##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

|    |  |                                                                     | 
|--- |  | ------------------------------------------------------------------- | 
|[x] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  | 
|    |  | EXCHANGE ACT OF 1934                                                | 
|    |  |                                                                     | 
|    |  | For the quarterly period ended September 30, 2003                   | 
|    |  |                                                                     | 
|    |  | OR                                                                  | 
|    |  |                                                                     | 
|[ ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES | 
|    |  | EXCHANGE ACT OF 1934                                                | 

For the transition period from    to

Commission file number 000-02479

DYNAMICS RESEARCH CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

|                                                                                 |  |                                                
|-------------------------------------------------------------------------------- |  | -----------------------------------------------
|Massachusetts
(State or other Jurisdiction of
Incorporation or Organization)     |  | 04-2211809
(I.R.S. Employer Identification No.)
|                                                                                 |  |                                                
|60 Frontage Road
Andover, Massachusetts
(Address of Principal Executive Offices) |  | 01810-5498
(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.

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No .

As of November 3, 2003, there were 8,421,399 shares of the Registrants Common
Stock, $0.10 par value, outstanding.





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TABLE OF CONTENTS



|                                                                   |                                                                                                   |  |  |  |  |  |  | 
|------------------------------------------------------------------ | ------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|                                                                   | Consolidated Balance Sheets                                                                      
|                                                                   | Consolidated Statements of Operations                                                            
|                                                                   | Consolidated Statements of Operations                                                            
|                                                                   | Consolidated Statements of Cash Flows                                                            
|                                                                   | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)                                           
|                                                                   | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
|Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|Item 4. DISCLOSURE CONTROLS AND PROCEDURES                        
|PART II. OTHER INFORMATION                                        
|Item 1. LEGAL PROCEEDINGS                                         
|Item 6. EXHIBITS AND REPORTS ON FORM 8-K                          
|SIGNATURES                                                        
|EX-31.1 SECTION 302 CERTIFICATION OF THE CEO                      
|EX-31.2 SECTION 302 CERTIFICATION OF THE CFO                      
|EX-32.1 SECTION 906 CERTIFICATION OF THE CEO                      
|EX-32.2 SECTION 906 CERTIFICATION OF THE CFO                      



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##### Table of Contents



DYNAMICS RESEARCH CORPORATION

INDEX

|           |  |                                                                                              |  |  |    |             |    | 
|---------- |  | -------------------------------------------------------------------------------------------- |  |  | -- | ----------- | -- | 
|           |  |                                                                                              |  |  |    | Page Number
|           |  |                                                                                              |  |  |    |            
|PART I.    |  | FINANCIAL INFORMATION                                                                        |  |  |    |            
|Item 1.    |  | Consolidated Financial Statements (unaudited)                                                |  |  |    |            
|           |  | Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002                   |  |  | 3  |            
|           |  | Consolidated Statements of Operations for the three months ended September 30, 2003 and 2002 |  |  | 4  |            
|           |  | Consolidated Statements of Operations for the nine months ended September 30, 2003 and 2002  |  |  | 5  |            
|           |  | Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002  |  |  | 6  |            
|           |  | Notes to Unaudited Consolidated Financial Statements                                         |  |  | 7  |            
|Item 2.    |  | Management's Discussion and Analysis of Financial Condition and Results of Operations        |  |  | 20 |            
|Item 3.    |  | Quantitative and Qualitative Disclosures about Market Risk                                   |  |  | 34 |            
|Item 4.    |  | Controls and Procedures                                                                      |  |  |    |            
|           |  |                                                                                              |  |  |    |             |    | 
|PART II.   |  | OTHER INFORMATION                                                                            |  |  |    |            
|Item 1.    |  | Legal Proceedings                                                                            |  |  | 35 |            
|Item 6.    |  | Exhibits and Reports on Form 8-K                                                             |  |  | 36 |            
|Signatures |  |                                                                                              |  |  |    |             | 37 | 

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Dynamics Research Corporation
Consolidated Balance Sheets
(in thousands, except share and per share data)
(unaudited)

|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |              |        |      |         | 
|------------------------------------ | ----------------------------- | ----------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------------- | ------- | ------------ | ------ | ---- | ------- | 
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        | September 30, |         | December 31,
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        | 2003          |         | 2002        
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|Assets                               |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     | Current assets                |                                                                                                                   |                                                                                                   |                                            |        |               |         |              |       
|                                     |                               | Cash and cash equivalents                                                                                         |                                                                                                   | $                                          | 2,694  |               |         | $            | 1,076  |     
|                                     |                               | Accounts receivable, net of allowances of $329 and $373
at September 30, 2003 and December 31, 2002, respectively |                                                                                                   |                                            | 26,723 |               |         |              | 29,819 |     
|                                     |                               | Unbilled expenditures and fees on contracts in process                                                            |                                                                                                   |                                            | 30,291 |               |         |              | 26,614 |     
|                                     |                               | Prepaid expenses and other current assets                                                                         |                                                                                                   |                                            | 5,053  |               |         |              | 1,727  |     
|                                     |                               | Discontinued operations                                                                                           |                                                                                                   |                                            |       |               |         |              | 3,432  |     
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   | Total current assets                       |        |               | 64,761  |              |        |      | 62,668  | 
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     | Noncurrent assets             |                                                                                                                   |                                                                                                   |                                            |        |               |         |              |       
|                                     |                               | Property, plant and equipment, net                                                                                |                                                                                                   |                                            | 18,760 |               |         |              | 15,608 |     
|                                     |                               | Deferred income taxes                                                                                             |                                                                                                   |                                            | 1,501  |               |         |              | 1,559  |     
|                                     |                               | Goodwill                                                                                                          |                                                                                                   |                                            | 26,613 |               |         |              | 26,169 |     
|                                     |                               | Intangible assets, net                                                                                            |                                                                                                   |                                            | 2,765  |               |         |              | 4,066  |     
|                                     |                               | Other noncurrent assets                                                                                           |                                                                                                   |                                            | 1,475  |               |         |              | 1,275  |     
|                                     |                               | Discontinued operations                                                                                           |                                                                                                   |                                            |       |               |         |              | 331    |     
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   | Total noncurrent assets                    |        |               | 51,114  |              |        |      | 49,008  | 
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   | Total assets                               |        | $             | 115,875 |              |        | $    | 111,676 | 
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|Liabilities and stockholders equity |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     | Current liabilities           |                                                                                                                   |                                                                                                   |                                            |        |               |         |              |       
|                                     |                               | Current portion of long-term debt                                                                                 |                                                                                                   | $                                          | 500    |               |         | $            | 500    |     
|                                     |                               | Notes payable and revolver                                                                                        |                                                                                                   |                                            | 8,500  |               |         |              | 14,644 |     
|                                     |                               | Deferred income taxes                                                                                             |                                                                                                   |                                            | 6,907  |               |         |              | 6,524  |     
|                                     |                               | Accounts payable                                                                                                  |                                                                                                   |                                            | 13,066 |               |         |              | 12,334 |     
|                                     |                               | Accrued payroll and employee benefits                                                                             |                                                                                                   |                                            | 15,042 |               |         |              | 11,898 |     
|                                     |                               | Other accrued expenses                                                                                            |                                                                                                   |                                            | 3,552  |               |         |              | 3,531  |     
|                                     |                               | Discontinued operations                                                                                           |                                                                                                   |                                            | 1,143  |               |         |              | 1,009  |     
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   | Total current liabilities                  |        |               | 48,710  |              |        |      | 50,440  | 
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     | Long-term liabilities         |                                                                                                                   |                                                                                                   |                                            |        |               |         |              |       
|                                     |                               | Long-term debt, less current portion                                                                              |                                                                                                   |                                            | 7,875  |               |         |              | 8,250  |     
|                                     |                               | Accrued pension liability                                                                                         |                                                                                                   |                                            | 11,778 |               |         |              | 11,778 |     
|                                     |                               | Other long-term liabilities                                                                                       |                                                                                                   |                                            | 931    |               |         |              | 1,399  |     
|                                     |                               | Discontinued operations                                                                                           |                                                                                                   |                                            | 605    |               |         |              |       |     
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   | Total long-term liabilities                |        |               | 21,189  |              |        |      | 21,427  | 
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   | Total liabilities                          |        |               | 69,899  |              |        |      | 71,867  | 
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     | Commitments and contingencies |                                                                                                                   |                                                                                                   |                                            |        |               |         |              |       
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     | Stockholders equity          |                                                                                                                   |                                                                                                   |                                            |        |               |         |              |       
|                                     |                               | Preferred stock, $0.10 par value, 5,000,000 shares authorized,
no shares issued                                   |                                                                                                   |                                            |       |               |         |              |       |     
|                                     |                               | Common stock, $0.10 par value, 30,000,000 shares authorized:                                                      |                                                                                                   |                                            |        |               |         |              |        |     
|                                     |                               |                                                                                                                   | Issued - 9,747,798 and 9,534,606 shares at September 30, 2003
and December 31, 2002, respectively |                                            |        | 974           |         |              |        | 954  |        
|                                     |                               |                                                                                                                   | Treasury stock -1,379,426 shares at both September 30, 2003
and December 31, 2002                 |                                            |        | (138          | )       |              |        | (138 | )      
|                                     |                               | Capital in excess of par value                                                                                    |                                                                                                   |                                            | 35,654 |               |         |              | 33,844 |     
|                                     |                               | Unearned compensation                                                                                             |                                                                                                   |                                            | (863   | )             |         |              | (816   | )   
|                                     |                               | Accumulated other comprehensive loss                                                                              |                                                                                                   |                                            | (6,881 | )             |         |              | (6,881 | )   
|                                     |                               | Retained earnings                                                                                                 |                                                                                                   |                                            | 17,230 |               |         |              | 12,846 |     
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   | Total stockholders equity                 |        |               | 45,976  |              |        |      | 39,809  | 
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             
|                                     |                               |                                                                                                                   |                                                                                                   | Total liabilities and stockholders equity |        | $             | 115,875 |              |        | $    | 111,676 | 
|                                     |                               |                                                                                                                   |                                                                                                   |                                            |        |               |         |             

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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Dynamics Research Corporation
Consolidated Statements of Operations
(unaudited)
(in thousands, except share and per share data)

|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |   |           |      | 
|------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------------------- | --------------------------------------------- | --------------------------- | - | ------------------ | ---- | ------ | - | --------- | ---- | 
|                                                                                                                                           |                                     |                                               |                             |   | Three months ended
|                                                                                                                                           |                                     |                                               |                             |   | September 30,     
|                                                                                                                                           |                                     |                                               |                             |   | 2003               |      | 2002  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |       
|Contract revenue                                                                                                                           |                                     | $                                             | 60,602                      |   |                    | $    | 45,633 |  
|Product sales                                                                                                                              |                                     |                                               | 1,830                       |   |                    |      | 1,521  |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     | Total revenue                                 |                             |   | 62,432             |      |        |   | 47,154    |     
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|Cost of contract revenue                                                                                                                   |                                     |                                               | 51,386                      |   |                    |      | 38,412 |  
|Cost of product sales                                                                                                                      |                                     |                                               | 1,342                       |   |                    |      | 1,137  |  
|Selling, engineering and administrative expenses                                                                                           |                                     |                                               | 5,018                       |   |                    |      | 4,203  |  
|Amortization of intangible assets                                                                                                          |                                     |                                               | 423                         |   |                    |      | 136    |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     | Total operating costs and expenses            |                             |   | 58,169             |      |        |   | 43,888    |     
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|Operating income                                                                                                                           |                                     |                                               | 4,263                       |   |                    |      | 3,266  |  
|Other income                                                                                                                               |                                     |                                               | 51                          |   |                    |      | 57     |  
|Interest expense, net                                                                                                                      |                                     |                                               | (182                        | ) |                    |      | (103   | )
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|Income from continuing operations before provision for income taxes                                                                        |                                     |                                               | 4,132                       |   |                    |      | 3,220  |  
|Provision for income taxes                                                                                                                 |                                     |                                               | 1,745                       |   |                    |      | 1,236  |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|Income from continuing operations                                                                                                          |                                     |                                               | 2,387                       |   |                    |      | 1,984  |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|Loss from discontinued operations, net of tax benefit of $100 and $118
in the three months ended September 30, 2003 and 2002, respectively |                                     |                                               | (147                        | ) |                    |      | (191   | )
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|Net income                                                                                                                                 |                                     | $                                             | 2,240                       |   |                    | $    | 1,793  |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|Net income per common share                                                                                                                |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           | Basic                               |                                               |                             |   |                    |      |        |   |          
|                                                                                                                                           |                                     | Income from continuing operations             |                             | $ | 0.29               |      |        | $ | 0.25      |     
|                                                                                                                                           |                                     | Loss from discontinued operations             |                             |   | (0.02              | )    |        |   | (0.03     | )   
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     |                                               | Net income per common share |   | $                  | 0.27 |        |   | $         | 0.22 | 
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           | Diluted                             |                                               |                             |   |                    |      |        |   |          
|                                                                                                                                           |                                     | Income from continuing operations             |                             | $ | 0.27               |      |        | $ | 0.22      |     
|                                                                                                                                           |                                     | Loss from discontinued operations             |                             |   | (0.02              | )    |        |   | (0.02     | )   
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     |                                               | Net income per common share |   | $                  | 0.25 |        |   | $         | 0.20 | 
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           | Weighted average shares outstanding |                                               |                             |   |                    |      |        |   |          
|                                                                                                                                           |                                     | Weighted average shares outstanding  basic   |                             |   | 8,259,833          |      |        |   | 7,986,550 |     
|                                                                                                                                           |                                     | Dilutive effect of options                    |                             |   | 735,157            |      |        |   | 952,967   |     
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  
|                                                                                                                                           |                                     | Weighted average shares outstanding  diluted |                             |   | 8,994,990          |      |        |   | 8,939,517 |     
|                                                                                                                                           |                                     |                                               |                             |   |                    |      |        |  

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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##### Table of Contents









Dynamics Research Corporation
Consolidated Statements of Operations
(unaudited)
(in thousands, except share and per share data)

|                                                                                                      |                                     |                                               |                             |   |                   |      |         |   |           |      | 
|----------------------------------------------------------------------------------------------------- | ----------------------------------- | --------------------------------------------- | --------------------------- | - | ----------------- | ---- | ------- | - | --------- | ---- | 
|                                                                                                      |                                     |                                               |                             |   | Nine months ended
|                                                                                                      |                                     |                                               |                             |   | September 30,    
|                                                                                                      |                                     |                                               |                             |   | 2003              |      | 2002   
|                                                                                                      |                                     |                                               |                             |   |                   |      |        
|Contract revenue                                                                                      |                                     | $                                             | 177,840                     |   |                   | $    | 136,057 |  
|Product sales                                                                                         |                                     |                                               | 5,336                       |   |                   |      | 5,961   |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     | Total revenue                                 |                             |   | 183,176           |      |         |   | 142,018   |     
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|Cost of contract revenue                                                                              |                                     |                                               | 150,389                     |   |                   |      | 115,861 |  
|Cost of product sales                                                                                 |                                     |                                               | 3,877                       |   |                   |      | 3,836   |  
|Selling, engineering and administrative expenses                                                      |                                     |                                               | 16,908                      |   |                   |      | 12,553  |  
|Amortization of intangible assets                                                                     |                                     |                                               | 1,301                       |   |                   |      | 203     |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     | Total operating costs and expenses            |                             |   | 172,475           |      |         |   | 132,453   |     
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|Operating income                                                                                      |                                     |                                               | 10,701                      |   |                   |      | 9,565   |  
|Other income                                                                                          |                                     |                                               | 131                         |   |                   |      | 60      |  
|Interest expense, net                                                                                 |                                     |                                               | (696                        | ) |                   |      | (186    | )
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|Income from continuing operations before provision for income taxes                                   |                                     |                                               | 10,136                      |   |                   |      | 9,439   |  
|Provision for income taxes                                                                            |                                     |                                               | 4,159                       |   |                   |      | 3,766   |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|Income from continuing operations                                                                     |                                     |                                               | 5,977                       |   |                   |      | 5,673   |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|Loss from discontinued operations, net of tax benefit of $914 and $391
in 2003 and 2002, respectively |                                     |                                               | (1,360                      | ) |                   |      | (590    | )
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|Loss on disposal of discontinued operations, net of tax benefit of
$157 in 2003                       |                                     |                                               | (233                        | ) |                   |      |        |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|Net income                                                                                            |                                     | $                                             | 4,384                       |   |                   | $    | 5,083   |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|Net income per common share                                                                           |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      | Basic                               |                                               |                             |   |                   |      |         |   |          
|                                                                                                      |                                     | Income from continuing operations             |                             | $ | 0.73              |      |         | $ | 0.72      |     
|                                                                                                      |                                     | Loss from discontinued operations             |                             |   | (0.16             | )    |         |   | (0.08     | )   
|                                                                                                      |                                     | Loss on disposal of discontinued operations   |                             |   | (0.03             | )    |         |   |          |     
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               | Net income per common share |   | $                 | 0.54 |         |   | $         | 0.64 | 
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      | Diluted                             |                                               |                             |   |                   |      |         |   |          
|                                                                                                      |                                     | Income from continuing operations             |                             | $ | 0.68              |      |         | $ | 0.64      |     
|                                                                                                      |                                     | Loss from discontinued operations             |                             |   | (0.15             | )    |         |   | (0.07     | )   
|                                                                                                      |                                     | Loss on disposal of discontinued operations   |                             |   | (0.03             | )    |         |   |          |     
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               | Net income per common share |   | $                 | 0.50 |         |   | $         | 0.57 | 
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      | Weighted average shares outstanding |                                               |                             |   |                   |      |         |   |          
|                                                                                                      |                                     | Weighted average shares outstanding  basic   |                             |   | 8,192,299         |      |         |   | 7,928,678 |     
|                                                                                                      |                                     | Dilutive effect of options                    |                             |   | 584,324           |      |         |   | 991,685   |     
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  
|                                                                                                      |                                     | Weighted average shares outstanding  diluted |                             |   | 8,776,623         |      |         |   | 8,920,363 |     
|                                                                                                      |                                     |                                               |                             |   |                   |      |         |  

The accompanying notes are an integral part of these unaudited consolidated financial statements.

5



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##### Table of Contents









Dynamics Research Corporation
Consolidated Statements of Cash Flows
(unaudited)
(in thousands)

|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |        |        |         |         |  
|---------------------------------------------------- | ---------------------------------------------------------------------------- | ------------------------------------------------------ | ------------------------------------------------------ | --------------------------------------------------- | ------ | ----------------- | ------ | ------ | ------ | ------- | ------- | -
|                                                     |                                                                              |                                                        |                                                        |                                                     |        | Nine months ended
|                                                     |                                                                              |                                                        |                                                        |                                                     |        | September 30,    
|                                                     |                                                                              |                                                        |                                                        |                                                     |        | 2003              |        | 2002  
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|Operating activities                                 |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     | Net income                                                                   |                                                        | $                                                      | 4,384                                               |        |                   | $      | 5,083  |       
|                                                     | Loss from discontinued operations                                            |                                                        |                                                        | (1,360                                              | )      |                   |        | (590   | )     
|                                                     | Loss on disposal of discontinued operations                                  |                                                        |                                                        | (233                                                | )      |                   |        |       |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     | Income from continuing operations                                            |                                                        |                                                        | 5,977                                               |        |                   |        | 5,673  |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     | Adjustments to reconcile net cash provided by (used in) operating activities |                                                        |                                                        |                                                     |        |                   |        |        |       
|                                                     |                                                                              | Depreciation                                           |                                                        |                                                     | 2,248  |                   |        |        | 2,247  |        
|                                                     |                                                                              | Non-cash interest expense                              |                                                        |                                                     | 116    |                   |        |        | 31     |        
|                                                     |                                                                              | Investment income from equity interest                 |                                                        |                                                     | (103   | )                 |        |        | (57    | )      
|                                                     |                                                                              | Stock compensation expense                             |                                                        |                                                     | 183    |                   |        |        | 143    |        
|                                                     |                                                                              | Tax benefit from stock options exercised               |                                                        |                                                     | 135    |                   |        |        | 177    |        
|                                                     |                                                                              | Amortization of intangible assets                      |                                                        |                                                     | 1,301  |                   |        |        | 203    |        
|                                                     |                                                                              | Deferred income taxes                                  |                                                        |                                                     | 441    |                   |        |        | (780   | )      
|                                                     | Change in operating assets and liabilities, net of effect of acquisitions    |                                                        |                                                        |                                                     |        |                   |        |        |       
|                                                     |                                                                              | Accounts receivable, net                               |                                                        |                                                     | 3,096  |                   |        |        | 4,858  |        
|                                                     |                                                                              | Unbilled expenditures and fees on contracts in process |                                                        |                                                     | (3,677 | )                 |        |        | 8,746  |        
|                                                     |                                                                              | Prepaid expenses and other current assets              |                                                        |                                                     | (3,362 | )                 |        |        | (1,942 | )      
|                                                     |                                                                              | Accounts payable                                       |                                                        |                                                     | 732    |                   |        |        | (8,382 | )      
|                                                     |                                                                              | Accrued payroll and employee benefits                  |                                                        |                                                     | 3,144  |                   |        |        | (742   | )      
|                                                     |                                                                              | Other accrued expenses                                 |                                                        |                                                     | 129    |                   |        |        | (659   | )      
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        | Net cash provided by continuing operations             |                                                     |        | 10,360            |        |        |        | 9,516   |        
|                                                     |                                                                              |                                                        | Net cash provided by (used in) discontinued operations |                                                     |        | (646              | )      |        |        | 72      |        
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        | Net cash provided by operating activities           |        |                   | 9,714  |        |        |         | 9,588   |  
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|Investing activities                                 |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     | Additions to property, plant and equipment                                   |                                                        |                                                        | (5,416                                              | )      |                   |        | (2,331 | )     
|                                                     | Proceeds from the sale of assets                                             |                                                        |                                                        |                                                    |        |                   |        | 3      |       
|                                                     | Purchase of businesses, net of cash acquired                                 |                                                        |                                                        | (378                                                | )      |                   |        | (9,554 | )     
|                                                     | (Increase) decrease in other assets                                          |                                                        |                                                        | (198                                                | )      |                   |        | 591    |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        | Net cash used in continuing operations                 |                                                     |        | (5,992            | )      |        |        | (11,291 | )      
|                                                     |                                                                              |                                                        | Net cash provided by discontinued operations           |                                                     |        | 2,950             |        |        |        |        |        
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        | Net cash used in investing activities               |        |                   | (3,042 | )      |        |         | (11,291 | )
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|Financing activities                                 |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     | Net repayments under revolving credit agreement and notes payable            |                                                        |                                                        | (6,144                                              | )      |                   |        |       |       
|                                                     | Repayments under loan agreement                                              |                                                        |                                                        |                                                    |        |                   |        | (700   | )     
|                                                     | Principal payments under mortgage agreement                                  |                                                        |                                                        | (375                                                | )      |                   |        | (375   | )     
|                                                     | Proceeds from the exercise of stock options and issuance of common stock     |                                                        |                                                        | 1,465                                               |        |                   |        | 1,874  |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        | Net cash provided by (used in) financing activities |        |                   | (5,054 | )      |        |         | 799     |  
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|Net increase (decrease) in cash and cash equivalents |                                                                              |                                                        | 1,618                                                  |                                                     |        |                   | (904   | )     
|Cash and cash equivalents, beginning of period       |                                                                              |                                                        | 1,076                                                  |                                                     |        |                   | 15,653 |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|Cash and cash equivalents, end of period             |                                                                              | $                                                      | 2,694                                                  |                                                     |        | $                 | 14,749 |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|Supplemental information                             |                                                                              |                                                        |                                                        |                                                     |        |                   |        |       
|                                                     | Cash paid for interest                                                       |                                                        | $                                                      | 670                                                 |        |                   | $      | 315    |       
|                                                     | Cash paid for income taxes                                                   |                                                        | $                                                      | 2,082                                               |        |                   | $      | 2,264  |       

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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##### Table of Contents



DYNAMICS RESEARCH CORPORATION







NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


NOTE 1. BASIS OF PRESENTATION

The unaudited consolidated financial statements of Dynamics Research
Corporation (DRC or the company) and its subsidiaries included herein have
been prepared in accordance with accounting principles generally accepted in
the United States of America. In the opinion of management, all material
adjustments that are of a normal and recurring nature necessary for a fair
presentation of the results for the periods presented have been reflected. All
material intercompany transactions and balances have been eliminated in
consolidation. Certain amounts in previously issued financial statements have
been reclassified to conform to current presentation. The results of the three
and nine month periods ended September 30, 2003 may not be indicative of the
results that may be expected for the year ended December 31, 2003. The
accompanying financial information should be read in conjunction with the
consolidated financial statements and notes thereto contained in the companys
Annual Report on Form 10-K, filed with the U.S. Securities and Exchange
Commission (SEC) for the year ended December 31, 2002.

On October 18, 2002, the company announced that it was actively pursuing the
divestiture of the Encoder Division, a manufactured products business
previously reported as a business segment, due to continued weakness in the
manufacturing sector. In accordance with Financial Accounting Standards Board
(FASB) Statement of Financial Accounting Standards (SFAS) No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, the
consolidated financial statements and footnotes thereto of the company have
been restated to reflect the discontinuation of the Encoder Division for all
periods presented. On May 2, 2003, the company completed the sale of its
Encoder Division assets and certain liabilities to GSI Lumonics in Billerica,
Massachusetts.

On December 20, 2002, the company completed its acquisition of Andrulis
Corporation (ANDRULIS). ANDRULIS provides information technology and
engineering solutions to federal government customers in the defense and
federal civilian sectors. On May 31, 2002, the company completed its
acquisition of HJ Ford Associates, Inc. (HJ Ford). HJ Ford helps its clients
manage operational processes and acquisition programs by drawing on core
competencies of systems and information engineering, information technology,
enterprise engineering and acquisition program support. These transactions
were recorded using the purchase method of accounting in accordance with
Financial Accounting Standards Board Statement No. 141,
Business Combinations (SFAS No. 141). Accordingly, the results of these acquired entities are
included in the companys Consolidated Statements of Operations and of Cash
Flows for the periods subsequent to their respective acquisitions.

As part of the HJ Ford purchase, the company acquired a 40% ownership interest
in a small disadvantaged business, as defined by the United States Government.
This business is accounted for using the equity method. This ownership
interest is reported as a component of Other assets in the companys
Consolidated Balance Sheets.

Income (Loss) Per Share

Basic income (loss) per share is computed by dividing net income (loss) by the
weighted average number of shares of common stock outstanding during the
period. For periods in which there is net income, diluted income per share is
determined by using the weighted average number of common and dilutive common
equivalent shares outstanding during the period unless the effect is
antidilutive.

Due to their antidilutive effect, approximately 71,100 and 24,600 options to
purchase common stock were excluded from the calculation of diluted income per
share for the third quarters of 2003 and 2002, respectively. Approximately
84,600 and 23,600 options to purchase common stock were excluded from the
calculation of diluted income per share for the nine months ended September 30,
2003 and 2002, respectively, as their effect would be antidilutive. However,
these options could become dilutive in future periods.

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

Stock-Based Compensation

The company accounts for stock option plans under APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. The
following table illustrates the effect of net income per common share as if the
company had applied the fair value based method of SFAS No. 123, Accounting for
Stock-Based Compensation, to all outstanding and unvested awards in each period
for the purpose of recording expense for stock option compensation (in
thousands of dollars, except per share data).

| |                                                                                                                                     |                      |   |                    |      |                   |   |       |      |      |   |        |      |  |   |        |      | 
| | ----------------------------------------------------------------------------------------------------------------------------------- | -------------------- | - | ------------------ | ---- | ----------------- | - | ----- | ---- | ---- | - | ------ | ---- |  | - | ------ | ---- | 
| |                                                                                                                                     |                      |   | Three Months Ended |      | Nine Months Ended
| |                                                                                                                                     |                      |   | September 30,      |      | September 30,    
| |                                                                                                                                     |                      |   | 2003               |      | 2002              |   | 2003  |      | 2002
| |                                                                                                                                     |                      |   |                    |      |                  
| | Net income, as reported                                                                                                             |                      | $ | 2,240              |      |                   | $ | 1,793 |      |      | $ | 4,384  |      |  | $ | 5,083  |     
| | Deduct: Total
stock-based employee
compensation
determined under
fair-value-based
method for all awards,
net of related tax
effects |                      |   | (513               | )    |                   |   | (571  | )    |      |   | (1,508 | )    |  |   | (1,714 | )   
| |                                                                                                                                     |                      |   |                    |      |                   |   |       |      |      |   |        |      |  |   |       
| | Pro forma net income                                                                                                                |                      | $ | 1,727              |      |                   | $ | 1,222 |      |      | $ | 2,876  |      |  | $ | 3,369  |     
| |                                                                                                                                     |                      |   |                    |      |                   |   |       |      |      |   |        |      |  |   |       
| |                                                                                                                                     |                      |   |                    |      |                   |   |       |      |      |   |        |      |  |   |       
| | Net income per share:                                                                                                               |                      |   |                    |      |                   |   |       |      |      |   |        |      |  |   |        |     
| |                                                                                                                                     | Basic, as reported   |   | $                  | 0.27 |                   |   | $     | 0.22 |      |   | $      | 0.54 |  |   | $      | 0.64 | 
| |                                                                                                                                     | Basic, pro forma     |   | $                  | 0.21 |                   |   | $     | 0.15 |      |   | $      | 0.35 |  |   | $      | 0.42 | 
| |                                                                                                                                     | Diluted, as reported |   | $                  | 0.25 |                   |   | $     | 0.20 |      |   | $      | 0.50 |  |   | $      | 0.57 | 
| |                                                                                                                                     | Diluted, pro forma   |   | $                  | 0.21 |                   |   | $     | 0.15 |      |   | $      | 0.35 |  |   | $      | 0.42 | 

The weighted average fair values of options granted were $8.76 and $13.33 in
the third quarters of 2003 and 2002, respectively. The weighted average fair
values of options granted were $6.63 and $13.22 in the nine months ended
September 30, 2003 and 2002, respectively. The fair value of each option for
the companys plans is estimated on the date of the grant using the
Black-Scholes option-pricing model, with the following weighted average
assumptions:

|                        |  |                    |      |                   |  |      |      |      |  |  |      |   |  |  |      |  
|----------------------- |  | ------------------ | ---- | ----------------- |  | ---- | ---- | ---- |  |  | ---- | - |  |  | ---- | -
|                        |  | Three Months Ended |      | Nine Months Ended
|                        |  | September 30,      |      | September 30,    
|                        |  | 2003               |      | 2002              |  | 2003 |      | 2002
|                        |  |                    |      |                  
|Expected volatility     |  |                    | 44.5 | %                 |  |      | 43.8 | %    |  |  | 43.8 | % |  |  | 57.8 | %
|Dividend yield          |  |                    |     |                   |  |      |     |      |  |  |     |   |  |  |     |  
|Risk-free interest rate |  |                    | 3.79 | %                 |  |      | 4.65 | %    |  |  | 3.93 | % |  |  | 5.09 | %
|Expected life in years  |  |                    | 7.71 |                   |  |      | 7.61 |      |  |  | 7.71 |   |  |  | 7.43 |  

Recent Accounting Pronouncements

In May 2003, the Emerging Issues Task Force (EITF), reached a consensus on
EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables(Issue
No. 00-21). Issue No. 00-21 addresses when an arrangement with multiple
deliverables should be divided into separate units of accounting. The company
adopted the consensus in the third quarter of 2003. The impact of adopting
Issue No. 00-21 did not have a material impact on the companys financial
position, results of operations or cash flows.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150
requires issuers to classify as liabilities (or assets in some circumstances)
three classes of freestanding financial instruments that embody obligations for
the issuer. Generally, SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003 and is otherwise effective at the
beginning of the first interim period beginning after June 15, 2003. The
company adopted the provisions of SFAS No. 150 on July 1, 2003. The company
did not have any financial instruments within the scope of SFAS No. 150 at
September 30, 2003, and, accordingly, the adoption of SFAS No. 150 did not have
any effect on its financial position, results of operations or cash flows.

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments and
hedging activities under SFAS No. 133 for decisions made: (a) as part of the
Derivative Implementation Group process that requires amendment to SFAS No.
133; (b) in connection with other FASB projects dealing with financial
instruments; and (c) in connection with the implementation issues raised
related to the application of the definition of derivative. SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003 and for
designated hedging relationships after June 30, 2003. SFAS No. 149 is required
to be applied prospectively. The company does not currently have any
derivative instruments and, accordingly, the adoption of SFAS No. 149 did not
have any effect on its financial position, results of operations or cash flows.

In January 2003, the FASB issued FASB Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.
The primary objectives of FIN 46 are to provide guidance on the identification
of entities for which control is achieved through means other than through
voting rights (variable interest entities) and how to determine when and
which business enterprise should consolidate the variable interest entity.
This new model for consolidation applies to an entity in which either: (a) the
equity investors (if any) do not have a controlling financial interest; or (b)
the equity investment at risk is insufficient to finance that entitys
activities without receiving additional subordinated financial support from
other parties. In addition, FIN 46 requires that both the primary and all
other enterprises with a significant variable interest in a variable interest
entity make additional disclosures. FIN 46 is effective immediately for
variable interest entities created after January 31, 2003. FIN 46 had
previously been effective for interim periods beginning after June 15, 2003,
for variable interests in place prior to February 1, 2003; however, on October
10, 2003, the FASB issued a statement deferring the implementation of FIN 46
for these variable interests until the first reporting period beginning after
December 15, 2003. The company acquired, as part of the May 31, 2002 purchase
of HJ Ford, a 40% ownership interest in a small disadvantaged business, as
defined by the United States Government, which has been accounted for using the
equity method. The company provided the business with a line of credit
guarantee, under which its maximum exposure is $0.2 million. The company is
currently evaluating the impact, if any, that the adoption of FIN 46 in the
fourth quarter of 2003, will have on the companys financial position, results
of operations or cash flows. The company currently has no other investments
subject to the provisions of FIN 46.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure-An Amendment of SFAS No. 123. SFAS No.
148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide
alternative methods of transition for a voluntary change to the
fair-value-based method of accounting for stock-based employee compensation.
Also, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in interim financial statements in addition to
the annual disclosures about the effect the fair value method would have had on
reported results. The transition and annual disclosure requirements of SFAS
No. 148 are effective for fiscal years ending after December 15, 2002. The
interim disclosure requirements are effective for interim periods beginning
after December 15, 2002. As permitted by SFAS No. 148, the company continues
to apply the disclosure-only alternative adopted under SFAS No. 123 to account
for its stock option grants to employees, under which compensation expense is
not typically recognized. The company adopted the interim disclosure
provisions of FAS No. 148 in its Form 10-Q for the quarterly period ended March
31, 2003.

Critical Accounting Policies

Use of Estimates

The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements. Estimates and assumptions also affect the amount of revenue and
expenses during the reported period. Actual results could differ from those
estimates. Management must make use of estimates in the areas discussed below.

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

Revenue Recognition

The companys systems and services business provides its services under time
and materials, cost reimbursable and fixed-price contracts including service
type contracts.

For time and materials contracts, revenue reflects the number of direct labor
hours expended in the performance of a contract multiplied by the contract
billing rate, as well as reimbursement of other billable direct costs. The
risk inherent in time and materials contracts is that actual costs differ
materially from negotiated billing rates in the contract, which directly
affects operating income.

For cost reimbursable contracts, revenue is recognized as costs are incurred
and include a proportionate amount of the fee earned. Cost reimbursable
contracts specify the contract fee in dollars or as a percentage of estimated
costs. The primary risk on a cost reimbursable contract is that a government
audit of direct and indirect costs could result in the disallowance of certain
costs, which would directly impact revenue and margin on the contract.
Historically, such audits have had no material impact on the companys revenue
and operating income.

Under fixed-price contracts, other than service-type contracts, revenue is
recognized under the percentage of completion method, on the basis of costs
incurred in relation to estimated total costs to complete the contract. Under
service-type contracts, costs incurred are not indicative of progression toward
completion of the contract. Revenue from service-type fixed price contracts is
recognized ratably over the contract period or by other appropriate output
methods to measure service provided, and contract costs are expensed as
incurred. The risk to the company on a fixed-price contract is that if actual
costs exceed the estimated costs to complete the contract, then profit is
eroded or losses are incurred.

For all types of contracts, the company recognizes anticipated contract losses
as soon as they become known and estimable. Out-of-pocket expenses that are
reimbursable by the customer are included in contract revenue and cost of
contract revenue.

Unbilled expenditures and fees on contracts in process are the amounts of
recoverable contract revenue that have not been billed at the balance sheet
date. Most of the companys unbilled expenditures and fees relate to revenue
that is billed in the month after services are performed. In certain
instances, billing is deferred in compliance with contract terms, such as
milestone billing arrangements and withholdings. Costs related to United
States Government contracts, including applicable indirect costs, are subject
to audit by the government. Revenue from such contracts has been recorded at
amounts the company expects to realize upon final settlement.

Valuation Allowances

The company provides for potential losses against specifically identified
accounts receivable and unbilled expenditures and fees on contracts in process
based on the companys expectation of a customers inability to pay. These
reserves are based primarily upon specific identification of potential
uncollectible accounts. In addition, payments to the company for performance
on United States Government contracts are subject to audit by the Defense
Contract Audit Agency. If necessary, the company provides an estimated reserve
for adjustments resulting from rate negotiations and audit findings. The
company routinely provides for these items when they are identified and can be
reasonably estimated.

Intangible and Other Long-lived Assets

The company uses assumptions in establishing the carrying value, fair value and
estimated lives of intangible and other long-lived assets. Long-lived assets
are reviewed for impairment whenever events or changes in circumstances
indicate that the asset carrying value may not be recoverable. Recoverability
is measured by a comparison of the assets continuing ability to generate
positive income from operations and positive cash flow in future periods
compared to the carrying value of the asset. If assets are considered to be
impaired, the impairment is recognized in the period of identification and is
measured as the amount by which the carrying value of the asset exceeds the
fair value of the asset.

The useful lives and related amortization of intangible assets are based on
their estimated residual value in proportion to the economic benefit consumed.
The useful lives and related depreciation of other long-lived assets are based
on the companys estimate of the period over which the asset will generate
revenue or otherwise be used by the company.

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

Goodwill

The company assesses goodwill for impairment at the segment level at least once
each year by applying a fair value test. Goodwill could be impaired due to
market declines, reduced expected future cash flows, or other factors or
events. Should the fair value of goodwill, as determined by the company at any
measurement date, fall below its carrying value, a charge for impairment of
goodwill would occur in that period.

Business Combinations

During 2002, the company acquired two companies, ANDRULIS and HJ Ford. The
company has determined and recorded the fair values of assets acquired and
liabilities assumed as of the dates of acquisition. The company has utilized
an independent valuation specialist to determine the fair values of
identifiable intangible assets acquired in order to allocate a portion of the
purchase price to these assets. The results of operations of these acquired
entities are included in the companys consolidated financial statements from
the dates of their respective acquisitions.

Pensions

Accounting and reporting for the companys pension plan requires the use of
assumptions, including but not limited to, discount rate, rate of compensation
increases and expected return on assets. If these assumptions differ
materially from actual results, the companys obligations under the pension
plan could also differ materially, potentially requiring the company to record
an additional pension liability. An actuarial valuation is performed each
year. The results of this actuarial valuation are reflected in the accounting
for the pension plan upon determination.

NOTE 2. DISCONTINUED OPERATIONS

On May 2, 2003, the company completed the sale of its Encoder Division assets
and certain liabilities to GSI Lumonics Inc. (GSI) in Billerica,
Massachusetts for $3.3 million in cash, subject to post-closing adjustments
related to a valuation of the net assets of the Encoder Division and the
assumption by GSI of certain of DRCs liabilities with respect to the assets
acquired.

In connection with this transaction, in the first quarter of 2003, the company
recorded charges aggregating $1.1 million before taxes as a loss on the
disposal of discontinued operations. The components of these charges were $0.3
million of professional fees and $0.8 million of exit costs, comprised of $0.5
million for severance costs for approximately 45 Encoder Division employees and
$0.3 million for future lease costs, net of contractual sublease income from
GSI for the Encoder facility.

During the first quarter of 2003, the company recognized, on a cash basis, $0.7
million received as the final royalty payment associated with the 1999 sale of
its discontinued Telecommunications Fraud control business, which was recorded
against the loss on the disposal of discontinued operations. This income, net
of the $1.1 million of charges described above, resulted in a loss on the
disposal of discontinued operations of $0.4 million before taxes, or a loss of
$0.2 million, net of $0.2 million of income tax benefit.

The companys loss from discontinued operations, net of taxes, was $147,000, or
$0.02 per diluted share, and $191,000, or $0.02 per diluted share, in the third
quarters of 2003 and 2002, respectively. The companys loss from discontinued
operations, net of taxes, was $1.4 million and $0.6 million, or $0.15 and $0.07
per diluted share, in the nine months ended September 30, 2003 and 2002,
respectively. The nine months ended September 30, 2003, include four months of
operating loss from the Encoder division, as well as costs incurred subsequent
to the transaction related to certain liabilities that GSI did not assume.
Included in the current years loss on discontinued operations are $1.1 million
of accrued lease costs, net of estimated sublease income for the Encoder
facility.

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

The activity for the three and nine months ended September 30, 2003, related to
the companys exit cost accrual is as follows (in thousands):

|          |  |                                                  |       |           |  |             |   |             |  |                 |    |               |  |   |      |   |  |   |       | 
|--------- |  | ------------------------------------------------ | ----- | --------- |  | ----------- | - | ----------- |  | --------------- | -- | ------------- |  | - | ---- | - |  | - | ----- | 
|          |  | Activity  Three Months Ended September 30, 2003
|          |  |                                                 
|          |  | Balance                                          |       |           |  |             |   | Adjustments |  | Expenditures    |    | Balance      
|          |  | June 30,                                         |       |           |  |             |   | for changes |  | charged against |    | September 30,
|          |  | 2003                                             |       | Provision |  | in estimate |   | accrual     |  | 2003           
|          |  |                                                 
|Severance |  | $                                                | 532   |           |  | $           |  |             |  | $               |   |               |  | $ | (163 | ) |  | $ | 369   | 
|Lease     |  |                                                  | 1,237 |           |  |             |  |             |  |                 | 69 |               |  |   | (132 | ) |  |   | 1,174 | 
|          |  |                                                  |       |           |  |             |   |             |  |                 |    |               |  |   |      |   |  |   |       | 
|          |  | $                                                | 1,769 |           |  | $           |  |             |  | $               | 69 |               |  | $ | (295 | ) |  | $ | 1,543 | 
|          |  |                                                  |       |           |  |             |   |             |  |                 |    |               |  |   |      |   |  |   |       | 

|          |  |                                                 |   |           |  |             |       |             |  |                 |    |               |  |   |      |   |  |   |       | 
|--------- |  | ----------------------------------------------- | - | --------- |  | ----------- | ----- | ----------- |  | --------------- | -- | ------------- |  | - | ---- | - |  | - | ----- | 
|          |  | Activity  Nine Months Ended September 30, 2003
|          |  |                                                
|          |  | Balance                                         |   |           |  |             |       | Adjustments |  | Expenditures    |    | Balance      
|          |  | December 31,                                    |   |           |  |             |       | for changes |  | charged against |    | September 30,
|          |  | 2002                                            |   | Provision |  | in estimate |       | accrual     |  | 2003           
|          |  |                                                
|Severance |  | $                                               |  |           |  | $           | 544   |             |  | $               |   |               |  | $ | (175 | ) |  | $ | 369   | 
|Lease     |  |                                                 |  |           |  |             | 1,325 |             |  |                 | 69 |               |  |   | (220 | ) |  |   | 1,174 | 
|          |  |                                                 |   |           |  |             |       |             |  |                 |    |               |  |   |      |   |  |   |       | 
|          |  | $                                               |  |           |  | $           | 1,869 |             |  | $               | 69 |               |  | $ | (395 | ) |  | $ | 1,543 | 
|          |  |                                                 |   |           |  |             |       |             |  |                 |    |               |  |   |      |   |  |   |       | 

In addition to the exit cost accruals described above, liabilities of
discontinued operations also include $205,000 related to liabilities of the
Encoder Division not assumed by GSI in the purchase transaction.

The balance sheet captions for discontinued operations include the following
(in thousands):

|                                                     |                                           |                           |                      |     |               |   |              |       |       |       | 
|---------------------------------------------------- | ----------------------------------------- | ------------------------- | -------------------- | --- | ------------- | - | ------------ | ----- | ----- | ----- | 
|                                                     |                                           |                           |                      |     | September 30, |   | December 31,
|                                                     |                                           |                           |                      |     | 2003          |   | 2002        
|                                                     |                                           |                           |                      |     |              
|Current assets                                       |                                           |                           |                      |     |               |   |              |      
|                                                     | Accounts receivable, net                  |                           | $                    |    |               |   | $            | 1,111 |      
|                                                     | Inventory, net                            |                           |                      |    |               |   |              | 2,316 |      
|                                                     | Prepaid expenses and other current assets |                           |                      |    |               |   |              | 5     |      
|                                                     |                                           |                           |                      |     |               |   |              |      
|                                                     |                                           |                           | Total current assets |     | $             |  |              |       | $     | 3,432 | 
|                                                     |                                           |                           |                      |     |               |   |              |      
|Noncurrent assets
Property, plant and equipment, net |                                           | $                         |                     |     |               | $ | 331          |      
|                                                     |                                           |                           |                      |     |               |   |              |      
|Current liabilities                                  |                                           |                           |                      |     |               |   |              |      
|                                                     | Accounts payable                          |                           | $                    |    |               |   | $            | 233   |      
|                                                     | Accrued payroll and employee benefits     |                           |                      | 369 |               |   |              | 127   |      
|                                                     | Other accrued expenses                    |                           |                      | 774 |               |   |              | 649   |      
|                                                     |                                           |                           |                      |     |               |   |              |      
|                                                     |                                           | Total current liabilities |                      | $   | 1,143         |   |              | $     | 1,009 |      
|                                                     |                                           |                           |                      |     |               |   |              |      
|Long-term liabilities                                |                                           |                           |                      |     |               |   |              |      
|                                                     | Other long-term liabilities               |                           | $                    | 605 |               |   | $            |      |      
|                                                     |                                           |                           |                      |     |               |   |              |      

The lease on the Encoder facility will expire in August 2005; accordingly,
lease payments and payments for other associated costs will be made and charged to the accrual
through that date. The difference between the fair value of the total lease costs and the total
cash payments will be charged to discontinued operations as expense through the expiration of the
lease term, including sublease income initially estimated at the time the accrual was recorded,
which may not be, or is expected not to be, subsequently realized. The severance costs associated
with the Encoder Division sale are expected to be paid over the next several months.

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

NOTE 3. BUSINESS ACQUISITIONS

ANDRULIS

On December 20, 2002, the company completed the acquisition of all of the
outstanding shares of capital stock of ANDRULIS, a provider of information
technology and engineering solutions to federal government customers in the
defense and federal civilian sectors. The transaction was accounted for as a
purchase transaction in accordance with SFAS No. 141. In consideration, the
company paid the selling stockholders $12.2 million of net cash and issued
three separate promissory notes payable aggregating $12.4 million, due January
2, 2003, at an interest rate of 4.0%. In addition, the company incurred $1.1
million of transaction costs and $0.7 million of exit costs. The notes were
settled in January 2003. The company used cash on hand and its $50.0 million
revolving credit facility to fund the cash payments to the selling
stockholders. The purchase price was finalized upon the completion of
independent appraisals and determination of the fair values of the assets
acquired and liabilities assumed, in accordance with the purchase agreement,
during the third quarter of 2003. As a result of this process, the company
made an additional payment of $0.3 million to the selling stockholders for the
amount that the acquired net assets exceeded the target asset value as
stipulated in the purchase agreement.

A portion of the excess of purchase price over the fair value of net tangible
assets acquired has been allocated to identifiable intangible assets with
estimated useful lives ranging between two and five years, based upon an
independent appraisal. These assets are being amortized using the
straight-line method. The balance of the excess purchase price was recorded as
goodwill.

A summary of the transaction and the allocation of the purchase price is as
follows (in thousands):

|                                                                        |                                                 |                                                  |        |        |        | 
|----------------------------------------------------------------------- | ----------------------------------------------- | ------------------------------------------------ | ------ | ------ | ------ | 
|Consideration:                                                          |                                                 |                                                  |        |       
|                                                                        | Cash, net of cash acquired of $1,709            |                                                  | $      | 12,172 |       
|                                                                        | Notes payable issued to selling stockholders    |                                                  |        | 12,400 |       
|                                                                        | Transaction costs                               |                                                  |        | 1,091  |       
|                                                                        | Exit costs                                      |                                                  |        | 705    |       
|                                                                        |                                                 |                                                  |        |       
|                                                                        |                                                 | Total consideration                              |        |        | 26,368 | 
|                                                                        |                                                 |                                                  |        |       
|Allocation of consideration to assets acquired/(liabilities assumed):   |                                                 |                                                  |        |       
|                                                                        | Working capital, net of cash acquired of $1,709 |                                                  |        | 4,532  |       
|                                                                        | Property and equipment                          |                                                  |        | 649    |       
|                                                                        | Other noncurrent assets                         |                                                  |        | 30     |       
|                                                                        | Other liabilities                               |                                                  |        | (1,934 | )     
|                                                                        |                                                 |                                                  |        |       
|                                                                        |                                                 | Total fair value of net tangible assets acquired |        |        | 3,277  | 
|                                                                        |                                                 |                                                  |        |       
|Excess of consideration over fair value of net tangible assets acquired |                                                 |                                                  | 23,091 |       
|                                                                        |                                                 |                                                  |        |       
|Allocation of excess consideration to identifiable intangible assets:   |                                                 |                                                  |        |       
|                                                                        | Customer relationships                          |                                                  |        | 1,300  |       
|                                                                        | Non-competition agreements                      |                                                  |        | 1,340  |       
|                                                                        |                                                 |                                                  |        |       
|                                                                        |                                                 |                                                  | 2,640  |       
|                                                                        |                                                 |                                                  |        |       
|Allocation of excess consideration to goodwill                          |                                                 | $                                                | 20,451 |       
|                                                                        |                                                 |                                                  |        |       

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

HJ Ford

On May 31, 2002, the company completed the acquisition of all of the
outstanding voting common stock of HJ Ford. HJ Ford helps its clients manage
operational process and acquisition programs through systems and information
engineering, information technology, enterprise engineering and acquisition
program support. The transaction was accounted for as a purchase in accordance
with SFAS No. 141. In consideration, the company paid the HJ Ford stockholders
$10.2 million of net cash and incurred $0.4 million and $0.1 million of
transaction costs and exit costs, respectively, for a total purchase price of
$10.7 million. The net cash payment to the selling stockholders includes $1.3
million for the sellers consent to treat the transaction as an asset purchase
for tax purposes, under Section 338(h)(10) of the Internal Revenue Code. This
tax treatment enables the company to take future tax deductions for the
amortization of goodwill for tax purposes related to the transaction.

The purchase agreement also requires the company to pay the sellers an
additional $1.0 million in 2005, contingent upon the occurrence of certain
events related to contract renewals. The contingent consideration will be
recorded as an addition to the purchase price at the time it becomes probable
that a payment will be required.

As part of this purchase, the company acquired a 40% ownership interest in a
small disadvantaged business. This business is accounted for using the equity
method. The company has continuing business relationships with this business
and has provided it with a line of credit guarantee in the amount of $0.2
million. There was no outstanding balance under this line of credit at
September 30, 2003.

A portion of the excess of purchase price over the fair value of net tangible
assets acquired has been allocated to identifiable intangible assets with
estimated useful lives ranging between two and four years, based upon an
independent appraisal. These assets are being amortized using the
straight-line method. The balance of the excess purchase price was recorded as
goodwill.

A summary of the transaction and the allocation of the purchase price is as
follows (in thousands):

|                                                                        |                                               |                                                  |       |        |        | 
|----------------------------------------------------------------------- | --------------------------------------------- | ------------------------------------------------ | ----- | ------ | ------ | 
|Consideration:                                                          |                                               |                                                  |       |       
|                                                                        | Cash, net of cash acquired of $554            |                                                  | $     | 10,251 |       
|                                                                        | Transaction costs                             |                                                  |       | 356    |       
|                                                                        | Exit costs                                    |                                                  |       | 140    |       
|                                                                        |                                               |                                                  |       |       
|                                                                        |                                               | Total consideration                              |       |        | 10,747 | 
|                                                                        |                                               |                                                  |       |       
|Allocation of consideration to assets acquired/(liabilities assumed):   |                                               |                                                  |       |       
|                                                                        | Working capital, net of cash acquired of $554 |                                                  |       | 3,054  |       
|                                                                        | Property and equipment                        |                                                  |       | 209    |       
|                                                                        | Other noncurrent assets                       |                                                  |       | 222    |       
|                                                                        | Long-term debt                                |                                                  |       | (700   | )     
|                                                                        |                                               |                                                  |       |       
|                                                                        |                                               | Total fair value of net tangible assets acquired |       |        | 2,785  | 
|                                                                        |                                               |                                                  |       |       
|Excess of consideration over fair value of net tangible assets acquired |                                               |                                                  | 7,962 |       
|                                                                        |                                               |                                                  |       |       
|Allocation of excess consideration to identifiable intangible assets:   |                                               |                                                  |       |       
|                                                                        | Customer relationships                        |                                                  |       | 1,400  |       
|                                                                        | Non-competition agreements                    |                                                  |       | 400    |       
|                                                                        |                                               |                                                  |       |       
|                                                                        |                                               |                                                  | 1,800 |       
|                                                                        |                                               |                                                  |       |       
|Allocation of excess consideration to goodwill                          |                                               | $                                                | 6,162 |       
|                                                                        |                                               |                                                  |       |       

The company fully paid the long-term debt of $0.7 million in the second quarter
of 2002 and canceled the related loan agreement.

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

Pro forma results of operations

The following pro forma results of operations for the three and nine months
ended September 30, 2002 have been prepared as if the ANDRULIS and HJ Ford
acquisitions had occurred as of January 1, 2002. These pro forma results
include adjustments for the amortization of intangible assets with finite
useful lives, the elimination of intercompany transactions and adjustments for
the effect of income taxes. This pro forma information has been prepared for
comparative purposes only, and does not purport to be indicative of the results
of operations that would have been attained had the acquisitions been made as
of January 1, 2002, or of results of operations that may occur in the future
(in thousands, except per share data):

|                                |  |                    |        |                    |  |   |         | 
|------------------------------- |  | ------------------ | ------ | ------------------ |  | - | ------- | 
|                                |  | Three months ended |        | Nine months ended 
|                                |  | September 30, 2002 |        | September 30, 2002
|                                |  |                    |        |                   
|Revenue                         |  | $                  | 56,914 |                    |  | $ | 182,585 | 
|Net income                      |  | $                  | 1,443  |                    |  | $ | 4,581   | 
|Net income per share  basic    |  | $                  | 0.18   |                    |  | $ | 0.58    | 
|Net income per share  dilutive |  | $                  | 0.16   |                    |  | $ | 0.51    | 

NOTE 4. GOODWILL AND INTANGIBLE ASSETS

Components of the companys identifiable intangible assets are as follows (in
thousands):

|                           |  |                    |       |                   |  |             |       |              |  |   |       |             |  |   |     | 
|-------------------------- |  | ------------------ | ----- | ----------------- |  | ----------- | ----- | ------------ |  | - | ----- | ----------- |  | - | --- | 
|                           |  | September 30, 2003 |       | December 31, 2002
|                           |  |                    |       |                  
|                           |  |                    |       |                   |  | Accumulated |       |              |  |   |       | Accumulated
|                           |  | Cost               |       | amortization      |  | Cost        |       | amortization
|                           |  |                    |       |                  
|Customer relationships     |  | $                  | 2,700 |                   |  | $           | 963   |              |  | $ | 2,700 |             |  | $ | 257 | 
|Non-competition agreements |  |                    | 1,740 |                   |  |             | 712   |              |  |   | 1,740 |             |  |   | 117 | 
|                           |  |                    |       |                   |  |             |       |              |  |   |       |             |  |   |     | 
|                           |  | $                  | 4,440 |                   |  | $           | 1,675 |              |  | $ | 4,440 |             |  | $ | 374 | 
|                           |  |                    |       |                   |  |             |       |              |  |   |       |             |  |   |     | 

The company recorded amortization expense for its identifiable intangible
assets of $0.4 million and $0.1 million for the three months ended September
30, 2003 and 2002, respectively, and $1.3 million and $0.2 million for the nine
months then ended. Estimated amortization expense on the companys
identifiable intangible assets for the remainder of the current year and each
of the four subsequent years is as follows (in thousands):

|                  |  |   |       | 
|----------------- |  | - | ----- | 
|Remainder of 2003 |  | $ | 423   | 
|2004              |  | $ | 1,520 | 
|2005              |  | $ | 489   | 
|2006              |  | $ | 166   | 
|2007              |  | $ | 167   | 

The changes in the carrying amount of goodwill for the nine months ended
September 30, 2003 are as follows (in thousands):

|                                                             |  |             |        |               |  |       |   |  |  |   |        | 
|------------------------------------------------------------ |  | ----------- | ------ | ------------- |  | ----- | - |  |  | - | ------ | 
|                                                             |  | Systems and |        |               |  |       |   |  |  |  
|                                                             |  | Services    |        | Metrigraphics |  | Total
|                                                             |  |            
|Balance at December 31, 2002                                 |  | $           | 26,169 |               |  | $     |  |  |  | $ | 26,169 | 
|Purchase accounting adjustments on prior period acquisitions |  |             | 444    |               |  |       |  |  |  |   | 444    | 
|                                                             |  |             |        |               |  |       |   |  |  |   |        | 
|Balance at September 30, 2003                                |  | $           | 26,613 |               |  | $     |  |  |  | $ | 26,613 | 
|                                                             |  |             |        |               |  |       |   |  |  |   |        | 

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

NOTE 5. STOCK PLANS

The company has stock option plans that are administered by the Compensation
Committee of the Board of Directors (the Committee). The Committee oversees
the granting of options to employees, the number of options granted and the
option prices of the shares covered by each stock option grant.

In May 2003, the companys shareholders approved the adoption of the 2003
Incentive Plan (the 2003 Plan). The 2003 Plan provides eligible participants
with the opportunity to receive a broad variety of equity-based and cash
incentives. A total of 400,000 shares of common stock have been reserved for
issuance under the 2003 Plan, subject to adjustment as provided in the 2003
Plan.

The companys 2000 Incentive Plan (the 2000 Plan) allows the company to grant
incentive stock options, nonqualified stock options, stock appreciation rights,
awards of nontransferable shares of restricted common stock and deferred grants
of common stock. The companys Executive Long Term Incentive Program (the
ELTIP), implemented under the provisions of the 2000 Plan, provides
incentives to program participants through a combination of stock options and
restricted stock grants, which vest fully in seven years. The ELTIP allows for
accelerated vesting contingent upon the companys achievement of specific
financial performance goals.

NOTE 6. BUSINESS SEGMENT, GEOGRAPHIC AND MAJOR CUSTOMER INFORMATION

The company has two reportable business segments: Systems and Services, and
Metrigraphics.

The Systems and Services segment provides technical and information technology
services to government customers. The segment is comprised of five operating
groups that provide similar services and are subject to similar regulations.
These services included the 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.

The Metrigraphics segment develops and builds components for original equipment
manufacturers in the computer peripheral device, medical electronics,
telecommunications and other industries, with the focus on the custom design
and manufacture of miniature electronic parts that meet high precision
requirements through the use of electroforming, thin film deposition and
photolithography technologies.

The company evaluates performance and allocates resources based on operating
income (loss). The operating income (loss) for each segment includes
amortization of intangible assets and selling, engineering and administrative
expenses directly attributable to the segment. All corporate operating
expenses are allocated between the segments based on segment revenues. Sales
between segments represent less than 1% of total revenue and are accounted for
at cost. Corporate assets are primarily comprised of cash and cash equivalents
and the companys corporate headquarters facility in Andover, Massachusetts.

Results of operations information for the companys business segments for the
three and nine month periods ended September 30, 2003 and 2002, is as follows
(in thousands):

|                 |                      |   |                    |        |                   |   |        |        |      |   |         |         |  |   |         |         | 
|---------------- | -------------------- | - | ------------------ | ------ | ----------------- | - | ------ | ------ | ---- | - | ------- | ------- |  | - | ------- | ------- | 
|                 |                      |   | Three Months Ended |        | Nine Months Ended
|                 |                      |   | September 30,      |        | September 30,    
|                 |                      |   | 2003               |        | 2002              |   | 2003   |        | 2002
|                 |                      |   |                    |        |                  
|Revenue          |                      |   |                    |        |                   |   |        |        |      |   |         |         |  |   |         |        
|                 | Systems and Services |   | $                  | 60,602 |                   |   | $      | 45,633 |      |   | $       | 177,840 |  |   | $       | 136,057 | 
|                 | Metrigraphics        |   |                    | 1,830  |                   |   |        | 1,521  |      |   |         | 5,336   |  |   |         | 5,961   | 
|                 |                      |   |                    |        |                   |   |        |        |      |   |         |         |  |   |         |        
|                 |                      | $ | 62,432             |        |                   | $ | 47,154 |        |      | $ | 183,176 |         |  | $ | 142,018 |        
|                 |                      |   |                    |        |                   |   |        |        |      |   |         |         |  |   |         |        
|Operating income |                      |   |                    |        |                   |   |        |        |      |   |         |         |  |   |         |        
|                 | Systems and Services |   | $                  | 4,027  |                   |   | $      | 3,202  |      |   | $       | 10,149  |  |   | $       | 8,516   | 
|                 | Metrigraphics        |   |                    | 236    |                   |   |        | 64     |      |   |         | 552     |  |   |         | 1,049   | 
|                 |                      |   |                    |        |                   |   |        |        |      |   |         |         |  |   |         |        
|                 |                      | $ | 4,263              |        |                   | $ | 3,266  |        |      | $ | 10,701  |         |  | $ | 9,565   |        
|                 |                      |   |                    |        |                   |   |        |        |      |   |         |         |  |   |         |        

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

Asset information for the companys business segments and a reconciliation of
segment assets to the corresponding consolidated amounts as of September 30,
2003 and December 31, 2002 is as follows (in thousands):

|                        |                      |                      |         |               |        |              |         |        |        | 
|----------------------- | -------------------- | -------------------- | ------- | ------------- | ------ | ------------ | ------- | ------ | ------ | 
|                        |                      |                      |         | September 30, |        | December 31,
|                        |                      |                      |         | 2003          |        | 2002        
|                        |                      |                      |         |              
|Segment assets          |                      |                      |         |               |        |              |         |       
|                        | Systems and Services |                      | $       | 92,350        |        |              | $       | 93,463 |       
|                        | Metrigraphics        |                      |         | 2,200         |        |              |         | 2,639  |       
|                        |                      |                      |         |               |        |              |         |       
|                        |                      | Total segment assets |         |               | 94,550 |              |         |        | 96,102 | 
|Corporate assets        |                      |                      | 21,325  |               |        |              | 11,811  |       
|Discontinued operations |                      |                      |        |               |        |              | 3,763   |       
|                        |                      |                      |         |               |        |              |         |       
|                        |                      | $                    | 115,875 |               |        | $            | 111,676 |       
|                        |                      |                      |         |               |        |              |         |       

Revenue is attributed to geographic areas based on the customers location.
The company does not have locations outside the United States; however, in rare
instances, it may have contracts with sales representatives located in foreign
countries and provide services at customer locations outside the United States.
Domestic revenue consistently represents approximately 98% of the companys
consolidated revenue.

Revenues from Department of Defense (DoD) customers accounted for 78.2% and
80.3% of total revenues, respectively, in the third quarters of 2003 and 2002,
respectively, and 77.7% and 79.5% of revenues, respectively, in the nine months
then ended. Revenues from one significant DoD contract represented 18.6% and
19.5% of total revenues in the third quarters of 2003 and 2002, respectively,
and 18.2% and 10.3% of revenues, respectively, in the nine months then ended.
Another significant DoD contract represented 11.7% and 10.0% of total revenues
in the third quarters of 2003 and 2002, respectively, and 11.6% and 16.0% of
revenues, respectively, in the nine month periods then ended. The company had
no other customer in either the three or nine months ended September 30, 2003
and 2002, that accounted for more than 10% of revenues.

NOTE 7. FINANCING ARRANGEMENTS

The company obtained a $50.0 million revolving credit agreement (the
Revolver), effective June 28, 2002. This Revolver replaced the companys
former revolving credit facility. The Revolver has a three-year term and is
available to the company for general corporate purposes, including strategic
acquisitions. The fee on the unused portion of the Revolver ranges from 0.25%
to 0.50%, depending on the companys most recently reported leverage ratio, and
is payable quarterly in arrears. The company has the option to elect a fixed
30, 60 or 90 day term, an interest rate of LIBOR plus 2.0% to 3.0%, depending
on the companys most recently reported leverage ratio, or the prime rate on
any outstanding balance. Interest on the outstanding balance of the Revolver
is payable monthly under the prime rate option or at the end of the elected
term for the LIBOR rate option. The interest rate on the outstanding Revolver
balance was 3.12% under the 30 day LIBOR option elected on September 12, 2003.
The companys outstanding balance under the Revolver was $8.5 million and $2.2
million at September 30, 2003 and December 31, 2002, respectively.

In connection with its 2002 acquisition of ANDRULIS, the company issued $12.4
million in notes payable, with interest rates of 4.0%, to the selling
stockholders, payable on January 2, 2003. The notes were settled in January
2003, with proceeds from the companys Revolver.

The company has a 10 year mortgage loan (the Mortgage), dated June 12, 2000,
as amended and restated on June 28, 2002, on its corporate office facility in
Andover, Massachusetts. The agreement requires quarterly principal payments of
$125,000, with a final payment of $5.0 million in May 2010. Interest on the
Mortgage accrues at the rate of LIBOR plus 2.0%. The interest rate on the
Mortgage under the 90-day LIBOR option, elected at July 14, 2003, was 3.11%,
which was effective at September 30, 2003. The companys outstanding balance
on the Mortgage was $8.4 million and $8.8 million at September 30, 2003 and
December 31, 2002, respectively.

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

The Revolver and Mortgage agreements, as currently amended, require the company
to meet certain financial covenants, including maintaining a minimum net worth
and certain cash flow and debt coverage ratios. The covenants also limit the
companys ability to incur additional debt, pay dividends, purchase capital
assets, sell or dispose of assets, make additional acquisitions or investments,
or enter into new leases, among other restrictions. In addition, the loan
agreements contain a subjective acceleration clause, allowing the lender to
require payment upon the occurrence of a material adverse change in the
companys financial position.

The company was in compliance with all loan covenants at September 30, 2003.

On December 26, 2002, the company entered into an installment payment agreement
in connection with the purchase of its enterprise business system software.
The company made the first payment on January 26, 2003, with the second and
last payment due on January 26, 2004. The company recorded the liability using
an imputed interest rate of 3.38%, which was its effective borrowing rate at
December 31, 2002.

NOTE 8. CONTINGENCIES

As a defense contractor, the company is subject to many levels of audit and
review from various government agencies, including the Defense Contract Audit
Agency, the Inspector General, the Defense Criminal Investigative Service, the
General Accounting Office, the Department of Justice and congressional
committees. Both related to and unrelated to its defense industry involvement,
the company is, from time to time, involved in audits, lawsuits, claims,
administrative proceedings and investigations. The company accrues for
liabilities associated with these activities when it becomes probable that
future expenditures will be made and such expenditures can be reasonably
estimated. The companys evaluation of the likelihood of expenditures related
to these matters is subject to change in future periods, depending on then
current events and circumstances, which could have material adverse effects on
the companys financial position, results of operations and cash flows.

As previously disclosed, on October 26, 2000, two former
company employees were indicted and charged with, among other
violations,
wire fraud and a conspiracy scheme to defraud the United States Air Force out of approximately
$10 million through kickbacks and overcharging for computer components and
services. The former employees collected the kickbacks and overcharges through
separate and independent businesses. The company received no money from their
scheme. When notified by the government of the employees conspiracy, the
company fired the two employees, and voluntarily cooperated with the
governments investigation. The company was not charged in the criminal case.
Both former employees pled guilty to the principal charges against them and were sentenced to prison. The company believes that the government has
recovered a substantial portion of the defrauded funds from the co-conspirators.
Notwithstanding the companys efforts to settle any claims against the company
arising from the employees scheme, on October 9, 2003 the United States
Attorney filed a civil complaint against the company in the United States
District Court for the District of Massachusetts based in substantial part upon
the actions and omissions of the former employees which gave rise to the
criminal cases against them. In the civil action, the United States Attorney is
asserting on behalf of the government claims against the company based upon the
False Claims Act and the Anti-Kickback Act, in addition to certain common law
and equitable claims. The United States Attorney seeks to recover up to three
times its actual damages and penalties under the False Claims Act, and double
damages and penalties under the Anti-Kickback Act and to recover costs and
interest. The company disputes the claims, believes it has substantive
defenses, and intends to vigorously defend itself. In addition, the company
intends to bring third party claims against parties associated with the scheme.
However, the outcome of such litigation, if unfavorable, could have a material
adverse effect on the companys financial position, results of operations and
cash flows.

On September 5, 2002, Genesis Tactical Group LLC (Genesis)
asserted a cross-claim against Lockheed Martin Corporation
(Lockheed) in the State of New York Supreme Court, County of Onondaga
seeking $50.0 million in damages and against the company seeking $35.0 million in damages.
These cross-claims arise out of a suit filed on July 30, 2002 by Lockheed
against Tactical Communications Group LLC, Genesis and the company in the State
of New York Supreme Court, County of Onondaga. The Lockheed suit relates to a
contract for services that was sold to Genesis by the company pursuant to an
asset purchase agreement in 2001. By the terms of the asset purchase
agreement, the companys liability to Genesis is limited to $300,000, other
than for intentional misrepresentation, willful breach or fraud. Lockheed and
Genesis have settled their outstanding issues, including a software ownership
issue, and filed a stipulation of dismissal with prejudice. The Genesis claim
for $35.0 million against the company was related to the software ownership
issue that was settled in favor of Genesis. Lockheeds settlement demand to
the company was $495,679 plus interest. The company believes that $311,679 of
the demanded amount is for extra work and materials procured by Lockheed from
Genesis and disputes the balance due to other mutually agreed contract changes
between Lockheed and Genesis. The company will continue to defend against any
and all claims by Lockheed and/or Genesis. While the company believes that the
possibility of a material adverse effect on the companys financial position,
results of operations or cash flows is remote, there can be no assurance as to
the outcome.

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DYNAMICS RESEARCH CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)

The company has provided documents in response to a previously disclosed grand
jury subpoena issued on October 15, 2002 by the United States District Court
for the District of Massachusetts directing the company to produce specified
documents dating back to 1996. The subpoena relates to an investigation,
currently focused on the period from 1996 to 1999, by the Antitrust Division of
the Department of Justice, into bidding and procurement activities involving
the company and several other defense contractors who have received similar
subpoenas and may also be subjects of the investigation. Although the company
is cooperating in the investigation, it does not have a sufficient basis to
predict the outcome of the investigation. Should the company be found to have
violated antitrust laws, the matter could have a material adverse effect on the
companys financial position, results of operations and cash flows.









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DYNAMICS RESEARCH CORPORATION

Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

Certain statements in this quarterly report constitute forward-looking
statements which involve known risks, uncertainties and other factors which
may cause the actual results, performance or achievements of Dynamics Research
Corporation (DRC or the company) to be materially different from any future
results, performance or achievements expressed or implied by such
forward-looking statements. Such factors include the Factors That May Affect
Future Results set forth in Managements Discussion and Analysis of Financial
Condition and Results of Operations, which is included in this report.
Precautionary statements made herein should be read as being applicable to all
related forward-looking statements whenever they appear in this report.

OVERVIEW

DRC, founded in 1955, provides information technology, engineering, logistics
and other consulting services to federal defense, civil and state agency
customers. 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 the 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 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 made two
strategic acquisitions in 2002: Andrulis Corporation (ANDRULIS) and HJ Ford
Associates, Inc. (HJ Ford).

DISCONTINUED OPERATIONS

On October 18, 2002, the company announced that it was actively pursuing the
divestiture of the Encoder division, a manufactured products business
previously reported as a business segment, due to continued weakness in the
manufacturing sector. In accordance with Financial Accounting Standards Board
(FASB) Statement of Financial Accounting Standards (SFAS) No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, the
consolidated financial statements and notes thereto of the company have been
restated to reflect the discontinuation of the Encoder Division for all periods
presented. On May 2, 2003, the company completed the sale of its Encoder
Division assets and certain liabilities to GSI Lumonics in Billerica,
Massachusetts.

ACQUISITIONS

On December 20, 2002, the company completed the acquisition of all of the
outstanding shares of capital stock of ANDRULIS, a provider of information
technology and engineering solutions to federal government customers in the
defense and federal civilian sectors. On May 31, 2002, the company completed
the acquisition of all of the outstanding voting common stock of HJ Ford. HJ
Ford helps its clients manage operational process and acquisition programs
through systems and information engineering, information technology, enterprise
engineering and acquisition program support. The acquisitions were recorded
using the purchase method of accounting in accordance with SFAS No. 141,
Business Combinations. Accordingly, the results of these acquired entities are
included in the companys Consolidated Statements of Operations and of Cash
Flows for the periods subsequent to their respective acquisitions.

As part of the HJ Ford purchase, the company acquired a 40% ownership interest
in a small disadvantaged business, as defined by the United States Government.
This business is accounted for using the equity method. This ownership interest is reported as a component of Other assets in the
companys Consolidated Balance Sheets.

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DYNAMICS RESEARCH CORPORATION







MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)


RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003,
COMPARED TO THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002

Revenues

The company reported revenues of $62.4 in the third quarter of 2003, compared
to $47.2 million in the same prior year period. The companys revenues for the
nine months ended September 30, 2003, were $183.2 million, compared to $142.0
million in the same prior year period. The increase in both the three and nine
month 2003 periods compared to the same prior year periods is primarily
attributable to the companys acquisitions.

Contract revenues for the Systems and Services segment increased 32.8%, to
$60.6 million, in the third quarter of 2003, compared to $45.7 million in the
same prior year period. For the first nine months of 2003 and 2002, contract
revenues were $177.9 million and $136.0 million, respectively. Defense
revenues grew 29.0%, or $10.9 million, in the third quarter of 2003, from $37.9 million
in the comparable prior year period. Defense revenues were $142.5 million and
$112.9 million in the nine months ended September 30, 2003 and 2002,
respectively. Revenues from federal civilian agencies were $9.2 million for
the quarter ended September 30, 2003, double the $4.6 million reported in the
comparable prior year period. Revenues from federal civilian agencies in the
nine months ended September 30, 2003 and 2002, were $27.3 million and $12.7
million, respectively. The increase in both of the current year periods from
the same prior year periods is primarily attributable to the acquisition of
ANDRULIS.

Through its acquisitions of ANDRULIS and HJ Ford, the company acquired a
federal defense and civilian revenue base of approximately $9.2 million and
$40.1 million, which contributed to the companys core business for the three
and nine months ended September 30, 2003, respectively. The remaining increase
in revenues was due to organic growth of the companys core business, which was
partially offset by a reduction, in the nine months ended September 30, 2003,
in subcontractor pass-through revenue with the Air Force Electronic Systems
Center and Navy Strategic Systems guidance work totaling $8.4 million.

State and local government revenues were $2.6 million and $3.2 million in the
third quarters of 2003 and 2002, respectively, and $8.1 million and $10.4
million for the nine month periods then ended. Significant state spending
cutbacks in response to state budget deficits have been the primary cause of
reduced state and local revenues.

Product sales for the Metrigraphics segment increased 20.3%, to $1.8 million in
the third quarter of 2003, from $1.5 million in the same quarter of 2002.
However, product sales decreased by $0.7 million in the nine month period ended
September 30, 2003, to $5.3 million, compared to the same prior year period.
The decrease in the nine month period reflects the continuing weak economic
conditions in the manufacturing sector. The company remains concerned that
further economic weakness could increase its adverse effect on this segment.

Gross Margin

Gross margins were 15.5% and 16.1% in the third quarters of 2003 and 2002,
respectively, and 15.8% and 15.7%, respectively, in the nine month periods
ended September 30, 2003 and 2002, respectively.

The companys Systems and Services segments gross margin on contract revenues
decreased to 15.2% in the third quarter of 2003, from 15.8% in the third
quarter of 2002. However, contract revenue gross margin increased to 15.4% in
the nine months ended September 30, 2003, from 14.8% in the comparable prior
year period. The decrease in the current quarter is primarily attributable to
increased subcontractor costs, partially offset by efficiencies realized from
the integration of recent acquisitions into the companys operations, primarily
facility consolidation and lower overhead as a percentage of revenues. These
efficiencies are the principal contributor to the companys improved
performance in the nine month period ended September 30, 2003, compared to the
same period of the prior year.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

The Metrigraphics segments gross margin on product sales increased to 26.7% in
the third quarter of 2003, from 25.2% in the third quarter of the prior year.
However, gross margin on product sales for the nine months ended September 30,
2003, decreased to 27.3%, from 35.6% in the same prior year period. The
overall decrease in gross margin on a year-over-year basis is primarily
attributable to continued weak economic conditions in this sector, resulting in
a lower revenue base over which to spread fixed costs. The company expects
these conditions to continue to exert downward pressure on its product sales
gross margins.

Operating Expenses

Selling, engineering and administrative expenses for the third quarter of 2003,
were $5.0 million, an increase of $0.8 million, compared to $4.2 million in the
same prior year quarter. Selling, engineering and administrative expenses for
the nine months ended September 30, 2003, were $16.9 million, an increase of
$4.3 million, from $12.6 million in the comparable prior year period. The
increased expense in the current quarter is primarily attributable to expenses
in support of the companys acquired businesses. The nine month increase is
primarily attributable to higher legal and benefits costs, coupled with the
aforementioned expenses in support of the companys acquired businesses.
However, the rate of increase on a quarterly basis in the current year has
begun to decline, reflecting the conclusion late in the second quarter of
document production for the Department of Justice anti-trust investigation.

Amortization expense totaled $0.4 million and $1.3 million in the three and
nine months ended September 30, 2003, and relates to intangible assets acquired
in the purchases of ANDRULIS and HJ Ford in 2002. Amortization expense of $0.1
million and $0.2 million in the three and nine months ended September 30, 2002,
relates to HJ Ford for the period subsequent to its May 31, 2002 acquisition.

Operating Income

The company reported operating income of $4.3 million, or 6.8% of revenues, and
$3.3 million, or 6.9% of revenues, in the third quarters of 2003 and 2002,
respectively. Operating income for the nine months ended September 30, 2003
and 2002, was $10.7 million, or 5.8% of revenues, and $9.6 million, or 6.7% of
revenues, respectively. The decrease in operating margin in both current year
periods is primarily attributable to higher selling, engineering and
administrative expenses and amortization expense. Lower gross margin in the
three months ended September 30, 2003 also contributed to the decrease in this
quarters operating margin, while increased margins in the nine months ended
September 30, 2003, partially offset the higher nine month operating expenses.

Interest Income and Expense

Interest income decreased to approximately $5,000 in the third quarter of 2003,
from approximately $32,000 in the comparable prior year period. Interest
income in the nine months ended September 30, 2003, was approximately $24,000,
compared to approximately $157,000 in the same prior year period. The decrease
in both the three and nine month periods is primarily a result of lower
interest rates coupled with lower balances available for investment. Interest
expense increased by approximately $52,000, to approximately $187,000, in the
third quarter of 2003, and by $0.4 million, to $0.7 million, in the nine months
then ended, compared to the same prior year periods. The increase in interest
expense in the current year is primarily attributable to the higher average
balance on the companys $50.0 million revolving credit facility (the
Revolver), which was used to help fund the ANDRULIS acquisition.

Income Tax Provision

The company recorded income tax provisions of $4.2 million and $3.8 million for
the nine month periods ended September 30, 2003 and 2002, respectively, or
41.0% and 39.9% of pre-tax income. The current year income taxes include a net
provision of $85,000 related to the completion of the 2002 income tax return,
which was identified and recorded as a component of the annual estimated
effective tax rate in the third quarter. This additional provision increased
the companys reported tax rate by ten basis points. The company assesses its
fourth quarter tax rate at 40.7%.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

Discontinued Operations

On May 2, 2003, the company completed the sale of its Encoder Division assets
and certain liabilities to GSI Lumonics Inc. (GSI) in Billerica,
Massachusetts for $3.3 million in cash, subject to post-closing adjustments
related to a valuation of the net assets of the Encoder Division and the
assumption by GSI of certain of DRCs liabilities with respect to the assets
acquired.

In connection with this transaction, in the first quarter of 2003, the company
recorded charges aggregating $1.1 million before taxes as a loss on the
disposal of discontinued operations. The components of these charges were $0.3
million of professional fees and $0.8 million of exit costs, comprised of $0.5
million for severance costs for approximately 45 Encoder Division employees and
$0.3 million for future lease costs, net of contractual sublease income from
GSI for the Encoder facility.

During the first quarter of 2003, the company recognized, on a cash basis, $0.7
million received as the final royalty payment associated with the 1999 sale of
its discontinued Telecommunications Fraud control business, which was recorded
against the loss on the disposal of discontinued operations. This income, net
of the $1.1 million of charges described above, resulted in a loss on the
disposal of discontinued operations of $0.4 million before taxes, or a loss of
$0.2 million, net of $0.2 million of income tax benefit.

The companys loss from discontinued operations, net of taxes, was $147,000, or
$0.02 per diluted share, and $191,000, or $0.02 per diluted share, in the third
quarters of 2003 and 2002, respectively. The companys loss from discontinued
operations, net of taxes, was $1.4 million and $0.6 million, or $0.15 and $0.07
per diluted share, in the nine months ended September 30, 2003 and 2002,
respectively. The nine months ended September 30, 2003, include four months of
operating loss from the Encoder division, as well as costs incurred subsequent
to the transaction related to certain liabilities that GSI did not assume.
Included in the current years loss on discontinued operations are $1.1 million
of accrued lease costs, net of estimated sublease income for the Encoder
facility.

Backlog

The companys funded backlog was $109.2 million at September 30, 2003 and
$111.1 million, excluding discontinued operations, at December 31, 2002. The
funded backlog generally is subject to possible termination at the convenience
of the contracting counter party. 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.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2003 and December 31, 2002, the company had cash and cash
equivalents aggregating $2.7 million and $1.1 million, respectively. The
increase in cash and cash equivalents is primarily the result of $9.7 million
of net cash provided by operating activities, including $0.6 million used in
discontinued operations; and $2.9 million of net cash proceeds from the sale of
the companys discontinued Encoder Division; partially offset by $6.0 million
and $5.1 million of net cash used in continuing operations investing and
financing activities, respectively.

Cash provided by operating activities was $9.7, and is primarily attributable
to $6.0 million of income from continuing operations, depreciation and
amortization expenses aggregating $3.5 million, a $3.1 million decrease in
accounts receivable and $3.1 million of increased payroll and employee benefit
accruals, partially offset by increases in unbilled expenditures and fees, and
prepaid expenses and other current assets totaling $3.7 million and $3.4
million, respectively, as well as $0.6 million of net cash used in discontinued
operations.

Cash used for investing activities for continuing operations was $6.0 million,
and is primarily attributable to $5.4 million of capital expenditures related
to the implementation of the companys enterprise business system and facility
renovation costs for its corporate headquarters in Andover, Massachusetts. The
companys capital expenditures are expected to total approximately $8 million
in 2003, principally for enterprise business systems and facilities
infrastructure consolidation and improvements.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

At December 31, 2002, the company had $12.4 million in notes payable associated
with the purchase of ANDRULIS. The notes had an interest rate of 4.0% and a
maturity date of January 2, 2003. In January 2003, the notes were paid in full
with proceeds from the companys revolving credit agreement.

Effective June 28, 2002, the company obtained a $50.0 million revolving credit
agreement (the Revolver), replacing the previous revolver. The Revolver has
a three-year term and is available to the company for general corporate
purposes, including strategic acquisitions. The fee on the unused portion of
the Revolver ranges from 0.25 % to 0.5% depending on the companys most
recently reported leverage ratio and is payable quarterly in arrears. The
company has the option to elect on a fixed 30, 60 or 90-day term, an interest
rate of LIBOR plus 2.0% to 3.0%, depending on the companys most recently
reported leverage ratio, or the prime rate on any outstanding balance.
Interest on the outstanding balance of the Revolver is payable monthly under
the prime rate option or at the end of the elected term for the LIBOR rate
option. At September 30, 2003, the outstanding balance under the Revolver was
$8.5 million. The interest rate on the outstanding balance under the Revolver
was 3.12% under a 30-day LIBOR option elected on September 12, 2003.

The company has a 10-year mortgage loan (the Mortgage), dated June 12, 2000,
as amended and restated on June 28, 2002, on the corporate office facility in
Andover, Massachusetts. The outstanding balance of the Mortgage was $8.4
million at September 30, 2003. The agreement requires quarterly principal
payments of $125,000, with a final payment of $5.0 million in May 2010.
Interest on the Mortgage accrued at the rate of LIBOR plus 2.5% through
November 5, 2001. Effective November 6, 2001, the interest rate on the
Mortgage was reduced to LIBOR plus 2.0%. The interest rate on the Mortgage
under the 90-day LIBOR option, elected on July 14, 2003, was 3.11%. This rate
was effective at September 30, 2003.

On December 26, 2002, the company entered into an installment payment agreement
in connection with the purchase of its enterprise business system software.
The company made the first payment on January 26, 2003, with the second and
last payment due on January 26, 2004. The company recorded the liability using
an imputed interest rate of 3.38%, which was its effective borrowing rate at
December 31, 2002. The obligation is reflected in the table below as a
purchase commitment.

The Revolver and Mortgage agreements, as currently amended, require the company
to meet certain financial covenants including maintaining a minimum net worth,
cash flow and debt coverage ratios, and limit the companys ability to incur
additional debt, pay dividends, purchase capital assets, sell or dispose of
assets, make additional acquisitions or investments, or enter into new leases,
among other restrictions. In addition, the loan agreements contain a
subjective acceleration clause allowing the lender to require payment upon the
occurrence of a material adverse change.

The company was in compliance with all loan covenants on September 30, 2003.

Cash used in financing activities was comprised of $6.1 million of net payments
under the companys revolving credit agreement and notes payable and $375,000
of principal payments on the mortgage on the companys corporate headquarters
facility. These amounts were partially offset by cash proceeds aggregating
$1.5 million from the exercise of stock options and issuance of shares under
the employee stock purchase plan.

The companys need for, cost of, and access to funds are dependent on future
operating results, the companys growth and acquisition activity, as well as
conditions external to the company. In 2002, the company increased the
capacity of its revolving credit facility from $20.0 million to $50.0 million
to enable pursuit of the companys acquisition strategy. In 2003, the company
will continue to consider acquisition opportunities, which align with its
strategic objectives, along with the possibility of utilizing the credit
facility as a source of financing. The company believes that internally
generated funds and cash available under its Revolver will be sufficient to
support the companys current operations for at least the next 12 months.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

The companys contractual obligations as of September 30, 2003 consist of the
following (in thousands):

|                     |                               |   |           |        |              |   |              |       |            |   |       |       |  |   |       |       |  |   |        |        | 
|-------------------- | ----------------------------- | - | --------- | ------ | ------------ | - | ------------ | ----- | ---------- | - | ----- | ----- |  | - | ----- | ----- |  | - | ------ | ------ | 
|                     |                               |   | Less than |        | Two to three |   | Four to five |       |            |   |       |       |  |   |      
|                     |                               |   | one year  |        | years        |   | years        |       | Thereafter |   | Total
|                     |                               |   |          
|Revolver             |                               | $ | 8,500     |        |              | $ |             |       |            | $ |      |       |  | $ |      |       |  | $ | 8,500  |       
|Long-term debt       |                               |   | 500       |        |              |   | 1,000        |       |            |   | 1,000 |       |  |   | 5,875 |       |  |   | 8,375  |       
|Operating leases     |                               |   | 4,183     |        |              |   | 6,067        |       |            |   | 3,153 |       |  |   | 3,773 |       |  |   | 17,176 |       
|Purchase commitments |                               |   | 554       |        |              |   |             |       |            |   |      |       |  |   |      |       |  |   | 554    |       
|                     |                               |   |           |        |              |   |              |       |            |   |       |       |  |   |       |       |  |   |        |       
|                     | Total contractual obligations |   | $         | 13,737 |              |   | $            | 7,067 |            |   | $     | 4,153 |  |   | $     | 9,648 |  |   | $      | 34,605 | 
|                     |                               |   |           |        |              |   |              |       |            |   |       |       |  |   |       |       |  |   |        |       

COMMITMENTS AND CONTINGENCIES

As part of the HJ Ford purchase, the company acquired a 40% ownership interest
in a small disadvantaged business, as defined by the United States Government.
This business is accounted for using the equity method. The company has
continuing business relationships with this business and has provided it with a
line of credit guarantee in the amount of $0.2 million. There was no
outstanding balance under this line of credit at September 30, 2003.

The company has change of control agreements with certain of its employees that
provide them with benefits should their employment with the company be
terminated other than for cause or their disability or death, or if they resign
for good reason within a certain period of time from the date of any change of
control of the company.

As a defense contractor, the company is subject to many levels of audit and
review from various government agencies, including the Defense Contract Audit
Agency, the Inspector General, the Defense Criminal Investigative Service, the
General Accounting Office, the Department of Justice and congressional
committees. Both related to and unrelated to its defense industry involvement,
the company is, from time to time, involved in audits, lawsuits, claims,
administrative proceedings and investigations. The company accrues for
liabilities associated with these activities when it becomes probable that
future expenditures will be made and such expenditures can be reasonably
estimated. The companys evaluation of the likelihood of expenditures related
to these matters is subject to change in future periods, depending on then
current events and circumstances, which could have material adverse effects on
the companys financial position, results of operations and cash flows.

As previously disclosed, on October 26, 2000, two former
company employees were indicted and charged with, among other
violations, wire fraud and a
conspiracy scheme to defraud the United States Air Force out of approximately
$10 million through kickbacks and overcharging for computer components and
services. The former employees collected the kickbacks and overcharges through
separate and independent businesses. The company received no money from their
scheme. When notified by the government of the employees conspiracy, the
company fired the two employees, and voluntarily cooperated with the
governments investigation. The company was not charged in the criminal case.
Both former employees pled guilty to the principal charges against them and were sentenced to prison. The company believes that the government has
recovered a substantial portion of the defrauded funds from the co-conspirators.
Notwithstanding the companys efforts to settle any claims against the company
arising from the employees scheme, on October 9, 2003 the United States
Attorney filed a civil complaint against the company in the United States
District Court for the District of Massachusetts based in substantial part upon
the actions and omissions of the former employees which gave rise to the
criminal cases against them. In the civil action, the United States Attorney is
asserting on behalf of the government claims against the company based upon the
False Claims Act and the Anti-Kickback Act, in addition to certain common law
and equitable claims. The United States Attorney seeks to recover up to three
times its actual damages and penalties under the False Claims Act, and double
damages and penalties under the Anti-Kickback Act and to recover costs and
interest. The company disputes the claims, believes it has substantive
defenses, and intends to vigorously defend itself. In addition, the company
intends to bring third party claims against parties associated with the scheme.
However, the outcome of such litigation, if unfavorable, could have a material
adverse effect on the companys financial position, results of operations and
cash flows.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

On September 5, 2002, Genesis Tactical Group LLC (Genesis) asserted a
cross-claim against Lockheed Martin Corporation
(Lockheed) in the State of New York Supreme Court, County
of Onondaga seeking $50.0
million in damages and against the company seeking $35.0 million in damages.
These cross-claims arise out of a suit filed on July 30, 2002 by Lockheed
against Tactical Communications Group LLC, Genesis and the company in the State
of New York Supreme Court, County of Onondaga. The Lockheed suit relates to a
contract for services that was sold to Genesis by the company pursuant to an
asset purchase agreement in 2001. By the terms of the asset purchase
agreement, the companys liability to Genesis is limited to $300,000, other
than for intentional misrepresentation, willful breach or fraud. Lockheed and
Genesis have settled their outstanding issues, including a software ownership
issue, and filed a stipulation of dismissal with prejudice. The Genesis claim
for $35.0 million against the company was related to the software ownership
issue that was settled in favor of Genesis. Lockheeds settlement demand to
the company was $495,679 plus interest. The company believes that $311,679 of
the demanded amount is for extra work and materials procured by Lockheed from
Genesis and disputes the balance due to other mutually agreed contract changes
between Lockheed and Genesis. The company will continue to defend against any
and all claims by Lockheed and/or Genesis. While the company believes that the
possibility of a material adverse effect on the companys financial position,
results of operations and cash flows is remote, there can be no assurance as to
the outcome.

The company has provided documents in response to a previously disclosed grand
jury subpoena issued on October 15, 2002 by the United States District Court
for the District of Massachusetts directing the company to produce specified
documents dating back to 1996. The subpoena relates to an investigation,
currently focused on the period from 1996 to 1999, by the Antitrust Division of
the Department of Justice into bidding and procurement activities involving the
company and several other defense contractors who have received similar
subpoenas and may also be subjects of the investigation. Although the company
is cooperating in the investigation, it does not have a sufficient basis to
predict the outcome of the investigation. Should the company be found to have
violated the antitrust laws, the matter could have a material adverse effect on
the companys financial position, results of operations and cash flows.

CRITICAL ACCOUNTING POLICIES

Use of Estimates

The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements. Estimates and assumptions also affect the amount of revenue and
expenses during the reported period. Actual results could differ from those
estimates. Management must make use of estimates in the areas discussed below.

Revenue Recognition

The companys systems and services business provides its services under time
and materials, cost reimbursable and fixed-price contracts including service
type contracts.

For time and materials contracts, revenue reflects the number of direct labor
hours expended in the performance of a contract multiplied by the contract
billing rate, as well as reimbursement of other billable direct costs. The
risk inherent in time and materials contracts is that actual costs differ
materially from negotiated billing rates in the contract, which directly
affects operating income.

For cost reimbursable contracts, revenue is recognized as costs are incurred
and include a proportionate amount of the fee earned. Cost reimbursable
contracts specify the contract fee in dollars or as a percentage of estimated
costs. The primary risk on a cost reimbursable contract is that a government
audit of direct and indirect costs could result in the disallowance of certain
costs, which would directly impact revenue and margin on the contract.
Historically, such audits have had no material impact on the companys revenue
and operating income.

Under fixed-price contracts, other than service-type contracts, revenue is
recognized under the percentage of completion method, on the basis of costs
incurred in relation to estimated total costs to complete the contract. Under
service-type contracts, costs incurred are not indicative of progression toward
completion of the contract. Revenue from service-type fixed price contracts is
recognized ratably over the contract period or by other appropriate output
methods to measure service provided, and contract costs are expensed as
incurred. The risk to the company on a fixed-price contract is that if actual
costs exceed the estimated costs to complete the contract, then profit is
eroded or losses are incurred.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

For all types of contracts, the company recognizes anticipated contract losses
as soon as they become known and estimable. Out-of-pocket expenses that are
reimbursable by the customer are included in contract revenue and cost of
contract revenue.

Unbilled expenditures and fees on contracts in process are the amounts of
recoverable contract revenue that have not been billed at the balance sheet
date. Most of the companys unbilled expenditures and fees relate to revenue
that is billed in the month after services are performed. In certain
instances, billing is deferred in compliance with contract terms, such as
milestone billing arrangements and withholdings. Costs related to United
States Government contracts, including applicable indirect costs, are subject
to audit by the government. Revenue from such contracts has been recorded at
amounts the company expects to realize upon final settlement.

Valuation Allowances

The company provides for potential losses against specifically identified
accounts receivable and unbilled expenditures and fees on contracts in process
based on the companys expectation of a customers inability to pay. These
reserves are based primarily upon specific identification of potential
uncollectible accounts. In addition, payments to the company for performance
on United States Government contracts are subject to audit by the Defense
Contract Audit Agency. If necessary, the company provides an estimated reserve
for adjustments resulting from rate negotiations and audit findings. The
company routinely provides for these items when they are identified and can be
reasonably estimated.

Intangible and Other Long-lived Assets

The company uses assumptions in establishing the carrying value, fair value and
estimated lives of intangible and other long-lived assets. Long-lived assets
are reviewed for impairment whenever events or changes in circumstances
indicate that the asset carrying value may not be recoverable. Recoverability
is measured by a comparison of the assets continuing ability to generate
positive income from operations and positive cash flow in future periods
compared to the carrying value of the asset. If assets are considered to be
impaired, the impairment is recognized in the period of identification and is
measured as the amount by which the carrying value of the asset exceeds the
fair value of the asset.

The useful lives and related amortization of intangible assets are based on
their estimated residual value in proportion to the economic benefit consumed.
The useful lives and related depreciation of other long-lived assets are based
on the companys estimate of the period over which the asset will generate
revenue or otherwise be used by the company.

Goodwill

The company assesses goodwill for impairment at the segment level at least once
each year by applying a fair value test. Goodwill could be impaired due to
market declines, reduced expected future cash flows, or other factors or
events. Should the fair value of goodwill, as determined by the company at any
measurement date, fall below its carrying value, a charge for impairment of
goodwill would occur in that period.

Business Combinations

During 2002, the company acquired two companies, ANDRULIS and HJ Ford. The
company has determined and recorded the fair values of assets acquired and
liabilities assumed as of the dates of acquisition. The company has utilized
an independent valuation specialist to determine the fair values of identified
intangible assets acquired in order to allocate a portion of the purchase price
to these assets. The results of operations of these acquired entities are
included in the companys consolidated financial statements from the dates of
their respective acquisitions.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

Pensions

Accounting and reporting for the companys pension plan requires the use of
assumptions, including but not limited to, discount rate, rate of compensation
increases and expected return on assets. If these assumptions differ
materially from actual results, the companys obligations under the pension
plan could also differ materially, potentially requiring the company to record
an additional pension liability. An actuarial valuation is performed each
year. The results of this actuarial valuation are reflected in the accounting
for the pension plan upon determination.

RECENT ACCOUNTING PRONOUNCEMENTS

In May 2003, the Emerging Issues Task Force (EITF), reached a consensus on
EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables(Issue
No. 00-21). Issue No. 00-21 addresses when an arrangement with multiple
deliverables should be divided into separate units of accounting. The company
adopted the consensus in the third quarter of 2003. The impact of adopting
Issue No. 00-21 did not have a material impact on the companys financial
position, results of operations or cash flows.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150
requires issuers to classify as liabilities (or assets in some circumstances)
three classes of freestanding financial instruments that embody obligations for
the issuer. Generally, SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003 and is otherwise effective at the
beginning of the first interim period beginning after June 15, 2003. The
company adopted the provisions of SFAS No. 150 on July 1, 2003. The company
did not have any financial instruments within the scope of SFAS No. 150 at
September 30, 2003, and, accordingly, the adoption of SFAS No. 150 did not have
any effect on its financial position, results of operations or cash flows.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments and
hedging activities under SFAS No. 133 for decisions made: (a) as part of the
Derivative Implementation Group process that requires amendment to SFAS No.
133; (b) in connection with other FASB projects dealing with financial
instruments; and (c) in connection with the implementation issues raised
related to the application of the definition of derivative. SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003 and for
designated hedging relationships after June 30, 2003. SFAS No. 149 is required
to be applied prospectively. The company does not currently have any
derivative instruments and, accordingly, the adoption of SFAS No. 149 did not
have any effect on its financial position, results of operations or cash flows.

In January 2003, the FASB issued FASB Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.
The primary objectives of FIN 46 are to provide guidance on the identification
of entities for which control is achieved through means other than through
voting rights (variable interest entities) and how to determine when and
which business enterprise should consolidate the variable interest entity.
This new model for consolidation applies to an entity in which either: (a) the
equity investors (if any) do not have a controlling financial interest; or (b)
the equity investment at risk is insufficient to finance that entitys
activities without receiving additional subordinated financial support from
other parties. In addition, FIN 46 requires that both the primary and all
other enterprises with a significant variable interest in a variable interest
entity make additional disclosures. FIN 46 is effective immediately for
variable interest entities created after January 31, 2003. FIN 46 had
previously been effective for interim periods beginning after June 15, 2003,
for variable interests in place prior to February 1, 2003; however, on October
10, 2003, the FASB issued a statement deferring the implementation of FIN 46
for these variable interests until the first reporting period beginning after
December 15, 2003. The company acquired, as part of the May 31, 2003 purchase
of HJ Ford, a 40% ownership interest in a small disadvantaged business, as
defined by the United States Government, which is accounted for using the
equity method. The company provided the business with a line of credit
guarantee, under which its maximum exposure is $0.2 million. The company is
currently evaluating the impact, if any, that the adoption of FIN 46 in the
fourth quarter of 2003, will have on the companys financial position, results
of operations or cash flows. The company currently has no other investments
subject to the provisions of FIN 46.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure-An Amendment of SFAS No. 123. SFAS No.
148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide
alternative methods of transition for a voluntary change to the
fair-value-based method of accounting for stock-based employee compensation.
Also, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in interim financial statements in addition to
the annual disclosures about the effect the fair value method would have had on
reported results. The transition and annual disclosure requirements of SFAS
No. 148 are effective for fiscal years ending after December 15, 2002. The
interim disclosure requirements are effective for interim periods beginning
after December 15, 2002. As permitted by SFAS No. 148, the company continues
to apply the disclosure-only alternative adopted under SFAS No. 123 to account
for its stock option grants to employees, under which compensation expense is
not typically recognized. The company adopted the interim disclosure
provisions of FAS No. 148 in its Form 10-Q for the quarterly period ended March
31, 2003.

FACTORS THAT MAY AFFECT FUTURE RESULTS

You should carefully consider the risks described below and the information in
our Annual Report on Form 10-K for the year ended December 31, 2002, filed with
the Securities and Exchange Commission (SEC) on March 31, 2003, as well as
our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K subsequently
filed with the SEC, before deciding to invest in shares of our common stock.
These are risks and uncertainties we believe are most important for you to
consider. Additional risks and uncertainties not presently known to us, or
which we currently deem immaterial, or which are similar to those faced by
other companies in our industry or business in general, may also impair our
business operations. If any of the following risks or uncertainties actually
occurs, our business, financial condition, results of operations or cash flows
would likely suffer. In that event, the market price of our common stock could
decline.

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 the nine months ended September 30, 2003 and in 2002, approximately 93% and
89% of our revenue, respectively, was derived from United States government
agencies, primarily the Department of Defense. In the past, our revenue 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 re-bid, as well as significant competitive pressure
to lower prices, which may reduce profitability in this area of our business.
Any reduction in the level of 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
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,
results of operations and cash flows.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

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:



| |  |  | adequately estimate the resources required to complete a project;                
| | - |  | ---------------------------------------------------------------------------------
| |  |  | properly determine the scope of an engagement; or                                
| |  |  | complete our contractual obligation in a manner consistent with the project plan.

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, results of operations and cash flows.

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
the ensure that companies competing for contracts intended for small business
are qualified as such at the time of the competition. In the nine months ended
September 30, 2003 and in 2002, the company derived $29.2 million and $17.1
million from a small business set aside contract held by its HJ Ford subsidiary
and due for re-competition 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, results of operations and cash flows.

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, results of operations and
cash flows.

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 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.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

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 and civil suit in the United States
District Court for the District 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 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 lost 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.

We Are Involved in Various Litigation Matters Which, If Not Resolved in Our
Favor, Could Harm Our Business.

On October 26, 2000, two former company employees were indicted and charged
with conspiracy to defraud the United States, and wire fraud, among other
charges, arising out of a scheme to defraud the United States out of
approximately $10 million. Both men subsequently pled guilty to the principal
charges against them. On October 9, 2003, the United States Attorneys office
filed a civil complaint in the District Court of Massachusetts against the
company based in substantial part upon the actions and omissions of the former
executives that gave rise to the criminal cases against them. In the civil
action, the United States is asserting claims against the company based on the
False Claims Act and the Anti-Kickback Act, in addition to certain common law
and equitable claims. The United States seeks to recover up to three times its
actual damages and penalties under the False Claims Act, and double damages and
penalties under the Anti-Kickback Act. The United States also seeks to recover
its costs and interest in this action. The company believes it has substantive
legal and factual defenses to these claims and intends to vigorously defend
itself. However, the outcome of this litigation and other proceedings to which
the company is a part, if unfavorable, could have a material adverse effect on
the companys financial position, results of operations and cash flows.

Additionally, the Antitrust Division of the Department of Justice is engaged in
an investigation, currently focused on the period from 1996 to 1999, into
bidding and procurement activities involving the company and several other
defense contractors who may also be subjects of the investigation. Although
the company is cooperating in the investigation, it does not have a sufficient
basis to predict the outcome of the investigation. Should the company be found
to have violated antitrust laws, the matter could have a material adverse
effect on the companys financial position, results of operations and cash
flows.

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 prior performance,
previous experience, technical competence and price.

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
product quality, the ability to specialize our engineering in order to meet our
customers specific system requirements and price. Our precision products
business has a number of competitors, many of which have significantly greater
financial, technical and marketing resources than we do. Competitive pressures
in our government and commercial businesses could have a material adverse
effect on our business, financial condition, results of operations and cash
flows.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

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 78% and 80% of our
total revenue during the nine months ended September 30, 2003 and during 2002.
Within the Department of Defense, individual services and program officers
account for a significant portion of our United States Government business. We
cannot provide any assurance 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, results of operations and cash
flows.

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 provide any assurance 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 condition, results of
operations and cash flows.

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 division. Significantly lower production
volumes resulting in under-utilization of our manufacturing facilities would
adversely affect our business, financial condition, results of operations and
cash flows.

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
provide any assurance 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 provide any assurance 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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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

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, results of operations and cash flows.

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:



| |  |  | the number, size and timing of client projects commenced and completed during a quarter;
| | - |  | ----------------------------------------------------------------------------------------
| |  |  | bid and proposal efforts undertaken;                                                    
| |  |  | progress on fixed-price projects during a given quarter;                                
| |  |  | employee productivity and hiring, attrition and utilization rates;                      
| |  |  | accuracy of estimates of resources required to complete ongoing projects; and           
| |  |  | general economic conditions.                                                            

Demand for our products and services in each of the markets we serve can vary
significantly from quarter to quarter due to revisions in customer budgets or
schedules and other factors beyond our control. In addition, because a high
percentage of our expenses is fixed and does vary relative to revenue, a
decrease in revenue may cause a significant variation in our operating results.

We May Not Make or Complete Future Mergers, Acquisitions or Strategic
Alliances or Investments.

In 2002, we acquired HJ Ford Associates, Inc. and Andrulis Corporation and we
may seek to continue to expand our operations through mergers, acquisitions or
strategic alliances with businesses that will complement our existing business.
However, we may not be able to find attractive candidates, or enter into
acquisitions on terms that are favorable to us, or successfully integrate the
operation so companies that we acquire. In addition, we may compete with other
companies for these acquisition candidates, which could make an acquisition
more expensive for us. If we are able to successfully identify and complete an
acquisition or similar transaction, it could involve a number of risks,
including, among others:



| |  |  | the difficulty of assimilating the acquired operations and personnel;                                                                       
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------
| |  |  | the potential disruption of our ongoing business and diversion of resources and management time;                                            
| |  |  | the potential failure to retain key personnel of the acquired business;                                                                     
| |  |  | the difficulty of integrating systems, operations and cultures; and                                                                         
| |  |  | the potential impairment of relationships with customers as a result
of changes in management or otherwise arising out of such transactions.

We cannot be assured that any acquisition will be made, that we will be able to
obtain financing needed to fund such acquisitions and, if any acquisitions are
so made, that the acquired business will be successfully integrated into our
operations or that the acquired business will perform as expected. In
addition, if we were to proceed with one or more significant strategic
alliances, acquisitions or investments in which the consideration consists of
cash, a substantial portion of our available cash could be used to consummate
the strategic alliances, acquisitions or investments. The financial impact of
acquisitions, investments and strategic alliances could have a material adverse
effect on our business, financial condition, results of operations and cash
flows and could cause substantial fluctuations in our quarterly and yearly
operating results.

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DYNAMICS RESEARCH CORPORATION
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)

The Market Price of Our Common Stock May Be Volatile.

The market price of securities of technology companies historically has faced
significant volatility. The stock market in recent years has also experienced
significant price and volume fluctuations that often have been unrelated or
disproportionate to the operating performance of particular companies. Many
factors that have influenced trading prices will vary from period to period,
including:



| |  |  | decreases in our earnings and revenue or quarterly operating results;
| | - |  | ---------------------------------------------------------------------
| |  |  | changes in estimates by analysts;                                    
| |  |  | market conditions in the industry;                                   
| |  |  | announcements and new developments by competitors; and               
| |  |  | regulatory reviews.                                                  

Any of these events could have a material adverse effect on the market price of
our common stock.







Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The company is subject to interest rate risk associated with our Mortgage and
Revolver, where interest payments are tied to either the LIBOR or prime rate.
At any time, a sharp rise in interest rates could have an adverse effect on net
interest expense as reported in the companys Consolidated Statements of
Operations. A one full percentage point increase in the interest rate on the
balance of the Mortgage and Revolver at September 30, 2003 would result in a
$0.2 million increase in interest expense per year. The company does not
currently hedge these interest rate exposures.

The company presently has minimal exposure to market interest rates on its
investments. At September 30, 2003, the company had investments of $1.2
million, which consisted primarily of money market accounts.

The company has no significant exposure to foreign currency fluctuations.
Foreign sales, which are nominal, are primarily denominated in United States
dollars.







Item 4.  DISCLOSURE CONTROLS AND PROCEDURES

An evaluation was performed under the supervision and with the participation of
the companys management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of our disclosure controls and
procedures as of September 30, 2003. Based on that evaluation, the companys
management, including our Chief Executive Office and Chief Financial Officer,
have concluded that the companys disclosure controls and procedures are
effective to ensure that information required to be disclosed in the reports
that the company files or submits under the Securities and Exchange Act of 1934
is recorded, processed, summarized and reported as specified in the Securities
and Exchange Commissions rules and forms.

We strive to maintain and strengthen internal controls and procedures that are
designed to ensure that information required to be disclosed in our Exchange
Act reports is recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms, and that such information is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. Accordingly, the company evaluates its internal
controls over financial reporting on a regular basis. Based upon the results
of these evaluations, the company considers what revisions, improvements and/or
corrective actions are necessary in order to ensure that its internal controls
over financial reporting are effective.

During the three months ended September 30, 2003, there has been no change in
our internal controls over financial reporting that has materially affected, or
is reasonably likely to materially affect, our internal controls over financial
reporting.

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DYNAMICS RESEARCH CORPORATION







PART II. OTHER INFORMATION







Item 1.  LEGAL PROCEEDINGS

As a defense contractor, the company is subject to many levels of audit and
review from various government agencies, including the Defense Contract Audit
Agency, the Inspector General, the Defense Criminal Investigative Service, the
General Accounting Office, the Department of Justice and congressional
committees. Both related to and unrelated to its defense industry involvement,
the company is, from time to time, involved in audits, lawsuits, claims,
administrative proceedings and investigations. The company accrues for
liabilities associated with these activities when it becomes probable that
future expenditures will be made and such expenditures can be reasonably
estimated. The companys evaluation of the likelihood of expenditures related
to these matters is subject to change in future periods, depending on then
current events and circumstances, which could have material adverse effects on
the companys financial position, results of operations and cash flows.

As previously disclosed, on October 26, 2000, two former
company employees were indicted and charged with, among other
violations, wire fraud and a
conspiracy scheme to defraud the United States Air Force out of approximately
$10 million through kickbacks and overcharging for computer components and
services. The former employees collected the kickbacks and overcharges through
separate and independent businesses. The company received no money from their
scheme. When notified by the government of the employees conspiracy, the
company fired the two employees, and voluntarily cooperated with the
governments investigation. The company was not charged in the criminal case.
Both former employees pled guilty to the principal charges against them and were sentenced to prison. The company believes that the government has
recovered a substantial portion of the defrauded funds from the co-conspirators.
Notwithstanding the companys efforts to settle any claims against the company
arising from the employees scheme, on October 9, 2003 the United States
Attorney filed a civil complaint against the company in the United States
District Court for the District of Massachusetts based in substantial part upon
the actions and omissions of the former employees which gave rise to the
criminal cases against them. In the civil action, the United States Attorney is
asserting on behalf of the government claims against the company based upon the
False Claims Act and the Anti-Kickback Act, in addition to certain common law
and equitable claims. The United States Attorney seeks to recover up to three
times its actual damages and penalties under the False Claims Act, and double
damages and penalties under the Anti-Kickback Act and to recover costs and
interest. The company disputes the claims, believes it has substantive
defenses, and intends to vigorously defend itself. In addition, the company
intends to bring third party claims against parties associated with the scheme.
However, the outcome of such litigation, if unfavorable, could have a material
adverse effect on the companys financial position, results of operations and
cash flows.

On September 5, 2002, Genesis Tactical Group LLC (Genesis) asserted a
cross-claim against Lockheed Martin Corporation
(Lockheed) in the State of New York Supreme Court, County
of Onondaga seeking $50.0
million in damages and against the company seeking $35.0 million in damages.
These cross-claims arise out of a suit filed on July 30, 2002 by Lockheed
against Tactical Communications Group LLC, Genesis and the company in the State
of New York Supreme Court, County of Onondaga. The Lockheed suit relates to a
contract for services that was sold to Genesis by the company pursuant to an
asset purchase agreement in 2001. By the terms of the asset purchase
agreement, the companys liability to Genesis is limited to $300,000, other
than for intentional misrepresentation, willful breach or fraud. Lockheed and
Genesis have settled their outstanding issues, including a software ownership
issue, and filed a stipulation of dismissal with prejudice. The Genesis claim
for $35.0 million against the company was related to the software ownership
issue that was settled in favor of Genesis. Lockheeds settlement demand to
the company was $495,679 plus interest. The company believes that $311,679 of
the demanded amount is for extra work and materials procured by Lockheed from
Genesis and disputes the balance due to other mutually agreed contract changes
between Lockheed and Genesis. The company will continue to defend against any
and all claims by Lockheed and/or Genesis. While the company believes that the
possibility of a material adverse effect on the companys financial position,
results of operations and cash flows is remote, there can be no assurance as to
the outcome.

The company has provided documents in response to a previously disclosed grand
jury subpoena issued on October 15, 2002 by the United States District Court
for the District of Massachusetts directing the company to produce specified
documents dating back to 1996. The subpoena relates to an investigation,
currently focused on the period from 1996 to 1999, by the Antitrust Division of
the Department of Justice into bidding and procurement activities involving the
company and several other defense contractors who have received similar
subpoenas and may also be subjects of the investigation. Although the company is cooperating in the investigation, it does not have a
sufficient basis to predict the outcome of the investigation. Should the
company be found to have violated the antitrust laws, the matter could have a
material adverse effect on the companys financial position, results of
operations and cash flows.

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Item 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)  The following Exhibits are filed herewith:

|     |  |                                                                                                                                                                                        
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1 |  | Certification of the Chief Executive Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|     |  |                                                                                                                                                                                        
|31.2 |  | Certification of the Chief Financial Officer pursuant to Rule
13a-14(a) under the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
|     |  |                                                                                                                                                                                        
|32.1 |  | Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002                                  
|     |  |                                                                                                                                                                                        
|32.2 |  | Certification of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002                                  

(b)  The following report on Form 8-K was furnished during the quarterly period
ended September 30, 2003:



| | (1) |  | Current Report on Form 8-K, filed on July 29, 2003, relating to the
press release of the companys quarterly results for the period ended
June 30, 2003.
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------

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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.

|                        |  |                                                                                      |  | 
|----------------------- |  | ------------------------------------------------------------------------------------ |  | 
|                        |  | DYNAMICS RESEARCH CORPORATION
(Registrant)                                           |  | 
|                       
|Date: November 11, 2003 |  | By: /s/ David KeleherDavid Keleher
Vice President and Chief Financial Officer        |  | 
|                       
|                        |  | /s/ Donald B. LevisDonald B. Levis
Corporate Controller and Chief Accounting Officer |  | 

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EXHIBIT INDEX

|        |  |                                                                                                                                                                                         |  |               
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------
|Exhibit |  |                                                                                                                                                                                         |  |               
|Number  |  | Exhibit Name                                                                                                                                                                            |  | Location      
|        |  |                                                                                                                                                                                         |  |               
|31.1    |  | Certification of the Chief Executive Officer
pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 |  | Filed herewith
|        |  |                                                                                                                                                                                         |  |               
|31.2    |  | Certification of the Chief Financial Officer
pursuant to Rule 13a-14(a) under the
Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 |  | Filed herewith
|        |  |                                                                                                                                                                                         |  |               
|32.1    |  | Certification of the Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002                                   |  | Filed herewith
|        |  |                                                                                                                                                                                         |  |               
|32.2    |  | Certification of the Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002                                   |  | Filed herewith