##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007
 OR
 o
    
    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
  MASSACHUSETTS
    
    04-2211809(State of Incorporation)
    
    (I.R.S. Employer Identification No.)
 60 FRONTAGE ROAD, ANDOVER, MASSACHUSETTS 01810-5498
 978-475-9090
 
 þ o
  o þ o
 o þ




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##### 



DYNAMICS RESEARCH CORPORATION
FORM 10-Q
For the Quarterly Period Ended March 31, 2007
Table of Contents
 PagePart I. Financial Information
    
    
    3Item 1. Financial Statements
    
    
    3Condensed Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006 (unaudited)
    
    
    3Condensed Consolidated Statements of Operations for the three months ended March 31, 2007
and 2006 (unaudited)
    
    
    4Condensed Consolidated Statements of Changes in Shareholders Equity and Comprehensive
Income for the three months ended March 31, 2007 and 2006 (unaudited)
    
    
    5Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2007
and 2006 (unaudited)
    
    
    6Notes to Condensed Consolidated Financial Statements (unaudited)
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    20Item 4. Controls and Procedures
    
    
    20Part II. Other Information
    
    
    21Item 1. Legal Proceedings
    
    
    21Item 1A. Risk Factors
    
    
    21Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    21Item 6. Exhibits
    
    
    22EX-31.1 SECTION 302 CERTIFICATION OF CEOEX-31.2 SECTION 302 CERTIFICATION OF CFOEX-32.1 SECTION 906 CERTIFICATION OF CEOEX-32.2 SECTION 906 CERTIFICATION OF CFO
  Special Note on Factors Affecting Future Results
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Condensed Consolidated Financial Statements
 DYNAMICS RESEARCH CORPORATION
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
(dollars in thousands, except share data)
 March 31,
    
    
    December 31,2007
    
    
    2006(restated)(See Note 1)AssetsCurrent assetsCash and cash equivalents
    
    $
    389
    
    
    $
    7,887Accounts receivable, net of allowances of $830 at
March 31, 2007 and $793 at December 31, 2006
    
    
    38,720
    
    
    
    27,136Unbilled expenditures and fees on contracts in process
    
    
    38,282
    
    
    
    36,764Prepaid expenses and other current assets
    
    
    3,525
    
    
    
    2,824Total current assets
    
    
    80,916
    
    
    
    74,611Noncurrent assetsProperty, plant and equipment, net
    
    
    11,193
    
    
    
    11,509Goodwill
    
    
    63,055
    
    
    
    63,055Intangible assets, net
    
    
    5,021
    
    
    
    5,671Deferred tax asset
    
    
    1,507
    
    
    
    1,507Other noncurrent assets
    
    
    3,076
    
    
    
    3,499Total noncurrent assets
    
    
    83,852
    
    
    
    85,241Total assets
    
    $
    164,768
    
    
    $
    159,852Liabilities and stockholders equityCurrent liabilitiesAccounts payable
    
    $
    14,807
    
    
    $
    18,195Accrued compensation and employee benefits
    
    
    15,016
    
    
    
    14,473Deferred taxes
    
    
    9,003
    
    
    
    9,864Other accrued expenses
    
    
    4,729
    
    
    
    5,201Total current liabilities
    
    
    43,555
    
    
    
    47,733Long-term liabilitiesLong-term debt
    
    
    24,900
    
    
    
    15,000Other long-term liabilities
    
    
    10,203
    
    
    
    12,805Total long-term liabilities
    
    
    35,103
    
    
    
    27,805Total liabilities
    
    
    78,658
    
    
    
    75,538Commitments and contingencies  Note 11Stockholders equityPreferred stock, $0.10 par value; 5,000,000 shares
authorized; no shares issued and outstanding
    
    
    
    
    
    
    Common stock, $0.10 par value; 30,000,000 shares
authorized; 9,378,220 and 9,314,962 shares issued and
outstanding at March 31, 2007 and December 31, 2006,
respectively
    
    
    938
    
    
    
    931Capital in excess of par value
    
    
    48,310
    
    
    
    47,644Accumulated other comprehensive loss
    
    
    (9,206
    )
    
    
    (9,206
    )Retained earnings
    
    
    46,068
    
    
    
    44,945Total stockholders equity
    
    
    86,110
    
    
    
    84,314Total liabilities and stockholders equity
    
    $
    164,768
    
    
    $
    159,852
  3




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##### Table of Contents



DYNAMICS RESEARCH CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(dollars in thousands, except per share data)
 Three Months EndedMarch 31,2007
    
    
    2006Contract revenue
    
    $
    55,912
    
    
    $
    66,759Product sales
    
    
    868
    
    
    
    1,454Total revenue
    
    
    56,780
    
    
    
    68,213Cost of contract revenue
    
    
    46,933
    
    
    
    56,945Cost of product sales
    
    
    1,148
    
    
    
    1,298Selling, general and administrative expenses
    
    
    5,598
    
    
    
    6,633Amortization of intangible assets
    
    
    650
    
    
    
    702Total operating costs and expenses
    
    
    54,329
    
    
    
    65,578Operating income
    
    
    2,451
    
    
    
    2,635Interest expense, net
    
    
    (456
    )
    
    
    (569
    )Other income (expense)
    
    
    (48
    )
    
    
    339Income before provision for income taxes
    
    
    1,947
    
    
    
    2,405Provision for income taxes
    
    
    824
    
    
    
    1,015Income before cumulative effect of accounting change
    
    
    1,123
    
    
    
    1,390Cumulative benefit of accounting change, net of tax of $62
    
    
    
    
    
    
    84Net income
    
    $
    1,123
    
    
    $
    1,474Earnings per common shareBasicIncome before cumulative effect of accounting change
    
    $
    0.12
    
    
    $
    0.15Cumulative effect of accounting change
    
    
    
    
    
    
    0.01Net income
    
    $
    0.12
    
    
    $
    0.16DilutedIncome before cumulative effect of accounting change
    
    $
    0.12
    
    
    $
    0.15Cumulative effect of accounting change
    
    
    
    
    
    
    0.01Net income
    
    $
    0.12
    
    
    $
    0.16Weighted average shares outstandingBasic
    
    
    9,256,566
    
    
    
    9,012,706Diluted
    
    
    9,507,446
    
    
    
    9,396,644
  4




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DYNAMICS RESEARCH CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME
(unaudited)
(in thousands)
 AccumulatedCapital in
    
    
    
    
    
    
    otherCommon stock
    
    
    excess of
    
    
    Unearned
    
    
    comprehensive
    
    
    RetainedShares
    
    
    Par value
    
    
    par value
    
    
    compensation
    
    
    loss
    
    
    earnings
    
    
    TotalBalance December 31, 2006 (audited)
    
    
    9,315
    
    
    $
    931
    
    
    $
    47,644
    
    
    $
    
    
    
    $
    (9,206
    )
    
    $
    44,396
    
    
    $
    83,765Impact of restatement  See Note 1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    549
    
    
    
    549Balance December 31, 2006 (unaudited)
    
    
    9,315
    
    
    
    931
    
    
    
    47,644
    
    
    
    
    
    
    
    (9,206
    )
    
    
    44,945
    
    
    
    84,314Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,123
    
    
    
    1,123Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,123Issuance of common stock through
stock options exercised and employee
stock purchase transactions
    
    
    52
    
    
    
    6
    
    
    
    417
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    423Issuance of restricted stock
    
    
    32
    
    
    
    3
    
    
    
    (3
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Forfeiture of restricted stock
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Release of restricted stock
    
    
    (17
    )
    
    
    (2
    )
    
    
    (173
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (175
    )Share-based compensation expense
    
    
    
    
    
    
    
    
    
    
    396
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    396Tax benefit from stock options
exercised and employee stock
purchase transactions
    
    
    
    
    
    
    
    
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29Balance March 31, 2007
    
    
    9,378
    
    
    $
    938
    
    
    $
    48,310
    
    
    $
    
    
    
    $
    (9,206
    )
    
    $
    46,068
    
    
    $
    86,110
 AccumulatedCapital in
    
    
    
    
    
    
    otherCommon stock
    
    
    excess of
    
    
    Unearned
    
    
    comprehensive
    
    
    RetainedShares
    
    
    Par value
    
    
    par value
    
    
    compensation
    
    
    loss
    
    
    earnings
    
    
    TotalBalance December 31, 2005 (audited)
    
    
    9,097
    
    
    $
    910
    
    
    $
    45,571
    
    
    $
    (1,850
    )
    
    $
    (10,768
    )
    
    $
    40,324
    
    
    $
    74,187Impact of restatement  See Note 1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    549
    
    
    
    549Balance December 31, 2005 (unaudited)
    
    
    9,097
    
    
    
    910
    
    
    
    45,571
    
    
    
    (1,850
    )
    
    
    (10,768
    )
    
    
    40,873
    
    
    
    74,736Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,474
    
    
    
    1,474Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,474Issuance of common stock through
stock options exercised and employee
stock purchase transactions
    
    
    63
    
    
    
    6
    
    
    
    594
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    600Issuance of restricted stock
    
    
    53
    
    
    
    5
    
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Forfeiture of restricted stock
    
    
    (12
    )
    
    
    (1
    )
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Release of restricted stock
    
    
    (12
    )
    
    
    (1
    )
    
    
    (163
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (164
    )Share-based compensation expense
    
    
    
    
    
    
    
    
    
    
    441
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    441Tax benefit from stock options
exercised and employee stock
purchase transactions
    
    
    
    
    
    
    
    
    
    
    107
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    107Reversal of unearned compensation
    
    
    
    
    
    
    
    
    
    
    (1,850
    )
    
    
    1,850
    
    
    
    
    
    
    
    
    
    
    
    Balance March 31, 2006
    
    
    9,189
    
    
    $
    919
    
    
    $
    44,696
    
    
    $
    
    
    
    $
    (10,768
    )
    
    $
    42,347
    
    
    $
    77,194
  5




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DYNAMICS RESEARCH CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
 Three Months EndedMarch 31,2007
    
    
    2006Cash flows from operating activities:Net income
    
    $
    1,123
    
    
    $
    1,474Adjustments to reconcile net cash used in operating activitiesDepreciation
    
    
    825
    
    
    
    790Amortization of intangible assets
    
    
    650
    
    
    
    702Share-based compensation, including cumulative effect of accounting change
    
    
    396
    
    
    
    441Non-cash interest expense
    
    
    37
    
    
    
    43Amortization of deferred gain on sale of building
    
    
    (169
    )
    
    
    (169
    )Investment income from equity interest
    
    
    (81
    )
    
    
    (44
    )Tax benefit from stock options exercised and employee stock purchase plan
transactions
    
    
    (29
    )
    
    
    (107
    )Deferred income taxes
    
    
    (861
    )
    
    
    (1,970
    )Gain on sale of investments and long-lived assets, net
    
    
    
    
    
    
    (211
    )Change in operating assets and liabilities:Accounts receivable, net
    
    
    (11,584
    )
    
    
    (5,094
    )Unbilled expenditures and fees on contracts in process
    
    
    (1,025
    )
    
    
    7,715Prepaid expenses and other current assets
    
    
    (701
    )
    
    
    (1,393
    )Accounts payable
    
    
    (3,388
    )
    
    
    (1,861
    )Accrued compensation and employee benefits
    
    
    543
    
    
    
    (652
    )Other accrued expenses
    
    
    (618
    )
    
    
    (1,373
    )Other long-term liabilities
    
    
    (2,433
    )
    
    
    151Net cash used in operating activities
    
    
    (17,315
    )
    
    
    (1,558
    )Cash flows from investing activities:Additions to property, plant and equipment
    
    
    (509
    )
    
    
    (1,061
    )Proceeds from sale of investments and long-lived assets
    
    
    
    
    
    
    211Dividends from equity investment
    
    
    
    
    
    
    2Increase in other assets
    
    
    (26
    )
    
    
    (110
    )Net cash used in investing activities
    
    
    (535
    )
    
    
    (958
    )Cash flow from financing activities:Borrowings under revolving credit agreement
    
    
    65,770
    
    
    
    37,924Repayments under revolving credit agreement
    
    
    (55,870
    )
    
    
    (29,888
    )Principal payments under loan agreements
    
    
    
    
    
    
    (4,277
    )Proceeds from the exercise of stock options and employee stock purchase plan
transactions
    
    
    423
    
    
    
    600Tax benefit from stock options exercised and employee stock purchase plan
transactions
    
    
    29
    
    
    
    107Net cash provided by financing activities
    
    
    10,352
    
    
    
    4,466Net increase (decrease) in cash and cash equivalents
    
    
    (7,498
    )
    
    
    1,950Cash and cash equivalents, beginning of period
    
    
    7,887
    
    
    
    1,020Cash and cash equivalents, end of period
    
    $
    389
    
    
    $
    2,970
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DYNAMICS
RESEARCH CORPORATION
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
 NOTE
1. BASIS OF PRESENTATION AND RESTATEMENT
    As of December 31, 2006Previously
    
    AsReported
    
    RestatedChanges to Consolidated Balance Sheet:Deferred income taxes
    
    $
    11,698
    
    
    $
    9,864Other accrued expenses
    
    $
    3,916
    
    
    $
    5,201Total current liabilities
    
    $
    48,282
    
    
    $
    47,733Total liabilities
    
    $
    76,087
    
    
    $
    75,538Retained earnings
    
    $
    44,396
    
    
    $
    44,945Total stockholders equity
    
    $
    83,765
    
    
    $
    84,314
  NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
   7




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DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
  NOTE 3. SHAREHOLDERS EQUITY
 Earnings Per Share
     Three Months EndedMarch 31,2007
    
    
    2006Weighted average shares outstanding  Basic
    
    
    9,256,566
    
    
    
    9,012,706Diluted effect of stock options and restricted stock grants
    
    
    250,880
    
    
    
    383,938Weighted average shares outstanding  Diluted
    
    
    9,507,446
    
    
    
    9,396,644
 Comprehensive Income
  NOTE 4. SHARE-BASED COMPENSATION
  Three Months EndedMarch 31,2007
    
    
    2006Cost of products and services
    
    $
    270
    
    
    $
    302Selling, general and administrative
    
    
    126
    
    
    
    285Cumulative effect of accounting change
    
    
    
    
    
    
    (146
    )Total share-based compensation expense
    
    $
    396
    
    
    $
    441
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DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
 Share-Based Payment Award Activity
  Stock Options
    
    
    Restricted StockWeighted
    
    
    
    
    
    
    WeightedNumber of
    
    
    Average
    
    
    Number of
    
    
    AverageShares
    
    
    Exercise Price
    
    
    Shares
    
    
    Fair ValueOutstanding at December 31, 2006
    
    
    1,140,679
    
    
    $
    8.37
    
    
    
    212,264
    
    
    $
    12.86Granted
    
    
    
    
    
    $
    
    
    
    
    32,500
    
    
    $
    10.08Exercised/Vested
    
    
    (32,345
    )
    
    $
    8.07
    
    
    
    (47,443
    )
    
    $
    15.42Cancelled
    
    
    (46,967
    )
    
    $
    9.29
    
    
    
    (4,170
    )
    
    $
    12.71Outstanding at March 31, 2007
    
    
    1,061,367
    
    
    $
    8.34
    
    
    
    193,151
    
    
    $
    11.77Outstanding at December 31, 2005
    
    
    1,239,393
    
    
    $
    8.51
    
    
    
    221,816
    
    
    $
    13.60Granted
    
    
    
    
    
    $
    
    
    
    
    52,400
    
    
    $
    14.17Exercised/Vested
    
    
    (28,000
    )
    
    $
    6.23
    
    
    
    (33,008
    )
    
    $
    17.35Cancelled
    
    
    (28,884
    )
    
    $
    10.15
    
    
    
    (11,934
    )
    
    $
    13.25Outstanding at March 31, 2006
    
    
    1,182,509
    
    
    $
    8.52
    
    
    
    229,274
    
    
    $
    13.17
  NOTE 5. SUPPLEMENTAL BALANCE SHEET INFORMATION
  March 31,
    
    
    December 31,2007
    
    
    2006Property and equipment, net:Production equipment
    
    $
    11,943
    
    
    $
    11,942Software
    
    
    11,432
    
    
    
    11,283Furniture and other equipment
    
    
    8,875
    
    
    
    8,792Leasehold improvements
    
    
    2,413
    
    
    
    2,137Property and equipment
    
    
    34,663
    
    
    
    34,154Less accumulated depreciation
    
    
    (23,470
    )
    
    
    (22,645
    )Property and equipment, net
    
    $
    11,193
    
    
    $
    11,509Other noncurrent assets:Equity investments
    
    $
    868
    
    
    $
    787Unbilled expenditures and fees on contracts in process
    
    
    
    
    
    
    493Other
    
    
    2,208
    
    
    
    2,219Other noncurrent assets
    
    $
    3,076
    
    
    $
    3,499
 9




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DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
 March 31,
    
    
    December 31,2007
    
    
    2006Accrued compensation and employee benefits:Accrued payroll and payroll taxes
    
    $
    5,838
    
    
    $
    5,956Accrued vacation
    
    
    5,081
    
    
    
    4,343Accrued pension liability
    
    
    2,000
    
    
    
    2,000Other
    
    
    2,097
    
    
    
    2,174Accrued compensation and employee benefits
    
    $
    15,016
    
    
    $
    14,473Other accrued expenses:Amount outstanding under letter of credit
    
    $
    1,016
    
    
    $
    1,016Accrued income taxes
    
    
    1,001
    
    
    
    946Deferred gain on sale of building
    
    
    676
    
    
    
    676Other
    
    
    2,036
    
    
    
    2,563Other accrued expenses
    
    $
    4,729
    
    
    $
    5,201Other long-term liabilities:Deferred gain on sale of building
    
    $
    5,238
    
    
    $
    5,407Long-term contract payments
    
    
    
    
    
    
    2,700Accrued pension liability
    
    
    1,745
    
    
    
    1,933Other
    
    
    3,220
    
    
    
    2,765Other long-term liabilities
    
    $
    10,203
    
    
    $
    12,805
 NOTE 6. GOODWILL AND INTANGIBLE ASSETS
  Remainder of 2007
    
    $
    1,9522008
    
    $
    2,0382009
    
    $
    1,031
  NOTE 7. INCOME TAXES
   10




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DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
  NOTE 8. DEFINED BENEFIT PENSION PLAN
  Three Months EndedMarch 31,2007
    
    
    2006Interest cost on projected benefit obligation
    
    $
    1,006
    
    
    $
    1,002Expected return on plan assets
    
    
    (1,464
    )
    
    
    (1,262
    )Recognized actuarial loss
    
    
    270
    
    
    
    440Net periodic pension cost
    
    $
    (188
    )
    
    $
    180
  NOTE 9. FINANCING ARRANGEMENTS
  NOTE 10. BUSINESS SEGMENT, MAJOR CUSTOMERS AND RELATED PARTY INFORMATION
 Business Segment
  Three Months EndedMarch 31,2007
    
    
    2006Revenues from external customersSystems and Services
    
    $
    55,912
    
    
    $
    66,759Metrigraphics
    
    
    868
    
    
    
    1,454$
    56,780
    
    
    $
    68,213Gross margin (loss)Systems and Services
    
    $
    8,979
    
    
    $
    9,814Metrigraphics
    
    
    (280
    )
    
    
    156$
    8,699
    
    
    $
    9,970Operating income (loss)Systems and Services
    
    $
    2,979
    
    
    $
    2,760Metrigraphics
    
    
    (528
    )
    
    
    (125
    )$
    2,451
    
    
    $
    2,635
 11




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##### Table of Contents



DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
  Major Customers
  Three Months Ended March 31,2007
    
    2006Revenue
    
    %
    
    Revenue
    
    %Air Force Aeronautical Systems Center
    
    $
    7,567
    
    
    
    13
    %
    
    $
    11,971
    
    
    
    18
    %
  March 31,
    
    December 31,2007
    
    2006Air Force Aeronautical Systems Center
    
    $
    7,012
    
    
    $
    2,159
  Related Party
 HMR HMR HMR HMR HMR HMR HMR HMR
 NOTE 11. COMMITMENTS AND CONTINGENCIES
   12




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DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except per share amounts)
    13




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  OVERVIEW
     CRITICAL ACCOUNTING POLICIES
   
    
    Revenue recognition
    
    Goodwill and other intangible assets
    
    Income taxes and deferred taxes
 14




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##### Table of Contents




    
    Pension obligations
  Income Taxes and Deferred Taxes
   RESULTS OF OPERATIONS
  Three Months Ended March 31,2007
    
    
    2006$(1)
    
    
    %(1)
    
    
    $(1)
    
    
    %(1)Contract revenue
    
    $
    55.9
    
    
    
    98.5
    %
    
    $
    66.8
    
    
    
    97.9
    %Product sales
    
    
    0.9
    
    
    
    1.5
    
    
    
    1.5
    
    
    
    2.1Total revenue
    
    $
    56.8
    
    
    
    100.0
    %
    
    $
    68.2
    
    
    
    100.0
    %Gross profit on contract revenue(2)
    
    $
    9.0
    
    
    
    16.1
    %
    
    $
    9.8
    
    
    
    14.7
    %Gross profit (loss) on product sales (2)
    
    
    (0.3
    )
    
    
    (32.3
    )%
    
    
    0.2
    
    
    
    10.7
    %Total gross profit (2)
    
    
    8.7
    
    
    
    15.3
    %
    
    
    10.0
    
    
    
    14.6
    %Selling, general and administrative
    
    
    5.6
    
    
    
    9.9
    
    
    
    6.6
    
    
    
    9.7Amortization of intangible assets
    
    
    0.7
    
    
    
    1.1
    
    
    
    0.7
    
    
    
    1.0Operating income
    
    
    2.5
    
    
    
    4.3
    
    
    
    2.6
    
    
    
    3.9Interest expense, net
    
    
    (0.5
    )
    
    
    (0.8
    )
    
    
    (0.6
    )
    
    
    (0.8
    )Other income, net
    
    
    0.0
    
    
    
    0.1
    
    
    
    0.3
    
    
    
    0.5Provision for income taxes
    
    
    (0.8
    )
    
    
    (1.5
    )
    
    
    (1.0
    )
    
    
    (1.5
    )Net income
    
    $
    1.1
    
    
    
    2.0
    %
    
    $
    1.5
    
    
    
    2.2
    %
 
 (1)
    
    Totals may not add due to rounding.(2)
    
    These amounts represent a percentage of contract revenues, product sales and total revenues,
respectively. Revenues
  15




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Contract Revenues
  Three Months Ended March 31,2007
    
    
    2006$(1)
    
    
    %(1)
    
    
    $(1)
    
    
    %(1)National defense and intelligence agencies
    
    $
    44.6
    
    
    
    79.8
    %
    
    $
    54.9
    
    
    
    82.3
    %Federal civilian agencies
    
    
    7.6
    
    
    
    13.5
    
    
    
    7.3
    
    
    
    11.0State and local government agencies
    
    
    3.5
    
    
    
    6.3
    
    
    
    4.3
    
    
    
    6.4Other
    
    
    0.2
    
    
    
    0.3
    
    
    
    0.2
    
    
    
    0.3Total contract revenue
    
    $
    55.9
    
    
    
    100.0
    %
    
    $
    66.8
    
    
    
    100.0
    %
 
 (1)
    
    Totals may not add due to rounding. HMR
    Three Months EndedMarch 31,2007
    
    
    2006Time and materials
    
    
    57
    %
    
    
    61
    %Cost reimbursable
    
    
    22
    %
    
    
    21
    %Fixed price, including service type contracts
    
    
    21
    %
    
    
    18
    %100
    %
    
    
    100
    %Prime contract
    
    
    61
    %
    
    
    67
    %Sub-contract
    
    
    39
    %
    
    
    33
    %100
    %
    
    
    100
    %
 Product Sales
  Funded Backlog
  16




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##### Table of Contents



Gross Profit
    Selling, general and administrative expenses
  Amortization of intangible assets
  Interest expense, net
  Other income (expense), net
 HMR HMR
 Income tax provision
  17




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##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES
     Operating activities
     18




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##### Table of Contents



Investing activities
   Financing activities
   RECENT ACCOUNTING PRONOUNCEMENTS
   19




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##### Table of Contents



Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
   
 Item 4. CONTROLS AND PROCEDURES
   20




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##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 1. LEGAL PROCEEDINGS
  
 Item 1A. RISK FACTORS
  
 Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  ApproximateTotal Number
    
    
    Dollar Valueof Shares
    
    
    of Shares thatPurchased as
    
    
    May Yet BePart of
    
    
    PurchasedTotal Number
    
    
    Average Price
    
    
    Publicly
    
    
    Under theof Shares
    
    
    Paid Per
    
    
    Announced
    
    
    ProgramsPeriod
    
    Purchased
    
    
    Share
    
    
    Programs
    
    
    (in millions)January 1, 2007 to January 31, 2007
    
    
    2,736
    
    
    $
    8.94
    
    
    
    
    
    
    $
    February 1, 2007 to February 28, 2007
    
    
    
    
    
    $
    
    
    
    
    
    
    
    
    March 1, 2007 to March 31, 2007
    
    
    14,253
    
    
    $
    10.58
    
    
    
    
    
    
    
    Total
    
    
    16,989
    
    
    $
    10.32
    
    
    
    
    
    
    $
    
  21




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##### Table of Contents



Item 6. EXHIBITS
  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.
 
 SIGNATURES
  DYNAMICS RESEARCH CORPORATION
(Registrant)Date: May 10, 2007
    /s/ David KeleherDavid KeleherSenior Vice President, Chief Financial Officer
and Treasurer /s/ Francis MurphyFrancis MurphyVice President, Corporate Controller and Chief
Accounting Officer 22