Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[x] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 1998.
OR
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Transition Period from to .
Commission File No.1-7348
DYNAMICS RESEARCH CORPORATION
(Exact name of registrant as specified in its charter)
Massachusetts 04-2211809
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
60 Frontage Road, Andover, Massachusetts 01810-5498
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (978) 475-9090
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 .
The number of shares outstanding of the Registrant's Common stock,
par value $.10 per share, at November 12, 1998 was 7,369,190 shares.
DYNAMICS RESEARCH CORPORATION
INDEX
Page
Part I Financial Information Number
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997 . . . . . 3
Consolidated Statements of Operations -
Three and Nine Months Ended September 30, 1998 and
September 30, 1997 . . . . . . . . . . . . . . . . 4
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1998 and
September 30, 1997 . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements . . . . . . 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations . . . 7
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . 12
Signature . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
PART I. FINANCIAL INFORMATION
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars except share data)
(unaudited)
ASSETS September 30, 1998 December 31, 1997
CURRENT ASSETS:
Cash and cash equivalents $ 704 $ 542
Receivables, less allowances of
$198 in 1998 and $217 in 1997 32,470 17,397
Unbilled expenditures and fees
on contracts in process 27,616 32,175
Inventories 2,697 3,377
Refundable income taxes 873 878
Prepaid expenses and other current assets 1,340 1,668
Total current assets 65,700 56,037
Property, plant and equipment, at cost
Land 1,126 1,126
Building 7,774 7,774
Machinery and equipment 44,078 41,426
Less accumulated depreciation
and amortization (32,582) (28,098)
Net property, plant and equipment 20,396 22,228
Excess of purchase price over net assets
of business acquired, net - 594
Total assets $ 86,096 $ 78,859
LIABILITIES AND SHAREHOLDERS' INVESTMENT
CURRENT LIABILITIES:
Accounts and drafts payable $ 6,489 $ 8,355
Accrued payroll and employee benefits 8,753 8,032
Other accrued expenses 3,089 4,251
Accrued and current deferred income taxes 8,685 8,999
Total current liabilities 27,016 29,637
Long-term debt 22,000 10,000
Deferred income taxes 75 75
SHAREHOLDERS' INVESTMENT:
Preferred stock, par value $.10 per share -
5,000,000 shares authorized, none issued
Common stock, par value $.10 per share -
Authorized - 30,000,000 shares
Issued - 8,733,016 shares in 1998
and 7,366,484 in 1997 873 737
Less: Treasury stock - 1,363,826 in 1998
and 1,077,612 in 1997, at par value (136) (108)
Capital in excess of par value 27,474 14,506
Retained earnings 8,794 24,012
Total shareholders' investment 37,005 39,147
Total liabilities and
shareholders' investment $ 86,096 $ 78,859
The accompanying notes are an integral part of these consolidated
financial statements.
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands of dollars, except per share data)
(unaudited)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
Sept. 30, 1998 Sept. 30, 1997 Sept. 30, 1998 Sept. 30, 1997
Product sales and
contract revenue:
Contract revenue $ 38,103 $ 36,206 $ 114,871 $ 96,402
Product sales 6,528 7,063 21,802 20,021
Total revenue 44,631 43,269 136,673 116,423
Cost and expenses:
Cost of contract
revenue 34,270 33,310 103,902 87,125
Cost of product
sales 5,274 4,940 16,926 15,319
Selling, engineering
and administrative
expenses 5,559 3,548 15,058 10,135
Total operating costs
and expenses 45,103 41,798 135,886 112,579
Operating income (loss) (472) 1,471 787 3,844
Interest expense
(income), net 408 (470) 1,163 (72)
Income (loss) before
provision for (benefit
from) income taxes (880) 1,941 (376) 3,916
Provision for (benefit
from) income taxes (375) 218 (164) 1,043
Net income (loss) $ (505) $ 1,723 $ (212) $ 2,873
Net income (loss)
per common share -
Basic * $ (.07) $ .23 $ (.03) $ .38
Net income (loss)
per common share -
Diluted * $ (.07) $ .22 $ (.03) $ .37
Weighted average common
shares outstanding -
Basic* 7,504,679 7,534,508 7,541,328 7,526,430
Weighted average common
shares outstanding -
Diluted* 7,504,679 7,795,155 7,541,328 7,787,077
* Retroactively adjusted for the May 1998 20% stock dividend.
The accompanying notes are an integral part of these consolidated financial
statements.
DYNAMICS RESEARCH CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
(unaudited)
Nine Nine
Months Ended Months Ended
September 30, 1998 September 30, 1997
Cash provided by (used for) operations:
Net income (loss) $ (212) $ 2,873
Depreciation and amortization 5,074 3,781
Deferred Income Taxes - (186)
Provision for receivable reserves (19) (16)
4,843 6,452
Cash provided by (used for)
working capital:
Receivables (15,054) (5,901)
Unbilled expenditures and fees
on contracts in process 4,559 (4,816)
Inventories 680 90
Refundable income taxes 5 155
Prepaid expenses and other
current assets 328 154
Accounts and drafts payable (1,866) (1,735)
Accrued payroll and employee benefits 721 1,923
Other accrued expenses (1,162) 2,028
Accrued and current deferred
income taxes (314) 1,941
(12,103) (6,161)
Net cash provided by (used for)
operations (7,260) 291
Cash used for investing activities:
Additions to property, plant
and equipment, net (2,652) (4,343)
Excess of purchase price over net assets
of business acquired, net - (125)
Net cash used for investing activities: (2,652) (4,468)
Cash provided by (used for)
financing activities:
Net borrowings under line
of credit agreements 12,000 5,625
Principal payments under
long-term borrowings - (1,501)
Proceeds from the exercise
of stock options 346 430
Purchase of treasury shares (2,272) (518)
Net cash provided by
financing activities 10,074 4,036
Net increase (decrease) in cash
and cash equivalents 162 (141)
Cash and cash equivalents at the
beginning of the year 542 234
Cash and cash equivalents at the
end of the period $ 704 $ 93
Supplemental disclosures of cash flow information:
Cash paid during the nine month period for:
Interest $ 531 $ 612
Income taxes $ 10 $ 339
The accompanying notes are an integral part of these consolidated financial
statements.
DYNAMICS RESEARCH CORPORATION
Notes to Consolidated Financial Statements
Note 1. The unaudited consolidated financial statements presented herein
have been prepared by the registrant pursuant to the rules and regulations
of the Securities and Exchange Commission. Certain information in footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles has been condensed or omitted
pursuant to such rules and regulations, although the registrant believes
that the disclosures are adequate to make the information presented not
misleading. The accompanying consolidated financial statements have not
been audited by independent accountants, but in the opinion of the management
such financial statements include all adjustments, consisting only of normal
recurring adjustments, necessary to fairly present the results of operations.
The results of operations for the three and nine months ended September 30,
1998 may not be indicative of the results that may be expected for the year
ending December 31, 1998.
Note 2. Inventories are comprised of the following (in thousands of dollars):
September 30, 1998 December 31, 1997
Work in process $ 598 $ 1,364
Raw materials and subassemblies 2,099 2,013
Total inventories $ 2,697 $ 3,377
Note 3. The Company adopted Statement of Financial Accounting Standard
No. 128, "Earnings per Share," ("SFAS 128") in the year ended December 31,
1997. SFAS 128 requires the presentation of basic and diluted EPS. Basic
net income per share is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding for
the period. Diluted net income per share is computed using the weighted
average number of common shares outstanding plus the dilutive effect of
common stock equivalents (using the treasury stock method).
The following table presents the calculation of earnings per share:
(in thousands except share and per share data)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
Sept. 30, 1998 Sept. 30, 1997 Sept. 30, 1998 Sept. 30, 1997
Net income (loss) $ (505) $ 1,723 $ (212) $ 2,873
Basic:
Weighted average
common shares
outstanding 7,504,679 7,534,508 7,541,328 7,526,430
Net income (loss)
per share $ (.07) $ .23 $ (.03) $ .38
Diluted:
Weighted average
common shares
outstanding 7,504,679 7,534,508 7,541,328 7,526,430
Dilutive effect
of stock options - 260,647 - 260,647
Weighted average
common and common
equivalent shares
outstanding 7,504,679 7,795,155 7,541,328 7,787,077
Net income (loss)
per share $ (.07) $ .22 $ (.03) $ .37
Item 2. Management's Discussion and Analysis
Overview
Dynamics Research Corporation (the "Company" or "DRC") provides
information technology services for government and private-sector clients.
The Company develops and operates complex computer systems and communications
networks, and provides engineering and management consulting services. DRC
also designs and manufactures high-precision components for industrial
measurement and control.
The Company has focused on broadening its customer base utilizing the
expertise and systems developed in serving the Department of Defense, to
service other government agencies and businesses. Non-defense information
technology services and sales of precision manufactured products accounted
for approximately 41% of revenues for the first nine months of 1998, up from
34% in calendar year 1997.
Results of Operations
Three Months Ended September 30, 1998 Compared to
Three Months Ended September 30, 1997
Total revenues increased 3% to $44,631,000 in the third quarter of 1998
compared with $43,269,000 in the third quarter of 1997. Contract revenue
for the systems and service segment increased 5% for the third quarter of
1998 compared with the third quarter of 1997. The growth was principally
attributable to performance on two major state contracts as well as
broad-based growth in the Company's defense business. The Company is
providing the State of Ohio's Department of Health and Human Services with
statewide computer network infrastructure. Similar infrastructure as well as
software implementation services are being provided for the State of
Colorado's child protection and juvenile justice agencies.
Revenue from sales of telecommunications fraud control systems decreased
57% to $250,000 in the third quarter of 1998 compared with $620,000 in the
third quarter of 1997. The reduction in revenues is attributable to a
limited market for the current version of the software pending release of a
new version currently under development and delays in introduction of a
related software product. There were no sales of VisualMagic software for
the third quarter of 1998 and $3,000 for the third quarter of 1997.
Third quarter 1998 product sales decreased 8% compared to the same period
in 1997. This decrease was primarily related to decreased sales of precision
components to the medical products sector and decreased sales to certain of
the Company's customers who have significant sales in Asian markets,
partially offset by increased sales of custom encoders to a customer in the
automotive industry.
Cost of contract revenue as a percentage of contract revenue decreased to
90% in the third quarter of 1998 compared to 92% in the third quarter of
1997. Included in costs of contract revenues are costs related to sales of
telecommunications fraud control systems of $987,000 and $1,087,000 in the
third quarter of 1998 and 1997, respectively.
Cost of product sales as a percentage of product sales for the third
quarter of 1998 increased to 81% from 70% for the same period in 1997. This
increase was related to a change in the precision manufactured products
sales mix away from certain high margin electroformed components in the
third quarter of 1998 as compared to the same period in 1997.
Selling, engineering and administrative expenses increased 57% for the
third quarter of 1998 compared to the third quarter of 1997. The increase
is a result of an increase in the Company's selling and engineering expenses
in connection with the Company's business development initiative in the
telecommunications industry.
DRC has made significant investments in telecommunications fraud control
systems and software technologies. Third quarter 1998 results include
$1,959,000 of net operating costs related to the telecommunications
business and $494,000 of costs related to VisualMagic development. Third
quarter 1997 results include $536,000 and $463,000 of costs related to the
telecommunications business and VisualMagic development, respectively.
Net interest expense increased to $408,000 in the third quarter of 1998
compared with income of $470,000 in the third quarter of 1997. The third
quarter of 1997 includes interest income of $688,000 related to a research
and development tax credit. Substantial revenue growth and delays in
billing certain state and government customers in 1998 resulted in higher
working capital requirements that were funded with additional borrowings.
The Company's effective income tax rate for the third quarter of 1998 was
a benefit of 43% compared with a provision of 11% for the third quarter of
1997. The Company's tax provision for the third quarter of 1997 reflects a
one-time benefit of $586,000 resulting from a refund of income taxes due to
the Company's prior years' research and development expenses. The Company
accounts for income taxes using the liability method as set forth in
Statement of Financial Accounting Standards No. 109 (SFAS 109).
Nine Months Ended September 30, 1998 Compared to
Nine Months Ended September 30, 1997
Total revenues increased 17% to $136,673,000 in the first nine months of
1998 compared with $116,423,000 in the same period of 1997. Contract revenue
for the systems and service segment increased 19% for the first nine months
of 1998 compared with the same period of 1997. The growth was principally
attributable to performance on the two major state contracts discussed
previously, as well as broad based growth in the Company's defense business.
Revenue from the sale of telecommunications fraud control systems
increased 24% to $1,989,000 in the first nine months of 1998 compared with
$1,609,000 in the first nine months of 1997. The increase in revenues is
attributable to software sales and ongoing maintenance revenues. Revenue for
VisualMagic software for the first nine months of 1998 and 1997 was minimal.
Product sales during the first nine months of 1998 increased 9% compared
to the same period in 1997. This growth was primarily related to increases
in sales of electroformed components to an inkjet printer manufacturer and
sales of custom encoders to a customer in the automotive industry. The
first nine months of 1998 reflect reduced sales to certain of the Company's
customers with significant Asian markets. To date, the impact of the Asian
crisis on the Company's product sales has been more than offset by the sales
increases discussed above.
Cost of contract revenue as a percentage of contract revenue increased to
90.5% in the first nine months of 1998 compared to 90.4% in the same period of
1997. Included in cost of contract revenue are costs related to sales of
telecommunications fraud control systems of $4,175,000 and $2,716,000 in the
first nine months of 1998 and 1997, respectively.
Cost of goods as a percentage of product sales increased to 78% in the
first nine months of 1998 from 77% for the same period in 1997.
Selling, engineering and administrative expenses increased 49% in the
first nine months of 1998 compared to the same period in 1997. As discussed
previously, this increase is a result of higher levels of selling and
engineering costs in connection with the Company's telecommunications
business initiative.
Results for the first nine months of 1998 include $5,304,000 of net
operating costs related to the telecommunications business and $1,502,000 of
costs related to Visual Magic development. Nine month 1997 results
include $1,440,000 and $1,516,000 of costs related to the telecommunications
business and Visual Magic development, respectively.
Net interest expense increased to $1,163,000 in the first nine months of
1998 compared with interest income of $72,000 in the first nine months of
1997. The first nine months of 1997 includes interest income of $688,000
related to a research and development tax credit. Substantial revenue
growth and delays in billing certain government customers resulted in higher
working capital requirements that were funded with additional borrowings.
The Company's effective income tax rates for the first nine months of
1998 and 1997 were a benefit of 44% and a provision of 23%, respectively. As
mentioned previously, the Company's tax provision for the third quarter of
1997 reflects a one-time benefit resulting from a refund of income taxes due
to the Company's prior years' research and development expenses.
Liquidity and Capital Resources
During the first nine months of 1998, the Company's primary source of
liquidity has been its revolving credit facility. Working capital
requirements related to the substantial increase in sales and delays in
billing certain government customers have been funded with additional
borrowings under the Company's credit facility. Working capital increased to
$38,684,000 at September 30, 1998 from $26,400,000 at December 31, 1997.
This increase was primarily attributable to increases in receivables
partially offset by decreases in unbilled expenditures and fees on contracts
in process. Debt increased $12,000,000 to $22,000,000 to support the
increase in working capital. Capital spending during the first nine months
of 1998 was $2,652,000, consisting principally of office computer equipment.
The Company spent $2,272,000 during the first nine months of 1998 for the
purchase of treasury shares compared with $518,000 during the first nine
months of 1997.
At September 30, 1998, $8,000,000 was available for working capital
purposes under the Company's revolving credit facility. The Company believes
that its current assets, cash flow from operations and available bank lines
of credit will be sufficient to support its normal operating and capital
requirements for the balance of 1998. The Company does not have any
significant capital commitments at September 30, 1998 outside the ordinary
course of business.
Year 2000 Disclosure
Many existing computer programs use only two digits, rather than four,
to represent a year. Date-sensitive software or hardware written or
developed in this fashion may not be able to distinguish between 1900 and
2000, and programs written in this manner that perform arithmetic operations,
comparisons or sorting of date fields may yield incorrect results when
processing a Year 2000 date. This Year 2000 problem could potentially cause
system failures or miscalculations that could disrupt operations.
The Company's State of Readiness
The Company is in the process of identifying and remediating Year 2000
issues in four areas: (i) information technology ("IT") and financial
systems, (ii) non-IT systems, (iii) third-party vendors and suppliers and
(iv) systems it has implemented and maintains for various customers. The
Company believes its IT and non-IT systems will be Year 2000 compliant by
the end of 1999.
The Company has completed a review of its financial and other
significant IT systems and is in the process of remediating identified
material Year 2000 problems. The primary required hardware and operating
system platform upgrade is scheduled for completion in January 1999.
Necessary application upgrades or remediation and testing are expected to be
completed by mid-1999. The Company also conducted a review of all its other
computers earlier this year (including desktops, servers and mainframes) and
has addressed all material Year 2000 problems. All of the Company's computer
and equipment vendors have been contacted to verify Year 2000 compliance.
Based on their responses, all products requiring replacement or upgrade are
expected to be Year 2000 compliant by the end of 1998. In the case of third
party licensed commercial off-the-shelf products, the Company has determined
that they are either Year 2000 compliant or the licensor has released a
compliant version that the Company will migrate to by mid-1999. While the
Company expects that all financial and significant IT-related systems will
be Year 2000 compliant by mid-1999, there can be no assurance that corrective
actions will be completed in a timely manner.
The Company has completed a full review of all process control
components, including safety equipment, in manufacturing and production
facilities. Currently, the Company is in the process of upgrading or
replacing certain components of the phone, security, building access, HVAC
and lighting systems, which is expected to be completed in early 1999. The
Company anticipates that all other process control components will be Year
2000 compliant by mid-1999. However, there can be no assurance that such
upgrades and replacements will occur in a timely manner.
The Company is in the process of requesting Year 2000 compliance
information from its employee benefit service suppliers and expects
responses from each supplier by early 1999. The Company is currently aware
of one supplier that has a Year 2000 compliance issue and is working toward
a resolution of such issue. The Company is also in the process of developing
Year 2000 questionnaires to be sent to its major power, energy and
communications service suppliers beginning in early 1999. The Company
expects to have addressed all Year 2000 issues with third party suppliers
by mid-year 1999. The Company has contacted its suppliers of financial
services regarding computer interface changes and has requested the status
of their Year 2000 programs, if this information is not readily available on
their web-sites. Any necessary interface upgrades are expected to be
completed by mid-1999, although the completion of such upgrades in a timely
manner depends upon the readiness and willingness of suppliers to cooperate
and provide this information in a timely manner, and cannot be assured.
However, the Company intends to identify and prioritize critical suppliers
and communicate with them regarding their plans and progress in addressing
Year 2000 issues.
The Company is in the process of completing its Year 2000 remediation,
validation testing and implementation activities for systems it had
previously implemented and has continued to maintain for various customers.
This process is scheduled to be completed and tested in early 1999. The
Company previously developed and marketed commercial off-the-shelf products
which are currently Year 2000 compliant.
The Company's Year 2000 Risk
Based on the efforts described above, the Company currently believes
that its systems will be Year 2000 compliant in a timely manner. The Company
has completed the process of identifying Year 2000 issues in its IT and
non-IT systems and expects to complete any remediation efforts by mid-1999.
However, there can be no assurance that all Year 2000 problems will be
successfully identified, or that the necessary corrective actions will be
completed in a timely manner. Failure to successfully identify and remediate
Year 2000 problems in critical systems in a timely manner could have a
material adverse effect on the Company's results of operations, financial
position or cash flow.
In addition, the Company believes that there is risk relating to
significant service suppliers' failure to remediate their Year 2000 issues
in a timely manner. Although the Company is communicating with its suppliers
regarding the Year 2000 problem, the Company does not know whether these
suppliers' systems will be Year 2000 compliant in a timely manner. If one
or more significant suppliers are not Year 2000 compliant, this could have a
material adverse effect on the Company's results of operations, financial
position or cash flow.
The Company's Contingency Plans
The Company plans by mid-year 1999 to develop contingency plans to be
implemented in the event planned solutions prove ineffective in solving Year
2000 compliance. If it were to become necessary for the Company to implement
a contingency plan, it is uncertain whether such plan would succeed in
avoiding a Year 2000 issue which may otherwise have a material adverse
effect on the Company's results of operations, financial position or cash
flow.
The Company's Costs of Year 2000 Remediation
The Company anticipates the total identified cost of its Year 2000
effort will be between $382,000 and $475,000, of which it has expensed
approximately $83,000 as of September 30, 1998. The estimate excludes labor
costs which predated the formal corporate Year 2000 effort and certain
current labor costs at the divisional level which would be difficult to
track. The total cost estimate includes estimated and actual amounts to
remediate or replace certain software, routers, security chips, the phone
system and any other items or systems identified in the Year 2000 effort,
consulting fees for a Year 2000 review, and approximately $198,000 of
redeployed labor expense. The total estimated cost of redeployed labor
within the corporate information systems department is equal to approximately
9% of that department's total maintenance labor budget through the end of the
Year 2000 effort. There can be no assurance that the costs associated with
the Year 2000 problem will not be greater than anticipated. The Company has
deferred a financial and project accounting system upgrade due to its Year
2000 efforts, but does not believe such deferral will have a material
adverse effect on the Company's business.
Forward-Looking Information
This report includes certain forward-looking statements about the
Company's business including developments and intentions relating to
strategic investment programs, cash flow requirements, research and
development spending, cash flow expectations and Year 2000 readiness.
Such forward-looking statements are subject to risk and uncertainties that
could cause the actual results to vary materially. These risks and
uncertainties, discussed in more detail in the Company's Form 10-K for the
year ended December 31, 1997, include ability to consummate strategic
transactions related to the Company's commercial business investments,
possible reductions in federal funding for the Company's customers and
potential customers, concentration of customers, risks of sustaining existing
contracts and orders thereunder at the same or increasing levels and of
obtaining new contracts, high levels of competition and difficulties of
entering new markets, government contracting issues, including audit
adjustments and costs of completing fixed-price contracts, supply
difficulties, warranty claims, and factors affecting the business segments
in which the Company operates and the economy generally.
PART II. OTHER INFORMATION
Item 6. (a) Exhibits
(27.1) Financial Data Schedule
Item 6. (b) Reports on Form 8-K
The Registrant did not file any reports on Form 8-K during the
three month period for which this report is filed.
SIGNATURE
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.
DYNAMICS RESEARCH CORPORATION
(Registrant)
Date: November 16, 1998 By: /s/ Douglas R. Potter
Douglas R. Potter
Vice President of Finance
and Chief Financial Officer
(Principal financial and
accounting officer)
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