provision
(benefit) for income taxes
(3)
|
|
|
(2.4
|
)
|
|
|
91.3
|
%
|
|
|
1.4
|
|
|
|
42.6
|
%
|
Net
income
|
|
$
|
(0.2
|
)
|
|
|
(0.4
|
)%
|
|
$
|
1.9
|
|
|
|
3.3
|
%
|
|
|
Nine
months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
(in
millions)
|
|
$
(1)
|
|
|
%
|
|
|
$
(1)
|
|
|
%
|
|
Contract
revenue
|
|
$
|
170.8
|
|
|
|
97.4
|
%
|
|
$
|
170.1
|
|
|
|
98.3
|
%
|
Product
sales
|
|
|
4.5
|
|
|
|
2.6
|
|
|
|
3.0
|
|
|
|
1.7
|
|
Total
revenue
|
|
$
|
175.3
|
|
|
|
100.0
|
%
|
|
$
|
173.1
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit on contract revenue
(2)
|
|
$
|
26.7
|
|
|
|
15.6
|
%
|
|
$
|
27.9
|
|
|
|
16.4
|
%
|
Gross
profit (loss) on product sales
(2)
|
|
|
0.2
|
|
|
|
4.7
|
%
|
|
|
(0.6
|
)
|
|
|
(18.8
|
)%
|
Total
gross profit
(2)
|
|
|
26.9
|
|
|
|
15.4
|
%
|
|
|
27.4
|
|
|
|
15.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
16.1
|
|
|
|
9.2
|
%
|
|
|
16.6
|
|
|
|
9.6
|
%
|
Provision
for litigation
|
|
|
14.8
|
|
|
|
8.5
|
%
|
|
|
0.2
|
|
|
|
0.1
|
%
|
Amortization
of intangible assets
|
|
|
1.7
|
|
|
|
1.0
|
%
|
|
|
2.0
|
|
|
|
1.1
|
%
|
Operating
income (loss)
|
|
|
(5.7
|
)
|
|
|
(3.3
|
)%
|
|
|
8.6
|
|
|
|
5.0
|
%
|
Interest
expense, net
|
|
|
(0.7
|
)
|
|
|
(0.4
|
)%
|
|
|
(1.3
|
)
|
|
|
(0.8
|
)%
|
Other
income, net
|
|
|
0.2
|
|
|
|
0.1
|
%
|
|
|
0.6
|
|
|
|
0.3
|
%
|
Provision
(benefit) for income taxes
(3)
|
|
|
(2.3
|
)
|
|
|
37.8
|
%
|
|
|
3.3
|
|
|
|
42.2
|
%
|
Net
income (loss)
|
|
$
|
(3.9
|
)
|
|
|
(2.2
|
)%
|
|
$
|
4.6
|
|
|
|
2.6
|
%
|
(1)
|
Totals
may not add due to rounding.
|
(2)
|
The
percent amounts represent a percentage of contract revenues, product sales
and total revenues,
respectively.
|
(3)
|
The
percentage of provision for income taxes relates to a percentage of income
(loss) before income taxes.
|
Revenues
Total
revenues were $63.5 million for the third quarter of 2008 compared with $58.3
million for the same period in 2007, up 8.9% on a reported basis. The organic
growth rate for the quarter was 1.5%, calculated by including the August and
September 2007 Kadix revenues of $4.2 million in the base period.
Our
revenues for the nine months ended September 30, 2008 and 2007 were $175.3
million and $173.1 million, respectively, representing an increase of $2.2
million or 1.2% from the same period in 2007.
Contract
Revenues
Contract
revenues in our Systems and Services segment were earned from the following
sectors:
|
|
Three
Months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
(in
millions)
|
|
$
(1)
|
|
|
%
(1)
|
|
|
$
(1)
|
|
|
%
(1)
|
|
National
defense and intelligence agencies
|
|
$
|
39.9
|
|
|
|
64.0
|
%
|
|
$
|
45.3
|
|
|
|
79.2
|
%
|
Federal
civilian agencies
|
|
|
9.6
|
|
|
|
15.4
|
|
|
|
7.2
|
|
|
|
12.6
|
|
Homeland
security
|
|
|
6.1
|
|
|
|
9.8
|
|
|
|
0.9
|
|
|
|
1.6
|
|
State
and local government agencies
|
|
|
6.2
|
|
|
|
10.0
|
|
|
|
3.5
|
|
|
|
6.2
|
|
Other
|
|
|
0.5
|
|
|
|
0.8
|
|
|
|
0.2
|
|
|
|
0.4
|
|
Total
contract revenue
|
|
$
|
62.3
|
|
|
|
100.0
|
%
|
|
$
|
57.2
|
|
|
|
100.0
|
%
|
|
|
Nine
months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
(in
millions)
|
|
$
(1)
|
|
|
%
(1)
|
|
|
$
(1)
|
|
|
%
(1)
|
|
National
defense and intelligence agencies
|
|
$
|
118.0
|
|
|
|
69.1
|
%
|
|
$
|
134.8
|
|
|
|
79.3
|
%
|
Federal
civilian agencies
|
|
|
23.0
|
|
|
|
13.5
|
|
|
|
21.4
|
|
|
|
12.6
|
|
Homeland
security
|
|
|
9.1
|
|
|
|
5.3
|
|
|
|
2.5
|
|
|
|
1.5
|
|
State
and local government agencies
|
|
|
18.8
|
|
|
|
11.0
|
|
|
|
10.8
|
|
|
|
6.4
|
|
Other
|
|
|
1.9
|
|
|
|
1.1
|
|
|
|
0.5
|
|
|
|
0.3
|
|
Total
contract revenue
|
|
$
|
170.8
|
|
|
|
100.0
|
%
|
|
$
|
170.1
|
|
|
|
100.0
|
%
|
(1)
|
Totals
may not add due to rounding.
|
The
decrease in revenues from national defense and intelligence agencies in the
three and nine months ended September 30, 2008 compared to the same periods in
2007 was due to decreased revenues derived from the U.S. Air Force ASC small
business set-aside CAPS contract and the transition from the U.S. Air Force
Electronic Systems Center (“ESC”) full and open ITSP II contract to the small
business set-aside PASS contract.
Revenues
derived from the CAPS contract during the three and nine months ended September
30, 2008 were $4.9 million and $14.3 million, respectively, compared to $5.7
million and $18.2 million for the three and nine months ended September 30,
2007, respectively.
In
January 2008, we purchased from THE CENTECH GROUP, Inc., a prime CAPS contract,
on which minimal work was being performed. While awaiting the government’s
decision on approval of the contract novation, through the CENTECH contract we
have won numerous task order re-competitions. We have received
notification that the U.S. Air Force has denied CENTECH’s request to novate
their CAPS contract to DRC. CENTECH and we are currently considering
avenues for reconsideration of this decision. Because we are able to
continue to perform as a subcontractor on the CENTECH CAPS contract, our
assessment is that this decision does not put our current work being performed
under this contract at risk.
Revenues
derived from ESC PASS contract and its predecessor ITSP II contract during the
three and nine months ended September 30, 2008 were $1.2 million and $7.3
million, respectively, compared to $5.9 million and $18.2 million for the three
and nine months ended September 30, 2007, respectively. Because the
PASS contract was re-competed as a small business set-aside, and certain
engineering work previously performed by the Company under ITSP II was directed
to a new contract, for which the Company did not receive an award, the Company’s
revenues with the ESC in 2008 will be approximately $12 million lower than in
2007.
The
increase in revenues from federal civilian agencies and Homeland Security in the
three and nine months ended September 30, 2008 compared to the same periods in
2007 was primarily due to added revenues from Kadix and increased revenues from
the Federal Deposit Insurance Corporation contract.
The
increase in revenues from state and local government agencies in the three and
nine months ended September 30, 2008 compared to the same period in 2007 was
primarily due to additional change orders under the State of Ohio contract
during 2007 and 2008. With the completion of the implementation phase of the
Ohio project in October 2008, revenues derived from the project, which were $1.7
million and $9.7 million for the three and nine months ended September 30, 2008,
and are anticipated at a reduced level for the last quarter of the year.
Revenues for the State of Ohio in the three months and nine months ended
September 30, 2007 were $2.1 million and $5.8 million,
respectively. Concurrently, in the second quarter of this year we
began a new child welfare system development project with the State of
Tennessee, which generated $3.0 million and $4.3 million of revenues in the
three and nine months ended September 30, 2008.
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,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Time
and materials
|
|
|
49
|
%
|
|
|
59
|
%
|
|
|
50
|
%
|
|
|
57
|
%
|
Cost
reimbursable
|
|
|
33
|
|
|
|
21
|
|
|
|
31
|
|
|
|
22
|
|
Fixed
price, including service type contracts
|
|
|
18
|
|
|
|
20
|
|
|
|
19
|
|
|
|
21
|
|
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime
contract
|
|
|
68
|
%
|
|
|
51
|
%
|
|
|
61
|
%
|
|
|
52
|
%
|
Sub-contract
|
|
|
32
|
|
|
|
49
|
|
|
|
39
|
|
|
|
48
|
|
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
Product
Sales
Product
sales for our Metrigraphics segment were $1.2 million and $1.1 million in the
three months ended September 30, 2008 and 2007, respectively, and $4.5 million
and $3.0 million, respectively, in the nine months then ended. The
increase in product sales from the prior year comparable periods was primarily
due to higher sales to a new medical device customer.
Funded
Backlog
Our
funded backlog was $148.4 million at September 30, 2008 compared to $116.5
million at December 31, 2007. We expect that substantially all of our backlog
will generate revenue during the subsequent twelve month
period.
Gross
Profit
Total
gross profit was $10.0 million and $9.3 million for the three months ended
September 30, 2008 and 2007, respectively, resulting in a gross margin of 15.7%
and 16.0% for the third quarters of 2008 and 2007, respectively. For
the nine months ended September 30, 2008 and 2007, the total gross profit was
$26.9 million and $27.4 million, respectively, resulting in a gross margin of
15.4% and 15.8%, respectively.
Our gross
profit on contract revenue was $10.0 million and $9.4 million for the three
months ended September 30, 2008 and 2007, respectively, and $26.7 million and
$27.9 million for the respective nine months then ended. The change in gross
profit on contract revenue resulted in a gross margin of 16.1% and 16.4% in the
third quarters of 2008 and 2007, respectively, and 15.6% and 16.4% in the
respective nine months then ended. The decrease in gross margin in
both comparable periods was primarily attributable to costs associated with
workforce reductions, partially offset by lower indirect cost.
During
the first half of 2008, we learned that our work on the Navy’s Trident Missile
program would be curtailed significantly in the second half of
2008. The gross profit for the nine months ended September 30, 2008
includes a provision of $753 for such work force reduction caused by this
curtailment.
Our gross
loss on product sales was $0.1 million in the third quarters of 2008 and 2007,
and $0.6 in the nine month period in 2007. Our gross margin on
product sales was $0.2 million for the nine months ended September 30,
2008. The increase in gross profit in the comparable nine month
periods was primarily attributable to higher medical device sales.
Selling,
general and administrative expenses
Selling,
general and administrative expenses were $5.5 million and $5.3 million in the
three months ended September 30, 2008 and 2007, respectively, and $16.1 million
and $16.6 million for the respective nine months then ended. Selling, general
and administrative expenses as a percent of total revenue in the third quarter
of 2008 and 2007 were 8.7% and 9.0%, respectively, and 9.2% and 9.6% for the
respective nine months then ended. Selling, general and
administrative expenses were higher in the third quarter of 2008 compared to
2007 due to the addition of Kadix’ selling, general and administrative expenses,
partially offset by lower deferred compensation costs and stock compensation
costs. Selling, general and administrative expenses were lower in the nine
months ended September 30, 2008 compared to September 30, 2007 due to lower
deferred compensation costs, legal costs and stock compensation costs, partially
offset by the addition of Kadix’ selling, general and administrative
expenses.
At
September 30, 2008, the market value of the pension plan assets was $55.3
million, a decline of $12.8 million since December 31, 2007. As a
result, we are anticipating that the unfunded status will increase significantly
at December 31, 2008 as compared to the funded status of $0.7 million recorded
at December 31, 2007. In accordance with SFAS No. 87 and SFAS No.
158, at December 31, 2008 we will record an increase in plan liabilities and
change accumulated other comprehensive income, a component of shareholders’
equity, to reflect any increase in the difference between plan assets and plan
liabilities. We also anticipate that the decline in the value of plan
assets will likely result in net periodic pension expense in 2009 rather than
the net periodic pension income recorded in 2008. The periodic
pension expenses for 2009 will not be determined prior to December 31,
2008.
Provision
for litigation
During
the third quarter of 2008, we increased the accrual for litigation to $15.0
million from $9.0 million in the first quarter of 2008 and from $0.2 million in
2007 based on a tentative settlement agreement. Further discussion
related to this ruling is referenced in Note 14 of our Notes to Condensed
Consolidated Financial Statements.
Amortization
of intangible assets
Amortization
expense was $0.7 million in the third quarters of 2008 and 2007, and $1.7
million and $2.0 million for the respective nine months then
ended. Amortization expense of $0.2 million relates to intangible
assets acquired in our acquisition of Kadix and the remaining amount relates to
intangible assets acquired in our 2004 acquisition of Impact Innovations Group
LLC. The remaining amortization expense for the last quarter of 2008
related to both acquisitions is expected to be approximately $0.8
million.
Interest
expense, net
We
incurred interest expense of $0.4 million in the third quarters of 2008 and
2007, and $0.7 million and $1.3 million for the respective nine months then
ended. The increase in interest expense in the third quarter of 2008 compared to
prior 2008 quarters was due to the addition of the $40 million term loan used to
finance the Kadix acquisition. We anticipate interest expense on the
term loan to be approximately $0.5 million in the fourth quarter of
2008.
Other
income (expense), net
We
recorded $0.2 million and $0.6 million of other income in the first nine months
of 2008 and 2007, respectively. In the first quarter of 2008, we
recorded $0.1 million of realized gains resulting from the sale of shares of
common stock of an actively traded public entity. Other income also
includes recognition of our portion of earnings in
HMR
Tech. Our
earnings related to this equity investment were $0.4 million in both nine month
periods of 2008 and 2007.
Income
tax provision
For the
nine months ended September 30, 2008, the effective income tax rate excluding
the $14.8 million litigation provision was 39.6%. We have estimated the tax
benefits associated with the litigation provision at $5.8 million. The effective
income tax rate for the comparable prior year period excluding the litigation
provision recorded in the nine months ended September 30, 2007 was
42.1%. The pool of excess tax benefits has been depleted and as a
result any future SFAS 123(R) tax deficiencies will be recorded directly to
earnings. The effective tax rate for the year ended December 31, 2007 was 39.7%,
reflecting adjustments to tax accruals and reserves plus favorable effects of
tax credits and state tax audits.
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.
Our
results of operations, cash flows and financial condition are subject to 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.
We
believe that selective acquisitions are an important component of our growth
strategy. We may acquire, from time to time, firms or properties 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 the credit
facility as a source of financing.
On August
1, 2008, we acquired Kadix for approximately $42 million in cash with the
potential for additional consideration of up to $5 million, based on the
achievement of certain conditions as more fully described in Note 3 of our
Notes to Condensed Consolidated Financial Statements. We also entered
into a new unsecured credit facility to restructure and increase the Company’s
credit facility to $65.0 million. The facility provides for a
$40.0 million, five-year term loan and a $25.0 million, five-year
revolving credit agreement for working capital as more fully described in
Note 7 of our Notes to Condensed Consolidated Financial
Statements.
Based
upon our present business plan and operating performance, we believe that cash
provided by operating activities, combined with amounts available for borrowing
under the revolver, will be adequate to fund the capital requirements of our
existing operations and our expected litigation settlement during the fourth
quarter of 2008 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.
At
September 30, 2008 and December 31, 2007, we had cash and cash equivalents
aggregating $10.8 million and $2.0 million, respectively. Our operating practice
is to apply cash received against any outstanding revolving credit facility
balances. As a result, cash balances at the end of each quarter
generally reflect the timing and size of cash receipts at the end of those
periods. At September 30, 2008, there was no outstanding balance on
our revolving credit facility.
Operating
activities
Net cash
provided by operating activities totaled $20.1 million in the first nine months
of 2008 compared to net cash used in operating activities of $3.2 million in the
same period of 2007. The cash provided by operating activities in the first nine
months of 2008 was primarily attributable to income from operating activities,
excluding the litigation provision. The cash used in the first nine
months of 2007 was primarily attributable to an increase in contract receivables
and a decrease in accounts payable.
During
the first nine months of 2008, we recorded a $14.8 million charge to increase
our estimated litigation liability to $15.0 million. This charge was reduced by
$5.7 million for estimated tax benefits which resulted in an after-tax effect of
$9.1 million. We expect the settlement of the litigation matter will
occur in the fourth quarter of 2008.
Contract
receivables were $67.6 million at September 30, 2008, or 90 days sales
outstanding (DSO), compared to $63.6 million, or 101 days at December 31, 2007.
Federal business DSO was 82 days at September 30, 2008, while balances related
to our contract with the States of Ohio and Tennessee at September 30, 2008
totaled $10.2 million, or 8 days sales outstanding, down from $7.6 million, or
10 days sales outstanding, at December 31, 2007.
Our net
deferred tax liability was $6.4 million at September 30, 2008 compared to $7.0
million at December 31, 2007. The decrease in deferred taxes was
principally due to deferred taxes on unbilled receivables which declined to $7.0
million at September 30, 2008 from $7.5 million at December 31,
2007. We paid $2.4 million in income taxes in the first nine months
of 2008 and currently do not anticipate any significant income tax payments in
the fourth quarter of 2008. 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 was elevated to the IRS National Office for
determination. On October 23, 2008, we received a notification of
ruling from the IRS National Office. This correspondence provided
clarification regarding the IRS position relating to the revenue recognition for
unbilled receivables. We are in the process of evaluating the impact
of this recent notification. As a result, we may incur interest
expense, penalties and our deferred tax liabilities may be adjusted and income
tax payments may be increased in future periods
Share-based
compensation was $0.9 million and $1.2 million in the first nine months of 2008
and 2007, respectively. As of September 30, 2008 the total
unrecognized compensation related to restricted stock awards was $1.3 million to
be recognized over approximately 2.1 years.
In May
2008, the Executive Long Term Incentive Program stock option and restricted
stock awards vested. The executives under this plan released
approximately 24,500 shares back to the Company to compensate for their tax
consequence of the restricted stock award vesting. The value of the
taxes was approximately $0.3 million which we paid during the second quarter in
lieu of the release of their stock awards.
Non-cash
amortization expense of our acquired intangible assets was $1.7 million and $2.0
million in the first nine months of 2008 and 2007, respectively. We
anticipate that non-cash expense for the amortization of intangible assets will
be approximately $0.8 million in the fourth quarter of 2008 and $3.1 million for
fiscal year 2009.
Investing
activities
Net cash
used in investing activities was $43.8 million and $1.2 million in the first
nine months of 2008 and 2007, respectively. The net cash used in 2008 was
primarily comprised of our purchase of Kadix for $42.4 million and capital
expenditures of $0.8 million. The net cash used in 2007 was primarily
comprised of capital expenditures of $1.2 million. We expect capital
expenditures of $2 million or less in 2008.
Financing
activities
During
the third quarter of 2008, we entered into a new unsecured credit facility and
an interest rate swap agreement. The new facility restructures and
increases our credit facility to $65.0 million and provides for a
$40.0 million, five-year term loan and a $25.0 million, five-year
revolving credit agreement for working capital. The swap effectively
fixes our interest rate on an initial notional amount of $20.0 million of the
term loan principal at 5.60% (3.60% swap fixed rate plus 2.00% margin)
throughout the term of the facility. The facility and swap agreements
are more fully described in Note 7 and Note 8 of our Notes to Condensed
Consolidated Financial Statements, respectively.
Net cash
provided in financing activities was $32.5 million in the first nine months of
2008, compared to net cash used of $2.2 million in the same period of 2007. The
amount of cash provided in 2008 represents proceeds from our term loan of $40.0
million and $0.7 million of proceeds from the issuance of common stock through
the exercises of stock options and employee stock purchase plan transactions,
partially offset by net payments under our revolving credit agreement of $7.7
million. The amount of cash used in 2007 represents net payments
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
weighted average interest rate on our $40.0 million term loan principal
outstanding during the period was 5.21%, based on $40.0 million principal at the
base rate from August 1, 2008 through September 4, 2008, and $40 million
principal split evenly between a 90-day LIBOR rate plus 2.00% and the swap fixed
rate of 5.60% through the end of September 30, 2008. The average
daily borrowing on our revolver for the first nine months of 2008 was $4.3
million at a weighted average interest rate of 5.83%, compared to an average
daily borrowing of $19.1 million at a weighted average interest rate of 7.45%
under our then existing revolver during the nine months ended September 30,
2007.
RECENT
ACCOUNTING PRONOUNCEMENTS
A
description of recent accounting pronouncements are referenced in Note 2 of our
Condensed Consolidated Financial Statements in Part I, Item 1 on this Form
10-Q.
Item
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
We are subject to interest
rate risk associated with our term loan and revolver, where interest payments
are tied to either LIBOR or the prime rate.
To manage this risk, we
entered into an interest rate swap agreement that fixed the floating portion of
the 90-day LIBOR at 3.60% on $20.0 million of our outstanding balance under
the term loan. We recorded a liability of $0.1 million for the change in fair
value of the swap instrument at September 30, 2008.
At any
time, a sharp rise in interest rates could have an adverse effect on net
interest expense of our unhedged portion of variable rate debt as reported in
our Condensed Consolidated Statements of Operations. A hypothetical
and instantaneous increase of one full percentage point in the interest rates on
our unhedged portion of variable rate debt would increase annual interest
expense by approximately $0.2 million.
We
presently have no investments in debt securities and, accordingly, no exposure
to market interest rates on investments. We have no significant exposure to
foreign currency fluctuations. Foreign sales, which are nominal, are primarily
denominated in United States dollars.
Item
4. CONTROLS AND PROCEDURES
The
Company’s principal executive officer (“CEO”) and principal financial officer
(“CFO”) evaluated, together with other members of senior management, the
effectiveness of the Company’s disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) as of September 30, 2008; and, based
on this review, the Company’s CEO and CFO concluded that, as of September 30,
2008, the Company’s disclosure controls and procedures were effective to ensure
that information required to be disclosed by it in the reports that it files or
submits under the Securities Exchange Act of 1934 (i) is recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and
forms and (ii) is accumulated and communicated to the Company’s management,
including the Company’s CEO and CFO, as appropriate, to allow timely decisions
regarding required disclosure.
There has
been no change in the Company’s internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the quarterly
period ended September 30, 2008 that has materially affected, or is reasonably
likely to materially affect, the Company’s internal control over financial
reporting.
PART II. OTHER
INFORMATION
Item
1. LEGAL PROCEEDINGS
As a
defense contractor, we are 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 our defense industry involvement,
we are, from time to time, involved in audits, lawsuits, claims, administrative
proceedings and investigations. We accrue for liabilities associated with these
activities when it becomes probable that future expenditures will be made and
such expenditures can be reasonably estimated. We are a party to or have
property subject to litigation and other proceedings referenced in Note 14 of
the Notes to Condensed Consolidated Financial Statements (Unaudited) included in
this Form 10-Q and in Note 12 of our Form 10-K for the year ended December 31,
2007. Our 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 a material adverse effect on our business,
financial position, results of operations and cash flows.
For
information regarding factors that could affect our results of operations,
financial condition and liquidity, refer to the section titled “Risk Factors” in
Part 1, Item 1A of our 2007 Form 10-K. There have been no material changes from
the risk factors previously disclosed in our most recent Form 10-K.
Item
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE
OF PROCEEDS
The
following table sets forth all purchases made by us or on our behalf by any
"affiliated purchaser," as defined in Rule 10b-18(a)(3) under the Exchange Act,
of shares of our common stock during each month in the third quarter of
2008. All shares repurchased were not part of a publicly announced
share purchase program and represent shares repurchased to cover payroll
withholding taxes in connection with the vesting of restricted stock
awards.
|
|
|
|
|
|
|
|
Total Number
|
|
|
Approximate
|
|
|
|
|
|
|
|
|
|
of
Shares
|
|
|
Dollar
Value
|
|
|
|
|
|
|
|
|
|
Purchased
as
|
|
|
of Shares that
|
|
|
|
|
|
|
|
|
|
Part
of
|
|
|
May
Yet Be
|
|
|
|
Total Number
|
|
|
Average
Price
|
|
|
Publicly
|
|
|
Purchased
|
|
|
|
of
Shares
|
|
|
Paid
Per
|
|
|
Announced
|
|
|
Under
the
|
|
Period
|
|
Purchased
|
|
|
Share
|
|
|
Programs
|
|
|
Programs
|
|
July
1, 2008 to July 31, 2008
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
|
$
|
-
|
|
August
1, 2008 to August 31, 2008
|
|
|
63
|
|
|
$
|
9.19
|
|
|
|
-
|
|
|
|
-
|
|
September
1, 2008 to September 30, 2008
|
|
|
223
|
|
|
$
|
9.04
|
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
|
286
|
|
|
$
|
9.07
|
|
|
|
-
|
|
|
$
|
-
|
|
The
following Exhibits are filed or furnished, as applicable, herewith:
|
|
Certification
of the Chief Executive Officer pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
Certification
of the Chief Financial Officer pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
Certification
of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
|
Certification
of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
SIGNATURE
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
10, 2008
|
/s/
David Keleher
|
|
Senior
Vice President, Chief Financial Officer and Treasurer
|
|
(Principal
Financial Officer and Principal Accounting
Officer)
|
Dynamics Research Corp. (MM) (NASDAQ:DRCO)
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