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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, 2001
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
(State or Other Jurisdiction of Incorporation or Organization)
04-2211809
(I.R.S. Employer Identification No.)
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:
Title of Each Class NONE
Name of Each Exchange on Which Registered 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 February 22, 2002, the aggregate market value of Common Stock held by
nonaffiliates of the Registrant was $147,832,002 and the number of shares of
Common Stock, $.10 par value, of the Registrant outstanding was 7,990,919.
Documents Incorporated By Reference
Portions of the Registrant's Proxy Statement for the 2002 Annual Meeting of
Shareholders are incorporated by reference in Part III.
The Exhibit Index is on page 46.
Form 10-K for the Fiscal Year Ended December 31, 2001
Part I Page
Item
1. Business 4
2. Properties 11
3. Legal Proceedings 11
4. Submission of Matters to a Vote of Security Holders 11
4A. Executive Officers of the Registrant 12
Part II
5. Market for Registrant's Common Equity and
Related Stockholder Matters 12
6. Selected Financial Data 12
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 13
7A. Quantitative and Qualitative Disclosures about Material Risk 19
8. Financial Statements and Supplementary Data 19
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 38
Part III
10. Directors and Executive Officers of the Registrant 38
11. Executive Compensation 38
12. Security Ownership of Certain Beneficial Owners
and Management 38
13. Certain Relationships and Related Transactions 38
Part IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 38
Part I
Item 1. Business
Overview
Dynamics Research Corporation ("DRC" or the "company") provides information
technology, engineering, logistics and other consulting services to federal
defense, civil and state agency customers. Founded in 1955 and headquartered in
Andover, Massachusetts, DRC has 1,517 employees in 36 offices in 19 states in
the United States.
DRC's core capabilities are focused on information technology, engineering and
technical subject matter expertise, which pertain to the knowledge domains
relevant to the company's core customers. More specifically, these capabilities
include design, development, operation and maintenance of information technology
systems, engineering services, complex logistics planning systems and services,
defense program administrative support services, simulation, modeling, training
systems and services and custom built electronic test equipment and services.
DRC applies proven processes and technologies to enhance the performance and
cost effectiveness of a variety of mission-critical customer systems. DRC
believes that one of its unique competitive advantages is its ability to provide
subject matter experts who work closely with specialists in disciplines such as
information technology, logistics, engineering, modeling, simulation and
training systems to develop innovative solutions to customer challenges.
In the company's precision manufacturing business DRC develops and produces
components for original equipment manufacturers in the computer, medical
electronics, telecommunications and factory automation industries. Manufacturing
core capabilities are focused on the custom design and manufacture of miniature
electronic parts meeting ultra-high precision requirements using electroforming,
thin film deposition and photolithography technologies, as well as on optical
encoders that convert analog motion and position information into digital
signals.
Markets
DRC's systems and services business, which accounted for 89 percent of revenues
in 2001, is focused on providing information technology and technical services
to government customers. The government market is composed of three sectors -
defense, federal civilian agencies, and state and local governments.
The United States Department of Defense spends, according to industry reports,
approximately $20 billion annually on information technology. Several factors
are driving growth in this market. First, increased spending on national
defense, the war on terrorism, sustaining military readiness, homeland security
and efforts to transform the United States military forces will focus on
technology-based solutions. Second, there is an increased reliance on
contractors to supply mission critical services due to government workforce
ceilings.
In the federal civilian agency sector annual information technology spending is
estimated by industry reports at more than $20 billion. Factors driving growth
in this sector include an on-going need for systems modernization and, as in the
defense sector, government workforce ceilings. These factors have and are
expected to continue to cause federal civilian agencies to turn to contractors
on an increasing basis to fill their needs for information technology services.
Customers in the third sector of the government market, states and local
jurisdictions, are estimated by industry reports to spend $39 billion annually
on information technology. Health and human services, an area in which DRC has
considerable experience, constitute the second largest area of state spending
with annual budgets totaling $8 billion. Factors driving growth in this sector
are infrastructure modernization and expansion, the migration of information and
training to the Web, and cost-sharing incentives to facilitate data exchange
with federal agencies. State government health and human services agencies are
among the organizations that most need information technology services to
upgrade and maintain their computer-based information systems. They have large
and burdensome caseloads and must maintain extensive records, reporting of
program data, elimination of errors, and more responsive management. Yet the
information systems of many such agencies are antiquated and have limited data
interfacing and reporting capabilities. While this market has excellent
long-term growth prospects, in the short-term state spending constraints are
limiting investments and growth in contracted services.
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DRC's Precision Manufacturing Group, which represented 11 percent of total
company revenues in 2001, serves the commercial high-tech original equipment
manufacturers' ("OEM") market. This market, which was in a downturn in 2001,
includes computing, electronic test, telecommunications, medical technology,
optical and industrial equipment. The Precision Manufacturing Group sells
exclusively to commercial customers.
Major Customers
The company's 2001 revenues, broken down by market sector, were 73 percent
defense, 6 percent federal civilian agencies, 10 percent state and local
governments, and 11 percent commercial OEMs. Federal civilian agencies and state
and local government were the fastest growing sectors for DRC in 2001.
Defense Sector
United States Air Force customers constituted the largest component of DRC's
defense revenues in 2001, representing 44 percent of total revenues, while Navy
revenues were 18 percent of the total, Army revenues represented 7 percent and
other agencies were 4 percent. DRC's defense sector revenues have grown at an
average annual rate of 11 percent since 1996. Key capabilities DRC offers
defense customers include program management services; modeling and simulation;
training products and systems; and software development and maintenance. In
addition, DRC's test equipment business develops, maintains and validates
hardware and software for complex weapons systems and operates a supercomputing
facility for semiconductor modeling for defense applications. Descriptions of
the work DRC performs for the company's major customers in this sector follow.
Air Force Electronic Systems Center
The mission of the Electronic Systems Center ("ESC"), headquartered at Hanscom
Air Force Base, Bedford, MA, is to serve as the Center of Excellence for command
and control and information systems to support the Air Force warfighter in war
and peace. ESC provides full spectrum architectures, weapon systems management
and technical cognizance throughout the life cycle of communications,
intelligence, surveillance, reconnaissance, and information systems.
DRC evaluates system requirements, provides software development and test
services, integrates products into airborne and ground weapons systems, and
provides management services supporting ESC systems program offices, including
the Combat Air Forces Command and Control, Military Satellite Communications,
Joint Surveillance Target Attack Radar, Airborne Warning and Control Systems,
and Defense Information Infrastructure offices.
DRC is the prime support contractor to the Combat Air Forces Command and Control
Systems Program Office, which manages the development and acquisition of command
and control systems. These systems gather and analyze information on hostile
forces, enabling commanders to rapidly make and communicate decisions to their
forces. This office is the Electronic System Center's largest and most advanced
information technology program. In addition to the services noted above, DRC
also is helping this program office with controlling costs. The company's
proprietary expense tracking and planning system has enabled the program to cut
operating and overhead costs by 20 percent.
Navy Trident Missile Program
For more than forty years, the company has provided services to the United
States Navy Strategic Systems Program office. DRC builds specialized equipment
that tests and validates the accuracy and operability of gyroscopes and other
navigational equipment for Trident II submarines and missiles. DRC develops and
maintains performance, reliability, and logistics databases for the inertial
guidance instruments housed in missile guidance systems and submarine inertial
guidance systems. It also provides independent analysis and monitoring of
submarine-based inertial guidance systems and electronic modules.
Air Force Depot Operations
DRC performs logistics analyses and operations for the United States Air Force's
three domestic Air Logistics Centers at Tinker, Warner Robins and Hill Air Force
Bases. The company provides logistics support, information technology management
and analysis, system engineering and technical services 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. Additional tasking has centered on providing support to
Air Force reengineering and business process improvement initiatives at these
Air Logistics Centers.
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DRC is also developing an analytical simulation model that will enable Tinker
Air Force Base to determine how to more efficiently conduct depot repairs on
aircraft engines, especially for the F-16. A key program objective is minimizing
the lifecycle costs of maintaining major weapons systems.
DRC has installed, integrated and is providing operational support for a
customized suite of commercial software products to improve productivity at the
United States Air Force's landing gear maintenance, repair and overhaul
operations at Hill Air Force Base in Ogden, Utah.
Aeronautical Systems Center, Air Force Materiel Command
The Aeronautical Systems Center, headquartered at Wright-Patterson Air Force
Base, Ohio is responsible for research, development, test, evaluation and
initial acquisition of aeronautical systems and related equipment for the Air
Force. Its major active programs are the B-2 and B-1B bombers, C-17 airlifter,
F-22 fighter and continuing work on the F-117A fighter, F-15 Eagle and F-16
Fighting Falcon. DRC provides technical and subject matter expertise supporting
a number of the offices responsible for these programs in carrying out their
mission-essential tasks and objectives such as product support, information
services, supply management, depot maintenance, science and technology, test and
evaluation, information management, installations and support, and combat
support.
Army Aviation/Missile Command
DRC provides programmatic consulting, engineering and logistics management to
the Army Materiel Command and Army program executive officers for acquisition of
major weapon systems. DRC engineers analyze and review airframe, avionics,
aeromechanics and propulsion issues for Army project managers, provide logistics
and fielding support, and prepare electronic technical manuals for rotary and
fixed-wing aircraft systems. DRC supports other United States Army activities
with acquisition logistics, systems engineering and other related program
management services at the United States Army Aviation Center, Tank-automotive
and Armaments Command and Communications-Electronics Command.
In 2001, DRC received a contract from the United States Army Aviation & Missile
Command located at Redstone Arsenal, Alabama to provide helicopter vibration
analysis, a program designed to improve the operational effectiveness of the
Army's helicopters through use of advanced identification, monitoring, and
analysis techniques to control adverse vibrations in dynamic components.
Army Research
In 2001 DRC received a five-year contract from the United States Army Medical
Research Acquisition Activity to expand its MedTeams(R) program for improving
teamwork and reducing medical error among emergency care hospital staff into
other medical specialties. The contract provides for research to expand MedTeams
into other specialties such as labor and delivery. It also includes provisions
for establishing MedTeams Centers of Excellence and a cadre of trainers to
deliver MedTeams training throughout the Department of Defense.
Recognizing the need for better communication and teamwork among Army air crews,
the United States Army Research Institute for the Behavioral and Social
Sciences, the Army's main research laboratory for personnel performance and
training, turned to DRC behavioral scientists. Based on the success of a program
originally created for the Army in 1993, DRC is developing a Web-based,
interactive training system that offers air crews anywhere in the world the
knowledge, teamwork skills and attitudes that will result in improved mission
effectiveness and lower accident rates. The first part of this three-phase
program is an 18-month contract valued at $1.8 million. DRC's team training and
evaluation system is one of the Army Aviation Safety Investment Strategy Team's
top 10 solutions for reducing aviation accidents.
Air Force Air Mobility Command
The Air Mobility Command, headquartered at Scott Air Force Base, Illinois has as
its primary mission rapid, global mobility and sustainment for America's armed
forces. The command also plays a crucial role in providing humanitarian support
at home and around the world. DRC provides technical and subject matter
expertise in support of this mission, providing program planning, decision
support, logistics analysis and financial analysis services.
Modeling, Simulation and Decision Support Programs
DRC applies its capabilities in the area of modeling and simulation on many
engagements, including projects for the United States Joint Forces Command, the
Defense Modeling and Simulation Office, the Naval Aviation Warfare Center, the
Chief of Naval Education and Training, Air National Guard, and the Air Force
Installations and Logistics Director of Supply.
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The United States Joint Forces Command Joint Warfighting Center orchestrates
military training exercises in various world theaters. These wargames entail
major geographic and functional commands, and thousands of troops, as well as
supplies, vehicles and equipment to support them. Such exercises require
top-level coordination to maximize effectiveness and avoid schedule and resource
conflicts. DRC developed and is now enhancing the Joint Training Information
Management System ("JTIMS"), a Web-based application that lets authorized
personnel collaboratively plan and execute wargames. The system enables
combatant commands, joint organizations and defense agencies to align training
with assigned missions, and helps ensure missions are consistent with
organizational priorities.
The United States Naval Aviation Warfare Center's Training Systems Division
develops instructional programs for Navy pilots and maintenance personnel. After
identifying aviation readiness as an area of concern, the Navy established a
program to improve aviator training. DRC's first task under an initial 10-month,
$2.75 million contract is to exhaustively analyze course content and determine
which material is best taught in the classroom, through self-study programs, at
simulators or in flight. DRC engineers and training specialists are also working
under an aggressive schedule to deconstruct and categorize flight mission tasks.
This information will be used to design flight simulators that provide the most
relevant, cost-effective training and accurate performance measures.
DRC is developing an analytical tool for the Chief of Naval Education & Training
to simulate the training pipeline and help the Navy predict demand for various
training programs. The system is being designed to help the Navy ascertain the
costs and risks of potential changes to training programs before they are made.
DRC has developed and maintains a system, called the Guard Information Analysis
Network, which is used daily to provide updates and performance reports on
aircraft capability, engine status, spare parts availability, and to provide
decision support to mission planning for the United States Air National Guard.
This real-time information system is currently playing a critical role in
homeland defense. DRC developed a similar system and provides similar services
for the Air Force Installations and Logistics Director of Supply under a program
known as Multi-Echelon Resources and Logistics Information, providing insight on
availability and capacity of Air Force assets, fleet-wide.
Air Force Materiel Support Group
One system, for which the Materiel Support Group ("MSG") is responsible, is the
Weapon Systems Management Information System, a key decision-support tool for
assessing the impacts of maintenance, parts and repair status on weapons systems
availability. DRC provides operations, maintenance and development support
services to MSG for this system.
Naval Aviation Systems Command
In 2000 DRC was awarded a five-year, multi-million dollar subcontract to provide
engineering and information services to the United States Naval Aviation Systems
Command Logistics Competency ("NAVAIR"). DRC is a primary subcontractor to
Lockheed Martin Systems Integration-Owego in assisting NAVAIR in the
modernization of naval aviation logistics information management systems.
Federal Civilian Agency Sector
United States Government federal civilian agencies present an important growth
market for DRC. While DRC currently has limited penetration in this market,
several of the company's core capabilities have direct applicability to the
needs of customers in this sector. A description of DRC's major customer
engagements in this sector follows.
Internal Revenue Service
The Internal Revenue Service is DRC's primary customer in this sector. DRC is a
key contractor on this program, having been awarded potentially more than $65
million in contracts to date. In July 2000, DRC signed a five-year contract with
the IRS to provide technical and management services in four task areas:
telecommunications, information services, organizational management and
operational support. In 2001 DRC was the recipient of a five-year information
system contract worth $20-36 million to support the Internal Revenue Services'
Dallas-based Mid-America Development Center. Currently, DRC's efforts focus on
two major projects: the Compliance Research Information System ("CRIS"), a tool
that helps IRS statisticians identify deviations that indicate potential tax
fraud; and the Integrated Collection System ("ICS"), a tool for more timely,
accurate and productive tax collection. DRC is helping convert CRIS to a
Web-based platform, giving hundreds of IRS statisticians access to the latest
version regardless of location or computer configuration. DRC is also assisting
with data warehousing, data mining and expanding the system for more
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users. On the ICS project, DRC is helping the IRS migrate from a legacy system
to a Windows NT environment, which will allow agents responsible for
apprehending tax evaders to access ICS, Microsoft Office and e-mail from laptops
while they're out in the field.
United States Customs Service Air and Marine Interdiction Division
The United States Customs Service National Aviation Center in Oklahoma City
trains pilots and other flight personnel for aerial border surveillance. DRC has
assisted agency flight experts to plan standardized training systems and develop
courseware. Manuals and other paper curriculum materials were converted to a
computer-based system and integrated into an overall instructional framework.
DRC now creates electronic training materials for use in classrooms, on
standalone computers, over the agency's local area network, and via a secure Web
site for distance learning.
State and Local Government Sector
DRC designs, develops, implements, maintains and supports software, networks and
systems for state health and human services agencies and local users of these
statewide systems. While DRC currently has limited penetration, the company has
several avenues for growth in this market. In addition to an expected increase
in state spending in these areas over the next several years, the company has
the ability to expand the scope of services provided to current customers and to
attract new customers in other agencies and in other states. A description of
DRC's major customer engagements in this sector follows.
Colorado Department of Human Services
Since 1997, DRC has worked with the state of Colorado to develop, deploy and
maintain an integrated statewide system, known as Colorado Trails ("Trails"),
that streamlines the workload for social workers, youth corrections officers and
administrators. DRC has developed and maintains the software and has installed a
network of 3,000 computers at 130 sites, providing users with new computers,
networking equipment, e-mail and the Trails application. Trails includes tools
for determining and managing such functions as client eligibility, court
appearances, residential facilities, finance, automatic payment generation
through the state's financial processing system and administration. DRC also
developed an award-winning online support tool with a computer-based training
program for social workers that incorporates links to electronic policy and
procedure manuals. To facilitate intra-agency coordination, Trails also
interfaces with systems supporting criminal justice and childcare tracking
functions. The network supported by DRC has been expanded to support the state's
benefits management system, which also is under the responsibility of the
Department of Human Services.
State of Ohio, Department of Job and Family Services
Since 1997, DRC has provided information technology expertise and implementation
to the state of Ohio's Support Enforcement Tracking System, a program that
tracks down "deadbeat parents." DRC has a dedicated network maintenance team
responsible for rapid-response repair of the agency's 19,000 computers, 600
printers, 240 file servers, and 520 routers and switches--across 88 counties.
DRC's team of engineers and network administrators must respond to trouble calls
within four hours and resolve the problem within eight hours. Since the program
began four years ago, DRC has achieved a perfect record for responding to and
repairing all reported problems.
DRC's Capabilities
Systems and Services
The core capabilities of DRC's systems and services business are focused on
information technology, engineering and technical subject matter expertise,
which pertain to the knowledge domains relevant to the company's core customers.
These include design, development, operation and maintenance of information
technology systems, acquisition and program support, engineering services,
complex logistics planning systems and services, defense program administrative
support services, modeling, simulation, training systems and services and custom
built electronic test equipment and services. More specific descriptions of
these capabilities follow.
Information Technology
Capabilities DRC offers include systems integration; applications development;
engineering of multi-level information system security; legacy system data
migration; development of decision support systems; integration of commercial
off-the-shelf software; network infrastructure design and maintenance; technical
management services and consulting; and independent verification and validation
services.
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Defense Program Management Services
Capabilities in this category include technology, planning and acquisition,
systems engineering, logistics systems planning, decision support, financial and
administrative services.
Engineering Services
Capabilities in this category include engineering analysis applied to
electronic, communication, aeronautical, naval and navigation systems; reverse
engineering of electronic components; precision component design; test,
maintenance and support of navigation and guidance systems; human factors
integration; and business process reengineering.
Logistics
Capabilities DRC offers include logistics analysis and support; supply chain
analysis and management; development of decision support systems; and
configuration of maintenance, repair and overhaul systems.
Modeling and Simulation
DRC's capabilities in this category include simulation of discrete and ongoing
events; simulation-based reengineering; logistics and supply chain modeling;
object-oriented modeling techniques; and simulation support services.
Training Analysis and Delivery
Capabilities in this category include training task analysis; development of
computer-based training programs and training delivery systems; and electronic
performance support systems.
Precision Manufacturing
The core capabilities of DRC's Precision Manufacturing Group are process focused
for the Metrigraphics Division and product focused for the Encoder Division.
Metrigraphics Division
The Metrigraphics Division's expertise centers on photolithography, thin film
deposition of metals and dielectrics, and electroforming. 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) inkjet printer cartridge nozzle plates and hard drive test
devices; 2) medical applications for micro-flex circuits used in angioplasty and
for blood testing; 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
microstructures.
Encoder Division
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, including
machine tools, robotics, engine fuel-control systems, packaging and factory
automation equipment, and semiconductor processing. The ability to custom design
products is a core capability for the Encoder Division.
Business Development
The company has a well-established capability of winning contract renewals and
re-competes, based on the company's line management knowledge of customer needs
and DRC's incumbent expertise.
The company's business development group is charged with identifying and winning
significant new business opportunities and supporting major competitions related
to existing customers and business. The group is centrally managed, with
resources aligned to operating line organizations. The group also maintains a
proposal development and publication capability.
The group operates with formal processes, which monitor the pipeline of
opportunities, align resources to significant opportunities and engage line and
executive management.
Government Contracts
The federal procurement process has changed significantly in recent years.
Whereas the traditional method of federal government procurement has been to
conduct a lengthy competitive bidding process for each award, today base
purchase agreements, indefinite delivery, indefinite quantity contracts and the
General Services
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Administration contract form and related schedules are the predominant forms of
contracting for IT and technical services. These vehicles have enabled
contracting officers to accelerate the pace of awards.
DRC's contracts with United States Government customers are generally subject to
termination at the convenience of the United States 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 United States 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 United States
Government requirements or budgetary concerns. If the United States Government
curtails expenditures for research, development and consulting activities, such
curtailment might have an adverse impact on the company's revenue and earnings.
The company's state contracts are generally either fixed-price or time and
materials. 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 reimbursable. 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
reimbursable 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, 2001, the company's funded backlog was approximately $91.4
million compared with $89.8 million at December 31, 2000. The company expects
that substantially all of its backlog at December 31, 2001 will be filled during
the year ending December 31, 2002. The company has a number of multi-year
contracts with agencies of the United States and state governments on which
actual funding generally occurs on an annual basis. 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.
Competition
The company's systems and services business competes with public and privately
held firms, which specialize in providing government information technology
services. These firms may be large or small. The company also competes with the
government services divisions of large commercial IT service firms and with
government IT service divisions of large defense weapons systems producers. The
United States 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 past performance, technical capabilities and price.
In the precision manufacturing business, the company competes with other
manufacturers of encoders, electroform vendors and suppliers of precision
measurement discs, scales, and reticles. 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 $0.5 million, inclusive of overhead and other
indirect costs, on new product and service development during the year ended
December 31, 2001, compared with expenditures of $0.2 million in 2000 and $1.5
million in 1999. The expenditures in 2001 were attributable mainly to the
development of MedTeams training products.
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.
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Employees
At December 31, 2001, the company had 1,517 employees. The company considers its
relationship with its employees to be satisfactory.
Proprietary Information
Patents, trademarks and copyrights are not materially important to the company's
business. The United States Government has certain proprietary rights in
processes and data developed by the company in its performance of government
contracts.
Item 2. Properties
The company leases approximately 323,000 square feet of office and manufacturing
space. This space is used for its federal and state government services,
manufacturing and warehousing operations as well as its marketing and
engineering offices. The company has 113,000 square feet of manufacturing and
office space in three Wilmington, Massachusetts facilities. The Wilmington
leases expire in 2005, with options to renew the leases to the year 2010. The
remaining leased facilities consist of offices in 32 locations across the United
States. The company owns a 135,000 square foot facility in Andover,
Massachusetts which serves as its corporate headquarters.
The company's total rental cost for 2001 was $4.1 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 2001.
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Item 4A. Executive Officers of the Registrant
The following is a list of the names and ages of the executive officers of the
company, 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.
Name and Position Age
James P. Regan
Chairman, President and Chief Executive Officer, Director 61
Richard A. Covel
Vice President and General Counsel 55
Chester Ju
Vice President and General Manager,
Precision Manufacturing Group 52
David Keleher
Vice President and Chief Financial Officer 52
John L. Wilkinson
Vice President and General Manager,
Human Resources 62
Messrs. Ju and Wilkinson have served in their respective positions for more than
five years.
Mr. Regan joined the company in 1999 as President, Chief Executive Officer and
Director. In April 2001, Mr. Regan was elected Chairman of the Board of
Directors. Prior to joining DRC, 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 1992 to 1996.
Mr. Covel joined the company as Vice President and General Counsel in December
2000. Prior to that, he was General Counsel, Patent Counsel and Clerk at
Foster-Miller, Inc. from 1985-2000.
Mr. Keleher joined the company as Vice President and Chief Financial Officer in
January 2000. Prior to that, he was employed by Raytheon Company as Group
Controller for the Commercial Electronics Division in 1999 and Assistant
Corporate Controller in 1998. Prior to that, he served in several senior
management positions in corporate finance and operations at Digital Equipment
Corporation from 1981 to 1997.
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 2001 and 2000 as reported on the
NASDAQ National Market are listed below. These market quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
necessarily represent actual transactions.
2001 2000
High Low High Low
- ----------------------------------------------------------------------------
First quarter $ 11.00 $ 7.75 $ 8.38 $ 6.94
Second quarter 10.38 8.16 8.63 7.00
Third quarter 14.69 8.86 8.53 6.75
Fourth quarter 19.50 12.79 9.25 7.13
- ----------------------------------------------------------------------------
As of December 31, 2001 there were 767 holders of record of the company's common
stock.
In September 1984, the Board of Directors voted 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 2001 and does not intend to
in the near future.
The Annual Meeting of the stockholders of Dynamics Research Corporation will be
held at 2:00 p.m. on Thursday, April 25, 2002 on the 2nd floor of the Hampshire
House, 84 Beacon Street, Boston, Massachusetts.
Item 6. Selected Financial Data
Five Year Summary of Selected Financial Information
2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------
(in thousands of dollars, except share, per share and employee data)
Revenue $ 201,112 $ 200,175 $ 191,621 $ 182,344 $ 156,733
Operating income (loss) 11,869 9,203 (11,378) 2,459 7,807
Income (loss) from continuing operations 6,483 4,353 (8,888) 491 5,177
Net income (loss) 6,545 4,559 (7,526) (5,971) 4,129
Income (loss) from continuing operations
per common share - basic .84 .57 (1.21) .07 .69
Income (loss) from continuing operations
per common share - diluted .80 .56 (1.21) .06 .66
Net income (loss) per common share - basic .85 .60 (1.02) (.80) .55
Net income (loss) per common share - diluted .81 .59 (1.02) (.77) .53
Total assets 81,825 78,702 75,188 88,067 77,629
Total debt 9,250 15,534 19,700 26,800 10,000
Stockholders' equity 37,138 29,289 23,805 31,246 39,147
Stockholders' equity per share 4.68 3.85 3.23 4.24 5.19
Return on stockholders' equity(1) 19.9% 17.1% (26.5)% (16.0)% 11.2%
Return on invested capital(1) 16.1% 12.0% (13.8)% 2.4% 10.6%
Backlog 91,404 89,843 83,549 105,427 110,001
Cash flow from operations 24,717 4,735 10,985 (11,406) 7,980
Research and development expense 488 150 1,478 2,739 1,249
Capital expenditures 3,752 3,120 2,702 3,171 5,104
Depreciation and amortization 3,457 3,746 6,060 6,219 5,240
Number of shares outstanding at end of year 7,940,610 7,601,519 7,363,324 7,369,190 7,546,646
Number of employees 1,517 1,504 1,613 1,557 1,455
- -----------------------------------------------------------------------------------------------------------
(1) Percentages are calculated using a 5-point average of equity and invested
capital.
See Management's Discussion and Analysis of Financial Condition and Results
of Operations for discussion of unusual items.
12
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Results of Operations
For the years ended December 31, 2001 2000 1999
- --------------------------------------------------------------------------------------------------------------
(expressed as a percentage of total revenue)
Contract revenue 89.2% 86.3% 86.0%
Product sales 10.8% 13.7% 14.0%
Total revenue 100.0% 100.0% 100.0%
Gross margin on contract revenue(1) 13.4% 9.5% 0.3%
Gross margin on product sales(1) 24.0% 30.3% 20.8%
Total gross margin 14.5% 12.4% 3.2%
Selling, engineering and administrative expenses 8.6% 7.8% 9.1%
Operating income (loss) 5.9% 4.6% (5.9)%
Interest expense, net 0.4% 0.9% 1.2%
Income (loss) from continuing operations
before provision (benefit) for income taxes 5.4% 3.7% (7.1)%
------------------------------------------------------------------------------------------------------------
(1) These amounts represent a percentage of contract revenue and product sales,
respectively.
13
Overview
Overall, Dynamics Research Corporation (the "company") became a stronger, more
balanced company in 2001. It bolstered its traditional competitive advantages,
including strong and relevant core competencies, a 47-year legacy of satisfied
customers, a reputation for thought leadership and innovation, and an intense
customer focus. The company also made further improvements in execution,
business development, and employee satisfaction. Financial results for the year
reflected improvements in every aspect of the company's operations, as well as
the growing strength of the markets it serves and customers' positive reaction
to a renewed focus on their successes. These advances served the company well in
2001 and should pave the way for more progress in 2002.
Revenue
Total revenue from continuing operations was $201.1 million, $200.2 million and
$191.6 million for 2001, 2000 and 1999, respectively, representing increases of
0.5% and 4.5% in 2001 and 2000, respectively. During 2001, the company changed
its contractual relationship with two major customers, moving from a prime
contractor position to one as a subcontractor. Further, work that was previously
subcontracted through the company is now directed to other companies, which were
awarded the prime contracts. As a result of these changes, $9.4 million of low
margin work performed by subcontractors to the company in 2000 no longer flows
through the company's operating results as revenue and cost of sales in 2001.
The comparison of revenue on a year-over-year basis is also affected by a
one-time $4.1 million purchase and resale of equipment to a major customer in
the second quarter of 2000. Analytically excluding the effect of these
non-recurring items revenue increased 7.7% in 2001, compared with 2000. This
increase reflects sales growth in government information technology sectors. In
2000, revenue increased $4.5 million, or 2.3%, when compared with 1999,
excluding the one-time $4.1 million resale of equipment in 2000 previously
discussed.
Contract Revenue
Contract revenue in the Systems and Services business was $179.4 million in 2001
compared with $172.8 million in 2000 and $164.8 million in 1999, representing
increases of 3.8% and 4.9% in 2001 and 2000, respectively. Excluding the
non-recurring items discussed above, Systems and Services revenue increased
12.7% in 2001, compared with 2000 and defense related revenue grew 8.5% in 2001
compared with 2000. Defense revenue grew primarily due to increased business
with the Navy and other Department of Defense agencies. Revenue from federal
civilian agencies primarily the Internal Revenue Service, increased $4.0
million, or 53.3%, in 2001 when compared with 2000. State and local revenue was
$20.0 million in 2001 and $16.0 million in 2000. The increase in state and local
revenue was primarily due to additional work related to the company's contracts
with the State of Colorado. Heightened interest and focus on defense and
homeland security did not significantly affect 2001 revenue. Government
expenditures in these areas are expected to increase significantly in the coming
years. The company expects that over time, these increases will favorably impact
the company's ability to increase revenue.
Contract revenue from systems engineering, logistics and systems support work,
primarily for the United States Air Force, increased nearly $13 million in 2000
when compared to 1999, offset by an expected decline in revenue from state and
local projects. As discussed above, revenue growth in 2000 when compared with
1999, was aided by a one-time $4.1 million purchase and resale of equipment to a
major customer in 2000.
The company provides services under time and materials, cost reimbursable and
fixed-price contracts. The following table expresses revenue by contract type as
a percentage of Systems and Services revenue:
For years ended December 31, 2001 2000 1999
- --------------------------------------------------------------------------------
Cost reimbursable 31% 31% 28%
Fixed-price 17% 14% 20%
Time and materials 52% 55% 52%
- --------------------------------------------------------------------------------
Total contracts 100% 100% 100%
================================================================================
The company follows generally accepted contract accounting principles for its
systems and services business. For time and materials contracts, revenue
reflects the number of direct labor hours expended in the performance of a
contract multiplied by the contract billing rate, as well as reimbursement of
other billable direct costs. Profits on time and materials contracts vary
depending on the extent to which actual per hour costs differ from negotiated
billing rates in the contract, which directly affects operating income. Under
fixed-price contracts, revenue is recognized under the percentage of completion
method, on the basis of costs incurred in relation to estimated total costs to
complete the contract. On a fixed-price contract, if actual costs exceed the
estimated costs to complete the contract, then profit is eroded or losses are
incurred. For cost reimbursable contracts, revenue is recognized as costs are
incurred and include a proportionate amount of the
14
fee earned. Cost reimbursable contracts specify the contract fee in dollars or
as a percentage of estimated costs. The primary risk on a cost reimbursable
contract is that a government audit of direct and indirect costs could result in
the disallowance of certain costs, which would directly impact revenue and
margin on the contract. Historically, such audits have had no material impact on
the company's revenue and margin.
For all types of contracts, the company recognizes anticipated contract losses
as soon as they become known and estimable. Out-of-pocket expenses that are
reimbursable by the customer are included in contract revenue and cost of
contract revenue.
Unbilled expenditures and fees on contracts in process are the amounts of
recoverable contract revenue, which had not been billed at the balance sheet
date. Costs related to United States Government contracts, including applicable
indirect costs, are subject to audit by the government. Revenue from such
contracts has been recorded at amounts expected to be realized upon final
settlement.
Product Sales
Product sales for the Precision Manufacturing Group, which consists of the
Encoder and Metrigraphics Divisions, decreased $5.6 million to $21.8 million in
2001 compared with 2000. Encoder Division sales decreased to $10.8 million for
2001 compared with $17.6 million in 2000. The Encoder Division has been
significantly affected by the current economic downturn in capital equipment
manufacturing. Currently, there is no indication of improvement. Metrigraphics
Division sales increased 11.9% to $10.9 million in 2001 compared with $9.8
million in 2000. Medical electronics customers contributed to the growth in
2001. The company remains cautious about the potential for further economic
weakness adversely affecting the Encoder and Metrigraphics Divisions.
Product sales increased 2.0% in 2000 compared with 1999. Encoder Division sales
of $17.6 million in 2000 were up 34% over 1999. Increased demand from automotive
and other customers was supported by strong economic conditions throughout 2000.
Metrigraphics Division sales decreased in 2000 by $3.5 million primarily due to
lower sales of inkjet printer cartridge nozzle plates to the Metrigraphics
Division's largest customer.
Revenue from product sales, less associated warranty costs, is generally
recognized at the time of shipment.
Gross Margin
Total gross margin was $29.2 million, $24.8 million and $6.1 million for 2001,
2000 and 1999, respectively, representing 14.5%, 12.4% and 3.2% of total revenue
for 2001, 2000 and 1999, respectively.
Gross margin on contract revenue was $24.0 million, $16.4 million and $0.5
million for 2001, 2000 and 1999, respectively, representing 13.4%, 9.5% and 0.3%
of contract revenue for 2001, 2000 and 1999, respectively. In 2001, the increase
in gross margin when compared with last year, was due to improved contract
pricing, a mix shift toward higher gross margin fixed-price work, control of
overhead costs and $1.2 million of contract close out credits, partially offset
by the pension plan curtailment discussed below.
The increase in the 2000 gross margin compared favorably to 1999 primarily due
to two unusual charges to cost of sales which were included in the Systems and
Services segment results for 1999: an $11.9 million loss provision on the
company's contract with the State of Colorado and a restructuring severance
provision of $1.0 million. Other factors contributing to improvement in gross
margin included: improved bidding and pricing practices, higher direct labor
utilization and curtailment in the level of discretionary overhead expenses.
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 for other unrecoverable contract costs.
Regarding the Colorado contract mentioned above and described in Note 2 of the
Notes to the Consolidated Financial Statements, entering 2001, the project was
scheduled for completion in the first half of the year, including rollout of the
first release of the new child welfare information and management system, plus
three releases of increased functionality. During 2001, the final releases of
the child welfare system functionality, although delayed, were deployed. Rollout
of the youth correction functionality, the final phase of the system, has been
delayed to the first half of 2002. The cost impact of these delays was reflected
in the results of operations, as necessary, when identified. While the company
believes it has reasonably estimated and provided for the costs to complete the
Colorado contract, estimates of project costs will continue to be updated and
changes in estimates provided for, as necessary, in each reporting period until
completion.
15
Accordingly, there can be no assurances that the actual costs on the project
will not differ materially from current estimates.
In 2001, 2000 and 1999, gross margin on Precision Manufacturing Group sales was
$5.2 million, $8.3 million and $5.6 million, respectively, representing 24.0%,
30.3% and 20.8% of product sales in 2001, 2000 and 1999, respectively. The
decrease in product sales gross margin in 2001, was due primarily to the decline
in Encoder revenue. During the second and third quarters of 2001, the company
provided $0.3 million for involuntary severance costs for 45 employees in the
Encoder Division. These costs were expended in the second half of 2001,
primarily for continuation pay. In 2000, the gross margin benefits of volume and
price increases in Encoder Division sales and a favorable shift in the
Metrigraphics product mix toward higher gross margin products more than offset
the somewhat negative impact of lower Metrigraphics revenue.
In December 2001, the Board of Directors approved to proceed with amendments
limiting future increases in benefits under the company's Defined Benefit
Pension Plan, freezing membership in the Plan, and providing for improvements to
the company's 401(k) Plan. Accordingly, the approval to amend the Defined
Benefit Pension Plan resulted in a curtailment charge of $0.8 million in the
fourth quarter of 2001.
Other Operating Items
Operating expense, which includes selling, engineering, and administrative
costs, increased to $17.3 million in 2001 compared with $15.6 million in 2000.
The increase reflects three factors, a planned increase in sales and marketing
activities, normal cost inflation of approximately 4%, and planned expenses
associated with employee-centered initiatives. In 2000, operating expenses were
down $1.9 million compared with 1999. In 1999, operating expense included the
write-off of the company's $1.4 million investment in Empresa, Inc. (see Note 13
of Notes to the Consolidated Financial Statements) in 1999 and $0.2 million of
restructuring charges described below.
Research and development expense (R&D) was $0.5 million, $0.2 million and $1.5
million in 2001, 2000 and 1999, respectively. The increase in R&D in 2001 when
compared with 2000, resulted from the development of MedTeams training products.
The decline in R&D in 2000, compared with 1999 was primarily the result of
discontinuing new software product development projects and focusing the company
on existing core businesses.
On June 1, 2001, the company completed the sale of its Tactical Communications
Group ("TCG") and the transfer of related employees and assets. TCG developed
and sold communications software for defense applications. For the first six
months of 2001, TCG recorded revenue of approximately $0.8 million and a loss of
$0.5 million. The sale resulted in a net loss of $0.2 million, shown as Other
expense on the Consolidated Statements of Operations. Proceeds from the
transaction were $0.1 million in cash, with a $50,000 note receivable due one
year from the date of the sale. In 2000, TCG recorded revenue of $2.3 million
and an after tax-loss of $0.9 million, including a $0.4 million pre-tax
impairment charge.
Net interest expense was $0.7 million, $1.8 million and $2.3 million in 2001,
2000 and 1999, respectively. The decrease in net interest expense reflects lower
average debt levels over the last two years, and in 2001, lower interest rates
and the net benefit of investment income on cash balances.
Income tax expense has been recorded at a rate of 40.7% and 40.9% of income from
continuing operations before taxes in 2001 and 2000, respectively, and an income
tax benefit of 34.8% of the loss from continuing operations before taxes in
1999. The 2001 and 2000 rate reflects the statutory federal rate of 34% combined
with an average state income tax rate, net of federal income tax benefit, of
6.7% and 6.9% in 2001 and 2000, 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 (see Note 13 of Notes to the
Consolidated Financial Statements).
In June 1999, the company completed the sale of its previously discontinued
Telecommunications Fraud Control business for $1.7 million plus royalties. The
sale resulted in a 1999 favorable pre-tax adjustment of $2.2 million to the
estimated pre-tax loss on disposal of discontinued operations of $4.1 million in
1998. Royalty income of $62,000 and $0.2 million, after taxes, was recognized in
2001 and 2000, respectively. The company may benefit modestly from future
royalty payments through July 31, 2002, up to a cap of $0.9 million, net of
taxes. These receipts will be recorded as gain from discontinued operations,
after deducting taxes, when received.
16
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. The remaining reserve balance from this
action was $0.2 million at December 31, 2000. During the first six months of
2001, the company expended the remaining restructuring reserve, primarily for
continuation pay for employees who had left the company prior to December 31,
2000.
Recent increases in the company's stock price have resulted in an increase in
the number of employee stock options counted as outstanding common equivalent
shares and included in the dilutive effect of options for the purpose of
computing diluted earnings per share. Outstanding common and common equivalent
shares increased from 7.7 million at December 31, 2000 to 8.1 million at
December 31, 2001.
The company's funded backlog was $91.4 million, $89.8 million and $83.5 million
at December 31, 2001, 2000 and 1999, 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
and is subject to reduction or cancellation.
Refer to Note 1 of Notes to the Consolidated Financial Statements for
significant accounting policies, and a discussion of new accounting
pronouncements and their impact on the company's financial statements.
Liquidity and Capital Resources
In 2001, cash provided by operating activities was $24.7 million. This primarily
resulted from net income, refundable income taxes, and improved working capital
management resulting in decreased accounts receivable and unbilled expenditures
and fees on contracts in process. Cash provided by operating activities of $4.7
million in 2000 primarily resulted from net income, a decrease in accounts
receivable and an increase in the deferred tax provision partially offset by an
increase in unbilled expenditures and fees on contracts in process and prepaid
expenses. The increase in prepaid expenses in 2000 was primarily due to $2.6
million of refundable federal income taxes, most of which was received in the
first quarter of 2001. Cash provided by operating activities of $11.0 million in
1999 primarily resulted from a significant reduction in unbilled expenditures
and fees on contracts in process.
Days sales outstanding ("DSO") on total receivables, both billed and unbilled,
were 84 days at the end of 2001, compared with 110 days at the end of 2000. In
2000, increased unbilled costs and fees associated with fixed-price contracts
affected DSO.
Inventories, which support the Encoder business, decreased slightly to $3.0
million in 2001 from $3.2 million at the end of 2000. The company has been
working to reduce inventory levels required to support a significantly lower
level of sales.
Capital spending for property, plant and equipment was $3.8 million, $3.1
million and $2.7 million in 2001, 2000 and 1999, respectively. In 2001, capital
investments were made primarily for enterprise information systems and equipment
and building improvements to the Andover corporate headquarters. The major
capital project for the company in 2000 was the development of an enterprise
human resource management system, which was put into service in January 2001.
The company's revolving credit agreement (the "Revolver") dated February 10,
2000, allows the company to borrow up to the lesser of $20.0 million or 80% of
eligible accounts receivable, as defined by the agreement. The Revolver expires
on February 10, 2003. Interest on the outstanding balance of the Revolver is
payable monthly. Prior to February 2001, interest accrued at the prime rate and
the agreement included a fee of 0.375% on the unused portion of the Revolver.
Beginning in February 2001, the company received the option to elect, on a fixed
30, 60 or 90-day term, an interest rate of LIBOR plus 2% or the prime rate. In
addition, the fee on the unused Revolver was reduced to 0.25%.
Effective June 30, 2001, the Revolver was amended (the "Amended Revolver") to
release the banks' security interests in the company's assets and to continue
the Amended Revolver on an unsecured basis. At December 31, 2001, there was no
outstanding balance under the Amended Revolver, and the company had $15.2
million of unused credit line available. At December 31, 2000, $5.8 million was
outstanding under the Revolver. Available interest rates on the Amended Revolver
at December 31, 2001, were 4.75% under the prime rate option and 3.88% under the
30-day LIBOR rate option.
17
The company has a 10-year mortgage loan (the "Mortgage"), dated June 12, 2000,
on the company's real estate. The outstanding balance of the Mortgage was $9.3
million and $9.8 million at December 31, 2001 and 2000, respectively. The
agreement requires quarterly principal payments of $125,000 beginning on August
1, 2000, with a final payment of $5.0 million in June 2010. Interest on the
Mortgage accrued at the rate of LIBOR plus 2.5% at December 31, 2000. Effective
November 6, 2001, the interest rate on the Mortgage was reduced to LIBOR plus
2.0%. The interest rate on the Mortgage under the 90-day LIBOR option elected at
October 15, 2001, was 4.51% on December 31, 2001. The Mortgage is secured by the
corporate office facility in Andover, Massachusetts.
The Amended Revolver and Mortgage require the company to meet certain financial
covenants including maintaining a minimum tangible net worth, cash flow and debt
coverage ratios, as well as limit 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 was in compliance with all
covenants on December 31, 2001.
In 2001, the company realized $1.3 million in proceeds from the exercise of
stock options and the issuance of shares under the employee stock purchase plan.
In 2000 and 1999, $0.8 million and $28,000, respectively, were realized from the
exercise of stock options.
The company's prospective cash flows are subject to certain trends, events and
uncertainties, including demands for capital to support growth, economic
conditions, government payment practices and contractual matters. The company's
capital expenditures are expected to be approximately $6 million in 2002,
primarily for technology advancements, infrastructure improvements and capacity
expansion in support of growth and operational performance enhancement.
Contractual financing obligations at December 31, 2001 were as follows:
Payments due by period
-----------------------------------------------------
Less than 1-3 4-5 After
1 year years years 5 years Total
- ------------------------------------------------------------------------------------------------
(in thousands of dollars)
Long-term debt $ 500 $ 1,500 $ 1,000 $ 6,250 $ 9,250
Operating leases 3,500 6,300 100 -- 9,900
- ------------------------------------------------------------------------------------------------
Total contractual obligations $ 4,000 $ 7,800 $ 1,100 $ 6,250 $ 19,150
================================================================================================
As a defense contractor, the company is subject to many levels of audit and
review, including the Defense Contract Audit Agency, the Inspector General, the
Defense Criminal Investigative Service, the General Accounting Office, the
Department of Justice and Congressional Committees. Both related to and
unrelated to its defense industry involvement, the company is, from time to
time, involved in audits, lawsuits, claims, administrative proceedings and
investigations, 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.
On October 26, 2000, the United States Attorney's Office announced the
indictment of two former company employees for conspiracy to defraud the United
States Air Force. Both former employees pled guilty. The United States
Attorney's Office has informed the company that it is not a target of the
investigation. Separately, the United States Attorney's Office is investigating
certain company activity and billing transactions from prior years. The company
does not know, at this time, what financial effects, if any, may result to the
company from these matters.
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. Based on its
current business plan, the company believes that its current assets, cash flows
from operations and available lines of credit are sufficient to support its
existing operations and capital requirements for the foreseeable future.
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
73% of revenue in 2001, are generally one year and
18
include salary increase factors for future years, thus reducing the potential
impact of inflation on the company.
Forward-Looking Information
Safe harbor statements under the Private Securities Litigation Reform Act of
1995: Some statements contained or implied in this annual report, which are not
historical fact such as financial forecasts, contain forward-looking
information. These statements may be identified by forward-looking words such as
"expect," "look," "believe," "anticipate," "may," "will" and other
forward-looking terminology. Such statements are subject to risks and
uncertainties that could cause actual results to differ materially, including
uncertainties regarding contractual requirements, actions by customers and
actual costs to complete; federal budget matters; government contracting risks
and competitive market conditions; customer requirements, schedules and related
funding; technological change; uncertainty of future financing; overall economic
factors; and the ability to successfully complete and integrate acquisitions and
other matters. These factors are discussed in more detail in Exhibit 99 of this
report. The company assumes no obligation to update any forward-looking
information.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The company is subject to interest rate risk associated with our Mortgage and
Amended Revolver where interest payments are tied to either the LIBOR or prime
rate. At any time a sharp rise in interest rates could have an adverse effect on
net interest expense as reported in the Statements of Operations. The company
does not currently hedge these interest rate exposures.
Item 8. Financial Statements and Supplementary Data
The following consolidated financial statements of the company and its
subsidiaries are on the pages listed below:
Page
Consolidated Balance Sheets at December 31, 2001 and 2000 20
Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999 21
Consolidated Statements of Stockholders' Equity
for the three years ended December 31, 2001, 2000 and 1999 22
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999 23
Schedule II - Valuation and Qualifying Accounts for
the years ended December 31, 2001, 2000 and 1999 45
19
Consolidated Balance Sheets
December 31, 2001 2000
- ----------------------------------------------------------------------------------------------------------
(in thousands of dollars, except share and per share data)
Assets
Current assets
Cash and cash equivalents $ 16,657 $ 527
Receivables, net of allowances of $1,355 in 2001 and $1,096 in 2000 22,946 31,967
Unbilled expenditures and fees on contracts in process 22,876 24,633
Inventories 2,960 3,208
Prepaid expenses and other current assets 1,789 3,926
---------------------------------------------------------------------------------------------------------
Total current assets 67,228 64,261
Net property, plant and equipment 14,597 14,441
- -----------------------------------------------------------------------------------------------------------
Total assets $ 81,825 $ 78,702
------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current liabilities
Current portion of long term debt $ 500 $ 500
Notes payable -- 5,784
Accounts payable 13,588 12,843
Accrued payroll and employee benefits 11,911 9,901
Other accrued expenses 2,913 5,711
Current deferred income taxes 4,275 4,575
---------------------------------------------------------------------------------------------------------
Total current liabilities 33,187 39,314
Long term debt 8,750 9,250
Deferred income taxes 2,750 849
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 - 9,320,036 shares in 2001 and 8,980,945 in 2000 932 898
Treasury stock - 1,379,426 shares in 2001 and 2000 (138) (138)
Capital in excess of par value 31,331 28,461
Unearned compensation (992) --
Accumulated other comprehensive income (608) --
Retained earnings 6,613 68
--------------------------------------------------------------------------------------------------------
Total stockholders' equity 37,138 29,289
-----------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 81,825 $ 78,702
===================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
20
Consolidated Statements of Operations
For the years ended December 31, 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------
(in thousands of dollars, except share and per share data)
Revenue
Contract revenue $ 179,350 $ 172,774 $ 164,766
Product sales 21,762 27,401 26,855
--------------------------------------------------------------------------------------------------------
Total revenue 201,112 200,175 191,621
Costs and expenses
Cost of contract revenue 155,394 156,327 164,278
Cost of product sales 16,548 19,087 21,257
Selling, engineering and administrative expenses 17,301 15,558 17,464
--------------------------------------------------------------------------------------------------------
Total operating costs and expenses 189,243 190,972 202,999
Operating income (loss) 11,869 9,203 (11,378)
Other expense 193 -- --
Interest expense, net 744 1,842 2,255
- ----------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
provision (benefit) for income taxes 10,932 7,361 (13,633)
Provision (benefit) for income taxes 4,449 3,008 (4,745)
- ----------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations 6,483 4,353 (8,888)
Gain on disposal of discontinued operations, net of tax
expense of $43 in 2001, $143 in 2000 and $835 in 1999 62 206 1,362
--------------------------------------------------------------------------------------------------------
Net income (loss) $ 6,545 $ 4,559 $ (7,526)
==========================================================================================================
Earnings (loss) per share
Per common share - basic
Income (loss) from continuing operations $ .84 $ .57 $ (1.21)
Gain from discontinued operations .01 .03 .19
-----------------------------------------------------------------------------------------------------
Net income (loss) $ .85 $ .60 $ (1.02)
===================================================================================================
Per common share - diluted
Income (loss) from continuing operations $ .80 $ .56 $ (1.21)
Gain from discontinued operations .01 .03 .19
-----------------------------------------------------------------------------------------------------
Net income (loss) $ .81 $ .59 $ (1.02)
===================================================================================================
Weighted average shares outstanding
Weighted average shares outstanding - basic 7,674,608 7,541,376 7,360,548
Dilutive effect of options 414,477 151,780 --
--------------------------------------------------------------------------------------------------------
Weighted average shares outstanding - diluted 8,089,085 7,693,156 7,360,548
========================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
21
Consolidated Statements of Stockholders' Equity
Common Stock
------------------------------- Accumulated Retained
Issued Treasury Stock Other Earnings
------------------------------- Capital in Unearned Comp- (Accum
For the three years Par Par Excess of Compen- rehensive -ulated
ended December 31, 2001 Shares Value Shares Value Par Value sation Income Deficit) Total
- -----------------------------------------------------------------------------------------------------------------------------
(in thousands)
Balance at December 31, 1998 8,733 $ 873 (1,364) $(136) $ 27,474 $ -- $ -- $ 3,035 $ 31,246
1999 Activity
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
2000 Activity
Stock options exercised 223 22 -- -- 789 -- -- -- 811
Stock compensation expense 15 2 -- -- 112 -- -- -- 114
Net income -- -- -- -- -- -- -- 4,559 4,559
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 8,981 898 (1,379) (138) 28,461 -- -- 68 29,289
2001 Activity
Stock options exercised 194 20 -- -- 1,329 -- -- -- 1,349
Restricted stock and
related compensation expense 145 14 -- -- 1,330 (992) -- -- 352
Accumulated other
comprehensive income(1) -- -- -- -- -- -- (608) -- (608)
Tax benefit from
stock options exercised -- -- -- -- 211 -- -- -- 211
Net income -- -- -- -- -- -- -- 6,545 6,545
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 9,320 $ 932 (1,379) $(138) $ 31,331 $ (992) $ (608) $ 6,613 $ 37,138
=============================================================================================================================
(1)Comprehensive income is as follows:
Year ended December 31, 2001
- -----------------------------------------------
Net income $ 6,545
Minimum pension liability adjustment,
net of tax effect of $405 (608)
---------------------------------------------
Comprehensive income $ 5,937
===============================================
The accompanying notes are an integral part of these consolidated financial
statements.
22
Consolidated Statements of Cash Flows
For the years ended December 31, 2001 2000 1999
- ---------------------------------------------------------------------------------------------------
(in thousands of dollars)
Cash provided by (used for) operations
Net income (loss) $ 6,545 $ 4,559 $ (7,526)
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Gain from discontinued operations (62) (206) (1,362)
Loss on disposal of assets 193 -- --
Non-cash stock compensation expense 90 114 116
Tax benefit from stock options exercised 211 -- --
Provision for impairment of investment in Empresa, Inc. -- -- 1,424
Depreciation and amortization 3,457 3,746 6,060
Deferred income tax provision 1,601 2,930 (5,043)
- ---------------------------------------------------------------------------------------------------
12,035 11,143 (6,331)
Cash provided by (used for) working capital
Receivables 8,293 2,950 (1,901)
Unbilled expenditures and fees on contracts in process 1,074 (6,024) 13,560
Inventories 248 (473) (88)
Prepaid expenses and other current assets 2,137 (2,333) (626)
Accounts payable 745 1,202 1,341
Accrued payroll and employee benefits 1,402 466 1,653
Other accrued expenses (1,279) (2,129) 5,210
- ---------------------------------------------------------------------------------------------------
12,620 (6,341) 19,149
Net cash provided by continuing operations 24,655 4,802 12,818
Net cash provided by (used for) discontinued operations 62 (67) (1,833)
- ---------------------------------------------------------------------------------------------------
Net cash provided by operating activities 24,717 4,735 10,985
Cash provided by (used for) investing activities
Additions to property, plant and equipment
related to continuing operations (3,752) (3,120) (2,702)
Proceeds from the sale of assets 100 -- --
Investments and acquisitions -- -- (682)
Proceeds from the sale of discontinued operations -- -- 1,700
- ---------------------------------------------------------------------------------------------------
Net cash used for investing activities (3,652) (3,120) (1,684)
Cash provided by (used for) financing activities
Net borrowings (repayments) under revolving credit agreement (5,784) 5,784 (7,100)
Repayment of working capital agreement -- (19,700) --
Proceeds from mortgage agreements -- 17,500 --
Repayment of interim mortgage -- (7,500) --
Principal payment under 10-year mortgage (500) (250) --
Proceeds from the exercise of stock options 1,349 811 28
Purchase of treasury stock -- -- (59)
- ---------------------------------------------------------------------------------------------------
Net cash used for financing activities (4,935) (3,355) (7,131)
Net increase (decrease) in cash and cash equivalents 16,130 (1,740) 2,170
Cash and cash equivalents at the beginning of the year 527 2,267 97
- ---------------------------------------------------------------------------------------------------
Cash and cash equivalents at the end of the year $ 16,657 $ 527 $ 2,267
===================================================================================================
Supplemental information
Cash paid for interest $ 858 $ 2,055 $ 2,451
Cash paid for taxes 2,185 2,893 199
Restricted stock issued 1,344 -- --
Minimum pension liability 1,013 -- --
The accompanying notes are an integral part of these consolidated financial
statements.
23
Notes to Consolidated Financial Statements
1. Significant Accounting Policies
Nature of Business
Dynamics Research Corporation ("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
There are certain business risks specific to the industries in which the company
operates, including 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. Estimates and
assumptions also affect the amount of revenue and expenses reported during the
year. Actual results could differ from those estimates.
Revenue Recognition
The company's systems and services business provides its services under time and
materials, cost reimbursable and fixed-price contracts. Accordingly, the company
adheres to generally accepted contract accounting principles. For time and
materials contracts, revenue reflects the number of direct labor hours expended
in the performance of a contract multiplied by the contract billing rate, as
well as reimbursement of other billable direct costs. The risk inherent in time
and materials contracts is that actual costs differ materially from negotiated
billing rates in the contract, which directly affects operating income. Under
fixed-price contracts, revenue is recognized under the percentage of completion
method, on the basis of costs incurred in relation to estimated total costs to
complete the contract. The risk to the company on a fixed-price contract is that
if actual costs exceed the estimated costs to complete the contract, then profit
is eroded or losses are incurred. For cost reimbursable contracts, revenue is
recognized as costs are incurred and include a proportionate amount of the fee
earned. Cost reimbursable contracts specify the contract fee in dollars or as a
percentage of estimated costs. The primary risk on a cost reimbursable contract
is that a government audit of direct and indirect costs could result in the
disallowance of certain costs, which would directly impact revenue and margin on
the contract. Historically, such audits have had no material impact on the
company's revenue and margin.
For all types of contracts, the company recognizes anticipated contract losses
as soon as they become known and estimable. Out-of-pocket expenses that are
reimbursable by the customer are included in contract revenue and cost of
contract revenue.
Unbilled expenditures and fees on contracts in process are the amounts of
recoverable contract revenue, which had not been billed at the balance sheet
date. Costs related to United States Government contracts, including applicable
indirect costs, are subject to audit by the government. Revenue from such
contracts has been recorded at amounts expected to be realized upon final
settlement.
Revenue from product sales, less associated warranty costs, 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. The deferred tax provision represents the change in the
deferred tax asset or liability balance.
24
Cash and Cash Equivalents
All cash investments, which consist primarily of money market accounts, have
original maturities of three months or less and are classified as 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, 2001 2000
- -------------------------------------------------------------------------------
(in thousands of dollars)
Work in process $ 296 $ 726
Raw materials and subassemblies 2,664 2,482
- -------------------------------------------------------------------------------
Total inventories $ 2,960 $ 3,208
===============================================================================
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Plant and equipment are
depreciated principally on a straight-line basis over their estimated useful
lives. Useful lives range from 3 to 8 years for equipment and 31 years for the
building. Leasehold improvements are amortized over the shorter of the remaining
term of the lease or the life of the related asset.
December 31, 2001 2000
- -----------------------------------------------------------------------------------------
(in thousands of dollars)
Land $ 1,126 $ 1,126
Building 8,587 7,774
Machinery and equipment 47,546 45,133
Leasehold improvements 2,723 2,551
- -----------------------------------------------------------------------------------------
Total property, plant and equipment, at cost 59,982 56,584
Less accumulated depreciation and amortization 45,385 42,143
- -----------------------------------------------------------------------------------------
Net property, plant and equipment $ 14,597 $ 14,441
=========================================================================================
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the asset carrying value may not be recoverable.
Impairment losses are measured based on the fair market value of the assets. In
2001, the company did not incur any impairment losses. See Notes 12 and 13 for a
discussion of prior year impairment losses.
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 because 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.
The disclosure alternative 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
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 included in other contracts
(collectively referred to as derivatives), and for hedging activities. SFAS No.
133 (as amended by SFAS No. 137 and SFAS No. 138) was effective January 1, 2001.
The adoption of SFAS No. 133 did not have a material impact on the company's
financial position or results of operations, because it has no derivative
instruments or hedging activities.
In June 2001, the FASB issued SFAS No. 141, Business Combinations and SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No. 141 requires business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method. It also specifies the types of acquired intangible assets
required to be recognized and reported separately from goodwill. SFAS No. 142
will require that goodwill and certain
25
intangibles no longer be amortized, but instead be tested for impairment at
least annually. SFAS No. 142 is required to be applied starting with fiscal
years beginning after December 15, 2001. The company believes that the adoption
of SFAS Nos. 141 and 142 will not have a material impact on the company's
financial position or results of operations, because it currently has no
goodwill or other intangible assets recorded.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144 modifies the rules for accounting
for the impairment of long-lived assets. The new rules are effective for the
company beginning January 1, 2002. The company does not believe that the
adoption of SFAS No. 144 will have a material impact 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 there is net income, diluted earnings per share is determined
by giving effect to the exercise of stock options and restricted stock using the
treasury stock method.
Due to their antidilutive effect, 7,500 and 437,500 stock options were excluded
from the calculation of earnings per share in 2001 and 2000, respectively. In
1999, because the company reported a net loss from continuing operations,
911,185 outstanding stock options were excluded from the weighted average number
of shares outstanding.
2. Contracts in Process and Contract Loss Provisions
In 1997, the company entered into a fixed-price software development contract
with the Colorado Department of Human Services. This contract encountered
difficulties, and as a result, the company recorded losses, including an $11.9
million charge in 1999. The losses are included in the results of operations of
the Systems and Services segment as a charge to cost of contract revenue. The
company continued to update its estimate of project cost and recorded, as
necessary, changes in estimates during each reporting period through 2001. The
company currently anticipates that the contract, except for the system warranty
period, will be completed during the first half of 2002. Although the company
believes it has reasonably estimated and provided for the costs to complete the
Colorado contract at December 31, 2001, estimates of project costs will continue
to be updated and changes in estimates provided for, as necessary, in each
reporting period until completion. Accordingly, there can be no assurances that
the actual costs on the project will not differ materially from current
estimates.
In 2000, the company incurred losses on communications software development
projects described in Note 12. 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 for other unrecoverable 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 $16.5 million and $16.6 million at December 31, 2001 and 2000,
respectively. Receivables under United States Government contracts were $11.1
million and $17.7 million at December 31, 2001 and 2000, 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 severance and other exit
costs for approximately 100 involuntarily terminated employees, 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 was
related to Massachusetts operations. The remainder of the charge related to a
number of other locations. The plan involved reducing personnel in certain
operating units, the consolidation and realignment of certain functions, and the
evaluation of strategic alternatives for certain operations. The affected
employees were primarily employed in an indirect capacity or in service lines
that the company did not intend to pursue in the future. As of December 31,
1999, no costs had been charged against accrued liability.
During 2000, the company expended approximately $0.9 million related to
severance costs and outplacement services for 58 employees. During the fourth
quarter of 2000, the company determined that
26
$0.1 million of reserves related to a specific business were no longer
necessary, and those reserves were reversed against cost of contract revenue.
The remaining restructuring reserve of $0.2 million at December 31, 2000 was
expended during the first half of 2001, primarily for continuation pay for
employees who had left the company prior to December 31, 2000.
During the second and third quarters of 2001, the company provided $0.3 million
for involuntary severance costs for 45 employees in the Encoder Division. These
costs were expended in the second half of 2001, primarily for continuation pay.
4. Discontinued Operations
In June 1999, the company completed the sale of its previously discontinued
Telecommunications Fraud Control business for $1.7 million plus royalties. The
sale resulted in a 1999 favorable pre-tax adjustment of $2.2 million to the
estimated pre-tax loss on disposal of discontinued operations of $4.1 million,
which was recorded in 1998. Royalty income of $62,000 and $0.2 million, after
taxes, was recognized in 2001 and 2000, respectively. The company may benefit
modestly from future royalty payments through July 31, 2002, up to a cap of $0.9
million, net of taxes. These receipts will be recorded as gain from discontinued
operations, after deducting taxes, when received.
The 1999 consolidated financial statements of the company were restated to
reflect the discontinuation of the Telecommunications Fraud Control business.
Accordingly, the revenue, costs, expenses and cash flows of the business were
excluded from the respective captions in the Consolidated Statements of
Operations and Consolidated Statements of Cash Flows and were reported as Gain
(loss) from discontinued operations, net of income taxes, 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. There was no revenue from
discontinued operations or operating loss of the business during 2001 and 2000
other than royalty income discussed above. Revenue and pre-tax net operating
losses for the Telecommunications Fraud Control business for the year ended
December 31, 1999 were $0.7 million and $2.4 million, 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, 2001 2000 1999
- -----------------------------------------------------------------------------------------------------------
(in thousands of dollars)
Currently payable
Federal $ 2,328 $ 68 $ 75
State 520 10 223
- -----------------------------------------------------------------------------------------------------------
2,848 78 298
Deferred
Federal 1,546 2,296 (3,584)
State 55 634 (1,459)
- -----------------------------------------------------------------------------------------------------------
1,601 2,930 (5,043)
- -----------------------------------------------------------------------------------------------------------
Total provision (benefit) $ 4,449 $ 3,008 $ (4,745)
===========================================================================================================
The major items contributing to the difference between the statutory United
States federal income tax rate of 34% and the company's effective tax rate are
as follows:
For the years ended December 31, 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------
(in thousands of dollars)
Provision (benefit) on income (loss) from continuing operations
at statutory rate $ 3,717 $ 2,503 $ (4,635)
State income taxes, net of federal tax benefit 380 425 (810)
Increase in valuation allowance -- -- 449
Other, net 352 80 251
- -----------------------------------------------------------------------------------------------------------
Provision (benefit) for income taxes $ 4,449 $ 3,008 $ (4,745)
===========================================================================================================
During 1999, the company recorded a tax valuation allowance related to a capital
loss from the sale of its investment in Empresa, Inc. (see Note 13). Currently,
the company does not expect that it will meet the
27
requirements necessary to deduct this loss for federal income tax purposes.
Accordingly, the company has recorded a valuation allowance for the full amount
of the potential tax benefit associated with the loss.
In 2000, the company generated a federal net operating loss carryforward of $1.8
million that the company will fully utilize to reduce 2001 federal taxable
income. In 1999, the company utilized $4.2 million of federal net operating loss
carryforwards to reduce 1999 federal taxable income.
The tax effects of significant temporary differences that comprise deferred tax
assets and liabilities are as follows:
December 31, 2001 2000
- ----------------------------------------------------------------------------------------------
(in thousands of dollars)
Unbilled costs and fees and deferred contract revenue, net $ (9,143) $ (10,510)
Accrued expenses 2,892 3,648
Receivables reserves 541 439
Inventory reserves 597 649
Pension liability 405 --
Federal net operating loss carryforwards -- 612
Other 433 587
- ----------------------------------------------------------------------------------------------
Current deferred tax liabilities, net (4,275) (4,575)
- -----------------------------------------------------------------------------------------------
Accelerated tax depreciation (899) 93
State net operating loss and credit carryforwards 163 383
Capital loss carryforward 449 449
Valuation allowance (449) (449)
Alternative minimum tax credit carryforward 153 153
DISC deferral (1,886) (966)
Other (281) (512)
- -----------------------------------------------------------------------------------------------
Non-current deferred tax liabilities, net (2,750) (849)
- -----------------------------------------------------------------------------------------------
Total deferred tax liabilities, net $ (7,025) $ (5,424)
===============================================================================================
Total deferred tax assets and total deferred tax liabilities were $6.5 million
and $13.5 million, respectively, at December 31, 2001, compared with $7.4
million and $12.8 million, respectively, at December 31, 2000.
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
the number of years an employee has worked 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.
Additional amounts are contributed to assure that plan assets will be adequate
to provide retirement benefits. Contributions are intended to provide for
benefits earned to date and also for those expected to be earned in the future.
In December 2001, the Board of Directors approved to proceed with amendments
limiting future increases in benefits under the company's Defined Benefit
Pension Plan, freezing membership in the Plan, and providing for improvements to
the company's 401(k) Plan. Accordingly, the approval to amend the Defined
Benefit Pension Plan resulted in a curtailment charge of $0.8 million in the
fourth quarter of 2001.
Periodic Pension Cost
For the years ended December 31, 2001 2000 1999
- ---------------------------------------------------------------------------------------------------
(in thousands of dollars)
Service cost - benefits earned during the period $ 2,470 $ 2,322 $ 2,502
Interest cost on projected benefit obligation 3,476 3,240 2,735
Expected return on plan assets (3,684) (3,450) (3,114)
Amortization of prior service cost 220 220 220
Amortization of transition obligation 35 35 35
Recognized actuarial loss 72 -- --
- ---------------------------------------------------------------------------------------------------
Net periodic pension cost 2,589 2,367 2,378
Recognized curtailment loss 819 -- --
- ---------------------------------------------------------------------------------------------------
Net periodic pension cost after curtailment loss $ 3,408 $ 2,367 $ 2,378
===================================================================================================
28
Changes in Benefit Obligations
December 31, 2001 2000
- --------------------------------------------------------------------------------------------
(in thousands of dollars)