FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 2, 1998 Commission file number 1-3879
DynCorp
(Exact name of registrant as specified in its charter)
Delaware 36-2408747
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
2000 Edmund Halley Drive, Reston, VA 20191-3436
(Address of principal executive offices) (Zip Code)
(703)264-0330
Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since
last report)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of August 14, 1998
Common Stock, $0.10 Par Value 10,458,358
DYNCORP AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED JULY 2, 1998
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Balance Sheets at
July 2, 1998 and December 31, 1997 3-4
Consolidated Condensed Statements of Operations for
Three and Six Months Ended July 2, 1998 and June 26, 1997 5
Consolidated Condensed Statements of Cash Flows for
Six Months Ended July 2, 1998 and June 26, 1997 6
Consolidated Statement of Permanent Stockholders' Equity 7
Notes to Consolidated Condensed Financial Statements 8-16
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 17-19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 4. Submission of Matters to a Vote of Security Holders 19-20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 20
<PAGE>
PART I. FINANCIAL INFORMATION
DYNCORP AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
JULY 2, 1998 AND DECEMBER 31, 1997
(In thousands)
July 2,
1998 December 31,
Unaudited 1997
--------- ------------
Assets
Current Assets:
Cash and cash equivalents $ 9,695 $ 24,602
Accounts receivable and contracts in process (Note 2) 223,886 202,758
Inventories of purchased products and supplies,
at lower of cost (first-in, first-out) or market 904 1,090
Other current assets 12,221 11,133
--------- ---------
Total current assets 246,706 239,583
Property and Equipment (net of accumulated
depreciation and amortization of $25,651 in
1998 and $22,412 in 1997) 19,624 19,620
Goodwill and Contracts Acquired (net of accumulated
amortization of $46,453 in 1998 and $45,205 in
1997) (Note 7) 46,410 46,750
Other Assets (Notes 2 and 9) 85,923 76,631
-------- --------
Total Assets $398,663 $382,584
======== ========
See accompanying notes to consolidated condensed financial statements.
<PAGE>
DYNCORP AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
JULY 2, 1998 AND DECEMBER 31, 1997
(In thousands, except share amounts)
July 2,
1998 December 31,
Unaudited 1997
--------- ------------
Liabilities and Stockholders' Equity
Current Liabilities:
Notes payable and current portion of long-term debt $ 2,285 $ 450
Accounts payable 41,589 46,109
Deferred revenue and customer advances 2,056 2,947
Accrued liabilities 117,449 105,833
-------- --------
Total current liabilities 163,379 155,339
Long-Term Debt (Notes 2) 152,156 152,239
Other Liabilities and Deferred Credits (Note 9) 77,661 77,780
Contingencies and Litigation (Note 9) - -
Temporary Equity (Note 3):
Redeemable Common Stock -
ESOP Shares, 7,049,100 and 6,887,119
shares issued and outstanding in 1998 and 1997,
respectively, subject to restrictions 170,925 151,823
Other, 125,714 shares issued and outstanding in
1998 and 1997 3,269 3,017
Permanent Stockholders' Equity (Note 4):
Common Stock, par value ten cents per share, authorized
20,000,000 shares; issued 5,001,997 shares in 1998
and 4,784,770 shares in 1997 500 478
Common Stock Warrants 422 1,259
Paid-in Surplus 126,191 125,412
Reclassification to temporary equity for redemption
value greater than par value (173,476) (154,138)
Deficit (87,978) ( 93,837)
Common Stock Held in Treasury, at cost; 1,714,927
shares and 170,716 warrants in 1998 and 1,677,511
shares and 170,716 warrants in 1997 (29,619) (28,703)
Unearned ESOP Shares (4,767) (8,085)
--------- ---------
Total Liabilities and Stockholders' Equity $398,663 $382,584
========= =========
See accompanying notes to consolidated condensed financial statements.
<PAGE>
DYNCORP AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
UNAUDITED
Three Months Ended Six Months Ended
------------------ ----------------
July 2, June 26, July 2, June 26,
1998 1997 1998 1997
------- -------- ------- --------
Revenues: $303,602 $288,695 $601,475 $559,832
Costs and Expenses:
Costs of services 287,927 276,374 571,863 536,168
Corporate selling and
administrative 4,793 4,353 10,061 8,792
Interest income (328) (637) (677) (998)
Interest expense 3,855 3,907 7,648 6,891
Other 1,502 1,018 1,868 1,294
-------- -------- -------- --------
Total costs and expenses 297,749 285,015 590,763 552,147
Earnings before income taxes
and minority interest 5,853 3,680 10,712 7,685
Provision for income taxes (Note 5) 2,130 1,442 3,906 2,728
-------- -------- -------- --------
Earnings before minority interest 3,723 2,238 6,806 4,957
Minority interest 528 203 947 611
-------- -------- -------- --------
Net earnings $ 3,195 $ 2,035 $ 5,859 $ 4,346
======== ======== ======== ========
Weighted average number of
shares outstanding for basic
earnings per share (Note 6) 10,255 8,863 10,135 8,733
Weighted average number of
shares outstanding for
diluted earnings per share (Note 6) 10,609 10,416 10,537 10,797
Basic earnings per share $ 0.31 $ 0.23 $ 0.58 $ 0.50
Diluted earnings per share $ 0.30 $ 0.20 $ 0.56 $ 0.40
See accompanying notes to consolidated condensed financial statements.
DYNCORP AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
Unaudited
Six Months Ended
----------------
July 2, June 26,
1998 1997
------- --------
Cash Flows from Operating Activities:
Net earnings $ 5,859 $ 4,346
Adjustments to reconcile net earnings from operations
to net cash provided (used):
Depreciation and amortization 4,142 5,043
Increase in reserves for divested businesses - 125
Proceeds from insurance settlement for asbestos claims 1,463 1,000
Other (58) (344)
Changes in current assets and liabilities, net of
acquisitions:
Increase in current assets except cash and cash equivalents (18,895) (60)
Increase in current liabilities except notes payable
and current portion of long term debt 5,264 1,104
-------- ------
Cash provided (used) by operating activities ( 2,225) 11,214
Cash Flows from Investing Activities:
Sale of property and equipment 299 51
Purchase of property and equipment (2,498) (2,926)
Assets and liabilities of acquired business (10,241) -
Increases in investment in unconsolidated affiliates (1,054) (677)
Other (3,231) (122)
-------- -------
Cash used by investing activities (16,725) (3,674)
Cash Flows from Financing Activities:
Treasury stock purchased (873) (284)
Payment on indebtedness (18,265) (463)
Retirement of Contract Receivable Collateralized
Notes 1992-1 - (98,500)
Proceeds from Contract Receivable Collateralized
Notes 1997-1 20,000 50,000
Proceeds from issuance of Senior Notes - 99,484
Stock released to Employee Stock Ownership Plan 3,318 2,595
Loan to Employee Stock Ownership Plan (Note 4) - (10,379)
Deferred financing expenses - (4,767)
Common stock and warrants purchased from investors - (37,819)
Other (137) (361)
------- --------
Cash provided (used) from financing activities 4,043 (494)
Net (Decrease) Increase in Cash and Cash Equivalents (14,907) 7,046
Cash and Cash Equivalents at Beginning of the Period 24,602 25,877
-------- --------
Cash and Cash Equivalents at End of the Period $ 9,695 $ 32,923
======== ========
Supplemental Cash Flow Information:
Cash paid for income taxes $ 4,253 $ 2,229
======== ========
Cash paid for interest $ 7,311 $ 5,938
======== ========
See accompanying notes to consolidated condensed financial statements.
<TABLE>
<CAPTION>
DYNCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF PERMANENT STOCKHOLDERS' EQUITY
(In thousands)
UNAUDITED
Adjustment
Common for Redemption Unearned
Common Stock Paid-in Value Greater Treasury ESOP
Stock Warrants Surplus than Par Value Deficit Stock Shares
------ -------- ------- -------------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ 478 $1,259 $125,412 $(154,138) $( 93,837) $(28,703) $(8,085)
Stock issued under
Restricted Stock Plan 2 126
Treasury stock issued 85
Treasury stock purchased (288) (1,001)
Stock warrants and options
exercised 35 (837) 941
Payment received on Employee
Stock Ownership Plan note 3,318
Net earnings 5,859
Reclassification to Redeemable
Common Stock (15) (19,338)
Balance, July 2, 1998 $ 500 $ 422 $126,191 $(173,476) $(87,978) $(29,619) $(4,767)
</TABLE>
<PAGE>
DYNCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
July 2, 1998
UNAUDITED
1. The unaudited consolidated condensed financial statements included herein
have been prepared by the Company pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although the
Company believes that the disclosures are adequate to make the information
presented not misleading. It is recommended that these condensed financial
statements be read in conjunction with the financial statements and the
notes thereto included in the Company's latest annual report on Form 10-K.
In the opinion of the Company, the unaudited consolidated condensed
financial statements included herein reflect all adjustments necessary to
present fairly the financial position, the results of operations and the
cash flows for such interim periods. The results of operations for such
interim periods are not necessarily indicative of the results for the full
year. Prior year financial statements have been reclassified to conform to
the 1998 presentation. Prior year earnings per share have been restated in
accordance with SFAS No. 128 "Earnings Per Share," which was adopted by the
Company on December 31, 1997 (See Note 6).
2. At July 2, 1998, the Company's wholly-owned subsidiary Dyn Funding
Corporation ("DFC") had outstanding borrowings of $2.0 million under the
Floating Rate Contract Receivable Collateralized Rates Notes, Series
1997-1, Class B. The amount was utilized to fund the Company's working
capital needs.
At July 2, 1998, $75.3 million of accounts receivable are restricted as
collateral for the Contract Receivable Collateralized Notes, Series 1997-1
Class A and B. Additionally, $1.5 million of cash is restricted as
collateral for the Notes and has been included in Other Assets on the
balance sheet at July 2, 1998 and December 31, 1997.
Accounts receivable are net of an allowance for doubtful accounts of
$1,216,000 as of July 2, 1998 and $476,000 as of December 31, 1997.
3. Common stock which is redeemable has been reflected as Temporary Equity at
each balance sheet date and consists of the following:
Balance at Balance at
Redeemable July 2, Redeemable December 31,
Shares Value 1998 Shares Value 1997
----- ---------- --------- ------ ---------- ------------
ESOP Shares 3,520,037 $26.00 $ 91,520,962 3,520,037 $24.00 $ 84,480,888
3,529,063 $22.50 79,403,918 3,367,082 $20.00 67,341,640
--------- ------------ --------- ------------
7,049,100 $170,924,880 6,887,119 $151,822,528
========= ============ ========= ============
Other Shares 125,714 $26.00 $ 3,268,564 125,714 $24.00 $ 3,017,136
========= ============ ========= ============
In accordance with ERISA regulations and the Employee Stock Ownership Plan
documents, the ESOP Trust or the Company is obligated to purchase
distributed common stock shares from ESOP participants on retirement or
termination at fair value as long as the Company's common stock is not
publicly traded. However, under the Subscription Agreement with the ESOP
dated September 9, 1988, the Company is permitted to defer put options if,
under Delaware law, the capital of the Company would be impaired as a
result of such repurchase.
In conjunction with the acquisition of Technology Applications, Inc. in
1993, the Company issued put options on 125,714 shares of its common stock
to the former owner. The holder may, at any time commencing on December
31, 1998 and ending on December 31, 2000, sell these shares to the Company
at a price per share equal to the greater of $17.50 or, (a) if the stock
is publicly traded, the market value at a specified date or, (b) if the
Company's stock is not publicly traded, the fair value at the time of
exercise.
4. The Company made loans to the Employee Stock Ownership Trust during 1997
to purchase shares and warrants as well as to pay off expiring loans. At
July 2, 1998, the unpaid balance on these loans, $4.8 million representing
226,891 shares, is reflected as a reduction in stockholders' equity.
5. The provision for income taxes in 1998 and 1997 is based upon an estimated
annual effective tax rate, including the impact of differences between the
book value of assets and liabilities recognized for financial reporting
purposes and the basis recognized for tax purposes.
6. The Company has adopted SFAS No. 128 "Earnings Per Share," which became
effective for financial statements for periods ending after December 15,
1997. The statement establishes new standards for computing and presenting
earnings per share ("EPS") and requires restatement of prior periods.
Specifically, the statement replaces the presentation of primary and fully
diluted EPS with a presentation of basic and diluted EPS and requires a
dual presentation on the face of the income statement and a reconciliation
of basic EPS to diluted EPS.
Basic EPS is computed by dividing earnings by the weighted average number
of common shares outstanding and contingently issuable shares. The
weighted average number of common shares outstanding includes issued
shares less shares held in treasury and any unallocated ESOP shares.
Shares earned and vested but unissued under the Restricted Stock Plan are
contingently issuable shares whose condition for issuance has been
satisfied and as such have been included in the calculation of basic EPS.
Diluted EPS is computed similarly except the denominator is increased to
include the weighted average number of stock warrants and options
outstanding, assuming the treasury stock method.
The reconciliation of basic EPS to diluted EPS is as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------ ----------------
July 2, 1998 June 26, 1997 July 2, 1998 June 26, 1997
------------ ------------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Earnings Per Earnings Per Earnings Per Earnings Per
Share Share Share Share
Basic Earnings Per Share
Income for basic earnings per share $3,195 $0.31 $2,035 $0.23 $5,859 $0.58 $4,346 $0.50
Weighted average shares outstanding 10,254,835 8,863,265 10,135,476 8,732,800
Diluted Earnings Per Share
Income for diluted earnings per share $3,195 $0.30 $2,035 $0.20 $5,859 $0.56 $4,346 $0.40
Weighted average shares outstanding 10,254,835 8,863,265 10,135,476 8,732,800
Effect of dilutive securities:
Warrants 169,505 1,416,258 243,598 1,931,871
Stock Options 184,956 136,430 158,114 131,860
Shares for diluted earnings per share 10,609,296 10,415,953 10,537,188 10,796,531
</TABLE>
<PAGE>
7. On February 2, 1998, the Company acquired a majority of the net assets of
FMAS Corporation ("FMAS"), a medical outcome measurement and data
abstraction services company headquartered in Rockville, MD, for $10.3
million in cash. FMAS is a leading provider of proprietary outcome
performance measurement systems to DoD treatment facilities as well as
other public and governmental facilities. The acquisition has been
accounted for as a purchase and $0.9 million of goodwill, which will be
amortized over 15 years, has been recorded based on a preliminary
allocation of the purchase price.
8. New Accounting Pronouncements
Statement of Financial Accounting Standards ("SFAS") No. 130 "Reporting
Comprehensive Income" was issued in June 1997, and became effective for
fiscal years beginning after December 15, 1997. The statement establishes
standards for the reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. The
Company has reviewed the requirements of SFAS No. 130 and at present the
Company does not report any additional transactions which would be deemed
to be included in comprehensive income.
In February 1998, the Financial Accounting Standards Board issued SFAS No.
132 "Employers' Disclosures about Pensions and Other Post Retirement
Benefits," which became effective for fiscal years beginning after
December 15, 1997. The statement standardizes the disclosure requirements
for pensions and other post retirement benefits. The statement addresses
disclosure requirements only. Because the Company does not have
significant post retirement benefits, adoption of the standard is not
expected to materially change the Company's disclosures.
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position No. (SOP) 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use," which
will be effective for fiscal years beginning after December 15, 1998. The
Statement of Position requires the capitalization of certain costs
incurred in connection with developing or obtaining software for internal
use after the date of adoption. Adoption of SOP No. 98-1 will not have a
material impact on the Company's financial statements.
AICPA SOP No. 98-5, "Reporting on the Costs of Start-up Activities," was
issued in April 1998 and is effective for fiscal years beginning after
December 15, 1998. The statement provides guidance on the financial
reporting of start-up costs and organization costs, and requires costs of
start-up activities to be expensed as incurred. The Company estimates that
adoption of this statement will not have a material impact on the
Company's financial statements.
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." The
Statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. The Company is required to adopt
the provisions of the standard during the first quarter of 2000. Because
of the Company's minimal use of derivatives, the Company does not expect
that the adoption of the new standard will have a material impact on the
results of operations or financial condition.
9. Contingencies and Litigation
The Company and its subsidiaries and affiliates are involved in various
claims and lawsuits, including contract disputes and claims based on
allegations of negligence and other tortuous conduct. The Company is also
potentially liable for certain personal injury, tax, environmental and
contract dispute issues related to the prior operations of divested
businesses. In addition, certain subsidiary companies are potentially
liable for environmental, personal injury and contract and dispute claims.
In most cases, the Company and its subsidiaries have denied, or believe
they have a basis to deny, liability, and in some cases have offsetting
claims against the plaintiffs, third parties or insurance carriers. The
total amount of damages currently claimed by the plaintiffs in these cases
is estimated to be approximately $139.6 million (including compensatory
punitive damages and penalties). The Company believes that the amount that
will actually be recovered in these cases will be substantially less than
the amount claimed. After taking into account available insurance, the
Company believes it is adequately reserved with respect to the potential
liability for such claims. The estimates set forth above do not reflect
claims that may have been incurred but have not yet been filed. The Company
has recorded such damages and penalties that are considered to be probable
recoveries against the Company or its subsidiaries.
(a) Asbestos Claims
An acquired and inactive subsidiary, Fuller-Austin, which discontinued its
business activities in 1986, has been named as one of many defendants in
civil lawsuits which have been filed in certain state courts (principally
Texas) beginning in 1986 against manufacturers, distributors and installers
of products allegedly containing asbestos. Fuller-Austin was a
non-manufacturer that installed and occasionally distributed industrial
insulation products. Fuller-Austin had discontinued the use of
asbestos-containing products prior to being acquired by the Company in
1974. These claims are not part of a class action.
The claimants generally allege injuries to their health caused by
inhalation of asbestos fibers. Many of the claimants seek punitive damages
as well as compensatory damages. The amount of damages sought is impacted
by a multitude of factors. These include the type and severity of the
disease sustained by the claimant (i.e., mesothelioma, lung cancer, other
types of cancer, asbestosis or pleural changes); the occupation of the
claimant; the duration of the claimant's exposure to asbestos-containing
products; the number and financial resources of the defendants; the
jurisdiction in which the claim is filed; the presence or absence of other
possible causes of the claimant's illness; the availability of legal
defenses, such as the statute of limitations; and whether the claim was
made on an individual basis or as part of a group claim.
Claim Exposure (number of plaintiffs, claims and per claim amounts not in
thousands)
As of July 31, 1998, 18,739 plaintiffs have filed claims against
Fuller-Austin and various other defendants. Of these claims, 2,325 have
been dismissed and 4,899 have been resolved without an admission of
liability at an average cost of $3,263 per claim, excluding legal defense
costs.
The following is a summary of the number of claims filed against
Fuller-Austin:
Years
--------------------------------------------
1994
& Prior 1995 1996 1997 1998 Total
------- ------ ------- ------ ------ ------
Claims Filed 4,057 4,527 4,122 3,807 2,226 18,739
Claims Dismissed (113) (51) (1,116) (931) (114) (2,325)
Claims Resolved (1,619) (189) (1,825) (460) (806) (4,899)
Claims Under Appeal (13) (13)
-------
Claims Outstanding,
as of July 31, 1998 11,502
=======
In connection with these claims, Fuller-Austin's primary insurance carriers
have incurred approximately $29.3 million (including $13.3 million of legal
defense costs) to defend and settle the claims and, in addition, jury
verdict judgments have been entered against Fuller-Austin in the aggregate
amount of $6.5 million, partially reduced by appeal during 1997 by $2.0
million, which have not been paid and which are under appeal by
Fuller-Austin.
Fuller-Austin has experienced a decline in the number of claims taken to
trial. During the 21-month period ending July 31, 1998, no cases were tried
by plaintiffs although approximately 1,113 cases were set for trial during
this period. Plaintiffs have instead elected to enter into settlements with
Fuller-Austin for amounts ranging from $250 to $14,500 for an average
during the period of $2,830 per claim. In addition, in connection with
these settlements, a significant number of claims filed against
Fuller-Austin were dismissed with no payment by Fuller-Austin or its
insurers. Fuller-Austin and its carriers will continue to evaluate
settlement proposals, but will be prepared to try cases that cannot be
settled in a manner consistent with recent settlement trends.
During the first quarter of 1998, Fuller-Austin agreed in principle to
settle with approximately 660 non-Texas claimants who were threatening to
amend pending lawsuits to add Fuller-Austin as a defendant. The settlement,
if concluded, will aggregate approximately $4.0 million, which is included
in the estimate of future claims set forth below. Fuller-Austin considers
the entire settlement to be covered by insurance.
The number of claims filed against Fuller-Austin has become significant
only since 1992, and therefore, Fuller-Austin has a relatively brief
history (compared to manufacturers and suppliers) of claims volume and a
limited data file upon which to estimate the number or costs of claims that
may be received in the future. Also, effective September 1, 1995, the State
of Texas (where most of these claims have been filed) enacted tort reform
legislation which Fuller-Austin believes has curtailed the number of
unsubstantiated asbestos claims filed against the subsidiary in Texas.
Fuller-Austin's defense counsel has analyzed the 11,502 claims outstanding
as of July 31, 1998. Based on this analysis and consultation with its other
professional advisors, Fuller-Austin has estimated its cost, including
legal defense costs, to be $9.5 million for claims filed and still
unsettled and $40.7 million as its minimum estimate of future costs of
claims and settlements, including legal defense costs. No upper limit of
exposure can presently be reasonably estimated. The Company cautions that
these estimates are subject to significant uncertainties, including the
future effect of tort reform legislation enacted in Texas and other states,
the success of Fuller-Austin's litigation strategy, the size of jury
verdicts, success of appeals in process, the number and financial resources
of future plaintiffs, and the actions of other defendants. Therefore,
actual claim experience may vary significantly from such estimates,
especially if certain Texas appeals are decided unfavorably to
Fuller-Austin and/or the level of claims filed in other states increases.
Fuller-Austin recorded an estimated liability for future indemnity payments
and defense costs related to currently unsettled claims and minimum
estimated future claims of $50.2 million at July 2, 1998 and December 31,
1997 (recorded as long-term liability).
Insurance Coverage
Defense has been tendered to and accepted by Fuller-Austin's primary
insurance carriers, and by certain of the Company's primary insurance
carriers that issued policies under which Fuller-Austin is named as an
additional insured; however, only one such primary carrier has partially
accepted defense without a reservation of rights. The Company believes that
Fuller-Austin has at least $2.7 million in unexhausted primary coverage
(net of deductibles and self-insured retentions, but including disputed
coverage) under its liability insurance policies to cover the unsettled
claims, verdicts and future unasserted claims and defense costs. The
primary carriers also have unlimited liability for defense costs (presently
running at an average annual rate of approximately $1.3 million) until such
time as the primary limits under these policies are exhausted. When the
primary limits are exhausted, liability for both indemnity and legal
defense will be tendered to the excess coverage carriers, all of which have
been notified of the pendency of the asbestos claims. The Company and
Fuller-Austin have approximately $390.0 million of additional excess and
umbrella insurance that is generally responsive to asbestos claims after
taking into consideration certain pending carrier settlements that are
discussed below. This amount excludes approximately $92.0 million of
coverage issued by insolvent carriers. After the $2.7 million of
unexhausted primary coverage, the Company has first tier excess coverage of
$39.0 million excluding a $40.0 million first tier excess segment of
insolvent coverage for policy years 1979 through 1984 (the "Insolvent
Segment"). All of the Company's and Fuller-Austin's liability insurance
policies cover indemnity payments and defense fees and expenses subject to
applicable policy terms and conditions.
Coverage Litigation
The Company and Fuller-Austin have instituted litigation in Los Angeles
Superior Court, California, against their primary and excess insurance
carriers to obtain declaratory judgments from the court regarding the
obligations of the various carriers to defend and pay asbestos claims. The
issues in this litigation include the aggregate liability of the carriers,
the triggering and drop-down of excess coverage to cover the Insolvent
Segment and allocation of losses among multiple carriers including
insolvent carriers and various other issues related to the interpretation
of the policy contracts. All of the carrier defendants have filed general
denial answers.
Although there can be no assurances as to the outcome of this litigation,
management believes that it is probable that Fuller-Austin will prevail in
obtaining judicial rulings confirming the availability of a substantial
portion of the coverage. Based on a review of the independent ratings of
these carriers, the Company and Fuller-Austin believe that a substantial
portion of this coverage will continue to be available to meet the claims.
Fuller-Austin recorded in Other Assets $49.0 million and $50.2 million at
July 2, 1998 and December 31, 1997 respectively, representing the amount
that it expects to recover from its insurance carriers for the payment of
currently unsettled and estimated future claims.
The Company cautions, however, that even though the existence and aggregate
dollar amounts of insurance are not generally being disputed, such
insurance coverage is subject to interpretation by the court and the timing
of the availability of insurance payments could, depending upon the outcome
of the litigation and/or carrier settlement negotiations, delay the receipt
of insurance company payments and require Fuller-Austin to assume
responsibility for making interim payment of asbestos defense and indemnity
costs at a time when it may not have adequate cash funds.
While the Company believes that Fuller-Austin has recorded sufficient
liability to satisfy Fuller-Austin's reasonably anticipated costs of
present and future asbestos claimants' suits, it is not possible to predict
the amount or timing of future suits or the future solvency of
Fuller-Austin's insurers. In the event that currently unresolved and future
claims exceed the recorded liability of $50.2 million, the Company and
Fuller-Austin believe that the judicially determined and /or negotiated
amounts of excess and umbrella insurance coverage that will be available to
cover additional claims will be significant; however, it is impossible to
predict whether or not such amounts will be adequate to cover all
additional claims without further contribution by Fuller-Austin.
Possible Global Settlement/Bankruptcy Filing
Representatives of Fuller-Austin are currently in discussions with
representatives of more than 75% of the asbestos claimants and a designated
but not confirmed representative of potential future asbestos claimants
regarding the possibility of a global settlement of all present and future
asbestos claims against Fuller-Austin. If successful, these discussions
could lead to the preparation and filing by Fuller-Austin of a bankruptcy
proceeding under the U.S. Bankruptcy Code (the "Code") that has been
previously approved by the asbestos claimants. It is contemplated that
presently negotiated settlements with certain of the carrier-defendants in
the coverage litigation would also be achieved by Fuller-Austin
concurrently with the confirmation of the Fuller-Austin reorganization plan
as part of the bankruptcy proceeding. The contemplated plan would call for
Fuller-Austin and certain of its insurance proceeds and rights to be placed
in a bankruptcy trust to be administered by unrelated parties for the
benefit of present and future asbestos claimants.
In furtherance of the proposed global settlement, representatives of
Fuller-Austin, its parent and sole stockholder, the Company, the present
asbestos claimants, and the representative of the future unknown claimants
have reached a separate agreement in principle ("Release Agreement"),
contingent on approval of the Plan by the Bankruptcy Court, under which the
Company would be released from any and all present and future liability for
Fuller-Austin asbestos liability in consideration of the transfer of
certain Company property and insurance rights to the Fuller-Austin
bankruptcy trust, and the payment to the trust of certain cash
consideration. The total amount reserved for this purpose was $14.0 million
at December 31, 1997. During the first six months of 1998, approximately
$2.0 million was used for legal and other related costs.
In the event Fuller-Austin is unsuccessful in concluding such negotiations
for a global settlement of all present and future asbestos claims, and
depending on the progress of the coverage litigation, the extent to which
carriers agree to voluntarily pay Fuller-Austin asbestos claims pending the
resolution of the coverage litigation, and the interim cash demands on
Fuller-Austin in connection with pending and future asbestos claims,
Fuller-Austin may seek protection under the Code without a global or other
settlement with the asbestos claimants. Fuller-Austin has been advised by
its bankruptcy counsel that, upon filing for such protection under the
Code, all pending claims against Fuller-Austin (including all asbestos
claims) would be stayed, and the disposition of such claims and all
Fuller-Austin assets, including its insurance assets, would be subject to
the jurisdiction of the U.S. Bankruptcy Court in which Fuller-Austin's
petition is filed.
There can be no assurance at this time that the global settlement will be
concluded. Also, it is impossible to determine whether it will be necessary
for Fuller-Austin to otherwise seek protection from its creditors
(including asbestos claimants) under the Code.
(b) General Litigation
The Company has retained certain liability in connection with its 1989
divestiture of its major electrical contracting business, Dynalectric
Company ("Dynalectric"). The Company and Dynalectric were sued in 1988 in
Bergen County Superior Court, New Jersey, by a former Dynalectric joint
venture partner/subcontractor (subcontractor). The subcontractor has
alleged that its subcontract to furnish certain software and services in
connection with a major municipal traffic signalization project was
improperly terminated by Dynalectric and that Dynalectric fraudulently
diverted funds due, misappropriated its trade secrets and proprietary
information, fraudulently induced it to enter the joint venture, and
conspired with other defendants to commit acts in violation of the New
Jersey Racketeering Influenced and Corrupt Organization Act. The aggregate
dollar amount of these claims has not been formally recited in the
subcontractor's complaint. Dynalectric has also filed certain counterclaims
against the former subcontractor. The Company and Dynalectric believe that
they have valid defenses, and/or that any liability would be offset by
recoveries under the counterclaims. The Company and Dynalectric were found
by a Special Master to have committed certain discovery abuses, but no
monetary amount of sanctions has yet been assessed. The Company and
Dynalectric expect to file an appeal with respect to this finding. In late
1997, the state court granted Dynalectric's Motion to Compel Arbitration
that originally had been filed in 1988. The arbitration commenced in July
1998 and is expected to be completed during 1998. The Company believes that
it has established adequate reserves for the contemplated defense costs and
for the cost of obtaining enforcement of arbitration provisions contained
in the contract.
In November, 1994, the Company acquired an information technology business
which was involved in various disputes with federal and state agencies,
including two contract default actions and a qui tam suit by a former
employee alleging improper billing of a federal government agency customer.
The Company has contractual rights to indemnification from the former owner
of the acquired subsidiary with respect to the defense of all such claims
and litigation, as well as all liability for damages when and if proven. In
October, 1995, one of the federal agencies asserted a claim against the
subsidiary and gave the Company notice that it intended to withhold
payments against the contract under which the claim arose. To date, the
agency has withheld approximately $3.0 million due the Company under one of
the aforementioned disputes. This subsidiary has submitted a demand for
indemnification to the former owner of the subsidiary, which has been
denied. The subsidiary recently received an arbitration award confirming
that it is entitled to indemnification.
As to environmental issues, neither the Company, nor any of its
subsidiaries, is named a Potentially Responsible Party (as defined in the
Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA)) at any site. The Company, however, did undertake, as part of the
1988 divestiture of a petrochemical engineering subsidiary, an obligation
to install and operate a soil and water remediation system at a subsidiary
research facility site in New Jersey and also is required to pay the costs
of continued operation of the remediation system. In addition, the Company,
pursuant to the 1995 sale of its Commercial Aviation Business, is
responsible for the costs of clean-up of environmental conditions at
certain designated sites. Such costs may include the removal and subsequent
replacement of contaminated soil, concrete, tanks, etc., that existed prior
to the sale of the Commercial Aviation Business.
The Company is a party to other civil and contractual lawsuits which have
arisen in the normal course of business for which potential liability,
including costs of defense, constitute the remainder of the $139.6 million
discussed above. The estimated probable liability for these issues is
approximately $10.0 million and is substantially covered by insurance. All
of the insured claims are within policy limits and have been tendered to
and accepted by the applicable carriers. The Company has recorded an
offsetting asset (Other Assets) and liability (long-term liability) of
$10.0 million at July 2, 1998 and December 31, 1997 for these items.
The Company has recorded its best estimate of the aggregate liability that
will result from these matters. While it is not possible to predict with
certainty the outcome of litigation and other matters discussed above, it
is the opinion of the Company's management, based in part upon opinions of
counsel, insurance in force and the facts currently known, that liabilities
in excess of those recorded, if any, arising from such matters would not
have a material adverse effect on the results of operations, consolidated
financial position or liquidity of the Company over the long-term. However,
it is possible that the timing of the resolution of individual issues could
result in a significant impact on the operating results and/or liquidity
for one or more future reporting periods.
The major portion of the Company's business involves contracting with
departments and agencies of, and prime contractors to, the U.S. Government,
and such contracts are subject to possible termination for the convenience
of the government and to audit and possible adjustment to give effect to
unallowable costs under cost-type contracts or to other regulatory
requirements affecting both cost-type and fixed-price contracts. Payments
received by the Company for allowable direct and indirect costs are subject
to adjustment and repayment after audit by government auditors if the
payments exceed allowable costs. Audits have been completed on the
Company's incurred contract costs through 1986 and are continuing for
subsequent periods. The Company has included an allowance for excess
billings and contract losses in its financial statements that it believes
is adequate based on its interpretation of contracting regulations and past
experience. There can be no assurance, however, that this allowance will be
adequate. The Company is aware of various costs questioned by the
government, but cannot determine the outcome of the audit findings at this
time. In addition, the Company is occasionally the subject of
investigations by the Department of Justice and other investigative
organizations, resulting from employee and other allegations regarding
business practices. In management's opinion, there are no outstanding
issues of this nature at July 2, 1998 that will have a material adverse
effect on the Company's consolidated financial position, results of
operations or liquidity.
10. The Company has three reportable segments: Information and Engineering
Technology (I&ET), Aerospace Technology (AT) and Enterprise Management
(EM).
Revenues, operating profit and identifiable assets by segment are presented
below:
Three Months Ended Six Months Ended
------------------ ----------------
July 2, June 26, July 2, June 26,
1998 1997 1998 1997
------- -------- ------- --------
Revenues
- --------
I&ET $ 77,866 $ 69,023 $152,024 $131,588
AT 119,915 113,441 236,412 218,035
EM 105,821 106,231 213,039 210,209
-------- -------- -------- --------
$303,602 $288,695 $601,475 $559,832
======== ======== ======== ========
Operating Profit
- ----------------
I&ET $ 3,677 $ 2,963 $ 8,089 $ 6,811
AT 4,936 4,881 8,976 7,961
EM 5,586 4,037 10,633 8,953
------- ------- ------- -------
14,199 11,881 27,698 23,725
Corporate selling and administrative 4,793 4,353 10,061 8,793
Interest (net expense) 3,527 3,270 6,971 5,893
Goodwill amortization 401 389 939 783
Minority interest included in
operating profit (528) (203) (947) (611)
Acquisition costs 177 318 357 1,212
Other miscellaneous (24) 74 (395) (30)
-------- ------- --------- --------
Earnings from continuing operations
before income taxes and minority
interest $ 5,853 $ 3,680 $ 10,712 $ 7,685
======== ======== ======== ========
July 2, December 31,
1998 1997
------- ------------
Identifiable Assets
- -------------------
I&ET $120,582 $118,016
AT 79,328 75,239
EM 96,183 70,026
Other (a) 51,195 51,575
Corporate 51,375 67,728
-------- --------
$398,663 $382,584
======== ========
(a) Includes assets related to probable insurance indemnification
recoveries pertaining to a former subsidiary
(See Note 9).
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of financial condition and results of operations should
be read in conjunction with the 1997 Form 10-K.
Working capital at July 2, 1998 was $83.3 million compared to $84.2 million
at December 31, 1997, a decrease of $0.9 million.
Cash used by operations was $2.2 million in the first six months of 1998, as
compared to $11.2 million cash provided in the first six months of 1997, an
increase in cash used of $13.4 million. The increase resulted mostly from
increases in accounts receivable, primarily from increase revenues and start-up
of new contracts such as Department of Justice contract for the Immigration and
Naturalization Service. Excluding the effect of changes in current assets and
liabilities, operating activities produced a positive cash flow of $11.4 million
in 1998 as compared to $10.2 million in 1997. The increase in cash flow
attributable to increased earnings from continuing operations was partially
offset by a decrease in non-cash charges, primarily depreciation and
amortization.
Investing activities used funds of $16.7 million in the first six months 1998,
principally for the acquisition of FMAS, the purchase of property and equipment,
and for the purchase of new software for internal use as part of the Company's
year 2000 plan. The Company has capitalized $3.1 million of internal use
software and anticipates capitalizing another $8.0 million over the next year.
During the first six months of 1997, cash used by investing activities was $3.7
million, principally for the purchase of property and equipment.
Financing activities provided funds of $4.0 million in the first six months of
1998. During the first half of 1998, the Company borrowed $20.0 million and
repaid $18.0 million of the Contract Receivable Collateralized Class B Variable
Rate Notes to finance working capital needs. During the first half of 1997,
financing activities used funds of $0.5 million. The proceeds from the issuance
of the 9.5% Senior Notes and the Contract Receivable Collateralized Notes Series
1997-1 were used to retire the Contract Receivable Collateralized Notes Series
1992-1, to a make a loan to the Employee Stock Ownership Plan to fund the
purchase of the Class C Preferred Stock, to fund the Company's purchase of
common stock and warrants from investors and to pay transaction fees associated
with the placement of the Senior Notes.
In the second half 1998, the Company anticipates a global settlement of the
Fuller-Austin Asbestos lawsuits under which the Company would be released from
any and all present and future liability for Fuller-Austin asbestos liability in
consideration of the transfer of certain Company property and insurance rights
to the Fuller Austin bankruptcy trust, and payment to the trust of certain cash
considerations. This settlement is expected to use cash of approximately $8.5
million to $10.5 million in the last six months of 1998.
At July 2, 1998, $75.3 million of accounts receivable are restricted as
collateral for the Contract Receivable Collateralized Notes Series 1997-1.
At July 2, 1998, backlog (including option years on government contracts) was
$3.5 billion compared to $3.6 billion at December 31, 1997, a net decrease of
$0.1 billion.
Results of Operations
Revenues for the second quarter and first half of 1998 were $303.6 million and
$601.5 million, respectively, as compared to $288.7 million and $559.8 million
for the comparable periods in 1997, an increase of $14.9 million and $41.6
million, respectively. Information and Engineering Technology (I&ET), Aerospace
Technology (AT) and Enterprise Management (EM) reported revenues of $77.9
million, $119.9 million and $105.8 million, respectively, for the second quarter
of 1998 as compared to $69.0 million, $113.4 million and $106.2 million for the
same quarter in 1997. Revenues for the first half of 1998 for I&ET, AT and EM
were $152.0 million, $236.4 million and $213.0 million, respectively, an
increase of $20.4 million, $18.4 million and $2.8 million, respectively, over
the same period in 1997. Increases in I&ET's second quarter and first half
revenues were attributable to increased tasking and level of effort on several
existing contracts and to the win of a new contract for Connecticut Medicaid.
AT's second quarter and first half revenue increases resulted primarily from
three new contract wins in Kuwait, Angola, and Qatar. Increased services on
existing contracts and the installation of a new information system at Fort
Rucker also contributed to second quarter and first half revenue increases.
Partially reducing these increases were reduced business volumes on several
existing contracts and a contract completion. Revenues increased slightly for EM
for the first half of 1998. Increases in revenues due to a Department of Justice
contract (Immigration and Naturalization Service), the addition of the
operations of a seventh ship in the marine services area, and the acquisition of
FMAS Corporation, a medical outcome measurement and data abstraction services
company, were offset by reduced level of services on several contracts as well
as completion of several contracts. For the second quarter 1998, decreases in
revenues were attributable to the aforementioned completion of several
contracts, coupled with the reduction in the level of effort on existing
contracts.
In July 1998, EM was informed that its customer at Rocky Flats would not
exercise the remaining two one-year options on its contract. This event will not
have a significant financial impact on 1998. This contract was expected to
generate revenues of $35 million to $50 million per year and operating profit of
$2.0 million to $3.0 million for the next two years. Management anticipates the
award of two significant contract wins in EM that will substantially offset this
lost business in those future years.
Cost of Services for the second quarter and first half of 1998 was 94.8% and
95.1% of revenue as compared to 95.7% and 95.8% for the comparable periods in
1997. This resulted in gross margins of $15.7 million (5.2%) for the second
quarter of 1998 as compared to $12.3 million (4.3%) for the second quarter of
1997 and $29.6 million (4.9%) and $23.7 million (4.2%) for the first half of
1998 and 1997, respectively. Contract wins and increased level of effort on
existing contracts contributed to the improvement in gross margin and offset any
decreases attributable to contract losses. Additionally, the Company charged
$0.5 million to Cost of Services in the first quarter of 1997, representing a
partial write-off of certain purchased software as the result of net realization
concerns and $0.4 million of residual losses recorded in conjunction with the
closure of the Company's operations in Mexico.
Interest expense was $3.9 million in the second quarter of 1998, unchanged from
the comparable period in 1997. For the first half of 1998, interest expense was
$7.6 million, up $0.7 million compared to $6.9 million for the first half of
1997, primarily due to increased levels of indebtedness.
The provision for income taxes in 1998 and 1997 is based upon an estimated
annual effective tax rate, including the impact of differences between the book
value of assets and liabilities recognized for financial reporting purposes and
the basis recognized for tax purposes.
Year 2000
The "Year 2000" issue ("Y2K") concerns the inability of some computer software
and hardware to accommodate "00" in the two digit data field used to identify
the year. An analysis of the Company's core systems (financial, payroll, and
human resources) software has been completed and a replacement of current
software with a new enterprise resource planning software is underway. Projected
completion of the replacement of all core systems is September 1999. The
implementation phase of the project is on schedule at the end of the second
quarter of 1998. Total expenditures of $15 million in 1998 and 1999 are
anticipated to complete this resystemization of which $11 million is expected to
be capitalized.
In the event the replacement of core systems cannot be completed before the end
of the millennium, a contingency plan calling for remediation of the current
commercial software packages is in place. This remediation has either been
completed by the vendors of the commercial packages, or is in process, and
compliant packages can be obtained if necessary.
A Year 2000 Program Management Plan has been developed and put in place to
address all other Y2K compliance issues. A multifunctional task group is
overseeing assessment and remediation or replacement efforts in the areas of
core systems, network and office automation and field IT and non-IT systems. The
assessment and remediation/replacement phases are well underway, and no major
problems have been identified that would materially affect the company's ability
to perform on any of its current contracts.
An employee awareness program has been initiated that is intended to inform
employees and managers of the potential for Y2K problems. This program is
intended to address "home grown" office automation systems. None of these types
of systems is considered mission critical to the company as a whole.
Infrastructure items that may have Y2K compliance problems such as desktop
workstations, network components, servers, etc. are being systematically
replaced as part of the normal infrastructure replacement strategy. The annual
expenditures for these components are not significantly above levels that can be
expected in the normal course of business. Depreciation and amortization
expenses for the resystemization and for these infrastructure components are
allowable costs under government contracts.
Forward Looking Statements
This Form 10-Q contains statements which, to the extent that they are not
recitations of historical fact, constitute "forward looking-statements" that are
based on management's expectations, estimates, projections and assumptions.
Words such as "expects," "anticipates," "plans," "believes," "estimates,"
variations of such words and similar expressions are intended to identify such
forward-looking statements that include, but are not limited to, projections of
future performance, assessment of contingent liabilities and expectations
concerning liquidity, cash flow and contract awards. Such forward-looking
statements are made pursuant to the safe harbor provision of the Private
Securities Litigation Reform Act of 1995. These statements are not guarantees of
future performance and involve certain risks and uncertainties that are
difficult to predict. Therefore, actual future results and trends may differ
materially from what is forecast in forward-looking statements due to a variety
of factors, including the Company's successful execution of internal performance
plans; the outcome of litigation in process; labor negotiations; changing
priorities or reductions in the U.S. Government defense budget; and termination
of government contracts due to unilateral government action.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
This item is incorporated herein by reference to Note 9 to the Consolidated
Condensed Financial Statements included elsewhere in this quarterly Report on
Form 10-Q.
ITEM 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of stockholders, held on July 1, 1998, at DynCorp's
headquarters in Reston, Virginia, the stockholders of DynCorp:
(a) Re-elected the following individuals to the Board of Directors for
three-year terms:
Votes Cast For Votes Withheld
Dan R. Bannister 9,121,351 522,263
Paul G. Kaminski 9,131,038 522,576
David L. Reichardt 9,171,936 481,678
(b) Ratified the appointment of Authur Andersen LLP, public accountants, to
audit the consolidated financial statements of the Company as of and for the
fiscal year ending December 31, 1998. There were 9,109,921 votes for the
appointment, 248,337 votes withheld, and 295,355 abstentions.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None filed
(b) Reports on Form 8-K
None filed
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNCORP
/s/ P. C. FitzPatrick
Date: August 17, 1998
P.C. FitzPatrick
Senior Vice President
and Chief Financial Officer
/s/ J. J. Fitzgerald
Date: August 17, 1998 J.J. Fitzgerald
Vice President and Controller
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
SECOND QUARTER FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FORM 10-Q
</LEGEND>
<S> <C>
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<PERIOD-END> JUL-02-1998
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