##### 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 September 30, 2005
 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 or other Jurisdiction of
    
    (I.R.S. Employer Identification No.)Incorporation or Organization)60 Frontage RoadAndover, Massachusetts
    
    01810-5498(Address of Principal Executive Offices)
    
    (Zip Code)
  þ o
 þ o
 o þ




---



Page NumberPART I. FINANCIAL INFORMATIONItem 1. Consolidated Financial StatementsConsolidated Balance Sheets as of September 30, 2005
(unaudited) and December 31, 2004 (audited)
    
    
    3Consolidated Statements of Operations for the three and nine
months ended September 30, 2005 and 2004 (unaudited)
    
    
    4Consolidated Statements of Changes in Stockholders Equity
and Comprehensive Income for the three and nine months ended
September 30, 2005 (unaudited)
    
    
    5Consolidated Statements of Changes in Stockholders Equity
and Comprehensive Income for the three and nine months ended
September 30, 2004 (unaudited)
    
    
    6Consolidated Statements of Cash Flows for the nine months
ended September 30, 2005 and 2004 (unaudited)
    
    
    7Notes to Consolidated Financial Statements (unaudited)
    
    
    8Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    21Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    39Item 4. Controls and Procedures
    
    
    39PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    41Item 5. Other Information
    
    
    41Item 6. Exhibits
    
    
    42Signatures
    
    
    43Ex-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
  2




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##### Table of Contents



September 30,
    
    
    December 31,2005
    
    
    2004(unaudited)
    
    
    (audited)AssetsCurrent assetsCash and cash equivalents
    
    $
    1,639
    
    
    $
    925Accounts receivable, net of allowances of $467 at September 30, 2005
and $644 at December 31 , 2004
    
    
    36,920
    
    
    
    45,978Unbilled expenditures and fees on contracts in process
    
    
    65,817
    
    
    
    48,119Prepaid expenses and other current assets
    
    
    1,675
    
    
    
    5,668Total current assets
    
    
    106,051
    
    
    
    100,690Noncurrent assetsProperty, plant and equipment, net
    
    
    22,689
    
    
    
    22,139Goodwill
    
    
    63,055
    
    
    
    63,055Deferred income taxes
    
    
    296
    
    
    
    Intangible assets, net
    
    
    9,240
    
    
    
    11,519Unbilled expenditures and fees on contracts in process
    
    
    262
    
    
    
    2,203Other noncurrent assets
    
    
    3,138
    
    
    
    5,528Total noncurrent assets
    
    
    98,680
    
    
    
    104,444Total assets
    
    $
    204,731
    
    
    $
    205,134Liabilities and stockholders equityCurrent liabilitiesCurrent portion of long-term debt
    
    $
    8,357
    
    
    $
    8,357Revolver
    
    
    7,889
    
    
    
    10,000Accounts payable
    
    
    26,170
    
    
    
    20,550Accrued payroll and employee benefits
    
    
    12,970
    
    
    
    17,914Deferred income taxes
    
    
    16,447
    
    
    
    15,418Other accrued expenses
    
    
    4,628
    
    
    
    4,869Total current liabilities
    
    
    76,461
    
    
    
    77,108Long-term liabilitiesLong-term debt, less current portion
    
    
    45,217
    
    
    
    51,485Deferred income taxes
    
    
    
    
    
    
    591Accrued pension liability
    
    
    7,576
    
    
    
    11,336Other long-term liabilities
    
    
    3,439
    
    
    
    3,296Total long-term liabilities
    
    
    56,232
    
    
    
    66,708Total liabilities
    
    
    132,693
    
    
    
    143,816Commitments and contingenciesStockholders equityPreferred 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 9,056,479 shares at September 30, 2005 and 8,737,562 shares
at December 31, 2004
    
    
    906
    
    
    
    874Capital in excess of par value
    
    
    45,107
    
    
    
    40,849Unearned compensation
    
    
    (2,108
    )
    
    
    (1,572
    )Accumulated other comprehensive loss
    
    
    (9,259
    )
    
    
    (7,724
    )Retained earnings
    
    
    37,392
    
    
    
    28,891Total stockholders equity
    
    
    72,038
    
    
    
    61,318Total liabilities and stockholders equity
    
    $
    204,731
    
    
    $
    205,134
  3




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##### Table of Contents



Three months ended
    
    
    Nine months endedSeptember 30,
    
    

September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Contract revenue
    
    $
    77,334
    
    
    $
    68,659
    
    
    $
    223,712
    
    
    $
    192,361Product sales
    
    
    1,779
    
    
    
    1,792
    
    
    
    5,131
    
    
    
    5,108Total revenue
    
    
    79,113
    
    
    
    70,451
    
    
    
    228,843
    
    
    
    197,469Cost of contract revenue
    
    
    64,174
    
    
    
    58,022
    
    
    
    187,927
    
    
    
    164,017Cost of product sales
    
    
    1,242
    
    
    
    1,274
    
    
    
    3,948
    
    
    
    3,774Selling, general and administrative
expenses
    
    
    6,722
    
    
    
    6,141
    
    
    
    19,429
    
    
    
    16,411Amortization of intangible assets
    
    
    760
    
    
    
    573
    
    
    
    2,279
    
    
    
    1,335Total operating costs and expenses
    
    
    72,898
    
    
    
    66,010
    
    
    
    213,583
    
    
    
    185,537Operating income
    
    
    6,215
    
    
    
    4,441
    
    
    
    15,260
    
    
    
    11,932Interest expense, net
    
    
    (1,061
    )
    
    
    (559
    )
    
    
    (3,193
    )
    
    
    (1,133
    )Other income
    
    
    119
    
    
    
    48
    
    
    
    2,221
    
    
    
    485Income before provision for income taxes
    
    
    5,273
    
    
    
    3,930
    
    
    
    14,288
    
    
    
    11,284Provision for income taxes
    
    
    2,136
    
    
    
    1,662
    
    
    
    5,787
    
    
    
    4,773Net income
    
    $
    3,137
    
    
    $
    2,268
    
    
    $
    8,501
    
    
    $
    6,511Earnings per common shareBasic
    
    $
    0.35
    
    
    $
    0.27
    
    
    $
    0.97
    
    
    $
    0.77Diluted
    
    $
    0.34
    
    
    $
    0.25
    
    
    $
    0.92
    
    
    $
    0.72Weighted average shares outstandingWeighted average shares outstanding  basic
    
    
    8,846,245
    
    
    
    8,538,353
    
    
    
    8,761,800
    
    
    
    8,464,854Dilutive effect of options and restricted
stock grants
    
    
    417,892
    
    
    
    551,109
    
    
    
    446,254
    
    
    
    567,252Weighted average shares outstanding -
diluted
    
    
    9,264,137
    
    
    
    9,089,462
    
    
    
    9,208,054
    
    
    
    9,032,106
  4




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##### Table of Contents



AccumulatedCommon stock
    
    
    Capital in
    
    
    
    
    
    
    otherIssued
    
    
    excess of
    
    
    Unearned
    
    
    comprehensive
    
    
    RetainedShares
    
    
    Par value
    
    
    par value
    
    
    compensation
    
    
    loss
    
    
    earnings
    
    
    TotalThree months ended September 30, 2005Balance June 30, 2005
    
    
    8,913
    
    
    $
    891
    
    
    $
    43,274
    
    
    $
    (2,309
    )
    
    $
    (9,259
    )
    
    $
    34,255
    
    
    $
    66,852Issuance of common stock through stock options exercised
and employee stock purchase plan
    
    
    141
    
    
    
    14
    
    
    
    1,494
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,508Issuance of restricted stock
    
    
    17
    
    
    
    2
    
    
    
    261
    
    
    
    (263
    )
    
    
    
    
    
    
    
    
    
    
    Forfeiture of restricted stock
    
    
    (14
    )
    
    
    (1
    )
    
    
    (259
    )
    
    
    260
    
    
    
    
    
    
    
    
    
    
    
    Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    204
    
    
    
    
    
    
    
    
    
    
    
    204Tax benefit from stock options exercised
    
    
    
    
    
    
    
    
    
    
    337
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    337Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,137
    
    
    
    3,137Balance September 30, 2005
    
    
    9,057
    
    
    $
    906
    
    
    $
    45,107
    
    
    $
    (2,108
    )
    
    $
    (9,259
    )
    
    $
    37,392
    
    
    $
    72,038Nine months ended September 30, 2005Balance December 31, 2004 (audited)
    
    
    8,737
    
    
    $
    874
    
    
    $
    40,849
    
    
    $
    (1,572
    )
    
    $
    (7,724
    )
    
    $
    28,891
    
    
    $
    61,318Issuance of common stock through stock options exercised
and employee stock purchase plan
    
    
    262
    
    
    
    26
    
    
    
    2,827
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,853Issuance of restricted stock
    
    
    108
    
    
    
    10
    
    
    
    1,756
    
    
    
    (1,766
    )
    
    
    
    
    
    
    
    
    
    
    Forfeiture of restricted stock
    
    
    (38
    )
    
    
    (3
    )
    
    
    (606
    )
    
    
    609
    
    
    
    
    
    
    
    
    
    
    
    Retirement of restricted stock
    
    
    (12
    )
    
    
    (1
    )
    
    
    (176
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (177
    )Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    621
    
    
    
    
    
    
    
    
    
    
    
    621Change in unrealized gain on investment, net of taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,535
    )
    
    
    
    
    
    
    (1,535
    )Tax benefit from stock options exercised
    
    
    
    
    
    
    
    
    
    
    457
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    457Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,501
    
    
    
    8,501Balance September 30, 2005
    
    
    9,057
    
    
    $
    906
    
    
    $
    45,107
    
    
    $
    (2,108
    )
    
    $
    (9,259
    )
    
    $
    37,392
    
    
    $
    72,038
  Three
    
    
    Ninemonths
    
    
    monthsended
    
    
    endedSeptember 30 ,2005Net income
    
    $
    3,137
    
    
    $
    8,501Change in unrealized gain on investment in Lucent
Technologies shares sold in June 2005, net of tax:Unrealized holding (loss) during the period
    
    
    
    
    
    
    (412
    )Reclassification adjustment of realized gain
included in net income
    
    
    
    
    
    
    (1,123
    )
    
    
    
    (1,535
    )Comprehensive income
    
    $
    3,137
    
    
    $
    6,966
  5




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##### Table of Contents



AccumulatedCommon stock
    
    
    Capital in
    
    
    
    
    
    
    otherIssued
    
    
    Treasury stock
    
    
    excess of
    
    
    Unearned
    
    
    comprehensive
    
    
    RetainedShares
    
    
    Par value
    
    
    Shares
    
    
    Par value
    
    
    par value
    
    
    compensation
    
    
    loss
    
    
    earnings
    
    
    TotalThree months ended September 30, 2004Balance June 30, 2004
    
    
    10,008
    
    
    $
    1,001
    
    
    
    (1,379
    )
    
    $
    (138
    )
    
    $
    39,538
    
    
    $
    (1,953
    )
    
    $
    (7,556
    )
    
    $
    23,761
    
    
    $
    54,653Issuance of common stock through stock options exercised
and employee stock purchase plan
    
    
    50
    
    
    
    5
    
    
    
    
    
    
    
    
    
    
    
    595
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    600Issuance of restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6
    
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    Forfeiture of restricted stock
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (34
    )
    
    
    34
    
    
    
    
    
    
    
    
    
    
    
    Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    182
    
    
    
    
    
    
    
    
    
    
    
    182Tax benefit from stock options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16Redesignation of treasury stock to common stock in accordance
with Massachusetts Business Corporation Act, Chapter 156D
    
    
    (1,379
    )
    
    
    (138
    )
    
    
    1,379
    
    
    
    138
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized gain on investment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,132
    
    
    
    
    
    
    
    2,132Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,268
    
    
    
    2,268Balance September 30, 2004
    
    
    8,677
    
    
    $
    868
    
    
    
    
    
    
    $
    
    
    
    $
    40,121
    
    
    $
    (1,743
    )
    
    $
    (5,424
    )
    
    $
    26,029
    
    
    $
    59,851Nine months ended September 30, 2004Balance December 31, 2003 (audited)
    
    
    9,822
    
    
    $
    982
    
    
    
    (1,379
    )
    
    $
    (138
    )
    
    $
    36,642
    
    
    $
    (797
    )
    
    $
    (7,556
    )
    
    $
    19,518
    
    
    $
    48,651Issuance of common stock through stock options exercised
and employee stock purchase plan
    
    
    171
    
    
    
    17
    
    
    
    
    
    
    
    
    
    
    
    1,969
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,986Issuance of restricted stock
    
    
    88
    
    
    
    9
    
    
    
    
    
    
    
    
    
    
    
    1,576
    
    
    
    (1,585
    )
    
    
    
    
    
    
    
    
    
    
    Forfeiture of restricted stock
    
    
    (22
    )
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    (246
    )
    
    
    248
    
    
    
    
    
    
    
    
    
    
    
    Repurchase and retirement of restricted stock
    
    
    (3
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (36
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (36
    )Amortization of unearned compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    391
    
    
    
    
    
    
    
    
    
    
    
    391Tax benefit from stock options exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    216
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    216Redesignation of treasury stock to common stock in accordance
with Massachusetts Business Corporation Act, Chapter 156D
    
    
    (1,379
    )
    
    
    (138
    )
    
    
    1,379
    
    
    
    138
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Unrealized gain on investment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,132
    
    
    
    
    
    
    
    2,132Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,511
    
    
    
    6,511Balance September 30, 2004
    
    
    8,677
    
    
    $
    868
    
    
    
    
    
    
    $
    
    
    
    $
    40,121
    
    
    $
    (1,743
    )
    
    $
    (5,424
    )
    
    $
    26,029
    
    
    $
    59,851
  Three
    
    
    Ninemonths
    
    
    monthsended
    
    
    endedSeptember 30, 2004Net income
    
    $
    2,268
    
    
    $
    6,511Adjustments to Accumulated other comprehensive loss:Unrealized gain on investment in Lucent Technologies
    
    
    2,132
    
    
    
    2,132Comprehensive income
    
    $
    4,400
    
    
    $
    8,643
  6




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##### Table of Contents



Nine months endedSeptember 30,2005
    
    
    2004Operating activitiesNet income
    
    $
    8,501
    
    
    $
    6,511Adjustments to reconcile net cash provided by (used in) operating activitiesDepreciation
    
    
    2,823
    
    
    
    2,648Amortization of intangible assets
    
    
    2,279
    
    
    
    1,335Stock compensation expense
    
    
    621
    
    
    
    391Non-cash interest expense
    
    
    98
    
    
    
    105Investment income from equity interest
    
    
    (140
    )
    
    
    (204
    )Tax benefit from stock options exercised
    
    
    457
    
    
    
    216Deferred income taxes
    
    
    1,135
    
    
    
    1,176(Gain) loss on sale of investments and equipment
    
    
    (2,001
    )
    
    
    4Change in operating assets and liabilitiesAccounts receivable, net
    
    
    9,058
    
    
    
    (10,987
    )Unbilled expenditures and fees on contracts in process, net
    
    
    (16,887
    )
    
    
    (12,194
    )Prepaid expenses and other current assets
    
    
    3,993
    
    
    
    461Accounts payable, net
    
    
    6,707
    
    
    
    3,296Accrued payroll and employee benefits
    
    
    (4,944
    )
    
    
    1,430Other accrued expenses
    
    
    (3,443
    )
    
    
    (35
    )Net cash provided by (used in) continuing operations
    
    
    8,257
    
    
    
    (5,847
    )Net cash used in discontinued operations
    
    
    (422
    )
    
    
    (775
    )Net cash provided by (used in) operating activities
    
    
    7,835
    
    
    
    (6,622
    )Investing activitiesAdditions to property, plant and equipment
    
    
    (3,373
    )
    
    
    (3,331
    )Purchase of business, net of cash acquired
    
    
    (128
    )
    
    
    (53,587
    )Dividends from equity investment
    
    
    60
    
    
    
    60Proceeds from sale of investments and equipment
    
    
    2,002
    
    
    
    10Increase in other assets
    
    
    (156
    )
    
    
    (984
    )Net cash used in investing activities
    
    
    (1,595
    )
    
    
    (57,832
    )Financing activitiesNet borrowings (repayments) under revolving credit agreement and notes payable
    
    
    (2,111
    )
    
    
    6,904Proceeds from the issuance of long-term debt
    
    
    
    
    
    
    55,000Principal payments under mortgage agreement
    
    
    (375
    )
    
    
    (375
    )Principal payments under loan agreements
    
    
    (5,893
    )
    
    
    (1,599
    )Proceeds from the exercise of stock options and issuance of common stock
    
    
    2,853
    
    
    
    1,950Net cash (used in) provided by financing activities
    
    
    (5,526
    )
    
    
    61,880Net increase (decrease) in cash and cash equivalents
    
    
    714
    
    
    
    (2,574
    )Cash and cash equivalents, beginning of period
    
    
    925
    
    
    
    2,724Cash and cash equivalents, end of period
    
    $
    1,639
    
    
    $
    150Supplemental informationCash paid for interest
    
    $
    2,986
    
    
    $
    1,366Cash (refunded) paid for income taxes, net
    
    $
    (686
    )
    
    $
    309
  7




---



##### Table of Contents



Earnings Per Share
    8




---



##### Table of Contents



Stock-Based Compensation
 Accounting for Stock
Issued to Employees Accounting for Stock-Based
Compensation
 Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income, as reported
    
    $
    3,137
    
    
    $
    2,268
    
    
    $
    8,501
    
    
    $
    6,511Deduct: Total
stock-based employee
compensation
determined under
fair-value-based
method for all awards,
net of related tax
effects, if applicable
    
    
    (135
    )
    
    
    (217
    )
    
    
    (557
    )
    
    
    (693
    )Pro forma net income
    
    $
    3,002
    
    
    $
    2,051
    
    
    $
    7,944
    
    
    $
    5,818Net income per share:Basic, as reported
    
    $
    0.35
    
    
    $
    0.27
    
    
    $
    0.97
    
    
    $
    0.77Basic, pro forma
    
    $
    0.34
    
    
    $
    0.24
    
    
    $
    0.91
    
    
    $
    0.69Diluted, as reported
    
    $
    0.34
    
    
    $
    0.25
    
    
    $
    0.92
    
    
    $
    0.72Diluted, pro forma
    
    $
    0.32
    
    
    $
    0.23
    
    
    $
    0.86
    
    
    $
    0.64
 Share-Based Payment in
2006.
  Nine months endedSeptember 30,2005
    
    
    2004Expected volatility
    
    
    66.38
    %
    
    
    69.30
    %Dividend yield
    
    
    
    
    
    
    Risk-free interest rate
    
    
    3.87
    %
    
    
    3.90
    %Expected life in years
    
    
    6.50
    
    
    
    7.00
  Investment Available for Sale
 Accounting for Certain Investments
in Debt and Equity Securities
 9




---



##### Table of Contents



Recent Accounting Pronouncements
 Accounting Changes and Error Corrections: a Replacement
of Accounting Principles Board (APB) Opinion No. 20 and FASB Statement No. 3
 Share-Based Payment Accounting for Stock Issued to
Employees
 Critical Accounting Policies
   Revenue Recognition
  10




---



##### Table of Contents



Accounting for Performance of Construction-Type and
Certain Production-Type Contracts
     Valuation Allowances
  Intangible and Other Long-lived Assets
  11




---



##### Table of Contents



Goodwill
  Business Combinations
  Deferred Taxes
  Pensions
    12




---



##### Table of Contents



Consideration:Cash
    
    $
    53,399Accrued estimated additional cash consideration
    
    
    473Transaction costs
    
    
    801Exit costs
    
    
    394Total consideration
    
    
    55,067Preliminary allocation of consideration to assets
acquired/(liabilities assumed):Working capital
    
    
    6,768Property and equipment
    
    
    562Other noncurrent assets
    
    
    57Long-term liabilities
    
    
    (164
    )Preliminary total fair value of net tangible assets acquired
    
    
    7,223Preliminary excess of consideration over fair value of net
tangible assets acquired
    
    
    47,844Preliminary allocation of excess consideration to identifiable
intangible assets:Customer relationships
    
    
    11,500Preliminary allocation of excess consideration to goodwill
    
    $
    36,344
  Balance at December 31, 2004
    
    $
    393Revision of accrual estimate
    
    
    (75
    )Expenditures charged against accrual
    
    
    (143
    )Balance at September 30, 2005
    
    $
    175
  13




---



##### Table of Contents



Three months
    
    
    Nine monthsended
    
    
    endedSeptember 30,
    
    
    September 30,2004
    
    
    2004Revenue
    
    $
    79,254
    
    
    $
    231,281Net income
    
    $
    2,699
    
    
    $
    6,910Earnings per shareBasic
    
    $
    0.32
    
    
    $
    0.82Diluted
    
    $
    0.30
    
    
    $
    0.76
   September 30,
    
    
    December 31,2005
    
    
    2004Cost
    
    $
    14,200
    
    
    $
    14,200Less accumulated amortization
    
    
    4,960
    
    
    
    2,681$
    9,240
    
    
    $
    11,519
  Remainder of 2005
    
    $
    7602006
    
    $
    2,8092007
    
    $
    2,6022008
    
    $
    2,0382009
    
    $
    1,031
       14




---



##### Table of Contents











Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004RevenueSystems and Services
    
    $
    77,334
    
    
    $
    68,659
    
    
    $
    223,712
    
    
    $
    192,361Metrigraphics
    
    
    1,779
    
    
    
    1,792
    
    
    
    5,131
    
    
    
    5,108$
    79,113
    
    
    $
    70,451
    
    
    $
    228,843
    
    
    $
    197,469Operating incomeSystems and Services
    
    $
    5,959
    
    
    $
    4,228
    
    
    $
    14,949
    
    
    $
    11,493Metrigraphics
    
    
    256
    
    
    
    213
    
    
    
    311
    
    
    
    439$
    6,215
    
    
    $
    4,441
    
    
    $
    15,260
    
    
    $
    11,932




September 30,
    
    
    December 31,2005
    
    
    2004Segment assetsSystems and Services
    
    $
    181,577
    
    
    $
    179,973Metrigraphics
    
    
    1,716
    
    
    
    1,859Total segment assets
    
    
    183,293
    
    
    
    181,832Corporate assets
    
    
    21,438
    
    
    
    23,302$
    204,731
    
    
    $
    205,134






15



---



##### Table of Contents



Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenue
    
    
    %
    
    
    Revenue
    
    
    %
    
    
    Revenue
    
    
    %
    
    
    Revenue
    
    
    %Customer A
    
    $
    12,450
    
    
    
    16
    %
    
    $
    10,927
    
    
    
    16
    %
    
    $
    34,932
    
    
    
    15
    %
    
    $
    33,098
    
    
    
    17
    %Customer B
    
    $
    6,469
    
    
    
    8
    %
    
    $
    7,999
    
    
    
    11
    %
    
    $
    21,120
    
    
    
    9
    %
    
    $
    23,338
    
    
    
    12
    %
  September 30,
    
    
    December 31,2005
    
    
    2004Customer A
    
    $
    5,950
    
    
    $
    4,650Customer B
    
    $
    2,907
    
    
    $
    2,698
      16




---



##### Table of Contents




    
    Any failure by the company and its subsidiaries to make any payment of principal,
interest and other sums due under the facility within three calendar days of the date
when such payment is due;
    
    Any breach by the company or any of its subsidiaries of certain covenants,
representations and warranties;
    
    Any default and acceleration of any indebtedness owed by the company or any of its
subsidiaries to any person (other than the bank group) which is in excess of
$1,000,000;
    
    Any final judgment against the company or any of its subsidiaries in excess of
$1,000,000 which has not been insured to the reasonable satisfaction of the
Administrative Agent;
    
    Any bankruptcy (voluntary or involuntary) of the company or any of its subsidiaries;
    
    Any material adverse change in the business or financial condition of the company and its subsidiaries; or
    
    Any change in control of the company.
 Acquisition term loan
  Term loan
  Revolver
  Excess cash flow recapture
  17




---



##### Table of Contents



Outstanding borrowings
  Outstanding
    
    
    InterestPrincipal
    
    
    rate
    
    
    Interest rate option and election dateSeptember 30, 2005Acquisition term loan
    
    $
    23,099
    
    
    
    5.94
    %
    
    90-day LIBOR Rate option elected on August 1, 200523,100
    
    
    
    6.17
    %
    
    180-day LIBOR Rate option elected on August 1, 2005Term loan
    
    
    7,375
    
    
    
    5.69
    %
    
    90-day LIBOR Rate option elected on August 1, 2005Revolver
    
    
    7,889
    
    
    
    6.75
    %
    
    Base Rate option; election date not applicable$
    61,463December 31, 2004Acquisition term loan
    
    $
    52,092
    
    
    
    5.41
    %
    
    90-day LIBOR Rate option elected on November 1, 2004Term loan
    
    
    7,750
    
    
    
    5.16
    %
    
    90-day LIBOR Rate option elected on November 1, 2004Revolver
    
    
    10,000
    
    
    
    5.28
    %
    
    30-day LIBOR Rate option elected on December 1, 2004$
    69,842
   Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Interest cost
    
    $
    959
    
    
    $
    993
    
    
    $
    2,953
    
    
    $
    2,947Expected return on plan assets
    
    
    (1,139
    )
    
    
    (945
    )
    
    
    (3,305
    )
    
    
    (2,903
    )Recognized actuarial loss
    
    
    334
    
    
    
    314
    
    
    
    1,127
    
    
    
    968Net periodic benefit cost
    
    $
    154
    
    
    $
    362
    
    
    $
    755
    
    
    $
    1,012
  18




---



##### Table of Contents



19




---



##### Table of Contents



20




---



##### Table of Contents



21




---



##### Table of Contents



Three months ended September 30,2005
    
    
    2004% of
    
    
    
    
    
    
    % of$ thousands
    
    
    revenues
    
    
    $ thousands
    
    
    revenuesContract revenue (Systems and Services)
    
    $
    77,334
    
    
    
    97.8
    %
    
    $
    68,659
    
    
    
    97.5
    %Product sales (Metrigraphics)
    
    
    1,779
    
    
    
    2.2
    %
    
    
    1,792
    
    
    
    2.5
    %Total revenue
    
    
    79,113
    
    
    
    100.0
    %
    
    
    70,451
    
    
    
    100.0
    %Gross profit/margin on contract revenue
    
    
    13,160
    
    
    
    17.0
    %
    
    
    10,637
    
    
    
    15.5
    %Gross profit/margin on product sales
    
    
    537
    
    
    
    30.2
    %
    
    
    518
    
    
    
    28.9
    %Total gross profit/margin
    
    
    13,697
    
    
    
    17.3
    %
    
    
    11,155
    
    
    
    15.8
    %Selling, general and administrative
expenses
    
    
    6,722
    
    
    
    8.5
    %
    
    
    6,141
    
    
    
    8.7
    %Amortization of intangible assets
    
    
    760
    
    
    
    1.0
    %
    
    
    573
    
    
    
    0.8
    %Operating income
    
    
    6,215
    
    
    
    7.9
    %
    
    
    4,441
    
    
    
    6.3
    %Interest expense, net
    
    
    (1,061
    )
    
    
    (1.3
    )%
    
    
    (559
    )
    
    
    (0.8
    )%Other income
    
    
    119
    
    
    
    0.2
    %
    
    
    48
    
    
    
    0.1
    %Income before provision for income taxes
    
    $
    5,273
    
    
    
    6.7
    %
    
    $
    3,930
    
    
    
    5.6
    %
 Nine months ended September 30,2005
    
    
    2004% of
    
    
    
    
    
    
    % of$ thousands
    
    
    revenues
    
    
    $ thousands
    
    
    revenuesContract revenue (Systems and Services)
    
    $
    223,712
    
    
    
    97.8
    %
    
    $
    192,361
    
    
    
    97.4
    %Product sales (Metrigraphics)
    
    
    5,131
    
    
    
    2.2
    %
    
    
    5,108
    
    
    
    2.6
    %Total revenue
    
    
    228,843
    
    
    
    100.0
    %
    
    
    197,469
    
    
    
    100.0
    %Gross profit/margin on contract revenue
    
    
    35,785
    
    
    
    16.0
    %
    
    
    28,344
    
    
    
    14.7
    %Gross profit/margin on product sales
    
    
    1,183
    
    
    
    23.1
    %
    
    
    1,334
    
    
    
    26.1
    %Total gross profit/margin
    
    
    36,968
    
    
    
    16.2
    %
    
    
    29,678
    
    
    
    15.0
    %Selling, general and administrative
expenses
    
    
    19,429
    
    
    
    8.5
    %
    
    
    16,411
    
    
    
    8.3
    %Amortization of intangible assets
    
    
    2,279
    
    
    
    1.0
    %
    
    
    1,335
    
    
    
    0.7
    %Operating income
    
    
    15,260
    
    
    
    6.7
    %
    
    
    11,932
    
    
    
    6.0
    %Interest expense, net
    
    
    (3,193
    )
    
    
    (1.4
    )%
    
    
    (1,133
    )
    
    
    (0.6
    )%Other income
    
    
    2,221
    
    
    
    1.0
    %
    
    
    485
    
    
    
    0.2
    %Income before provision for income taxes
    
    $
    14,288
    
    
    
    6.2
    %
    
    $
    11,284
    
    
    
    5.7
    %
 22




---



##### Table of Contents



Revenues
  Contract revenues (Systems and Services segment)
  Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Defense and intelligence agencies
    
    $
    63,970
    
    
    $
    52,563
    
    
    $
    179,961
    
    
    $
    154,313Federal civilian agencies
    
    
    6,785
    
    
    
    9,478
    
    
    
    24,560
    
    
    
    23,034State and local government agencies
    
    
    5,946
    
    
    
    6,171
    
    
    
    16,996
    
    
    
    14,497Other
    
    
    633
    
    
    
    447
    
    
    
    2,195
    
    
    
    517$
    77,334
    
    
    $
    68,659
    
    
    $
    223,712
    
    
    $
    192,361
     Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Time and materials
    
    
    55
    %
    
    
    57
    %
    
    
    56
    %
    
    
    60
    %Cost reimbursable
    
    
    21
    %
    
    
    22
    %
    
    
    20
    %
    
    
    22
    %Fixed price,
including
service-type
contracts
    
    
    24
    %
    
    
    21
    %
    
    
    24
    %
    
    
    18
    %100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %Prime contract
    
    
    68
    %
    
    
    73
    %
    
    
    68
    %
    
    
    71
    %Sub-contract
    
    
    32
    %
    
    
    27
    %
    
    
    32
    %
    
    
    29
    %100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 23




---



##### Table of Contents



Product revenues (Metrigraphics segment)
  Funded backlog
  Gross margin
    24




---



##### Table of Contents



Selling, general and administrative expenses
  Amortization of intangible assets
  Operating income
   Interest income and expense
   Other income, net
  25




---



##### Table of Contents



Income tax provision
    Operating activities
       26




---



##### Table of Contents



Investing activities
    Financing activities
   27




---



##### Table of Contents




    
    Any failure by the company and its subsidiaries to make any payment of principal,
interest and other sums due under the facility within three calendar days of the date
when such payment is due;
    
    Any breach by the company or any of its subsidiaries of certain covenants,
representations and warranties;
    
    Any default and acceleration of any indebtedness owed by the company or any of its
subsidiaries to any person (other than the bank group) which is in excess of
$1,000,000;
    
    Any final judgment against the company or any of its subsidiaries in excess of
$1,000,000 which has not been insured to the reasonable satisfaction of the
Administrative Agent;
    
    Any bankruptcy (voluntary or involuntary) of the company or any of its subsidiaries; and
    
    Any material adverse change in the business or financial condition of the company and its subsidiaries; or
    
    Any change in control of the company.
  28




---



##### Table of Contents



Commitments
  Payments due by periodLess than
    
    
    Two to three
    
    
    Four to fiveTotal
    
    
    one year
    
    
    years
    
    
    years
    
    
    ThereafterRevolver
    
    $
    7,889
    
    
    $
    7,889
    
    
    $
    
    
    
    $
    
    
    
    $
    Long-term debt
    
    
    53,574
    
    
    
    8,357
    
    
    
    16,714
    
    
    
    28,503
    
    
    
    Operating leases
    
    
    27,584
    
    
    
    5,646
    
    
    
    9,684
    
    
    
    7,949
    
    
    
    4,305Total contractual obligations
    
    $
    89,047
    
    
    $
    21,892
    
    
    $
    26,398
    
    
    $
    36,452
    
    
    $
    4,305
      29




---



##### Table of Contents



Revenue Recognition
    Accounting for Performance of Construction-Type and
Certain Production-Type Contracts
     Valuation Allowances
  30




---



##### Table of Contents



Intangible and Other Long-lived Assets
   Goodwill
  Business Combinations
  Deferred Taxes
  Pensions
  31




---



##### Table of Contents



Accounting Changes and Error Corrections: a Replacement
of Accounting Principles Board (APB) Opinion No. 20 and FASB Statement No. 3
 Share-Based Payment Accounting for Stock Issued to
Employees
 FACTORS THAT MAY AFFECT FUTURE RESULTS
  Our Revenue is Highly Concentrated on the Department of Defense and Other Federal
Agencies, and a Significant Portion of Our Revenue is Derived From a Few Customers.
Decreases in Their Budgets, Changes in Program Priorities or Military Base Closures
Could Affect Our Results
    32




---



##### Table of Contents



We Must Bear the Risk of Various Pricing Structures Associated With Government
Contracts.
   
    
    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.
   Our Contracts and Subcontracts with Government Agencies Are Subject to a
Competitive Bidding Process and to Termination Without Cause by the Government.
    33




---



##### Table of Contents



We Are Subject to a High Level of Government Regulations and Audits Under Our
Government Contracts and Subcontracts.
  Loss of Key Personnel Could Limit Our Growth.
  34




---



##### Table of Contents



Our Failure to Obtain and Maintain Necessary Security Clearances May Limit Our
Ability to Perform Classified Work for Government Clients, Which Could Harm Our
Business.
  Security Breaches in Sensitive Government Systems Could Harm Our Business.
  Our Employees May Engage in Misconduct or Other Improper Activities, Which Could
Harm Our Business.
  We Are Involved in Various Litigation Matters Which, If Not Resolved in Our Favor,
Could Harm Our Business.
  If We Are Unable to Effectively and Efficiently Eliminate the Material Weaknesses
and Significant Deficiencies in Our Internal Controls and Procedures, We May Not Be
Able to Accurately Report Our
 35




---



##### Table of Contents



Financial Results. As a Result, Current and Potential Stockholders Could Lose
Confidence in Our Financial Reporting, Which Would Harm Our Business and the Trading
Price of Our Stock.
    We Operate in Highly Competitive Markets and May Have Difficulties Entering New
Markets.
    We May Be Subject to Product or Service Liability Claims.
  36




---



##### Table of Contents



Economic Events May Affect Our Business Segments.
  Our Products and Services Could Become Obsolete Due to Rapid Technological Changes
in the Industry.
  Our Financing Requirements May Increase and We Could Have Limited Access to
Capital Markets.
  Accounting System Upgrades and Conversions May Delay Billing and Collections of
our Accounts Receivable.
  Our Quarterly Operating Results May Vary Significantly From Quarter to
Quarter.
  
    
    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;
    
    the trend in interest rates; and
    
    general economic conditions.
 37




---



##### Table of Contents



We May Not Make or Complete Future Mergers, Acquisitions or Strategic Alliances or
Investments.
  
    
    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.
  The Market Price of Our Common Stock May Be Volatile.
  
    
    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.
  38




---



##### Table of Contents



Information Technology Access Controls
 Evidence of Compliance with Approval Authority Policy
 Evidence of the Performance of Review Controls
 Assessment of the Effectiveness of Internal Controls
 39




---



##### Table of Contents



-
    
    Implementation of a remediation action plan, which is substantially complete;-
    
    Significant changes in and strengthening of management processes and methodologies to the assessment process;-
    
    Earlier completion of activities;-
    
    Risk evaluation and mitigation plans, and-
    
    Application of additional resources.
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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.
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DYNAMICS RESEARCH CORPORATION(Registrant)Date:
November 9, 2005
    
    /s/ David KeleherDavid KeleherSenior Vice President and Chief Financial Officer/s/ Francis MurphyFrancis MurphyVice President, Corporate Controller and Chief AccountingOfficer
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ExhibitNumber
    
    Exhibit Name
    
    Location31.1
    
    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 herewith31.2
    
    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 herewith32.1
    
    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.
    
    Furnished herewith32.2
    
    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.
    
    Furnished herewith
 44