-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UUmkZqG6LXUlKPWJ8RpTi6Px30r3o50WhhV23VBAxLdwNl2AiBMz+YS1Oe/rebk6 F1ibGt7VycMQEEXUdljObg== 0000030822-96-000002.txt : 19960401 0000030822-96-000002.hdr.sgml : 19960401 ACCESSION NUMBER: 0000030822-96-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19951230 FILED AS OF DATE: 19960329 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: DYNAMICS RESEARCH CORP CENTRAL INDEX KEY: 0000030822 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 042211809 STATE OF INCORPORATION: MA FISCAL YEAR END: 1229 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-02479 FILM NUMBER: 96540771 BUSINESS ADDRESS: STREET 1: 60 CONCORD ST CITY: WILMINGTON STATE: MA ZIP: 01887 BUSINESS PHONE: 5084759090 MAIL ADDRESS: STREET 1: 60 CONCORD ST CITY: WILMINGTON STATE: MA ZIP: 01887 10-K 1 25837107 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [ X ]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 30, 1995 OR [ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 1-7348 DYNAMICS RESEARCH CORPORATION (Exact Name of Registrant as Specified in Its Charter) Massachusetts 04-2211809 (State or Other Jurisdiction of(I.R.S. Employer Identification No.) Incorporation or Organization) 60 FRONTAGE ROAD ANDOVER, MASSACHUSETTS 01810-5498 (Address of Principal Executive Offices)(Zip Code) Registrant's telephone number, including area code: (508) 475-9090 Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange on Title of Each Class Which Registered NONE NOT APPLICABLE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.10 Par Value (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No . (Continued) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 18xx, 1996, the aggregate market value of Common Stock held by nonaffiliates of the Registrant was $31xx,045xxx,092xxx and the number of shares of Common Stock, $.10 par value, of the Registrant outstanding was 5x,663xxx,042xxx. Documents Incorporated By Reference Portions of the 1995 Annual Report to Shareholders are incorporated by reference in Parts I and II. Portions of the Registrant's Proxy Statement for the 1996 Annual Meeting of Shareholders are incorporated by reference in Part III. The Exhibit Index is on pages 240 and 251. DYNAMICS RESEARCH CORPORATION Form 10-K For the Fiscal Year Ended December 30, 1995 Part I Page Item 1. Business 4 2. Properties 111 3. Legal Proceedings 122 4. Submission of Matters to a Vote of Security Holders 122 4A. Executive Officers of the Registrant 122 Part II 5. Market for Registrant's Common Equity and Related Stockholder Matters 133 6. Selected Financial Data 133 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 133 8. Financial Statements and Supplementary Data 133 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 144 Part III 10. Directors and Executive Officers of the Registrant 155 11. Executive Compensation 155 12. Security Ownership of Certain Beneficial Owners and Management 155 13. Certain Relationships and Related Transactions 155 Part IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 166 PART I Item 1. Business Dynamics Research Corporation (referred to herein as "DRC" or the "Company") was organized in 1955 under the laws of the Commonwealth of Massachusetts. The Company is principally engaged in providing a broad range of technical services including informationcomputer-based systems development and operation, engineering, and management support services to organizations of the United States Department of Defense (DoD), other agencies of the U.S. Government and commercial companies. The Company also designs, and manufactures and sells digital instruments and precision componentsproducts and measurement devices,that are often used as components in computer- controlled systems. The Company's products and services fall within the following broad categories: Information systems development and operation Engineering and management support services Digital instruments and components The following sections describe each of these business areas and related major programs and products. Information Systems Development and Operation DRC maintains a multi-vendor data processing environment with professionals who provides systems analysis and programming support primarily to government customers. The Company designs, develops, installs, operates, and maintains custom-engineered data systems. Systems developed by DRC gather information electronically from various sources, organize the data and store it in large databases. The Company's systems enable customers to track product location and configuration, and perform detailed reliability, maintainability, quality assurance, vendor qualification and cost analyses. The Company has developed systems for transit vehicles, missiles, submarines, surface ships, land warfare weapons, and aircraft. The Company's major DoD information systems programs are sometimes referred to as logistics information systems. These systems are essentially product management information systems and involve inventory requirements and control, maintenance and repair, warranty analysis, supply, distribution and other functions critical to effective and economical support of system hardware and software throughout the system's life. Under contract with the U.S. Air Force, the Company has designed, developed, implemented and operates TICARRS (Tactical Interim CAMS and REMIS Reporting System) for the F-16 aircraft. The TICARRS databases accept data entries and requests from numerous Air Force user organizations worldwide. The TICARRS databases are continuously expanded and provide, upon request by the Air Force user organizations worldwide, a variety of operational reports. Data include results from worldwide F-16 flight operations and maintenance activities. While remote computer terminals and communications interfaces are an integral part of the system, the host computer facility and its associated F-16 databases are located at a Company facility where system operations are supported around the clock. Based on TICARRS, DRC developed a Smart Data System (SDS) for the F- 117A Stealth Fighter Program by special request of the U.S. Air Force. It was used in the Persian Gulf to support Operation Desert Storm. The SDS is an on-line interactive aircraft maintenance data reporting and analysis system supporting operational, staff, depot and contractor organizations. For nearly thirty years, the Company has assisted the U.S. Navy's Fleet Ballistic Missile program office in the design, development, and operation of inertial systems. The Company has extensive experience with the Polaris, Poseidon, and Trident missile guidance systems and submarine inertial navigation systems. The Company develops and maintains performance, reliability, and logistics databases for the inertial guidance instruments housed in those systems. These databases track detailed information on thousands of component parts comprising the systems. This information is used by the customer for a wide range of operating management tasks and decision making. Also for the U.S. Navy, the Company provides independent analysis and monitoring of submarine-based inertial guidance systems and electronic modules. The Company's support capabilities include its Inertial Instrument Test Laboratory, which is equipped for full-scale performance testing of navigational quality inertial instruments. Weapon Systems Management Information System (WSMIS) is a primary Air Force decision support tool for assessing the impacts of logistics status on potential wartime capabilities. WSMIS computes inventory requirements and purchasing needs for high-tech, high-cost aircraft spare parts to meet aircraft availability requirements. WSMIS also controls repair, manufacturing and distribution schedules to meet customer demands. WSMIS assesses the "health" and capability of the Air Force's weapon systems to meet wartime objectives. DRC served as the overall functional integrator of WSMIS and the developer of certain WSMIS modules. Currently, the Company continues to provides operational support for the system as well as software development modifications and other changes. During 1994, DRC completed work as subcontractor under the U.S. Air Force Aircraft Mishap Prevention (AMP) Program. The Company developed a new system to facilitate aircraft accident analysis. The system helps analysts systematically identify safeguards, corrective actions, and countermeasures to reduce the number and impact of human factors that contribute to aircraft mishaps. Critical to the development of information systems is the Company's software development process and related tools. The Company's approach to mission-critical software stresses principles of continuous software quality evaluation and increased visibility throughout the software development life cycle. The Company uses commercially available software development tools and internally developed tools to meet the needs of software acquisition managers and developers. The Company has also developed computer-based tools thatwhich evaluate the quality of software programs and determine how well they adhere to predetermined standards. One of these tools, AdaMAT, is licensed to both government and commercial customers as a tool for an Ada software engineering environment. The Company designed this static code analyzer for use with the Ada programming language. AdaMAT helps Ada users and managers of Ada development efforts adhere to specific programming practices and program development goals during coding, testing, and maintenance of the software. by AdaMAT allowings visibility into the quality of the code at any given point in time. AdaMAT incorporates a hierarchy of software metrics including management-related concerns such as reliability, portability, maintainability; and software-related concerns such as code simplicity, modularity, and self-descriptiveness. Engineering and Management Support Services Under various DoD contracts, the Company has performed a variety of services for its U.S. Government customers to assist them in the planning and managing of their large system development programs. This business area utilizes a wide range of technical and management skills of Company personnel to plan, analyze, design, test, support, train, maintain, and dispose of a variety of complex physical systems. Systems include radar, C3I, missile, aircraft, information, software, munitions, and soldier protective gear. The Company provides support at all stages of a system's life. In response to emerging requirements, the Company helps customersclients define, develop, and initiate new programs. The Company also helps customersclients obtainreceive program approval, conduct strategic planning, and evaluate proposals from industry. After prime contract awards, the Company helps clients monitor contractor activities, evaluate progress, and measure performance against program requirements. Under the umbrella of the U.S. Air Force Technical and Engineering Management Support (TEMS) and System Design and Analysis Support (SDAS) contracts, the Company has supported, among others, the following programs out of the Air Force Electronic Systems Center at Hanscom Air Force Base in Massachusetts: o Milstar o Airborne Warning and Control System (AWACS) o Joint Surveillance Target Attack Radar System (JSTARS) o Mission Planning Systems o Cheyenne Mountain Upgrade o U.S. Transportation Command/Air Mobility Command Support o PEACE SHIELD Air Defense System o Airborne Battlefield Command and Control Center o Over-the-Horizon Radar o Theater Battle Management Core Systems (TBMCS) DRC served as a prime contractor under the TEMS program from 1984 to 1993. During 1993, the Air Force recompeted the TEMS program and awarded contracts to eight contractors, including several small and "disadvantaged" businesses. DRC was a subcontractor on one of the winning teams, and has been subsequently added as a subcontractor to several of the other winning bidders. In addition, in January 1996, the Company acquired the Massachusetts-based operations of Support Systems Associates, Inc. The acquired assets included a prime contract to provide support services under the TEMS program.As a result, DRC has retained substantially all the tasks it had previously performed as a prime contractor, although. As discussed in the Company's third and fourth quarter reports during 1993, financial results have been adversely affected by the reduced hourly rates available as a subcontractor.. To favorably position itself for future TEMS programs as a prime contractor with the Air Force Electronic Systems Center (ESC), the Company acquired a Massachusetts based business of Support Systems Associates, Incorporated (SSAI) in January 1996. "The acquisition of the Massachusetts based operations of Support Systems Associates, Inc. (SSAI) in January, 1996 is a major accomplishment in our effort to strengthen the Air Force management support services portion of our Systems Division. The combination of our existing business base and resources with the SSAI contrctual vehicles enhances our competitiveness in this important business area." In February 1995, the U.S. Air Force awarded to the Company a 5-year contract (one year plus four option years), valued depending on customer task ordering at up to $23.7 million. Under the contract, DRC will provide technical and engineering services to the U.S. Air Force Air Logistics Center at Tinker AFB, Oklahoma. Initial tasking under the new contract included orders to provide independent test and evaluation services of certain avionics and software under the Air Force B-1B aircraft program. DRC has been supporting the B-1B programthis program office since 1990. In November 1993, the Defense Information Systems Agency (DISA) awarded its Defense Enterprise Integration Services (DEIS) contract, an estimated $900 million, five- year program, to six competitors. DRC is a member of the winning Computer Sciences Corporation team. DEIS is an indefinite order, indefinite quantity program that may be a vehicle for a wide variety of tasks which DRC will perform for DISA and related agencies. In particular, DRC brings its experience in Business Process Re-Engineering (BPR), as well as systems development, integration and migration, to the DEIS program. In particular, DRC brings its experience in Business Process Re-Engineering (BPR), as well as systems development, integration and migration, to the DEIS program. The Company is also supporting the DoD in the area of acquisition logistics. DRC technical staff helpassist the customers to plan and manage the implementation of program requirements throughout all phases of the acquisition process. From 1987 to present the Company has provided services to the Ballistic Missile Defense Organization (BMDO) that include operating and support considerations during the early conceptual phases of the BMDO program. In 1995, the Company received a five-year contract (one year plus four option years) to provide logistics modeling and analysis for the U.S. Air Force Air Staff, with a potential value depending upon tasking of up to $6.9 million. The Company also received a $400,000 contract from the Federal Aviation Administration for a radar performance monitoring and analysis system and a $600,000 contract for logistics modeling support for the DoD's Joint Advanced Strike Technology program. From 1987 to present the Company has provided acquisition logistics services to the Ballistic Missile Defense Organization (BMDO). In February 1995, the Company received a $0.7 million contract to provide logistics modeling support for the Joint Advanced Strike Technology program. Also in February 1995, an indefinite quantity contract was awarded to the Company to provide logistics support to the Air Staff. The Company combines its expertise in the weapon system acquisition process with expertise in systems analysis, design, training and simulation, and human factors to perform human-systems integration and force analysis. DRC has been provideding force analysis support to the Army Research Laboratory since 1987. Force Analysis activities are focused on developing tools that support analysis of soldier and system effectiveness, identify and assess force improvement options (doctrine, training, leader development, organization, and material), and ensure that soldier considerations are addressed in force improvements. In 1995, DRC won a $22.5 million 5-year contract from the U.S. Army Research Laboratory to providewhich builds on the Company's capabilities providing analysis, system development and support in several functional areas, including assessment of manpower, personnel and training issues, analysis of soldier systems performance, and integration of methods and databases for use by system designers. Under the Company's previouscurrent contract, begun in 1991, DRC developed a set of automated manpower and personnel integration analysis tools that are used to analyze system cost versus performance to help maintain optimal system performance at an affordable price. DRC also developed methods for analyzing training requirements to promote standardized training across the military services. In addition, DRC developed advanced crew coordination training methods for the Army aviation community designed to help reduce aviation mishaps. from the U.S. Army Research Laboratory which singA follow-on to the current contract is presently under evaluation with award expected during the first half of 1995. Through its human-systems integration efforts, the Company helps the military benefit through improved performance and effectiveness, by matching soldiers to the tasks they must perform; cost and resource savings, by making soldiers more effective and by automating tasks; and more effective system design, by documenting relationships of design options to eventual performance. HARDMAN III, a suite of microcomputer-based tools developed by DRC, estimates a weapon system's manpower and training requirements, calculating manpower requirements by military specialty, skill level, pay grade, and maintenance level for every unit within a specified force structure. This suite of tools also allows analysts to locate and distribute system-level requirements to lower-level tasks with consistency; estimate and set required parameters for personnel quality constraints that affect job performance; and evaluate contractor designs on the basis of performance requirements, available maintenance support, and operator crew sizes. The training model estimates a weapon system's total course costs, costs per graduate, instructor requirements, and training man-day requirements. The HARDMAN software has been used on over fifteen Army weapon systems. , including the APACHE helicopter, and can produce manpower requirements for the Active Army, Reserves, and National Guard components. DRC is a subcontractor to Loral Federal Systems for the Close Combat Tactical Trainer program (CCTT). CCTT will simulate Army tank and mechanized infantry units from vehicle crews to the battalion level. CCTT will use distributed, interactive simulation technology to provide a "virtual" training environment. DRC will conduct all manpower and personnel integration activities such as training, human factors engineering, system safety, health hazards, and survivability, and will develop modules of software for CCTT that generate tactical exercises and that assess unit performance. DRC has been supporting the B-1B Program Office since 1990. We provide independent, third party test and evaluation services to ensure the proper installation and implementation of avionics and software modifications. In 1994, the Company received an award to continue these services through the Government's 1995 fiscal year. DRC staff in offices in Oklahoma City, Oklahoma and Andover, Massachusetts support this program. , insert proven technology into the design of new and existing Air Force systems and processes resulting in improvements to life-cycle cost, productivity, efficiency, reliability, maintainability, supportability and survivability provide technical and engineering services DRC staff in offices in Oklahoma City, Oklahoma and Andover, Massachusetts support this program. The Company's Test Equipment Division provides a variety of research, engineering, and manufacturing services in support of the U.S. Navy, including test equipment services for the Trident submarine's inertial gyroscopes, accelerometers, and other components. Also for the Navy, the Company has developed an automated system used for the design, simulation, synthesis, analysis, and verification of integrated circuits, printed circuit boards, and entire electronic systems. During 1994, the Company's Systems and Test Divisions competitively bid and won an Air Force contract to produce a test system for secure tactical communications devices. Company systems engineers are responsible for the integration of commercially available components with sophisticated software supplied by a subcontractor. The system operates with a DEC Alpha workstation. Future system sales depend on system performance capabilities as well as cost and customer budget factors. During 1995, DRC was awarded two major prime contracts awards as a result of a concerted multi-year effort to serve Federal agencies other than DoD., traditionally our principal customer. successful in accomplishing its plans to penetrate the non-DoD information technology business by being awarded two prime contracts: the The first award was fromwith the U.S. Department of the Treasury to provide information technology support services to the Internal Revenue Service and other Treasury departments. The contract is for one year plus four one-year options with an aggregate ceiling of $200 million. The contract may be used for a broad range of information system development, acquisition support, and other management services. The Treasury made multiple awards and expects the best technical and management performing contractors to obtain the highest level of tasking over the life of the program. The secondAlso was with award, from the General Services Administration,, permits DRC to provide a broad range of information technology services including software management, communications systems support, satellite communications systems, acquisition support, and system engineering under the GSA's Federal Systems Integration and Management program (FEDSIM). This contract may serve as a vehicle for services to the GSA as well as other Federal agencies. The amount of revenue that DRC may achieve under this contract is uncertain. The FEDSIM program is for $840 million over 5 years among eight winning teams. Digital Instruments and Precision Components The Company operates two units that produce digital instuments and precision components manufactured products for commercial markets, the Encoder Division and the Metrigraphics Division. The Encoder Division designs, manufactures and markets a line of digital encoders used to sense position in a wide range of equipment. These products use optical techniques to convert motion to digital signals that can then be used to control the speed and position of devices such as machine tools, computer peripherals, robotics arms and medical equipment. Beginning in late 1992 and continuing through 1993, the Company invested in a specialized production line and produced a line of encoders for an automotive industry manufacturing customer. This line of encoders is designed into a fuel pump and is used to control fuel flow and reduce emissions. Manufacturing on the line commenced in 1993, and became fullywas fully operational infor 1994 and has continued through 1995, contributing sales of approximately $5 million in 1995. The continuation of this business throughout 1995 and beyond depends on follow-on orders on mutually satisfactory terms and conditions, end user demand for the vehicles equipped with the system and other factors. The Metrigraphics Division uses photolithographic processes to manufacture optical discs, scales and reticles thatwhich are used for precision measurement. Metrigraphics also uses various metals deposition processes, including electroplating and electroforming, to produce a variety of precision components. Products include printheads and oriface plates used in electronic printers. Using a process called electroforming, DRC manufactures precision components used in inkjet cartridges. During 1995, the Metrigraphics DivisionDRC received a $10 million order to produce these components. The order is for delivery in 1996. In December 1995, the Company leased 27,000 square feet in Wilmington, Massachusetts to provide space for a second electroform production facility. Approximately $5 million has been committed for the purchase of production equipment for the new facility, $1.9 million of which was incurred in 1995.and is the largest commercial order ever received by DRC. Uu,. manufactures precision components used in inkjet cartridges. DRC has been investing capital funds during 1995 to increase electroform production capacity, and has recently committed to an additional $3.0 million capital expansion program to meet customer requirements.committed to a $2.4 million capital expansion program to meet customer requirements. The customers for both of these dDivisionsproducts are primarily manufacturingOEM companies which integrate the Company's components into their equipment. Encoder and Metrigraphics engineers work closely with customer engineers to design and develop prototypes to meet customer product requirements. Repeat orders for these customer-designed components are a significant factorelement of sales. High quality standards and competitive unit costs are critical aspects of this business. United States Government Contracts Contracts for the Company's defense services are obtained by marketing and technical personnel employed by the Company. The Company's other products are sold by sales personnel employed by the Company and sales representatives. During 1995, the Company's revenues from contracts with the DoDDepartment of Defense, either as prime contractor or subcontractor, accounted for approximately 78% of the Company's total revenues. The Company's government contracts can fall into one of three categories: (1) fixed price, (2) time and materials, andor (3) cost plus fixed fee. Under a fixed price contract, the customer pays an agreed upon price for the Company's services or products, and the Company bears the risk that increased or unexpected costs may reduce its profits or cause it to incur a loss. Conversely, to the extent the Company incurs actual costs below anticipated costs on these contracts, the Company could realize greater profits. Under a time and materials contract, the government pays the Company a fixed hourly rate intended to cover salary costs and related indirect expenses plus a certain profit margin. Under a cost plus fixed fee contract, the government reimburses the Company for its allowable expenses and allowable costs and pays a negotiated fee. In 1995, approximately xx56% of the Company's government contracts revenue was under fixed price or time and material contracts, while approximately xx44% of revenue was under costs plus fixed fee contracts. During 1995, the Company's U.S. Government business consisted of approximately 135 separate contracts on 60xx different programs. The Company's contracts with the government are generally subject to termination at the convenience of the government; however, the Company would be reimbursed for its allowable costs to the time of termination and would be paid a proportionate amount of the stipulated profit attributable to the work actually performed. Although government contracts may extend for several years, they are generally funded on an annual basis and are subject to reduction or cancellation in the event of changes in government requirements or budgetary concerns. If the U.S. Government significantly curtails expenditures for research, development and consulting activities, such curtailment might have an adverse impact on the Company's sales and earnings. Backlog At December 30, 1995, the Company's backlog of unfilled orders was approximately $61,284,000 compared with $43,679,000 at December 31, 1994. The Company expects that substantially all of its backlog on December 30, 1995 will be filled during itsthe fiscal year ending December 28, 1996. The bBacklog at December 30, 1995 consisted of funded amounts under contracts. Backlog at December 30, 1995 included $xx25,528xxx,000xxx of unfunded amounts under ongoing programs which were contractually committed by the procuring Government agency. The Company has a number of multi-year contracts with agencies of the U.S. Government on which actual funding generally occurs on an annual basis. The Company's business does not have seasonal characteristics but a portion of its funded backlog is based on annual purchase contracts, and the amount of funded backlog as of any date can be affected by the timing of order receipts and deliveries thereunder. Competition The Company competes with both domestic and foreign firms, including larger diversified companies and smaller specialized firms. The U.S. Government's own in-house capabilities are also, in effect, competitors of the Company becausesince various agencies perform certain types of services which might otherwise be performed by the Company. The principal competitive factors for dDefense sServices are price, performance, technical competence and reliability. In addition, in the our commercial business, the Company also competes with other manufacturers of encoders, electroform vendors and photolithographic suppliers of precision measurement scales. The principal competitive factors effecting the precision components manufacturing business are price, product quality and custom engineering to meet customer system requirements. Research and Development The Company expended approximately $1,949,000 (inclusive of overhead and other indirect costs) on new product and service development during the year ended December 30, 1995, as compared to expenditures of $224,000 during 1994 and $2,007,000 during 1993. Raw Materials Raw materials and components are purchased from a large number of independent sources and are generally available in sufficient quantities to meet current requirements. Environmental Matters Compliance with federal, state and local provisions relating to the protection of the environment has not had and is not expected to have a material effect upon the capital expenditures, earnings or competitive position of the Company. Employees At December 30, 1995, the Company had approximately 1,249 employees. Proprietary Information Patents, trademarks and copyrights are not materially important to the business of the Company. The United States Government has certain proprietary rights in processes and data developed by the Company in its performance of government contracts. Item 2. Properties The Company leases offices and other facilities, totaling approximately 231,000170,000 square feet, which are utilized for its defense services, manufacturing and warehousing operations as well as its marketing and engineering offices. The Company has manufacturing and office space in Wilmington, Massachusetts under threetwo leases totaling 11385,000 square feet, expiring in 20001995, with options to the year 20050. The remaining leased facilities consist of offices in 242 locations across the United States. The Company owns aits 135,000 square foot facility in Andover, Massachusetts. This building was purchased in 1993 and is utilized for its defense service operations and corporate administrative offices. The Company's total rental cost for 1995 was $1,636,000. The Company believes its properties are adequate for its present needs. See Note 7 to the Consolidated Financial Statements included in the Company's 1995 Annual Report to Shareholders for a description of the Company's lease obligations. Item 3. Legal Proceedings None.The information set forth in the last paragraph of Note 7 to the Consolidated Financial Statements included in the Company's Annual Report to Shareholders for 1995 is incorporated herein by reference. The complaint described therein, filed in the United States District Court for Massachusetts by the United States Government, was dismissed in connection with a settlement agreement entered into by the Company in April 1994. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. Item 4A. Executive Officers of the Registrant The following is a list of the names and ages of the executive officers of the Company indicating all positions and offices held by each person and each person's principal occupations or employment during the past five years. The executive officers were elected by the Board of Directors and will hold office until the next annual election of officers and their successors are elected and qualified, or until their earlier resignation or removal by the Board of Directors. There are no family relationships between any executive officers and directors. Years of Age Service Position John S. Anderegg, Jr. 72 41 Chairman Albert Rand 69 36President and Chief Executive Officer John L. Wilkinson 56 14 Vice President, Human Resources Douglas R. Potter 45 2 Vice President of Finance, Chief Financial Officer Each of the persons named above has served in the position indicated for more than five years, with the exception of Douglas R. Potter. Mr. Potter was appointed Vice President of Finance and Chief Financial Officer in November 1993. Previously hHe was Vice President, Treasurer, and Chief Financial Officer of SofTech, Inc. of Waltham, Massachusetts fromsince 1990 to 1993. and Corporate Controller from 1985 to 1990. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The common stock of Dynamics Research Corporation is traded on the National Market System of the National Association of Securities Dealers, Inc., Automated Quotation System (NASDAQ - NMS) under the symbol DRCO. The high and low bid prices for the quarters in 1994 and 1995 and the number of holders of record of the Company's common stock are described in the Company's Annual Report to Shareholders for 1995 under the caption "Stock Prices" and "Number of Shareholders," and such information is incorporated herein by reference. In September 1984, the Board of Directors indicated its intention not to declare cash dividends to preserve cash for the future growth and development of the Company. The Company did not declare any cash dividends betweenduringbetween 1984 and 19954 and does not anticipate doing so for the foreseeableforseeable future. Item 6. Selected Financial Data The section entitled, "Five Year Summary of Selected Financial Data" in the Company's Annual Report to Shareholders for 1995 is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The section entitled, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report to Shareholders for 1995 is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data The following financial statements are filed as part of this Annual Report: Report of Independent Public Accountants Consolidated Balance Sheets at December 30, 1995, December 31, 1994 and December 25, 1993 Consolidated Statements of Operations for the three years ended December 30, 1995 Consolidated Statements of Shareholders' Investment for the three years ended December 30, 1995 Consolidated Statements of Cash Flows for the three years ended December 30, 1995 Notes to Consolidated Financial Statements (The consolidated financial statements and related notes listed above are incorporated by reference to the Company's Annual Report to Shareholders for the year 1995.) Report of Independent Public Accountants on Schedules to Consolidated Financial Statements Schedule VIII - Valuation and Qualifying Accounts for the three years ended December 30, 1995 The foregoing schedule is included as part of Item 14 of this Annual Report on Form 10-K All other financial statements and schedules have been omitted because the information required to be submitted has been included in the financial statements and related notes or they are either not applicable or not required under the rules of Regulation S-X. Quarterly financial data presented on page 13, and Management's Discussion and Analysis of Financial Condition and Results of Operations presented on pages 26-28, of the Company's Annual Report to Shareholders for the year 1995, are also incorporated herein by reference. With the exception of the portions listed in the above index, the Annual Report referred to above is not to be deemed filed as part of the financial statements. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant Information with respect to Directors of the Registrant in the section entitled "Election of Directors" in the Company's definitive proxy Statement for the 1995 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 30, 1995, is incorporated herein by reference. Information relating to the Executive Officers of the Company is included in Item 4A of Part I of this Form 10K. Item 11. Executive Compensation Information called for by this item is incorporated by reference from the section entitled "Compensation and Related Matters" in the Company's definitive Proxy Statement for the 1995 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 30, 1995. Item 12. Security Ownership of Certain Beneficial Owners and Management Information called for by this item is incorporated by reference from the sections entitled "Common Stock Ownership of Certain Beneficial Owners and Management" in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year ended December 30, 1995. Item 13. Certain Relationships and Related Transactions Not applicable. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) (1) and (2) Financial Statements and Schedules - See Item 8. (a) (3) Exhibits. The exhibits thatwhich are filed with this Form 10- K or thatwhich are incorporated herein by reference are set forth in the Exhibit Index, which appears in Part IV of this report on pages 240 and 251. (b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during the last quarter of fiscal 19954. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES TO CONSOLIDATED FINANCIAL STATEMENTS To Dynamics Research Corporation: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Dynamics Research Corporation's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 16, 19965. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the accompanying index is the responsibility of the company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Boston, Massachusetts, February 126, 19965 IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS The following factors, among others, could cause the Company's actual results and performance to differ materially from those contained in forward-looking statements made in this report and presented elsewhere by or on behalf of the Company from time to time. Uncertainties as to Department of Defense and Other Federal Agency Budgets The Company has historically derived a substantial portion of its revenue from contracts and subcontracts with the Government, and currently more than 78% of the Company's revenue is derived from the Department of Defense business. Over the past several years, the Company's defense business has been adversely affected by significant changes in defense spending. Overall U.S. defense budgets have been declining, and the effects of this general decline and attendant increased competition within the consolidating defense industry is expected to continue over the next several years. Funding limitations could result in a reduction, delay, or cancellation of existing or emerging programs. These factors, among others, have reduced the Company's revenue and operating margins on its defense contracts in recent fiscal periods. The Company anticipates that competition in all defense-related areas will continue to be intense and that, accordingly, there will be continued significant competition when the Company's defense contracts are rebid and continued significant competitive pressure to lower prices, which may reduce profitability in this area of the Company's business. Any reduction in the level or profitability of the Company's defense business, if not offset by new commercial business or other business with the federal government, will adversely affect the Company's business, financial condition and results of operations. A significant portion of the Company's Government contracts are renewable on an annual basis, or are subject to the exercise of contractual options. Also, multi-year contracts often require funding actions by the Government on an annual or more frequent basis. As a result, the Company's business could experience material adverse consequences should the Government budget not include funds required to sustain the programs under which DRC operates. Government Contracting Risks A significant portion of the Company's Government contracts are of a time and materials nature, with fixed hourly rates that are intended to cover salaries, benefits, other indirect costs of operating the business and profit. The pricing of such contracts is based upon estimates of future costs and assumptions as to the aggregate volume of business that the Company will perform in a certain business division or other relevant unit. For long term contracts, the Company must estimate the costs necessary to complete the defined statement of work and recognize revenues or losses in accordance with such estimates. However, actual costs may vary materially from the estimates made from time to time, necessitating adjustments to reported revenue and net income. Underestimates of the costs associated with a project would adversely affect the Company's overall profitability and could have a material adverse effect on the Company's business, financial condition and results of operations. The Government's awards of contracts are subject to regulations and procedures that permit formal protests by losing bidders. Such protests may result in significant delays in the commencement of expected contractual effort, or the reversal of a previous award decision, which could have a material adverse effect on the Company's business, financial condition and results of operations. Because of the complexity and scheduling of contracting with the Government, from time to time costs are incurred in advance of contractual funding by the Government. In some circumstances, such costs may not be recovered in whole or in part under subsequent Government contractual actions. Failure to collect such amounts may have material adverse consequences on the Company's business, financial condition and results of operations. Costs incurred in connection with Government contracts are generally subject to after-the-fact audits. Such audits may result in material disallowances, which could have an adverse effect on the Company's business, financial condition and results of operations. A substantial portion of the Company's Government contracting business is as a subcontractor. In such circumstances, the Company generally bears the risk that the prime contractor will meet its performance obligations to the Government under the prime contract and that the prime contractor will have the financial capability to pay the Company amounts due under the subcontract. The inability of a prime contractor to perform or make required payments could have a material adverse effect on the Company's business, financial condition and results of operations. The Government has the right to terminate contracts for convenience. In such a termination, the Company would generally recover costs incurred to termination, costs required to be incurred in connection with the termination, and a portion of the fee earned commensurate with the work performed to termination. However, significant adverse effects on the Company's indirect cost pools may not be recoverable in connection with a termination for convenience. Dependence or Key Personnel The Company is dependent on its key technical personnel. In addition, certain technical contributors may have specific knowledge and experience related to various Government customer operations that would be difficult to replace in a timely fashion. The loss of the services of key personnel could have a material adverse effect on the Company's ability to perform required services under certain contracts, or to retain such business after the expiration of the current contract, or to win new business where certain personnel have been identified as key personnel in the proposal, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. Competition The Government contracting business is subject to intense competition, both technical and pricing, from numerous companies, many of which have significantly greater financial, technical and marketing resources than the Company. Competition in the market for the Company's commercial products is also intense. There is a significant lead time for developing such business, and it involves significant capital investment including development of prototypes and investment in manufacturing equipment. The Company's precision products business has a number of competitors, many of which have significantly greater financial, technical and marketing resources than the Company. Risks Associates with New Markets and New Products In its efforts to enter new markets, including Government agencies other than the Department of Defense and commercial markets, the Company faces significant competition from other companies that have prior experience with such potential customers as well as significantly greater financial, technical and marketing resources than the Company. As a result, the Company's efforts to enter such new markets may be unsuccessful or may not achieve the level of success sought by the Company. The Company has announced software products for commercial markets. There is no assurance that the Company's software products will meet with market acceptance or that the Company will be able to compete in the development and distribution of such products with competitors that have significantly greater resources and experience. Concentration of Customers Within the Department of Defense, individual services and program offices account for a significant portion of the Company's Government business. Two customers account for a significant portion of the revenue of the Company's commercial manufacturing divisions. No assurance can be provided that any of these customers will continue as such or will continue at current levels. A decrease in orders from these customers would have an adverse effect on the Company's profitability, and the loss of any large customer could have a material adverse effect on the Company's business, financial condition and results of operations. Risk of Product Claims The Company's precision manufactured products are generally designed to operate as important components of complex systems or products, and defects in DRC products could cause the customer's product or systems to fail or perform below expectations. Like other manufacturing companies, the Company may be subject to claims for alleged performance issues relating to its products. There can be no assurance any such claims, if made, will not have a material adverse effect on the Company's business, financial conditions or results of operations. Risk of Economic Events Effecting the Company's Business Segments Certain of the Company's precision products are components of commercial products. Factors that affect the production and demand for such products, including economic events, competition, technological change and productions stoppages, could adversely affect demand for the Company's products. Certain of the Company's products are incorporated into capital equipment, such as machine tools and other automated production equipment, used in the manufacture of other products. As a result, this portion of the Company's business may be subject to fluctuations in the manufacturing sector of the overall economy. An economic recession could have a material adverse effect on the rate of orders received by the commercial divisions. Significantly lower production volumes resulting in under-utilization of the Company's manufacturing would adversely impact the Company's profitability. Technological Change The Company's knowledge base and skills in the Government contracting area are sophisticated and involve areas in which there have been and are expected to be significant technological change. There is no assurance that the Company will continue to be able to offer services that satisfy its customers' requirements at a competitive price. Many of the Company's products are incorporated into sophisticated machinery, equipment or electronic systems. Technological changes may be incorporated into competitor's products that may adversely affect the market for the Company's products. Further, there can be no assurance that the Company's research and product development efforts will be successful and result in new or improved products that may be required to sustain the Company's market position. Uncertainty of Future Financing Although the Company has no immediate plans to raise additional capital, it may in the future need to raise additional funds through public or private debt or equity financings. There can be no assurance that any such funding will be available or of the terms or timing of any such funding. SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 25, 1996 DYNAMICS RESEARCH CORPORATION by: /s/ Albert Rand Albert Rand, President (Principal Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on the 25th of March, 1996. /s/ Albert Rand Albert Rand Director, President, Chief Executive Officer /s/ Douglas R. Potter Douglas R. Potter Vice President of Finance, Chief Financial Officer (Principal Financial and Accounting Officer) /s/ John S. Anderegg, Jr. John S. Anderegg, Jr. Director, Chairman /s/ Francis J. Aguilar Dr. Francis J. Aguilar Director /s/ Thomas J. Troup Thomas J. Troup Director /s/ James P. Mullins Gen. James P.Mullins Director SCHEDULE VIII DYNAMICS RESEARCH CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED DECEMBER 30, 1995 (in thousands of dollars) ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURNS Balance, December 26, 1992 $356 Additions charged to expense 63 Write-off of uncollectible accounts, net (1) Balance, December 25, 1993 $418 Additions charged to expense 222 Write-off of uncollectible accounts, net (54) Balance, December 31, 1994 $586 NetAdditions recoveries charged to expense (2) Write-off of uncollectible accounts, net (182) Balance, December 30, 1995 $402 EXHIBIT INDEX 3.0 Certificate of Incorporation and By-Laws. 3.1 Restated Articles of Organization dated May 22, 1987. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/13/87) 3.2 By-Laws dated May 22, 1987. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/13/87) 4.0 Instruments defining the rights of security holders, including indentures. 4.1 Common stock included in Exhibit 3.1 through 3.2. 4.2 Preferred stock included in Exhibit 3.1 through 3.2. 4.3 Rights Agreement dated as of July 14, 1988 ("Rights Agreement") between the Company and American Stock Transfer & Trust Company, as Rights Agent.* (Incorporated by reference to the Registrant's Form 8-K on July 14, 1988) 4.4 Rights Agreement Amendment No. 1 dated as of September 6, 1989.* (Incorporated by reference to the Registrant's Form 8-K on September 12, 1989) 10.0 Material Contracts 10.1 Amended 1983 Stock Option Plan. dated January 14, 1987 (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/27/87) Plan terminated during 1993.* 10.2 1993 Equity Incentive Plan. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/12/93) 10.3 1995 Stock Option Plan for non-employee directors. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/31/94) 10.42 Form of Dynamics Research Corporation Indemnification Agreement for Directors as of July, 1988. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91)* 10.53 Form of Dynamics Research Corporation Severance Agreement for Messrs. Anderegg and Rand as of July, 1988. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91)* 10.64 Dynamics Research Corporation Deferred Compensation Plan for Non-Employee Directors as of October 22, 1991. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91)* 10.75 Mortgage Aagreement dated February 5, 1993 on the Andover office building as referred above between Dynamics Research Corporation and ABN AMRO Bank, N.V., Boston branch of a Connecticut corporation. (Incorporated by reference to the Registrant's Form 8-K on May 5, 1993) 10.6 1993 Equity Incentive Plan dated April 27, 1993. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 6/12/93)* 10.7 1995 Stock Option Plan for non-employee directors filed herewith.* 13.0 Annual Report to security holders, Form 10-Q or quarterly reports to security holders. 13.1 The Company's Annual Report to Shareholders for the year ended December 30, 1995 filed herewith with the exception of the information incorporated by reference in parts I, II and IV of this Form 10-K is not deemed to be filed as part of this report. 23.0 Consents of experts and counscel 23.1 Consent of Independent Accountants (Arthur Andersen LLP) dated March 26XX, 1996 filed herewith. 99.0 Important Factors Regarding Forward-Looking Statements. * Management contract or compensatory plan or arrangement. EX-27 2
5 1000 YEAR DEC-30-1995 DEC-30-1995 777 0 32,478 0 2,612 37,437 42,252 25,743 53,946 18,264 2,717 0 0 662 32,544 53,946 23,185 103,941 17,579 90,656 12,267 (184) 171 847 288 559 0 0 0 559 .10 .10
EX-13 3 Dynamics Research Corporation ANNUAL REPORT 1995 Solutions Through Information Technology About The Cover Building upon wide-ranging capabilities in information technology, systems integration and engineering, Dynamics Research Corporation serves a diverse customer base whose systems and products must meet demanding performance and cost requirements. As the cover suggests, broad technical, management and manufacturing capabilities form the basis of DRC+s continuing success and strength. Financial Highlights 1995 1994 Revenue $ 103,941 $ 102,964 Net income $ 559 $ 224 Net income per share $ .10 $ .04 Backlog $ 61,284 $ 43,679 Number of employees 1,249 1,130 Number of shares outstanding 5,622,772 5,631,448 Corporate Profile Dynamics Research Corporation applies information system and manufacturing technologies to create innovative solutions for its customers. Our solutions are designed to enhance the performance, reliability, and cost-effectiveness of complex systems. Our mission is to help our customers compete and win in their markets through the continuous improvement of their products and processes. We believe that our innovative people, equipped with the best technology the market has to offer, can create new ways to help our customers deliver better products more cost effectively. To Our Shareholders To Our Shareholders For the year ended December 30, 1995, Dynamics Research Corporation had revenue of $104 million, up from $103 million in 1994. Net income for the year was $559,000, or $.10 per share, an improvement over $224,000, or .04 per share, earned in 1994.Over the past five years, DRC+s sales have been generally flat, in the range of $98 million to $104 million, with declining profits until a modest recovery in 1995. Overall sales have been sustained by an increase of our commercial manufactured products business from $10.9 million in 1991 to $23 million in 1995. Meanwhile defense services peaked at $92 million in 1992 and declined to $81 million in 1995. This situation was unsatisfactory and we adjusted our strategies in each of our business units. Our new strategies were in essence a commitment of resources to developing business in markets with greater potential for growth. The significant contract awards and other events in 1995 are an outgrowth of this sustained strategic effort and make us optimistic for 1996 and beyond. In our Government services business, we recharged our new business development efforts, both with the DoD and with other government agencies. This commitment of resources hurt our profitability, particularly in a period when sales were declining. However, we had significant wins in 1995, including major awards from the Department of the Treasury and the General Services Administration, as described in the following paragraphs. In February 1995, the U.S. Air Force Air Logistics Center at Oklahoma+s Tinker Air Force Base awarded DRC a prime contract to provide technical and engineering services .Valued at up to $23.7 million, this contract initiated a working relationship with an important new customer. This award enables DRC to build its presence at Tinker AFB and to compete more effectively for new business at other Air Logistic Centers in Utah, Georgia, and Texas. Another win of note in 1995 was a $22.5 million, five-year contract from the U.S. Army Research Laboratory. This contract builds on our long experience in manpower planning, training, force analysis and human/system performance factors. This award in these technical specialties provides a vehicle to increase our business in 1996 and beyond. Our long-term Navy customer renewed its contracts with DRC supporting Trident inertial guidance and navigation systems for the government+s 1996 fiscal year at an increased level over 1995. We also continue to provide operation and maintenance system support for all of the Air Force+s F-15 and F-16 aircraft. In June 1995, DRC was awarded a prime contract by the U.S. Department of the Treasury to provide information processing support services to the Internal Revenue Service and other Treasury organizations. The contract is for one year plus four one-year options. Each year under the contract carries a $40 million ceiling. Our goal is to provide the hi ghest quality services, thereby improving our chances of capturing increasing levels of tasking. With a strong team of subcontractors, we believe we are now positioned to compete for tasking in a number of key areas. At the end of December, DRC was awarded a prime contract by the General Services Administration (GSA). The five-year award is a vehicle for providing services to all Federal agencies under the GSA+s Federal Systems Integration and Management program (FEDSIM). Awards were made to DRC and seven other companies who will compete for tasking with a total order limitation of $840 million. The Treasury and GSA contracts are neither an assurance of future revenues nor did they generate significant revenue in 1995. But they position DRC to compete effectively and open the door for future opportunities. As we expand beyond our traditional focus on the Department of Defense, these contracts also provide credibility for DRC in competing for commercial systems and services work. In our precision components manufacturing business, we also recognized the need to change our strategy to achieve growth. We determined that more aggressive marketing and communication of our technological capabilities was needed and the development of higher volume products was necessary for growth and improved profitability. This new strategy began to pay off with sales growth in 1993 which is continuing in 1996. Sales of commercial products accounted for 22% of total revenue in 1995 and we have targeted commercial product sales in 1996 at 27% of total revenue. The highlight for 1995 was a $10 million order received in October for inkjet printer cartridge components. This order represents 1996 delivery requirements under a three-year supply agreement with the customer. To meet the expanding demands, we have leased a 27,000 square foot facility, which will provide manufacturing and office space for our Metrigraphics Division and we are making significant capital investments in production equipment. We want to call your attention to two additional important developments. First, in January 1996, DRC completed the acquisition of the Massachusetts-based operations of Support Systems Associates Inc. This acquisition strengthens our Air Force management support business at Hanscom Air Force Base, in Bedford, Massachusetts, where we have been active for over a decade. Second, the software development process within our Systems Division underwent a rigorous review and attained -Level 2+ certification under standards established by the Software Engineering Institute. This signifies a proven and repeatable software management system with effective quality control processes. It adds to DRC+s impressive credentials in software development for large systems projects. Underlying DRC+s progress and our optimism for the future is the dedication and high quality work of our employees. To all of them we extend our thanks. Albert Rand John S. Andregg, Jr. President and Chairman Chief Executive Officer Building on a base of distinctive competence in information technology, Dynamics Research provides technical, engineering, and management support services to a wide range of clients in the Department of Defense and other federal agencies. l Our systems analysis, design, and software development skills produce innovative solutions for our clients. l As systems integrators, we design, build, and test a variety of advanced systems. l A creative technical staff dedicated to the highest level of service for our clients is at the heart of DRC+s success. Using the Power of Digital Technology: A Common Thread Across DRC+s Business Dynamics Research Corporation+s business includes a broad mix of technical services and engineered products. A common thread that connects this diverse business is the application of digital technologies to enhance system capabilities and performance. Our service efforts include development of large computer-based information systems with specialized features designed to allow managers of expensive systems to use their assets for maximum effectiveness. We build computer controlled systems to test other complex systems. We support our customers in the acquisition and management of electronic systems and the insertion of advanced technologies into existing systems. We utilize current software and hardware technologies to transition older technology systems to new, higher performance computer technology. In the systems and services part of our business, we continue our long association with many different branches and agencies of the Department of Defense, providing a wide range of technical, engineering, and management support services. Our experience in information technology and project management is now finding new markets in non-defense government agencies. Our precision products include encoders that convert motion and position information into digital signals used to control machine tools, robotics, engine performance and many other electronically controlled systems. We also manufacture components critical to the operation of computer controlled inkjet printers. We produce high precision products that give our customers a competitive edge in their markets. Our success in this growing business is based on our expertise in encoder technology and electroforming processes. Innovative techniques for quality control have enhanced our ability to meet exacting specifications while adhering to demanding production schedules for our customers. The following sections of this report describe important developments and other aspects of our principal business areas. High Precision Manufacturing For Commercial Markets Dynamics Research manufactures a growing family of high precision encoders. These motion sensing devices convert analog information to digital form and are essential components in a wide range of computer controlled systems and equipment. With automation becoming increasingly important in manufacturing operations,semiconductor processing, and medical equipment, opportunities for encoder sales continue to increase. A key strategy for expanding our encoder business is to develop strong working relationships with OEM customers. We provide custom engineering services that adapt our products to specific requirements and enable us to explore a variety of new opportunities. While these projects may initially involve only modest production, many have the potential for growth. The largest single factor in the growth of our encoder business is a product used in automotive fuel control systems. These devices are manufactured in volume in our high speed, highly automated facility now in its second full year of operation. Electroformed products are manufactured in our Metrigraphics Division. Using sophisticated metal deposition technology, we create a variety of microminiature components to precision standards. The ability to hold critical tolerances with superior edge definition is important in the manufacture of products used in a wide range of high technology applications. Our largest market is currently for nozzles used in ink jet printers, a growth market fueled by rising sales of computer printers for home and business use.In addition to volume manufacturing of electroformed parts, we produce prototype parts for use in new equipment under test and development. Our ability to provide a high level of responsive service for low volume requirements allows us to develop early working relationships with customers as they attempt to position emerging products for growth in new markets. New processes are being developed by Metrigraphics to electroform three dimensional precision structures which are expected to have an expanding number of future uses in miniaturized products and systems. DRC+s encoders and electroformed parts are designed to meet critical requirements for precision and performance. These devices are manufactured using sophisticated equipment that allows us to achieve consistently superior quality and reliability. l Quality of miniature electroformed parts is maintained in our clean room manufacturing environments. l Using advanced metal deposition techniques, Metrigraphics produces precise microminiaturized structures. l Our use of automated inspection technology ensures high standards of quality in manufacturing. Our successful history of service with DoD is opening new opportunities to provide other federal agencies with technical services, including software management, data communications, systems integration, and business process re-engineering. l Our staff builds on years of specialized experience to help customers improve system effectiveness. l We offer a step-by-step process of systems re-engineering to help clients reduce costs and streamline their business processes. l We help customers capitalize on the latest technologies and use existing resources in new, more efficient ways. Opening New Markets With Government Customers In recent years, Dynamics Research has made a concerted effort to broaden its business by providing services to customers throughout the Federal government. These efforts were rewarded in 1995 with the receipt of two significant contracts, one from the U.S. Department of the Treasury and the other from the General Services Administration (GSA). The Treasury Department selected Dynamics Research as a prime contractor to provide information processing support services to the Internal Revenue Service in connection with their long-term systems modernization program, as well as other Treasury organizations. The scope of work will be spread over three functional areas: information systems and services, federal information processing acquisitionservices, and socio-technical services. To win this award, we assembled a team of industry experts whose capabilities complement ours. Our GSA contract, which was announced in December 1995, positions Dynamics Research to provide a broad range of information technology services to federal agencies. Services may be provided in several functional areas, including: software management, data communications, satellite communications, system acquisition support, business process re-engineering, and systems integration. DRC+s many years of high-quality service to the Department of Defense, in a wide array of information technologies and management support areas, provided the basis for the Treasury and GSA selections. As a result of these two contracts, Dynamics Research is well positioned to expand its customer base beyond the DoD agencies and provide a wide range of technical, engineering, and management support services to other areas of the Federal government. High-Quality Services For Our DoD Customers Dynamics Research continues to build on its long working relationship with the U.S. Department of Defense. In recent years, we have adapted our services to respond to the changing needs of our military customers. Through our involvement with high priority projects, our services improve deployability and joint operations, while increasing readiness on a cost-effective basis. Dynamics Research has provided engineering and information technology services to the U.S. Navy for 40 years. Continuing this long association, we are using Internet techniques and protocols to develop a private and secure network for the Trident community. This electronic network will allow Trident personnel to communicate more effectively, to update critical information more rapidly, and to access a wide range of information on the Trident guidance system. This paperless system will replace older methods and create new efficiencies in analyzing and avoiding problems. The U.S. Air Force is also a major core customer of Dynamics Research. We provide operations and maintenance system support for F-15 and F-16 aircraft; we provide logistics, modeling, and analysis services; and we perform a wide array of acquisition management support services for Air Force electronic systems. In 1995, Dynamics Research won a significant contract to provide technical and engineering services to the Air Force Logistics Center at Tinker Air Force Base in Oklahoma. We will be helping to insert new technology into existing Air Force systems to improve lifecycle costs, productivity, efficiency, and reliability. Business process re-engineering is part of this effort as we develop new working methods that take advantage of new labor-saving technologies. We work closely with military clients to help them take advantage of advances in information technology. Through our involvement with priority projects, we assist clients in achieving high levels of mission readiness at reduced costs. l We use -reverse engineering+ and software simulation to design components for insertion into older systems. l Rigorous testing ensures that DRC hardware meets exacting standards of performance and reliability. l We are developing systems to support the assessment of manpower and training requirements for joint service operations. High-Quality Services For Our DoD Customers - Continued Information technology and the power of digital systems are at the core of DRC+s business. For the U.S. Army Research Laboratory, we are providing analysis, system development, and support in the assessment of manpower, personnel, and training issues. One aspect of this work is our support of a high-visibility project for the Joint Chiefs of Staff in which we are documenting the Universal Joint Task List used in planning and training for all branches of the military. Software is being developed for this program to provide greater efficiency in analyzing and measuring the performance and lifecycle costs of military systems. In our Test Division, we are developing innovative ways to permit rugged and highly stable replacement electronics for older military systems to be available from a secure source at an affordable cost. We are developing and applying -reverse+ engineering techniques in which we analyze existing electronic components, determine the key operating p arameters, and reproduce these components together with appropriate documentation for installation and maintenance. Using software techniques to design and test these components on an -as you go+ basis, we are able to develop replacement components in a highly cost-effective manner. To provide the level of service and hands-on involvement that our customers require, we have established field offices at several different locations, including: Arlington, VA, St. Louis, Oklahoma City, Colorado Springs, Dayton, OH and Scott Air Force Base, IL. These field offices keep us close to our customers and allow us to respond quickly to new opportunities in our areas of expertise, including logistics, systems integration, business process re-engineering, training, and engineering support. FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA
(in thousands of dollars, except per share data)1995 1994 1993 1992 1991 Revenue $103,941$102,964$101,102$102,581$97,701 Operating income 1,018 632 3,242 6,377 5,684 Net income 559 224 1,834 4,014 3,630 Net income per common share** .10 .04 .33 .70 .61 Total assets 53,946 53,977 59,494 48,877 45,397 Long-term debt (excluding current portion) 1,500 2,717 3,900 - - Shareholders' investment 33,206 32,713 32,437 30,805 27,550 Shareholders' investment per share** 5.91 5.81 5.78 5.47 4.74 Return on shareholders' investment (%) 1.7 .7 5.7 13.0 13.2 Backlog 61,284 43,679 51,257 54,547 52,609 Cash flow from operations 7,499 5,721 1,397 9,468 3,416 Research and development expense1,949 224 2,007 1,463 698 Capital expenditures 4,441 2,444 12,144 4,732 3,710 Number of shares outstanding at end of year**5,622,7725,631,4485,610,8785,632,264 5,815,598 Number of employees 1,249 1,130 1,188 1,189 1,195
QUARTERLY DATA*** (in thousands of dollars, except per share data) unaudited 1995 1st Qtr2nd Qtr 3rd Qtr4th Qtr Revenue $21,929$23,936 $24,354$33,722 Operating income/ (lLoss) (602) 550 544 526 Net income/ (lLoss) (388) 318 309 320 Net income/ (lLoss) per common share (.07) .06 .06 .06 1994 1st Qtr2nd Qtr 3rd Qtr4th Qtr Revenue $22,692$23,656 $21,573$35,043 Operating income/ (lLoss) 696 580 (2,699) 2,055 Net income/ (lLoss) 390 302 (1,734) 1,266 Net income/ (lLoss) per common share .07 .05 (.31) .22 1993 1st Qtr2nd Qtr 3rd Qtr4th Qtr Revenue $23,026$24,382 $21,892$31,802 Operating income 1,118 1,034 368 722 Net income 651 594 189 400 Net income per common share* .12 .11 .03 .07 * Retroactively adjusted for the May 1994, February 1993, and February 1992 stock dividends.* Retroactively adjusted for the May 1994 and February 1993 stock dividends. **** The Company uses a 13-period accounting year, each with four weeks. The first three quarters contain 12 weeks, and the fourth fiscal quarter contains 16 weeks. The 1994 fiscal year covered a 53-week period with 17 weeks in the fourth fiscal quarter. CONSOLIDATED BALANCE SHEETS At December 30, l995, December 31, 1994 and December 25, 1993 (in thousands of dollars, except per share data) 1995 1994 1993 Assets Current assets: Cash and cash equivalents $ 777 $ 206 $140 Receivables, less allowances of $402, $586 and $418 16,095 14,939 20,016 Unbilled expenditures and fees on contracts in process 16,383 18,194 17,053 Inventories 2,612 2,353 2,630 Refundable income taxes 286 885 553 Prepaid expenses and other current assets 1,284 1,330 1,315 Total current assets $37,437 $37,907 $41,707 Property, plant and equipment, at cost: Land 1,126 1,126 1,126 Building 7,774 7,774 7,774 Machinery and equipment 31,537 28,857 27,637 Leasehold improvements 1,815 1,377 1,835 Total property, plant and equipment, at cost 42,252 39,134 38,372 Less-accumulated depreciation and amortization 25,743 23,064 20,585 Net property, plant and equipment 16,509 16,070 17,787 Total assets $53,946 $53,977 $ 59,494 Liabilities and Shareholders' Investment Current liabilities: Notes payable $ - $1,200 $3,301 Accounts and drafts payable 3,550 3,442 4,327 Accrued payroll and employee benefits 1,1436,416 5644,649 1,1474,736 Accrued pension 2,363 1,329 909 Accrued vacation 2,061 1,863 1,970 Other accrued benefits 849 893 710 Deferred contract and other revenue 983 894 3,073 Other accrued expenses 1,691210 1,535 944 Current deferred income taxes 4,407888 4,741 4,531 Current portion of long-term debt 1,217 1,221 1,200 Total current liabilities 18,264 17,68222,112 Long-term debt, less current portion 1,500 2,717 3,900 Deferred income taxes 976 865 1,045 Commitments and contingencies Shareholders' Investment Preferred stock, par value, $.10 per share, 5,000,000 shares authorized, none issued Common stock, par value, $.10 per share: Authorized - 15,000,000 shares Issued - 6,618,880 shares in 1995, 6,571,495 shares in 1994 and 6,028,155 shares in 1993 662 657 603 Less: Treasury stock - 996,108 shares in 1995, 940,047 shares in 1994 and 927,357 shares in 1993, at par value (100) (94) (93) Capital in excess of par value 9,219 9,284 6,977 Retained earnings 23,425 22,866 24,950 Total shareholders' investment 33,206 32,713 32,437 Total liabilities and shareholders' investment$53,946 $53,977 $ 59,494 The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF OPERATIONS For the three years ended December 30, 1995 (in thousands of dollars, except per share data) 1995 1994 1993 Revenue: Contract revenue $80,756 $84,891 $88,085 Product sales 23,185 18,073 13,017 Total revenue 103,941 102,964 101,102 Costs and expenses: Cost of contract revenue 73,077 77,398 74,523 Cost of goods 17,579 14,571 10,768 Selling, engineering and administrative expenses 12,267 10,363 12,569 Total operating costs and expenses 102,923 102,332 97,860 Operating income 1,018 632 3,242 Interest expense, net 171 431 250 Income before provision for income taxes 847 201 2,992 Provision (benefit) for income taxes 288 (23) 1,158 Net income $ 559 $ 224 $1,834 Net income per common share** $ .10 $ .04 $ .33 Weighted average number of common shares outstanding** 5,603,111 5,638,700 5,633,354 * Retroactively adjusted for the May 1994 stock dividend and February 1993 stock dividends. * Retroactively adjusted for the May 1994 and February 1993 stock dividends. The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' INVESTMENT For the three years ended December 30, 1995 (in thousands) Common Stock Capital in Issued Treasury StockExcess ofRetained SharesPar ValueSharesPar ValuePar ValueEarnings Balance at December 26, 1992 5,961 $596(841) $ (84) $7,199 $23,094 Year 1993 Stock dividend adjustment(5) - - - (22) 22 Stock options exercised 72 7 - - 206 - Treasury stock purchased - - (86) (9) (406) - Net income - - - - - 1,834 Balance at December 25, 1993 6,028 $603(927) $ (93) $6,977 $24,950 Year 1994 10% stock dividend 509 51 - - 2,255(2,308) Stock options exercised 34 3 - - 94 - Treasury stock purchased - - (13) (1) (42) - Net income - - - - - 224 Balance at December 31, 1994 6,571 $657(940) $ (94) $9,284 $22,866 Year 1995 Stock options exercised 48 5 - - 159 - Treasury stock purchased - - (56) (6) (224) - Net income - - - - - 559 Balance at December 30, 1995 6,619 $662(996) $(100) $9,219 $23,425 The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS For the three years ended December 30, 1995 (in thousands of dollars) 1995 1994 1993 Cash provided by operations: Net income $ 559 $ 224 $1,834 Depreciation and amortization 4,002 4,161 3,872 Increase (decrease) in deferred income taxes111 (180) (32) Provision for receivable reserves (1842) 222 63 4,488670 4,427 5,737 Cash provided by (used for) working capital: Receivables (9721,154) 4,855(4,269) Unbilled expenditures and fees on contracts in process 1,811 (1,141) (839) Inventories (259) 277 (623) Refundable income taxes 599 (332) 997 Prepaid expenses and other current assets 46 (15) (442) Accounts and drafts payable 108 (885) (550) Accrued payroll and employee benefits 1,767 (87) 58 Deferred contract and other revenue 89 (2,179) 193 Other accrued expenses 156(325) 591 365 Accrued and Ccurrent deferred income taxes(334)147210 770 3,0112,829 1,294(4,340) Net cash generated in operations 7,499 5,721 1,397 Cash used for investing activities: Additions to property and equipment, net(4,441)(2,444)(12,144) Cash provided by (used for) financing activities: Net borrowings (repayments) under line of credit agreementsline-of-credit agreements (1,20021) (2,065) 3,081 Proceeds from issuance of the mortgage loan - - 6,000 Principal payment under long-term borrowingsmortgage agreement (1,22100) (1,200) (900) Proceeds from exercise of stock options 164 97 213 Purchase of treasury shares (230) (43) (415) Net cash provided by generated (used for) in financing activities (2,487) (3,211) 7,979 Net increase (decrease) in cash and cash equivalents 571 66 (2,768) Cash and cash equivalents at the beginning of the year206 140 2,908 Cash and cash equivalents at the end of the year $ 777 $ 206 $ 140 Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 435 $ 583 $ 276 Income taxes $ 160 $ 265 $ 905 The accompanying notes are an integral part of these consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of consolidation. The accompanying consolidated financial statements include the accounts of Dynamics Research Corporation and its wholly-owned subsidiaries (the Company). All material intercompany transactions and balances have been eliminated in consolidation. Revenue recognition. Revenues under cost-reimbursement and fixed-price contracts are recognized as costs are incurred and include applicable fees in the proportion that costs incurred bear to total estimated costs. When a loss is indicated on any contract in process, provision for the total estimated loss is made at that time. Unbilled expenditures and fees on contracts in process represent the revenue recognized on certain contracts in excess of the billings to date. Deferred contract revenue represents the amounts billed on certain contracts in excess of costs and fees incurred to date. Overhead and general and administrative costs charged to U.S. government contracts are subject to audit for years after 1992. Income taxes. Effective December 27, 1992, Tthe Company accounts for income taxes using adopted the liability method as set forth in of accounting for income taxes as set forth in Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes." Under the liability method, deferred taxes are determined based upon the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Deferred tax provision represents the change in deferred tax asset/liability balance. Deferred tax expense represents the change in the deferred tax asset/liability balance. The adoption of SFAS 109 in 1993 did not have a material effect on the Company's consolidated financial statements. Prior to fiscal 1993, the Company recorded income taxes on timing differences between financial statement and tax treatment of income and expenses under Accounting Principle Board Opinion No. 11. Inventories. Inventories are stated at the lower of cost (first-in, first- out) or market, and consist of materials, labor and overhead. There are no amounts in inventories relating to contracts having production cycles longer than one year. (in thousands of dollars) 1995 1994 1993 Work in process $ 686 $ 603 $ 632 Raw materials and subassemblies 1,926 1,750 1,998 Total $2,612 $2,353 $2,630 Property, plant & equipment. Property, plant and equipment are recorded at cost. Depreciation and amortization are provided in amounts sufficient to amortize the cost of such assets over their estimated useful lives using principally the straight-line method for plant and equipment. Leasehold improvements are amortized over the remaining term of the lease or the life of the related asset, whichever is shorter. Cash and cash equivalents. The Company considers all cash investments with original maturities of three months or less to be cash equivalents. Fair Value of Financial Instruments. In 1995, the Company adopted Statement of Financial Accounting Standards No. 107 (SFAS 107), "Disclosures About the Fair Value of Financial Instruments," which requires disclosure about financial instruments, whether or not recognized on the balance sheet. The carrying amount reported in the balance sheet for cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to the short term nature of these instruments. The mortgage note bears a variable interest rate of LIBOR plus 1% and, as such, the fair value of the note approximates the carrying value. Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Net Income Per Common Share. Net income per common share is based on net income and the weighted average number of common shares outstanding during each year after giving effect to stock options considered to be dilutive common stock equivalents. Fully diluted net income per common share is not materially different from primary net income per common share. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 2. INCOME TAXES The components of the provisions (benefit) for federal and state income taxes are as follows: (in thousands of dollars) 1995 1994 1993 Currently payable (refundable) Federal $ 447 $(354) $ 517 State 160 (24) 172 Total $ 607 $(378) $ 689 Deferred Federal $(26035)$297 $ 366 State (5984) 58 103 Total $(319) $355 $ 469 Total provision (benefit) $ 288 $(23) $1,158 The differences between the statutory U.S. federal income tax rate and the Company's effective tax rates are as follows: (in thousands of dollars) 1995 1994 1993 Provision at statutory rate $ 288 $ 68 $1,017 State income tax, net of federal tax benefit 50 23 182 R&D tax credit (50) (100) - Other, net - (14) (41) Provision (benefit) for income taxes $ 288 $(23) $1,158 Significant items comprising deferred tax assets and liabilities are as follows: (in thousands of dollars) 1995 1994 Unbilled costs and fees and deferred contract revenue, net $ (6,557) $(6,768) Accrued expenses 1,559334 1,338 Receivable reserves 161 230 Inventory reserves 21695 155 Other 214588 304 Current deferred tax liabilities, net $(4,407379)$(4,741) Accelerated tax depreciation $(516) $(581) Other (460) (284) Non-current deferred tax liabilities $(976) $(865) Total deferred tax liabilities, net $(5,38355) $(5,606) Total deferred tax assets and total deferred tax liabilities were $27,150533196,000 and $7,5332,178817,000, respectively at December 30, 1995 compared with $27,027633,000 and $72,633027,000, respectively at December 31, 1994 . NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 3. EMPLOYEE BENEFIT PROGRAMS The Company has a noncontributory defined benefit pension plan covering substantially all of its employees. Pension plan benefits are generally based on years of service and compensation during final years of employment. The Company's funding policy is to contribute at least the minimum amount required by the Employee Retirement Income Security Act of 1974 or additional amounts to assure that plan assets will be adequate to provide retirement benefits. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. Net pension cost for 1995, 1994 and 1993 included the following components: (in thousands of dollars) 1995 1994 1993 Service cost - benefits earned during the period $1,042 $1,309 $ 1,108 Interest cost on projected benefit obligation 1,822 1,666 1,544 Actual return on plan assets (3,704) 685 (1,662) Net amortization and deferred items 2,195 (2,198) (116) Net periodic pension cost $1,355 $1,462 $ 874 The following table sets forth the plan's funded status and amounts recognized in the Company's consolidated financial statements at December 30, 1995, December 31, 1994 and December 25, 1993: (in thousands of dollars) 1995 1994 1993 Actuarial present value of benefit obligations: Vested $23,845 $18,327$19,814 Nonvested 560 466 569 Accumulated benefit obligation 24,405 18,793 20,383 Effect of projected future salary increases 3,608 2,644 2,595 Projected benefit obligation for service rendered to date 28,013 21,437 22,978 Plan assets at fair market value 23,104 19,600 19,639 Projected benefit obligation less than (in excess of) plan assets (4,909) (1,837) (3,339) Unrecognized net gain from past experience different from that assumed and effects of changes in assumptions 196 (2,097) (430) Prior service cost not yet recognized in net periodic pension cost 2,139 2,359 2,579 Unrecognized net obligation at January 1, 1987 being recognized over 15 years 211 246 281 Net pension liability recognized in the Consolidated Balance Sheets at December 30, 1995, December 31, 1994 and December 25, 1993 $ (2,363) $(1,329)$(909) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED The weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7.25% and 3.5% in 1995, 8.5% and 3.5% in 1994 and 7.25% and 3% in 1993. The expected long-term rate of return on assets was 9% in 1995, 1994 and 1993. A substantial portion of the projected benefit obligation increase from 1994 to 1995 was attributable to the decrease in the discount rate to reflect current market conditions, while the substantial decrease from 1993 to 1994 was due to the increase of the discount rate resulting from the increase in long-term corporate rates. The Company also maintains a cash or deferred savings plan (401(k) plan), under which employees may reduce their compensation and have such "elective deferrals" contributed to the plan on their behalf. The Company contributes to the plan an amount equal to 25% of the first 6% of employee's elective deferrals. The Company contributed $578,120 to the plan for 1995, $581,305 for 1994 and $534,321 for 1993. The elective deferrals are invested in one or more collective investment funds at the participant's direction. The Company's contributions are invested in guaranteed investment contracts and are paid to the employee upon termination, subject to forfeiture of any non-vested portion if termination occurs within the first five years of employment. 4. NOTES PAYABLE AND LINES OF CREDIT At December 30, l995, the Company had unsecured lines of credit with various banks that provide for maximum borrowings of $21,000,000, of which none was utilized. Borrowings under these lines of credit are payable on demand and bear interest at the prevailing prime interest rate (8.5% at December 30, 1995) or at a lower rate quoted by the respective banks. The Company's average interest rate on outstanding borrowings at December 31, 1994 and December 25, 1993 was 7.0% and 3.8% respectively. While the arrangements do not have termination dates, the terms are reviewed and may be revised periodically. 5. LONG-TERM DEBT (in thousands of dollars) Long-term debt consists of the following: 1995 1994 Mortgage note payable to a bank, bearing interest at LIBOR plus 1% (6.9% through February 1, 1996, at which time the interest rate is to be adjusted) due in quarterly payments of $300,000 plus interest through February 1998, secured by certain land and buildings.$ 2,700 $ 3,900 Other 17 38 Less - current portion (1,217) (1,221) $1,500 $2,717 Future maturities of long-term debt are as follows:1996 $ 1,217 1997 1,200 1998 300 $2,717 The Mortgage Agreement, as amendedammended February 1, 1995, contains covenants concerning certain operating ratios, minimum balances of net worth and specified fixed charge coverage ratios. The Company, during the third and fourth quarters of 1994 was not in compliance with the covenants which require specified fixed charge coverage ratios. The bank has waived these defaults. The Mortgage Agreement was amended and Tthe Company washas been in compliance with the amended covenants throughout 1995. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 6. STOCK OPTION PLANS The Company has stock option plans which are administered by the Compensation Committee of the Board of Directors who determine the employees to receive options and the number and option price of shares covered by each such option. The Company accounts for these plans under APB No. 25 under which no compensation has been recognized. On April 27, 1993, the Company's shareholders approved Tthe 1993 Equity Incentive Plan (1993 Plan) to replace the Company's 1983 Stock Option Plan (1983 Plan), which terminated in 1993. The 1993 Plan permits the Company to grant incentive stock options, stock appreciation rights (SAR), awards of nontransferable shares of restricted common stock and deferred grants of common stock under the Company's 1983 Stock Option Plan (1983 Plan) which terminated in 1993. Options granted under the 1983 Plan on or before December 31, 1986 must be exercised in the order grantedare not exercisable, while previously granted options are outstanding. Options granted under both plans may be either incentive stock options or non-qualified stock options. The option price shall not be less than the fair market value at the time the option is granted, and the option period may not be greater than 10 ten years from the date the option is granted. Options under the plans have normally been exercisable in three equal installments commencing one year from the date of the grant. The Company's 1995 Stock Option Plan for Non-Employee Directors provides for each outside director to receive options to purchase 5,000 shares of Common Stock at the first annual meeting at which such director is elected, and options to purchase 1,000 shares of Common Stock at each annual meeting thereafter so long as he or she remains an eligible director. Such directors cannot be an employee of the Company or one of its subsidiaries or a holder of five percent or more of the Company's Common Stock. The exercise price of such options will be the fair market value of the Common Stock on the date of grant. Each option is non-transferable except upon death, expires 10 years after the date of grant and becomes exercisable in three equal installments on the first, second and third anniversary of the date of grant. A total of 100,00 shares has been reserved for issuance of which 85,000 shares remained available at December 31, 1995. Transactions involving the plans are summarized as follows:** 1995 1994 1993 Shares under option: Outstanding at beginning of year 360,892 429,129 481,704 Granted 18671,000 - 38,500 Exercised (47,385) (34,120) (79,986) Canceled - (34,117) (11,089) Outstanding at end of year 49984,507 360,892 429,129 Price range of options outstanding$3.38-$7.42$3.46-$7.42$2.60-$7.42 Exercisable at end of year 302,510 315,602 315,205 * Retroactively restated for the May 1994 stock dividend * Retroactively adjusted for the May 1994 stock dividend. At December 30, l995, under the 1993 Plan, 440,000 shares have been reserved, of which 247,000 shares wereare available for future grants. On April 25, 1995, the Company's shareholders approved the 1995 Stock Option Plan for Non-Employee Directors which terminates in 2005. The exercise price of each option shall be 100% of the fair market value per share of the stock on the date the option is granted, and the option period may not be greater than 10 years from the date the option is granted. Options under the plan are normally exercisable in three equal installments commencing one year from the date of the grant. Transactions involving the plan are summarized as follows: 1995 Shares Under Option: Outstanding at beginning of year 100,000 Granted 15,000 Exercised - Canceled - Outstanding at end of year 85,000 Price of options outstanding $4.38 Exercisable at end of year None Note: The Company Elected not to implement the Statement of Financial Accounting Standard No. 123 - Accounting for Stock-Based Compensation for the fiscal year ended 1995. The Company plans to comply with Statement No. 123 by providing footnote disclosure for the fiscal year ending December, 1996. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 7. COMMITMENTS AND CONTINGENCIES The Company conducts certain of its operations in facilities which are under long-term operating leases expiring at various dates through 20011999, with various options to renew through 20054. Rent expense under these leases (exclusive of real estate taxes, insurance and other expenses payable under the terms of the leases) was approximately $1,636,000 in 1995 and $1,800,000 in 1994 and $1,887,000 in 1993. The aggregate minimum lease commitment for the Company's facilities on December 30, 1995 was $7,071,000, payable as follows: $1,964,000 in 1996, $1,967,000 in 1997, $1,551,000 in 1998, $897,000 in 1999, $662,000 in 2000 and $30,000 in 2001. The Company also leases certain equipment. Rent expense under these leases was approximately $46,000 in 1994 and $429,000 in 1993. There was no such rent expense in 1995. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED The Company entered into a settlement agreement in April, 1994 with the Department of Justice whereby the Company paid $1,790,000, to the U.S. Government and a civil suit against the Company, filed by the Department of Justice in 1991, was dismissed. The amount of the settlement had been fully reserved and had no impact on reported results during 1994. 8. PREFERRED STOCK PURCHASE RIGHTS On July 14, 1988, and as amended on September 6, 1989, the Company declared a dividend distribution of one preferred stock purchase right (Right) for every outstanding share of common stock. The Rights have attached to all outstanding shares of common stock, and no separate Rights certificates will be issued. The Rights will become exercisable upon the earlier to occur of (i) the date which is the tenth business day following a public announcement that a person or group of affiliated or associated persons has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of common stock or (ii) the tenth business day following the commencement or announcement of an intention to make a tender offer or exchange offer that would result in a person or group owning 30% or more of the outstanding common stock. When exercisable, each Right entitles the registered holder to purchase from the Company one tenth of a share of its Series A Participating Preferred Stock, $.10 par value, at a price of $40.00 per each one tenth share of preferred stock. Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the Company including, without limitation, the right to vote or to receive dividends. The Rights may be redeemed by the Company at the discretion of the Board of Directors, at a price of $.01 per Right, and they expire on July 27, 1998. 9. SUBSEQUENT EVENT On January 23, 1996, The Company acquired the Massachusetts-based operations of Support Systems Associates, Inc. (SSAI), a private company headquartered in Hauppuage, New York. The CompanyDRC paid $2,000,000 million in cash for the acquired business,contractacquired business which had revenue of approximately $5.,900,000 million in 1995. in support of the U.S. Air Force Electronics Systems Center at Hanscom Air Force Base. The acquired assets included a prime contract to provide The Massachusetts- based operation of SSAI included a prime contract to provide services under the Air Force's Technical & Engineering Management Support (TEMS) program. This TEMS contract has an unfunded backlog with a potential value of approximately $24,000,000 million that may be used to support both existing businesses and new tasking over the next three years. The acquisition will be accounted for as a purchase. 10. BUSINESS SEGMENTS The Company provides computer systems services, other engineering and management support services and manufactures position and motion sensors and other precision components. The Systems and services segment provides specialized technical services to the Department of Defense and other customers and produced approximately 78% of total Company revenues in 1995. These services include the development and operation of computer-based management information systems where sophisticated software programs are applied to collect, analyze, store and retrieve information regarding the location, design, configuration, maintenance status and performance test history of the individual component parts of major weapons systems. The PrecisionCommercial products segment produces encoders, which are used to measure rotary or linear movement, and precision-patterned glass and electroformed metal products. The Precision products segment's primary market is located in the United States. Sales to two commercial customers represents 7% of the total Company sales. These customers operate in the automotive and computer-peripheral industries. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED 10. BUSINESS SEGMENTS Identifiable assets by business segment include both assets directly identified with those operations and an allocable share of jointly used assets. General corporate assets consist primarily of cash and the Company's Andover, MA corporate headquarterscorporate headquarters. Summarized financial information by business segment for 1995, 1994 and 1993 are as follows: (in thousands of dollars) 1995 1994 1993 Revenue: Defense Ssystems and services $80,756 $84,891$88,085 PrecisionCommercial products 23,185 18,073 13,017 Total Revenue $103,941$102,964 $101,102 Operating income: Defense Ssystems and services $(1,907)$(290) $3,457 PrecisionCommercial products 2,925 922 (215) Total operating income $1,018 $ 632 $3,242 Total assets: Defense Ssystems and services $34,95636 $36,573 $41,744 PrecisionCommercial products 9,58752 6,878 7,432 Corporate 9,406758 10,526 10,318 Total Assets $53,946 $53,977$59,494 Depreciation and amortization: Defense Ssystems and services $2,663522 $2,932 $2,726 PrecisionCommercial products 87945 772 674 Corporate 46035 457 472 Total depreciation and amortization $4,002 $4,161 $3,872 Capital expenditures: Defense Ssystems and services $1,75436$1,971 $2,207 PrecisionCommercial products 2,4942 347 779 Corporate 51943 126 9,158 Total capital expenditures $4,441 $2,444 $12,144 10. BUSINESS SEGMENTS - CONTINUED Unbilled expenditures and fees on contracts in process consist of costs and estimated earnings in excess of billings on uncompleted government contracts and are comprised principally of amounts, including retainage, for which billings could not be presented under the terms of the contracts at the balance sheet dates. Unbilled expenditures and fees on contracts in process with the U.S. Government at December 30, 1995 were $16,383,000 compared to $18,194,000 at December 31, 1994, and $17,053,000 at December 25, 1993. The approximate number of U.S. Government contracts has varied between 100 and 150 during the past five years, with 135 contracts open at December 30, 1995. Receivables under U.S. Government contracts at December 30, 1995 were $12,551,000 compared to $12,505,000 at December 31, 1994, and $17,580,000 at December 25, 1993. MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS The management of Dynamics Research Corporation is responsible for the accuracy and internal consistency of all information contained in this annual report, including the consolidated financial statements. Management has followed those generally accepted accounting principles which it believes to be most appropriate to the circumstances of the Company, and has made what it believes to be reasonable and prudent judgments and estimates where necessary. Dynamics Research Corporation operates under a system of internal accounting controls designed to provide reasonable assurance that its financial records are accurate, that the assets of the Company are protected, and that the financial statements present fairly the financial position and results of operations of the Company. The internal accounting control system is tested, monitored and revised as necessary. Three directors of the Company, not members of management, serve as the Audit Committee of the Board of Directors and are the principal means through which the Board supervises the performance of the financial reporting duties of management. The Audit Committee meets with management and the Company's independent auditors several times a year to review the results of external audits of the Company and to discuss plans for future audits. At these meetings the Audit Committee also meets privately with the independent auditors to assure its free access to them. The Company's independent auditors, Arthur Andersen LLP, audited the financial statements prepared by the management of Dynamics Research Corporation. Their report on these statements is presented below. Albert Rand Douglas R. Potter President, Chief Executive OfficerVice President of Finance, Chief Financial Officer REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Dynamics Research Corporation: We have audited the accompanying consolidated balance sheets of DYNAMICS RESEARCH CORPORATION (a Massachusetts corporation) and subsidiaries as of December 30, 1995, December 31, 1994 and December 25, 1993, and the related consolidated statements of operations, shareholders' investment and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of DYNAMICS RESEARCH CORPORATION and subsidiaries as of December 30, 1995, December 31, 1994 and December 25, 1993, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Boston, Massachusetts, February 14, 1996 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND OPERATING RESULTS RESULTS OF OPERATIONS This discussion and analysis should be read in conjunction with and is intended to supplement the information set forth in the Company's consolidated financial statements and related notes. The following table sets forth, for the periods indicated, the percentage which certain items in the Consolidated Statements of Operations bear to revenue: 1995 1994 1993 Revenue Contract revenue 77.7% 82.4% 87.1% Product sales 22.3 17.6 12.9 Total revenue 100.0 100.0 100.0 Cost of contract revenue* 90.50 91.2 84.6 Cost of product sales* 75.8 80.6 82.7 Total cost of sales 87.2 89.3 84.4 Selling, engineering and administrative expenses 11.8 10.112.4 Total operating costs 99.0 99.4 96.8 Operating income 1.0 0.6 3.2 Interest expense (income), net 0.2 0.4 0.2 Income before income taxes 0.8 0.2 3.0 Provision for income taxes 0.3 0.0 1.2 Net income 0.5% 0.2% 1.8% *These amounts represent a percentage of contract revenue and product sales, respectively. The following comments should be read in conjunction with the foregoing table: Contract revenue decreased by 4.9% or $4,135,000 in 1995 over 1994 compared to a 3.6% or $3,194,000 decrease in 1994 over 1993. The decrease in contract revenue in 1995 wasis principally attributabledue to the reduced contractual scope on the Company's long-running aircraft operations and maintenance data system, known as TICARRStion in effort on the Company's Air Force logistics information systems programs, partially offset by growth in new program areas. During 1994, the Company experienced revenue reductions in several areas including the Air Force Technical, Engineering and Management Support(TEMS) program at Hanscom Air Force Base. Also reflected iIn 1994, TICARRS revenue was reduced by a $1,.000,000 million third quarter adjustment in connection with a contract with the United States Air Force to reflect the uncertainty of recovery of certain costs incurred to date. Defense budget pressures and priorities may alter the future scope of defense programs, and the potential impact of these changes on the Company's future contract revenue is difficult to predict. Much of the Company's revenue relates to the development and operation of computer- based management information and logistics support systems. The Company is The Company is continuing to pursue additional programs both within the Department of Defense(DoD) and with other government agencies. Contract revenue decreased 4.9% or $4,135,000 in 1995 over 1994 as compared to a 3.6% or $3,194,000 decrease in 1994 over 1993. During 1995, the Company experienced reductions in several areas including the Air Force Technical, Engineering and Management Support (TEMS) program at Hanscom Air Force Base. Also, reflected in 1994 revenue was a $1.0 million third quarter adjustment in connection with a contract with the United States Air Force to reflect the uncertainty of recovery of certain costs incurred to date. Defense budget pressures and priorities may alter the future scope of defense programs, and the potential impact of these changes on the Company's future contract revenue is difficult to predict. However, much of the Company's revenue relates to the development and operation of computer based management information and logistics support systems which continue to receive budgetary suppport. The Company is continuing to pursue additional programs both within the Department of Defense (DoD) and with other government agencies. The 1993 decrease in revenue primarily resulted from the Company continuing TEMS work as a subcontractor, rather than as prime contractor. Product sales in 1995 increased 28.3% or $5,112,000 as compared with 1994. This was principally the result of growing production of electroformed components for commercial printers and increased sales of encoders and other precision products across a wide customer base. Product sales in 1994 increased 38.8% or $5,056,000 as compared with 1993. This principally resulted from full production of a new line of customer encoders for a customer in the automotive industryincrease came from both of the Company's commercial manufacturing Divisions, Encoder and Metrigraphics.. The Encoder Division experienced strong demand for its line of motion and position sensing devices, including its optical encoder used in a high volume automotive application. The Metrigraphics Division's growth is attributable to sales of its electroformed nozzle plate used in inkjet printer cartridges, combined with increased standard product business across a wide customer base. Product sales in 1994 increased 38.8% or $5,056,000 as compared with 1993. This was principally the result of full production from the new lines of custom encoder devices and electroformed components as well as increased business of standard and specialty devices. Product sales in 1995 increased 28.3% or $5,112,000 as compared with 1994. This was principally the result of full production of a new line of custom encoder devices for a customer in the automotive industry and of electroformed components for commercial printers and increased business across a wide customer base. Product sales in 1994 increased 38.8% or $5,056,000 as compared with 1993. This principally resulted from commencement of sales of the new product lines. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND OPERATING RESULTS - CONTINUED Cost of contract revenue as a percentage of contract revenue decreased from 91.2% in 1994 to 90.5% in 1995. In the third quarter of 1994, a nonrecurring charge of This decrease principally due to increased research and development efforts in 1995 (which are classified under selling, engineering and administrative expense) coupled with a nonrecurring charge of $750,000 was taken relating to staff reductions, consisting mainly of separation costs.which was taken in the third quarter of 1994 relating to staff reductions, consisting mainly of separation costs. Cost reduction actions were also taken in the fourth quarter of 1993, consisting primarily of indirect labor staff reductions and consolidation of office space. The high level of cost of contract revenue in 1995 and 1994, as compared to 1993, reflects reduced profitability on the Company's major Air Force programs, TEMS and TICARRS. Under TEMS, the Company has operated as a subcontractor during 1994 and 1995 at reduced hourly rates as compared with prior prime contractor status. TICARRS, a fixed price contract, showed a loss in 1994 and continued in 1995 with no recorded profit. The cost of contract revenue, measured as a percentage of contract revenue, increased from 84.6% in 1993 to 91.2% in 1994. This increase was attributable to lower profit margins on specific contracts in 1994. Cost of contract revenue as a percentage of contract revenue decreased from 91.2% in 1994 to 90.5% in 1995. This decrease was due principally to increased research and development efforts in 1995 and a nonrecurring charge of $750,000 was taken in the third quarter of 1994 relating to staff reductions, consisting primarily of seperation costs. Cost reduction actions were taken in the fourth quarter of 1993, consisting primarily of indirect labor staff reductions and consolidation of office space. Facility costs were significantly reduced in 1994 and 1993 compared to 1992 due to the January 1993 purchase of the Andover, Massachusetts building occupied by its Corporate offices and Systems Division. The cost of contract revenue, measured as a percentage of contract revenue, increased from 84.6% in 1993 to 91.2% in 1994. This was attributable to lower profit margins on specific contracts in 1994. Cost of Goods as a percentage of product sales decreased from 80.6% in 1994 to 75.8% in 1995. This decrease was primarily the result of the benefit of increased production levels of the new electroformed components for commercial printers, resulting in manufacturing efficiencies, coupled with a reduction in facility costs from the 1994 level. Cost of goods as a percentage of product sales decreased from 82.7% in 1993 to 80.6% in 1994. This decrease was primarily the result of the attainment of full production levels of the new custom encoder product line and increased production levels of the newof electroformed components for commercial printers. Start-up costs for these product lines were incurred in 1993 and into 1994. Production volumes for these products were achieved during 1994 and targeted unit production levels for these products were achieved in 1994 1995. Cost of goods as a percentage of product sales decreased from 80.6% in 1994 to 75.8% in 1995. This decrease was primarily the result of the benefit of increased production levels of the new electroformed components for commercial printers. Start-up costs for these product lines were incurred in 1993 and targeted unit production levels for these products were achieved in 1994. Cost of goods as a percentage of product sales decreased from 82.7% in 1993 to 80.6% in 1994. This decrease was primarily the result of full production levels of the new custom encoder product line and increased production of electroformed components for commercial printers. Start-up costs for these product lines were incurred in 1993 and targeted unit production levels for these products were achieved in 1994. Selling, engineering and administrative expenses increased 18.4% or $1,904,000 in 1995 from 1994. The increase was principally due to increased research and development efforts by the Company during 1995 in connection with a software design and development tool expected to be introduced in 1996.related to specific new applications. These internal research and development efforts are expected to continue in 1996.This increased level of research and development will continue in 1996. There was also a decrease in general and administrative expenses as a percentage of sales due to cost reductions taken during the year. Selling ,engineering and administrative expenses decreased 17.6% or $2,206,000 in 1994 over 1993. The decrease was principally due to the completion of research and development efforts by the Company in late 1993 related to the Company's maintenance data system for the Air Force. There was also a decrease in general and administrative expenses due to staff reductions in late 1993. Selling, engineering and administrative expenses increased $1,904,000 or 18.4% in 1995 from 1994. The increase was principally due to research and development efforts by the Company related to specific programs. These internal research and development efforts will continue in 1996. There was also a decrease in general and administrative expenses due to reversing a reserve taken in 1994. Selling, engineering and administrative expenses decreased $2,206,000 or 17.6% in 1994 over 1993. The decrease was principally due to the completion of research and development efforts by the Company in late 1993 related to the Company's maintenance data system for the Air Force. There was also a decrease in general and administrative expenses due to staff reductions in late 1993. Interest expense (income), net decreased to $171,000 in 1995 from $431,000 in 1994 due to a decrease in the average level of the Company's borrowing in 1995., The principal drivers of cash flow are earnings, adjusted for depreciation and amortization, aggregate billed and unbilled receivables in the Company's government business, and capital expenditures. The sum of receivables and unbilled expenditures and fees on contracts in process decreased significantly from the end of 1993 to 1994 and then decreased slightly at the end of 1995. Capital expenditures increased to $4,400,000 in 1995 in connnection with a program to increase electroforming manufacturing capacity. Early in 1993, the Company acquired its headquarters building with a combination of cash and mortgage financing. partially offset by higher interest rates. Interest expense, net increased to $431,000 in 1994 from $250,000 in 1993 due to an increase in the average level of the Company's borrowings in 1994 combined with higher interest rates. The sum of receivables and unbilled expenditures and fees on contracts in process decreased from 1993 to 1994 by $3,936,000 and decreased from 1994 to 1995 by $665,000. Early in 1993, the Company acquired its headquarters building in Andover, MA with a combination of cash and mortgage financing. Interest expense (income), net decreased to $171,000 in 1995 from $431,000 in 1994 due to a decrease in the average level of the Company's borrowings in 1995 combined with lower average interest rates in 1995. The sum of receivables and unbilled expenditures and fees on contracts in process decreased from the end of 1993 to 1994 and then increased at the end of 1995. Early in 1993, the Company acquired its headquarters building with a combination of cash and mortgage financing. Provision (benefit) for income taxes was 34.0% for 1995, compared to (11.4%) for 1994 and 38.7% for 1993. The 1995 and 1994 rates were favorably affected by research and development expenditure credits as well as somewhat lower state income tax rates. Effective December 27, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." This statement requires the use of the liability method forof computing the current and deferred provisions for income taxes. The adoption of this method did not have a material impact on the Company's tax provision. The 1995 and 1994 tax rates were favorably affected by research and development expenditure credits as well as somewhat lower net state income taxes. The Company's backlog of unfilled orders at the end of 1995 was $61,284,000, an increase of 40.3% from the $43,679,000 at the end of 1994. A portion of the Company's backlog is based on annual purchase contracts and the amount of the backlog as of any date can be affected by the timing of such order receipts and deliveries thereunder. The 1995 balance includes $10,000,000 related to a commercial order for inkjet printer components. Provision (benefit) for income taxes was 34.0% for 1995, (11.4%) for 1994, and 38.7% for 1993. Effective December 27, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." This statement requires the use of the liability method for computing the current and deferred provisions for income taxes. The adoption of this method did not have a material impact on the Company's tax provision. The 1994 tax rate was favorably affected by research and development expenditure credits as well as somewhat lower net state income taxes. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND OPERATING RESULTS - CONTINUED The Company's backlog of unfilled orders at the end of 1995 was $61,284,000, an increase of 40.3% from $43,679,000 in 1994. A portion of the Company's backlog is based on annual purchase contracts, and the amount of the backlog as of any date can be affected by the timing of such order receipts and deliveries thereunder. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of liquidity have been cash flow from operations and bank credit lines. The ratio of current assets to current liabilities was 2.0 to 1 at December 30, 1995 compared to 2.1 to 1 at the end of 1994. The change in this ratio is attributable to anthe increase in accrued payablesroll .and benefits from $4.6 million at year-end 1994 to $6.4 million at year-end 1995, partially offset by a $1.2 million decrease in notes payable during 1995. During 1995, noncash expenses for depreciation and amortization and the timing of payables favorable collections (receivables and unbilled expenditures and fees) enabled the Company to generate $7,000,000.5 million from operations despite having net income of only $600,000.6 million. The Company had $3,000,000 of planned capital spending as of December 30, 1995 related to the planned increase in electroform production capacity. Also, in January 1996, the Company paid $2,000,000 to acquire the Massachusetts-based operations of an Air Force services contractor.Further receivable reductions are expected during 1996. In order to support the growth of the Company's commercial products business, a capital spending plan has been developed to scale up production capacity over the next several years. Outstanding capital commitments at December 30, 1995 include $3.0 million to increase electroform production capacity. At December 30, 1995, $21,000,000 was available under the Company's current lines of credit. The Company believes that its liquid assets, cash flows from operations and available bank lines of credit will support its operating and capital requirements for 19965. The Company's primary sources of liquidity have been cash flow from operations and bank credit lines. The ratio of current assets to current liabilities was 2.0 to 1 at December 30, 1995 compared to 2.1 to 1 at the end of 1994. The change in this ratio is attributable an increase in payables due to timing. During 1995, noncash expenses for depreciation and amortization and the timing of payables enabled the Company to generate $7 million from operations despite net income of only $.6 million. The Company had no large capital spending commitments as of December 30, 1995. At December 30, 1995, $21,000,000 was available under the Company's current lines of credit. The Company believes that its liquid assets, cash flows from operations and available bank lines of credit will support its operating and capital requirements for 1996. IMPACT OF INFLACTION AND CHANGING PRICES Overall, inflation has not had a material impact on the Company's operations. Increased costs and expenses have been offset by price increases, cost reduction programs and improved productivity. In addition, the terms of Defense contracts, which accounted for approximately 78% of the Company's revenues in 1995, are generally for one year, and include salary increase factors for future years, thus reducing the potential impact of inflation on the Company. FORWARD LOOKING INFORMATION This report includes certain forward-looking statements about the Company's business including the effect of the federal budget on the Company's sales, response to the Company's product and services offerings, growth in revenues, capital spending, research and development spending and customer mix. Such forward-looking statements are subject to risk and uncertainties that could cause the actual results to vary materially. These risks and uncertainties, discussed in more detail in the Company's Form 10-K for the year ended December 30, 1995, include possible reductions in federal funding for the Company's customers and potential customers, concentration of customers, risks of sustaining existing contracts and orders thereunder at the same or increasing levels and obtaining of new contracts, high levels of competition and difficulties of entering new markets, government contracting issues including audit adjustments and costs of completing fixed price contracts, supply difficulties, warranty claims, and factors affecting the business segments in which the Company operated and the economy generally.Overall, inflation has not had a material impact on the Company's operations. Increased costs and expenses have been offset by price increases, cost reduction programs and improved productivity. In addition, the terms of Defense contracts, which account for approximately 78% of the Company's revenues in 1995 are generally for one year, thus reducing the potential impact of inflation on the Company. CORPORATE HEADQUARTERS 60 Frontage Road Andover, Massachusetts 01810-5498 Telephone: (508) 475-9090 Fax: (508) 475-8205 AUDITORS Arthur Andersen LLP One International Place, Boston, Massachusetts 02110 LEGAL COUNSEL Ropes & Gray One International Place, Boston, Massachusetts 02110 TRANSFER AGENT American Stock Transfer & Trust Company 99 Wall Street, New York, New York 10005 Telephone: (800) 937-5449 STOCK PRICES Bid price by quarter 1995 1994* High LowHigh Low First quarter $4.75 $2.75$4.77 $3.86 Second quarter 4.75 2.754.55 3.64 Third quarter 7.50 4.134.00 3.38 Fourth quarter 9.50 5.503.75 2.75 * Retroactively adjusted for the May 1994 stock dividend. The bid and asked prices of the Company's common stock on February 22XX, 1996 were $7.13X.XX and $7.38X.XX, respectively. Prices shown reflect inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions. Source: Monthly Statistical Report of the National Association of Securities Dealers, Inc. - - NASDAQ. COMMON STOCK The Company's stock is traded on the NASDAQ National Market System, Symbol: DRCO; and listed in newspapers as DynamR., DynRsh. or DynRsearch. NUMBER OF SHAREHOLDERS The approximate number of shareholders of record at February 16xx, 1996 was 1,032x,xxx. As of February 16xx, 1996 there were 5,663,042x,xxx,xxx common shares outstanding. FORM 10-K A copy of DRC's Form 10-K, which is filed annually with the Securities and Exchange Commission, will be sent without charge to any shareholder requesting it in writing to the Treasurer's office, Dynamics Research Corporation, 60 Frontage Road, Andover, Massachusetts 01810-5498. ANNUAL MEETING The 1996 Annual Meeting of Shareholders will be held at 3:30 PM on April 23, 1996 at the State Street Bank and Trust Building, 33rd floor, 225 Franklin Street, Boston, Massachusetts 02110. DIRECTORS Dr. Francis J. Aguilar** Professor of Business Administration, Harvard University, Graduate School of Business Administration John S. Anderegg, Jr. Chairman, Dynamics Research Corporation General James P. Mullins** USAF retired Albert Rand President and Chief Executive Officer, Dynamics Research Corporation Thomas J. Troup* Vice Chairman, Burr-Brown Corporation * Member of the Audit Committee. ** Member of the Audit and Compensation Committees OFFICERS John S. Anderegg, Jr. Chairman Albert Rand President, Chief Executive Officer Arthur Brown Vice President, Contracts, Systems Division William G. Clautice Vice President, Strategic Programs Dr. Joseph W. Griffin, Jr. Vice President, Systems Development, Systems Division Edward C. Johnson Vice President, Marketing Chester Ju Vice President, Encoder Division and Metrigraphics Division Jonn M. Nauseff Vice President, Dayton Operations Douglas R. Potter Vice President of Finance and Chief Financial Officer Richard P. Rappaport Vice President, Test Equipment Division John L. Wilkinson Vice President, Human Resources David C. Proctor Treasurer and Assistant Clerk Frederick Eromin Controller, Systems Division John R.D. McClintock Clerk FINANCIAL HIGHLIGHTS (In thousands of dollars, except share data) 1995 1994 Revenue $103,941 $102,964 Net income 559 224 Net income per share* .10 .04 Backlog 61,284 43,679 Number of employees 1,249 1,130 Number of shares outstanding* 5,622,772 5,631,448 *Retroactively adjusted for the May 1994 stock dividend. -----END PRIVACY-ENHANCED MESSAGE-----