##### 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 JUNE 30, 2006
 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
 
 R £
  £ R £
 £ R




---



##### 



DYNAMIC RESEARCH CORPORATION
FORM 10-Q
For the Quarterly Period Ended June 30, 2006
Table of Contents
 PagePart I. Financial Information
    
    
    3Item 1. Financial Statements
    
    
    3Condensed Consolidated Balance Sheets as of June 30, 2006 (unaudited) and December 31,
2005 (audited)
    
    
    3Condensed Consolidated Statements of Operations for the three and six months ended June
30, 2006 and 2005 (unaudited)
    
    
    4Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006
and 2005 (unaudited)
    
    
    5Notes to Condensed Consolidated Financial Statements (unaudited)
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    23Item 4. Controls and Procedures
    
    
    23Part II. Other Information
    
    
    24Item 1. Legal Proceedings
    
    
    24Item 1A. Risk Factors
    
    
    24Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    26Item 4. Submissions of Matters to a Vote of Security Holders
    
    
    27Item 6. Exhibits
    
    
    27EX-31.1 Section 302 Certification of C.E.O.EX-31.2 Section 302 Certification of C.F.O.EX-32.1 Section 906 Certification of C.E.O.EX-32.2 Section 906 Certification of C.F.O.
  Special Note on Factors Affecting Future Results
  2




---



##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. Condensed Consolidated Financial Statements
 DYNAMICS RESEARCH CORPORATION
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (dollars in thousands, except share data)
 June 30,
    
    
    December 31,2006
    
    
    2005(unaudited)
    
    
    (audited)AssetsCurrent assetsCash and cash equivalents
    
    $
    329
    
    
    $
    1,020Accounts receivable, net of allowances of $575 at
June 30, 2006 and $588 at December 31, 2005
    
    
    35,840
    
    
    
    32,894Unbilled expenditures and fees on contracts in process
    
    
    46,409
    
    
    
    60,210Prepaid expenses and other current assets
    
    
    3,323
    
    
    
    1,483Total current assets
    
    
    85,901
    
    
    
    95,607Noncurrent assetsProperty, plant and equipment, net
    
    
    12,184
    
    
    
    12,252Goodwill
    
    
    63,055
    
    
    
    63,055Intangible assets, net
    
    
    7,075
    
    
    
    8,480Other noncurrent assets
    
    
    7,629
    
    
    
    8,359Total noncurrent assets
    
    
    89,943
    
    
    
    92,146Total assets
    
    $
    175,844
    
    
    $
    187,753Liabilities and stockholders equityCurrent liabilitiesCurrent portion of long-term debt
    
    $
    7,857
    
    
    $
    10,170Accounts payable
    
    
    21,144
    
    
    
    25,668Deferred taxes
    
    
    14,953
    
    
    
    19,825Accrued compensation and employee benefits
    
    
    17,928
    
    
    
    18,761Other accrued expenses
    
    
    3,880
    
    
    
    6,392Total current liabilities
    
    
    65,762
    
    
    
    80,816Long-term liabilitiesLong-term debt, less current portion
    
    
    15,539
    
    
    
    15,242Other long-term liabilities
    
    
    16,557
    
    
    
    17,508Total long-term liabilities
    
    
    32,096
    
    
    
    32,750Total liabilities
    
    
    97,858
    
    
    
    113,566Commitments and contingenciesStockholders 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; 9,251,912 and 9,096,893 shares issued and
outstanding at June 30, 2006 and December 31, 2005,
respectively
    
    
    925
    
    
    
    910Capital in excess of par value
    
    
    45,855
    
    
    
    45,571Unearned compensation
    
    
    
    
    
    
    (1,850
    )Accumulated other comprehensive loss
    
    
    (10,768
    )
    
    
    (10,768
    )Retained earnings
    
    
    41,974
    
    
    
    40,324Total stockholders equity
    
    
    77,986
    
    
    
    74,187Total liabilities and stockholders equity
    
    $
    175,844
    
    
    $
    187,753
  3




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (unaudited)
 (in thousands, except per share data)
 Three months ended
    
    
    Six months endedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Contract revenue
    
    $
    65,720
    
    
    $
    74,539
    
    
    $
    132,479
    
    
    $
    146,378Product sales
    
    
    1,558
    
    
    
    1,649
    
    
    
    3,012
    
    
    
    3,352Total revenue
    
    
    67,278
    
    
    
    76,188
    
    
    
    135,491
    
    
    
    149,730Cost of contract revenue
    
    
    58,353
    
    
    
    62,947
    
    
    
    115,298
    
    
    
    123,753Cost of product sales
    
    
    1,256
    
    
    
    1,297
    
    
    
    2,554
    
    
    
    2,706Selling, general and administrative expenses
    
    
    6,036
    
    
    
    6,686
    
    
    
    12,669
    
    
    
    12,707Amortization of intangible assets
    
    
    703
    
    
    
    765
    
    
    
    1,405
    
    
    
    1,519Total operating costs and expenses
    
    
    66,348
    
    
    
    71,695
    
    
    
    131,926
    
    
    
    140,685Operating income
    
    
    930
    
    
    
    4,493
    
    
    
    3,565
    
    
    
    9,045Interest expense, net
    
    
    (566
    )
    
    
    (1,046
    )
    
    
    (1,135
    )
    
    
    (2,132
    )Other income
    
    
    12
    
    
    
    2,077
    
    
    
    351
    
    
    
    2,102Income before provision for income taxes
    
    
    376
    
    
    
    5,524
    
    
    
    2,781
    
    
    
    9,015Provision for income taxes
    
    
    200
    
    
    
    2,251
    
    
    
    1,215
    
    
    
    3,651Income before cumulative effect of accounting
change
    
    
    176
    
    
    
    3,273
    
    
    
    1,566
    
    
    
    5,364Cumulative benefit of accounting change, net
of income taxes of $62
    
    
    
    
    
    
    
    
    
    
    84
    
    
    
    Net income
    
    $
    176
    
    
    $
    3,273
    
    
    $
    1,650
    
    
    $
    5,364Earnings per common shareBasicIncome before cumulative effect of
accounting change
    
    $
    0.02
    
    
    $
    0.37
    
    
    $
    0.17
    
    
    $
    0.62Cumulative benefit of accounting change
    
    
    
    
    
    
    
    
    
    
    0.01
    
    
    
    Net income
    
    $
    0.02
    
    
    $
    0.37
    
    
    $
    0.18
    
    
    $
    0.62DilutedIncome before cumulative effect of
accounting change
    
    $
    0.02
    
    
    $
    0.36
    
    
    $
    0.17
    
    
    $
    0.58Cumulative benefit of accounting change
    
    
    
    
    
    
    
    
    
    
    0.01
    
    
    
    Net income
    
    $
    0.02
    
    
    $
    0.36
    
    
    $
    0.18
    
    
    $
    0.58Weighted average shares outstandingBasic
    
    
    9,079,011
    
    
    
    8,743,516
    
    
    
    9,057,556
    
    
    
    8,719,577Diluted
    
    
    9,439,954
    
    
    
    9,202,013
    
    
    
    9,426,269
    
    
    
    9,207,035
  4




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (unaudited)
 (in thousands)
 Six months endedJune 30,2006
    
    
    2005Cash flows from operating activities:Net income
    
    $
    1,650
    
    
    $
    5,364Adjustments to reconcile net cash provided by operating activitiesDepreciation
    
    
    1,620
    
    
    
    1,908Amortization of intangible assets
    
    
    1,405
    
    
    
    1,519Stock compensation expense, including cumulative effect of accounting change
    
    
    1,032
    
    
    
    477Non-cash interest expense
    
    
    79
    
    
    
    98Amortization of deferred gain on sale of building
    
    
    (338
    )
    
    
    Income from equity interest
    
    
    (116
    )
    
    
    (89
    )Tax benefit from stock options exercised
    
    
    
    
    
    
    120Deferred income taxes
    
    
    (4,872
    )
    
    
    2,320Gain on sale of investments and long-lived assets, net
    
    
    (194
    )
    
    
    (1,999
    )Change in operating assets and liabilities:Accounts receivable, net
    
    
    (2,946
    )
    
    
    8,992Unbilled expenditures and fees on contracts in process
    
    
    14,526
    
    
    
    (9,024
    )Prepaid expenses and other current assets
    
    
    (1,840
    )
    
    
    1,847Accounts payable
    
    
    (4,524
    )
    
    
    2,170Accrued payroll and employee benefits
    
    
    (833
    )
    
    
    1,155Other accrued expenses
    
    
    (2,690
    )
    
    
    (1,454
    )Other long-term liabilities
    
    
    (613
    )
    
    
    (2,668
    )Net cash provided by continuing operations
    
    
    1,346
    
    
    
    10,736Net cash used in discontinued operations
    
    
    
    
    
    
    (316
    )Net cash provided by operating activities
    
    
    1,346
    
    
    
    10,420Cash flows from investing activities:Additions to property, plant and equipment
    
    
    (1,571
    )
    
    
    (2,426
    )Purchase of business
    
    
    
    
    
    
    (128
    )Proceeds from sale of investments and long-lived assets
    
    
    213
    
    
    
    2,001Dividends from equity investment
    
    
    122
    
    
    
    60Increase in other assets
    
    
    (80
    )
    
    
    (217
    )Net cash used in investing activities
    
    
    (1,316
    )
    
    
    (710
    )Cash flow from financing activities:Net borrowings (repayments) under revolving credit agreement
    
    
    4,225
    
    
    
    (6,987
    )Principal payments under loan agreements
    
    
    (6,241
    )
    
    
    (4,179
    )Proceeds from the exercise of stock options and issuance of common stock
    
    
    1,139
    
    
    
    1,345Tax benefit from stock options exercised
    
    
    156
    
    
    
    Net cash used in financing activities
    
    
    (721
    )
    
    
    (9,821
    )Net decrease in cash and cash equivalents
    
    
    (691
    )
    
    
    (111
    )Cash and cash equivalents, beginning of period
    
    
    1,020
    
    
    
    925Cash and cash equivalents, end of period
    
    $
    329
    
    
    $
    814
  5




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (dollars in thousands, except per share amounts)
 NOTE 1. BASIS OF PRESENTATION
    NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
    6




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
 NOTE 3. SHAREHOLDERS EQUITY
 Earnings Per Share
     Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2006
    
    2005
    
    2006
    
    2005Weighted average shares outstanding  Basic
    
    
    9,079,011
    
    
    
    8,743,516
    
    
    
    9,057,556
    
    
    
    8,719,577Dilutive effect of stock options and restricted stock grants
    
    
    360,943
    
    
    
    458,497
    
    
    
    368,713
    
    
    
    487,458Weighted average shares outstanding  Diluted
    
    
    9,439,954
    
    
    
    9,202,013
    
    
    
    9,426,269
    
    
    
    9,207,035
 Comprehensive Income
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net income
    
    $
    176
    
    
    $
    3,273
    
    
    $
    1,650
    
    
    $
    5,364Adjustments to accumulated other comprehensive income:Change in unrealized gain (loss) on investments
available for sale
    
    
    
    
    
    
    88
    
    
    
    
    
    
    
    (324
    )Reclassification adjustment of realized gain
included in net income
    
    
    
    
    
    
    (1,211
    )
    
    
    
    
    
    
    (1,211
    )Adjustments to comprehensive income
    
    
    
    
    
    
    (1,123
    )
    
    
    
    
    
    
    (1,535
    )Comprehensive income
    
    $
    176
    
    
    $
    2,150
    
    
    $
    1,650
    
    
    $
    3,829
 NOTE 4. SHARE-BASED COMPENSATION
  7




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
  Pro forma Information for Periods Prior to the Adoption of SFAS 123R
  Three Months
    
    
    Six MonthsEnded
    
    
    EndedJune 30,
    
    
    June 30,2005
    
    
    2005Net income, as reported
    
    $
    3,273
    
    
    $
    5,364Add: Share-based employee compensation
expense included in reported net income,
net of related tax effects
    
    
    151
    
    
    
    285Deduct: Total share-based employee
compensation expense determined under the
fair value based method for all awards,
net of related tax effects
    
    
    (329
    )
    
    
    (708
    )Pro forma net income
    
    $
    3,095
    
    
    $
    4,941Earnings per common share:As reported:Basic
    
    $
    0.37
    
    
    $
    0.62Diluted
    
    $
    0.36
    
    
    $
    0.58Pro forma:Basic
    
    $
    0.35
    
    
    $
    0.57Diluted
    
    $
    0.34
    
    
    $
    0.54
  Impact of the Adoption of SFAS 123R
   8




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
 Three Months
    
    
    Six MonthsEnded
    
    
    EndedJune 30,
    
    
    June 30,2006
    
    
    2006Stock options
    
    $
    179
    
    
    $
    357ESPP
    
    
    109
    
    
    
    225Impact on operating income
    
    
    288
    
    
    
    582Cumulative effect of accounting change
    
    
    
    
    
    
    (146
    )Impact after cumulative effect of accounting change
    
    $
    288
    
    
    $
    436Impact on net income
    
    $
    (200
    )
    
    $
    (315
    )Impact on earnings per common share:Basic
    
    $
    (0.02
    )
    
    $
    (0.03
    )Diluted
    
    $
    (0.02
    )
    
    $
    (0.03
    )
  Three Months
    
    
    Six MonthsEnded
    
    
    EndedJune 30,
    
    
    June 30,2006
    
    
    2006Cost of products and services
    
    $
    298
    
    
    $
    600Selling, general and administrative
    
    
    293
    
    
    
    578Cumulative effect of accounting change
    
    
    
    
    
    
    (146
    )Total share-based compensation expense
    
    $
    591
    
    
    $
    1,032
 Valuation Assumptions
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2006 (1)
    
    2005 (1)
    
    2006 (1)
    
    2005Stock Options:Risk-free interest rate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.87
    %Dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Volatility
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    66.38
    %Expected life in years
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6.5ESPP:Risk-free interest rate
    
    
    4.71
    %
    
    
    2.93
    %
    
    
    4.60
    %
    
    
    2.29
    %Dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Volatility
    
    
    32.21
    %
    
    
    31.64
    %
    
    
    32.85
    %
    
    
    32.04
    %Expected life in months
    
    
    3.0
    
    
    
    3.0
    
    
    
    3.0
    
    
    
    3.0
 
 (1)
    
    During the three months ended June 30, 2006 and 2005 and the six months ended June 30, 2006,
the Company did not grant any stock option awards. Share-Based Payment Award Activity
  9




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
 Stock Options
    
    Restricted StockWeighted
    
    
    
    
    
    WeightedAwards
    
    Average
    
    Awards
    
    AverageOutstanding
    
    Exercise Price
    
    Outstanding
    
    Fair ValueBalance at March 31, 2006
    
    
    1,182,509
    
    
    $
    8.52
    
    
    
    229,274
    
    
    $
    13.17Granted
    
    
    
    
    
    $
    
    
    
    
    17,500
    
    
    $
    14.69Exercised
    
    
    (15,568
    )
    
    $
    7.66
    
    
    
    (9,399
    )
    
    $
    15.77Cancelled
    
    
    (7,166
    )
    
    $
    18.75
    
    
    
    (4,404
    )
    
    $
    15.03Balance at June 30, 2006
    
    
    1,159,775
    
    
    $
    8.47
    
    
    
    232,971
    
    
    $
    13.14Balance at December 31, 2005
    
    
    1,239,393
    
    
    $
    8.51
    
    
    
    221,816
    
    
    $
    13.60Granted
    
    
    
    
    
    $
    
    
    
    
    69,900
    
    
    $
    14.30Exercised
    
    
    (43,568
    )
    
    $
    6.74
    
    
    
    (42,407
    )
    
    $
    17.00Cancelled
    
    
    (36,050
    )
    
    $
    11.86
    
    
    
    (16,338
    )
    
    $
    13.73Balance at June 30, 2006
    
    
    1,159,775
    
    
    $
    8.47
    
    
    
    232,971
    
    
    $
    13.14Balance at March 31, 2005
    
    
    1,461,364
    
    
    $
    8.86
    
    
    
    235,444
    
    
    $
    13.81Granted
    
    
    
    
    
    $
    
    
    
    
    15,000
    
    
    $
    15.21Exercised
    
    
    (5,142
    )
    
    $
    9.20
    
    
    
    (4,732
    )
    
    $
    15.56Cancelled
    
    
    (80,109
    )
    
    $
    10.40
    
    
    
    (22,993
    )
    
    $
    14.80Balance at June 30, 2005
    
    
    1,376,113
    
    
    $
    8.77
    
    
    
    222,719
    
    
    $
    13.80Balance at December 31, 2004
    
    
    1,499,105
    
    
    $
    8.75
    
    
    
    192,408
    
    
    $
    12.90Granted
    
    
    15,000
    
    
    $
    18.57
    
    
    
    90,800
    
    
    $
    16.57Exercised
    
    
    (53,371
    )
    
    $
    7.79
    
    
    
    (36,836
    )
    
    $
    16.20Cancelled
    
    
    (84,621
    )
    
    $
    10.77
    
    
    
    (23,653
    )
    
    $
    14.89Balance at June 30, 2005
    
    
    1,376,113
    
    
    $
    8.77
    
    
    
    222,719
    
    
    $
    13.80
  Three Months
    
    Six MonthsEnded
    
    EndedJune 30,
    
    June 30,2006
    
    2006Amounts realized or received from stock option exercises:Cash proceeds received
    
    $
    118
    
    
    $
    293Intrinsic value realized
    
    $
    113
    
    
    $
    172Income tax benefit realized
    
    $
    42
    
    
    $
    138
    10




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
 Options Outstanding
    
    
    Options ExercisableWeighted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    WeightedWeighted
    
    
    Average
    
    
    
    
    
    
    
    
    
    
    Weighted
    
    
    AverageAverage
    
    
    Remaining
    
    
    
    
    
    
    
    
    
    
    Average
    
    
    RemainingRange of
    
    Number
    
    
    Exercise
    
    
    Contractual
    
    
    Intrinsic
    
    
    Number
    
    
    Exercise
    
    
    Contractual
    
    
    IntrinsicExercise Prices
    
    of Options
    
    
    Price
    
    
    Life
    
    
    Value
    
    
    of Options
    
    
    Price
    
    
    Life
    
    
    Value$  3.13  $  7.50
    
    
    344,060
    
    
    $
    5.08
    
    
    
    3.21
    
    
    $
    2,911
    
    
    
    344,060
    
    
    $
    5.08
    
    
    
    3.21
    
    
    $
    2,911$  7.51  $13.68
    
    
    728,505
    
    
    
    8.90
    
    
    
    4.75
    
    
    
    3,380
    
    
    
    188,505
    
    
    
    8.79
    
    
    
    4.25
    
    
    
    896$13.69  $18.60
    
    
    67,210
    
    
    
    17.17
    
    
    
    6.71
    
    
    
    
    
    
    
    44,541
    
    
    
    17.75
    
    
    
    5.91
    
    
    
    $18.61  $24.50
    
    
    20,000
    
    
    
    21.83
    
    
    
    5.70
    
    
    
    
    
    
    
    20,000
    
    
    
    21.83
    
    
    
    5.70
    
    
    
    1,159,775
    
    
    
    8.47
    
    
    
    4.42
    
    
    $
    6,291
    
    
    
    597,106
    
    
    
    7.76
    
    
    
    3.82
    
    
    $
    3,807
 NOTE 5. SUPPLEMENTAL BALANCE SHEET INFORMATION
  June 30,
    
    
    December 31,2006
    
    
    2005Property, plant and equipment, net:Machinery and equipment
    
    $
    31,905
    
    
    $
    31,307Leasehold improvements
    
    
    1,916
    
    
    
    1,011Property, plant and equipment
    
    
    33,821
    
    
    
    32,318Less accumulated depreciation
    
    
    (21,637
    )
    
    
    (20,066
    )Property, plant and equipment, net
    
    $
    12,184
    
    
    $
    12,252Other noncurrent assets:Deferred tax asset
    
    $
    3,916
    
    
    $
    3,916Unbilled expenditures and fees on contracts in process
    
    
    824
    
    
    
    1,549Equity investment
    
    
    713
    
    
    
    719Other
    
    
    2,176
    
    
    
    2,175Other noncurrent assets
    
    $
    7,629
    
    
    $
    8,359Accrued compensation and employee benefits:Accrued pension liability
    
    $
    5,220
    
    
    $
    5,818Accrued vacation
    
    
    5,208
    
    
    
    4,705Other
    
    
    7,500
    
    
    
    8,238Accrued compensation and employee benefits
    
    $
    17,928
    
    
    $
    18,761Other accrued expenses:Accrued income taxes
    
    $
    
    
    
    $
    2,433Other
    
    
    3,880
    
    
    
    3,959Other accrued expenses
    
    $
    3,880
    
    
    $
    6,392Other long-term liabilities:Deferred gain on sale of building
    
    $
    5,739
    
    
    $
    6,158Accrued pension liability
    
    
    6,286
    
    
    
    5,328Other
    
    
    4,532
    
    
    
    6,022Other long-term liabilities
    
    $
    16,557
    
    
    $
    17,508
 NOTE 6. INVESTMENTS AVAILABLE FOR SALE
   11




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
 NOTE 7. GOODWILL AND INTANGIBLE ASSETS
  June 30, 2006
    
    
    December 31, 2005Accumulated
    
    
    
    
    
    
    AccumulatedCost
    
    
    Amortization
    
    
    Cost
    
    
    AmortizationCustomer relationships
    
    $
    12,800
    
    
    $
    (5,725
    )
    
    $
    14,200
    
    
    $
    (5,720
    )Non-competition agreements
    
    
    
    
    
    
    
    
    
    
    1,740
    
    
    
    (1,740
    )$
    12,800
    
    
    $
    (5,725
    )
    
    $
    15,940
    
    
    $
    (7,460
    )
  Remainder of 2006
    
    $
    1,4042007
    
    $
    2,6022008
    
    $
    2,0382009
    
    $
    1,031
  NOTE 8. INCOME TAXES
   NOTE 9. DEFINED BENEFIT PENSION PLAN
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Interest cost
    
    $
    1,002
    
    
    $
    997
    
    
    $
    2,004
    
    
    $
    1,994Expected return on plan assets
    
    
    (1,262
    )
    
    
    (1,083
    )
    
    
    (2,524
    )
    
    
    (2,166
    )Recognized acturial loss
    
    
    440
    
    
    
    397
    
    
    
    880
    
    
    
    793Net periodic benefit cost
    
    $
    180
    
    
    $
    311
    
    
    $
    360
    
    
    $
    621
 12




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
  NOTE 10. FINANCING ARRANGEMENTS
  Outstanding
    
    
    InterestPrincipal
    
    
    Rate
    
    
    Interest Rate Option and Election DateJune 30, 2006Acquisition term loan
    
    $
    19,171
    
    
    
    6.90
    %
    
    90-day LIBOR Rate option elected on May 1, 2006Revolver
    
    
    4,225
    
    
    
    8.25
    %
    
    Base Rate option elected on June 30, 2006Total Debt
    
    
    23,396Less: Current portion of long-term debt
    
    
    (7,857
    )Long-term debt
    
    $
    15,539December 31, 2005Acquisition term loan
    
    $
    23,100
    
    
    
    6.17
    %
    
    180-day LIBOR Rate option elected on August 1, 2005Acquisition term loan
    
    
    2,312
    
    
    
    7.25
    %
    
    Base Rate option elected on December 30, 2005Total Debt
    
    
    25,412Less: Current portion of long-term debt
    
    
    (10,170
    )Long-term debt
    
    $
    15,242
  NOTE 11. BUSINESS SEGMENT, MAJOR CUSTOMERS AND RELATED PARTY INFORMATION
 Business Segment
     13




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
   Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenues from external customersSystems and Services
    
    $
    65,720
    
    
    $
    74,539
    
    
    $
    132,479
    
    
    $
    146,378Metrigraphics
    
    
    1,558
    
    
    
    1,649
    
    
    
    3,012
    
    
    
    3,352$
    67,278
    
    
    $
    76,188
    
    
    $
    135,491
    
    
    $
    149,730Gross profitSystems and Services
    
    $
    7,367
    
    
    $
    11,592
    
    
    $
    17,181
    
    
    $
    22,625Metrigraphics
    
    
    302
    
    
    
    352
    
    
    
    458
    
    
    
    646$
    7,669
    
    
    $
    11,944
    
    
    $
    17,639
    
    
    $
    23,271Operating Income (Loss)Systems and Services
    
    $
    899
    
    
    $
    4,440
    
    
    $
    3,659
    
    
    $
    8,990Metrigraphics
    
    
    31
    
    
    
    53
    
    
    
    (94
    )
    
    
    55$
    930
    
    
    $
    4,493
    
    
    $
    3,565
    
    
    $
    9,045
 Major Customers
  Three Months Ended June 30,
    
    Six Months Ended June 30,2006
    
    2005
    
    2006
    
    2005$
    
    %
    
    $
    
    %
    
    $
    
    %
    
    $
    
    %Air Force
Aeronautical
Systems Center
    
    $
    14,742
    
    
    
    22
    %
    
    $
    12,452
    
    
    
    16
    %
    
    $
    26,713
    
    
    
    20
    %
    
    $
    23,307
    
    
    
    16
    %Air Force
Electronic Systems
Center
    
    $
    5,158
    
    
    
    8
    %
    
    $
    8,051
    
    
    
    11
    %
    
    $
    10,505
    
    
    
    8
    %
    
    $
    15,762
    
    
    
    11
    %
  June 30,
    
    December 31,2006
    
    2005Air Force Aeronautical Systems Center
    
    $
    4,925
    
    
    $
    4,740Air Force Electronic Systems Center
    
    $
    2,473
    
    
    $
    1,770
  Related Party
  14




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(dollars in thousands, except share amounts)
 NOTE 12. COMMITMENTS AND CONTINGENCIES
     15




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Overview
     16




---



##### Table of Contents



Results of Operations
  Three Months Ended June 30,2006
    
    2005$ millions
    
    %
    
    $ millions
    
    %Contract revenue
    
    $
    65.7
    
    
    
    97.7
    %
    
    $
    74.5
    
    
    
    97.8
    %Product sales
    
    $
    1.6
    
    
    
    2.3
    %
    
    $
    1.6
    
    
    
    2.2
    %Total revenue
    
    $
    67.3
    
    
    
    100.0
    %
    
    $
    76.2
    
    
    
    100.0
    %Gross profit on contract revenue (1)
    
    $
    7.4
    
    
    
    11.2
    %
    
    $
    11.6
    
    
    
    15.6
    %Gross profit on product sales (1)
    
    $
    0.3
    
    
    
    19.4
    %
    
    $
    0.4
    
    
    
    21.3
    %Total gross profit (1)
    
    $
    7.7
    
    
    
    11.4
    %
    
    $
    11.9
    
    
    
    15.7
    %Selling, general and administrative
    
    $
    6.0
    
    
    
    9.0
    %
    
    $
    6.7
    
    
    
    8.8
    %Amortization of intangible assets
    
    $
    0.7
    
    
    
    1.0
    %
    
    $
    0.8
    
    
    
    1.0
    %Operating income
    
    $
    0.9
    
    
    
    1.4
    %
    
    $
    4.5
    
    
    
    5.9
    %Interest expense, net
    
    $
    (0.6
    )
    
    
    (0.8
    )%
    
    $
    (1.0
    )
    
    
    (1.4
    )%Other income, net
    
    $
    
    
    
    
    
    
    
    $
    2.1
    
    
    
    2.7
    %Provision for income taxes
    
    $
    (0.2
    )
    
    
    (0.3
    )%
    
    $
    (2.3
    )
    
    
    (3.0
    )%Net income
    
    $
    0.2
    
    
    
    0.3
    %
    
    $
    3.3
    
    
    
    4.3
    %
 Six Months Ended June 30,2006
    
    2005$ millions
    
    %
    
    $ millions
    
    %Contract revenue
    
    $
    132.5
    
    
    
    97.8
    %
    
    $
    146.4
    
    
    
    97.8
    %Product sales
    
    $
    3.0
    
    
    
    2.2
    %
    
    $
    3.4
    
    
    
    2.2
    %Total revenue
    
    $
    135.5
    
    
    
    100.0
    %
    
    $
    149.7
    
    
    
    100.0
    %Gross profit on contract revenue (1)
    
    $
    17.2
    
    
    
    13.0
    %
    
    $
    22.6
    
    
    
    15.5
    %Gross profit on product sales (1)
    
    $
    0.5
    
    
    
    15.2
    %
    
    $
    0.6
    
    
    
    19.3
    %Total gross profit (1)
    
    $
    17.6
    
    
    
    13.0
    %
    
    $
    23.3
    
    
    
    15.5
    %Selling, general and administrative
    
    $
    12.7
    
    
    
    9.4
    %
    
    $
    12.7
    
    
    
    8.5
    %Amortization of intangible assets
    
    $
    1.4
    
    
    
    1.0
    %
    
    $
    1.5
    
    
    
    1.0
    %Operating income
    
    $
    3.6
    
    
    
    2.6
    %
    
    $
    9.0
    
    
    
    6.0
    %Interest expense, net
    
    $
    (1.1
    )
    
    
    (0.8
    )%
    
    $
    (2.1
    )
    
    
    (1.4
    )%Other income, net
    
    $
    0.4
    
    
    
    0.3
    %
    
    $
    2.1
    
    
    
    1.4
    %Provision for income taxes
    
    $
    (1.2
    )
    
    
    (0.9
    )%
    
    $
    (3.7
    )
    
    
    (2.4
    )%Net income
    
    $
    1.7
    
    
    
    1.2
    %
    
    $
    5.4
    
    
    
    3.6
    %
 
 (1)
    
    These amounts represent a percentage of contract revenues, product sales and total revenues,
respectively. Revenues
  Contract Revenues
 17




---



##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005National defense and intelligence agencies
    
    $
    53.5
    
    
    $
    60.0
    
    
    $
    108.5
    
    
    $
    116.0Federal civilian agencies
    
    
    9.0
    
    
    
    8.6
    
    
    
    16.3
    
    
    
    17.8State and local government agencies
    
    
    3.0
    
    
    
    5.3
    
    
    
    7.3
    
    
    
    11.0Other
    
    
    0.2
    
    
    
    0.6
    
    
    
    0.4
    
    
    
    1.6$
    65.7
    
    
    $
    74.5
    
    
    $
    132.5
    
    
    $
    146.4
     Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2006
    
    2005
    
    2006
    
    2005Time and materials
    
    
    61
    %
    
    
    57
    %
    
    
    61
    %
    
    
    56
    %Cost reimbursable
    
    
    20
    %
    
    
    20
    %
    
    
    20
    %
    
    
    20
    %Fixed price, including service type contracts
    
    
    19
    %
    
    
    23
    %
    
    
    19
    %
    
    
    24
    %100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 18




---



##### Table of Contents



Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2006
    
    2005
    
    2006
    
    2005Prime contract
    
    
    69
    %
    
    
    66
    %
    
    
    68
    %
    
    
    68
    %Sub-contact
    
    
    31
    %
    
    
    34
    %
    
    
    32
    %
    
    
    32
    %100
    %
    
    
    100
    %
    
    
    100
    %
    
    
    100
    %
 Product Sales
  Funded Backlog
   Gross Profit
    Selling, general and administrative expenses
 19




---



##### Table of Contents



Amortization of intangible assets
  Interest expense, net
  Other income, net
  Income tax provision
  LIQUIDITY AND CAPITAL RESOURCES
  Operating activities
 20




---



##### Table of Contents



Investing activities
   21




---



##### Table of Contents



Financing activities
      RECENT ACCOUNTING PRONOUNCEMENTS
    22




---



##### Table of Contents



Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
   
 Item 4. CONTROLS AND PROCEDURES
  23




---



##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 1. LEGAL PROCEEDINGS
   
 Item 1A. RISK FACTORS
  Our Contracts and Subcontracts with Government Agencies are Subject to a Competitive Bidding
Process and to Termination Without Cause by the Government.
    24




---



##### Table of Contents



We Are Involved in Various Litigation Matters Which, If Not Resolved in Our Favor, Could Harm Our
Business.
   25




---



##### Table of Contents



Our
Financing Requirements May Increase and We Could Have Limited Access
to Capital Markets.
  
 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
    
    
    Publicly
    
    
    Under theof Shares
    
    
    Price Paid
    
    
    Announced
    
    
    ProgramsPeriod
    
    Purchased
    
    
    Per Share
    
    
    Programs
    
    
    (in millions)January 1, 2006 to January 31, 2006
    
    
    732
    
    
    $
    18.52
    
    
    
    
    
    
    $
    February 1, 2006 to February 28, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    March 1, 2006 to March 31, 2006
    
    
    11,196
    
    
    
    13.54
    
    
    
    
    
    
    
    Total
    
    
    11,928
    
    
    $
    13.85
    
    
    
    
    
    
    $
    April 1, 2006 to April 30, 2006
    
    
    127
    
    
    $
    14.90
    
    
    
    
    
    
    $
    May 1, 2006 to May 31, 2006
    
    
    130
    
    
    
    14.65
    
    
    
    
    
    
    
    June 1,
2006 to June 30, 2006
    
    
    687
    
    
    
    14,09
    
    
    
    
    
    
    
    Total
    
    
    944
    
    
    $
    14.28
    
    
    
    
    
    
    $
    
 26




---



##### Table of Contents



Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  (a)
    
    The number of votes to elect two Class I directors for a term of three years
expiring at the 2009 Annual Meeting of Stockholders and a Class II director for a
one-year term expiring at the 2007 Annual Meeting of Stockholders, was as follows:
 Number of
    
    Number ofShares Voted
    
    SharesFor
    
    WithheldClass I Directors:Lieutenant General Charles P. McCausland (U.S.A.F., retired)
    
    
    6,941,897
    
    
    
    301,523General George T. Babbitt, Jr. (U.S.A.F., retired)
    
    
    7,031,502
    
    
    
    211,918Class II Director:Mr. Nickolas Stavropoulos
    
    
    6,861,157
    
    
    
    382,263
 There were 5,857 shares abstaining from voting for each director and no broker
non-voting shares cast. Continuing Class II directors and Class III directors with
terms expiring at the 2007 Annual Meeting of Stockholders and 2008 Annual Meeting
of Stockholders, respectively, were as follows:
 Class II Directors:
     Mr. Francis J. Aguilar
     Mr. John S. Anderegg, Jr.
Class III Directors:
     Mr. Kenneth F. Kames
     Mr. James P. Regan
 (b)
    
    Amendments to the Companys 2000 Employee Stock Purchase Plan (ESPP) that
provide for an increase in the number of shares of common stock available for issuance
under the ESPP by 500,000 shares to a total of 1,300,000 shares. A total of 5,168,800
shares voted in favor of the amendment, 183,510 shares voted against the amendment,
83,318 shares abstained from voting and there were 1,813,649 shares representing broker
non-votes.
 
 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.
 27




---



##### Table of Contents



DYNAMICS RESEARCH CORPORATION
(Registrant)Date: August 9, 2006
    /s/ David KeleherDavid KeleherSenior Vice President and Chief Financial Officer/s/ Francis MurphyFrancis MurphyVice President, Corporate Controller and Chief
Accounting Officer 28