-----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, WvR59i0ttiK7gWpffKEGPwRvxlMI6axUZaJFDAfSXteU2+qxILXujI/TY9KQ6WaX OxfRjfq8zGNuuomArIgb+w== 0000927016-00-001093.txt : 20000331 0000927016-00-001093.hdr.sgml : 20000331 ACCESSION NUMBER: 0000927016-00-001093 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 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: SEC FILE NUMBER: 000-02479 FILM NUMBER: 588276 BUSINESS ADDRESS: STREET 1: 60 FRONTAGE ROAD CITY: ANDOVER STATE: MA ZIP: 01810-5498 BUSINESS PHONE: 9784759090 MAIL ADDRESS: STREET 1: 60 FRONTAGE ROAD CITY: ANDOVER STATE: MA ZIP: 01810-5498 10-K 1 FORM 10-K 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 31, 1999 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: (978) 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 [ ]. 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 10, 2000, the aggregate market value of Common Stock held by nonaffiliates of the Registrant was $49,486,770 and the number of shares of Common Stock, $.10 par value, of the Registrant outstanding was 7,528,724. Documents Incorporated By Reference Portions of the 1999 Annual Report to Shareholders are incorporated by reference in Parts I and II. Portions of the Registrant's Proxy Statement for the 2000 Annual Meeting of Shareholders are incorporated by reference in Part III. The Exhibit Index is on pages 23 and 24. DYNAMICS RESEARCH CORPORATION Form 10-K For the Fiscal Year Ended December 31, 1999 Part I Page Item 1. Business 4 2. Properties 10 3. Legal Proceedings 11 4. Submission of Matters to a Vote of Security Holders 11 4A. Executive Officers of the Registrant 11 Part II 5. Market for Registrant's Common Equity and Related Stockholder Matters 12 6. Selected Financial Data 13 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 8. Financial Statements and Supplementary Data 13 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 14 Part III 10. Directors and Executive Officers of the Registrant 14 11. Executive Compensation 15 12. Security Ownership of Certain Beneficial Owners and Management 15 13. Certain Relationships and Related Transactions 15 Part IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 15 PART I Item 1. Business Dynamics Research Corporation (referred to as DRC or the company) was incorporated in 1955 under the laws of the Commonwealth of Massachusetts. The company is an innovative solutions provider, partnering with customers to apply proven processes and technologies. The company delivers engineering, logistics and information technology services and precision manufactured products that enhance the performance and cost effectiveness of its customers' mission critical systems. The company's Systems and Services segment represented 86% of revenue from continuing operations for the year ended December 31, 1999. Precision manufactured products, which includes the Encoder and Metrigraphics business segments, represented 14% of 1999 revenue from continuing operations. Systems and Services Segment The company provides systems analysis, integration and software design and development services. The Segment's information technology offerings also include installation, systems operation, and maintenance. Systems built by the company are used for aircraft maintenance and parts tracking, supply chain management, training requirements, and for managing state government health and human services commitments. The company's major Department of Defense (referred to as DoD) information systems programs are often referred to as logistics information systems. These systems manage data related to inventory requirements and control, maintenance and repair, warranty analysis, supply, and distribution of numerous products and parts. For more than thirty years, the company has provided services to the U.S. Navy Strategic Systems Program office in three areas. First, the company develops and maintains performance, reliability, and logistics databases for the inertial guidance instruments housed in missile guidance systems and submarine inertial guidance systems. These databases track detailed information on thousands of component parts comprising the systems. In connection with these databases, the company has successfully integrated customer workflow and database activity information with Internet technology. Second, the company provides independent analysis and monitoring of submarine-based, inertial guidance systems and electronic modules. The company designs, constructs, installs and supports test equipment used in the U.S. Navy Trident program. Third, the company is involved in the design of a closed-loop system used in the field of parameter control in semiconductor manufacture. This process is being developed together with other companies under the auspices of the U.S. Navy in the San Diego, California, Space and Naval Warfare Systems Center. The company performs computer-aided, semiconductor circuit analysis for its Navy customer as well as commercial companies. The DRC-developed Weapon Systems Management Information System (WSMIS) assesses the "health" and capability of the U.S. Air Force weapon systems to meet wartime objectives. The company has served as the overall functional integrator of WSMIS and the developer of most WSMIS modules. The company currently provides WSMIS operational and software development support. As a decision-support tool for assessing the impacts of logistics status on potential wartime capabilities, WSMIS computes inventory requirements, purchasing needs, and logistics capability assessments for complex, high-priced aircraft spare parts necessary to meet aircraft availability requirements. A major component of the company's DoD business consists of a wide variety of engineering, technical assistance and management support services performed under various indefinite order, indefinite quantity contracts. Work performed under these contracts is generally done on a time and materials basis utilizing a wide range of the company's technical and management skills to plan, analyze, design, test, support, train, maintain, and dispose of a variety of complex systems. Systems include radar, missile, aircraft, information, logistics and munitions. The company provides support at all stages of a system's life cycle. In response to emerging requirements, the company helps its Federal Government customers define, develop, and initiate new programs. The company also helps customers obtain program approval, conduct strategic planning, and evaluate proposals from private contractors. After prime contract awards, the company helps monitor contractor activities, evaluate progress, and measure performance against program requirements. Products and services include computer-based training, systems integration, and business process improvement/reengineering. Under a variety of contracts, the company supports the U.S. Air Force at bases such as Hanscom Air Force Base, Scott Air Force Base, Langley Air Force Base, Maxwell Air Force Base, Gunter Annex, Peterson Air Force Base, and Eglin Air Force Base. The company provides engineering services in excess of $35 million per year to the Electronics Systems Center (ESC). Under the Information Technology Support Program (ITSP), the company provides acquisition management, systems engineering, systems integration, test and evaluation, and computer based training to ESC's System Program Offices and Product Acquisition Directorates. In 1995, the U.S. Air Force awarded the company a five-year contract for Technology Task-Order Engineering Services (TTOES). Originally valued at up to $23.7 million, in 1997 the contract ceiling was increased to $31.2 million. The company has provided engineering, logistics, and software support on programs such as the B-1B, the B-2, the B-52, the KC-135, and the E-3A aircraft repair, maintenance, and upgrade programs. From its origin at the Oklahoma City Air Logistics Center (ALC), DRC has expanded its TTOES task orders to include work at other ALC's located at Warner Robins, GA; Ogden, UT; and San Antonio, TX. Additional tasking has centered on providing support to Air Force reengineering and business process improvement initiatives at these ALC's. Recently, the company was awarded a prime contract for the Design Engineering Support Program at Ogden ALC. The company has designed, developed, installed and, since August 1999, has operated a logistics and supply chain information management system to support the U.S. Air Force's landing gear maintenance, repair and overhaul (MRO) operations at Hill Air Force Base in Ogden, Utah. Recently, the company was awarded additional MRO workload for Gas Turbine Engines, Hydraulics and Armament Systems at Ogden. Since 1993, the company has provided the US Army Aviation and Missile Command with specialized studies and analyses in aviation/missile system development, acquisition and sustainment. Since 1996, the company has been a prime contractor on a five-year, $33 million contract under a U.S. Army program known as Programmatic and Technical Support. The company supports a broad range of helicopter and missile systems in varying life cycle stages. Additionally, the company supports other U.S. Army activities with acquisition logistics, systems engineering and other related program management services at the Tank-Automotive Command and Communications-Electronics Command from its office in Huntsville, Alabama. Combining its expertise in weapon system acquisition processes with its expertise in systems analysis, design, training and simulation and human factors, the company performs human-systems integration and force analysis. Since 1987, the company has provided force analysis support to the Army Research Laboratory. These activities are focused on developing tools that support analyzing soldier and system effectiveness, identifying and assessing force improvement options (doctrine, training, leader development, organization and material), and ensuring soldier considerations are addressed in force improvements. Also, under contract from the U.S. Army Research Laboratory, the company provides analysis, system development and support in several functional areas which include assessment of manpower, personnel and training issues; analysis of soldier systems performance; and integration of methods and databases for use by system designers. DRC is the developer of the Training System Requirements Analysis (TSRA) Tools, which are a set of computer programs designed to help instructional designers perform the initial phases of the Instructional Systems Development (ISD) process. The TSRA Tools have been developed with the Naval Air Warfare Center Training Systems Division and are widely used throughout the DoD by government and contractor organizations. The market for DRC's TSRA Tools has expanded beyond the military to include the Federal Aviation Administration and National Mine Health and Safety Academy. As a subcontractor to Lockheed Martin, the company is supporting the U.S. Army's Warfighter Simulation 2000, a simulation system supporting the training of commanders and staff under a wide variety of battlefield scenarios. The company's services include providing military subject matter experts, software and human factors engineering, database development for equipment and knowledge acquisition, as well as manpower staffing reduction analysis. The company is also a subcontractor to Lockheed Martin for the Close Combat Tactical Trainer (CCTT) program. CCTT simulates Army tank and mechanized infantry units from vehicle crews to the battalion level. CCTT uses distributed, interactive simulation technology to provide a "virtual" training environment. DRC conducts all manpower and personnel integration activities associated with the CCTT. DRC is playing a similar role as a subcontractor to Lockheed Martin on the United Kingdom Combined Arms Tactical Trainer, the UK's version of the CCTT. The company is a subcontractor to Raytheon on the U.S. Air Force National Air and Space Model. The company develops conceptual models and collects data on mission space objects and processes. In 1996, the company began working on a U.S. Army, four-year contract to implement, apply, and manage DRC-developed teamwork training designed to improve teamwork and reduce errors in emergency medicine. The program, called MedTeams, has been instituted in a dozen military and civilian hospitals in the United States. In March 1998, DRC was awarded a contract under the Air Force Aeronautical Systems Center Advisory and Assistance Services (A&AS) Omnibus program. The purpose of this contract is to provide support for engineering, manufacturing, configuration/data management, acquisition management and test and evaluation required in the acquisition, development, production and sustainment of various equipment and weapons systems. The contract provides DRC the opportunity to compete against other companies for tasks under the A&AS Omnibus program over three years. In recent years, the company has expanded beyond the DoD marketplace and won various state and Federal agency contracts. The company provides systems design, development, implementation and support services to Health and Human Services Departments in four states-Ohio, New Hampshire, Arkansas and Colorado. The company implemented a distributed computer-based Statewide Automated Child Welfare Information System (SACWIS) for the State of New Hampshire. This system manages child welfare cases handled by the State's Department of Health and Human Services. Under ongoing contracts DRC provides additional functional and technical enhancements to the SACWIS system as well as other information technology services. The company is also developing a SACWIS for the State of Arkansas. In December 1997, the company received a three-year contract from the State of Colorado Department of Human Services to serve as a prime contractor for its Children, Youth and Families project. The contract was a result of a competitive procurement for the design, development and implementation of a child welfare and youth corrections system consisting of software, training and a state-wide computer network infrastructure. In addition, the company installed, under a prime contract, the Ohio state-wide computer network infrastructure for the Support Enforcement, Tracking Systems and Ohio Works First Programs. The company continues to provide the U.S. Department of Treasury with information technology services for the Internal Revenue Service and other Treasury departments. During 1998 and 1999 the company's work for the IRS focused on year 2000 procedures. In 2000, the company will be focusing on full life cycle development of the Compliance Research Information Service. Precision Manufactured Products The company's precision manufacturing business consists of two business segments, Encoder and Metrigraphics. The Encoder Division designs, manufactures, and markets a line of optical encoders that convert analog motion and position information into digital signals used in a wide variety of industrial products and systems which include: machine tools, robotics, engine fuel-control systems, packaging equipment and factory automation equipment. Optical encoders are essential elements of today's electronically-controlled systems and equipment. The Metrigraphics Division's expertise centers on photolithography, thin film deposition of metals and dielectrics and electro forming. Metrigraphics' superior ability to design and manufacture components and maintain critical tolerances is an important driver for a wide range of high-technology applications. The company currently applies these technologies in four distinct applications: 1) computer printer nozzle plates and hard drive test devices; 2) medical applications for micro flex circuits used in angioplasty and for bloodtesting; 3) electrical test devices for application in flexible interposers and 3-D microstructures; and 4) devices used in the manufacture of fiber optic system components requiring precision alignment and 3-D micro structures. Metrigraphics' highest volume application is currently for nozzles used in inkjet printer cartridges. In addition to its electroform parts for printers and medical instruments, Metrigraphics manufactures precision glass parts for computer peripherals, factory automation equipment, electronic instrumentation and semiconductor equipment. Telecommunications Fraud Control Systems In 1996, the company was licensed to enhance, market and maintain a telecommunications fraud control system developed by Pacific Bell Telephone Company. The company made significant investments in this and related systems and software technologies to broaden the types of telephone fraud detected and to position the product for sale to competitive local exchange carriers and others. The company's customers included the regional Bell operating telephone companies. In December 1998, the company adopted a plan to exit this business during 1999. The business was sold in June 1999. Software Development Technology In 1998, the company exited its Visual Magic business which developed object-oriented software for Internet applications. The company sold an exclusive license to the software and other assets in exchange for an equity interest in the acquiring company, Empresa, Inc. In 1999, Empresa ceased operations, and the company wrote off its investment of $1.4 million. Sales and Marketing Contracts with defense, state and other government agency customers 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 outside sales representatives. Government Contracts During 1999, the company's revenues from contracts with the DoD, either as prime contractor or subcontractor, accounted for approximately 66% of the company's total revenues. 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 revenues and earnings. The company's revenues from contracts with four different states accounted for 16% of 1999 revenues. Revenues under various contracts with the State of Ohio accounted for approximately 7% of 1999 revenues. The company's state contracts are generally either fixed-price or time and material. In certain instances, funding for these contracts is subject to annual state legislative approval. 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 government 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. Backlog At December 31, 1999, the company's backlog of unfilled orders was approximately $106.7 million compared with $105.4 million at December 31, 1998. The company expects that substantially all of its backlog at December 31, 1999 will be filled during the year ending December 31, 2000. The company has a number of multi-year contracts with agencies of the U.S. and state governments 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 because various agencies perform certain types of services which might otherwise be performed by the company. The principal competitive factors for systems and services are price, performance, technical competence and reliability. In the commercial businesses, the company competes with other manufacturers of encoders, electroform vendors and suppliers of precision measurement scales. The principal competitive factors affecting the precision components manufacturing businesses are price, product quality and custom engineering to meet customers' system requirements. Research and Development The company expended approximately $1.5 million (inclusive of overhead and other indirect costs) on new product and service development during the year ended December 31, 1999, as compared to expenditures of $2.7 million during 1998 and $1.2 million during 1997. 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 31, 1999, the company had 1,613 employees. Proprietary Information Patents, trademarks and copyrights are not materially important to the business of the company. The U.S. 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 479,000 square feet, which are utilized for its federal and state government 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 26 locations across the United States. The company owns a 135,000 square foot facility in Andover, Massachusetts that is utilized for its DoD service operations and corporate administrative offices. The company's total rental cost for 1999 was $3.7 million. The company believes its properties are adequate for its present needs. 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. Position Age -------- --- John S. Anderegg, Jr. Chairman and Director 76 James P. Regan President, Chief Executive Offficer 59 and Director John L. Wilkinson Vice President, Human Resources 60 David Keleher Vice President of Finance, 50 Chief Financial Officer Chester Ju Vice President, Encoder Division 50 and Metrigraphics Division Alan R. Cormier Vice President and General Counsel 49 Messrs. Anderegg, Wilkinson and Ju has served in his respective position for at least five years. Mr. Regan joined the company in 1999 as President, Chief Executive Officer and Director. Prior to that he was President and Chief Executive Officer of CVSI, Inc. from 1997 to October 1999 and served as Senior Vice President of Litton PRC from 1993 to 1996. Mr. Keleher joined DRC as Vice President of Finance and Chief Financial Officer in January 2000. Prior to that he was employed by Raytheon Corporation as Group Controller in 1999 and Assistant Corporate Controller in 1998. Prior to that he served as corporate controller of Act Manufacturing, Inc. in 1997 and as Manager, Corporate Accounting and Reporting at Digital Equipment Corporation from 1991 to 1997. Mr. Cormier joined the company as Vice President and General Counsel in January 2000. Prior to that he was Associate General Counsel at Wang Laboratories Inc. from 1995 to 1999. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The common stock of the company is traded on the NASDAQ National Market under the symbol DRCO. The high and low prices for the quarters in 1998 and 1999 are listed below. 1999 1998 High Low High Low First quarter $ 7.19 $ 2.88 $ 10.02 $ 9.72 Second quarter 6.63 4.25 11.47 11.18 Third quarter 6.25 3.50 9.43 9.06 Fourth quarter 9.50 3.94 6.00 5.52 The number of holders of record of the company's common stock are described in the company's Annual Report to Shareholders for 1999 under the caption "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 1999 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 1999 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 1999 is incorporated herein by reference. The company has made and may make statements from time to time which constitute or contain forward-looking information as that term is defined within the meaning of the Federal securities laws. These statements may be identified by such forward-looking words or other forward-looking terminology. Forward-looking statements are not guarantees of future performance and actual results may differ materially from those in the forward-looking statements as the results of risks and uncertainties including those identified in Exhibit 99. The company assumes no obligation to update any forward-looking information. 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 31, 1999 and December 31, 1998 Consolidated Statements of Operations for the three years ended December 31, 1999 Consolidated Statements of Stockholder's Equity for the three years ended December 31, 1999 Consolidated Statements of Cash Flows for the three years ended December 31, 1999 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 1999.) Report of Independent Public Accountants on Schedule to Consolidated Financial Statements Schedule II - Valuation and Qualifying Accounts for the three years ended December 31, 1999 The foregoing report of independent public accountants and schedule II are included as part of Item 14 of this Annual Report on Form 10-K and are set forth on page 16 and 22 filed herewith. 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 8, and Management's Discussion and Analysis of Financial Condition and Results of Operations presented on pages 9-12, of the company's Annual Report to Shareholders for the year 1999, 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 2000 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 31, 1999, is incorporated herein by reference. Information relating to the Executive Officers of the company is included in Item 4A of Part I of this Form 10K. Item 11. Executive Compensation Information called for by this item is incorporated by reference from the section entitled "Compensation and Related Matters" in the company's definitive Proxy Statement for the 2000 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 31, 1999. 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 1999 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 31, 1999. 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. (b) (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 23 and 24. (c) Reports on Form 8-K. The company filed a report on Form 8-K on October 7, 1999 to report the signing of the Second Amended and Restated Revolving Credit Agreement dated as of September 30, 1999. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE 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 11, 2000. 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 11, 2000 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 27, 2000 DYNAMICS RESEARCH CORPORATION by: /s/ James P. Regan ------------------ James P. Regan, 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 27th of March, 2000. /s/ James P. Regan - ----------------------------- James P. Regan President, Chief Executive Officer and Director /s/ David Keleher - ----------------------------- David Keleher Vice President of Finance, Chief Financial Officer (Principal Financial and Accounting Officer) /s/ John S. Anderegg, Jr. - ----------------------------- John S. Anderegg, Jr. Chairman and Director /s/ Francis J. Aguilar - ----------------------------- Dr. Francis J. Aguilar Director /s/ Martin V. Joyce, Jr. - ----------------------------- Martin V. Joyce, Jr. Director /s/ Kenneth F. Kames - ----------------------------- Kenneth F. Kames Director /s/ James P. Mullins - ----------------------------- Gen. James P. Mullins Director SCHEDULE II DYNAMICS RESEARCH CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED DECEMBER 31, 1999 (in thousands of dollars) ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES RETURNS Balance, December 28, 1996 $ 340 Additions charged to expense 86 Write-off of uncollectible accounts, net (209) ------- Balance, December 31, 1997 $ 217 Additions charged to expense 149 Write-off of uncollectible accounts, net (50) ------- Balance, December 31, 1998 $ 316 Additions charged to expense 491 Write-off of uncollectible accounts, net (17) ------- Balance, December 31, 1999 $ 790 ======= ACCRUAL OF LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS Balance, December 31, 1997 $ -- Additions charged to discontinued operations expense 4,148 ------- Balance, December 31, 1998 $ 4,148 Results from discontinued operations charged against accrual (1,510) Gain on disposal of discontinued operations (2,197) Balance, December 31, 1999 $ 441 ======= PROVISION FOR RESTRUCTURING COSTS Balance, December 31, 1997 $ -- Balance, December 31, 1998 -- Additions charged to restructuring expense 1,157 ------- Balance, December 31, 1999 $ 1,157 ======= 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 Certificate of Vote of Directors Establishing Series B Preferred Stock (Incorporated by reference to the Registrant's Form 8-K on June 25, 1998). 4.3 Amendment to Certificate of Vote Establishing Series B Preferred Stock. 4.4 Rights Agreement dated as of February 17, 1998 between the Company and American Stock Transfer & Trust Company, as Rights Agent. (Incorporated by reference to the Registrant's Form 8-K on June 25, 1998) 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 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) 10.3 Form of Dynamics Research Corporation Severance Agreement for Mr. Anderegg. (Incorporated by reference to the Registrant's Form 10-K for the year ended 12/28/91) 10.4 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) 10.5 Form of Consulting Agreement between Dynamics Research Corporation and Albert Rand. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 3/31/97) 10.6 Form of Supplemental Retirement Pension Agreement between Dynamics Research Corporation and Albert Rand. (Incorporated by reference to the Registrant's Form 10-Q for the quarter ended 3/31/97) 10.7 Amended 1993 Equity Incentive Plan 10.8 Amended 1995 Stock Option Plan for Non-Employee Directors 10.9 Loan and Security Agreement dated as of February 10, 2000 by and among Dynamics Research Corporation, and its subsidiaries and Brown Brothers Harriman & Co. and Family Bank FSB. (Incorporated by reference to the Registrant's Form 8-K dated March 24, 2000.) 10.10 Mortgage Security Agreement and Assignment dated as of February 10, 2000 by and among Dynamics Research Corporation and Brown Brothers Harriman & Co. and Family Bank FSB. (Incorporated by reference to the Registrant's Form 8-K dated March 24, 2000.) 10.11 Form of Employment Agreement between Dynamics Research Corporation and James P. Regan. 10.12 Form of Change of Control Agreement between Dynamics Research Corporation and James P. Regan. 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 31, 1999 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 29, 2000 filed herewith. 99.0 Important Factors Regarding Forward-Looking Statements. All documents incorporated by reference may be found at Commission file number 1-7348. EX-10.11 2 AGREEMENT BETWEEN DYNAMICS AND JAMES P. REGAN EXHIBIT 10.11 DYNAMICS RESEARCH CORPORATION 60 Frontage Road Andover, Massachusetts 01810 (978) 475-9090 September 10, 1999 Mr. James P. Regan 930 Towlston Road McLean, Virginia 22102 Dear Jim: This letter will confirm the agreement between you and Dynamics Research Corporation (the "Company") concerning your employment: 1. POSITION AND DUTIES. a. Effective no later than October 1, 1999, you will be employed by the Company, on a full-time basis, as its President and Chief Executive Officer. In addition, during your employment, and without further compensation, you will serve as a member of the Board of Directors of the Company (the "Board") and will also serve as a director or officer of one or more of the Affiliates, if so elected or appointed from time to time. b. You agree to perform the duties of your position and such other duties, consistent with your position, as may reasonably be assigned to you from time to time. You also agree that, while employed by the Company, you will devote your full business time and your best efforts, business judgment, skill and knowledge exclusively to the advancement of the business and interests of the Company and the Affiliates and to the discharge of your duties and responsibilities to them. 2. COMPENSATION AND BENEFITS. During your employment, as compensation for all services performed by you for the Company and the Affiliates, and subject to your performance of your duties and obligations to them, the Company will provide you the following pay and benefits: a. BASE SALARY. The Company will pay you a base salary at the rate of Three Hundred Thousand Dollars ($300,000) per year, payable in accordance with the regular payroll practices of the Company for its executives and subject to increase from time to time by the Board in its discretion. b. BONUS COMPENSATION. Commencing in calendar year 2000, you will be eligible to earn a bonus of up to seventy-five percent (75%) of your base salary for each full calendar year during your employment with the Company, based on the Company's achievement of objectives which you and the Board shall mutually determine from time to time. This bonus shall be awarded, if at all, instead of and not in addition to, any bonus that from time to time may be available to executives of the Company generally. c. STOCK OPTIONS. On the effective date of this agreement (as set forth in Section 1.a above), the Company shall grant you an option to purchase, at their fair market value on the effective date, 250,000 shares of common stock of the Company. The option shall become exercisable at the rate of twenty percent (20%) on the date of grant and on each of the first four anniversaries thereof. Except as otherwise provided in this Section 2.c or in Section 5.a and c, the option granted you hereunder shall be pursuant to the terms of the Company's Equity Incentive Plan. d. OTHER BENEFITS. i. During your employment, except as otherwise provided in this agreement, you shall be entitled to participate in all employee benefit plans made available to executives of the Company generally, all as in effect from time to time, including term life insurance in an amount equal to your base salary. Your participation will be subject to the terms of the applicable plan documents and generally applicable Company policies. ii. In addition to the foregoing, during your employment, the Company will pay or reimburse the premium cost of up to $600,000 of term life insurance coverage maintained by you. iii. During your employment, the Company will provide an automobile for your business use and will pay or reimburse expenses of that automobile in accordance with Company policy, as in effect from time to time. e. RELOCATION AND RELATED EXPENSES. To assist you in your relocation to the Andover, Massachusetts area, the Company will (i) reimburse your relocation expenses to the extent provided under the Company's current relocation policy; and, to the extent not duplicative of reimbursement provided you under the Company's relocation policy; (ii) compensate you for the difference, if any, between the price you paid to - 2 - purchase your current residence in McLean, Virginia and the selling price of that residence, provided that you make reasonable efforts to obtain fair market value for the residence; and (iii) reimburse your reasonable temporary living expenses in the Andover, Massachusetts area and commuting expenses between Massachusetts and Virginia for up to six months or, if less, until you and your family have permanently relocated to the Andover, Massachusetts area. Notwithstanding any contrary provision in the Company's relocation policy, you will be permitted to select the real estate agents for the sale of your Virginia residence and the purchase of a Massachusetts residence. For the purpose of this Section 2.e, "living expenses" shall include reasonable costs for lodging, meals, laundry, groceries, dry cleaning, and telephone calls, but will not include expenses that normally would be incurred by you if you were not relocating such as, but not limited to, mileage to and from work, car insurance and car repairs. f. MEMBERSHIP DUES. During your employment, the Company will pay or reimburse your annual membership dues for the country club in the Washington, D.C. area of which you are currently a member and up to twenty-five thousand ($25,000) of your entrance fees as well as your annual membership dues for a country club in Massachusetts, to the extent such dues or fees are not duplicative of reimbursement provided you under the Company's expense reimbursement policy. g. PAID TIME AWAY. You will be entitled to five weeks of Paid Time Away per year, to be used for vacation, sickness, unofficial holidays, special leaves, etc. at such times and intervals as you shall determine, subject to the reasonable business needs of the Company. In the event of termination of this agreement for any reason, you shall be entitled to cash compensation for Paid Time Away not used as of the date of termination, but only to the extent such Paid Time Away has been accrued during the calendar year of termination. h. BUSINESS EXPENSES. The Company will pay or reimburse you for all reasonable business expenses incurred or paid by you in the performance of your duties and responsibilities for the Company, subject to Company policies as in effect from time to time, to any maximum annual limit and other restrictions on such expenses set by the Board and to your providing such reasonable substantiation and documentation as may be specified by the Company from time to time. - 3 - 3. CONFIDENTIAL INFORMATION AND RESTRICTED ACTIVITIES. a. CONFIDENTIAL INFORMATION. During the course of your employment with the Company, you will learn of Confidential Information, as defined below, and you may develop Confidential Information on behalf of the Company and the Affiliates. You agree that you will never use or disclose to any Person (except as required by applicable law or for the proper performance of your duties and responsibilities to the Company and the Affiliates) any Confidential Information. You understand that this restriction shall continue to apply after your employment terminates, regardless of the reason for such termination. b. PROTECTION OF DOCUMENTS. All documents, records and files, in any media of whatever kind and description, relating to the business, present or otherwise, of the Company and the Affiliates and any copies ("Documents"), whether or not prepared by you, shall be the sole and exclusive property of the Company and the Affiliates. You agree to safeguard all Documents and to surrender to the Company, at the time your employment terminates or at such earlier time or times as the Company may specify, all Documents then in your possession or control. c. NON-COMPETITION. You acknowledge and agree that the following restrictions on your activities during and after your employment are necessary to protect the goodwill, Confidential Information and other legitimate interests of the Company and the Affiliates: i. While you are employed by the Company and during the period of one year immediately following termination of your employment (the "Non-Competition Period"), you shall not, directly or indirectly, whether as owner, partner, investor, consultant, agent, employee, co-venturer or otherwise, compete with the Company or be associated with any competitor of the Company. The foregoing shall not prevent your passive ownership of three percent (3%) or less of the equity securities of any publicly-traded company. ii. You agree that during the Non-Competition Period, you will not, directly or indirectly, (1) hire or solicit for hiring any employee of the Company or any of the Affiliates or any person who has been such an employee in the preceding three months or seek to persuade any employee of the Company or any of the Affiliates to discontinue employment, (2) solicit or encourage any customer of the Company or any of the Affiliates or independent contractor providing services to the Company or any of the Affiliates to terminate or diminish its relationship with them or (3) seek to persuade any customer or prospective customer of the Company or any of the Affiliates to conduct with anyone else any business or activity that such customer or prospective customer conducts or could conduct with the Company or any of the Affiliates. - 4 - e. ASSIGNMENT OF INTELLECTUAL PROPERTY. You agree to promptly and fully disclose to the Company all Intellectual Property, as defined below. You hereby assign and agree to assign to the Company (or as otherwise directed by the Company) your full right, title and interest to all Intellectual Property. You further agree to execute any and all applications for domestic and foreign patents, copyrights and other proprietary rights and do such other acts (including, among others, the execution and delivery of instruments of further assurance or confirmation) requested by the Company to assign the Intellectual Property to the Company and to permit the Company to enforce any patents, copyrights and other proprietary rights in the Intellectual Property. You agree that you will not charge the Company for time spent in complying with these obligations. All copyrightable works that you create shall be considered "work made for hire." f. You agree that, until the expiration of the Non-Competition Period, you will provide the Company with such pertinent information concerning your business activity as the Company may reasonably request in order to determine your continued compliance with your obligations under this Section 3. You agree to inform any new or prospective employer of this agreement and of your obligations under this Section 3. g. In signing this agreement, you give the Company assurance that you have carefully read and considered all the terms and conditions of this agreement, including the restraints imposed on you under this Section 3. You agree without reservation that these restraints are necessary for the reasonable and proper protection of the Company and the Affiliates; that each and every one of the restraints is reasonable in respect to subject matter, length of time and geographic area; and that these restraints will not prevent you from obtaining other suitable employment during the Non-Competition Period. You further agree that, were you to breach any of the covenants contained in this Section 3, the damage to the Company and the Affiliates would be irreparable. You therefore agree that the Company, in addition to any other remedies available to it, shall be entitled to preliminary and permanent injunctive relief against any breach or threatened breach by you of any of those covenants, without having to post bond, and that you will not take, and you will not permit anyone else to take on your behalf, any position in a court or any other forum inconsistent with any of your covenants and agreements herein. You and the Company further agree that, in the event that any provision of this Section 3 is determined by any court of competent jurisdiction to be unenforceable by reason of its being extended over too great a time, too large a geographic area or too great a range of activities, that provision shall be deemed to be modified to permit its enforcement to the maximum extent permitted by law. It is also agreed that each of the Affiliates shall have the right to enforce all of your obligations to that Affiliate under this agreement, including without limitation pursuant to this Section 3. 4. TERMINATION OF EMPLOYMENT. Your employment under this agreement shall continue until terminated pursuant to this Section 4. - 5 - a. BY THE COMPANY (i) The Company may terminate your employment other than for Cause at any time upon six months' notice; provided, however, that the Company may elect to pay you your base salary for some or all of the six month period in lieu of notice. (ii) The Company may terminate your employment for Cause upon notice to you setting forth in reasonable detail the nature of the Cause. Only the following shall constitute Cause for termination: (1) your willful failure to perform (other than by reason of disability), or gross negligence in the performance of, your duties and responsibilities to the Company or any of the Affiliates; (2) your material breach of any provision of Section 3 of this agreement; or (3) other serious misconduct by you that is reasonably anticipated to result in material injury to the business, interests or reputation of the Company or any of the Affiliates; provided, however, that to the extent that the acts or omissions giving rise to such termination are capable of being cured by you, you will be afforded 30 days to correct such acts or omissions specified in the termination notice provided by the Company. b. BY YOU. You may terminate your employment, other than for Good Reason or for Good Reason, upon six months' notice to the Company. If you terminate for Good Reason, the notice must set forth in reasonable detail the nature of such Good Reason. In the event of your termination of your employment hereunder, the Company may elect to waive some or all of the notice period and, in that event, shall continue to pay you your base salary and benefits for that portion of the notice period waived. Only the following shall constitute Good Reason for termination: (a) the Company's assignment of any duties to you that are materially inconsistent with your positions, duties, responsibilities or reporting requirements with the Company, (b) the Company's material reduction of your responsibilities, authority or status with the Company, (c) the Company's reduction of your compensation or any benefit provided by this Agreement or (d) the Company's material breach of its obligations under this Agreement or any other material agreement between the Company and you; provided, however, that to the extent that the acts or omissions giving rise to such termination are capable of being cured by the Company, the Company will be afforded 30 days to correct such acts or omissions specified in the termination notice provided by you. c. BY REASON OF DISABILITY. In the event you become disabled during employment through any illness, injury, accident or condition of either a physical or psychological nature and, as a result, are unable to perform substantially all of your duties hereunder, the Company will continue to pay you your base salary, less the amount of any benefits provided you through a Company-provided disability plan, and will continue to provide you benefits in accordance with Section 2.d above for up to six months of disability during any rolling period of three hundred and sixty-five (365) consecutive calendar days. If you are unable to return to work after six months of disability, the Company may terminate your employment, upon notice to you. If any question shall arise as to whether you are disabled to the extent that you are unable to perform substantially all of your duties - 6 - hereunder, you shall, at the Company's request, submit to a medical examination by a physician selected by the mutual agreement of you (or your guardian, if any) and the Company to determine whether you are so disabled and such determination shall for the purposes of this agreement be conclusive of the issue. If such a question arises and you fail to submit to the requested medical examination, the Company's determination of the issue shall be binding on you. 5. SEVERANCE PAYMENTS AND OTHER MATTERS RELATED TO TERMINATION. a. In the event of termination of your employment by the Company other than for Cause in accordance with Section 4.a.i. or by you for Good Reason in accordance with Section 4.b, and provided that no severance benefits are payable to you under the change of control agreement between you and the Company of even date (the "Change of Control Agreement"), the Company will, notwithstanding that you may have become employed by another employer, continue to pay you your base salary and continue to provide all of your group health and life insurance benefits, including the benefit provided by Section 2.d.ii, for a period of twelve months (the "Severance Pay Period"). The Company will also pay you on the date of termination any base salary and bonus compensation earned but not paid through the date of termination (including a pro-rated portion of any earned bonus for the year in which the termination occurs) and pay for any Paid Time Away accrued but not used to that date. In addition, all options granted you by the Company shall become exercisable on the date of termination and shall remain exercisable for one year following the date of termination. b. Severance payments will be in the form of salary and benefits continuation, payable in accordance with the normal payroll practices of the Company and will begin on the Company's next regular payday following the effective date of termination of your employment or, in the event that the Company elects to provide you pay in lieu of notice for some or all of the notice period, on the Company's next regular payday following the period for which pay is provided in lieu of notice; provided, however, that coverage under the Company's group health plan will terminate at such time as you and/or your dependents become eligible for coverage under the health plan of another employer. Your participation in all other employee benefit plans and programs other than those specified in Section 5.a will cease as of the date of termination of your employment, without regard to any continuation of base salary or other payment to you following termination. c. In the event of termination of your employment by you or by the Company for Cause, the Company will pay you (i) any base salary earned but not paid through the date of termination, (ii) bonus for any prior year that was granted but not paid and bonus for the current year prorated through the date of termination, and (iii) pay for - 7 - any Paid Time Away accrued but not used to that date, but shall have no further obligation to you. All unvested options granted you by the Company shall be forfeited in the event of termination of your employment for Cause. d. Provisions of this agreement shall survive any termination if so provided in this agreement or if necessary or desirable to accomplish the purpose of other surviving provisions, including without limitation your obligations under Section 3 of this agreement. The obligation of the Company to make payments to you in lieu of notice under Section 4.a or 4 b hereof or severance payments under Section 5.a is expressly conditioned upon your continued full performance of your obligations under Section 3 hereof. 6. DEFINITIONS. For purposes of this agreement, the following definitions apply: "Affiliates" means all persons and entities directly or indirectly controlling, controlled by or under common control with the Company, where control may be by management authority, equity interest or otherwise. "Confidential Information" means any and all information of the Company and the Affiliates that is not generally known by others with whom any of them competes or does business or with whom any of them plans to compete or do business and any and all information, publicly known in whole or in part or not, which, if disclosed by the Company or the Affiliates, would assist in competition against them. Confidential Information includes, without limitation, information relating to (i) the development, research, testing, marketing and financial activities of the Company and the Affiliates, (ii) their products and services, (iii) the costs, sources of supply, financial performance and strategic plans of the Company and the Affiliates, (iv) the identity and special needs of the customers and prospective customers of the Company and the Affiliates and (v) the people and organizations with whom the Company and the Affiliates have business relationships and those relationships. Confidential Information also includes any information received by the Company or any of the Affiliates from any Person with any understanding, express or implied, that it will not be disclosed and any information designated by the Company or any of the Affiliates as confidential. "Intellectual Property" means any invention, formula, process, discovery, development, design, innovation or improvement (whether or not patentable or registrable under copyright statutes) made, conceived, or first actually reduced to practice by you solely or jointly with others, during your employment by the Company; provided, however, that, as used in this agreement, the term "Intellectual Property" shall not apply to any invention that you develop on your own time, without using the equipment, supplies, facilities or trade secret information of the Company or any of the Affiliates, unless such invention relates at - 8 - the time of conception or reduction to practice of the invention (i) to the business of the Company, (ii) to the business of an Affiliate for whom you have performed services, (iii) to the actual or demonstrably anticipated research or development of the Company or any of the Affiliates, provided that, in the case of an Affiliate, you have, or would reasonably be expected to have, knowledge of such research or development as a result of your employment or (iv) results from any work performed by you for the Company or any of the Affiliates. "Person" means an individual, a corporation, an association, a partnership, an estate, a trust and any other entity or organization, other than the Company or any of the Affiliates. 7. CONFLICTING AGREEMENTS. You hereby represent and warrant that, subject to your termination of your current employment, your signing of this agreement and the performance of your obligations under it will not breach or be in conflict with any other agreement to which you are a party or are bound and that you are not now subject to any covenants against competition or similar covenants or court order that would affect the performance of your obligations under this agreement. You agree that you will not disclose to or use on behalf of the Company any proprietary information of a third party without that party's consent. 8. WITHHOLDING. All payments made by the Company under this agreement shall be reduced by any tax or other amounts required to be withheld by the Company under applicable law. 9. ARBITRATION. Any controversy or claim arising out of or relating to this agreement shall be referred to and finally resolved by arbitration in Boston, Massachusetts in accordance with the Commercial Arbitration Rules of the American Arbitration Association, and judgment on the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. The expenses of arbitration shall be shared equally. This Section 9 shall not, however, limit the right of the Company to obtain provisional remedies for violation of Section 3 pending the outcome of arbitration proceedings. 10. ASSIGNMENT. Neither you nor the Company may make any assignment of this agreement or any interest in it, by operation of law or otherwise, without the prior written consent of the other; provided, however, that the Company may assign its rights and obligations under this agreement without your consent in the event that the Company shall hereafter affect a reorganization, consolidate with, or merge into any Person or transfer all or substantially all of its properties or assets to any Person. This agreement shall inure to the benefit of and be binding upon you and the Company, and each of our respective successors, executors, administrators, heirs and permitted assigns. - 9 - 11. SEVERABILITY. If any portion or provision of this agreement shall to any extent be declared illegal or unenforceable by a court of competent jurisdiction, then the remainder of this agreement, or the application of such portion or provision in circumstances other than those as to which it is so declared illegal or unenforceable, shall not be affected thereby, and each portion and provision of this agreement shall be valid and enforceable to the fullest extent permitted by law. 12. MISCELLANEOUS. This agreement sets forth the entire agreement between you and the Company and replaces all prior and contemporaneous communications, agreements and understandings, written or oral, with respect to the terms and conditions of your employment, excluding the Change of Control Agreement, which shall remain in full force and effect in accordance with its terms. This agreement may not be modified or amended, and no breach shall be deemed to be waived, unless agreed to in writing by you and an expressly authorized representative of the Company. The headings and captions in this agreement are for convenience only and in no way define or describe the scope or content of any provision of this agreement. This agreement may be executed in two or more counterparts, each of which shall be an original and all of which together shall constitute one and the same instrument. This is a Massachusetts contract and shall be governed and construed in accordance with the laws of the Commonwealth of Massachusetts, without regard to the conflict of laws principles thereof. 13. NOTICES. Any notices provided for in this agreement shall be in writing and shall be effective when delivered in person or deposited in the United States mail, postage prepaid, and addressed to you at your last known address on the books of the Company or, in the case of the Company, to it at its principal place of business, attention of Chairman of the Board, or to such other address as either party may specify by notice to the other actually received. If the foregoing is acceptable to you, please sign the enclosed copy of this letter in the space provided and return it to me, at which time this letter and that copy will take effect as a binding agreement between you and the Company on the basis set forth above. Sincerely yours, By: /s/ John S. Anderegg, Jr. ______________________________ Title: Chairman ___________________________ Accepted and Agreed: /s/ James P. Regan ___________________________________ Date: 9/10/99 _____________________________ - 10 - EX-10.12 3 CHANGE OF CONTROL AGREEMENT EXHIBIT 10.12 DYNAMICS RESEARCH CORPORATION CHANGE OF CONTROL AGREEMENT AGREEMENT, made this 3rd day of November, 1999 by and between James P. Regan ("Executive") and Dynamics Research Corporation. (the "Company"); RECITALS: 1. The Board of Directors of the Company (the "Board") recognizes that the possibility of a change in control may exist and that such possibility, and the uncertainty and questions which it may raise among management personnel, may result in the departure or distraction of management personnel to the detriment of the Company and its stockholders; 2. The Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of members of the Company's management, including Executive, to their duties, to assisting the Board in assessing proposals with respect to a change in control and to advising the Board as to the best interests of the Company and its shareholders with respect to such potential change in control, without distraction and conflict arising from the possibility of a change in control; 3. The Board wishes to induce Executive to remain in the employ of the Company and to assure him of fair severance should his employment terminate in specified circumstances following a change of control of the Company. NOW, THEREFORE, in consideration of the promises and the mutual covenants contained herein, the parties hereto agree as follows: 1. If within 24 months following a Change of Control (as defined in Exhibit A) (the "Post Change of Control Period") Executive's employment with the Company is terminated (i) by the Company for any reason (other than for "Cause" or "Disability" (as defined paragraph 4 below) or as a result of Executive's death), or (ii) Executive terminates such employment for Good Reason (as defined in paragraph 4 below): (1) The Company will pay to Executive within five business days of such termination of employment a lump-sum cash payment in an amount equal to the sum of (i) Executive's annual base salary ("Base Salary") at the time of termination through the date of such termination of employment to the extent not theretofore paid, (ii) a prorated portion of Executive's target bonus compensation for the fiscal year in which such termination shall occur, calculated by multiplying (A) such bonus compensation times (B) a fraction, the numerator of which is the number of days in the fiscal year through the date of termination of employment, and the denominator of which is 365, (iii) if Executive has not been paid bonus compensation with respect to the fiscal year prior to the year in which such termination occurs and during which Executive was employed by the Company (except where prior to the Change of Control the Board had determined that no such incentive compensation was to be paid to Executive with respect to such prior year), Executive's target bonus for such prior fiscal year prorated for the period of his employment by the Company if less than a full year and (iv) any accrued and unpaid vacation pay through the date of termination; and (2) Any stock, stock option or other awards granted to Executive by the Company shall immediately vest and, if applicable, become exercisable in full, notwithstanding any provision to the contrary, and shall remain exercisable, if applicable, until the earlier of the fourth anniversary of such termination of employment or the latest date on which such grant could have been exercised, any restrictions on any restricted stock, deferred stock or other awards shall immediately terminate and all such awards shall immediately be vested in full, and any certificates for any deferred stock shall be delivered to Executive no later than five business days following such termination; (3) The Company will pay to Executive within five business days of such termination of employment a lump-sum cash payment in an amount equal to two times the sum of (A) the amount of Executive's Base Salary at the rate in effect immediately prior to the date of termination or at the rate in effect immediately prior to the Change of Control, whichever is higher, and (B) the amount of Executive's target bonus compensation for the fiscal year during which the termination of employment occurs or the amount of Executive's target bonus compensation in effect immediately prior to the Change of Control, whichever is higher. (4) Executive, together with his dependents, will continue following such termination of employment to participate fully in the life and medical insurance plans maintained or sponsored by the Company immediately prior to the Change of Control on the same basis they participated prior to the Change in Control until the earlier of (i) the second anniversary of such termination or any longer period as may be provided by the terms of such plan or (ii) the date Executive becomes re-employed with another employer and is eligible to receive substantially equivalent life and medical benefits under another employer provided plan, provided that if the continued participation of Executive and his dependents is not possible under the terms of any of such Company plans, the Company shall instead either arrange to provide Executive and his dependents with substantially equivalent benefits or pay to Executive (within five days of the date of termination) an amount equal to the full value thereof in cash; and -2- (5) the Company will promptly reimburse Executive for any and all legal fees and expenses (including, without limitation, stenographer fees and printing costs) incurred by him as a result of such termination of employment, including without limitation all fees and expenses incurred to enforce the provisions of this Agreement or contest or dispute that the termination of his employment is for Cause or other than for Good Reason (regardless of the outcome thereof). Notwithstanding anything herein to the contrary, (i) to the extent that any payment or benefit provided for herein is required to be paid or vested on any earlier date under the terms of any plan, agreement or arrangement, such plan, agreement or arrangement shall control; and (ii) if the Company terminates Executive's employment for a reason other than Cause prior to the date upon which the Change of Control occurs, and Executive reasonably demonstrates that such termination of employment (x) was at the request of a third party who has taken steps reasonably calculated to effect a Change of Control or (y) otherwise arose in connection with or in anticipation of a Change of Control, then for all purposes of this Agreement, Executive shall be entitled to the benefits provides in Section 1 above. To avert duplication of benefits, if Executive receives any payment of Base Salary, incentive compensation or severance other than under this Agreement ("Other Termination Payments") upon the termination of his employment with the Company, the amount of such payments shall be deducted from the amount paid under this Agreement and the benefits to be provided hereunder shall be provided only to the extent additional to the benefits to be provided other than under this Agreement; provided, however, that neither this paragraph nor the provisions of any other agreement shall be interpreted to reduce the amount payable to Executive below the amount that would otherwise have been payable under this Agreement if such Other Termination Payments had not been made. 2. Death, Disability, Cause, Other Than For Good Reason (1) If Executive's employment shall terminate during the Post Change of Control Period by reason of Executive's death, this Agreement shall terminate without further obligations to Executive's legal representatives under this Agreement. (2) If Executive's employment is terminated during the Post Change of Control Period by reason of Executive's Disability, in accordance with Section 4.c of the employment agreement between the Company and the Executive of even date, this Agreement shall terminate without further obligations to Executive. (3) If Executive's employment shall be terminated for Cause (as defined in Section 4 below) during the Post Change of Control Period, this Agreement shall terminate without further obligations to Executive other -3- than the obligation to pay Executive (A) his Base Salary through the date of termination and (B) Other Benefits, in each case to the extent theretofore unpaid. (4) If Executive voluntarily terminates employment during the Post Change of Control Period, excluding a termination for Good Reason, this Agreement shall terminate without further obligations to Executive. 3. "Cause" means only: (a) commission of a felony or gross neglect of duty by Executive rising to the level of deliberate dereliction, (b) conviction of a crime involving moral turpitude, or (c) willful failure by Executive in the performance of his duties to the Company which failure is deliberate on Executive's part, results in material injury to the Company, and continues for more than 30 days after written notice given to Executive pursuant to a two- thirds vote of all of the members of the Board at a meeting called and held for such purpose (after reasonable notice to Executive) and at which meeting Executive and his counsel were given an opportunity to be heard, such vote to set forth in reasonable detail the nature of the failure. For purposes of this definition of Cause, no act or omission shall be considered to have been "willful" unless it was not in good faith and Executive had knowledge at the time that the act or omission was not in the best interest of the Company. Any act or failure to act based on authority given pursuant to a resolution duly adopted by the Board or based on the advice of counsel of the Company shall be conclusively presumed to be done, or omitted to be done, by Executive in good faith and in the best interest of the Company. Cause shall not include willful failure due to incapacity resulting from physical or mental illness or any actual or anticipated failure after Notice of Termination for Good Reason. 4. Executive shall be deemed to have voluntarily terminated his employment for Good Reason if Executive leaves the employ of the Company for any reason following: (1) The assignment to Executive of any duties inconsistent in any respect with Executive's position (including status, offices, titles and reporting requirements), authority, duties or responsibilities immediately prior to the Change of Control; or the diminution or adverse alteration in any material adverse respect of such position, authority, duties or responsibilities, excluding for this purpose an isolated, insubstantial and inadvertent action not taken in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by Executive; (2) Any reduction in Executive's rate of Base Salary for any fiscal year to less than 100% of the rate of Base Salary payable for the fiscal year immediately preceding the Change of Control or of the Base Salary provided for such fiscal year in any agreement between Executive and the Company, or reduction in Executive's total cash and stock compensation -4- opportunities, including Base Salary and incentives, for any fiscal year to less than 100% of the total cash and stock compensation opportunities made available to him immediately preceding the Change of Control for the then current fiscal year or of the total cash and stock compensation opportunities which were to be made available to him for the fiscal year pursuant to any agreement between Executive and the Company (for this purpose, such opportunities shall be deemed reduced if the objective standards by which Executive's incentive compensation measured becomes more stringent, the target or maximum amounts of such incentive compensation are reduced, or the amount of such incentive compensation is reduced on a discretionary basis from the amount that would be payable solely by reference to the objectives); or (3) Failure of the Company to continue in effect any retirement, life, medical, dental, disability accidental death or travel insurance plan or other benefit plan or practice, in which Executive was participating immediately prior to the Change of Control unless the Company provides Executive with a plan or plans or practices that provide substantially similar benefits, or the taking of any action by the Company that would adversely affect Executive's participation in or materially reduce Executive's benefits under any of such plans or practices or deprive Executive of any material fringe benefit enjoyed by Executive immediately prior to the Change of Control other than an isolated, insubstantial and inadvertent failure not occurring in bad faith and which is remedied by the Company promptly after receipt of notice thereof given by Executive; or (4) The Company requires Executive to be based at any office or location further than 40 miles from Andover, Massachusetts, or the Company requires Executive to travel on Company business to a substantially greater extent than required immediately prior to the date of the Change of Control; or (5) Any failure by the Company to comply with and satisfy Section 6 of this Agreement. Executive's right to terminate his employment pursuant to this section shall not be affected by his incapacity due to physical or mental illness. Executive's continued employment shall not constitute consent to, or a waiver of rights with respect to, any circumstances constituting Good Reason hereunder. 5. In the case of any dispute under this Agreement, Executive may initiate binding arbitration in Boston, Massachusetts before the American Arbitration Association by serving a -5- notice to arbitrate upon the Company or, at Executive's election, institute judicial proceedings. The Company shall not have the right to initiate binding arbitration, and agrees that upon the initiation of binding arbitration by Executive pursuant to this paragraph 5 the Company shall cause to be dismissed any judicial proceedings it has brought against Executive relating to this Agreement. The Company authorizes Executive from time to time to retain counsel of his choice to represent Executive in connection with any and all actions, proceedings, and/or arbitration, whether by or against the Company or any director, officer, shareholder, or other person affiliated with the Company, which may affect Executive's rights under this Agreement. Company agrees to (i) pay the fees and expenses of such counsel, (ii) to pay the cost of such arbitration and/or judicial proceeding, and (iii) pay interest to Executive on all amounts owed to Executive under this Agreement during any period of time that such amounts are withheld pending arbitration and/or judicial proceedings. Such interest shall be simple interest at the Prime Rate as published in the "Money Rates" section of The Wall Street Journal on the effective date of Executive's notice hereunder, but in no event higher than the maximum rate permissible under applicable law; provided, however, that the interest rate will be adjusted to the Prime Rate on each subsequent anniversary (or on the next subsequent date for which such rate is published). In addition, notwithstanding any existing or prior attorney-client relationship between the Company and counsel retained by Executive, the Company irrevocably consents to Executive entering into an attorney-client relationship with such counsel and agrees that a confidential relationship shall exist between Executive and such counsel. 6. If the Company is at any time before or after a Change of Control merged or consolidated into or with any other corporation or other entity (whether or not the Company is the surviving entity), or if substantially all of the assets thereof are transferred to another corporation or other entity, the provisions of this Agreement will be binding upon and inure to the benefit of the corporation or other entity resulting from such merger or consolidation or the acquirer of such assets (the "Successor Entity"), and this paragraph 6 will apply in the event of any subsequent merger or consolidation or transfer of assets. The Company will require any such Successor Entity to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform if no such transaction had taken place. As used in this Agreement, "Company" shall mean the Company as hereinbefore defined and any Successor Entity which assumes and agrees to perform this Agreement by operation of law or otherwise. In the event of any merger, consolidation, or sale of assets described above, nothing contained in this Agreement will detract from or otherwise limit Executive's right to or privilege of participation in any stock option or purchase plan or any bonus, profit sharing, pension, group insurance, hospitalization, or other incentive or benefit plan or arrangement which may be or become applicable to executives of the corporation resulting from such merger or consolidation or the corporation acquiring such assets of the Company. -6- In the event of any merger, consolidation, or sale of assets described above, references to the Company in this Agreement shall unless the context suggests otherwise be deemed to include the entity resulting from such merger or consolidation or the acquiror of such assets of the Company. 7. Any termination by the Company for Cause, or by Executive for Good Reason, shall be communicated by Notice of Termination to the other party hereto given in accordance with the last paragraph of Section 12 of this Agreement. For purposes of this Agreement, a "Notice of Termination" means a written notice that (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated and (iii) if the Date of Termination (as defined below) is other than the date of receipt of such notice, specifies the termination date (which date shall be not more than thirty days after the giving of such notice). The failure by Executive or the Company to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of Executive or the Company, respectively, hereunder or preclude Executive or the Company, respectively, from asserting such fact or circumstance in enforcing Executive's or the Company's rights hereunder. "Date of Termination" means (i) if Executive's employment is terminated by the Company for Cause, or by Executive for Good Reason, the date of receipt of the Notice of Termination or any later date specified therein, as the case may be, (ii) if Executive's employment is terminated by the Company other than for Cause or Disability, the Date of Termination shall be the date on which the Company notifies Executive of such termination and (iii) if Executive's employment is terminated by reason of death or Disability, the Date of Termination shall be the date of death of Executive or the effective date of the Disability, as the case may be. 8. All payments required to be made by the Company hereunder to Executive or his dependents, beneficiaries, or estate will be subject to the withholding of such amounts relating to tax and/or other payroll deductions as may be required by law. In the event that it is determined that any payment or benefit provided by the Company to or for the benefit of Executive, either under this Agreement or otherwise, will be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code or any successor provision(s) ("Section 4999"), the Company will, prior to the date on which any amount of the excise tax must be paid or withheld, make an additional lump-sum payment (the "Gross-up Payment") to Executive in an amount sufficient, after giving effect to all federal, state and other taxes and charges (including interest and penalties, if any) with respect to the gross-up payment, to make Executive whole for all taxes (including withholding taxes) and any associated interest and penalties, imposed under or as a result of Section 4999. -7- Determinations under this Section 8 will be made by the accounting firm employed by the Company unless Executive has reasonable objections to the use of that firm, in which case the determinations will be made by a comparable firm chosen by Executive after consultation with the Company (the firm making the determinations to be referred to as the "Firm"). The determinations of the Firm will be binding upon the Company and Executive except as the determinations are established in resolution (including by settlement) of a controversy with the Internal Revenue Service to have been incorrect. All fees and expenses of the Firm will be paid by the Company. If the Internal Revenue Service asserts a claim that, if successful, would require the Company to make a Gross-up Payment or an additional Gross-up Payment, the Company and Executive will cooperate fully in resolving the controversy with the Internal Revenue Service. The Company will make or advance such Gross-up Payments as are necessary to prevent Executive from having to bear the cost of payments made to the Internal Revenue Service in the course of, or as a result of, the controversy. The Firm will determine the amount of such Gross-up Payments or advances and will determine after final resolution of the controversy whether any advances must be returned by Executive to the Company. The Company will bear all expenses of the controversy and will gross Executive up for any additional taxes that may be imposed upon Executive as a result of its payment of such expenses. 9. There shall be no requirement on the part of Executive to seek other employment or otherwise mitigate damages in order to be entitled to the full amount of any payments and benefits to which Executive is entitled under this Agreement, and the amount of such payments and benefits shall not be reduced by any compensation or benefits received by Executive from other employment other than with respect to certain welfare benefits as provided in the first proviso to Section 1(d). 10. Nothing contained in this Agreement shall be construed as a contract of employment between Company and Executive, or as a right of Executive to continue in the employ of Company, or as a limitation of the right of Company to discharge Executive with or without Cause; provided that Executive shall have the right to receive upon termination of his employment the payments and benefits provided in this Agreement and shall not be deemed to have waived any rights he may have either at law or in equity in respect of such discharge. 11. No amendment, change, or modification of this Agreement may be made except in writing, signed by both parties. 12. This Agreement shall terminate on November 3, 2002, provided, however, that commencing on November 3, 2000 and on each annual anniversary of such date (each such date hereinafter referred to as a "Renewal Date"), unless previously terminated, the term of this -8- Agreement shall be automatically extended so as to terminate three years from such Renewal Date, unless at least sixty days prior to the Renewal Date the Company shall give notice to Executive that the term of this Agreement shall not be so extended. This Agreement shall not apply to a Change of Control which takes place after the termination of this Agreement. The provisions of this Agreement shall be binding upon and shall inure to the benefit of Executive, his executors, administrators, legal representatives and assigns, and the Company and its successors. The validity, interpretation, and effect of this Agreement shall be governed by the laws of The Commonwealth of Massachusetts, without regard to the conflict of laws provisions thereof. Any ambiguities in this Agreement shall be construed in favor of Executive. The invalidity or unenforceability of any provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. The Company shall have no right of set-off or counterclaims, in respect of any claim, debt, or obligation, against any payments to Executive, his dependents, beneficiaries, or estate provided for in this Agreement. No right or interest to or in any payments shall be assignable by Executive; provided, however, that this provision shall not preclude him from designating one or more beneficiaries to receive any amount that may be payable after his death and shall not preclude the legal representative of his estate from assigning any right hereunder to the person or persons entitled thereto under his will or, in the case of intestacy, to the person or persons entitled thereto under the laws of intestacy applicable to his estate. The term "beneficiaries" as used in this Agreement shall mean a beneficiary or beneficiaries so designated to receive any such amount, or if no beneficiary has been so designated, the legal representative of Executive's estate. No right, benefit, or interest hereunder, shall be subject to anticipation, alienation, sale, assignment, encumbrance, charge, pledge, hypothecation or set- off in respect of any claim, debt or obligation, or to execution, attachment, levy or similar process, or assignment by operation of law. Any attempt, voluntary or involuntary, to effect any action specified in the immediately preceding sentence shall, to the full extent permitted by law, be null, void, and of no effect. All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows: -9- If to Executive: James P. Regan --------------- 930 Towlston Road McLean, Virginia 22102 If to the Company: Dynamics Research Corporation ----------------- 60 Frontage Road Andover, MA 01810 Attention: Chairman of the Board or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee. IN WITNESS WHEREOF, the Company and Executive have each caused this Agreement to be duly executed and delivered as of the date set forth above. DYNAMICS RESEARCH CORPORATION By: /s/ James P. Regan ______________________________ ________________________________ James P. Regan -10- EXHIBIT A Change of Control. For the purposes of this Agreement, a "Change of ----------------- Control" shall mean: (a) The acquisition by any person, corporation, partnership, limited liability company or other entity (a "Person", which term shall include a group within the meaning of section 13(d) of the Securities Exchange Act of 1934 (the "Exchange Act")) of ultimate beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act), directly or indirectly of 30% or more of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that for purposes of this subsection (a), the following acquisitions shall not constitute a Change of Control: (i) any such acquisition directly from the Company, except for acquisition of securities upon conversion of other securities of the Company (ii) any such acquisition by the Company, (iii) any such acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (iv) any such acquisition by any corporation pursuant to a transaction which complies with clauses (i), (ii) and (iii) of subsection (c) of this Exhibit A; or (b) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election, by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (c) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company in one or a series of transactions (a "Business Combination"), in each case, unless, following such Business Combination, (i) all or substantially all of -11- the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, immediately following such Business Combination more than 50% of, respectively, the outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) ultimately beneficially owns, directly or indirectly, 30% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (iii) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (d) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. -12- EX-13.1 4 ANNUAL REPORT TO SHAREHOLDERS Exhibit 13 Selected Financial Information
Five Year Summary of Selected Financial Information 1999 1998 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------ (in thousands of dollars, except share, per share data and employees) Revenue $ 191,621 $ 182,344 $ 156,733 $ 129,997 $ 103,941 Operating income (loss) (11,378) 2,459 7,807 4,283 1,018 Income (loss) from continuing operations (8,888) 491 5,177 2,311 1,018 Net income (loss) (7,526) (5,971) 4,129 1,729 559 Income (loss) from continuing operations per common share - basic (1.21) .07 .69 .31 .08 Income (loss) from continuing operations per common share - diluted (1.21) .06 .66 .30 .07 Net income (loss) per common share - basic (1.02) (.80) .55 .23 .08 Net income (loss) per common share - diluted (1.02) (.77) .53 .22 .07 Total assets 75,188 88,067 77,629 70,950 53,946 Total debt 19,700 26,800 10,000 300 1,500 Stockholders' equity 23,805 31,246 39,147 35,239 33,206 Stockholders' equity per share 3.23 4.24 5.19 4.69 4.47 Return on stockholders' equity (31.6)% (19.1)% 10.6% 4.9% 1.7% Backlog 106,692 105,427 110,001 73,200 61,284 Cash flow from operations 10,985 (11,406) 7,980 1,035 7,499 Research and development expense 1,478 2,739 1,249 2,189 1,611 Capital expenditures 2,702 3,171 5,104 9,266 4,441 Depreciation and amortization 6,060 6,219 5,240 4,910 4,002 Number of shares outstanding at end of year 7,363,324 7,369,190 7,546,646 7,515,630 7,422,059 Number of employees 1,613 1,557 1,455 1,349 1,249
Quarterly Information (unaudited) 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr - ------------------------------------------------------------------------------------------------------------------------ (in thousands of dollars, except per share data) 1999 - ---- Revenue $ 46,549 $ 48,810 $ 48,241 $ 48,021 Operating income (loss) 2,563 (9,545) (200) (4,196) Income (loss) from continuing operations 1,182 (6,075) (602) (3,393) Gain on discontinued operations -- 1,362 -- -- Net income (loss) 1,182 (4,713) (602) (3,393) Income (loss) from continuing operations per common share - diluted .16 (.83) (.08) (.46) Gain on discontinued operations per common share - diluted -- .19 -- -- Net income (loss) per common share - diluted .16 (.64) (.08) (.46) 1998 - ---- Revenue $ 41,988 $ 48,317 $ 44,379 $ 47,660 Operating income (loss) 2,408 2,056 1,419 (3,424) Income (loss) from continuing operations 1,203 955 579 (2,246) Loss on discontinued operations (566) (1,299) (1,084) (3,513) Net income (loss) 637 (344) (505) (5,759) Income (loss) from continuing operations per common share - diluted .15 .12 .07 (.30) Loss on discontinued operations per common share - diluted (.07) (.17) (.14) (.48) Net income (loss) per common share - diluted .08 (.05) (.07) (.78)
See Management's Discussion and Analysis of Financial Condition and Results of Operations for discussion of unusual items. Management's Dicussion and Analysis of Financial Condition and Results of Operations
Results of Operations For the years ended December 31, 1999 1998 1997 - --------------------------------------------------------------------------------------- (expressed as a percentage of total revenue) Contract revenue 86.0% 84.6% 82.4% Product sales 14.0% 15.4% 17.6% Total revenue 100.0% 100.0% 100.0% Gross margin on contract revenue* 0.3% 8.9% 11.3% Gross margin on product sales* 20.8% 21.3% 25.0% Total gross margin 3.2% 10.8% 13.7% Selling, engineering and administrative expenses 9.1% 9.4% 8.7% Operating income (loss) (5.9)% 1.4% 5.0% Interest expense, net 1.2% 0.9% 0.1% Income (loss) from continuing operations before provision (benefit) for income taxes (7.1)% 0.5% 4.9% - ---------------------------------------------------------------------------------------
* These amounts represent a percentage of contract revenue and product sales, respectively. Overview - -------------------------------------------------------------------------------- Dynamics Research Corporation (the "company") has an outstanding 45-year legacy of customer satisfaction, strong information technology and logistics management skills--expertise that is in high demand in defense, civil and commercial markets. But, most of all, the company's potential derives from its highly skilled and dedicated employees. Despite these positives and a 5% increase in revenue in 1999 to $191.6 million, the company has faltered recently in several areas. The impact is evident in the financial results for the past two years. The company has posted net losses of $7.5 million, or $1.02 per diluted share, for 1999 and $6.0 million, or $.77 per diluted share, for 1998. The shortcomings manifested in these results are primarily attributable to becoming overextended, by moving too far, too fast into new business areas. The losses include, on an after-tax basis: o Provisions for cost overruns on three fixed-price contracts totaling $8.7 million in 1999 and $1.5 million in 1998; o A loss on the discontinued Telecommunications Fraud Control business of $6.5 million in 1998, partially offset by a gain on the sale of the business of $1.4 million in 1999; and o Losses on the divested VisualMagic business and Empresa, Inc. investments of $0.9 million in 1999 and $1.2 million in 1998. Results also reflect a restructuring charge of $0.8 million, after tax, recorded in the fourth quarter of 1999, stemming from cost reduction and efficiency improvements. Revenue - -------------------------------------------------------------------------------- Total revenue from continuing operations was $191.6 million, $182.3 million and $156.7 million for 1999, 1998 and 1997, respectively, representing increases of 5.1% and 16.3% in 1999 and 1998, respectively. Contract revenue in the Systems and Services segment was $164.8 million in 1999 compared with $154.3 million in 1998 and $129.1 million in 1997, representing increases of 6.8% and 19.5% in 1999 and 1998, respectively. The increase in Systems and Services segment revenue in 1999 compared with the prior year was primarily due to growth in the company's field offices, logistics and material acquisition services to the United States Air Force and Army, partially offset by a decrease in the company's state health and human services contracts. For 1998, the increase in Systems and Services segment revenue was principally due to performance on two major state contracts as well as broad based growth in the defense business. Product sales decreased 4.1% in 1999 compared with 1998 principally due to a $3.6 million, or 21.5%, decline in Encoder division sales related to a reduction in sales of a custom encoder to an automotive customer. The decrease in Encoder division sales was partially offset by a $2.5 million, or 22.2% increase, in Metrigraphics division revenue related to increased sales of electroformed components. Product sales increased slightly in 1998 compared with the prior year due to higher sales of electroformed components. Gross Margin - -------------------------------------------------------------------------------- Total gross margin was $6.1 million, $19.7 million and $21.4 million for 1999, 1998 and 1997, respectively, representing 3.2%, 10.8% and 13.7% of total revenue for 1999, 1998 and 1997, respectively. Gross margin on contract revenue was $0.5 million, $13.7 million and $14.5 million for 1999, 1998 and 1997, respectively, representing 0.3%, 8.9% and 11.3% of contract revenue for 1999, 1998 and 1997, respectively. In 1999 and 1998 the company recorded contract loss provisions of $11.9 million and $2.6 million, respectively, on its fixed-price software development contract with the Colorado Department of Human Services. In 1999, an $11.0 million loss provision was recorded in the second quarter and the remainder was recorded in the fourth quarter of the year. The $2.6 million 1998 loss provision was recorded in the fourth quarter of the year. These losses are included in the results of the Systems and Services segment. Delays related to a 1999 customer stop work request, a revised development schedule, and higher incurred and estimated software development costs resulted in the loss provisions on the Colorado contract. While the company believes it has reasonably estimated the costs to complete the Colorado contract, there can be no assurance that actual costs on the project, which is expected to be substantially completed in the year 2000, will not differ materially from current estimates. The company also recorded charges of $0.7 million, $1.3 million and $0.2 million in the second, third and fourth quarters of 1999, respectively, to provide for estimated contract losses on two other fixed-price software development contracts, and $1.8 million and $1.7 million in the fourth quarter of 1999 and 1998, respectively, for other unrecoverable contract costs. Approximately $1.0 million of restructuring charges, described below, are included in the fourth quarter of 1999 cost of contract revenue. In 1999, 1998 and 1997, gross margin on product sales was $5.6 million, $6.0 million and $6.9 million, respectively, representing 20.8%, 21.3% and 25.0% of product sales in 1999, 1998 and 1997, respectively. The decrease in 1999 compared with the prior year was principally due to lower Encoder division revenue allocated over constant fixed costs, partially offset by higher revenue and margin in the Metrigraphics division. In 1998, the decrease in product sales gross margin percentage compared with the prior year was due to an increase in per unit depreciation of certain Metrigraphics equipment, costs related to the installation of new manufacturing technology and a reduction in encoder sales, partially offset by an increase in sales of electroformed components. Other Operating Items - -------------------------------------------------------------------------------- Selling, engineering, and administrative expenses (S,E&A) were flat in 1999 compared with 1998, and increased $3.6 million, or 26.3% in 1998 from 1997. In the second quarter of 1999, the company wrote off its $1.4 million investment in Empresa, Inc. (see Note 12). S,E&A expense for 1999 also reflects a $1.3 million decline in research and development expense from 1998. Also included in 1999 S,E&A expense is $0.2 million of restructuring charges, described below. The 1998 increase in S,E&A expense compared with 1997 resulted from a $2.0 million increase in administrative costs related to higher transaction processing volumes and accounting system changes. Additionally, 1998 S,E&A expense reflects a $1.5 million increase in research and development expense, compared with 1997, associated with a new software product developed for sale to the United States Air Force and to other defense contractors. Net interest expense was $2.3 million, $1.6 million and $0.1 million in 1999, 1998 and 1997, respectively. The increases were due to higher average borrowing levels and higher interest rates (see Note 7). Income tax expense or benefit has been provided at rates of 35%, 42% and 33% of income or loss from continuing operations before taxes in 1999, 1998 and 1997, respectively. The 1999 tax benefit is net of a $0.4 million provision for an unrecoverable capital loss carryforward related to the write off of the Empresa investment. The 1997 tax provision reflects a one-time benefit of $0.7 million resulting from an income tax refund related to prior year research and development expenses (see Note 5). In June 1999, the company completed the sale of its previously discontinued Telecommunications Fraud Control business for $1.7 million and royalties of up to $1.8 million over the next three years, which the company will recognize when received. The sale resulted in a favorable pre-tax adjustment of $2.2 million to the estimated pre-tax loss on disposal of discontinued operations of $4.1 million, recorded in the fourth quarter of 1998. Results for 1998 and 1997 Telecommunications Fraud Control business have been shown as discontinued operations. In the fourth quarter of 1999, the company adopted a restructuring plan intended to reduce overhead costs and increase efficiencies. The company recorded a restructuring charge of $1.2 million to provide for the exit costs related to the plan. Approximately half the charge is related to Massachusetts operations. The remainder of the charge relates to a number of other locations. The charge is comprised primarily of severance costs and outplacement services to be provided to involuntarily terminated employees. The plan Management's Discussion and Analysis of Financial Condition and Results of Operations involves reducing personnel in certain operating units, the consolidation and realignment of certain functions, and the evaluation of strategic alternatives for certain operations. The program will be implemented in stages during 2000, and will result in a reduction of approximately 100 employees through layoffs or attrition. The affected employees are primarily employed in an indirect capacity or in service lines that the company does not intend to pursue in the future. As of December 31, 1999, no costs had been charged against the accrued liability. The company's backlog of unfilled orders was $106.7 million, $105.4 million and $110.0 million at December 31, 1999, 1998 and 1997, respectively. A portion of the company's backlog is based on annual purchase contracts. The amount of backlog as of any date may be affected by the timing of order receipts and associated deliveries. Liquidity and Capital Resources - -------------------------------------------------------------------------------- At December 31, 1998, the company was operating under an unsecured working capital agreement that was due to expire in October 2000 and provided for financing of up to $40 million. Interest on the outstanding balance was the prime rate plus an applicable margin or, at the company's option, LIBOR plus an applicable margin based on the company's debt coverage ratios. The agreement included a fee on the unused portion of the credit line of 0.375%. At December 31, 1998, $26.8 million was outstanding under the agreement. On September 30, 1999, the company entered into an amended agreement with a syndicate of banks. The amended agreement provided a secured working capital line of credit of up to $35 million, based on assets consisting of inventory, receivables and real estate. Interest on the outstanding balance was the prime rate plus 2%. The agreement included a fee of 0.375% on the unused portion of the credit line. At December 31, 1999, the company was not in compliance with a covenant included in the agreement regarding minimum earnings before income taxes. The amended agreement expired January 31, 2000. At December 31, 1999, $19.7 million was outstanding under the agreement. On February 10, 2000, the company finalized a three-year $20 million secured revolving credit agreement (the "Revolver") and a six-month $7.5 million interim mortgage loan (the "Mortgage") on the company's real estate. Proceeds were used to pay off existing debt. The Revolver expires on February 10, 2003. The company plans to refinance the Mortgage prior to maturity on August 10, 2000. The Revolver provides for borrowings of up to the lesser of $20 million or 80% of eligible accounts receivable. Interest on the outstanding balance of the Revolver and the Mortgage is the prime rate and is payable monthly. The agreement includes a fee of 0.375% on the unused portion of the Revolver. Beginning in 2001, in the event that the company achieves certain financial milestones, the company may elect an interest rate of LIBOR plus 2%, and the fee on the unused Revolver will be reduced to 0.25%. Substantially all the company's assets serve as collateral under the Revolver, except for the corporate office facility in Andover, Massachusetts, which collateralizes the Mortgage. The Revolver requires the company to meet certain financial covenants including maintaining a minimum tangible net worth, cash flow and debt coverage ratios, as well as limits the company's ability to incur additional debt, to pay dividends, to purchase capital assets, to sell or dispose of assets, to make additional acquisitions or investments, or to enter into new leases, among other restrictions. Cash provided by continuing operations of $12.8 million in 1999 resulted primarily from a significant reduction in unbilled expenditures and fees. Cash used by continuing operations of $8.2 million in 1998 was primarily the result of a $16.0 million increase in receivables. Cash provided by continuing operations of $9.0 million in 1997 was the result of positive cash earnings, which included $5.2 million of depreciation and amortization and $3.3 million of deferred income taxes. Capital spending for property, plant and equipment related to continuing operations was $2.7 million, $2.9 million and $4.1 million in 1999, 1998, and 1997, respectively. The company's expected cash flows for the year 2000 are subject to certain trends, events and uncertainties. The company's requirements for additional property, plant and equipment are expected to be in the range of expenditures incurred over the past three years. Related to the Colorado contract described previously, the company has accrued at December 31, 1999 and expects in the year 2000 to expend an estimated $3 million in excess of amounts to be received under the contract in order to complete its obligations under the contract. Regarding the previously described restructuring plan, substantially all of the $1.2 million of expenditures accrued at December 31, 1999 are expected to be paid in the year 2000. Also, as described more fully in Note 9 to the Consolidated Financial Statements, early in the year 2000 payment on a portion of the company's billings to the United States government has been temporarily deferred. The company's need for, cost of, and access to funds are dependent on future operating results, as well as conditions external to the company. The company believes that its current assets, cash flows from operations and available lines of credit are sufficient to support its normal operations and capital requirements for the foreseeable future. Management's Discussion and Analysis of Financial Conditions and Results of Operations Impact of Inflation and Changing Prices - -------------------------------------------------------------------------------- Overall, inflation has not had a material impact on the company's operations. Additionally, the terms of Defense contracts, which accounted for approximately 66% of revenue in 1999, are generally one year and include salary increase factors for future years, thus reducing the potential impact of inflation on the company. Year 2000 Date Conversion - -------------------------------------------------------------------------------- The Year 2000 problem concerns the inability of information systems to recognize properly and process data-sensitive information beyond January 1, 2000. The company has not experienced any material Year 2000 problems to date and does not expect to experience any such difficulties. The company completed the process of identifying and remediating Year 2000 issues in four areas: (i) information technology ("IT") and financial systems, (ii) non-IT systems, (iii) third-party vendors and suppliers and (iv) systems it has implemented and maintains for various customers. The company was Year 2000 compliant by December 31, 1999. At December 31, 1999, the company had completed a review of its financial and other significant IT systems and had remediated material Year 2000 problems. The primary required hardware and operating platform upgrade was completed in January 1999. Necessary application upgrades or remediation and testing was completed by December 31, 1999. All of the company's computer and equipment vendors were contacted to verify Year 2000 compliance. Based on their responses, all products requiring replacement or upgrades were Year 2000 compliant by the end of 1999. In the case of third party licensed commercial off-the-shelf products, the company determined that they were either Year 2000 compliant or the licensor released a compliant version that the company installed by the end of 1999. The company completed a full review of all process control components, including safety equipment, in manufacturing and production facilities. The company completed the process of upgrading or replacing certain components of the phone, security, building access, HVAC and lighting systems, in the third quarter of 1999. The company received Year 2000 compliance information from its employee benefit service and other critical suppliers and monitored its major power, energy and communications service suppliers. The company contacted its suppliers of financial services regarding computer interface changes and the status of their Year 2000 programs, if this information was not readily available on their web sites. Based on their responses, no material changes were necessary and all interface upgrades were completed by the end of the fourth quarter of 1999. The company developed contingency plans to be implemented in the event that planned solutions proved to be ineffective in solving Year 2000 compliance issues. However, it has not been necessary to implement those plans to date. The total identified cost of the company's Year 2000 effort was approximately $0.4 million, mostly redeployed labor. Forward-Looking Information - -------------------------------------------------------------------------------- This report includes certain forward-looking statements about the company's business, including, but not limited to, the effect of the federal budget on the company's sales, response to the company's product and service offerings, growth in revenue, costs to complete fixed-price contracts, capital spending, restructuring spending and the benefits thereof, customer mix and changes in capital markets. Such forward-looking statements are subject to risk and uncertainties that could cause actual results to vary materially from those expected. These risks and uncertainties, discussed in more detail in the company's Form 10-K for the year ended December 31, 1999, include, but are not limited to, possible reductions in federal or state funding for the company's customers and potential customers, concentration of customers in a particular industry, risk of sustaining existing contracts and orders at the same or increasing levels and obtaining new contracts, high levels of competition and difficulties of entering into new markets, government contracting issues including the outcomes of audits and investigations, costs of completing fixed-price contracts, changes in interest rates and capital market funds availability, supply difficulties, warranty claims, factors affecting the business segments in which the company operates and the economy in general. Dynamics Research Corporation Consolidated Balance Sheets
December 31, 1999 1998 - ----------------------------------------------------------------------------------------------------------------- (in thousands of dollars, except share and per share data) Assets Current assets Cash and cash equivalents $ 2,267 $ 97 Receivables, net of allowances of $790 in 1999 and $316 in 1998 34,917 33,016 Unbilled expenditures and fees on contracts in process 18,609 32,169 Inventories 2,735 2,647 Prepaid expenses and other current assets 1,593 967 -------- -------- Total current assets 60,121 68,896 Net property, plant and equipment 15,067 18,429 Other non-current assets -- 742 -------- -------- Total assets $ 75,188 $ 88,067 -------- -------- Liabilities and Stockholders' Equity Current liabilities Notes payable $ 19,700 $ -- Accounts payable 11,641 10,300 Accrued payroll and employee benefits 9,435 7,782 Other accrued expenses 7,840 2,630 Current deferred income taxes 1,575 7,189 Net liabilities of discontinued operations 273 1,772 -------- -------- Total current liabilities 50,464 29,673 Long-term debt -- 26,800 Deferred income taxes 919 348 Commitments and contingencies Stockholders' Equity Preferred stock, par value, $.10 per share, 5,000,000 shares authorized, none issued Common stock, par value, $.10 per share: Authorized - 30,000,000 shares Issued - 8,742,750 shares in 1999 and 8,733,016 shares in 1998 874 873 Treasury stock - 1,379,426 shares in 1999 and 1,363,826 shares in 1998, at par value (138) (136) Capital in excess of par value 27,560 27,474 Retained earnings (accumulated deficit) (4,491) 3,035 -------- -------- Total stockholders' equity 23,805 31,246 -------- -------- Total liabilities and stockholders' equity $ 75,188 $ 88,067 -------- --------
The accompanying notes are an integral part of these consolidated financial statements. Dynamics Research Corporation Consolidated Statements of Operations
For the years ended December 31, 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------- (in thousands of dollars, except share and per share data) Revenue Contract revenue $ 164,766 $ 154,336 $ 129,135 Product sales 26,855 28,008 27,598 ----------- ----------- ----------- Total revenue 191,621 182,344 156,733 Costs and expenses Cost of contract revenue 164,278 140,653 114,603 Cost of goods 21,257 22,029 20,700 Selling, engineering and administrative expenses 17,464 17,203 13,623 ----------- ----------- ----------- Total operating costs and expenses 202,999 179,885 148,926 Operating income (loss) (11,378) 2,459 7,807 Interest expense, net 2,255 1,612 108 ----------- ----------- ----------- Income (loss) from continuing operations before provision (benefit) for income taxes (13,633) 847 7,699 Provision (benefit) for income taxes (4,745) 356 2,522 ----------- ----------- ----------- Income (loss) from continuing operations (8,888) 491 5,177 Loss from discontinued operations, net of tax benefit of $1,989 in 1998 and $514 in 1997 -- (3,890) (1,048) Gain (loss) on disposal of discontinued operations, net of tax expense of $835 in 1999 and tax benefit of $1,576 in 1998 1,362 (2,572) -- ----------- ----------- ----------- Gain (loss) from discontinued operations 1,362 (6,462) (1,048) Net income (loss) $ (7,526) $ (5,971) $ 4,129 ----------- ----------- ----------- Earnings (loss) per share Per common share - basic Income (loss) from continuing operations $ (1.21) $ .07 $ .69 Gain (loss) from discontinued operations .19 (.87) (.14) ----------- ----------- ----------- Net income (loss) $ (1.02) $ (.80) $ .55 ----------- ----------- ----------- Per common share - diluted Income (loss) from continuing operations $ (1.21) $ .06 $ .66 Gain (loss) from discontinued operations .19 (.83) (.13) ----------- ----------- ----------- Net income (loss) $ (1.02) $ (.77) $ .53 ----------- ----------- ----------- Weighted average shares outstanding Basic 7,360,548 7,501,604 7,530,546 Diluted 7,360,548 7,771,315 7,807,216
The accompanying notes are an integral part of these consolidated financial statements. Dynamics Research Corporation Consolidated Statements of Stockholders' Equity
Common Stock Retained ----------------------------------------- Capital in Earnings Issued Treasury Stock Excess of (Accumulated For the three years ended December, 31, 1999 Shares Par Value Shares Par Value Par Value Deficit) Total - ---------------------------------------------------------------------------------------------------------------------------- (in thousands) Balance at December 28, 1996 6,690 $ 669 (996) $ (100) $ 9,516 $ 25,154 $ 35,239 Year 1997 - --------- Stock options exercised 107 11 -- -- 540 -- 551 Treasury stock purchased -- -- (82) (8) (760) -- (768) 10% Stock dividend 569 57 -- -- 5,210 (5,271) (4) Net income -- -- -- -- -- 4,129 4,129 -------- -------- -------- -------- -------- -------- -------- Balance at December 31, 1997 7,366 737 (1,078) (108) 14,506 24,012 39,147 Year 1998 - --------- Stock options exercised 103 10 -- -- 581 -- 591 Treasury stock purchased -- -- (286) (28) (2,489) -- (2,517) 20% Stock dividend 1,264 126 -- -- 14,876 (15,006) (4) Net loss -- -- -- -- -- (5,971) (5,971) -------- -------- -------- -------- -------- -------- -------- Balance at December 31, 1998 8,733 873 (1,364) (136) 27,474 3,035 31,246 Year 1999 - --------- Stock options exercised 10 1 -- -- 27 -- 28 Treasury stock purchased -- -- (15) (2) (57) -- (59) Stock option compensation expense -- -- -- -- 116 -- 116 Net loss -- -- -- -- -- (7,526) (7,526) -------- -------- -------- -------- -------- -------- -------- Balance at December 31, 1999 8,743 $ 874 (1,379) $ (138) $ 27,560 $ (4,491) $ 23,805 -------- -------- -------- -------- -------- -------- --------
The accompanying notes are an integral part of these consolidated financial statements. Dynamics Research Corporation Consolidated Statements of Cash Flows
For the years ended December 31, 1999 1998 1997 - ------------------------------------------------------------------------------------------------- (in thousands of dollars) Cash provided by (used for) operations Net income (loss) $ (7,526) $ (5,971) $ 4,129 Adjustments to reconcile net income (loss) to cash provided by (used for) operating activities: (Gain) loss from discontinued operations (1,362) 6,462 1,048 Non-cash stock compensation expense 116 -- -- Provision for impairment of investment in Empresa, Inc. 1,424 -- -- Depreciation and amortization 6,060 6,219 5,240 Deferred income tax provision (5,043) (1,347) 3,269 Provision for receivable reserves 474 99 (123) -------- -------- -------- (5,857) 5,462 13,563 Cash provided by (used for) working capital Receivables (2,375) (16,015) 2,459 Unbilled expenditures and fees on contracts in process 13,560 128 (9,607) Inventories (88) 730 (166) Prepaid expenses and other current assets (626) 1,568 137 Accounts payable 1,341 1,945 (570) Accrued payroll and employee benefits 1,653 (199) 990 Other accrued expenses 5,210 (1,810) 2,222 -------- -------- -------- 18,675 (13,653) (4,535) Net cash provided by (used for) continuing operations 12,818 (8,191) 9,028 Net cash used for discontinued operations (1,833) (3,215) (1,048) -------- -------- -------- Cash provided by (used for) operating activities 10,985 (11,406) 7,980 Cash provided by (used for) investing activities Additions to property, plant and equipment relating to continuing operations (2,702) (2,874) (4,065) Additions to property, plant and equipment relating to discontinued operations -- (297) (1,039) Investments and acquisitions (682) (742) (250) Proceeds from the sale of discontinued operations 1,700 -- -- -------- -------- -------- Net cash used for investing activities (1,684) (3,913) (5,354) Cash provided by (used for) financing activities Net borrowings (repayments) under line of credit agreements (7,100) 16,800 (10,600) Principal payment on long-term borrowings -- -- 8,499 Proceeds from exercise of stock options 28 346 551 Purchase of treasury shares (59) (2,272) (768) -------- -------- -------- Net cash provided by (used for) financing activities (7,131) 14,874 (2,318) Net increase (decrease) in cash and cash equivalents 2,170 (445) 308 Cash and cash equivalents at beginning of year 97 542 234 -------- -------- -------- Cash and cash equivalents at end of year $ 2,267 $ 97 $ 542 -------- -------- -------- Supplemental information Cash paid for interest $ 2,451 $ 1,640 $ 792 Cash paid for income taxes $ 199 $ 150 $ 430 Cashless options exercised $ -- $ 245 $ --
The accompanying notes are an integral part of these consolidated financial statements. Notes to Consolidated Financial Statements 1. Significant Accounting Policies Nature of Business - -------------------------------------------------------------------------------- Dynamics Research Corporation (the "company") is an innovative solutions provider, partnering with customers to apply proven processes and technology. The company delivers engineering, logistics and information technology services and precision manufactured products that enhance the performance and cost effectiveness of its customers' mission critical systems. Principles of Consolidation - -------------------------------------------------------------------------------- The accompanying consolidated financial statements include the accounts of the company and its wholly-owned subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to current year presentation. Risks, Uncertainties and Use of Estimates - -------------------------------------------------------------------------------- The company is subject to certain business risks specific to the industries in which it operates, specifically estimates of costs to complete contract obligations, changes in government policies and procedures, government contracting issues and risks associated with technological development. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue Recognition - -------------------------------------------------------------------------------- The company provides services under fixed-price, cost-reimbursement, time and material, and level of effort contracts. Revenue under cost-reimbursement and fixed-price contracts is 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 types of contracts, revenue is recorded as the 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 United States Government. Revenue from such contracts has been recorded at amounts expected to be realized upon final settlement. Revenue from sales of precision products is generally recognized at the time of shipment. Income Taxes - -------------------------------------------------------------------------------- The company accounts for income taxes using the liability method. Under the liability method deferred taxes are determined based upon the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The deferred tax provision represents the change in the deferred tax asset or 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.
December 31, 1999 1998 - -------------------------------------------------------------------------------- (in thousands of dollars) Work in process $ 630 $ 475 Raw materials and subassemblies 2,105 2,172 -------- -------- Total $ 2,735 $ 2,647 -------- --------
Property, Plant and Equipment - -------------------------------------------------------------------------------- Property, plant and equipment are stated at cost. Depreciation and amortization are provided in amounts sufficient to amortize the cost of such assets over their estimated useful lives, 3 to 8 years for equipment and 31 years for the building, using principally the straight-line method. Certain manufacturing equipment is depreciated under a units of production method. Leasehold improvements are amortized over the remaining term of the lease or the life of the related asset, whichever is shorter.
December 31, 1999 1998 - -------------------------------------------------------------------------------- (in thousands of dollars) Land $ 1,126 $ 1,126 Building 7,774 7,774 Machinery and equipment 42,016 39,790 Leasehold improvements 2,548 2,481 -------- -------- Total property, plant and equipment, at cost 53,464 51,171 Less accumulated depreciation and amortization 38,397 32,742 -------- -------- Net property, plant and equipment $ 15,067 $ 18,429 -------- --------
Fair Value of Financial Instruments - -------------------------------------------------------------------------------- The carrying values of cash and cash equivalents, accounts receivable, unbilled expenditures and fees on contracts in process, and accounts payable approximate fair value because of the short-term nature of these instruments. The fair value of debt approximates carrying value as the debt bears interest at a variable market rate. Stock-Based Compensation - -------------------------------------------------------------------------------- The company adopted the disclosure alternative under Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for Stock-Based Compensation, which requires the presentation of the pro forma effects on earnings (loss) and earnings (loss) per share as if stock-based compensation had been recognized, as well as the disclosure of certain other information. New Accounting Pronouncements - -------------------------------------------------------------------------------- The company adopted SFAS No. 130, Reporting Comprehensive Income, in the first quarter of 1998. SFAS No. 130 requires the reporting and presentation of comprehensive income and its components in the financial statements. The company's total comprehensive income (loss) for the years ended December 31, 1999, 1998, and 1997 was the same as net income (loss) reported for those periods. In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. As issued, SFAS No. 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999, with earlier application encouraged. In May 1999, the FASB delayed the effective date of SFAS No. 133 for one year to fiscal years beginning after June 15, 2000. The company does not currently have derivative instruments and does not expect the adoption of SFAS No. 133 to have a material impact on its financial position or results of operations. In December 1999, the Securities and Exchange Commission released Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements. SAB 101 provides interpretative guidance on the recognition, presentation and disclosure of revenue. SAB 101 must be applied to financial statements no later than the first quarter of 2000. The company does not believe that the application of SAB 101 will have a material effect on the company's financial position or results of operations. Earnings (Loss) Per Common Share - -------------------------------------------------------------------------------- Basic earnings (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the year. For years in which earnings are positive, diluted earnings per share is determined by giving effect to the exercise of stock options using the treasury stock method. In 1999, because the company reported a net loss, 911,185 outstanding stock options were excluded from the weighted average number of shares outstanding. Additionally, 58,800 and 108,850 stock options were excluded in 1998 and 1997, respectively, because their effect was antidilutive.
Calculation of Earnings (Loss) per Share - ---------------------------------------- For years ended December 31, 1999 1998 1997 - -------------------------------------------------------------------------------------------------- (in thousands, except per share data) Income (loss) from continuing operations $ (8,888) $ 491 $ 5,177 Gain (loss) from discontinued operations 1,362 (6,462) (1,048) --------- --------- --------- Net income (loss) $ (7,526) $ (5,971) $ 4,129 --------- --------- --------- Weighted-average shares outstanding 7,361 7,502 7,531 Dilutive effect of options -- 269 276 --------- --------- --------- Adjusted weighted-average shares outstanding 7,361 7,771 7,807 --------- --------- --------- Income (loss) from continuing operations per share - basic $ (1.21) $ .07 $ .69 Gain (loss) from discontinued operations per share - basic .19 (.87) (.14) --------- --------- --------- Net income (loss) per share - basic $ (1.02) $ (.80) $ .55 --------- --------- --------- Income (loss) from continuing operations per share - diluted $ (1.21) $ .06 $ .66 Gain (loss) from discontinued operations per share - diluted .19 (.83) (.13) --------- --------- --------- Net income (loss) per share - diluted $ (1.02) $ (.77) $ .53 --------- --------- ---------
2. Contracts in Process and Contract Loss Provisions In 1999 and 1998, the company recorded contract loss provisions of $11.9 million and $2.6 million, respectively on its fixed-price software development contract with the Colorado Department of Human Services. Delays related to a 1999 customer stop work request, a revised development schedule together with higher software development costs incurred and estimated costs to complete resulted in a significantly higher current estimate of total contract cost compared to earlier periods. The loss is included in the results of operations of the Systems and Services segment as a charge to cost of contract revenue. Also in 1999, the company recorded charges of $2.2 million to provide for estimated contract losses on two other fixed-price software development contracts and $1.8 million in 1999 and $1.7 million in 1998 for other unrecoverable Notes to Consolidated Financial Statements contract costs. These charges are reflected in the results of the Systems and Services segment as a charge to cost of contract revenue. Unbilled expenditures and fees on contracts in process with the United States Government were $16.4 million and $18.2 million at December 31, 1999 and 1998, respectively. Receivables under United States Government contracts were $19.7 million and $18.5 million at December 31, 1999 and 1998, respectively. 3. Restructuring In the fourth quarter of 1999, the company adopted a restructuring plan intended to reduce overhead costs and increase efficiencies. The company recorded a restructuring charge of $1.2 million to provide for the exit costs related to the plan, of which $1.0 million was recorded as cost of contract revenue and the remainder as selling, engineering and administrative expense. Approximately half the charge is related to Massachusetts operations. The remainder of the charge relates to a number of other locations. The charge is comprised primarily of severance costs and outplacement services to be provided to involuntarily terminated employees. The plan involves reducing personnel in certain operating units, the consolidation and realignment of certain functions, and the evaluation of strategic alternatives for certain operations. The program will be implemented in stages during 2000, and will result in a reduction of approximately 100 employees through layoffs or attrition. The affected employees are primarily employed in an indirect capacity or in service lines that the company does not intend to pursue in the future. As of December 31, 1999, no costs had been charged against the reserve. 4. Discontinued Operations In December 1998, the company adopted a plan of disposal for its Telecommunications Fraud Control business and recorded an estimated pre-tax loss on disposal of $4.1 million. In June 1999, the company sold this business for $1.7 million plus royalties of up to $1.8 million through June 2002, based on the buyer's fraud control product sales. Any royalties paid pursuant to the agreement will be included in discontinued operations when received. As of December 31, 1999, the company had not received any royalty payments under this agreement. The sale resulted in a favorable adjustment to the estimated loss on disposal of discontinued operations recorded in fiscal 1998. Accordingly, a pre-tax gain on disposal of discontinued operations of $2.2 million was recorded in the second quarter of 1999. Included in the accompanying balance sheet is $0.3 million of accrued liabilities related to the discontinued operations. Liability for severance payments to former employees and leases that were not assumed by the buyer are included in the remaining accrual. The consolidated financial statements of the company have been restated to reflect the discontinuation of the Telecommunications Fraud Control business. Accordingly, the revenues, costs, expenses, assets, liabilities and cash flows of the business have been excluded from the respective captions in the Consolidated Statements of Operations, Consolidated Balance Sheets and Consolidated Statements of Cash Flows and have been reported as "Gain (loss) from discontinued operations, net of income taxes," as "Net liabilities of discontinued operations," and as "Net cash used for discontinued operations" for all periods presented. The results of discontinued operations do not reflect any interest expense or any allocation of corporate general and administrative expense. Revenue for the Telecommunications Fraud Control business for the years ended December 31, 1999, 1998 and 1997 was $0.7 million, $2.8 million and $2.6 million, respectively. Pre-tax net operating losses of the business were $2.4 million, $5.9 million and $1.6 million for the years ended December 31, 1999, 1998 and 1997, respectively. The results for 1999 were charged to the accrual established at the date the plan of disposal was adopted. 5. Income Taxes The components of the provision (benefit) for federal and state income taxes from continuing operations are as follows:
For the years ended December 31, 1999 1998 1997 - -------------------------------------------------------------- (in thousands of dollars) Currently payable (refundable) Federal $ 75 $ 1,301 $ (747) State 223 402 -- ------- ------- ------- 298 1,703 (747) Deferred Federal (3,584) (1,073) 2,881 State (1,459) (274) 388 ------- ------- ------- (5,043) (1,347) 3,269 ------- ------- ------- Total provision (benefit) $(4,745) $ 356 $ 2,522 ------- ------- -------
The major items contributing to the difference between the statutory United States federal income tax rate of 34% and the company's effective tax rates are as follows:
For the years ended December 31, 1999 1998 1997 - -------------------------------------------------------------- (in thousands of dollars) Provision (benefit) on income (loss) from continuing operations at statutory rate $(4,635) $ 288 $ 2,618 State income tax, net of federal tax benefit (810) 50 457 Increase in valuation allowance 449 -- -- Tax credit refund -- -- (747) Other, net 251 18 194 ------- ------- ------- Provision (benefit) for income taxes $(4,745) $ 356 $ 2,522 ------- ------- -------
During 1999, the company recorded a tax valuation allowance related to a capital loss on its investment in Empresa, Inc., discussed further in Note 12. The company currently has no expectation that it will meet the requirements necessary to deduct this loss for federal income tax purposes. Accordingly, the company recorded a valuation allowance for the full amount of the potential tax benefit associated with the loss. In 1999, the company utilized $3.7 million of federal net operating loss carryforwards to reduce 1999 federal taxable income. Also in 1999, the company filed returns to carry back $2.5 million of prior year federal net operating losses for federal income tax purposes, resulting in refundable income taxes of $0.9 million which were included in prepaid expenses and other current assets on the Consolidated Balance Sheet. At December 31, 1999, the company had federal net operating loss carryforwards of approximately $1.3 million available to offset future taxable income. These carryforwards expire through 2014 and are subject to review and possible adjustment by the Internal Revenue Service. The United States Tax Reform Act of 1986 contains provisions that may limit the net operating loss carryforwards available to be used in any given year under certain circumstances, including significant changes in ownership interests. The tax effects of significant temporary differences that comprise deferred tax assets and liabilities are as follows:
December 31, 1999 1998 - ---------------------------------------------------------------- (in thousands of dollars) Unbilled costs and fees and deferred contract revenue, net $ (7,148) $(12,834) Accrued expenses 4,240 2,422 Receivable reserves 317 127 Inventory reserves 518 608 Federal net operating loss carryforwards 429 2,555 Other 69 (67) -------- -------- Current deferred tax liabilities, net (1,575) (7,189) -------- -------- Accelerated tax depreciation (500) (319) State net operating loss carryforwards 464 392 Capital loss carryforward 449 -- Valuation allowance (449) -- Other (883) (421) -------- -------- Non-current deferred tax liabilities (919) (348) -------- -------- Total deferred tax liabilities, net $ (2,494) $ (7,537) -------- --------
Total deferred tax assets and total deferred tax liabilities were $10.4 million and $12.9 million, respectively, at December 31, 1999, compared with $6.6 million and $14.1 million, respectively, at December 31, 1998. 6. Employee Benefit Programs The company has a noncontributory defined benefit pension plan covering substantially all of its employees. Pension plan benefits are generally based on years of service and compensation during final years of employment. The company's funding policy is to contribute at least the minimum amount required by the Employee Retirement Income Security Act of 1974 or additional amounts to assure that plan assets will be adequate to provide retirement benefits. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future.
Periodic Pension Cost - --------------------- For the years ended December 31, 1999 1998 1997 - --------------------------------------------------------------- (in thousands of dollars) Service cost - benefits earned during the period $ 2,502 $ 1,933 $ 1,555 Interest cost on projected benefit obligation 2,735 2,499 2,235 Expected return on plan assets (3,114) (2,723) (2,304) Amortization of prior service cost 220 220 220 Amortization of transition obligation 35 35 35 ------- ------- ------- Net periodic pension cost $ 2,378 $ 1,964 $ 1,741 ------- ------- -------
Changes in Benefit Obligations - ------------------------------ December 31, 1999 1998 - --------------------------------------------------------------- (in thousands of dollars) Projected benefit obligation at beginning of year $ 42,072 $ 35,693 Service cost - benefits earned during the period 2,502 1,933 Interest cost on projected benefit obligation 2,735 2,499 Benefits paid (1,123) (934) Actuarial (gain) loss (2,533) 2,881 -------- -------- Projected benefit obligations at end of year $ 43,653 $ 42,072 -------- --------
Change in Plan Assets - --------------------- December 31, 1999 1998 - --------------------------------------------------------------- (in thousands of dollars) Fair value of plan assets at beginning of year $ 34,596 $ 30,256 Actual return on plan assets 2,005 2,998 Employer contributions 2,288 2,276 Benefits and expenses paid (1,190) (934) -------- -------- Fair value of plan assets at end of year $ 37,699 $ 34,596 -------- --------
Funded Status - ------------- December 31, 1999 1998 - --------------------------------------------------------------- (in thousands of dollars) Plan assets less than projected benefit obligation $ 5,954 $ 7,476 Unrecognized net transition obligation (70) (105) Unrecognized prior service costs (1,259) (1,479) Unrecognized net actuarial loss (2,626) (3,983) ------- ------- Accrued pension liability $ 1,999 $ 1,909 ------- -------
Weighted Average Assumptions - ---------------------------- December 31, 1999 1998 - --------------------------------------------------------------- Discount rate 7.5% 6.5% Rate of compensation increase 4.0% 4.0% Expected rate of return on assets 9.0% 9.0% - ---------------------------------------------------------------
Plan assets consist primarily of equity and fixed income securities. Fluctuations in the fair market value of plan assets will affect pension expense in future years. The company has established a Supplemental Executive Retirement Plan ("SERP") for a certain former key employee providing for annual benefits commencing on the sixth anniversary of the executive's retirement. The cost of these benefits is being charged to expense and accrued using a projected unit credit method. Expense related to this plan was $13,000, $12,000 and $203,000 for the years ended December 31, 1999, 1998 and 1997, respectively. 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 $0.9 million to the plan for 1999, $0.9 million for 1998 and $0.7 million for 1997. The elective deferrals are invested in one or more collective investment funds at the participant's direction. The company's contributions are invested in guaranteed investment contracts and are paid to the employee upon termination, subject to forfeiture of any non-vested portion if termination occurs within the first five years of employment. 7. Debt At December 31, 1998, the company was operating under an unsecured working capital agreement that was due to expire in October 2000 and provided for financing of up to $40 million. Interest on the outstanding balance was the prime rate plus an applicable margin or, at the company's option, LIBOR plus an applicable margin based on the company's debt coverage ratios. The agreement included a fee on the unused portion of the credit line of 0.375%. At December 31, 1998, $26.8 million was outstanding under the agreement. On September 30, 1999, the company entered into an amended agreement with a syndicate of banks. The amended agreement provided a secured working capital line of credit of up to $35 million, based on assets consisting of inventory, receivables and real estate. Interest on the outstanding balance was the prime rate plus 2%. The agreement included a fee of 0.375% on the unused portion of the credit line. At December 31, 1999, the company was not in compliance with a covenant included in the agreement regarding minimum earnings before income taxes. The amended agreement expired January 31, 2000. At December 31, 1999, $19.7 million was outstanding under the agreement. On February 10, 2000, the company finalized a three-year $20 million secured revolving credit agreement (the "Revolver") and a six-month $7.5 million interim mortgage loan (the "Mortgage") on the company's real estate. Proceeds were used to pay off existing debt. The Revolver expires on February 10, 2003. The company plans to refinance the Mortgage prior to maturity on August 10, 2000. The Revolver provides for borrowings of up to the lesser of $20 million or 80% of eligible accounts receivable. Interest on the outstanding balance of the Revolver and the Mortgage is the prime rate and is payable monthly. The agreement includes a fee of 0.375% on the unused portion of the Revolver. Beginning in 2001, in the event that the company achieves certain financial milestones, the company may elect an interest rate of LIBOR plus 2%, and the fee on the unused Revolver will be reduced to 0.25%. Substantially all the company's assets serve as collateral under the Revolver, except for the corporate office facility in Andover, Massachusetts, which collateralizes the Mortgage. The Revolver requires the company to meet certain financial covenants including maintaining a minimum tangible net worth, cash flow and debt coverage ratios, as well as limits the company's ability to incur additional debt, to pay dividends, to purchase capital assets, to sell or dispose of assets, to make additional acquisitions or investments, or to enter into new leases, among other restrictions. The company's average interest rate on outstanding borrowings at December 31, 1999, 1998, and 1997 was 10.5%, 8.0%, and 6.4%, respectively. 8. Stock Option Plans The company has stock option plans which are administered by the Compensation Committee of the Board of Directors. The Committee determines which employees receive options and the number and option price of shares covered by each such option. The 1993 Equity Incentive Plan (the "1993 Plan") permits the company to grant incentive stock options, stock appreciation rights, 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 (the "1983 Plan"), which terminated in 1993. Options granted under both plans may be either incentive stock options or non-qualified stock options. The option price of incentive stock options 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. Under the 1993 plan, 580,800 shares have been reserved through shareholder approval, none of which were available for future grants at December 31, 1999. The company's 1995 Stock Option Plan for Non-Employee Directors provides for each outside director to receive options to purchase 5,000 shares of common stock at the first annual meeting at which such director is elected, and options to purchase 1,000 shares of common stock at each annual meeting thereafter so long as he or she remains an eligible director. Such directors cannot be an employee of the company or one of its subsidiaries or a holder of five percent or more of the company's common stock. The exercise price of such options will be the fair market value of the common stock on the date of grant. Each option is not 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 132,000 shares has been reserved for issuance of which 85,040 shares remained available at December 31, 1999. In 1999, unrelated to the 1993 and 1995 plans, the company granted an officer 250,000 non-qualified stock options to purchase shares of the company's common stock at $4.44, which was the fair market value of the common stock at the date of grant. Twenty percent of the options vested immediately, with an additional 20% vesting in each successive year from the date of grant. The options expire 10 years from the date of grant. On January 18, 2000, the company's shareholders approved the adoption of the 2000 Plan. The 2000 Plan permits the company to grant stock options, stock appreciation rights, awards of nontransferable shares of restricted common stock and deferred grants of common stock up to a total of 1.5 million shares. Options may be either incentive stock options or non-qualified stock options. The option price may not be less than the fair market value at the date of grant in the case of incentive stock options and the option period may not exceed 10 years from the date of grant. The terms of the 2000 Plan are substantially similar to those of the 1993 Plan. The company has computed the pro forma disclosures required under SFAS No. 123 for options granted subsequent to December 31,1994 using the Black-Scholes option pricing model prescribed by SFAS No. 123.
Black-Scholes Assumptions 1999 1998 1997 - --------------------------------------------------------------- Risk free interest rate 7% 6% 6% Expected option life (years) 8.9 8.8 9.2 Stock volatility 73.49% 71.01% 69.70% - ---------------------------------------------------------------
Options to purchase 310,500 shares, 99,800 shares and 71,220 shares were granted in 1999, 1998, and 1997, respectively, with a weighted average fair value of $3.59, $6.75 and $5.92, respectively. The company accounts for its plans under APB Opinion No. 25 under which no compensation cost has been recognized. Had compensation costs for these plans been recognized consistent with SFAS No. 123, the company's net income (loss) and earnings (loss) per share would have approximated the following pro forma amounts:
Pro Forma Results - ----------------- For the years ended December 31, 1999 1998 1997 - -------------------------------------------------------------------------------- (in thousands, except per share data) Income (loss) from continuing operations $ (9,416) $ (222) $ 4,522 Income (loss) from continuing operations per share - basic $ (1.28) $ (.03) $ .60 Income (loss) from continuing operations per share - diluted $ (1.28) $ (.03) $ .56 Net income (loss) $ (8,054) $ (6,684) $ 3,474 Net income (loss) per share - basic $ (1.09) $ (.89) $ .46 Net income (loss) per share - diluted $ (1.09) $ (.89) $ .43 - --------------------------------------------------------------------------------
The SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, thus the resulting pro forma compensation cost may not be representative of that to be expected in future years.
Stock Option Activity - --------------------- For the years ended December 31, 1999 1998 1997 - ----------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Number Average Number Average Number Average of Shares Price of Shares Price of Shares Price - ----------------------------------------------------------------------------------------------------- Outstanding at beginning of year 627,630 $ 5.32 687,163 $ 4.93 746,841 $ 4.53 Granted 310,500 $ 4.53 99,800 $ 8.66 71,220 $ 7.54 Exercised (9,785) $ 2.92 (118,413) $ 3.69 (130,898) $ 4.14 Canceled (17,160) $ 5.59 (40,920) $ 7.78 -- $ -- Outstanding at end of year 911,185 $ 5.07 627,630 $ 5.32 687,163 $ 4.93 -------- -------- -------- -------- -------- -------- Exercisable at end of year 562,393 $ 4.79 441,190 $ 4.34 415,744 $ 4.24
Notes to Consolidated Financial Statements
Stock Options Outstanding - ------------------------- Options Outstanding Options Exercisable - ------------------------------------------------------------------------------ ---------------------------------- Weighted-Average Weighted- Weighted- Number Remaining Average Number Average Range of Outstanding as of Contractual Exercise Exercisable as of Exercise Exercise Prices December 31, 1999 Life (Years) Price December 31, 1999 Price - --------------------------------------------------------------------------------------------------------------------- $ 2.21 - $ 3.31 177,840 2.7 $ 2.99 177,840 $ 2.99 $ 3.32 - $ 4.41 35,460 6.6 $ 3.81 20,460 $ 3.70 $ 4.42 - $ 5.52 513,400 8.1 $ 4.83 273,400 $ 5.08 $ 5.53 - $ 6.63 20,065 7.1 $ 5.92 14,565 $ 5.78 $ 6.64 - $ 7.73 105,620 7.9 $ 7.28 52,528 $ 7.25 $ 7.74 - $ 9.94 12,000 7.7 $ 9.27 8,000 $ 9.27 $ 9.95 - $11.04 46,800 8.2 $10.11 15,600 $10.11 $ 2.21 - $11.04 911,185 6.9 $ 5.07 562,393 $ 4.79 - ---------------------------------------------------------------------------------------------------------------------
9. Commitments and Contingencies The company conducts certain of its operations in facilities which are under long-term operating leases expiring at various dates through 2004, with various options to renew through 2005. It is expected that in the normal course of business, leases that expire will be renewed or replaced. Rent expense under these leases (exclusive of real estate taxes and insurance) was approximately $3.7 million in 1999, $3.6 million in 1998, and $2.5 million in 1997. The aggregate minimum lease commitment for the company's facilities on December 31, 1999 was $7.8 million, payable as follows: $3.2 million in 2000, $2.0 million in 2001, $1.4 million in 2002, $0.9 million in 2003, and $0.3 million in 2004. As a defense contractor, the company is subject to many levels of audit and review, including the Defense Contract Audit Agency (DCAA), the Inspector General, the Defense Criminal Investigative Service, the General Accounting Office, the Department of Justice and Congressional Committees. As a result of certain DCAA audit findings, the United States Government is temporarily deferring a portion of its payments to the company. The company believes it has substantially remedied the findings of the DCAA and expects the effects of payment deferral will be temporary and not significant. Both related and unrelated to its defense industry involvement, the company is, from time to time, involved in audits, lawsuits, claims, administrative proceedings and investigations, and accrues for liabilities associated with these activities, if any, for which the company considers it probable that future expenditures will be made and for which such expenditures can be reasonably estimated. In management's opinion, the outcome from such audits and other matters discussed above is not expected to have a material adverse effect on the company's financial position or results of operations. In 1999, 70% of the company's sales were to United States government agencies, primarily the Department of Defense. All of the company's United States government contracts are subject to termination for convenience in accordance with government regulations. In 1999, 16% of the company's sales were to agencies of state governments. The cost-reimbursable and fixed-price contracts the company has won are generally multi-year efforts. In accordance with state laws, funding must be approved annually by the state's legislatures. 10. Preferred Stock Purchase Rights On February 17, 1998, the company declared a dividend distribution of one preferred stock purchase right (the "Right") for every outstanding share of common stock, effective July 27, 1998. The Rights attach to all outstanding shares of common stock, and no separate Right certificates will be issued. The Rights will become exercisable upon the tenth business day following the earlier of (i) the date of 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 of the company or (ii) the commencement or announcement of an intention to make a tender offer or exchange offer that would result in a person or group owning 15% or more of the outstanding common stock of the company. When exercisable, each Right entitles the registered holder to purchase from the company one-twelfth of a share of its Series B Participating Preferred Stock, $.10 par value, at a price of $54.17 per each one-twelfth share of preferred stock. Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the company, including, without limitation, the right to vote or to receive dividends. Under certain circumstances, each share of the Series B Participating Preferred Stock would be convertible into a number of shares of the company's common stock having a value equal to twice the exercise price of the preferred stock purchase right. The Rights may be redeemed by the company at the discretion of the Board of Directors at a price of $.0083 per Right. The Rights expire on July 27, 2008. 11. Business Segments Over the 1997 to 1999 period the company had five reportable business segments: Systems and Services, Metrigraphics, Encoder, VisualMagic and Telecommunications Fraud Control business. Each of the segments represents a separate product line, has different customer requirements and
Financial Information by Business Segment - ----------------------------------------- Identifiable Continuing Telecommuni- Systems Visual Operations cations Fraud Identifiable and Services Encoder Metrigraphics Magic Total Control(1) Total - --------------------------------------------------------------------------------------------------------------------------------- 1999 - ---- Net sales(2) $ 164,766 $ 13,214 $ 13,641 $ -- $ 191,621 $ -- $ 191,621 Operating profit (loss)(3) (12,988) (785) 4,100 (1,424) (11,097) -- (11,097) Identifiable assets at year end 55,191 5,818 2,527 -- 63,536 -- 63,536 Depreciation and amortization expense 1,967 618 2,841 -- 5,426 -- 5,426 Capital expenditures 1,442 262 786 -- 2,490 -- 2,490 --------- --------- --------- --------- --------- --------- --------- 1998 - ---- Net sales(2) $ 154,336 $ 16,842 $ 11,166 $ -- $ 182,344 $ 2,775 $ 185,119 Operating profit (loss) 1,077 254 3,160 (1,859) 2,632 (5,879) (3,247) Identifiable assets at year end 67,030 5,892 4,680 -- 77,602 1,425 79,027 Depreciation and amortization expense 2,411 681 2,323 103 5,518 272 5,790 Capital expenditures 2,172 261 277 54 2,764 297 3,061 --------- --------- --------- --------- --------- --------- --------- 1997 - ---- Net sales(2) $ 129,135 $ 18,226 $ 9,344 $ 28 $ 156,733 $ 2,644 $ 159,377 Operating profit (loss) 5,329 1,316 3,142 (1,980) 7,807 (1,562) 6,245 Identifiable assets at year end 51,055 7,435 6,898 239 65,627 1,230 66,857 Depreciation and amortization expense 2,831 693 1,147 108 4,779 136 4,915 Capital expenditures 2,204 518 547 42 3,311 1,040 4,351 --------- --------- --------- --------- --------- --------- ---------
(1) As discussed in Note 4, Discontinued Operations, during 1998, the Company adopted a plan to exit the Telecommunications Fraud Control business and subsequently sold the business during 1999. Accordingly, the results of the unit are presented as discontinued operations in the consolidated statements of operations. Total 1998 Telecommunications Fraud Control business results exclude the estimated loss on the disposal of the business. (2) Net sales and operating profit are presented after the elimination of intersegment transactions. (3) Systems and Services Segment includes a $1.2 million restructuring charge. Reconciliations of amounts related to identifiable continuing operations to amounts included in the Consolidated Balance Sheets, Consolidated Statements of Operations and Consolidated Statements of Cash Flows are as follows:
As of and for the years ended December 31, 1999 1998 1997 - ----------------------------------------------------------------------------- (in thousands) Identifiable operating profit $(11,097) $ 2,632 $ 7,807 Other corporate income and expense (281) (173) -- -------- -------- -------- Income from continuing operations before interest and income taxes $(11,378) $ 2,459 $ 7,807 -------- -------- -------- Identifiable assets(4) $ 63,536 $ 77,602 $ 65,627 Corporate assets(5) 11,652 10,465 12,002 -------- -------- -------- Total assets $ 75,188 $ 88,067 $ 77,629 -------- -------- -------- Identifiable depreciation and amortization $ 5,426 $ 5,518 $ 4,779 Corporate depreciation and amortization 634 701 461 -------- -------- -------- Total depreciation and amortization $ 6,060 $ 6,219 $ 5,240 -------- -------- -------- Identifiable capital expenditures $ 2,490 $ 2,764 $ 3,311 Corporate capital expenditures 212 110 754 -------- -------- -------- Total capital expenditures $ 2,702 $ 2,874 $ 4,065 -------- -------- --------
(4) Identifiable assets by business segment include both assets directly identified with those operations and an allocable share of jointly used assets. (5) Corporate assets consist primarily of cash and the company's Andover, Massachusetts corporate headquarters. Notes to Consolidated Financial Statements production processes and operate in different industries. The Systems and Services segment is the aggregation of two divisions that provide similar services to the Department of Defense and operate in the same regulatory environment. The segments follow the same accounting polices described in Note 1, Significant Accounting Policies. Certain general and administrative expenses, including provisions for doubtful accounts and legal expenses, are recorded as corporate expenses when recognized and are only included in segment profit or loss when amounts are written off or paid. The company evaluates performance based upon profit or loss before interest and taxes. Intersegment sales represent less than 1% of total revenue and are accounted for at cost. Revenue is attributed to geographic areas based upon the customer's location. The company does not have locations outside the United States, but does contract with sales representatives located in foreign countries and the company's employees and subcontractors provide services at customer locations outside the United States. Domestic revenue represented 99% of revenue from continuing operations in each of the years 1999, 1998 and 1997. One customer accounted for 7%, 14% and 11% of total revenue from continuing operations in 1999, 1998 and 1997, respectively. During 1999, 1998 and 1997, revenue from Department of Defense (DoD) customers represented approximately 66%, 59% and 66% of total revenue from continuing operations, respectively. Revenue earned from one significant DoD contract represented 12%, 14% and 18% of revenue from continuing operations in 1999, 1998 and 1997, respectively. Systems and Services - -------------------------------------------------------------------------------- The Systems and Services segment provides specialized technical services to the DoD, federal agencies, state governments and other customers and produced approximately 86% of total company revenue in 1999. These services include engineering services, development and operation of computer-based management systems and other management services. The Systems and Services segment provides network infrastructure for state human services as well as software system implementation services. Metrigraphics - -------------------------------------------------------------------------------- The Metrigraphics Division uses photolithographic and material deposition processes to manufacture optical discs, scales and reticles that are used for precision measurement. Metrigraphics produces a variety of precision components including printheads and orifice plates used in electronic printers and fine line circuits used in certain medical instruments. An increase in per unit depreciation of certain equipment was implemented in the second half of 1997 resulting in increased depreciation expense of $1.2 million and $0.2 million in 1998 and 1997, respectively. Encoder - -------------------------------------------------------------------------------- The Encoder Division designs, manufactures and markets a line of digital encoders that convert analog motion and position information into digital signals used in a wide variety of industrial products and systems which include machine tools, robotics, engine fuel-control systems, packaging equipment and other capital equipment. Encoder's digital encoding devices are essential elements of today's electronically controlled systems and equipment. Telecommunications Fraud Control - -------------------------------------------------------------------------------- Between 1996 and the second quarter of 1999, the company operated under an exclusive license to enhance, develop and market a telephone fraud-detection control system. Telecommunication customers included five regional bell operating companies. As discussed further in Note 4, Discontinued Operations, during 1998, the company adopted a plan to exit the business. In 1999 the company sold the business. VisualMagic - -------------------------------------------------------------------------------- Over a number of years, the company invested in the research and development of VisualMagic, an object-oriented development environment. This development environment has proven to be especially useful in the design of internet applications. As discussed further in Note 12, during 1998, the company acquired an interest in Empresa, Inc., formerly Electronic Press Services Group, Inc., in exchange for a license to VisualMagic, cash and the assets of the business. Empresa also hired most of the segment's employees. 12. Investment in Empresa, Inc. On December 23, 1998, the company made an investment in Empresa, Inc., a privately held company based in Cambridge, Massachusetts, engaged in electronic commerce services. The company contributed a perpetual license to the VisualMagic development environment, the assets of the VisualMagic segment and cash. The cash contributions were made in December 1998, February 1999, and May 1999. In the second quarter of 1999, the company wrote off its investment in Empresa due to the uncertainties of the early stage business resulting in an impairment charge of $1.4 million which is included in selling, engineering and administrative expenses in the Consolidated Statement of Operations. Subsequently, Empresa ceased operations. EX-23.1 5 CONSENT OF ARTHUR ANDERSEN 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 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. 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 in the United States. 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 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles in the United States. Arthur Andersen LLP Boston, Massachusetts, February 11, 2000 [TYPE] EX-27 [DESCRIPTION] FINANCIAL DATA SCHEDULE [ARTICLE] 5 [MULTIPLIER] 1,000 [PERIOD-TYPE] 12-MOS [FISCAL-YEAR-END] DEC-31-1999 [PERIOD-END] DEC-31-1999 [CASH] 2,267 [SECURITIES] 0 [RECEIVABLES] 53,526 [ALLOWANCES] 0 [INVENTORY] 2,735 [CURRENT-ASSETS] 60,121 [PP&E] 53,464 [DEPRECIATION] 38,397 [TOTAL-ASSETS] 75,188 [CURRENT-LIABILITIES] 50,464 [BONDS] 0 [PREFERRED-MANDATORY] 0 [PREFERRED] 0 [COMMON] 874 [OTHER-SE] 23,850 [TOTAL-LIABILITY-AND-EQUITY] 75,188 [SALES] 26,855 [TOTAL-REVENUES] 191,621 [CGS] 21,257 [TOTAL-COSTS] 185,535 [OTHER-EXPENSES] 17,464 [LOSS-PROVISION] 0 [INTEREST-EXPENSE] 2,255 [INCOME-PRETAX] (13,633) [INCOME-TAX] (4,745) [INCOME-CONTINUING] (8,888) [DISCONTINUED] 1,362 [EXTRAORDINARY] 0 [CHANGES] 0 [NET-INCOME] (7,526) [EPS-BASIC] (1.02) [EPS-DILUTED] (1.02)
EX-99 6 IMPORTANT FACTORS RE FORWARD-LOOKING STATEMENTS 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 or implied 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 In 1999, approximately 66% of the company's revenue was with the U.S.Department of Defense. In the past, the company's defense business has been adversely affected by significant changes in defense spending during periods of declining U.S. defense budgets. Among the effects of this general decline has been increased competition within a consolidating defense industry. It is not possible for the company to predict whether defense budgets will increase or decline in the future. Further, changing missions and priorities in the defense budget may have adverse effects on the company's business. Funding limitations could result in a reduction, delay, or cancellation of existing or emerging programs. The company anticipates there will continue to be significant competition when the company's defense contracts are rebid as well as 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, will adversely affect the company's business, financial condition and results of operations. Government Contracting Risks The company has historically derived a substantial portion of its revenue from contracts and subcontracts with the U.S. Government. In recent years, the company has entered into significant information technology services contracts with various state governments. A significant portion of the company's federal and state 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. 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 could 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. A significant portion of the company's federal and state government contracts are renewable on an annual basis, or are subject to the exercise of contractual options. Multi-year contracts often require funding actions by the U.S. Government, state legislature or others on an annual or more frequent basis. As a result, the company's business could experience material adverse consequences should such funding actions or other approvals not be taken. 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 government agencies, 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 contractual actions. Failure to collect such amounts may have material adverse consequences on the company's business, financial condition and results of operations. As a defense contrator, the company is subject to many levels of audit and review, including the Defense Contract Audit Agency (DCAA), the Inspector General, the Defense Criminal Investigative Service, the General Accounting Office, the Department of Justice and Congressional Committees. These audits and reviews may result in fines, penalties, the withholding of payments due to the company or the prohibtion from participating in certain Government requests for proposals. A substantial portion of the company's U.S. Government 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 U.S. 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 U.S. 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 on 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 Associated with New Markets and New Products In its efforts to enter new markets, including Government agencies other than the DoD 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 not achieve the level of success sought by the company, if any. Concentration of Customers Within the DoD, 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 any of 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 related 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 both domestically and in other regions of the world, competition, technological change and production disruption, 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, either in the U.S. or elsewhere in the world, 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 business financial condition and results of operations. Technological Change The company's knowledge base and skills in the systems and services segment area are sophisticated and involve areas in which there have been and are expected to continue 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 competitors' 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 or result in new or improved products that may be required to sustain the company's market position. Financing Requirements and Access to Capital Markets While the company believes that its current resources and access to capital markets is adequate to support operations over the near term and foreseeable future, there can be no assurance that these circumstances will remain unchanged. The company's need for capital is dependent on operating results and may be greater than expected. The company's ability to maintain its current sources of debt financing is dependent on the company remaining in compliance with certain covenants included in the financing agreements. Changes in capital markets may restrict the availability of funds or increase the cost of funds. -----END PRIVACY-ENHANCED MESSAGE-----