-----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, JuMyQXK8t2CRtYDKmaQwhYueq3ebznWm9DLI/P8OWRGaaCkmLQuTXB+js5utAwlt xjqaO5kkPrtT+dYkh2Go0A== 0000030822-97-000002.txt : 19970328 0000030822-97-000002.hdr.sgml : 19970328 ACCESSION NUMBER: 0000030822-97-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19961228 FILED AS OF DATE: 19970327 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: 97565439 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 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 28, 1996 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. [ ] As of March 14, 1997, the aggregate market value of Common Stock held by nonaffiliates of the Registrant was $42,889,183 and the number of shares of Common Stock, $.10 par value, of the Registrant outstanding was 5,698,325. Documents Incorporated By Reference Portions of the 1996 Annual Report to Shareholders are incorporated by reference in Parts I and II. Portions of the Registrant's Proxy Statement for the 1997 Annual Meeting of Shareholders are incorporated by reference in Part III. The Exhibit Index is on pages 25 and 26. DYNAMICS RESEARCH CORPORATION Form 10-K For the Fiscal Year Ended December 28, 1996 Part I Page Item 1. Business 4 2. Properties 12 3. Legal Proceedings 13 4. Submission of Matters to a Vote of Security Holders 13 4A. Executive Officers of the Registrant 13 Part II 5. Market for Registrant's Common Equity and Related Stockholder Matters 14 6. Selected Financial Data 14 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 8. Financial Statements and Supplementary Data 13 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 15 Part III 10. Directors and Executive Officers of the Registrant 16 11. Executive Compensation 16 12. Security Ownership of Certain Beneficial Owners and Management 16 13. Certain Relationships and Related Transactions 16 Part IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 17 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 information 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. and state governments and commercial companies. The Company also designs, manufactures and sells digital instruments and precision components that are primarily used in computer-controlled systems. Information Systems Development and Operation DRC 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 to perform detailed reliability, maintainability, quality assurance, vendor qualification and cost analyses. The Company has developed such 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 both hardware and software throughout the system's life. 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. Under contract with the U.S. Air Force, the Company designed, developed, implemented and operates Tactical Interim CAMS and REMIS Reporting System (TICARRS). The TICARRS databases support the operation of F-15 and F-16 aircraft and provide, upon request by the Air Force user organizations worldwide, a variety of operational reports. Data include results from flight operations and maintenance activities. Although remote computer terminals and communications interfaces are an integral part of the system, the host computer facility and its associated databases are located at a Company facility. During 1996, the Company received a subcontract to participate in the development of the Air Force's Integrated Maintenance Data System ("IMDS") as a successor to TICARRS and other existing systems. 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 provides operational support for the system as well as software development modifications and other changes. During 1996, the Company was awarded a contract to implement a distributed computer-based system for managing child welfare cases handled by the State of New Hampshire's Department of Health and Human Services. In February of 1997, DRC announced the award of a $36 million contract- $24 million of which is slated for 1997 - to install and maintain computer hardware and communication systems for the State of Ohio's Department of Health and Human Services. 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 achieved certification Level II under standards of the Software Engineering Institute. The Company has developed AdaMAT, a software program licensed to both government and commercial customers, as a tool for an Ada software engineering environment. 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 allowing visibility into the quality of the code at any given point in time. Engineering and Management Support Services The Company increased its research and development efforts during 1995 and 1996 in connection with an object-oriented system and software development tool which enables developers to build applications using diagrams. This tool supports team-based development and includes capabilities for automated source code and documentation generation. During 1996, the Company entered into an agreement with Pacific Bell, a subsidiary of Pacific Telsis Group, to market, support and enhance Pacific Bell's telephone fraud control system known as "Sleuth". The Sleuth system is used to detect potential fraudulent usage of "alternate billing services" such as calling cards, and is currently used by five other Regional Bell Operating Companies (RBOC's) in addition to Pacific Bell. The Company intends to enhance the Sleuth system to support the existing Sleuth user group, and to market the system to other potential users. Under various DoD contracts, the Company has performed a variety of services for its U.S. Government customers to assist them in planning and managing 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 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 customers define, develop, and initiate new programs. The Company also helps customers obtain program approval, conduct strategic planning, and evaluate proposals from industry. After prime contract awards, the Company helps 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) contract, 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. DRC was a subcontractor on one of the winning teams, and was subsequently added as a subcontractor to several of the other winning bidders. A 1996 acquisition included a prime contract to provide support services under the TEMS program. In 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 as well as other Air Force logistics centers. 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 program since 1990. In 1996, the Defense Information Systems Agency (DISA) awarded multiple contracts under its Defense Enterprise Integration Services (DEIS-II) program. DRC is a member of the winning Computer Sciences Corporation team. DEIS-II 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-II program. DRC also performed as a subcontractor to Computer Sciences Corporation under the predecessor DEIS contract since 1993. The Company supports the DoD in the area of acquisition logistics. DRC technical staff help customers plan and manage the implementation of program requirements throughout all phases of the acquisition process. 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 contract from the Federal Aviation Administration for a radar performance monitoring and analysis system and a 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). 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 provided 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 provide 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 previous 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. 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. During 1996, the Company was awarded a 4-year U.S. Army contract valued at approximately $13 million, to apply certain teamwork training principles developed to improve performance in high pressure environments, to emergency room settings in civilian and military hospitals. 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. Recently, the suite of HARDMAN III tools has been consolidated into a single windows-based application called "IMPRINT" (Improved Performance Research Integration Tool). DRC is a subcontractor to Lockheed Martin on the U.S. Army's Warfighter 2000 Simulation. WARSIM will provide training for commanders and their staffs. DRC is leading the conceptual modeling, MANPRINT, and safety aspects of the effort. DRC is also providing system engineering and software engineering support to the Integrated Development Team. DRC is a subcontractor to Lockheed Martin 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. 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 1996, the Company increased its support for the Navy in connection with the development of new processes for fabricating semiconductors "hardened" to survive severe environments. 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 prime contracts to serve Federal agencies other than DoD. The first award was from 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. Through the end of 1996, the Company has achieved approximately $1.3 million of revenue under this contract. The second 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. Digital Instruments and Precision Components The Company operates two units that produce digital instuments and precision components 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 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, became fully operational in 1994 and has continued through 1996. The Metrigraphics Division uses photolithographic processes to manufacture optical discs, scales and reticles that are used for precision measurement. Metrigraphics also uses various metal 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. These products are a substantial portion of the sales of the Metrigraphics Division. In December 1995, the Company leased 27,000 square feet in Wilmington, Massachusetts to provide space for a second electroform production facility. During 1995 and 1996, approximately $7 million has been incurred for the purchase of production equipment to expand the Company's electroform capacity. The customers for both of these divisions are primarily manufacturing 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 element 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 1996, the Company's revenues from contracts with the DoD, either as prime contractor or subcontractor, accounted for approximately 74% of the Company's total revenues. The Company's government contracts fall into one of three categories: (1) fixed price, (2) time and materials, and (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 profit margin. Under a cost plus fixed fee contract, the government reimburses the Company for its allowable direct expenses and allowable and allocable indirect costs and pays a negotiated fee. In 1996, approximately 65% of the Company's government contracts revenue was under fixed price or time and material contracts, while approximately 35% of revenue was under costs plus fixed fee contracts. During 1996, the Company's U.S. Government business consisted of approximately 105 separate contracts on 60 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 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 28, 1996, the Company's backlog of unfilled orders was approximately $73,200,000 compared with $61,284,000 at December 30, 1995. The Company expects that substantially all of its backlog on December 28, 1996 will be filled during the year ending December 31, 1997. 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 because various agencies perform certain types of services which might otherwise be performed by the Company. The principal competitive factors for defense services are price, performance, technical competence and reliability. In addition, in the commercial business, the Company also competes with other manufacturers of encoders, electroform vendors and 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 $2,702,000 (inclusive of overhead and other indirect costs) on new product and service development during the year ended December 28, 1996, as compared to expenditures of $1,949,000 during 1995 and $224,000 during 1994. 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 28, 1996, the Company had 1,349 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 231,000 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 three leases totaling 113,000 square feet, expiring in 2000, with options to the year 2005. The remaining leased facilities consist of offices in 24 locations across the United States. The Company owns a 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 1996 was $2,014,000. The Company believes its properties are adequate for its present needs. See Note 8 to the Consolidated Financial Statements included in the Company's 1996 Annual Report to Shareholders for a description of the Company's lease obligations. Item 3. Legal Proceedings The Company is not a party to any material litigation. 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. 73 42 Chairman Albert Rand 70 37 President and Chief Executive Officer John L. Wilkinson 57 15 Vice President, Human Resources Douglas R. Potter 46 3 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. He was Vice President, Treasurer, and Chief Financial Officer of SofTech, Inc. of Waltham, Massachusetts from 1990 to 1993. 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 NASDAQ National Market under the symbol (DRCO). The high and low bid prices for the quarters in 1995 and 1996 and the number of holders of record of the Company's common stock are described in the Company's Annual Report to Shareholders for 1996 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 between 1984 and 1996 and does not anticipate doing so for the foreseeable 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 1996 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 1996 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 28, 1996, December 30, 1995 and December 31, 1994 Consolidated Statements of Operations for the three years ended December 28, 1996 Consolidated Statements of Shareholders' Investment for the three years ended December 28, 1996 Consolidated Statements of Cash Flows for the three years ended December 28, 1996 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 1996.) Report of Independent Public Accountants on Schedules to Consolidated Financial Statements Schedule VIII - Valuation and Qualifying Accounts for the three years ended December 28, 1996 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 11, and Management's Discussion and Analysis of Financial Condition and Results of Operations presented on pages 12-14, of the Company's Annual Report to Shareholders for the year 1996, 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 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 28, 1996, 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. Mr. Albert Rand, president and chief executive officer reported on form 5 the sale of shares of the Company's Common Stock during 1996 for which form 4 was inadvertently not filed. 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 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 28, 1996. 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 28, 1996. 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 that are filed with this Form 10-K, or that are incorporated herein by reference, are set forth in the Exhibit Index, which appears in Part IV of this report on pages 24 and 25. (b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during the last quarter of fiscal 1996. 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 7, 1997. 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 7, 1997 Exhibit 99 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 74% of the Company's revenue is derived from the Department of Defense business. During the past, 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. 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. Governmental 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 up 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. Contracts with state and other governmental entities are subject to the same or similar risks. 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 affect 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 21, 1997 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 21st of March, 1997. /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 28, 1996 (in thousands of dollars) ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURNS Balance, December 25, 1993 $418 Additions charged to expense 222 Write-off of uncollectible accounts, net (54) Balance, December 31, 1994 $586 Additions charged to expense (2) Write-off of uncollectible accounts, net (182) Balance, December 30, 1995 $402 Additions charged to expense (54) Write-off of uncollectible accounts, net (8) Balance, December 28, 1996 $340 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 certificate. 4.2 Preferred stock certificate. 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. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/27/87) 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) 10.4 Form of Dynamics Research Corporation Indemnification Agreement for Directors. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91) 10.5 Form of Dynamics Research Corporation Severance Agreement for Messrs. Anderegg and Rand. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91) 10.6 Dynamics Research Corporation Deferred Compensation Plan for Non-Employee Directors. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91) 10.7 Mortgage Agreement dated February 5, 1993 between Dynamics Research Corporation and ABN AMRO Bank, N.V. (Incorporated by reference to the Registrant's Form 8-K on May 5, 1993) 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 28, 1996 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 counsel 23.1 Consent of Independent Accountants (Arthur Andersen LLP) dated March 26, 1997 filed herewith. 99.0 Important Factors Regarding Forward-Looking Statements. * Management contract of compensatory plan or arrangement. EX-27 2
5 1,000 12-MOS DEC-28-1996 DEC-28-1996 234 0 42126 0 3211 48254 49870 28266 71102 34709 1501 0 0 669 34570 71102 29285 130163 20476 112988 13830 (62) 547 2798 1069 1729 0 0 0 1729 .3 .3
EX-13 3 Financial Highlights 1994 1995 1996 (In thousands of dollars, except share and employee data) Revenue $ 102,964 $ 103,941 $ 130,163 Net income 224 559 1,729 Net income per share .04 .10 .30 Backlog 43,679 61,284 73,200 Number of employees 1,130 1,249 1,349 Number of shares outstanding 5,631,448 5,622,772 5,693,659 To Our Shareholders In 1996 Dynamics Research Corporation's revenue grew 25 percent to $130.2 million, finally moving up from a plateau just above $100 million where the Company's sales had been for several years. Importantly, this growth was achieved across all of our operations. We expect that the initiatives now in place-in particular, a strategy of applying our core business competencies as a defense contractor to other federal and state agencies, as well as the private sector-will yield strong results in 1997. Net income for 1996 more than tripled to $1,729,000 or $.30 per share, from $559,000, or $.10 per share the prior year. For the final 16 weeks of 1996, revenue rose 34 percent to $45.2 million from $33.7 million for the corresponding quarter last year. Net income for the quarter was $191,000, or $.03 per share, compared with $320,000, or $.06 per share, for the same period in 1995, reflecting a one-time pre-tax charge of $1.8 million for certain nonrecoverable costs related to a U.S. Air Force Contract. Revenue growth was broad based across our four principal operating divisions-Systems, Test Equipment, Encoder and Metrigraphics-with each group achieving top-line sales growth in excess of 23 percent. Sales for the Systems and Test Equipment divisions totaled $100.9 million, or 77 percent of revenues, while commercial sales for the precision manufactured products divisions rose 26 percent to $29.3 million, accounting for 23 percent of 1996 revenues. Leveraging Information Technology Expertise Much of our growth was due to the leveraging of our information technology expertise to secure several major new contracts or expand existing contracts within the Systems and Test Equipment divisions. These include: A one-year, $4.5 million contract for an auto-mated case-management system for the State of New Hampshire's Department of Health and Human Services. A four-year contract valued at potentially $13 million from the U.S. Army to analyze and improve teamwork among emergency room personnel in both civilian and military hospitals. Expansion of our existing core Navy program with an award from the U.S. Navy for approximately $5 million in 1996 to develop advanced capabilities for design and fabrication of radiation-hardened semiconductors for use in Trident II missiles. In addition, through the January 1996 acquisition of the Massachusetts operations of Support Systems Associates, Inc., DRC was able to increase the level of management and technical support to the U.S. Air Force's Electronics Systems Center. Building upon many years of aircraft maintenance systems experience, DRC won a role as a subcontractor in developing the next-generation aircraft maintenance information system. The Company is also subcontracting to Computer Sciences Corporation on a $3 billion worldwide integration and systems engineering program for the U.S. Defense Information Systems Agency. Subsequent to year end, DRC's Systems Division was awarded a $36 million contract-$24 million of which is slated for 1997-to install and maintain computer hardware and communications systems for the State of Ohio's Department of Health and Human Services. The move toward upgrading computer systems for state agencies responsible for child welfare programs should yield new business opportunities for DRC beyond its current New Hampshire and Ohio contracts. We also see opportunities for the expansion of a broad contract with the U.S. Department of Treasury, which includes support for the Internal Revenue Service's tax modernization program. Going After High-Volume Commercial Sales During the year we saw strong growth in our two precision manufactured products divisions, Encoder and Metrigraphics, primarily due to a strategy of identifying high-volume manufacturing opportunities for major commercial customers. An ongoing contract for the production of nozzles for ink-jet printer cartridges represented $8 million in sales in 1996, while encoders for diesel-engine fuel pumps accounted for $5.5 million in sales. We are working to ensure the extension of these existing contracts and are aggressively seeking new high-volume medical, consumer and other applications for our electroforming and sensor manufacturing capabilities. Investing for Future Growth DRC made significant investments in capital equipment and research and development programs in 1996. Approximately $5 million was spent on capital equipment for the Metrigraphics Division, providing us with state-of-the-art quality control systems and ample capacity for precision manufacturing business growth. We continue to invest in the development of new business areas. DRC has assumed responsibility for supporting the Sleuth fraud control system developed by Pacific Bell Telephone Company. Sleuth is currently used by six regional Bell operating companies. 1997 Goals and Outlook Rapid advances in computer and communications technology, and the dynamic shift in the organizational structure, objectives and budget for the Department of Defense (DoD) has resulted in new business opportunities for DRC. We view ourselves as a strategic partner, helping our customers adapt to these changes and operate in a leaner, more efficient fashion. We also strive to attune ourselves to the marketplace and identify opportunities for transferring DRCOs expertise into new areas. In addition to increasing DoD work, one of our primary objectives for 1997 is to expand the proportion of business from the private sector, as well as federal and state agencies. Ultimately, our long-range goal is to achieve a 50/50 balance between our defense and commercial work. Looking ahead, overall company growth, as well as a changing business mix should help us to compete effectively in existing and new markets and to improve profitability. Long-term plans call for growing our current divisions and seeking selective acquisitions that will strengthen our business base in information technology and commercial manufacturing. An important addition was made to DRC's senior management team in October with the recruitment of Dr. Martin M. Dresser to the post of vice president and general manager of DRC's Systems Division. He brings to the job stellar technical credentials and years of senior management experience in growing new business lines for pre-eminent engineering and defense concerns. The early 1990's presented a difficult business climate for DRC, but we emerged a much stronger and strategically diversified company. Credit for this accomplishment lies with our employees, whose diligence, inventiveness and adaptability drive our business. Their talents and efforts are greatly appreciated. Sincerely, Albert Rand John S. Anderegg, Jr. President and Chairman Chief Executive Officer Trident II: Managing Lifecycle Requirements Constant testing and evaluation is necessary to verify the integrity of original components and the operability of replacement parts throughout a weapon system's lifecycle. As an extension of its longstanding program, supporting the U.S. Navy's Polaris, Poseidon and Trident missile guidance and navigation systems, DRC's Test Equipment Division supplies manufacturers with test equipment to ensure the accuracy of navigational instruments for Trident II missiles. DRC also re-engineers and replaces obsolete circuits through a process of extracting their electrical characteristics and reproducing functionality using state-of-the-art semiconductor components. At a Naval research center, DRC is supporting development of new processes for fabricating semiconductors that will survive severe conditions. Integrated Expertise Since the close of the Cold War, the military has sought more efficient, cost- effective ways to conduct operations without jeopardizing the readiness or reliability of weapons systems, personnel and equipment. This goal has resulted in a number of initiatives, including the re-engineering of many systems and programs, and the integration of new technologies. DRC develops innovative conceptual approaches for guiding the military through these changes by mobilizing integrated teams of experts in information technology, manpower and skills analysis, logistics and engineering. U.S. Air Force Electronics Systems Center As part of a multi-year contract to support the U.S. Air Force, DRC provides a range of services in support of the acquisition of electronics systems. DRC's work for the Air Force's Air Mobility Command (AMC), after it assumed responsibility for the Air Force's fleet of aerial refueling tankers, is representative of the Company's unique blend of expertise. AMC had to plan for tanker maintenance and flight crews, and ensure that the tankers were in the right place at the right time. DRC brought in a team with experience in military cargo transport, systems engineering and logistics to analyze and define requirements for a management information system that tracks and directs the tankers. New Hampshire BRIDGES A federal initiative to improve the flow of information between state and federal agencies tracking child welfare cases created an incentive for states to replace their outdated database systems. In 1995, DRC began marketing its information technology services to state health and human services and child welfare programs. Within less than a year, the Company was awarded a one-year, $4.5 million contract to provide software and networking capabilities for an automated case-management system, known as BRIDGES, for the State of New Hampshire's Department of Health and Human Services. The system provides caseworkers and the courts with up-to-date information for tracking more than 11,000 children. Venturing into New Markets Leveraging its expertise in large-scale military information systems, DRC is aggressively targeting business opportunities with nondefense federal and state agencies, as well as the commercial sector. Among its current projects are major implementations of distributed network computing systems in New Hampshire and Ohio, and the development of tools for performing cost/benefit analyses related to the tax system modernization program underway at the Internal Revenue Service. Under an innovative contract, DRC is bridging civilian and military markets to bring technology developed to improve aircraft crew performance under high- stress conditions to the medical emergency room arena. MedTeams Hospital emergency room staffs and combat flight crews all work in high pressure environments. Decisions they must make in as little as 20 seconds may well have life or death consequences. The ability to manage information and function as a cohesive team greatly increases the probability of a positive outcome. DRC's behavioral scientists recognized an opportunity to adapt a teamwork training program designed for U.S. Army Aviation cockpit crews-a program that annually saves an estimated 12 to 15 lives and $30 million-to a medical setting. DRC scientists pursued the concept and in 1996 secured a four-year contract valued at potentially $13 million from the U.S. Army Research Laboratory for Team Performance in Emergency Medicine (MedTeams) to analyze and improve emergency room teamwork in civilian and military hospitals. Diesel Fuel Pumps DRC's Encoder Division designs and assembles electro-mechanical devices that calibrate and control motion in sensitive, expensive machinery. A 1994 regulatory mandate for stricter controls on diesel emissions created a major new market opportunity for DRC. The Company now manufactures encoders for engine fuel pumps for diesel-powered sport utility vehicles, pickup trucks and commercial vans. The encoder is a critical component of a computer control system that gauges the amount of fuel injected into the cylinders, so the optimum amount is used, minimizing the unburned fuel that creates exhaust fumes. Competitive Drive The engine behind much of DRC's growth and improved profitability in 1996 was the Company's Precision Manufactured Products segment, which is comprised of two divisions: Encoder and Metrigraphics. Since 1992, segment revenues have grown at an annualized rate of 30 percent due to a strategy of securing high-volume manufacturing contracts in broad commercial markets. Both divisions are driven by the imperative to make customers more competitive by providing them with custom-designed components that result in higher performance, precision and more cost-competitive machinery and products. Medical Electronics Metrigraphics designs and produces circuits, disks and screens using a process known as electroforming, whereby a thin, flexible metal film is deposited in precise patterns. Medical devices such as electronic cameras incorporated into heart catheters represent a major potential market for Metrigraphics' technology. These miniature cameras enable medical technicians to view blockage within the aorta during angioplasty procedures. DRC's Metrigraphics Division produces miniature flexible circuits that connect the electronics in the camera head. The Company's ability to manufacture precise and finely calibrated circuits gives it a competitive edge in this fast-growing market. Growth Through Adaptation The ability to identify and move quickly to take advantage of new opportunities in a fast-changing business environment is crucial to DRC's growth. In addition to investing heavily in research and development and employee training programs, DRC has long fostered an "intrepreneurial" culture that encourages employees to incubate and champion new business lines. This organizational philosophy has made the Company adept at evolving and thriving in a highly transitional marketplace. Sleuth Fraud Control Employees from DRC's Beaverton, Oregon office targeted Pacific Bell Telephone Company as a strategic business prospect that could benefit from DRC's unique combination of technical skills and long-term customer support capabilities. DRC's efforts resulted in an exclusive license to maintain and market Pacific Bell's Sleuth telephone fraud detection and control software system, which is currently used by six regional Bell operating companies. Five Year Summary of Selected Financial Data
1996 1995 1994 1993 1992 (in thousands of dollars, except share and employee data) Revenue $130,163 $103,941 $102,964 $101,102 $102,581 Operating income 3,345 1,018 632 3,242 6,377 Net income 1,729 559 224 1,834 4,014 Net income per common share .30 .10 .04 .33 .70 Total assets 71,102 53,946 53,977 59,494 48,877 Long-term debt (excluding current portion) 300 1,500 2,717 3,900 - Shareholders' investment 35,239 33,206 32,713 32,437 30,805 Shareholders' investment 6.19 5.91 5.81 5.78 5.47 per share Return on shareholders' investment(%) 4.9 1.7 .7 5.7 13.0 Backlog 73,200 61,284 43,679 51,257 54,547 Cash flow from operations 1,035 7,499 5,721 1,397 9,468 Research and development expense 2,702 1,949 224 2,007 1,463 Capital expenditures 9,266 4,441 2,444 12,144 4,732 Number of shares outstanding at end of year 5,693,659 5,622,772 5,631,448 5,610,878 5,632,264 Number of employees 1,349 1,249 1,130 1,188 1,189
Quarterly Data* 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr (in thousands of dollars, except per share data) unaudited 1996 Revenue $26,627 $28,373 $29,929 $45,234 Operating income 434 873 1,465 573 Net income 209 498 831 191 Net income per common share .04 .09 .15 .03 1995 Revenue $21,929 $23,936 $24,354 $33,722 Operating income (loss) (602) 550 544 526 Net income (loss) (388) 318 309 320 Net income (loss) per common share (.07) .06 .06 .06 1994 Revenue $22,692 $23,656 $21,573 $35,043 Operating income (loss) 696 580 (2,699) 2,055 Net income (loss) 390 302 (1,734) 1,266 Net income (loss) per common share .07 .05 (.31) .22 * 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. 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: 1996 1995 1994 Revenue Contract revenue 77.5% 77.7% 82.4% Product sales 22.5 22.3 17.6 Total revenue 100.0 100.0 100.0 Costs and Expenses Cost of contract revenue* 91.7 90.5 91.2 Cost of goods* 69.9 75.8 80.6 Total cost of sales 86.8 87.2 89.3 Selling, engineering and administrative expenses 10.6 11.8 10.1 Total operating costs 97.4 99.0 99.4 Operating income 2.6 1.0 0.6 Interest expense, net 0.4 0.2 0.4 Income before provision for income taxes 2.2 0.8 0.2 Provision for income taxes 0.8 0.3 0.0 Net income 1.4% 0.5% 0.2% *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 Contract revenue increased by 24.9% or $20,122,000 in 1996 over 1995 compared to a 4.9% or $4,135,000 decrease in 1995 over 1994. The increase in contract revenue in 1996 was broad-based with growth contributions from additional work received under the Company's long-running core Navy program, the January 1996 acquisition of the Massachusetts-based operations of an Air Force services business, and Department of Defense logistics and engineering support contracts awarded in 1995 and 1996, as well as new state contracts. Much of the Company's revenue relates to the development and operation of computer-based management information and logistics support systems, as well as other information technology services. The Company is continuing to pursue additional programs both within the Department of Defense and with other government agencies. Product Sales Product sales in 1996 increased 26.3% or $6,100,000 as compared with 1995. This was principally the result of increased sales of electroformed components for a line of commercial ink-jet printers, and increased sales of a line of custom encoders for a customer in the automotive industry. The growth in product sales in 1995, 28.3% or $5,112,000, as compared with 1994 was attributable to increased production of parts for commercial ink-jet printers. Cost of Contract Revenue Cost of contract revenue as a percentage of contract revenue increased from 90.5% in 1995 to 91.7% in 1996. In the fourth quarter of 1996, the Company incurred a one-time pre-tax charge of $1,800,000 for unrecoverable costs associated with an Air Force contract. Cost of contract revenue as a percentage of contract revenue decreased from 91.2% in 1994 to 90.5% in 1995, partially the result of a nonrecurring charge of $750,000 which was taken during 1994 relating to staff reductions. The high level of cost of contract revenue in 1995 and 1994 reflected reduced profitability on the Company's major Air Force programs, TEMS and TICARRS. Under TEMS, the Company operated as a subcontractor during 1994 and 1995 at reduced hourly rates as compared with its prior prime-contractor status. TICARRS, a fixed-price contract, showed a loss in 1994 and continued in 1995 with no recorded profit. Cost of Goods Cost of Goods as a percentage of product sales decreased from 80.6% in 1994 to 75.8% in 1995 and 69.9% in 1996. This decrease was primarily the result of increasing production levels of electroformed components for a line of ink-jet printers and a custom encoder product line. Both of these product lines became fully operational during 1994. Selling, Engineering and Administrative Expenses Selling, engineering and administrative expenses increased by 12.7% or $1,563,000 in 1996 from 1995, and by 18.4% or $1,904,000 in 1995 from 1994. These increases were principally due to increased research and development efforts by the Company during both 1995 and 1996 in connection with a software design and development tool and research and development spending in 1996 in connection with the Company's efforts to enter the telecommunication fraud detection market. Excluding research and development expenses, selling, engineering and administrative costs represented 8.5% sales in 1996 and 9.9% in 1995. Interest Expense, Net Interest expense, net increased to $547,000 in 1996 from $171,000 in 1995 due to an increase in the average level of the Company's borrowing during 1996. Capital expenditures in 1996 of $9,266,000 principally in connection with a program to increase electroforming manufacturing capacity, combined with the Company's January 1996 acquisition, resulted in the higher level of borrowings for 1996. Provision (Benefit) for Income Taxes Provision (benefit) for income taxes was 38.2% for 1996, compared to 34.0% for 1995 and (11.4%) for 1994. The Company accounts for income taxes using the liability method as set forth in Statement of Financial Accounting Standards No. 109. The 1995 and 1994 rates were favorably affected by research and development credits as well as somewhat lower net state tax rates. 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 1.4 to 1 at December 28, 1996 compared to 2.1 to 1 at the end of 1995. The change in this ratio is principally attributable to the funding required to support the 1996 capital expenditure program coupled with a January 1996 acquisition. 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 slightly from the end of 1994 to 1995, while increasing at the end of 1996 as a result of the 24.9% increase in sales. However, the 1996 billed and unbilled balance is comparable to 1995 when measured in terms of days sales. Capital expenditures increased to $9,266,000 in 1996 and to $4,441,000 in 1995 from $2,444,000 in 1994 principally in connection with a program to increase electroform manufacturing capacity. At December 28, 1996, $8,400,000 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 be sufficient to support its normal operating and capital requirements for 1997. In February 1997, the Company announced that it had been awarded a $36 million, five-year contract by the State of Ohio to provide information technology products and services. During 1997, significant expenditures are expected to be made to acquire and install computer hardware under this contract, which may require increased levels of borrowings. As of December 28, 1996, the Company does not have any major capital commitments. The Company's backlog of unfilled orders at the end of 1996 was $73,200,000, an increase of 19.4% from the $61,284,000 at the end of 1995. The Company's backlog at the end of 1994 was $43,679,000. The 1995 balance included $10,000,000 related to a commercial order for ink-jet printer components. A portion of the Company's backlog is based on annual purchase contracts and the amount of the backlog as of any date is affected by the timing of such order receipts and deliveries thereunder. Impact of Inflation and Changing Prices Overall, inflation has not had a material impact on the Company's operations. In addition, the terms of Department of Defense contracts, which accounted for approximately 74% of the Company's revenues in 1996, 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 28, 1996, 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 operates and the economy generally. Consolidated Balance Sheets At December 28, 1996, December 30, 1995 and December 31, 1994 (in thousands of dollars, except share data)
1996 1995 1994 Assets Current Assets: Cash and cash equivalents $ 234 $ 777 $ 206 Receivables, less allowances of $340, $402 and $586 19,436 16,095 14,939 Unbilled expenditures and fees on contracts in process 22,690 16,383 18,194 Inventories 3,211 2,612 2,353 Refundable income taxes 1,436 286 885 Prepaid expenses and other current assets 1,247 1,284 1,330 Total current assets 48,254 37,437 37,907 Property, Plant and Equipment, at Cost: Land 1,126 1,126 1,126 Building 7,774 7,774 7,774 Machinery and equipment 38,861 31,537 28,857 Leasehold improvements 2,109 1,815 1,377 Total property, plant and equipment, at cost 49,870 42,252 39,134 Less-accumulated depreciation and amortization 28,266 25,743 23,064 Net property, plant and equipment 21,604 16,509 16,070 Excess of purchase price over net assets of business acquired, net of amortization 1,244 - - Total assets $ 71,102 $ 53,946 $ 53,977 Liabilities and Shareholders' Investment Current Liabilities: Notes payable $ 10,600 $ - $ 1,200 Accounts and drafts payable 8,925 3,550 3,442 Accrued payroll and employee benefits 6,998 6,416 4,649 Deferred contract and other revenue 42 983 894 Other accrued expenses 852 1,691 1,535 Current deferred income taxes 6,091 4,407 4,741 Current portion of long-term debt 1,201 1,217 1,221 Total current liabilities 34,709 18,264 17,682 Long-term debt, less current portion 300 1,500 2,717 Deferred income taxes 854 976 865 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 - 6,689,767 shares in 1996, 6,618,880 shares in 1995 and 6,571,495 shares in 1994 669 662 657 Less: Treasury stock - 996,108 shares in 1996 and 1995, and 940,047 shares in 1994, at par value (100) (100) (94) Capital in excess of par value 9,516 9,219 9,284 Retained earnings 25,154 23,425 22,866 Total shareholders' investment 35,239 33,206 32,713 Total liabilities and shareholders' investment $ 71,102 $ 53,946 $ 53,977
The accompanying notes are an integral part of these consolidated financial statements. Consolidated Statements of Operations
For the three years ended December 28, 1996 1996 1995 1994 (in thousands of dollars, except per share data) Revenue: Contract revenue $100,878 $ 80,756 $ 84,891 Product sales 29,285 23,185 18,073 Total revenue 130,163 103,941 102,964 Costs and Expenses: Cost of contract revenue 92,512 73,077 77,398 Cost of goods 20,476 17,579 14,571 Selling, engineering and administrative expenses 13,830 12,267 10,363 Total operating costs and expenses 126,818 102,923 102,332 Operating Income 3,345 1,018 632 Interest expense, net 547 171 431 Income Before Provision for Income Taxes 2,798 847 201 Provision (benefit) for income taxes 1,069 288 (23) Net Income $ 1,729 $ 559 $ 224 Net Income Per Common Share $ .30 $ .10 $ .04 Weighted Average Number of Common Shares Outstanding 5,675,609 5,603,111 5,638,700 The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Statements of Shareholders' Investment For the three years ended December 28, 1996 (in thousands)
Common Stock Issued Treasury Stock Capital in Retained Shares Par Value Shares Par Value Excess of Earnings Par Value 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 Year 1996 Stock options exercised 71 7 - - 297 - Net income - - - - - 1,729 Balance at December 28, 1996 6,690 $ 669 (996) $(100) $ 9,516 $ 25,154
The accompanying notes are an integral part of these consolidated financial statements. Consolidated Statements of Cash Flows For the three years ended December 28, 1996 (in thousands of dollars) 1996 1995 1994 Cash Provided by Operations: Net income $ 1,729 $ 559 $ 224 Depreciation and amortization 4,927 4,002 4,161 Increase (decrease) in deferred income taxes (122) 111 (180) Provision for receivable reserves (62) (184) 222 6,472 4,488 4,427 Cash Provided by (Used for) Working Capital: Receivables (3,279) (972) 4,855 Unbilled expenditures and fees on contracts in process (6,307) 1,811 (1,141) Inventories (599) (259) 277 Refundable income taxes (1,150) 599 (332) Prepaid expenses and other current assets 37 46 (15) Accounts and drafts payable 5,375 108 (885) Accrued payroll and employee benefits 582 1,767 (87) Deferred contract and other revenue (941) 89 (2,179) Other accrued expenses (839) 156 591 Current deferred income taxes 1,684 (334) 210 (5,437) 3,011 1,294 Net cash provided by operations 1,035 7,499 5,721 Cash Used for Investing Activities: Additions to property and equipment, net (9,266) (4,441) (2,444) Acquisition (2,000) - - Net cash used for investing activities (11,266) (4,441) (2,444) Cash Provided by (Used for) Financing Activities: Net borrowings (repayments) under line of credit agreements 10,600 (1,200) (2,065) Principal payment under long-term borrowings (1,216) (1,221) (1,200) Proceeds from exercise of stock options 304 164 97 Purchase of treasury shares - (230) (43) Net cash provided by (used for) financing activities 9,688 (2,487) (3,211) Net Increase (Decrease) in Cash and Cash Equivalents (543) 571 66 Cash and Cash Equivalents at the Beginning of the Year 777 206 140 Cash and Cash Equivalents at the End of the Year $ 234 $ 777 $ 206 Supplemental Disclosures of Cash Flow Information: Cash paid during the year for: Interest $ 635 $ 435 $ 583 Income taxes $ 1,237 $ 160 $ 265 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 The Company provides services under fixed-price, cost-reimbursement, time-and-material, and level-of-effort contracts. 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. For time-and-material and level-of-effort contracts, revenues are recorded as costs are incurred. Unbilled expenditures and fees on contracts in process represent the recoverable amounts of contract revenue under contracts in process which were not billable at the balance sheet date. Such amounts generally become billable upon completion of a specific phase of the contract, negotiation of contract modifications, completion of government audit or upon acceptance by the government. Costs related to certain contracts, including applicable indirect costs, are subject to audit by the U.S. Government. Revenues from such contracts have been recorded at amounts expected to be realized upon final settlement. Deferred contract revenue represents the amounts billed on certain contracts in excess of costs and fees incurred to date. Income Taxes The Company accounts for income taxes using the liability method 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 tax rates currently in effect in the years in which the differences are expected to reverse. The deferred tax provision represents the change in the net deferred tax liability balance. Cash and Cash Equivalents The Company considers all cash investments with original maturities of three months or less to be cash equivalents. 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. 1996 1995 1994 (in thousands of dollars) Work in process $ 1,411 $ 686 $ 603 Raw materials and subassemblies 1,800 1,926 1,750 Total $ 3,211 $ 2,612 $ 2,353 Property, Plant and 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. 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, notes payable and accounts payable approximates 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. Stock-Based Compensation The Company accounts for its stock-based compensation plans under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation," which is effective for 1996. SFAS No. 123 establishes a fair value based method of accounting for stock-based compensation plans. The Company has adopted the disclosure only alternative under SFAS No. 123, which requires disclosure of the pro forma effects on earnings and earnings per share as if SFAS No. 123 had been adopted as well as certain other information. See Note 7 - Stock Option Plans for required disclosures. 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. 2. U.S. Government Contracts The approximate number of U.S. Government contracts to which the Company is a party has varied between approximately 100 and 150 during the past five years, with 105 contracts open at December 28, 1996. Receivables under U.S. Government contracts at December 28, 1996 were $14,363,000 compared to $12,551,000 at December 30, 1995, and $12,505,000 at December 31, 1994. Unbilled expenditures and fees on contracts in process consist of costs and estimated earnings in excess of billings on incompleted 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 28, 1996 were $22,690,000 compared to $16,383,000 at December 30, 1995, and $18,194,000 at December 31, 1994. Overhead and general and administrative costs charged to U.S. Government contracts are subject to audit for the years after 1994. 3. Income Taxes The components of the provisions (benefit) for federal and state income taxes are as follows: 1996 1995 1994 (in thousands of dollars) Currently Payable (Refundable) Federal $ (513) $ 447 $ (354) State (101) 160 (24) Total (614) 607 (378) Deferred Federal 1,253 (260) 297 State 430 (59) 58 Total 1,683 (319) 355 Total provision (benefit) $ 1,069 $ 288 $ (23) The major items contributing to the difference between the statutory U.S. federal income tax rate of 34% and the Company's effective tax rates are as follows: 1996 1995 1994 (in thousands of dollars) Provision at statutory rate $ 951 $ 288 $ 68 State income tax, net of federal tax benefit 217 50 23 R&D tax credit - (50) (100) Other, net (99) - (14) Provision (benefit) for income taxes $ 1,069 $ 288 $ (23)
The tax effects of significant temporary differences that comprise the deferred tax assets and liabilities as of December 28,1996 and December 30, 1995 are as follows: 1996 1995 (in thousands of dollars) Unbilled costs and fees and deferred contract revenue, net $ (8,730) $ (6,557) Accrued expenses 2,044 1,559 Receivable reserves 130 161 Inventory reserves 239 216 Other 226 214 Current deferred tax liabilities, net (6,091) (4,407) Accelerated tax depreciation (285) (516) Other (569) (460) Non-current deferred tax liabilities (854) (976) Total deferred tax liabilities, net $ (6,945) $ (5,383) Total deferred tax assets and total deferred tax liabilities were $2,639,000 and $9,584,000, respectively at December 28, 1996 compared with $2,150,000 and $7,533,000, respectively at December 30, 1995. The Company has state investment tax credit and federal research and development credit carry forwards of $320,000 and $111,000, respectively at December 28, 1996. 4. 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. 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 1996, 1995 and 1994 included the following components: 1996 1995 1994 (in thousands of dollars) Service cost - benefits earned during the period $ 1,380 $ 1,042 $ 1,309 Interest cost on projected benefit obligation 2,031 1,822 1,666 Actual return on plan assets (1,599) (3,704) 685 Net amortization and deferred items (225) 2,195 (2,198) Net periodic pension cost $ 1,587 $ 1,355 $ 1,462 The following table sets forth the plan's funded status and amounts recognized in the Company's consolidated financial statements at December 28, 1996, December 30, 1995 and December 31, 1994: 1996 1995 1994 (in thousands of dollars) Actuarial Present Value of Benefit Obligations: Vested $ 26,459 $ 23,845 $ 18,327 Nonvested 639 560 466 Accumulated benefit obligation 27,098 24,405 18,793 Effect of projected future salary increases 3,734 3,608 2,644 Projected benefit obligation for service rendered to date 30,832 28,013 21,437 Plan assets at fair market value 25,609 23,104 19,600 Projected benefit obligation in excess of plan assets (5,223) (4,909) (1,837) Unrecognized net loss (gain) from past experience different from that assumed and effects of changes in assumptions 727 196 (2,097) Prior service cost not yet recognized in net periodic pension cost 1,919 2,139 2,359 Unrecognized net obligation at January 1, 1987 being recognized over 15 years 175 211 246 Net pension liability recognized in the Consolidated Balance Sheets at December 28, 1996, December 30, 1995 and December 31, 1994 $ (2,402) $ (2,363) $ (1,329) 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 1996 and 1995 and 8.5% and 3.5% in 1994. The expected long-term rate of return on assets was 9% in 1996, 1995 and 1994. 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. 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 an employee's elective deferrals. The Company contributed $634,462 to the plan for 1996, $578,120 for 1995 and $581,305 for 1994. 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 nonvested portion if termination occurs within the first five years of employment. 5. Notes Payable and Lines of Credit At December 28, 1996, the Company had unsecured lines of credit with various banks that provide for maximum borrowings of $19,000,000, of which $10,600,000 was utilized. Borrowings under these lines of credit are payable on demand and bear interest at the prevailing prime interest rate (8.25% at December 28, 1996) or at a lower rate quoted by the respective banks. The Company's average interest rate on outstanding borrowings at December 28, 1996 and December 31, 1994 was 6.3% and 7.0%, respectively. While the arrangements do not have termination dates, the terms are reviewed and may be revised periodically. 6. Long-term Debt Long-term debt consists of the following: 1996 1995 (in thousands of dollars) Mortgage note payable to a bank, bearing interest at LIBOR plus 1%, adjusted quarterly (6.5% through February 3, 1997), due in quarterly payments of $300,000 plus interest through February 1998, secured by certain land and buildings $ 1,500 $ 2,700 Other 1 17 Less-current portion (1,201) (1,217) $ 300 $ 1,500 Future maturities of long-term debt are $1,201,000 in 1997 and $300,000 in 1998. The Mortgage Agreement, as amended December 18, 1996, contains covenants requiring maintenance of certain operating ratios, minimum balances of net worth and specified fixed charge coverage ratios. The Company was in compliance with all covenants at December 28, 1996 or obtained a waiver for any events of non-compliance. 7. Stock Option Plans The Company has stock option plans which are administered by the Compensation Committee of the Board of Directors which determines the employees to receive options and the number and option price of shares covered by each such option. The 1993 Equity Incentive Plan (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. Options also remain outstanding under the Company's 1983 Stock Option Plan (1983 Plan), which terminated in 1993. Options granted under both plans may be either incentive stock options or non-qualified stock options. In the case of an incentive stock option, 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 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 employees of the Company or holders 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 100,000 shares has been reserved for issuance, of which 82,000 shares remained available at December 28, 1996. Transactions involving the plans are summarized as follows:
1996 1995 1994 Weighted Weighted Weighted Number of Average Number of Average Number of Average Shares Price Shares Price Shares Price Outstanding at beginning of year 499,507 $5.19 360,892 $4.66 429,129 $4.52 Granted 139,000 7.97 186,000 5.77 - - Exercised (70,887) 4.26 (47,385) 3.45 (34,120) 2.86 Canceled (1,830) 5.80 - - (34,117) 4.75 Outstanding at end of year 565,790 $5.97 499,507 $5.19 360,892 $4.66 Exercisable at end of year 303,789 302,510 315,602
At December 28, 1996, under the 1993 Plan, 440,000 shares have been reserved, of which 111,000 shares were available for future grants. The Company has computed the pro forma disclosures required under SFAS No. 123 for options granted in 1995 and 1996 using the Black-Scholes option pricing model required by SFAS No. 123. The assumptions in the Black-Scholes calculation were that the risk free interest rate was 6%, the expected life of the option was 9.5 years, the volatility of the Company's stock was 71% and there was no expected dividend yield. Options to acquire 139,000 shares were granted in 1996 with a weighted average fair value of $6.22 and options to purchase 186,000 shares were granted in 1995 with a weighted average fair value of $4.58. For the year ended December 28, 1996, the pro forma net income, giving effect to SFAS No. 123, would have been $1,272,000 or $.23 per share, compared to the reported net income of $1,729,000 or $.30 per share. For the year ended December 30, 1995, the pro forma net income, giving effect to SFAS No. 123, would have been $419,000 or $.07 per share, compared to the reported net income of $559,000 or $.10 per share. 8. Commitments and Contingencies The Company conducts certain of its operations in facilities which are under long-term operating leases expiring at various dates through 2003, with various options to renew through 2005. Rent expense under these leases (exclusive of real estate taxes, insurance and other expenses payable under the terms of the leases) was approximately $2,130,000 in 1996, $1,636,000 in 1995 and $1,800,000 in 1994. The aggregate minimum lease commitment for the Company's facilities on December 28, 1996 was $6,531,000, payable as follows: $2,197,000 in 1997, $1,806,000 in 1998, $1,171,000 in 1999, $850,000 in 2000, $241,000 in 2001, $198,000 in 2002 and $68,000 in 2003. 9. 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, its holder, 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. 10. Acquisition On January 23, 1996 the Company acquired the Massachusetts-based operations of Support Systems Associates, Inc. (SSAI) for $2,000,000 in cash. The acquired operations had revenue of approximately $5,900,000 in 1995 and included a prime contract to provide services to the U.S. Air Force. In January 1997, the Company paid an additional $125,000 to the seller based upon the achievement of certain thresholds as provided for in the acquisition agreement, this amount will be included in the "Excess of purchase price over net of business acquired." A second payment of $125,000 may be due in late 1997 or in 1998. The acquisition was accounted for as a purchase and the excess of the purchase price over the fair market value of the net assets acquired is being amortized over 30 months. 11. Business Segments The Company provides computer systems services and 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 77% of total Company revenues in 1996. 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 Precision 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 represented 11% of the total Company sales in 1996. These customers operate in the automotive and computer-peripheral industries. 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, Massachusetts corporate headquarters. Summarized financial information by business segment for 1996, 1995 and 1994 are as follows: 1996 1995 1994 (in thousands of dollars) Revenue: Systems and services $ 100,878 $ 80,756 $ 84,891 Precision products 29,285 23,185 18,073 Total Revenue $ 130,163 $ 103,941 $ 102,964 Operating Income: Systems and services $ (2,263) $ (1,907) $ (290) Precision products 5,608 2,925 922 Total operating income $ 3,345 $ 1,018 $ 632 Total Assets: Systems and services $ 44,292 $ 34,953 $ 36,573 Precision products 15,556 9,587 6,878 Corporate 11,254 9,406 10,526 Total Assets $ 71,102 $ 53,946 $ 53,977 Depreciation and Amortization: Systems and services $ 2,848 $ 2,663 $ 2,932 Precision products 1,640 879 772 Corporate 439 460 457 Total depreciation and amortization $ 4,927 $ 4,002 $ 4,161 Capital Expenditures: Systems and services $ 2,583 $ 1,753 $ 1,971 Precision products 5,999 2,494 347 Corporate 684 194 126 Total capital expenditures $ 9,266 $ 4,441 $ 2,444 Management's Responsibility for Financial Statement 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 Officer Vice 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 28, 1996, December 30, 1995 and December 31, 1994, 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 28, 1996, December 30, 1995 and December 31, 1994, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. Boston, Massachusetts, February 7, 1997 Arthur Andersen LLP Corporate Information Auditors Arthur Andersen LLP 225 Franklin Street, Boston, Massachusetts 02110 Legal Councel Ropes & Gray One International Place Boston, Massachusetts 02110 Transfer Agent American Stock Transfer & Trust Company 40 Wall Street, 46th floor New York, New York 10005 Telephone: 800-937-5449 Stock Prices Bid price by quarter 1996 1995 High Low High Low First quarter $ 8.50 $ 5.75 $ 4.75 $ 2.75 Second quarter 9.00 6.25 4.75 4.00 Third quarter 10.13 7.50 7.50 4.13 Fourth quarter 11.00 8.63 9.50 5.50 The bid and asked prices of the Company's common stock on February 7, 1997 were $9.625 and $10.125, 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, Symbol: DRCO; and listed in newspapers as DynamR., DynRsh. or DynRsearch. Number of Shareholders The approximate number of shareholders of record at February 7, 1997 was 1000. As of February 7, 1997 there were 5,693,659 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 TreasurerOs office, Dynamics Research Corporation, 60 Frontage Road, Andover, Massachusetts 01810-5498. Annual Meeting The 1997 Annual Meeting of Shareholders will be held at 3:30 PM on April 22, 1997 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, Emeritus, 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, Test Equipment Division Dr. Martin M. Dresser Vice President, General Manager, Systems Division Victor J. Garber Vice President, Acquisition Engineering, Systems Division Dr. Joseph W. Griffin, Jr. Vice President, Systems Development, Systems Division Edward C. Johnson Vice President, Marketing, Systems Division Chester Ju Vice President, Encoder Division and Metrigraphics Division John M. Nauseef Vice President, Dayton Operations, Systems Division Douglas R. Potter Vice President of Finance, 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 John R.D. McClintock Clerk -----END PRIVACY-ENHANCED MESSAGE-----