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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2002

OR

For the transition period from            to            

Commission file number 1-7348

DYNAMICS RESEARCH CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s telephone number, including area code: (978) 475-9090

Securities registered pursuant to Section 12(b) of the Act:

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.  x

Indicate by check mark whether the registrant is an accelerated filer as defined in the Exchange Act Rule

2b-2.  Yes  x  No  ¨

As of June 30, 2002, the aggregate market value of Common Stock held by nonaffiliates of the Registrant was $195,491,657 and the number of shares of Common Stock, $.10 par value, of the Registrant outstanding was 8,084,808.

Documents Incorporated By Reference

Portions of the Registrant’s Proxy Statement for the 2003 Annual Meeting of Shareholders are incorporated by reference in Part III.

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DYNAMICS RESEARCH CORPORATION

FORM 10-K         FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

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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 1,858 employees, including 93 employees associated with discontinued operations, in 45 offices in 20 states in the United States. The company operates through its parent corporation and its wholly owned subsidiaries, HJ Ford Associates, Inc. (“HJ Ford”) and Andrulis Corporation (“ANDRULIS”).

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 these 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 competitive advantages is its ability to provide subject matter experts who work closely with specialists in disciplines such as logistics, engineering, information technology, modeling, simulation and training systems to develop innovative solutions to customer challenges.

DRC has a balanced organic and acquisition growth strategy. The company’s strategy is to supplement organic growth through the acquisition of firms with similar capabilities. Consistent with this strategy, the company acquired two companies in 2002, HJ Ford and ANDRULIS.

On October 18, 2002, DRC announced that it was actively pursuing the divestiture of its Encoder Division. Effective in the fourth quarter of 2002, the company began reporting the Encoder Division, which manufactures optical encoders that convert analog motion and position information into digital signals, as a discontinued operation on a restated basis. The company’s remaining precision manufacturing business, the Metrigraphics Division, develops and produces components for original equipment manufacturers in the computer peripheral device, medical electronics, telecommunications and other industries. Manufacturing core capabilities are focused on the custom design and manufacture of miniature electronic parts that meet ultra-high precision requirements through the use of electroforming, thin film deposition and photolithography technologies. Financial data and other information about the company’s operating segments can be found in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I, Item 7, and in Note 12, Business Segments of the company’s financial statements, Part II, Item 8.

DRC maintains an Internet website at http://www.drc.com. The company’s Annual Report on Form 10-K, its quarterly reports on Form 10-Q and its current reports on Form 8-K and all amendments to these reports are available free of charge through the company’s website by clicking on the “Investor Relations” page and selecting “SEC Filings”. These filings are also accessible on the Securities and Exchange Commission’s website at  http://www.sec.gov. The company does not intend that the information contained on the company’s website be deemed a part of this report or to be deemed filed with the Securities and Exchange Commission.

MARKETS

DRC’s systems and services business, which accounted for 96% of revenue in 2002, is focused on providing technical and information technology services to government customers. The government market is composed of three sectors; defense, federal civilian agencies, and state and local governments.

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According to the Office of Management and Budget, federal spending on technical services and information technology is projected to be $54 billion for the fiscal year ended September 30, 2003. In addition, a 9% increase has been proposed in the President’s budget submission to Congress for fiscal year 2004.

Several factors are driving growth in the defense sector of this market. First, increased spending on 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.

Factors driving growth in the federal civilian agency sector include homeland security needs, an on-going need for systems modernization, and as in the defense sector, government workforce ceilings. Proposed information technology spending for the recently created Department of Homeland Defense is approximately $4 billion for the government’s fiscal 2004. 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.

In the state and local government sector, state and local jurisdictions are expected to spend $40 billion on information technology products and services in 2003 and $42 billion in 2004. DRC has considerable experience in providing information technology expertise in the health and human services areas. 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. They have large and burdensome caseloads. These agencies must maintain extensive records, report program data, eliminate errors, and work towards a more responsive management. Yet the information systems of many such agencies are antiquated and have limited data interfacing and reporting capabilities. The need to address severe budget deficits is expected to continue in the states during 2003, forcing spending cuts and reassessment of technology priorities, which could have an adverse impact on the company’s business.

DRC’s Precision Manufacturing business represented 4% of total company revenue in 2002, not including the Encoder Division, which is reported as a discontinued operation. The Precision Manufacturing business serves the commercial original equipment manufacturers (“OEM”) market. This market, which continued to decline in 2002, includes manufacturers of computer peripheral devices, telecommunications and medical technology equipment. The Precision Manufacturing business sells exclusively to commercial customers.

MAJOR CUSTOMERS

The company’s 2002 revenue, broken down by market sector, was derived 80% from the defense sector, 9% from federal civilian agencies, 7% from state and local governments, and 4% from commercial OEMs. Federal civilian agency revenue, which grew by more than 50% in 2002 from 2001, was the fastest growing sector for DRC in 2002.

Defense Sector

United States Air Force customers constituted the largest component of DRC’s defense revenue in 2002, representing 49% of total revenue, while Navy revenue represented 20%, Army revenue represented 7% and other agencies represented 4%. Key capabilities that 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, Massachusetts, 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.

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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, Global Command and Control, Airborne Warning and Control Systems, and Defense Information Infrastructure offices.

DRC is the prime support contractor to the Joint Surveillance Target Attack Radar System (“Joint STARS”) Program Office, which has played a key role in warfare and peacekeeping operations. The surveillance system is designed to detect, classify and track ground targets in all weather conditions on land or at sea within a 155-mile range. DRC supports Joint STARS providing advisory, engineering, logistics and program management services. Under this program, DRC will also support the Multi-Sensor Command and Control Aircraft System (“MC2A”), a next-generation airborne integrated ground surveillance system that is intended to eventually supercede Joint STARS.

Navy Trident Missile Program

For more than forty years, the company has provided services to the United States Navy’s 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. The company 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. 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. The company also provides support to Air Force reengineering and business process improvement initiatives at these Air Logistics Centers.

Aeronautical Systems Center, Air Force Materiel Command

The Aeronautical Systems Center, headquartered at Wright-Patterson Air Force Base in Dayton, 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, Unmanned Combat Air Vehicle and F/A-22 RAPTOR. There is also continuing work on the F-117A fighter, F-15 Eagle and F-16 Fighting Falcon. Through prime contracts held by the company’s HJ Ford subsidiary, 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.

In 2002, DRC was awarded prime contracts as the lead integrator providing F/A-22 and Unmanned Combat Air Vehicle Systems Program Offices acquisition logistics, systems engineering and other program management services. The F/A-22 RAPTOR, currently in low rate of initial production, is widely regarded as the most advanced fighter in the world. The Unmanned Combat Aerial Vehicle contract award will support on-going program management activities related to the migration of the previously unarmed Unmanned Aerial Vehicles to an expanded role as a weapons platform.

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

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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 and Missile Command located at Redstone Arsenal in Huntsville, Alabama to provide helicopter vibration analysis. The Vibration Management Enhancement Program (“VMEP”) is 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. In 2002, DRC received a $3.3 million extension to its initial contract for the VMEP initiative.

Army Research

In 2001, DRC received a five-year contract from the United States Army Medical Research Acquisition Activity to expand its MedTeams^® 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 Defense Department.

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 will be able to provide air crews anywhere in the world the knowledge and teamwork skills designed to result in improved mission effectiveness and lower accident rates.

Air Force Air Mobility Command

The Air Mobility Command, headquartered at Scott Air Force Base in Belleville, Illinois, has as its primary mission rapid, global mobility and sustainment for America’s armed forces. The command also plays an important role in providing humanitarian support in the United States 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.

Air National Guard

Through its work on the Guard Information Analysis Network (“GUARDIAN”), DRC is playing a key role in the transformation of the Air National Guard and its preparedness for homeland defense. Initially created by DRC as a Web-enabled database, GUARDIAN is intended to fulfill a critical need for real-time information on aircraft readiness and performance information. In late 2002, DRC’s work on GUARDIAN was extended with a $3.5 million contract award for the first year of a proposed six-year, $37 million effort to support Air National Guard offices in Virginia and Maryland. DRC is now working to expand GUARDIAN’s functionality so it can be used to determine and forecast manpower resources and munitions readiness. The system is also being converted so it is compatible with the Global Combat Support System (“GCSS”) architecture for eventual migration to the Air Force and other branches of the service.

Office of Naval Research

DRC provides engineering and information technology services to the Office of Naval Research’s Navy Manufacturing Technology Program, known as MANTECH. This is a new five-year contract with an approximate potential value of $25 million to continue supporting MANTECH, as well as a related program known as Lean Pathways and the Office of the Secretary of Defense’s own ManTech initiative. MANTECH’s mission is to drive down costs for Navy weapons systems through the development of and transition to advanced manufacturing technology. DRC provides support in the annual strategic planning process, as well as project tracking and benefits analysis. For Lean Pathways, DRC provides a transformation process to eliminate waste and drive enterprise-wide improvements at small- and medium-sized suppliers. It supports improved value chain performance and weapon systems affordability.

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Missile Defense Agency

The Missile Defense Agency is chartered with developing the future space-based missile defense capabilities. DRC currently provides research on manufacturability and research services to this client, under multi-year contracts.

Air Force Materiel Support Group

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, is the responsibility of the Materiel Support Group (“MSG”). 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 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.

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, and the Chief of Naval Education and Training.

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 the 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 is designed to enable combatant commands, joint organizations and defense agencies to align training with assigned missions, and helps ensure missions are consistent with organizational priorities.

Based on the work performed under the JTIMS program, in September 2002, DRC was awarded a $2 million contract with the United States Joint Forces Command to develop a software system for the worldwide coordinating and scheduling of deployable United States forces. Known as the Joint Event Scheduling System (“JESS”), the web-based program is intended to develop a worldwide collaborative system to provide visibility and coordination on United States military activities.

Also, DRC has developed an analytical tool for the Chief of Naval Education and Training to simulate the training pipeline and help the Navy predict demand for various training programs. The system has been designed to help the Navy ascertain the costs and risks of potential changes to training programs before they are made.

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 has completed the first phase of this program, by analyzing course content and recommending which material is best taught in the classroom, through self-study programs, at simulators or in flight for an initial set of aircraft. The next phase of this program will involve extending the analysis to additional aircraft. 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 intended to provide relevant, cost-effective training and accurate performance measures.

Federal Civilian Agency Sector

The company believes that the United States Government federal civilian agencies present an important growth market for DRC. Growth in spending in this sector is being driven by the threat of domestic terrorism, as well as a high need for modernization. Civilian agencies must also prepare for potential changes in their workforces.

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Approximately half of all federal employees engaged in program management are estimated to become eligible for retirement over the next four years. With its core capabilities in the design, development, acquisition, deployment and support of high technology systems, DRC believes it is well positioned to attract new customers in this sector. A description of DRC’s major customer engagements in this sector follows.

Internal Revenue Service

The Internal Revenue Service (“IRS”) is DRC’s largest customer in the federal civilian agency sector. DRC is a significant contractor to the IRS, having been awarded contracts to date with revenue which could potentially exceed $65 million over the expected contract period from 2000 to 2005. 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 million to $36 million to support the IRS’s 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 detect deviances 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 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 are out in the field.

National Emergency Disaster Information Center

Working under the auspices of the National Guard, DRC is building a data repository of best practices in a logical decision tree structure that the first responder can call up on a hand-held device. This program is in response to the National Emergency Disaster Information Center, mandated by Congress in 2002, to provide emergency personnel, those who are often the first to respond to an accident or disaster, with an on-the-spot knowledge bank to help them follow best practices when making rapid life-or-death decisions in emergencies they may not have encountered before. This program is the first step in developing a system for assisting the National Guard in responding most effectively to national disasters, including those involving weapons of mass destruction. The concept includes an information center whose staff will also use the database and back the first responders by anticipating what’s needed next, such as alerting nearby hospitals or summoning firefighters from a neighboring county.

Bureau of Citizenship and Immigration Service

The Bureau of Citizenship and Immigration Service (“BCIS”) provides benefits processing and a wide range of other services to immigrants and applicants for naturalization. These services are provided at BCIS headquarters, district offices, sub-offices, satellite offices and 131 application service centers throughout the United States, and in Puerto Rico, the Virgin Islands and Guam.

Ensuring consistent and high quality processes and service is a primary concern. DRC assists the BCIS with the development and implementation of standard operating procedures for use at all of its facilities, and conducts quality assurance process reviews. DRC’s employees work in the field conducting quarterly or semi-annual reviews at BCIS offices to view processes, applicant files and other supporting documentation to verify that practices are consistent and compliant with agency policies and procedures.

United States Customs Service Air and Marine Interdiction Division

The United States Customs Service National Aviation Center in Oklahoma City, Oklahoma 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 stand alone computers, over the agency’s local area network, and via a secure web site for distance learning.

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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. Demand for Information Technology (“IT”) services in this sector has been weak over the past year due to state budget deficits. As a result, during 2002, DRC’s revenue with the State of Ohio was reduced on an annualized basis by approximately $5 million from 2001 revenue of $7.4 million. The company remains profitable in this sector, and believes it is in a position to expand its presence in this market when conditions improve. 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 Enhancement Tracking System and other programs. In February 2002, Ohio began curtailing existing IT maintenance contracts and making decisions to downsize or eliminate certain follow-on contracts expected later in the year. This cutback resulted in reductions in revenue in 2002 as the year progressed.

New Hampshire Department of Health and Human Services

DRC has developed and implemented the statewide child welfare information system. Currently, the company provides support, maintenance and enhancement services related to this system.

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.

Defense Program Management Services

DRC’s Defense Program Management Services capabilities include technology, planning and acquisition, system engineering, logistics systems planning, decision support, financial and administrative services.

Engineering Services

DRC’s engineering services capabilities include engineering analysis applied to electronic, communication, aeronautical, naval and navigation systems; reverse engineering of electronic components; precision component design; maintenance and support of navigation and guidance systems; human factors integration; and business process reengineering.

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Logistics

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.

Information Technology

Information technology capabilities offered by DRC 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.

Modeling and Simulation

DRC’s modeling and simulation capabilities 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

DRC’s training analysis and delivery capabilities include training task analysis, development of computer-based training programs and training delivery systems, and electronic performance support systems.

Precision Manufacturing

The Metrigraphics Division’s expertise centers on photolithography, thin film deposition of metals and dielectrics, and electroforming. The company believes that 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.

BUSINESS DEVELOPMENT

The company believes it has a well-established record of winning contract renewals and re-competitions 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 had been to conduct a lengthy competitive bidding process for each award, today base purchase agreements, indefinite delivery, indefinite quantity contracts, the General Services Administration contract and other government-wide acquisition contract vehicles, referred to as GWACS, are the predominant forms of contracting for IT and technical services. These vehicles have enabled contracting officers to accelerate the pace of awards.

The company’s government contracts fall into one of three categories: (1) fixed-price, including service type contracts, (2) time and materials, and (3) cost reimbursable. Under a fixed-price contract, the government pays an

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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.

The company’s state contracts are generally either fixed-price, including service type contracts, or time and materials. In certain instances, funding for these contracts is subject to annual state legislative approval and to termination provisions.

DRC’s contracts with United States Government and state customers generally are subject to termination at the convenience of the United States Government or the state. However, in the event that a United States Government or state contract is terminated by the respective government, the company would be reimbursed for its allowable costs up 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 or state 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 or state requirements, appropriations failures or budgetary concerns. If the United States Government or state curtails expenditures for research, development and consulting activities, such curtailment could have a material adverse impact on the company’s revenue and earnings.

BACKLOG

The company’s funded backlog, excluding discontinued operations, was $111.1 million at December 31, 2002, $90.4 million at December 31, 2001 and $88.0 million at December 31, 2000. The company expects that substantially all of its backlog at December 31, 2002 will be filled during the year ending December 31, 2003. The funded backlog generally is subject to possible termination at the convenience of the contracting counterparty. 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 subject to annual governmental approval or appropriations legislation, 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 a large number of public and privately held firms, which specialize in providing government information technology services.

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 competition varies depending on the customer, geographic market and required capabilities. The United States Government’s own in-house capabilities are also, in effect, competitors because various agencies are able to perform services, which might otherwise be performed by the company. The principal competitive factors for systems and services are past performance, technical competence and price.

In the precision manufacturing business, the company competes with other manufacturers of 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

Excluding discontinued operations and including overhead and other indirect costs, the company expended approximately $0.2 million on web-based capabilities during the year ended December 31, 2002, compared with expenditures of $0.4 million in 2001 and no expenditures in 2000. The expenditures in 2001 were attributable mainly to the development of MedTeams training products.

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RAW MATERIALS

Raw materials and components are purchased from a large number of independent sources and are generally available in sufficient quantities to meet current requirements.

ENVIRONMENTAL MATTERS

Compliance with federal, state and local provisions relating to the protection of the environment has not had and is not expected to have a material effect upon the capital expenditures, earnings or competitive position of the company.

EMPLOYEES

At December 31, 2002, the company had 1,858 employees, including 93 employees associated with discontinued operations. 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.

IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

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 from these forward-looking statements, 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 below. The company assumes no obligation to update any forward-looking information.

Our Revenue is Highly Dependent on the Department of Defense and Other Federal Agencies and Any Decreases in Their Budgets Could Affect Our Results

In 2002, approximately 89% of our revenue was derived from United States Government agencies, primarily the Department of Defense. In the past, our defense business has been adversely affected by significant changes in defense spending during periods of declining United States defense budgets. Among the effects of this general decline has been increased competition within a consolidating defense industry.

It is not possible for us to predict whether defense budgets will increase or decline in the future. Further, changing missions and priorities in the defense budget may have adverse effects on our business. Funding limitations could result in a reduction, delay or cancellation of existing or emerging programs. We anticipate there will continue to be significant competition when our defense contracts are rebid, as well as significant competitive pressure to lower prices, which may reduce profitability in this area of our business. Any reduction in the level or profitability of our defense business, if not offset by new commercial business or other business, will adversely affect our business, financial condition and results of operations.

We Must Bear the Risk of Various Pricing Structures Associated with Government Contracts

We historically have derived a substantial portion of our revenue from contracts and subcontracts with the United States Government. A significant portion of our federal and state government contracts are undertaken on a time

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and materials nature, with fixed hourly rates that are intended to cover salaries, benefits, other indirect costs of operating the business and profit. The pricing of such contracts is based upon estimates of future costs and assumptions as to the aggregate volume of business that we will perform in a given business division or other relevant unit. For long-term contracts, we must estimate the costs necessary to complete the defined statement of work and recognize revenue or losses in accordance with such estimates. Actual costs may vary materially from the estimates made from time to time, necessitating adjustments to reported revenue and net income. Underestimates of the costs associated with a project could adversely affect our overall profitability and could have a material adverse effect on our business, financial condition and results of operations.

Alternatively, we undertake various government projects on a fixed-price basis, as distinguished from billing on a time and materials basis. Under a fixed-price contract, the government pays an agreed upon price for our services or products, and we bear the risk that increased or unexpected costs may reduce our profits or cause us to incur a loss. Significant cost overruns can occur if we fail to:

The potential for cost overruns may be heightened if we act as a subcontractor on a fixed-price project, because we have a limited ability to control project variables and to negotiate directly with the ultimate client. We cannot be certain that any of our existing or future time and materials or fixed-price projects will be profitable.

A substantial portion of our United States Government business is as a subcontractor. In such circumstances, we generally bear the risk that the prime contractor will meet its performance obligations to the United States Government under the prime contract and that the prime contractor will have the financial capability to pay us amounts due under the subcontract. The inability of a prime contractor to perform or make required payments to us could have a material adverse effect on the company’s business, financial condition and results of operations.

Our Contracts and Subcontracts with Government Agencies are Subject to a Competitive Bidding Process and to Termination Without Cause by the Government

A significant portion of our federal and state government contracts are renewable on an annual basis, or are subject to the exercise of contractual options. Multi-year contracts often require funding actions by the United States Government, state legislature or others on an annual or more frequent basis. As a result, our business could experience material adverse consequences should such funding actions or other approvals not be taken.

Recent federal regulations and renewed congressional interest in small business set aside contracts is likely to influence decisions pertaining to contracting methods for many of the company’s customers. These regulations require more frequent review and certification of small business contractor status, so as to ensure that companies competing for contracts intended for small business are qualified as such at the time of the competition. In 2002, the company derived $17.1 million in revenue from a small business set aside contract held by its HJ Ford subsidiary and due for recompetition in 2005. The company does not know what effects these events, including HJ Ford’s loss of small business status now that it is part of DRC, will have on future financial results.

Governmental awards of contracts are subject to regulations and procedures that permit formal bidding procedures and protests by losing bidders. Such protests may result in significant delays in the commencement of expected contracts, the reversal of a previous award decision or the reopening of the competitive bidding process, which could have a material adverse effect on our business, financial condition and results of operations.

Because of the complexity and scheduling of contracting with government agencies, from time to time we may incur costs before receiving contractual funding by the United States Government. In some circumstances, we may not be able to recover such costs in whole or in part under subsequent contractual actions. Failure to collect such amounts may have material adverse consequences on our business, financial condition and results of operations.

In addition, the United States Government has the right to terminate contracts for convenience. If the government terminated contracts with us, we would generally recover costs incurred up to termination, costs required to be incurred in connection with the termination and a portion of the fee earned commensurate with the work we have

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performed to termination. However, significant adverse effects on our indirect cost pools may not be recoverable in connection with a termination for convenience. Contracts with state and other governmental entities are subject to the same or similar risks.

We Are Subject to a High Level of Government Regulations and Audits Under Our Government Contracts and Subcontracts

As a defense contractor, we are subject to many levels of audit and review, including by the Defense Contract Audit Agency, the Inspector General, the Defense Criminal Investigative Service, the General Accounting Office, the Department of Justice and congressional committees. These audits, reviews and the pending grand jury investigation in the United States District Court of Massachusetts could result in the termination of contracts, the imposition of fines or penalties, the withholding of payments due to us or the prohibition from participating in certain United States Government contracts for a specified period of time.

Loss of Key Personnel or Increased Government Regulation of Immigration Could Limit our Growth

We are dependent on our ability to attract and retain highly skilled technical personnel. Many of our technical personnel may have specific knowledge and experience related to various government customer operations and these individuals would be difficult to replace in a timely fashion. In addition, qualified technical personnel are in high demand worldwide and are likely to remain a limited resource. The loss of services of key personnel could impair our ability to perform required services under some of our contracts, to retain such business after the expiration of the existing contract, or to win new business in the event that we lose the services of individuals who have been identified in a given proposal as key personnel in the proposal. Any of these situations could have a material adverse effect on our business, financial condition and results of operations.

In addition, we recruit technical professionals globally and, as a result, we must comply with the immigration laws in the countries in which we operate, particularly the United States. As of December 31, 2002, less than 1% of our workforce was working under H-1B temporary work permits in the United States. Government regulation limits the number of new H-1B permits that may be approved in a fiscal year. If the limit is reached in any year, we may not be able to recruit enough technical professionals to meet our personnel requirements. This could materially affect our business. Congress and administrative agencies with jurisdiction over immigration matters have periodically expressed concern over the level of legal and illegal immigration into the United States, which may reduce the number of work permits that may be issued. Recently there have been substantial delays in approval of petitions filed by employers with the Bureau of Citizenship and Immigration Services (the successor agency to the INS). These delays, coupled with the uncertain and lengthy visa issuance process at United States consulates abroad, may create delays in foreign national personnel being available to work in the United States. Any change making it more difficult for us to hire foreign nationals, or limiting our ability to retain foreign employees, could require us to incur additional unexpected labor costs and other expenses.

We Operate in Highly Competitive Markets and May Have Difficulties Entering  New Markets

The markets for our services are highly competitive. The government contracting business is subject to intense competition from numerous companies, many of which have significantly greater financial, technical and marketing resources than we do. The principal competitive factors are price performance, technical competence and reliability.

Competition in the market for our commercial products is also intense. There is a significant lead-time for developing such business, and it involves substantial capital investment including development of prototypes and investment in manufacturing equipment. Principal competitive factors are price, product quality and the ability to specialize our engineering in order to meet our customers’ specific system requirements. Our precision products business has a number of competitors, many of which have significantly greater financial, technical and

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marketing resources than we do. Competitive pressures in our government and commercial businesses could have a material adverse effect on our business, financial condition and results of operations.

In our efforts to enter new markets, including commercial markets and United States Government agencies other than the Department of Defense, we generally face significant competition from other companies that have prior experience with such potential customers, as well as significantly greater financial, technical and marketing resources than we have. As a result, we may not achieve the level of success that we expect in our efforts to enter such new markets.

Our Business is Highly Concentrated and a Significant Portion of Our Revenue is Derived from a Few Customers

Our revenue from contracts with the Department of Defense, either as prime contractor or subcontractor, accounted for approximately 80% of our total revenue during 2002. Within the Department of Defense, individual services and program offices account for a significant portion of our United States Government business. We cannot be assured that any of these customers will continue as such or will continue at current levels. A decrease in orders from the Department of Defense or any of these customers would have an adverse effect on our profitability, and the loss of any large customer could have a material adverse effect on our business, financial condition and results of operations.

We May be Subject to Product Liability Claims

Our precision manufactured products are generally designed to operate as important components of complex systems or products. Defects in our products could cause our customer’s product or systems to fail or perform below expectations. Although we attempt to contractually limit our liability for such defects or failures, we cannot be assured that our attempts to limit our liability will be successful. Like other manufacturing companies, we may be subject to claims for alleged performance issues related to our products. Such claims, if made, could damage our reputation and could have a material adverse effect on our business, financial conditions or results of operations.

Economic Events May Affect Our Business Segments

Many of our precision products are components of commercial products. Factors that affect the production and demand for such products, including economic events both domestically and in other regions of the world, competition, technological change and production disruption, could adversely affect demand for our products. Many of our products are incorporated into capital equipment, such as machine tools and other automated production equipment, used in the manufacture of other products. As a result, this portion of our business may be subject to fluctuations in the manufacturing sector of the overall economy. An economic recession, either in the United States or elsewhere in the world, could have a material adverse effect on the rate of orders received by the commercial divisions. Significantly lower production volumes resulting in under-utilization of our manufacturing would adversely affect our business, financial condition and results of operations.

Our Products and Services Could Become Obsolete Due to Rapid Technological Changes in the Industry

We offer sophisticated products and services in areas in which there have been and are expected to continue to be significant technological changes. Many of our products are incorporated into sophisticated machinery, equipment or electronic systems. Technological changes may be incorporated into competitors’ products that may adversely affect the market for our products. If our competitors introduce superior technologies or products, we cannot be assured that we will be able to respond quickly enough to such changes or to offer services that satisfy our customers’ requirements at a competitive price. Further, we cannot be assured that our research and product development efforts will be successful or result in new or improved products that may be required to sustain our market position.

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Our Financing Requirements May Increase and We Could Have Limited Access  to Capital Markets

While we believe that our current resources and access to capital markets are adequate to support operations over the near term and foreseeable future, we cannot be assured that these circumstances will remain unchanged. Our need for capital is dependent on operating results and may be greater than expected. Our ability to maintain our current sources of debt financing depends on our ability to remain in compliance with certain covenants contained in our financing agreements, including, among other requirements, maintaining a minimum total net worth and minimum cash flow and debt coverage ratios. If changes in capital markets restrict the availability of funds or increase the cost of funds, we may be required to modify, delay or abandon some of our planned expenditures, which could have a material adverse effect on our business, financial condition and results of operations.

Our Quarterly Operating Results May Vary Significantly From Quarter to Quarter

Our revenue and earnings may fluctuate from quarter to quarter depending on a number of factors, including:

Demand for our products and services in each of t