FORM 10-Q
For the Quarterly Period Ended September 30, 2010
Table of Contents
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Page
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Part I. Financial Information
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Item 1.
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Financial Statements
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3
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4
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5
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6
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7
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8
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Item 2.
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17
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Item 3.
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24
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Item 4.
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24
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Part II. Other Information
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Item 1.
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25
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Item 1A.
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25
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Item 2.
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25
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Item 6.
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26
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
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September 30,
2010
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December 31, 2009
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(unaudited)
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Assets
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Current assets
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Cash and cash equivalents
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$
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22,539
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$
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55
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Contract receivables, net
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52,071
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72,569
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Prepaid expenses and other current assets
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2,965
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5,702
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Discontinued operations
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-
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2,058
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Total current assets
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77,575
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80,384
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Noncurrent assets
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Property and equipment, net
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12,843
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13,915
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Goodwill
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97,641
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97,641
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Intangible assets, net
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2,918
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4,074
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Deferred tax asset
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4,133
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4,252
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Other noncurrent assets
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3,751
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3,335
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Total noncurrent assets
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121,286
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123,217
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Total assets
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$
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198,861
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$
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203,601
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Liabilities and stockholders' equity
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Current liabilities
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Current portion of long-term debt
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$
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8,000
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$
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8,000
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Accounts payable
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17,473
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18,299
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Accrued compensation and employee benefits
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15,057
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16,357
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Deferred taxes
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467
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7,046
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Other accrued expenses
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9,329
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3,708
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Discontinued operations
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-
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186
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Total current liabilities
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50,326
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53,596
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Long-term liabilities
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Long-term debt
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16,000
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23,973
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Other long-term liabilities
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28,138
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31,936
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Total long-term liabilities
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44,138
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55,909
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Total liabilities
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94,464
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109,505
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Commitments and contingencies
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Stockholders' equity
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Preferred stock, $0.10 par value per share; 5,000,000 shares authorized; no shares issued and outstanding
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-
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-
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Common stock, $0.10 par value per share; 30,000,000 shares authorized; 10,040,026 and 9,923,357 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively
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1,004
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992
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Capital in excess of par value
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54,160
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52,580
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Accumulated other comprehensive loss, net of taxes
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(20,510
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)
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(20,505
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)
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Retained earnings
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69,743
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61,029
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Total stockholders' equity
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104,397
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94,096
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Total liabilities and stockholders' equity
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$
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198,861
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$
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203,601
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The accompanying notes are an integral part of these condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(dollars in thousands, except share data)
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Three Months Ended
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Nine Months Ended
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September 30,
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September 30,
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2010
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2009
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2010
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2009
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Revenue
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$
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68,420
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$
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67,504
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$
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202,312
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$
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202,835
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Cost of revenue
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57,630
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56,882
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170,568
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169,840
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Gross profit
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10,790
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10,622
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31,744
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32,995
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Selling, general and administrative expenses
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5,197
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5,755
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16,233
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18,277
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Amortization of intangible assets
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385
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809
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1,156
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2,754
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|
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Operating income
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5,208
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4,058
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14,355
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11,964
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Interest expense, net
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(339
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)
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(434
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)
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(1,082
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)
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(1,530
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)
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Other income, net
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151
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|
264
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|
234
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|
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|
585
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Income from continuing operations before provision for income taxes
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5,020
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3,888
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13,507
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11,019
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Provision for income taxes
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2,014
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|
992
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5,185
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|
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3,992
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|
Income from continuing operations
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|
3,006
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|
|
|
2,896
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|
|
8,322
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|
|
|
7,027
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|
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Effect of discontinued operations, net of tax
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|
87
|
|
|
|
59
|
|
|
|
392
|
|
|
|
(251
|
)
|
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Net income
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|
$
|
3,093
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|
|
$
|
2,955
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|
|
$
|
8,714
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|
|
$
|
6,776
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|
|
|
|
|
|
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Earnings per share
(1)
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Basic
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
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Income from continuing operations
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|
$
|
0.30
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|
|
$
|
0.30
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|
|
$
|
0.84
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|
|
$
|
0.73
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|
|
Effect of discontinued operations, net of tax (Note 3)
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|
|
0.01
|
|
|
|
0.01
|
|
|
|
0.04
|
|
|
|
(0.03
|
)
|
|
Net income
|
|
$
|
0.31
|
|
|
$
|
0.31
|
|
|
$
|
0.88
|
|
|
$
|
0.70
|
|
|
Diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from continuing operations
|
|
$
|
0.30
|
|
|
$
|
0.29
|
|
|
$
|
0.83
|
|
|
$
|
0.71
|
|
|
Effect of discontinued operations, net of tax (Note 3)
|
|
|
0.01
|
|
|
|
0.01
|
|
|
|
0.04
|
|
|
|
(0.03
|
)
|
|
Net income
|
|
$
|
0.31
|
|
|
$
|
0.30
|
|
|
$
|
0.87
|
|
|
$
|
0.69
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
9,937,470
|
|
|
|
9,678,983
|
|
|
|
9,879,905
|
|
|
|
9,631,659
|
|
|
Diluted
|
|
|
10,060,980
|
|
|
|
9,983,825
|
|
|
|
10,057,211
|
|
|
|
9,840,605
|
|
|
(1)
|
Totals may not add due to rounding.
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009 (unaudited)
(in thousands)
|
|
|
Common Stock
Shares
|
|
|
Common Stock Par
Value
|
|
|
Capital in Excess of Par
Value
|
|
|
Accumulated Other Comprehensive
Loss
|
|
|
Retained
Earnings
|
|
|
Total
|
|
|
Balance at June 30, 2010
|
|
|
10,018
|
|
|
$
|
1,002
|
|
|
$
|
53,789
|
|
|
$
|
(20,508
|
)
|
|
$
|
66,650
|
|
|
$
|
100,933
|
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,093
|
|
|
|
3,093
|
|
|
Other comprehensive income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in unrealized loss on derivative instruments
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(2
|
)
|
|
|
-
|
|
|
|
(2
|
)
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,091
|
|
|
Issuance of common stock through stock plan transactions
|
|
|
26
|
|
|
|
2
|
|
|
|
227
|
|
|
|
-
|
|
|
|
-
|
|
|
|
229
|
|
|
Issuance of restricted stock
|
|
|
3
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Forfeiture of restricted stock
|
|
|
(3
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Release of restricted stock
|
|
|
(4
|
)
|
|
|
-
|
|
|
|
(41
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(41
|
)
|
|
Share-based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
189
|
|
|
|
-
|
|
|
|
-
|
|
|
|
189
|
|
|
Tax benefit from stock plan transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
(4
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(4
|
)
|
|
Balance at September 30, 2010
|
|
|
10,040
|
|
|
$
|
1,004
|
|
|
$
|
54,160
|
|
|
$
|
(20,510
|
)
|
|
$
|
69,743
|
|
|
$
|
104,397
|
|
|
|
|
Common Stock
Shares
|
|
|
Common Stock Par
Value
|
|
|
Capital in Excess of Par
Value
|
|
|
Accumulated Other Comprehensive
Loss
|
|
|
Retained
Earnings
|
|
|
Total
|
|
|
Balance at June 30, 2009
|
|
|
9,762
|
|
|
$
|
976
|
|
|
$
|
52,433
|
|
|
$
|
(22,118
|
)
|
|
$
|
54,678
|
|
|
$
|
85,969
|
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,955
|
|
|
|
2,955
|
|
|
Other comprehensive income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in unrealized loss on derivative instruments
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(25
|
)
|
|
|
-
|
|
|
|
(25
|
)
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,930
|
|
|
Issuance of common stock through stock plan transactions
|
|
|
60
|
|
|
|
7
|
|
|
|
549
|
|
|
|
-
|
|
|
|
-
|
|
|
|
556
|
|
|
Issuance of restricted stock
|
|
|
23
|
|
|
|
2
|
|
|
|
(2
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Forfeiture of restricted stock
|
|
|
(3
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Release of restricted stock
|
|
|
(4
|
)
|
|
|
(1
|
)
|
|
|
(48
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(49
|
)
|
|
Share-based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
193
|
|
|
|
-
|
|
|
|
-
|
|
|
|
193
|
|
|
Tax benefit from stock plan transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
46
|
|
|
|
-
|
|
|
|
-
|
|
|
|
46
|
|
|
Balance at September 30, 2009
|
|
|
9,838
|
|
|
$
|
984
|
|
|
$
|
53,171
|
|
|
$
|
(22,143
|
)
|
|
$
|
57,633
|
|
|
$
|
89,645
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009 (unaudited)
(in thousands)
|
|
|
Common Stock
Shares
|
|
|
Common Stock Par
Value
|
|
|
Capital in Excess of Par
Value
|
|
|
Accumulated Other Comprehensive
Loss
|
|
|
Retained
Earnings
|
|
|
Total
|
|
|
Balance at December 31, 2009
|
|
|
9,923
|
|
|
$
|
992
|
|
|
$
|
52,580
|
|
|
$
|
(20,505
|
)
|
|
$
|
61,029
|
|
|
$
|
94,096
|
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
8,714
|
|
|
|
8,714
|
|
|
Other comprehensive income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in unrealized loss on derivative instruments
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(5
|
)
|
|
|
-
|
|
|
|
(5
|
)
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,709
|
|
|
Issuance of common stock through stock plan transactions
|
|
|
124
|
|
|
|
12
|
|
|
|
1,078
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,090
|
|
|
Issuance of restricted stock
|
|
|
28
|
|
|
|
3
|
|
|
|
(3
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Forfeiture of restricted stock
|
|
|
(16
|
)
|
|
|
(1
|
)
|
|
|
1
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Release of restricted stock
|
|
|
(19
|
)
|
|
|
(2
|
)
|
|
|
(209
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(211
|
)
|
|
Share-based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
553
|
|
|
|
-
|
|
|
|
-
|
|
|
|
553
|
|
|
Tax benefit from stock plan transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
160
|
|
|
|
-
|
|
|
|
-
|
|
|
|
160
|
|
|
Balance at September 30, 2010
|
|
|
10,040
|
|
|
$
|
1,004
|
|
|
$
|
54,160
|
|
|
$
|
(20,510
|
)
|
|
$
|
69,743
|
|
|
$
|
104,397
|
|
|
|
|
Common Stock
Shares
|
|
|
Common Stock Par
Value
|
|
|
Capital in Excess of Par
Value
|
|
|
Accumulated Other Comprehensive
Loss
|
|
|
Retained
Earnings
|
|
|
Total
|
|
|
Balance at December 31, 2008
|
|
|
9,675
|
|
|
$
|
967
|
|
|
$
|
51,919
|
|
|
$
|
(22,268
|
)
|
|
$
|
50,857
|
|
|
$
|
81,475
|
|
|
Comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,776
|
|
|
|
6,776
|
|
|
Other comprehensive income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in unrealized gain on derivative instruments
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
125
|
|
|
|
-
|
|
|
|
125
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,901
|
|
|
Issuance of common stock through stock plan transactions
|
|
|
96
|
|
|
|
10
|
|
|
|
811
|
|
|
|
-
|
|
|
|
-
|
|
|
|
821
|
|
|
Issuance of restricted stock
|
|
|
100
|
|
|
|
10
|
|
|
|
(10
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Forfeiture of restricted stock
|
|
|
(15
|
)
|
|
|
(1
|
)
|
|
|
1
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Release of restricted stock
|
|
|
(18
|
)
|
|
|
(2
|
)
|
|
|
(152
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(154
|
)
|
|
Share-based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
547
|
|
|
|
-
|
|
|
|
-
|
|
|
|
547
|
|
|
Tax benefit from stock plan transactions
|
|
|
-
|
|
|
|
-
|
|
|
|
55
|
|
|
|
-
|
|
|
|
-
|
|
|
|
55
|
|
|
Balance at September 30, 2009
|
|
|
9,838
|
|
|
$
|
984
|
|
|
$
|
53,171
|
|
|
$
|
(22,143
|
)
|
|
$
|
57,633
|
|
|
$
|
89,645
|
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(dollars in thousands)
|
|
|
Nine Months Ended
|
|
|
|
|
September 30,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
Net income
|
|
$
|
8,714
|
|
|
$
|
6,776
|
|
|
Effect of discontinued operations, net of tax (Note 3)
|
|
|
392
|
|
|
|
(251
|
)
|
|
Income from continuing operations
|
|
|
8,322
|
|
|
|
7,027
|
|
|
Adjustments to reconcile net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
2,660
|
|
|
|
2,180
|
|
|
Amortization of intangible assets
|
|
|
1,156
|
|
|
|
2,754
|
|
|
Share-based compensation
|
|
|
553
|
|
|
|
547
|
|
|
Investment income from equity interest
|
|
|
(142
|
)
|
|
|
(316
|
)
|
|
Tax benefit from stock plan transactions
|
|
|
(160
|
)
|
|
|
(55
|
)
|
|
Litigation payment
|
|
|
-
|
|
|
|
(15,000
|
)
|
|
Deferred income taxes
|
|
|
(6,456
|
)
|
|
|
7,000
|
|
|
Other
|
|
|
(381
|
)
|
|
|
(510
|
)
|
|
Change in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Contract receivables, net
|
|
|
20,498
|
|
|
|
(302
|
)
|
|
Prepaid expenses and other current assets
|
|
|
2,737
|
|
|
|
(1,734
|
)
|
|
Accounts payable
|
|
|
1,841
|
|
|
|
(2,452
|
)
|
|
Accrued compensation and employee benefits
|
|
|
(1,300
|
)
|
|
|
3,477
|
|
|
Other accrued expenses
|
|
|
5,570
|
|
|
|
(2,857
|
)
|
|
Other long-term liabilities
|
|
|
(3,427
|
)
|
|
|
835
|
|
|
Net cash provided by continuing operations
|
|
|
31,471
|
|
|
|
594
|
|
|
Net cash provided by (used in) discontinued operations
|
|
|
(161
|
)
|
|
|
(705
|
)
|
|
Net cash provided by (used in) operating activities
|
|
|
31,310
|
|
|
|
(111
|
)
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
Purchase of business, net of cash acquired
|
|
|
-
|
|
|
|
(4,250
|
)
|
|
Additions to property and equipment
|
|
|
(4,266
|
)
|
|
|
(2,196
|
)
|
|
Proceeds from sale of business
|
|
|
1,750
|
|
|
|
-
|
|
|
Proceeds from sale of investments and long-lived assets
|
|
|
19
|
|
|
|
210
|
|
|
Dividends from equity investment
|
|
|
139
|
|
|
|
456
|
|
|
Increase in other assets
|
|
|
330
|
|
|
|
(114
|
)
|
|
Net cash used in continuing operations
|
|
|
(2,028
|
)
|
|
|
(5,894
|
)
|
|
Net cash used in discontinued operations
|
|
|
(75
|
)
|
|
|
(67
|
)
|
|
Net cash used in investing activities
|
|
|
(2,103
|
)
|
|
|
(5,961
|
)
|
|
Cash flow from financing activities:
|
|
|
|
|
|
|
|
|
|
Repayments under term loan
|
|
|
(6,000
|
)
|
|
|
(6,000
|
)
|
|
Borrowings under revolving credit agreement
|
|
|
34,156
|
|
|
|
50,121
|
|
|
Repayments under revolving credit agreement
|
|
|
(36,129
|
)
|
|
|
(45,823
|
)
|
|
Proceeds from the exercise of stock plan transactions
|
|
|
1,090
|
|
|
|
821
|
|
|
Tax benefit from stock plan transactions
|
|
|
160
|
|
|
|
55
|
|
|
Net cash used in financing activities
|
|
|
(6,723
|
)
|
|
|
(826
|
)
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
22,484
|
|
|
|
(6,898
|
)
|
|
Cash and cash equivalents, beginning of period
|
|
|
55
|
|
|
|
7,111
|
|
|
Cash and cash equivalents, end of period
|
|
$
|
22,539
|
|
|
$
|
213
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
The unaudited condensed consolidated financial statements of Dynamics Research Corporation (the “Company”) and its subsidiaries included herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and, accordingly, include amounts based on informed estimates and judgments of management with consideration given to materiality. Estimates and judgments also affect the amount of revenue and expenses during the reported period. Actual results could differ from those estimates. The year end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. Unless otherwise noted, dollar amounts are reported in thousands.
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. Interim results are not necessarily indicative of the financial results that may be expected for the current fiscal year. The accompanying financial information should be read in conjunction with the consolidated financial statements and notes contained in the Company’s Form 10-K/A, filed with the United States Securities and Exchange Commission (“SEC”) for the year ended December 31, 2009. The Company has reclassified certain prior period amounts to conform with the current period presentation.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2010-06,
Improving Disclosures about Fair Value Measurements.
The standard amends Accounting Standards Codification (“ASC”) Topic 820,
Fair Value Measurements and Disclosures,
to require additional disclosures related to transfers between levels in the hierarchy of fair value measurement. The Company adopted this standard on January 1, 2010. The standard does not change how fair values are measured; accordingly, the standard will not have an impact on the Company’s consolidated financial statements. At September 30, 2010, the Company did not transfer any assets or liabilities that are measured at fair value on a recurring basis between Levels 1 and 2, and did not have any transfers into and out of Level 3. See Note 8 for additional disclosures.
In February 2010, the FASB issued ASU No. 2010-09,
Amendments to Certain Recognition and Disclosure Requirements
. The standard amends ASC Topic 855 to address certain implementation issues related to an entities requirement to perform and disclose subsequent-event procedures. The standard requires SEC filers to “evaluate subsequent events through the date the financial statements are issued” and exempts SEC filers from disclosing the date through which subsequent events have been evaluated. The Company evaluates subsequent events through the date and time of the filing of the applicable periodic report with the SEC. The Company evaluated subsequent events through the date of issuance of its Quarterly Report on Form 10-Q.
In July 2010, the FASB issued ASU No. 2010-26,
Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses
. The purpose of the additional disclosures is to enable users of financial statements to better understand the nature of credit risk inherent in an entity’s portfolio of financing receivables and how that risk is analyzed. For end of period balances, the new disclosures are required to be made in all interim and annual periods ending on or after December 15, 2010. For activity during a reporting period, the disclosures are required to be made in all interim and annual periods after January 1, 2011. These changes will not have an impact on the consolidated financial results as this guidance only relates to additional disclosures.
NOTE 3. DISCONTINUED OPERATIONS
In the fourth quarter of 2009 the Company entered into a plan to sell Metrigraphics, as management determined that Metrigraphics was not core to the Company’s mission and strategy. At December 31, 2009, Metrigraphics was classified as held for sale and presented as a discontinued operation. As a result, the Company’s consolidated financial statements and notes thereto were adjusted to reflect the discontinuation of Metrigraphics for all periods presented.
Effective July 19, 2010, the Company sold Metrigraphics for consideration of $2.5 million, which consisted of $1.75 million in cash and $0.75 million in the form of a subordinated note. Interest on the subordinated note is
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
payable quarterly and the repayment of principal is due in full on July 20, 2012, the maturity date of the subordinated note. The financial effects of the sale were reflected in the three months ended June 30, 2010 and September 30, 2010.
The operating results of Metrigraphics classified as discontinued operations are summarized below:
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
Product revenue
|
|
$
|
386
|
|
|
$
|
1,733
|
|
|
$
|
4,790
|
|
|
$
|
4,589
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before benefit for income taxes
|
|
$
|
236
|
|
|
$
|
86
|
|
|
$
|
806
|
|
|
$
|
(471
|
)
|
|
(Provision) benefit for income taxes
|
|
|
(93
|
)
|
|
|
(27
|
)
|
|
|
(322
|
)
|
|
|
220
|
|
|
Income (loss) from operations of discontinued operations, net of tax
|
|
|
143
|
|
|
|
59
|
|
|
|
484
|
|
|
|
(251
|
)
|
|
Loss on sale of discontinued operations, net of tax
|
|
|
(56
|
)
|
|
|
-
|
|
|
|
(92
|
)
|
|
|
-
|
|
|
Effect of discontinued operations, net of tax
|
|
$
|
87
|
|
|
$
|
59
|
|
|
$
|
392
|
|
|
$
|
(251
|
)
|
Details of the balance sheet items for Metrigraphics are summarized below:
|
|
|
December 31,
|
|
|
|
|
2009
|
|
|
Accounts receivable
|
|
$
|
946
|
|
|
Inventory
|
|
|
864
|
|
|
Prepaid expenses and other current assets
|
|
|
22
|
|
|
Property and equipment, net
|
|
|
226
|
|
|
Total current assets
|
|
$
|
2,058
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
186
|
|
|
Total current liabilities
|
|
$
|
186
|
|
NOTE 4. SUPPLEMENTAL BALANCE SHEET INFORMATION
The composition of selected balance sheet accounts are as follows:
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Contract receivables, net
|
|
|
|
|
|
|
|
Billed receivables
|
|
$
|
21,009
|
|
|
$
|
28,203
|
|
|
Unbilled receivables
(1)
:
|
|
|
|
|
|
|
|
|
|
Revenues recorded in excess of milestone billings on a fixed price contract with the State of Tennessee
|
|
|
932
|
|
|
|
18,004
|
|
|
Retainages and fee withholdings
|
|
|
236
|
|
|
|
689
|
|
|
Other unbilled receivables
|
|
|
30,534
|
|
|
|
26,256
|
|
|
Total unbilled receivables
|
|
|
31,702
|
|
|
|
44,949
|
|
|
Allowance for doubtful accounts
|
|
|
(640
|
)
|
|
|
(583
|
)
|
|
Contract receivables, net
|
|
$
|
52,071
|
|
|
$
|
72,569
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid expenses and other current assets:
|
|
|
|
|
|
|
|
|
|
Refundable income taxes
|
|
$
|
-
|
|
|
$
|
1,604
|
|
|
Restricted cash
|
|
|
343
|
|
|
|
262
|
|
|
Other
|
|
|
2,622
|
|
|
|
3,836
|
|
|
Prepaid expenses and other current assets
|
|
$
|
2,965
|
|
|
$
|
5,702
|
|
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Property and equipment, net:
|
|
|
|
|
|
|
|
Software
|
|
$
|
12,515
|
|
|
$
|
12,107
|
|
|
Furniture and other equipment
|
|
|
10,088
|
|
|
|
9,679
|
|
|
Leasehold improvements
|
|
|
7,114
|
|
|
|
6,445
|
|
|
Production equipment
|
|
|
374
|
|
|
|
440
|
|
|
Property and equipment
|
|
|
30,091
|
|
|
|
28,671
|
|
|
Less accumulated depreciation
|
|
|
(17,248
|
)
|
|
|
(14,756
|
)
|
|
Property and equipment, net
|
|
$
|
12,843
|
|
|
$
|
13,915
|
|
|
|
|
|
|
|
|
|
|
|
|
Other noncurrent assets:
|
|
|
|
|
|
|
|
|
|
Deferred compensation plan investments
|
|
$
|
1,505
|
|
|
$
|
1,378
|
|
|
Equity investment
|
|
|
981
|
|
|
|
978
|
|
|
Other
|
|
|
1,265
|
|
|
|
979
|
|
|
Other noncurrent assets
|
|
$
|
3,751
|
|
|
$
|
3,335
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued compensation and employee benefits:
|
|
|
|
|
|
|
|
|
|
Accrued compensation and related taxes
|
|
$
|
7,879
|
|
|
$
|
9,029
|
|
|
Accrued vacation
|
|
|
4,675
|
|
|
|
4,724
|
|
|
Accrued pension liability
|
|
|
536
|
|
|
|
840
|
|
|
Other
|
|
|
1,967
|
|
|
|
1,764
|
|
|
Accrued compensation and employee benefits
|
|
$
|
15,057
|
|
|
$
|
16,357
|
|
|
|
|
|
|
|
|
|
|
|
|
Other accrued expenses:
|
|
|
|
|
|
|
|
|
|
Accrued income taxes
|
|
$
|
4,349
|
|
|
$
|
-
|
|
|
Deferred gain on sale of building
|
|
|
676
|
|
|
|
676
|
|
|
Other
|
|
|
4,304
|
|
|
|
3,032
|
|
|
Other accrued expenses
|
|
$
|
9,329
|
|
|
$
|
3,708
|
|
|
|
|
|
|
|
|
|
|
|
|
Other long-term liabilities:
|
|
|
|
|
|
|
|
|
|
Accrued pension liability
|
|
$
|
17,935
|
|
|
$
|
20,666
|
|
|
Deferred gain on sale of building
|
|
|
2,874
|
|
|
|
3,381
|
|
|
Deferred compensation plan liability
|
|
|
1,505
|
|
|
|
1,378
|
|
|
Other
|
|
|
5,824
|
|
|
|
6,511
|
|
|
Other long-term liabilities
|
|
$
|
28,138
|
|
|
$
|
31,936
|
|
|
(1)
|
At September 30, 2010 and December 31, 2009, $0.2 million and $0.5 million, respectively, of unbilled retainages and fee withholdings are not anticipated to be billed within one year.
|
NOTE 5. GOODWILL AND INTANGIBLE ASSETS
The Company changed the date as of which its annual goodwill impairment analysis is performed from December 31
st
to November 30
th
. This change in timing is considered a change in accounting principle. The Company believes the new date is preferable because the timing coincides with the Company’s long-range planning process and it allows the Company more time to complete the analysis prior to the date the Company reports its results for the fourth quarter. There were no changes in the carrying amount of goodwill for the nine months ended September 30, 2010.
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
Components of the Company’s identifiable intangible assets are as follows:
|
|
|
September 30, 2010
|
|
|
December 31, 2009
|
|
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
|
|
|
|
|
Amount
|
|
|
Amortization
|
|
|
Net
|
|
|
Amount
|
|
|
Amortization
|
|
|
Net
|
|
|
Customer relationships
|
|
$
|
1,900
|
|
|
$
|
(366
|
)
|
|
$
|
1,534
|
|
|
$
|
13,400
|
|
|
$
|
(11,643
|
)
|
|
$
|
1,757
|
|
|
Customer contracts
|
|
|
3,500
|
|
|
|
(2,701
|
)
|
|
|
799
|
|
|
|
3,500
|
|
|
|
(2,234
|
)
|
|
|
1,266
|
|
|
Non-competition agreements
|
|
|
1,400
|
|
|
|
(815
|
)
|
|
|
585
|
|
|
|
1,400
|
|
|
|
(349
|
)
|
|
|
1,051
|
|
|
8(a) contract transition
|
|
|
130
|
|
|
|
(130
|
)
|
|
|
-
|
|
|
|
130
|
|
|
|
(130
|
)
|
|
|
-
|
|
|
Total
|
|
$
|
6,930
|
|
|
$
|
(4,012
|
)
|
|
$
|
2,918
|
|
|
$
|
18,430
|
|
|
$
|
(14,356
|
)
|
|
$
|
4,074
|
|
During the first quarter of 2010, the Company wrote-off $11.5 million of fully amortized intangible assets. The Company recorded amortization expense for its identifiable intangible assets of $0.4 million and $0.8 million for the three months ended September 30, 2010 and 2009, respectively, and $1.2 million and $2.8 million for the nine months then ended.
At September 30, 2010, estimated future amortization expense related to identifiable intangible assets was as follows:
|
Remainder of 2010
|
|
$
|
386
|
|
|
2011
|
|
$
|
1,188
|
|
|
2012
|
|
$
|
492
|
|
|
2013
|
|
$
|
349
|
|
|
2014
|
|
$
|
299
|
|
|
2015 and thereafter
|
|
$
|
204
|
|
NOTE 6. INCOME TAXES
The Company recorded income tax provisions of $2.0 million and $1.0 million in the three months ended September 30, 2010 and 2009, respectively, and $5.2 million and $4.0 million, respectively, in the nine months then ended. The effective income tax rate for the nine months ended September 30, 2010 and 2009 was 38.4% and 36.2%, respectively. On April 5, 2010, the Company received a tax refund of $0.3 million related to 2003 tax deductions, which was recorded in the first quarter of 2010. Absent the refund, the Company’s effective tax rate for the nine months ended September 30, 2010 was 40.3%. The 2009 effective tax rate was favorably affected by an adjustment to the Company’s unrecognized tax benefits and a reduction of state tax expense associated with the filing of the 2008 tax returns.
As of September 30, 2010 the Company had $0.5 million of unrecognized tax benefits, of which $0.2 million would affect its effective tax rate if recognized. Accrued penalties and interest were $0.2 million at September 30, 2010 and 2009.
The Internal Revenue Service (“IRS”) had challenged the deferral of income for tax reporting 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 ruling provided clarification regarding the IRS position relating to revenue recognition for tax purposes regarding its unbilled receivables. During September 2009, the IRS completed its examination of the Company’s tax returns for 2004 through 2007 and issued a Revenue Agent Report (“RAR”), which reduced the deferral of income for tax reporting purposes. As a result the Company reclassified approximately $1.0 million from deferred to current taxes payable. The RAR also included an assessment of interest of $0.5 million. The Company has filed a protest letter with the IRS to appeal the assessment. The Company believes the appeal will be successful and has made no provision for the interest associated with the assessment.
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
NOTE 7. FINANCING ARRANGEMENTS
The Company’s outstanding debt at September 30, 2010 was $24.0 million which consisted of borrowings under a term loan. The interest rate on the term loan outstanding balance at September 30, 2010 was 2.53% based on the 90-day LIBOR rate option that was in effect on September 30, 2010. The outstanding debt at December 31, 2009 was $32.0 million which consisted of an outstanding balance of $30.0 million under the term loan and $2.0 million of net borrowings under a revolver.
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, 2010, the remaining available balance to borrow against the revolver was $24.6 million. At September 30, 2010, the Company was in compliance with its loan covenants.
As further discussed in Note 9, the Company has an interest rate swap agreement to mitigate the floating interest rate risk on half of the outstanding term loan.
NOTE 8. FAIR VALUE MEASUREMENTS
The following tables present our assets and liabilities that are measured at fair value on a recurring basis:
|
|
|
|
Fair Value Measurements
|
|
|
|
|
|
|
|
|
At September 30, 2010 Using
|
|
|
|
|
|
|
Balance Sheet Location
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments held in Rabbi Trusts
|
Other noncurrent assets
|
|
$
|
1,505
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,505
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap
|
Other long-term liabilities
|
|
$
|
-
|
|
|
$
|
577
|
|
|
$
|
-
|
|
|
$
|
577
|
|
|
|
|
|
Fair Value Measurements
|
|
|
|
|
|
|
|
|
At December 31, 2009 Using
|
|
|
|
|
|
|
Balance Sheet Location
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments held in Rabbi Trusts
|
Other noncurrent assets
|
|
$
|
1,378
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,378
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap
|
Other long-term liabilities
|
|
$
|
-
|
|
|
$
|
569
|
|
|
$
|
-
|
|
|
$
|
569
|
|
The following is a description of the valuation methodologies used for these items, as well as the general classification of such items:
Investments Held in Rabbi Trusts –
The investments include exchange-traded equity securities and mutual funds. Fair values for these investments were based on quoted prices in active markets and were therefore classified within Level 1 of the fair value hierarchy.
Interest Rate Swap –
The derivative is a receive-variable, pay-fixed interest rate swap based on the LIBOR rate and is designated as a fair value hedge. Fair value was based on a model-driven valuation using the LIBOR rate, which was observable at commonly quoted intervals for the full term of the swap. Therefore, our interest rate swap was classified within Level 2 of the fair value hierarchy.
The carrying values of other cash and cash equivalents, contract receivables and accounts payable approximate fair value because of the short-term nature of these instruments. The carrying value of debt also approximates fair value because the interest rate is variable.
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
NOTE 9. DERIVATIVE FINANCIAL INSTRUMENTS
The Company has an interest rate swap agreement that effectively fixes the interest rate on half of the outstanding term loan at 5.60% which includes the applicable margin of 2.00%. The notional amounts of the swap agreement at September 30, 2010 and December 31, 2009 were $12.0 million and $15.0 million, respectively. The Company recorded a liability to recognize the fair value of the swap which has been accounted for as a component of the accumulated other comprehensive loss as the swap qualifies for hedge accounting.
The fair value effect on the financial statements from derivative instruments designated as a cash flow hedge is as follows:
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
Other long-term liabilities
|
|
$
|
577
|
|
|
$
|
569
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
Gain (loss) recognized in other comprehensive income, net of tax
|
|
$
|
(2
|
)
|
|
$
|
(25
|
)
|
|
$
|
(5
|
)
|
|
$
|
125
|
|
NOTE 10. DEFINED BENEFIT PENSION PLAN
The components of net periodic pension expense for the Company’s defined benefit pension plan are as follows:
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
Interest cost on projected benefit obligation
|
|
$
|
1,056
|
|
|
$
|
1,067
|
|
|
$
|
3,163
|
|
|
$
|
3,200
|
|
|
Expected return on plan assets
|
|
|
(1,129
|
)
|
|
|
(964
|
)
|
|
|
(3,345
|
)
|
|
|
(2,892
|
)
|
|
Recognized actuarial loss
|
|
|
274
|
|
|
|
303
|
|
|
|
824
|
|
|
|
909
|
|
|
Net periodic pension expense
|
|
$
|
201
|
|
|
$
|
406
|
|
|
$
|
642
|
|
|
$
|
1,217
|
|
During the third quarter of 2010, the Company made a discretionary contribution payment of $2.8 million to fund the pension plan.
NOTE 11. SHARE-BASED COMPENSATION
On June 2, 2010 the Company’s shareholders approved the 2010 Executive Long-Term Incentive Plan (“2010 ELTIP”) which is administered by the Compensation Committee of the Company. The Company recorded compensation costs for all share-based compensation as noted in the table below. Additional information regarding the 2010 ELTIP is included in the Company Proxy Statement under the heading Approval of Executive Long-Term Incentive Plan, filed with the Securities Exchange Commission on Form DEF14 A on April 15, 2010.
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,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
Cost of products and services
|
|
$
|
86
|
|
|
$
|
87
|
|
|
$
|
261
|
|
|
$
|
234
|
|
|
Selling, general and administrative
|
|
|
103
|
|
|
|
106
|
|
|
|
292
|
|
|
|
313
|
|
|
Total share-based compensation expense
|
|
$
|
189
|
|
|
$
|
193
|
|
|
$
|
553
|
|
|
$
|
547
|
|
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 and exercisable at December 31, 2009
|
|
|
606,843
|
|
|
$
|
9.62
|
|
|
|
1.5
|
|
|
$
|
981
|
|
|
Granted
|
|
|
30,000
|
|
|
$
|
13.27
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(115,150
|
)
|
|
$
|
8.53
|
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
(2,900
|
)
|
|
$
|
19.35
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2010
|
|
|
518,793
|
|
|
$
|
10.02
|
|
|
|
1.4
|
|
|
$
|
600
|
|
|
Exercisable at September 30, 2010
|
|
|
488,793
|
|
|
$
|
9.82
|
|
|
|
0.9
|
|
|
$
|
600
|
|
As of September 30, 2010 the total unrecognized compensation cost related to stock option awards was $0.2 million which is expected to be amortized over approximately 2.6 years.
The fair value of share-based awards for employee stock option awards was estimated using the Black-Scholes pricing model. The following weighted average assumptions were used to calculate the per share fair value of $6.47 for stock options issued during 2010: risk-free rate of 2.6%; dividend yield of zero; volatility of 48.2%; and expected life of 6 years.
The Company selected the assumptions used in the Black-Scholes pricing model using the following criteria:
Risk-free interest rate.
The Company bases the risk-free interest rate on implied yields available on a U.S. Treasury note with a maturity term equal to or approximating the expected term of the underlying award.
Dividend yield.
The Company does not intend to pay dividends on its common stock for the foreseeable future and, accordingly, uses a dividend yield of zero.
Volatility.
The expected volatility of the Company’s shares was estimated based upon the historical volatility of the Company’s share price with consideration given to the expected life of the award.
Expected life
. The expected term was estimated based upon exercise experience made in the past to employees.
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,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
Amounts realized or received from stock option exercises:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash proceeds received
|
|
$
|
139
|
|
|
$
|
465
|
|
|
$
|
808
|
|
|
$
|
564
|
|
|
Intrinsic value realized
|
|
$
|
21
|
|
|
$
|
114
|
|
|
$
|
419
|
|
|
$
|
137
|
|
|
Income tax benefit realized
|
|
$
|
-
|
|
|
$
|
45
|
|
|
$
|
133
|
|
|
$
|
53
|
|
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
Restricted Stock Award Activity
The following table summarizes restricted stock activity:
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
Number of
|
|
|
Grant-Date
|
|
|
|
|
Shares
|
|
|
Fair Value
|
|
|
Nonvested at December 31, 2009
|
|
|
165,701
|
|
|
$
|
9.39
|
|
|
Granted
|
|
|
28,300
|
|
|
$
|
11.00
|
|
|
Vested
|
|
|
(70,978
|
)
|
|
$
|
9.80
|
|
|
Cancelled
|
|
|
(16,501
|
)
|
|
$
|
9.31
|
|
|
Nonvested at September 30, 2010
|
|
|
106,522
|
|
|
$
|
9.55
|
|
The total fair value of restricted shares vested during both three months periods ended September 30, 2010 and 2009 was $0.1 million, and $0.7 million and $0.8 million, respectively, during the nine months then ended. As of September 30, 2010, the total unrecognized compensation cost related to restricted stock awards was $0.8 million, which is expected to be amortized over a weighted-average period of 1.9 years.
NOTE 12. EARNINGS PER SHARE
For the three and nine months ended September 30, 2010 and 2009, basic earnings per share are computed by dividing net income 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, 2010 and 2009, diluted earnings per share are determined by using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Due to the anti-dilutive effect, approximately 90,000 and 55,800 options to purchase common stock were excluded from the calculation of diluted earnings per share for the three months ended September 30, 2010 and 2009, respectively, and 90,000 and 64,800, respectively, options for the nine months then ended.
The following table illustrates the reconciliation of the weighted average shares outstanding:
|
|
|
Three Months Ended
|
|
|
Nine months Ended
|
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
Weighted average shares outstanding - Basic
|
|
|
9,937,470
|
|
|
|
9,678,983
|
|
|
|
9,879,905
|
|
|
|
9,631,659
|
|
|
Diluted effect of stock options and restricted stock grants
|
|
|
123,510
|
|
|
|
304,842
|
|
|
|
177,306
|
|
|
|
208,946
|
|
|
Weighted average shares outstanding - Diluted
|
|
|
10,060,980
|
|
|
|
9,983,825
|
|
|
|
10,057,211
|
|
|
|
9,840,605
|
|
NOTE 13. BUSINESS SEGMENT, MAJOR CUSTOMERS AND RELATED PARTY INFORMATION
Business Segment
With the decision to discontinue the operations of the Metrigraphics segment in the fourth quarter of 2009, the Company now operates in one reportable business segment. The Company provides support to its customers in the primary mission areas of information technology, logistics and readiness, information assurance and cybersecurity, homeland security, health care, and intelligence and space. The Company offers several business solutions to its customers, often combining two or more solutions to achieve customer goals, including business transformation, information technology infrastructure, training and performance support, business intelligence, automated case management, program management, engineering, human capital management, information assurance and cybersecurity, and health care.
DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
Major Customers
Revenues from U.S. Government agency customers in aggregate accounted for approximately 93% and 91% of total revenues in the nine months ended September 30, 2010 and 2009, respectively. No individual agency customer accounted for more than 10% of revenue in the three or nine months ended September 30, 2010 and 2009.
Contract receivables from State and local government agency customers in aggregate accounted for approximately 15% and 33% of total contract receivables at September 30, 2010 and December 31, 2009, respectively. The outstanding contract receivable balance of the State of Tennessee contract at December 31, 2009 was $18.8 million. No other individual customer accounted for more than 10% of total contract receivables at September 30, 2010 and December 31, 2009.
Related Party
The Company has a 40% interest in
HMR
Tech which is accounted for using the equity method. Revenues from
HMR
Tech included in contract revenues for the three and nine months ended September 30, 2010 and 2009 and amounts due from
HMR
Tech included in contract receivables at September 30, 2010 and December 31, 2009 were immaterial. In addition,
HMR
Tech charged the Company relating to contract work of $0.4 million in both the three months ended September 30, 2010 and 2009, and $1.4 million and $1.0 million, respectively, for the nine months then ended. At September 30, 2010 and December 31, 2009, the Company had a related payable of $0.6 million and $0.2 million, respectively.
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 such expenditures can be reasonably estimated. Except as noted below, the Company does not presently believe it is reasonably likely that any of these matters would have a material adverse effect on the Company’s business, financial position, results of operations or cash flows. The Company’s evaluation of the likelihood of expenditures related to these matters is subject to change in future periods, depending on then current events and circumstances, which could have material adverse effects on the Company’s business, financial position, results of operations and cash flows.
On June 28, 2005, 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. In July 2010, the Company and the plaintiff agreed upon principle terms of settlement, the cost of which was accrued on the balance sheet as of June 30, 2010. In October 2010, the Company received an executed settlement agreement by the plaintiff requiring approval by the courts, which is expected to occur during the fourth quarter of 2010.
The following discussion and analysis of our financial condition and results of operations should be read together with the consolidated financial statements and the notes to those statements that appear elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K/A filed with the Securities Exchange Commission on April 12, 2010.
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.
Some of the statements in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and elsewhere in this Quarterly Report on 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 DRC that are based on our 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. Such statements are subject to factors that could cause actual results to differ materially from anticipated results. Such factors include, but are not limited to, the following:
|
|
·
|
Our dependency on the Federal government and changes in federal spending priorities;
|
|
|
·
|
Failure to obtain new government contracts or retain existing contracts;
|
|
|
·
|
The effect of Federal government in-sourcing on our business;
|
|
|
·
|
The loss of skilled personnel;
|
|
|
·
|
The risk of security breaches in systems we develop, install or maintain;
|
|
|
·
|
Failure by Congress to timely approve budgets governing spending by Federal agencies;
|
|
|
·
|
Risks due to government contract provisions providing for rights unfavorable to us, including the ability to terminate contracts at any time for convenience;
|
|
|
·
|
Potential systems or service failures that could result in liability to our company;
|
|
|
·
|
Risks associated with various, complex Federal government procurement laws and regulations;
|
|
|
·
|
Adverse effects in the event of an unfavorable Federal audit of our contracts;
|
|
|
·
|
Failure to adequately safeguard confidential information;
|
|
|
·
|
An adverse outcome related to ongoing legal proceedings;
|
|
|
·
|
Competitive conditions in current markets and difficulties in entering new markets;
|
|
|
·
|
Our ability to maintain sufficient sources of financing and the risk that our financing requirements should increase;
|
|
|
·
|
The adverse effect on earnings should our recorded goodwill from prior investments become impaired; and
|
|
|
·
|
Economic conditions in the United States and global market conditions that are beyond our control.
|
These and other risk factors are more fully described in our Annual Report on Form 10-K/A for the year ended December 31, 2009 under the section entitled “Risk Factors”, and from time to time, in other filings with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document. Actual results may differ materially and adversely from those expressed in any forward-looking statements. 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.
OVERVIEW
Dynamics Research Corporation, headquartered in Andover, Massachusetts, is a leading provider of innovative management consulting, engineering, technical and information technology (“IT”) services and solutions to federal and state governments. We provide support to our customers in the primary mission areas of IT, logistics and readiness, cybersecurity and information assurance, homeland security, health care, and intelligence and space.
Effective July 19, 2010, DRC sold Metrigraphics for consideration of $2.5 million, which consisted of $1.75 million in cash and $0.75 million in the form of a subordinated note. In connection with this transaction, we recorded an immaterial loss from the sale in the second and third quarter of 2010.
We are cognizant of funding challenges and changing priorities of the federal government. TechAmerica, a leading trade association in the industry, estimates federal spending on information technology will increase slightly in the next five years even as overall defense spending declines. Growth is likely to be constrained by deficit-cutting measures and uncertainty related to program freezes and the consolidation of data centers. The federal IT spending is predicted at a compound annual growth rate of 2.8%, from $79.6 billion in fiscal 2011 to $91.3 billion in fiscal 2016.
Customers have moved away from using General Services Administration schedule contracts in favor of agency-wide multiple-award indefinite-delivery, indefinite-quantity multi-year contract vehicles. Over the past several years, we have won or acquired many of these contracts including the Department of Homeland Security (“DHS”) EAGLE and Professional Program Management Support Services (“PPMSS”) management and IT services contracts, the military health care TRICARE Evaluation, Analysis, and Management Support, or TEAMS, contract, the Air Force Design and Engineering Support Program (“DESP”) II engineering services contract, the Department of Defense-wide Logistics Management Support Services logistics services contract, the Office of Personnel Management Training and Management Assistance contract, and the Alliant government-wide contract. This year, for three of the contracts, the DHS EAGLE and PPMSS contracts and the Air Force DESP II contract, the government has or is expected to solicit proposals for follow-on multi-year multiple award ID/IQ contracts with the award of new contracts anticipated to be made in 2011.
In recent years, there has been an increase in the portion of contracts issued on a fixed price basis, compared with time and materials or cost-plus, in an effort to reduce the risk to the government of cost overruns. We believe our contract cost management capabilities are strong and view this trend as favorable to the Company. The amount of our revenue derived from fixed price contracts in the third quarter of 2010 was 45%, up from 40% in the same period in 2009.
The federal government also has set as a high priority and is initiating programs focused on strengthening the government workforce with particular emphasis on personnel responsible for acquisition, such as acquiring products and services for the government. The government has set targets for adding to the government workforce with some of these positions coming from a reduction in the number of contractor positions supporting the government, known as in-sourcing. We have experienced a reduction in billable positions and revenue from in-sourcing and related government cost reduction actions and anticipate continuation of these initiatives through 2010 and into 2011.
Outlook
Our business is conducted primarily with U.S. Government customers under both short-term and long-term contracts. We have aligned our service offerings to current economic conditions and customer needs. The U.S. Government’s budgetary processes give us good visibility regarding future spending and the threat areas that they are addressing. Management believes that our current contracts, and backlog of previously awarded contracts, are well aligned with the direction of our customers’ future needs, and this provides us with good insight regarding future cash flows. Since 2007, we recorded improved operating results absent the effect of the provision for litigation which, when included, resulted in a net loss for 2008. Nonetheless, management recognizes that the
current economic situation and significant changes in priorities under the new administration likely will result in significant changes in federal spending with increases in some areas and decreases in others. While we may benefit from the increases, certain programs in which we participate may be subject to reductions.
RESULTS OF OPERATIONS
Operating results expressed as a percentage of total revenue are as follows:
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
(in millions)
|
|
$
(1)
|
|
%
(1)
|
|
|
$
(1)
|
|
%
(1)
|
|
|
|
Revenue
|
|
$
|
68.4
|
|
|
|
|
$
|
67.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
10.8
|
|
|
15.8
|
%
|
|
$
|
10.6
|
|
|
15.7
|
%
|
|
|
Selling, general and administrative
|
|
|
5.2
|
|
|
7.6
|
%
|
|
|
5.8
|
|
|
8.5
|
%
|
|
|
Amortization of intangible assets
|
|
|
0.4
|
|
|
0.6
|
%
|
|
|
0.8
|
|
|
1.2
|
%
|
|
|
Operating income
|
|
|
5.2
|
|
|
7.6
|
%
|
|
|
4.1
|
|
|
6.0
|
%
|
|
|
Interest expense, net
|
|
|
(0.3
|
)
|
|
(0.5
|
)%
|
|
|
(0.4
|
)
|
|
(0.6
|
)%
|
|
|
Other income, net
|
|
|
0.2
|
|
|
0.2
|
%
|
|
|
0.3
|
|
|
0.4
|
%
|
|
|
Provision for income taxes
|
|
|
2.0
|
|
|
40.1
|
%
|
(2)
|
|
1.0
|
|
|
25.5
|
%
|
(2)
|
|
Effect of discontinued operations, net of taxes
|
|
|
0.1
|
|
|
0.1
|
%
|
|
|
0.1
|
|
|
0.1
|
%
|
|
|
Net income
|
|
$
|
3.1
|
|
|
4.5
|
%
|
|
$
|
3.0
|
|
|
4.4
|
%
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
2010
|
|
|
2009
|
|
|
|
(in millions)
|
|
$
(1)
|
|
%
(1)
|
|
|
$
(1)
|
|
%
(1)
|
|
|
|
Revenue
|
|
$
|
202.3
|
|
|
|
|
$
|
202.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
31.7
|
|
|
15.7
|
%
|
|
$
|
33.0
|
|
|
16.3
|
%
|
|
|
Selling, general and administrative
|
|
|
16.2
|
|
|
8.0
|
%
|
|
|
18.3
|
|
|
9.0
|
%
|
|
|
Amortization of intangible assets
|
|
|
1.2
|
|
|
0.6
|
%
|
|
|
2.8
|
|
|
1.4
|
%
|
|
|
Operating income
|
|
|
14.4
|
|
|
7.1
|
%
|
|
|
12.0
|
|
|
5.9
|
%
|
|
|
Interest expense, net
|
|
|
(1.1
|
)
|
|
(0.5
|
)%
|
|
|
(1.5
|
)
|
|
(0.8
|
)%
|
|
|
Other income, net
|
|
|
0.2
|
|
|
0.1
|
%
|
|
|
0.6
|
|
|
0.3
|
%
|
|
|
Provision for income taxes
|
|
|
5.2
|
|
|
38.4
|
%
|
(2)
|
|
4.0
|
|
|
36.2
|
%
|
(2)
|
|
Effect of discontinued operations, net of taxes
|
|
|
0.4
|
|
|
0.2
|
%
|
|
|
(0.3
|
)
|
|
(0.1
|
)%
|
|
|
Net income
|
|
$
|
8.7
|
|
|
4.3
|
%
|
|
$
|
6.8
|
|
|
3.3
|
%
|
|
|
(1)
|
Totals may not add due to rounding.
|
|
(2)
|
The percentage of provision for income taxes relates to a percentage of income from continuing operations before income taxes.
|
Revenues
We reported total revenue of $68.4 million and $67.5 million in the three months ended September 30, 2010 and 2009, respectively. Total revenues for the third quarter of 2010 represent an increase of $0.9 million, or 1.4%, from the same period in 2009. Total revenues for the nine months ended September 30, 2010 and 2009 were $202.3 million and $202.8 million, respectively, a decrease of $0.5 million, or 0.3%.
Revenues have been reclassified to conform to current period presentation. Revenues were earned from the following sectors:
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months
|
|
|
|
|
Three Months Ended
|
|
|
Ended
|
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
September 30,
|
|
|
September 30,
|
|
|
(in millions)
|
|
2010
(1)
|
|
|
2010
(1)
|
|
|
2010
(1)
|
|
|
2010
(1)
|
|
|
National defense and intelligence agencies
|
|
$
|
44.3
|
|
|
$
|
40.6
|
|
|
$
|
45.5
|
|
|
$
|
130.4
|
|
|
Homeland security
|
|
|
12.9
|
|
|
|
13.2
|
|
|
|
13.5
|
|
|
|
39.7
|
|
|
Federal civilian agencies
|
|
|
6.0
|
|
|
|
6.2
|
|
|
|
5.4
|
|
|
|
17.6
|
|
|
Total revenue from federal agencies
|
|
|
63.2
|
|
|
|
60.0
|
|
|
|
64.4
|
|
|
|
187.6
|
|
|
State and local government agencies
|
|
|
5.4
|
|
|
|
5.3
|
|
|
|
4.0
|
|
|
|
14.7
|
|
|
Other
|
|
|
0.0
|
|
|
|
0.0
|
|
|
|
0.0
|
|
|
|
0.0
|
|
|
Total revenue
|
|
$
|
68.6
|
|
|
$
|
65.3
|
|
|
$
|
68.4
|
|
|
$
|
202.3
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
March 31,
|
|
|
June 30,
|
|
|
September 30,
|
|
|
December 31,
|
|
|
Fiscal
|
|
|
(in millions)
|
|
2009
(1)
|
|
|
2009
(1)
|
|
|
2009
(1)
|
|
|
2009
(1)
|
|
|
2009
(1)
|
|
|
National defense and intelligence agencies
|
|
$
|
40.5
|
|
|
$
|
40.9
|
|
|
$
|
41.5
|
|
|
$
|
40.4
|
|
|
$
|
163.2
|
|
|
Homeland security
|
|
|
13.4
|
|
|
|
14.2
|
|
|
|
13.9
|
|
|
|
13.1
|
|
|
|
54.6
|
|
|
Federal civilian agencies
|
|
|
7.4
|
|
|
|
6.6
|
|
|
|
6.0
|
|
|
|
6.4
|
|
|
|
26.5
|
|
|
Total revenue from federal agencies
|
|
|
61.3
|
|
|
|
61.6
|
|
|
|
61.4
|
|
|
|
60.0
|
|
|
|
244.3
|
|
|
State and local government agencies
|
|
|
5.8
|
|
|
|
6.5
|
|
|
|
6.0
|
|
|
|
5.7
|
|
|
|
24.0
|
|
|
Other
|
|
|
0.1
|
|
|
|
0.1
|
|
|
|
0.1
|
|
|
|
0.1
|
|
|
|
0.3
|
|
|
Total revenue
|
|
$
|
67.2
|
|
|
$
|
68.1
|
|
|
$
|
67.5
|
|
|
$
|
65.8
|
|
|
$
|
268.7
|
|
|
(1)
|
Totals may not add due to rounding.
|
Federal revenue included revenue derived from 8(a) contracts received with the 2008 Kadix acquisition of $0.3 million and $0.9 million in the third quarter of 2010 and 2009, respectively, and $1.1 million and $4.8 million, respectively, for the nine months then ended. Absent the effect of 8(a) contract expirations, federal revenue grew by 5.9% and 3.9% in the third quarter and first nine months of 2010, respectively, over the comparable period in 2009.
During the third quarter and first nine months of 2010, we lost 24 and 68 billable positions, respectively, to the government’s in-sourcing and related cost reduction initiatives. While the Department of Defense has announced a discontinuation of in-sourcing, we anticipate the in-sourcing initiatives which were underway at the time of announcement will continue, and these may result in additional in-sourcing of an estimated 20 positions in the fourth quarter of 2010 or the first quarter of 2011. In total, we continue to project the total affect of the government’s in-sourcing initiative at 80 to 100 positions, equating to annualized revenue of approximately $15 million.
Revenues from state and local government agencies declined in the third quarter and first nine months of 2010 compared to the same periods in 2009 primarily due to the our child welfare system contract with the State of Tennessee, which deployed in September 2010. Revenues for the Tennessee contract were $0.6 million and $3.5 million in the third quarter of 2010 and 2009, respectively, and $5.0 million and $11.1 million, respectively, for the nine months then ended.
Revenues by contract type as a percentage of revenues were as follows:
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
Fixed price, including service type contracts
|
|
|
45
|
%
|
|
|
40
|
%
|
|
|
45
|
%
|
|
|
38
|
%
|
|
Time and materials
|
|
|
34
|
|
|
|
41
|
|
|
|
34
|
|
|
|
43
|
|
|
Cost reimbursable
|
|
|
21
|
|
|
|
19
|
|
|
|
21
|
|
|
|
19
|
|
|
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime contract
|
|
|
73
|
%
|
|
|
70
|
%
|
|
|
72
|
%
|
|
|
71
|
%
|
|
Sub-contract
|
|
|
27
|
|
|
|
30
|
|
|
|
28
|
|
|
|
29
|
|
|
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
Backlog and Bookings
Our backlog position was as follows:
|
|
|
September 30,
|
|
|
December 31,
|
|
|
(in millions)
|
|
2010
|
|
|
2009
|
|
|
Backlog:
|
|
|
|
|
|
|
|
Funded
|
|
$
|
158.0
|
|
|
$
|
158.5
|
|
|
Unfunded
|
|
|
268.2
|
|
|
|
276.0
|
|
|
Total
|
|
$
|
426.2
|
|
|
$
|
434.5
|
|
Funded bookings were $95.4 million and $73.7 million in the three-month periods ending September 30, 2010 and December 31, 2009, respectively, and generated a book-to-bill ratio of approximately 1.4 to 1 and 1.1 to 1, respectively. The ending funded backlog as of September 30, 2010 and December 31, 2009 covered approximately 6.9 and 7.2 months of revenue, respectively. We expect that substantially all of our funded backlog at September 30, 2010 will generate revenue during the subsequent twelve month period. The funded backlog generally is subject to possible termination at the convenience of the contracting party. Contracts are generally funded on an annual basis or incrementally for shorter time periods.
Total gross profit was $10.8 million and $10.6 million for the third quarter of 2010 and 2009, respectively, resulting in a gross margin of 15.8% and 15.7%, respectively. For the first nine months of 2010 and 2009, gross profit was $31.7 million and $33.0 million, respectively, resulting in a gross margin of 15.7% and 16.3%, respectively. The decrease in gross profit margin was a result of lower direct labor content of revenue which resulted primarily from government in-sourcing and was partially offset by indirect cost efficiencies.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $5.2 million and $5.8 million in the third quarter of 2010 and 2009, respectively, and $16.2 million and $18.3 million, respectively, in the nine months then ended. Selling, general and administrative expenses as a percent of total revenue in the third quarter of 2010 and 2009 were 7.6% and 8.5%, respectively, and 8.0% and 9.0%, respectively, in the nine months then ended. The decrease in selling, general and administrative expenses in 2010 was due to a reduced level of administrative staff and lower facility costs and legal fees.
Amortization of Intangible Assets
Amortization expense was $0.4 million and $0.8 million in the third quarter of 2010 and 2009, respectively, and $1.2 million and $2.8 million, respectively, in the nine months then ended. The decrease in amortization expense primarily relates to the intangible assets acquired from our 2004 acquisition of Impact Innovations which fully amortized in the third quarter of 2009. Amortization expense for the fourth quarter of 2010 is expected to be approximately $0.4 million.
Interest Expense, net
Net interest expense was $0.3 million and $0.4 million in the third quarter of 2010 and 2009, respectively, and $1.1 million and $1.5 million, respectively, for the nine months then ended. The decrease in interest expense was due to lower debt levels and interest rates during 2010.
Other Income, net
Other income, net of expenses consists of our portion of earnings in
HMR
Tech, gains and losses realized from our deferred compensation plan and results from other non-operating transactions, all of which were immaterial to our results.
Provision for Income Taxes
We recorded income tax provisions of $2.0 million and $1.0 million in the third quarter of 2010 and 2009, respectively, and $5.2 million and $4.0 million, respectively, for the nine months then ended. The effective income tax rate was 38.4% in the first nine months of 2010 and 36.2% in the first nine months of 2009. On April 5, 2010, we received a tax refund of $0.3 million related to 2003 tax deductions, which we recorded in the first quarter of 2010. Absent the refund, our effective tax rate for the first nine months of 2010 was 40.3%. The 2009 effective tax rate was favorably affected by an adjustment to the Company’s unrecognized tax benefits and a reduction of state tax expense associated with the filing of the 2008 tax returns.
LIQUIDITY AND CAPITAL RESOURCES
The following discussion analyzes liquidity and capital resources by operating, investing and financing activities as presented in our Consolidated Statements of Cash Flows. Our principal sources of liquidity are cash flows from operations and borrowings from our revolving credit facility. At September 30, 2010, the borrowing capacity available under our revolver was $24.6 million.
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 have evaluated our future liquidity needs, both from a short-term and long-term basis. We believe we have sufficient funds to meet our working capital and capital expenditure needs for the short term. Cash on hand plus cash generated from operations along with cash available under our line of credit is expected to be sufficient in 2010 to service debt, finance capital expenditures, pay federal and state income taxes and fund the pension plan, if necessary. To provide for long-term liquidity, we believe we can generate substantial positive cash flow, as well as obtain additional capital, if necessary, from the use of subordinated debt or equity. 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.
We believe that selective acquisitions are an important component of our growth strategy. We may acquire, from time to time, businesses or contracts 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.
At September 30, 2010 and December 31, 2009, we had cash and cash equivalents aggregating $22.5 million and $0.1 million, respectively. The increase in our cash and cash equivalents is primarily due to the collections on our contract with the State of Tennessee.
Operating Activities
Net cash provided by operating activities from continuing operations totaled $31.5 million in the first nine months of 2010 compared to $0.6 million in the same period of 2009. The cash provided by operating activities in 2010 was primarily attributable to the collections of contracts receivables and net earnings realized.
Contract receivables were $52.1 million at September 30, 2010, or 68 days sales outstanding (“DSO”), compared to $72.6 million, or 99 days at December 31, 2009. Billed receivables decreased $7.2 million and unbilled receivables decreased $13.2 million in the first nine months of 2010. Federal business DSO, which excludes the effect of our state contracts, was 61 days at September 30, 2010 compared to 73 days at December 31, 2009. The states of Ohio and Tennessee had a combined contract receivable balance outstanding of $2.2 million and $19.9 million at September 30, 2010 and December 31, 2009, respectively. In the first nine months of 2010, we received $22.7 million in payments from the State of Tennessee. We anticipate receipts of an additional $0.3 million from the State of Tennessee in the fourth quarter of 2010.
Our net deferred tax asset was $3.7 million at September 30, 2010 compared to a net deferred tax liability of $2.8 million at December 31, 2009. The increase in the deferred tax asset was due to a decline in unbilled receivables related to our contract with the State of Tennessee. We paid $5.7 million in income taxes, net of a $3.2 million refund, in the first nine months of 2010. In July 2010, we received $3.0 million from a federal net operating loss carryback claim. Currently we anticipate additional income tax payments of $2.3 million in the fourth quarter of 2010.
The IRS had challenged the deferral of income for tax reporting purposes related to unbilled receivables including the applicability of a Letter Ruling issued by the IRS to DRC in January 1976 which granted us deferred tax treatment of the 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 ruling provided clarification regarding the IRS position relating to revenue recognition for tax purposes regarding our unbilled receivables. During September 2009, the IRS completed its examination of our tax returns for 2004 through 2007 and issued a Revenue Agent Report, which reduced the deferral of income for tax reporting purposes. As a result we reclassified approximately $1.0 million from deferred to current taxes payable. The IRS report also included an assessment of interest of $0.5 million. We have filed a protest with the IRS to appeal the assessment. We believe the appeal will be successful and have therefore made no provision for the interest associated with the assessment.
Share-based compensation was $0.6 million and $0.5 million in the first nine months of 2010 and 2009, respectively. As of September 30, 2010 the total unrecognized compensation cost related to restricted stock and stock option awards was $0.8 million and $0.2 million, respectively, which is expected to be amortized over approximately 1.9 years and 2.6 years, respectively.
Non-cash amortization expense of our acquired intangible assets was $1.2 million and $2.8 million in the first nine months of 2010 and 2009, respectively. We anticipate that non-cash expense for the amortization of intangible assets will remain at a comparable level for the fourth quarter of 2010. We expect capital expenditure to be approximately $0.8 million in the fourth quarter of 2010.
Investing Activities
Net cash used in investing activities from continuing operations was $2.0 million and $5.9 million in the first nine months of 2010 and 2009, respectively. The net cash used in 2010 primarily comprised of capital expenditures of $4.3 million, partially offset by proceeds of $1.8 million from the sale of Metrigraphics. The net cash used in 2009 primarily consisted of additional consideration paid of $4.3 million as part of the Kadix acquisition and capital expenditures of $2.2 million.
Financing Activities
Net cash used in financing activities was $6.7 million and $0.8 million in the first nine months of 2010 and 2009, respectively. The amount of cash used in both periods included payments of $6.0 million under our term loan. During the first nine months of 2010, we also made net repayments of an additional $2.0 million on our revolver compared to $4.3 million of net borrowings during the same period in 2009.
The average daily borrowing on our revolver for the first nine months of 2010 and 2009 was $1.3 million and $2.0 million, respectively, at an interest rate of 3.25% for both periods. The average outstanding balance of combined term loan and swap agreement during the first nine months of 2010 and 2009 was $27 million and $35 million, respectively, at an average interest rate of 3.97% and 4.37%, respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
A description of recent accounting pronouncements are referenced in Note 2 of our Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q.
We are subject to interest rate risk associated with our term loan and revolver, where interest payments are tied to either the LIBOR or prime rate. The interest rate at September 30, 2010 on our $24 million term loan outstanding was 2.53%. The interest rate on our swap agreement effectively fixes the interest rate on half of our outstanding term loan at 5.60%, which includes the current applicable margin of 2.00%. At any time, a sharp rise in interest rates could have an adverse effect on net interest expense as reported in our consolidated statements of operations. Our potential loss over one year that would result in a hypothetical and instantaneous increase of one full percentage point in the interest rate on half of our term loan would increase annual interest expense by approximately $0.1 million.
In addition, historically our investment positions have been relatively small and short-term in nature. We typically invest excess cash in money market accounts with original maturities of three months or less with no exposure to market interest rates. We have no significant exposure to foreign currency fluctuations. Foreign sales, which are nominal, are primarily denominated in U.S. dollars.
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, 2010; and, based on this review, the Company’s CEO and CFO concluded that, as of September 30, 2010, 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, 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
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. 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.
In July 2010, the Company and the plaintiff for a class action employee suit agreed upon principle terms of settlement, the cost of which was accrued on the balance sheet as of June 30, 2010. In October 2010, the Company received an executed settlement agreement by the plaintiff requiring approval by the courts, which is expected to occur during the fourth quarter of 2010.
For information regarding factors that could affect our results of operations, financial condition and liquidity, refer to the section titled “Risk Factors” in Part I, Item 1A of our 2009 Form 10-K/A. There have been no material changes from the risk factors previously disclosed in our most recent Form 10-K/A.
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 2010. 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
|
|
|
|
|
Total
|
|
|
Average
|
|
|
Part of
|
|
|
May Yet Be
|
|
|
|
|
Number
|
|
|
Price
|
|
|
Publicly
|
|
|
Purchased
|
|
|
|
|
of Shares
|
|
|
Paid Per
|
|
|
Announced
|
|
|
Under the
|
|
|
|
|
Purchased
|
|
|
Share
|
|
|
Programs
|
|
|
Programs
|
|
|
July 1, 2010 to July 31, 2010
|
|
|
190
|
|
|
$
|
12.62
|
|
|
|
-
|
|
|
$
|
-
|
|
|
August 1, 2010 to August 31, 2010
|
|
|
7,129
|
|
|
$
|
9.96
|
|
|
|
-
|
|
|
|
-
|
|
|
September 1, 2010 to September 30, 2010
|
|
|
1,017
|
|
|
$
|
10.48
|
|
|
|
-
|
|
|
|
-
|
|
|
Total
|
|
|
8,336
|
|
|
$
|
10.09
|
|
|
|
-
|
|
|
$
|
-
|
|
The following Exhibits are filed or furnished, as applicable, herewith:
|
18.1
|
Letter re change in accounting principles
|
|
|
|
|
31.1
|
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.
|
|
|
|
|
31.2
|
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.
|
|
|
|
|
32.1
|
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.
|
|
|
|
|
32.2
|
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 3, 2010
|
/s/ David Keleher
|
|
|
Senior Vice President, Chief Financial Officer and Treasurer
|
|
|
(Principal Financial Officer)
|
|
|
|
|
Date: November 3, 2010
|
/s/ Shaun N. McCarthy
|
|
|
Vice President, Corporate Controller and Chief Accounting Officer
|
|
|
(Principal Accounting Officer)
|
|
|
|
|
|
|
26