FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 27, 2002 Commission file number 1-3879
DynCorp
(Exact name of registrant as specified in its charter)
Delaware 36-2408747
(State of incorporation or organization) (I.R.S. Employer Identification No.)
11710 Plaza America Drive, Reston, Virginia 20190
(Address of principal executive offices) (Zip Code)
(703) 261-5000
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. |X| Yes |_| No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding as of August 12, 2002
----- ---------------------------------
Common Stock, $0.10 par value 10,575,692
DYNCORP AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTER ENDED JUNE 27, 2002
INDEX
Page
PART I. FINANCIAL INFORMATION
- -------------------------------
Item 1. Financial Statements (Unaudited)
Consolidated Condensed Balance Sheets at
June 27, 2002 and December 27, 2001 (Revised - See Note 2) 3-4
Consolidated Condensed Statements of Operations for
Three and Six Months Ended June 27, 2002 and
June 28, 2001 (Revised - See Note 2) 5
Consolidated Condensed Statements of Cash Flows for
Six Months Ended June 27, 2002 and
June 28, 2001 (Revised - See Note 2) 6
Consolidated Statement of Stockholders' Equity for
Six Months Ended June 27, 2002 7
Notes to Consolidated Condensed Financial Statements 8-17
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 18-28
Item 3. Quantitative and Qualitative Disclosures About Market Risk 28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 29-31
Item 6. Exhibits and Reports on Form 8-K 31
Signatures 32
PART I. FINANCIAL INFORMATION
DYNCORP AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
JUNE 27, 2002 AND DECEMBER 27, 2001
(In thousands)
UNAUDITED
December 27,
June 27, 2001
2002 (Revised - See Note 2)
---- ---------------------
Assets
- ------
Current Assets:
Cash and cash equivalents $ 41,167 $ 15,078
Accounts receivable (net of allowance for doubtful accounts
of $7,879 in 2002 and $6,637 in 2001) 351,878 353,990
Other current assets 50,047 33,551
--------- ---------
Total current assets 443,092 402,619
Property and Equipment (net of accumulated depreciation
and amortization of $27,127 in 2002 and $26,599 in 2001) 21,229 20,959
Goodwill 107,814 103,185
Intangible Assets (net of accumulated amortization of
$25,163 in 2002 and $24,454 in 2001) 19,981 27,240
Other Assets 29,487 48,687
--------- ---------
Total Assets $ 621,603 $ 602,690
========= =========
The accompanying notes are an integral part of these consolidated condensed
financial statements.
DYNCORP AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
JUNE 27, 2002 AND DECEMBER 27, 2001
(In thousands, except share amounts)
UNAUDITED
December 27,
June 27, 2001
2002 (Revised - See Note 2)
---- ----------------------
Liabilities and Stockholders' Equity
- ------------------------------------
Current Liabilities:
Notes payable and current portion of long-term debt $ 25,047 $ 20,123
Accounts payable 29,827 19,420
Deferred revenue and customer advances 5,531 6,195
Accrued liabilities 217,491 206,718
--------- -----------
Total current liabilities 277,896 252,456
Long-Term Debt 249,099 264,482
Other Liabilities and Deferred Credits 49,210 46,018
Contingencies and Litigation
Temporary Equity:
Redeemable common stock at redemption value -
ESOP shares, 7,077,838 and 7,142,510
shares issued and outstanding in 2002 and 2001,
respectively, subject to restrictions 368,649 326,368
Other redeemable common stock, 286,217 shares issued
and outstanding in 2002 and 2001 7,944 6,967
Stockholders' Equity:
Common stock, par value ten cents per share, authorized 20,000,000 shares;
issued 5,364,244 and 5,296,146 shares
in 2002 and 2001, respectively 536 530
Paid-in surplus 137,290 138,052
Accumulated other comprehensive loss (741) (1,081)
Reclassification to temporary equity for redemption value
greater than par value (375,860) (332,596)
Deficit (50,928) (55,438)
Common stock held in treasury, at cost; 2,152,607 and
2,196,853 shares in 2002 and 2001, respectively (41,492) (43,068)
--------- -----------
Total Liabilities and Stockholders' Equity $ 621,603 $ 602,690
========= ===========
The accompanying notes are an integral part of these consolidated condensed
financial statements.
DYNCORP AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
UNAUDITED
Three Months Ended Six Months Ended
------------------ ----------------
June 28,2001 June 28, 2001
June 27, (Revised - June 27, (Revised - See
2002 See Note2) 2002 Note 2)
---- ---------- ---- -------
Revenues $595,011 $476,900 $1,139,790 $916,973
Costs and expenses:
Costs of services 562,518 449,657 1,077,700 865,252
Corporate general and administrative 7,216 7,199 14,834 14,026
Interest income (172) (159) (240) (453)
Interest expense 6,963 8,032 14,156 16,409
Amortization of intangibles of acquired companies 519 1,738 1,037 3,649
Other expense (other income) 18,081 6 19,873 (51)
-------- -------- ---------- ---------
Total costs and expenses 595,125 466,473 1,127,360 898,832
(Loss) earnings before income taxes and minority interest (114) 10,427 12,430 18,141
(Benefit) provision for income taxes (38) 4,082 4,251 7,136
-------- -------- ---------- ---------
(Loss) earnings before minority interest (76) 6,345 8,179 11,005
Minority interest 1,429 934 2,692 1,545
-------- -------- ---------- ---------
Net (loss) earnings $(1,505) $ 5,411 $ 5,487 $ 9,460
========= ======== ========== =========
Accretion of other redeemable common stock to
redemption value 496 568 977 1,119
Common stockholders' share of net (loss) earnings $(2,001) $ 4,843 $ 4,510 $ 8,341
========= ======== ========== =========
Basic (loss) earnings per share $ (0.19) $ 0.46 $ 0.42 $ 0.79
========= ======== ========== =========
Diluted (loss) earnings per share $ (0.19) $ 0.44 $ 0.39 $ 0.75
========= ======== ========== =========
Weighted average number of shares
outstanding for basic earnings per share 10,662 10,559 10,654 10,552
Weighted average number of shares
outstanding for diluted earnings per share 10,662 11,106 11,566 11,061
The accompanying notes are an integral part of these consolidated condensed
financial statements.
DYNCORP AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
UNAUDITED
Six Months Ended
----------------
June 28,
2001
June 27, (Revised -
2002 See Note 2)
---- -----------
Cash Flows from Operating Activities:
Common stockholders' share of net earnings $ 4,510 $ 8,341
Adjustments to reconcile net earnings to net cash provided by (used in)
operating activities:
Depreciation and amortization 7,757 10,325
Accretion of other redeemable common stock to redemption value 977 1,119
Gain on sale of assets of DynServices.com (130) -
Deferred taxes (4,819) -
Non-cash net losses of unconsolidated affiliates 2,219 527
Change in minority interest 1,460 429
Changes in pension asset and other postretirement benefit obligations 2,591 1,404
Non-cash reserve of investment in unconsolidated
affiliate 15,812 -
Other (877) (425)
Changes in current assets and liabilities, net of acquisitions
and dispositions:
(Increase) decrease in current assets and certain other assets except
cash and cash equivalents (11,094) 10,388
Increase (decrease) in current liabilities and certain other
liabilities excluding notes payable and current portion of 21,713 (38,110)
long-term debt --------- --------
Cash provided by (used in) operating activities 40,119 (6,002)
--------- --------
Cash Flows from Investing Activities:
Proceeds from sale of property and equipment 211 2,942
Purchases of property and equipment (4,009) (3,348)
Proceeds from investments in unconsolidated affiliates 307 29
Proceeds from the sale of assets of DynServices.com 400 -
Capitalized software costs (267) -
Other - (489)
---------- --------
Cash used in investing activities (3,358) (866)
---------- --------
Cash Flows from Financing Activities:
Payments on indebtedness (73,622) (159,250)
Proceeds from debt issuance 62,950 159,250
Other 142
---------- --------
Cash (used in) provided by financing activities (10,672) 142
---------- --------
Net Increase (Decrease) in Cash and Cash Equivalents 26,089 (6,726)
Cash and Cash Equivalents at Beginning of the Period 15,078 12,954
---------- --------
Cash and Cash Equivalents at End of the Period $41,167 $ 6,228
========== ========
Supplemental Cash Flow Information:
Cash paid for income taxes $ 9,563 $ 7,270
========== ========
Cash paid for interest $ 13,011 $ 17,618
========== ========
The accompanying notes are an integral part of these consolidated condensed
financial statements.
DYNCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands)
UNAUDITED
Adjustment for
Redemption Value Deficit Accumulated Other
Common Paid-in Greater than Par (Revised - Treasury Comprehensive
Stock Surplus Value See Note 2) Stock Loss
------ ------- ----- ----------- ----- ----
Balance, December 27, 2001 $ 530 $138,052 $(332,596) $(55,438) $(43,068) $(1,081)
Employee compensation plans
(option exercises, restricted
stock plan, incentive bonus) (1,739) 1,576
Reclassification to redeemable
common stock 6 (42,287)
Accretion of other redeemable
common stock to redemption value 977 (977) (977)
Adjustment to fair value of
derivative financial instrument 337
Translation adjustment and other 3
Net earnings 5,487
----- -------- ---------- ---------- --------- ------
Balance, June 27, 2002 $ 536 $137,290 $(375,860) $ (50,928) $(41,492) $(741)
===== ======== ========== ========== ========= ======
The accompanying notes are an integral part of these consolidated condensed
financial statements.
DYNCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
JUNE 27, 2002
(Dollars in thousands, except per share amounts)
UNAUDITED
Note 1. Basis of Presentation and Significant Accounting Policies
The Company has prepared the unaudited consolidated condensed financial
statements included herein pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. It is
recommended that these condensed financial statements be read in
conjunction with the financial statements and the notes thereto included in
the Company's latest annual report on Form 10-K/A. See Note 2 "Revision of
Financial Statements" for further comments on the Form 10-K/A. In the
opinion of the Company, the unaudited consolidated condensed financial
statements included herein reflect all adjustments (consisting of normal
recurring adjustments) necessary to present fairly the financial position,
the results of operations and the cash flows for such interim periods. The
results of operations for such interim periods are not necessarily
indicative of the results for the full year. Certain amounts presented for
prior periods have been reclassified to conform to the 2002 presentation.
Contract Accounting
Revenues for cost-reimbursement contracts are recorded as reimbursable
costs are incurred, including a pro-rata share of the contractual fees. For
time-and-material contracts, revenue is recognized to the extent of
billable rates times hours delivered plus material and other reimbursable
costs incurred. For long-term fixed price production contracts,
units-of-delivery is generally used as the measurement basis for revenue
recognition. Revenue from other long-term fixed price contracts is
recognized ratably over the contract period or by other appropriate methods
to measure services provided. Because the Company assumes the risk of
performing a fixed price contract at a set price, the failure to accurately
estimate ultimate costs or to control costs during performance of the work
could result, and in some instances has resulted, in reduced profits or
losses for such contracts. Anticipated losses on contracts are recognized
when identified. Disputes arise in the normal course of the Company's
business on projects where the Company is contesting with customers for
collection of funds because of events such as delays, changes in contract
specifications and questions of cost allowability or collectibility. Such
disputes, whether claims or unapproved change orders in the process of
negotiation, are recorded at the lesser of their estimated net realizable
value or actual costs incurred, and only when realization is probable and
can be reliably estimated. Claims against the Company are recognized where
loss is considered probable and reasonably determinable in amount. Because
there are estimates and judgments involved, the actual results could be
different from those estimates.
Investment Recoverability
The Company periodically evaluates the recoverability of its equity
investments, in accordance with Accounting Principles Board No. 18, "The
Equity Method of Accounting for Investments in Common Stock," and if
circumstances arise where a loss in value is considered to be other than
temporary, the Company will record a write-down of excess investment cost.
The Company's recoverability analysis is based on the projected
undiscounted cash flows of the investments, which is the lowest level of
cash flow information available. During the second quarter of 2002, the
Company recorded a write-off of approximately $15.8 million, which
represented the net balance of a certain investment, which was stated in
excess of its net realizable value. The total charge was included in Other
Expense (Other Income) on the Consolidated Condensed Statement of
Operations at June 27, 2002.
Note 2. Revision of Financial Statements
The Company has revised certain information in the Consolidated Condensed
Financial Statements for the three and six months ended June 28, 2001
following discussions with the staff of the SEC regarding accounting
principles articulated in Statement of Financial Accounting Standards No.
38, "Accounting for Preacquisition Contingencies of Purchased Enterprises"
("SFAS No. 38") and Accounting Principles Board Opinion No. 16, "Business
Combinations" ("APB 16") as they relate to the Company's acquisition of DIS
from GTE Corporation in December 1999 and also regarding its method of
accounting for long-term service contracts and the related applicability of
percentage of completion method to service contracts with the Federal
Government.
When the Company purchased DIS in December 1999, issues existed relating to
the financial performance of certain DIS contracts and realization of
certain DIS receivables. The Company disclosed in its 1999 Form 10-K that
its purchase accounting was preliminary. During 2000, the Company continued
its evaluation of the status of contracts at the date of acquisition.
Primarily in the third quarter of 2000, the Company finalized its
evaluation of the impact of the future cash flows related to the contracts
based on information obtained through that quarter and recorded an increase
to reserves through a purchase accounting adjustment. The purchase
accounting adjustment also resulted in an increase to goodwill and deferred
tax assets. At the end of the third quarter of 2001, the Company reversed a
significant amount of the contract loss reserves as a result of entering
into a modification of one of the contracts acquired. This was also
accounted for as a purchase accounting adjustment, which resulted in a
decrease to goodwill and deferred tax assets.
According to SFAS No. 38, the allocation period for purchase accounting
adjustments ends when the acquiring enterprise is no longer waiting for
information that it has arranged to obtain and that is known to be
available or obtainable at the acquisition date. Items identified during
the initial purchase period as "preacquisition contingencies" shall be
included in the allocation of the purchase price based on the fair value of
the contingency. The Company previously believed that the allocation period
related to these preacquisition contingencies was still open during those
periods. Although the Company stated in its 1999 Form 10-K that the
purchase price allocation was preliminary, after discussions with the SEC's
staff, the Company has determined that the allocation period for these
preacquisition contingencies was no longer open in 2000 and 2001, and
therefore the adjustments made should have been accounted for directly
through the statement of operations, rather than as a resolution of the
identified preacquisition contingencies, with a corresponding adjustment to
the original purchase accounting. As a result, the financial statements of
the Company for the years ended December 28, 2000, and December 27, 2001
have been revised to reflect the adjustments directly in the statements of
operations. In addition, the 1999 financial statements have been revised
for the allocation of the DIS purchase price with respect to the valuation
of an acquired contract in progress. The Company has filed its December 28,
2000 and December 27, 2001 Forms 10-K/A to reflect these changes. The
second quarter and six months ended June 28, 2001 common stockholders'
share of net earnings and diluted share effects are included in the table
below as "As Revised."
In 2002, the Company also changed its method of accounting for long-term
service contracts. Previously, the Company followed the historical
industry-wide practice of recording income from long-term service contracts
using the percentage of completion method, in accordance with the AICPA
"Audit and Accounting Guide, Audits of Federal Government Contractors,"
which incorporates as an appendix AICPA Statement of Position No. 81-1
"Accounting for Performance of Construction Type and Certain
Production-Type Contracts." Under this method, income is recognized ratably
over the period of performance based on the estimated profit margin at the
completion of the contract. Such a method has resulted in deferral of costs
or profits on certain contracts. Following discussions with its new
accountants and the SEC's staff, it has been determined that percentage-
of-completion accounting should not be utilized and costs or profits should
not be deferred in order to recognize a consistent profit margin on these
long-
term contracts. Profit on a given long-term service contract, therefore,
could fluctuate from one accounting period to another due to fluctuations
in the revenue earned and costs incurred in a given accounting period. As a
result,the financial statements of the Company for the three and six months
ended June 28, 2001 and for the three months ended March 28, 2002 have
been revised to eliminate the deferral of such costs or profits on service
contracts. The Company has decided to apply this change retroactive to
January 2000 and to the acquistion of DIS. The Company also intends to
amend its previously filed 2001 Form 10-K/A to revise the financial state-
ments for each of the fiscal years 2001, 2000 and 1999, as well as its Form
10-Q for the three months ended March 28, 2002. The change did not have any
effect on the Company's cash flows or revenues in 2002, 2001, 2000 or 1999.
As a result of the revisions described above, reported common stockholders'
share of net earnings increased by $1.0 million, from $3.8 million to $4.8
million for the three months ended June 28, 2001 and by $1.9 million, from
$6.5 million to $8.3 million for the six months ended June 28, 2001.
Reported common stockholders' share of net earnings per diluted share
increased from $0.34 to $0.44 for the three-month period ended June 28,
2001 and from $0.59 to $0.75 for the six-month period ended June 28, 2001.
The impacts on the June 28, 2001 Statement of Operations data for the
revisions discussed above are presented in the table below:
Three Months Ended (Unaudited) Six Months Ended (Unaudited)
------------------------------ ----------------------------
June 28, June 28, June 28, June 28,
2001 2001 2001 2001
Statement of Operations Data: As Reported As Revised As Reported As Revised
- ----------------------------- ----------- ---------- ----------- ----------
Revenues $476,900 $476,900 $916,973 $916,973
Cost of services 451,064 449,657 867,731 865,252
Earnings before income taxes
and minority interest 8,630 10,427 14,882 18,141
Common stockholders' share of
net earnings 3,819 4,843 6,483 8,341
Common stockholders' share of net earnings
per common share:
Basic earnings per share $ 0.36 $ 0.46 $ 0.61 $ 0.79
Diluted earnings per share $ 0.34 $ 0.44 $ 0.59 $ 0.75
The impact of the revisions discussed above on the 2001 quarterly financial
data and first quarter 2002 is presented in the tables below:
2001 Quarters
(Unaudited)
-----------
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
Statement of Operations Data: As As As As As As As As
- ----------------------------- Reported Revised Reported Revised Reported Revised Reported Revised
-------- ------- -------- ------- -------- ------- -------- -------
Revenues $440,073 $440,073 $476,900 $476,900 $504,113 $504,113 $539,289 $539,289
Cost of Services 416,667 415,595 451,064 449,657 471,675 429,000 516,881 516,359
Earnings before
income taxes and
minority interest 6,252 7,714 8,630 10,427 16,402 59,467 24,330 24,812
Common
stockholders' share 2,665 3,498 3,819 4,843 9,058 36,678 15,066 15,548
of net earnings
Common stockholders'
share of net
earnings per common share:
Basic earnings per share $ 0.25 $ 0.33 $ 0.36 $ 0.46 $ 0.86 $ 3.47 $ 1.42 $ 1.47
Diluted earnings per share $ 0.24 $ 0.31 $ 0.34 $ 0.44 $ 0.82 $ 3.30 $ 1.35 $ 1.40
Balance Sheet Data:
- -------------------
Accounts receivable, net of
allowance for doubtful
accounts $313,558 $314,825 $321,643 $322,910 $315,386 $316,653 $353,990 $353,990
Other current assets 40,788 33,019 37,356 31,070 40,542 33,259 39,436 33,551
Intangible assets, net
of accumulated 178,390 132,346 175,548 129,893 150,270 129,030 126,107 130,425
amortization
Other assets 49,925 48,178 46,804 45,212 38,205 37,388 49,330 48,687
Total assets 618,588 564,295 612,232 559,966 583,411 555,337 604,900 602,690
Accrued liabilities 156,342 154,834 159,807 159,033 163,428 162,058 209,269 206,718
Other liabilities
and deferred credits 88,038 85,590 88,897 86,719 46,300 38,782 45,251 46,018
Deficit (62,170) (112,508) (58,352) (107,667) (49,292) (68,477) (55,012) (55,438)
(Unaudited)
First Quarter Ended March 28, 2002
----------------------------------
As As
Statement of Operations Data: Reported Revised
- ----------------------------- -------- -------
Revenues $544,779 $544,779
Cost of Services 514,341 515,182
Earnings before income taxes and minority
interest 13,385 12,544
Common stockholders' share of net earnings 7,035 6,511
Common stockholders' share of net earnings
per common share:
Basic earnings per share $ 0.66 $ 0.61
Diluted earnings per share $ 0.61 $ 0.57
Balance Sheet Data:
- -------------------
Other current assets $ 56,199 $49,357
Goodwill 103,496 107,814
Intangible assets, net of
accumulated amortization 20,835 20,835
Other assets 48,448 47,950
Total assets 617,007 613,985
Accrued liabilities 202,758 199,919
Deficit (47,977) (48,927)
The Form 10-K/A for 2001 as previously filed, reflects the revision for
issues related to SAB 38 and APB 16, but does not reflect the percentage of
completion issue. The table below reflects the impacts for the percentage
of completion issue on fiscal years 2001 and 2000. The Company intends to
amend its Form 10-K/A for fiscal year 2001, which will include amended
financial information for each affected quarter in 2001 and 2000. Because
the Company's prior independent accountants, Arthur Andersen LLP, are no
longer servicing the marketplace, the revisions will require the Company to
engage new independent accountants to audit the Company's financial
statements for fiscal years 2001, 2000 and 1999; thus, the Company may not
be in a position to make the amended filings for several months.
(Unaudited)
-----------
2001 As 2001 As 2000 As 2000 As
Reported Revised Reported Revised
Statement of Operations Data: in the Form 10-K/A in the Form 10-K/A
- ----------------------------- ------------------ ------- ------------------ -------
Revenues $1,960,375 $1,960,375 $1,809,109 $1,809,109
Cost of Services 1,813,991 1,810,611 1,781,825 1,784,285
Earnings (loss) before income taxes (benefit)
and minority interest 99,200 102,421 (56,233) (58,853)
Common stockholders' share of net earnings
(loss) 58,522 60,567 (40,654) (42,357)
Common stockholders' share of net earnings
(loss) per common share:
Basic earnings (loss) per share $ 5.54 $ 5.74 $ (3.88) $ (4.04)
Diluted earnings (loss) per share $ 5.27 $ 5.45 $ (3.88) $ (4.04)
Balance Sheet Data:
- -------------------
Accounts receivable, net of allowance for
doubtful accounts $ 353,990 $ 353,990 $ 335,621 $3 36,813
Prepaid income taxes 2,126 1,887 1,139 1,139
Other current assets 37,310 31,664 34,707 25,234
Intangible assets, net of accumulated
amortization 126,107 130,425 130,766 135,244
Other assets 49,330 48,687 40,203 38,942
Total assets 604,900 602,690 593,495 588,431
Accrued income taxes 603 603 6,474 6,474
Accrued liabilities 208,666 206,115 200,006 197,413
Deferred income taxes 8,648 9,415 - -
Other liabilities and deferred credits 36,603 36,603 87,566 87,566
Deficit (55,012) (55,438) (113,534) (116,006)
Note 3. Other Current Assets
Other current assets as of June 27, 2002 and December 27, 2001 included
$20.8 million and $8.7 million of inventories on long-term contracts,
respectively.
Note 4. Accrued Liabilities
Accrued liabilities as of June 27, 2002 and December 27, 2001 included
$119.3 million and $106.1 million of accrued salaries, respectively.
Note 5. Redeemable Common Stock
Effective January 1, 2001, the Company established two new plans: the
Savings and Retirement Plan and the Capital Accumulation and Retirement
Plan (collectively, the "Savings Plans"). At the same time, the Employee
Stock Ownership Plan ("ESOP") was merged into the two plans. The Company
stock accounts of participants in the ESOP were transferred to one or the
other of the Savings Plans, and the Savings Plans
participants have the same distribution and put rights for these ESOP
shares as they had in the ESOP. All rights and obligations of the ESOP re-
main intact in the new plans. In accordance with the Employee Retire-
ment Income Security Act regulations and the Savings Plans' documents,
the Company is obligated, unless the Savings Plans' Trust purchases the
shares, to purchase certain distributed common stock shares, transferred
from the former ESOP, from former participants in the ESOP on retirement or
termination at fair value as long as the Company's common stock is not
publicly traded. However, the Company is permitted to defer put options
if, under Delaware law, the capital of the Company would be impaired as a
result of such repurchase.
On December 10, 1999, the Company entered into an agreement with various
financial institutions for the sale of 426,217 shares of the Company's
stock and Subordinated Notes. Under a contemporaneous registration rights
agreement, the holders of these shares of stock will have a put right to
the Company commencing on December 10, 2003, at a price of $40.53 per
share, unless one of the following events has occurred prior to such date
or the exercise of the put right: (1) an initial public offering of the
Company's common stock has been consummated; (2) all the Company's common
stock has been sold; (3) all the Company's assets have been sold in such a
manner that the holders have received cash payments; or (4) the Company's
common stock has been listed on a national securities exchange or
authorized for quotation on the Nasdaq National Market System for which
there is a public market of at least $100 million for the Company's common
stock. If, at the time of the holders' exercise of the put right the
Company is unable to pay the put price because of financial covenants in
loan agreements or other provisions of law, the Company will not honor the
put at that time, and the put price will escalate for a period of up to
four years, at which time the put must be honored. The escalation rate
increases during such period until the put is honored, and the rate varies
from an annualized factor of 22% for the first quarter after the put is not
honored up to 52% during the sixteenth quarter. The annual accretion in the
fair value of these shares is reflected as a reduction of common
stockholders' share of net earnings on the consolidated statements of
operations.
Common stock which is redeemable has been reflected as Temporary Equity at
the redemption value at each balance sheet date and consists of the
following:
Balance at Balance at
Redeemable June 27, Redeemable December 27,
Shares Value 2002 Shares Value 2001
------ ----- ---- ------ ----- -----
ESOP Shares 2,954,885 $53.25 $157,348 2,995,783 $47.00 $140,802
4,122,953 $51.25 211,301 4,146,727 $44.75 185,566
--------- -------- --------- --------
7,077,838 $368,649 7,142,510 $326,368
========= ======== ========= ========
Other Shares 286,217 $27.76 $ 7,944 286,217 $24.34 $ 6,967
========= ======== ========= ========
Note 6. Income Taxes
The provisions for income taxes in 2002 and 2001 are based upon estimated
effective tax rates. These rates include the impact of permanent
differences between the book bases of assets and liabilities recognized for
financial reporting purposes and the bases recognized for tax purposes.
Note 7. Earnings Per Share ("EPS")
The following table sets forth (in thousands) the reconciliation of shares
for basic EPS to shares for diluted EPS. Basic EPS is computed by dividing
common stockholders' share of net earnings by the weighted average number
of common shares outstanding and contingently issuable shares. The weighted
average number of common shares outstanding includes issued shares less
shares held in treasury and any unallocated Savings' Plans shares. Shares
earned and vested but unissued under the Restricted Stock Plan are
contingently issuable shares whose conditions for issuance have been
satisfied and as such have been included in the calculation of basic EPS.
Diluted EPS is computed similarly except the denominator is
increased to include the weighted average number of stock options
outstanding, assuming the treasury stock method. The diluted loss per share
for the three months ended June 27, 2002 was computed in the same manner as
the basic loss per share, since adjustments related to the dilutive effects
of stock options would have been antidilutive.
Three Months Ended Six Months Ended
------------------ ----------------
June 27, June 28, June 27, June 28,
2002 2001 2002 2001
---- ---- ---- ----
Weighted average shares outstanding for basic EPS 10,662 10,559 10,654 10,552
Effect of dilutive securities:
Stock options - 547 912 509
------ ------ ------ ------
Weighted average shares outstanding for diluted EPS 10,662 11,106 11,566 11,061
====== ====== ====== ======
Note 8. Goodwill and Other Intangible Assets - Adoption of Statement 142
The Company has adopted SFAS No. 142, "Goodwill and Other Intangible
Assets," beginning December 28, 2001, the first day of fiscal 2002. The
provisions of SFAS No. 142 eliminate amortization of goodwill and require
an impairment assessment at least annually by applying a fair-value based
test. Accordingly, the Company has eliminated amortization in 2002 for
goodwill, which includes assembled workforce of $4.6 million as of June 27,
2002 and December 27, 2001 previously classified as an intangible asset.
The total carrying amount for goodwill is $107.8 million and $103.2 million
as of June 27, 2002 and December 27, 2001, respectively. The Company has
identified the reporting units to be tested for the goodwill impairment
test, which will be measured as of the beginning of the fiscal year. The
Company has completed the first step of the transitional impairment test in
accordance with the provisions of SFAS No. 142. The Company has concluded
that there has been no impairment of such assets as of the beginning of
fiscal year 2002.
The Company's contract backlog, patent, and core development intangible
assets are still subject to amortization under SFAS No. 142. Amortization
for the first half of 2002 for these intangible assets totaled $1.0
million. Estimated aggregate amortization expense for these intangible
assets for the next five years totals: $2.1 million in each of 2002 and
2003, $2.0 million in 2004, and $0.5 million in 2005 and 2006,
respectively. The following table presents these intangible assets, net of
accumulated amortization, as of June 27, 2002 that are required to continue
to be amortized under SFAS No. 142:
Intangible Assets, Net of Gross Accumulated
Accumulated Amortization Carrying Amount Amortization
------------------------ --------------- ------------
Contracts acquired $ 1,703 $ 1,543
Patent 7,100 1,845
Core and developed technology 7,700 3,955
----- -----
$16,503 $ 7,343
======= =======
The table above excludes capitalized software that is not covered by SFAS
No. 142. Capitalized software, net of accumulated amortization totals $10.8
million and $12.4 million as of June 27, 2002 and December 2001,
respectively. The following table presents adjusted net income and earnings
per share for the three and six months ended June 28, 2001, in comparison
to the results for the three and six months ended June 27, 2002, to show
what the impact would have been if SFAS No. 142 had been adopted at the
beginning of fiscal 2001. The adjusted results presented below are net of
taxes.
Three Months Ended Six Months Ended
------------------ ----------------
June 28, 2001 June 28, 2001
June 27, (Revised - June 27, (Revised -
2002 See Note 2) 2002 See Note 2)
---- ----------- ----- -----------
Common stockholders' share of net (loss) earnings $ (2,001) $ 4,843 $ 4,510 $ 8,341
Add back: Goodwill amortization - 564 - 1,089
Add back: Assembled workforce amortization - 133 - 267
--------- -------- ------- -------
Adjusted common stockholders' share of net (loss)
earnings $ (2,001) $ 5,540 $ 4,510 $ 9,697
========== ======= ======= =======
Basic earnings per share:
Common stockholders' share of net (loss) earnings $ (0.19) $ 0.46 $ 0.42 $ 0.79
Goodwill amortization - 0.05 - 0.10
Assembled workforce amortization - 0.01 - 0.03
--------- --------- ---------- ---------
Adjusted common stockholders' share of net (loss)
earnings $ (0.19) $ 0.52 $ 0.42 $ 0.92
========== ======== ========== =========
Diluted earnings per share:
Common stockholders' share of net (loss) earnings $ (0.19) $ 0.44 $ 0.39 $ 0.75
Goodwill amortization - 0.05 - 0.10
Assembled workforce amortization - 0.01 - 0.03
--------- -------- ---------- ---------
Adjusted common stockholders' share of net (loss)
earnings $ (0.19) $ 0.50 $ 0.39 $ 0.88
========== ======== ========== =========
Note 9. Recently Issued Accounting Pronouncements
In April 2002,the Financial Accounting Standards Board ("FASB")issued SFAS
No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13 and Technical Corrections." SFAS No. 145 rescinds
SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," which
required that all gains and losses from extinguishment of debt to be
aggregated and classified as an extraordinary item if material. SFAS No.
145 requires that gains and losses from extinguishment of debt be
classified as extraordinary only if they meet criteria in Accounting
Principles Board Opinion No. 30, thus distinguishing transactions that are
part of recurring operations from those that are unusual or infrequent, or
that meet the criteria for classification as an extraordinary item. SFAS
No. 145 amends SFAS No. 13, "Accounting for Leases", to require that lease
modifications that have economic effects similar to sale-leaseback
transactions be accounted for in the same manner as sale-leaseback
transactions. In addition, SFAS No. 145 rescinds SFAS No. 44, "Accounting
for Intangible Assets of Motor Carriers," and SFAS No. 64, "Extinguishments
of Debt Made to Satisfy Sinking-Fund Requirements," which are not currently
applicable to the Company. The provisions of SFAS No. 145 as they relate to
the rescission of SFAS No. 4 shall be applied in fiscal year 2003. Certain
provisions related to SFAS No. 13 are effective for transactions
occurring after May 15, 2002. Management does not expect SFAS No. 145 to
have a material impact on the Company's results of operations or financial
condition.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred and states that an entity's
commitment to a plan, by itself, does not create a present obligation to
others that meets the definition of a liability. SFAS No. 146 also
establishes that fair value is the objective for initial measurement of the
liability. Provisions of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002, with early
application encouraged. Management does not expect SFAS No. 146 to have a
material impact on the Company's results of operations or financial
condition.
Note 10. Business Segments
Effective January 2002, the Company realigned its five strategic business
segments into four segments. DynCorp Information and Enterprise Technology
("DI&ET") and DynCorp Information Systems LLC ("DIS") were combined into
one strategic business segment, DynCorp Systems and Solutions ("DSS"), in
order to structure one business segment providing integrated information
technology and business functional outsourcing to the federal government.
The business segment information for 2001 has been restated to give effect
to this change. DSS provides a wide range of information technology
services and other professional services including network and
communications engineering, government operational outsourcing, security
and intelligence programs. DynCorp International LLC ("DI") operates the
Company's overseas business, including information technology solutions,
technical services, and worldwide maintenance support to U.S. military
aircraft. DynCorp Technical Services ("DTS") provides a wide variety of
specialized technical services including aviation services, range technical
services, base operations, and logistics support. AdvanceMed ("ADVMED") is
structured as a business-to-business, eHealth decision support solution
organization and provides an integrated set of decision support tools to
meet the needs of healthcare payers and providers.
Revenues, operating profit and identifiable assets for the Company's four
business segments for 2002 and the comparable periods for 2001 are
presented below:
Three Months Ended Six Months Ended
------------------ ----------------
June 28, 2001 June 28, 2001
June 27, (Revised - See June 27, (Revised - See
2002 Note 2) (c) 2002 Note 2) (c)
---- ----------- ---- -----------
Revenues
- --------
DSS $242,076 $201,426 $ 467,672 $390,948
DI 178,620 131,316 343,008 249,884
DTS 161,309 128,097 301,964 245,191
ADVMED 13,006 16,061 27,146 30,950
------- ------ ---------- --------
$595,011 $476,900 $1,139,790 $916,973
======== ======== ========== ========
Operating Profit (Loss) (a)
- -----------------------
DSS $ 17,142 $ 12,171 $ 33,128 $ 22,914
DI 10,741 8,424 17,889 16,862
DTS 6,157 4,281 12,267 8,667
ADVMED 114 1,399 (619) 1,696
------- ------ ------ --------
34,154 26,275 62,665 50,139
Corporate general and administrative 7,216 7,199 14,834 14,026
Interest income (172) (159) (240) (453)
Interest expense 6,963 8,032 14,156 16,409
Goodwill amortization - 959 - 1,850
Amortization of other intangibles of acquired companies 519 779 1,037 1,799
Minority interest included in operating profit (1,429) (934) (2,692) (1,545)
Other miscellaneous (b) 21,171 (28) 23,140 (88)
------- ------ -------- -------
(Loss) earnings before income taxes and minority interest $ (114) $ 10,427 $ 12,430 $18,141
======= ======== ======== =======
December 27,
June 27,
2002 2001 (c)
---- --------
Identifiable Assets
-------------------
DSS $277,172 $290,398
DI 96,802 94,241
DTS 139,149 109,763
ADVMED 23,370 26,880
Corporate 85,110 81,408
--------- ---------
$621,603 $ 602,690
========= =========
(a) Defined as the excess of revenues over operating expenses and certain
non-operating expenses.
(b) Other miscellaneous includes $15.8 million for the reserve of an
investment in an unconsolidated affiliate in the second quarter of
2002 (see Note 1).
(c) Data has been revised to give recognition to the current reportable
segment structure.
Note 11. Contingencies and Litigation
The Company is a guarantor on a fixed price services contract for
non-emergency transportation brokerage services. Management perceives
the exposure of financial losses on this guarantee could possibly be
in the range of $4.0 million to $12.5 million over the next twelve
months. At this time, management does not believe a reserve is
required because no claim has been asserted and one is not considered
probable.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
General
- -------
The following discussion and analysis provides information that management
believes is relevant to an assessment and understanding of the consolidated
results of operations and financial condition of DynCorp and its subsidiaries
(collectively, the "Company"). The discussion should be read in conjunction with
the interim condensed consolidated financial statements and notes thereto and
the Company's annual report on Form 10-K/A for the year ended December 27, 2001.
Results of Operations
- ---------------------
The Company provides diversified management, technical, engineering and
professional services primarily to U.S. Government customers throughout the
United States and internationally. The Company's customers include various
branches of the U.S. Departments of Defense, Energy, State, Justice, and
Treasury, the National Aeronautics and Space Administration, and various other
U.S. state and local government agencies, commercial clients, and foreign
governments. Generally, these services are provided under both prime contracts
and subcontracts, which may be fixed price, time-and-material or cost
reimbursement contracts depending on the work requirements and other individual
circumstances. The following discusses the Company's results of operations and
financial condition for the three and six months ended June 27, 2002 and the
comparable periods for 2001.
Revision of Financial Statements
- --------------------------------
The Company has revised certain information in the Consolidated Condensed
Financial Statements for the three and six months ended June 28, 2001 following
discussions with the staff of the SEC regarding accounting principles
articulated in Statement of Financial Accounting Standards No. 38, "Accounting
for Preacquisition Contingencies of Purchased Enterprises" ("SFAS No. 38") and
Accounting Principles Board Opinion No. 16, "Business Combinations" ("APB 16")
as they relate to the Company's acquisition of DIS from GTE Corporation in
December 1999 and also regarding its method of accounting for long-term service
contracts and the related applicability of percentage of completion method to
service contracts with the Federal Government.
When the Company purchased DIS in December 1999, issues existed relating to the
financial performance of certain DIS contracts and realization of certain DIS
receivables. The Company disclosed in its 1999 Form 10-K that its purchase
accounting was preliminary. During 2000, the Company continued its evaluation of
the status of contracts at the date of acquisition. Primarily in the third
quarter of 2000, the Company finalized its evaluation of the impact of the
future cash flows related to the contracts based on information obtained through
that quarter and recorded an increase to reserves through a purchase accounting
adjustment. The purchase accounting adjustment also resulted in an increase to
goodwill and deferred tax assets. At the end of the third quarter of 2001, the
Company reversed a significant amount of the contract loss reserves as a result
of entering into a modification of one of the contracts acquired. This was also
accounted for as a purchase accounting adjustment, which resulted in a decrease
to goodwill and deferred tax assets.
According to SFAS No. 38, the allocation period for purchase accounting
adjustments ends when the acquiring enterprise is no longer waiting for
information that it has arranged to obtain and that is known to be available or
obtainable at the acquisition date. Items identified during the initial purchase
period as "preacquisition contingencies" shall be included in the allocation of
the purchase price based on the fair value of the contingency. The Company
previously believed that the allocation period related to these preacquisition
contingencies was still open during those periods. Although the Company stated
in its 1999 Form 10-K that the purchase price allocation was preliminary, after
discussions with the SEC's staff, the Company has determined that the allocation
period for these preacquisition contingencies was no longer open in 2000 and
2001,
and therefore the adjustments made should have been accounted for directly
through the statement of operations, rather than as a resolution of the
identified preacquisition contingencies, with a corresponding adjustment to the
original purchase accounting. As a result, the financial statements of the
Company for the years ended December 28, 2000, and December 27, 2001 have been
revised to reflect the adjustments directly in the statements of operations. In
addition, the 1999 financial statements have been revised for the allocation of
the DIS purchase price with respect to the valuation of an acquired contract in
progress. The Company has filed its December 28, 2000 and December 27, 2001
Forms 10-K/A to reflect these changes.
In 2002, the Company also changed its method of accounting for long-term service
contracts. Previously, the Company followed the historical industry-wide
practice of recording income from long-term service contracts using the
percentage of completion method, in accordance with the AICPA "Audit and
Accounting Guide, Audits of Federal Government Contractors," which incorporates
as an appendix AICPA Statement of Position No. 81-1 "Accounting for Performance
of Construction Type and Certain Production-Type Contracts." Under this method,
income is recognized ratably over the period of performance based on the
estimated profit margin at the completion of the contract. Such a method has
resulted in deferral of costs or profits on certain contracts. Following
discussions with its new accountants and the SEC's staff, it has been determined
that percentage of completion accounting should not be utilized and costs or
profits should not be deferred in order to recognize a consistent profit margin
on these long-term contracts. Profit on a given long-term service contract,
therefore, could fluctuate from one accounting period to another due to
fluctuations in the revenue earned and costs incurred in a given accounting
period. As a result, the financial statements of the Company for the three and
six months ended June 28, 2001 and for the three months ended March 28, 2002
have been revised to eliminate the deferral of such costs or profits on service
contracts. The Company has decided to apply this change retroactive to January
2000 and to the acquisition of DIS. The Company also intends to amend its
previously filed 2001 Form 10-K/A to revise the financial statements for each of
the fiscal years 2001, 2000 and 1999, as well as its Form 10-Q for the three
months ended March 28, 2002. The change did not have any effect on the Company's
cash flows or revenues in 2002, 2001, 2000 or 1999.
As a result of the revisions described above, reported common stockholders'
share of net earnings increased by $1.0 million, from $3.8 million to $4.8
million for the three months ended June 28, 2001 and by $1.9 million, from $6.5
million to $8.3 million for the six months ended June 28, 2001. Reported common
stockholders' share of net earnings per diluted share increased from $0.34 to
$0.44 for the three-month period ended June 28, 2001 and from $0.59 to $0.75 for
the six-month period ended June 28, 2001.
The impacts on the June 28, 2001 statement of operations data, 2001 quarterly
financial data and the March 28, 2002 financial data for the revisions discussed
above are presented in Note 2 to these Consolidated Condensed Financial
Statements.
The Form 10-K/A for 2001, as previously filed, reflects the revision for issues
related to SAB 38 and APB 16, but does not reflect the percentage of completion
issue. See table that reflects the impacts for the percentage of completion
issue on fiscal years 2001 and 2000 in Note 2 to these Consolidated Condensed
Financial Statements. The Company intends to amend its Form 10-K/A for fiscal
year 2001, which will include amended financial information for each affected
quarter in 2001 and 2000. Because the Company's prior independent accountants,
Arthur Andersen LLP, are no longer servicing the marketplace, the revisions will
require the Company to engage new independent accountants to audit the Company's
financial statements for fiscal years 2001, 2000 and 1999; thus, the Company may
not be in a position to make the amended filings for several months.
Effective January 2002, the Company realigned its five strategic business
segments into four segments. DynCorp Information and Enterprise Technology
("DI&ET") and DynCorp Information Systems LLC ("DIS") were combined into one
strategic business segment, DynCorp Systems and Solutions ("DSS"), in order to
structure one business segment providing integrated information technology and
business functional outsourcing
to the federal government (see Note 10 to the Consolidated Condensed Financial
Statements) and therefore the DIS results of operations and financial position
have been included in the DSS financial information.
Revenues and Operating Profit
- -----------------------------
Revenues for the three months ended June 27, 2002 increased by $118.1 million,
or 24.8%, to $595.0 million as compared to $476.9 million for the same period in
2001. Revenues for the six months ended June 27, 2002 increased by $222.8
million, or 24.3%, to $1.1 billion as compared to $917.0 million for the same
period in 2001. Operating profit was $34.2 million and $62.7 million for the
three and six months ended June 27, 2002, increases of $7.9 million, or 30.0%,
and $12.5 million, or 25.0%, respectively from the same periods in 2001.
Operating profit is defined as the excess of revenues over cost of services and
certain non-operating income and expenses, which are included in Other Expense
(Other Income) on the Consolidated Condensed Statements of Operations. See the
"Revision of Financial Statements" discussion above and in Note 2 to the
Consolidated Condensed Financial Statements for the impacts on operating profit
from revised loss estimates on a contract acquired with the purchase of DIS in
December 1999 and from the percentage of completion accounting issue. The
increase in both revenues and operating profit was attributable primarily to
several new contract wins and increased tasking on existing contracts. Operating
profits grew faster than revenues due to losses on several contracts in the
first half of 2001 that did not continue in the first half of 2002 and increased
profit due to additional revenue in the first half of 2002 for contract costs
that were recognized in a prior period.
DynCorp Systems and Solutions ("DSS") had revenues of $242.1 million and $467.7
million in the three and six months ended June 27, 2002, compared to revenues of
$201.4 million and $390.9 million in the same periods in 2001. The increases in
revenue in the second quarter and first half of 2002 of $40.7 million, or 20.2%,
and $76.7 million, or 19.6%, respectively resulted primarily from the start-up
of two new contracts and increased tasking on existing contracts. The two new
contracts consisted of one which started in the third quarter of 2001 for
updated office automation, including desktop computers, servers, and networks,
for the Federal Bureau of Investigation ("FBI") and which provided the majority
of the increase in revenues, and the other to manage and operate the
infrastructure facilities, hardware, software and systems relating to non-EDGAR
systems to the SEC. These two contracts provided combined revenues of $42.0
million and $90.4 million in the three and six months ended June 27, 2002. Also,
contributing to the revenue growth was expansion of a Department of Defense
("DoD") program for vaccine production, growth in a contract that provides
battlefield simulation and virtual training system support services and
maintenance for the U.S. Army, and growth in a DoD contract that provides
security background investigations that was awarded in the second quarter of
2000. Partially offsetting these increases in revenue was the completion of a
subcontract providing operations management to the Department of Energy ("DoE")
in September 2001. Revenues for the three and six months ended June 28, 2001 for
this subcontract were $23.5 million and $48.3 million, respectively. Also
offsetting these increases in revenues for DSS was the divesture of DynCorp
Management Resources, Inc. ("DMR") in December 2001, which provided $7.3 million
and $14.4 million for the three and six months ended June 28, 2001.
For the second quarter and six months ended June 27, 2002, operating profit for
DSS increased by $5.0 million, or 40.8%, and $10.2 million, or 44.6%,
respectively, to $17.1 million and $33.1 million, respectively. The operating
profit increases for DSS resulted primarily from the new FBI contract and, to a
lesser extent, the new SEC contract discussed above. These two contracts
provided combined operating profits of $3.1 million and $4.9 million for the
three and six months ended June 27, 2002. In addition, operating profit
increased due to increased tasking and a larger award fee pool on the vaccine
production, battlefield simulation, and the security background investigations
contracts that are all noted above. Also contributing to the increase in
operating profits were the losses on the DMR contracts in the three and six
months ended June 28, 2001 that did not continue in 2002. Partially offsetting
these increases to operating profit was the completion of the DoE subcontract in
the third quarter of 2001, which is noted above. Operating profit on this DoE
subcontract for the three and six months ended June 28, 2001 was $0.4 million
and $1.4 million, respectively.
DynCorp International's ("DI") second quarter and six-month 2002 revenues grew
by 36.0% and 37.3% to $178.6 million and $343.0 million, respectively, as
compared to the same prior year periods of $131.3 million and $249.9 million,
respectively. The increase in revenues resulted primarily from growth in a
contract that provides maintenance, storage, and security support of war reserve
materials to the United States Central Command Air Forces, growth on a contract
with the U.S. Armed Forces that started up in the second half of 2001 that
provides maintenance and parts to military aircraft, increased tasking on a
contract with the Department of State ("DoS") in support of the government's
drug eradication program, primarily in South America, and increased tasking on a
contract which provides combat service support augmentation and Force Provided
Training Modules primarily to the U.S. Army. DI also commenced performance on a
new commercial subcontract in Saudi Arabia involving repair and maintenance of
Saudi military aircraft, which was awarded in the fourth quarter of 2001 and
became fully operational in 2002. This contract provided revenues of $5.7
million and $12.1 million in the three and six months ended June 27, 2002. In
addition, DI was also awarded a new contract with the U.S. Air Force in March
2002 supporting aerial counter-drug surveillance missions in central South
America and the Caribbean and including providing base operations support for
personnel and aircraft. This contract provided $4.8 million in the first half of
2002. Partially offsetting the increases in revenues was the decreased manning
requirements on the DoS international police task force contract in the second
quarter of 2002.
DI's second quarter and six-month 2002 operating profits grew by 27.5% and 6.1%
to $10.7 million and $17.9 million, respectively, as compared to the same prior
year periods of $8.4 million and $16.9 million, respectively. The increases in
operating profits resulted from the increased tasking on several contracts and
the new contracts as mentioned above. DI's operating profit was also positively
impacted due to additional revenue on contract costs that were recognized in a
prior period. Partially offsetting the increases in operating profits was the
decreased manning requirements on the DoS international police task force
contract in the second quarter of 2002. The contract, which provides combat
service support augmentation and Force Provided Training Modules primarily to
the U.S. Army, is expected to be substantially complete by the end of 2002. This
contract provided revenues of $16.1 million and $22.1 million and operating
profits of $0.8 million and $1.1 million, respectively, in the three and six
months ended June 27, 2001. Management expects that the new contracts discussed
above will offset the lost revenue and operating profit.
DynCorp Technology Services' ("DTS") revenues for the three and six months ended
June 27, 2002, grew 25.9% and 23.2%, respectively, to $161.3 million and $302.0
million, respectively, compared to $128.1 million and $245.2 million for the
comparable periods in 2001. The increases in the DTS revenues resulted from new
contracts and increased tasking on existing contracts. DTS was awarded a new
contract in the second quarter of 2002 with the National Aeronautics and Space
Administration ("NASA"), which provides base operations and maintenance support
for the Johnson Space Center. This contract provided $8.3 million in revenues in
the second quarter of 2002. DTS was also awarded a contract to provide repair
and maintenance to the California Department of Forestry helicopters in the
first quarter of 2002, which provided $4.9 million in revenues in the first half
of 2002. In addition, revenues increased due to increased tasking on two U.S.
Air Force contracts providing aircraft maintenance and base operations support.
One of these contracts is at Andrews AFB and was awarded in the first quarter of
2001 and the other is at Vance AFB and was awarded in October 2000. Revenues
also increased due to increased tasking on a U.S. Military Sealift Command
contract, which manages, operates, and maintains non-combat oceangoing U.S. Navy
ships and on a contract that provides range operations and maintenance support
to the U.S. Navy. DTS reported revenue increases at Fort Rucker due to increased
contract requirements that have resulted in additional personnel and the
negotiation of a new collective bargaining agreement that resulted in a higher
wage and fringe package for the employees. This contract provided $12.4 million
and $16.7 million for the second quarter and six-month revenue increases in
2002. Management expects revenue growth on a U.S. Air Force contract that
provides base operations and support services at Maxwell AFB, which will become
fully operational in the second half of 2002.
DTS operating profits for the three and six months ended June 27, 2002, grew
43.8% and 41.5%, respectively, to $6.2 million and $12.3 million, respectively,
compared to $4.3 million and $8.7 million for the comparable periods in 2001.
DTS operating profits increased due to the new contracts and increased tasking
on the contracts discussed above. Operating profits grew faster than revenues
due to improved profit margins on some of DTS' base operations and aviation
support services contracts.
AdvanceMed ("ADVMED") reported revenues of $13.0 million and $27.1 million in
the three and six months ended June 27, 2002, respectively, as compared to $16.1
million and $31.0 million in the same prior year periods. ADVMED's operating
profits (loss) were $0.1 million and $(0.6) million in the three and six months
ended June 27, 2002, respectively, as compared to $1.4 million and $1.7 million
in the comparable periods of 2001. The decrease in revenues resulted mostly from
the reduction in work scope on a contract that provides external quality review
to health care organizations in the State of Texas and the successful completion
of two tasks that review Medicaid and Medicare claims data. These lost revenues
will be replaced in part by two task awards, which will provide support services
to Medicaid and Medicare, and will begin operations in the third quarter of
2002. The decrease in operating profit resulted from increased costs on a
commercial product introduction and the addition of a sales team for this
commercial product, which was not reflected in prior year costs. The commercial
product provides performance measurement portfolios designed to improve the
delivery of high-risk, high-cost healthcare services. ADVMED has strategies in
place to grow new customers for this commercial contract and expects future
revenue and operating profit increases from these strategies.
Cost of Services
- ----------------
Cost of services as a percentage of revenue remained consistent for the three
and six months ended June 27, 2002, as compared to the same periods in 2001.
Cost of services was 94.5% and 94.6% of revenue for the three and six months
ended June 27, 2002, respectively, as compared to 94.3% and 94.4%, respectively,
for the comparable periods in 2001. Cost of services was $562.5 million and $1.1
billion, respectively, compared to $449.7 million and $865.3 million for the
comparable periods in 2001, increases of $112.9 million and $212.4 million,
respectively. Cost of services as a percentage of revenue was higher in 2002 due
to higher balances of deferred costs that were expensed in 2002 compared to 2001
due to the revisions for the change in accounting method as described above and
in Note 2 to the Consolidated Condensed Financial Statements. Offsetting these
increases in cost of services as a percentage of revenue as compared to 2001
were lower percentages due to DTS operating profits growing faster than revenues
from improved profit margins on some of its base operations and aviation support
services contracts. Cost of services for the Company includes mainly direct
labor, direct overhead, and direct facility costs.
Corporate General and Administrative Expense
- --------------------------------------------
Corporate general and administrative expense was relatively unchanged at $7.2
million for the second quarter of 2002 as compared to the same period in 2001
and increased slightly in the first six months of 2002 to $14.8 million as
compared to $14.0 million in the same period in 2001. Corporate general and
administrative expense as a percentage of revenue was 1.2% and 1.3% for the
three and six months ended June 27, 2002 and 1.5% for the same periods in 2001.
The slight increase in corporate general and administrative expense was due to
costs associated with the management efforts to explore the potential sale of
the Company to or its merger with a third party. In the first quarter of 2002,
the Board of Directors authorized management to consider interests of third
parties in a merger or sale of the Company. No formal agreement has been
negotiated or executed at this time. The Company has notified its stockholders
and participants in its Savings and Retirement Plan, Capital Accumulation and
Retirement Plan, and former Employee Stock Ownership Plan of these
circumstances.
Interest Expense
- ----------------
Interest expense was $7.0 million and $14.2 million, respectively, for the three
and six months ended June 27, 2002, compared to $8.0 million and $16.4 million
for the comparable periods in 2001. Interest expense as a percentage of revenue
was 1.2% for the three and six months ended June 27, 2002, as compared to 1.7%
and 1.8% for the comparable periods in 2001. The decrease in interest expense
was attributable to lower average debt levels and lower average interest rates
in the three and six months of 2002 as compared to the same periods in 2001. The
average levels of indebtedness were approximately $280.5 million and $285.7
million in the six months ended June 27, 2002 and June 28, 2001, respectively.
Amortization of Intangibles of Acquired Companies
- -------------------------------------------------
Amortization of intangibles of acquired companies was $0.5 million and $1.0
million for the second quarter and first six months of 2002, respectively, as
compared to $1.7 million and $3.6 million for the comparable periods of 2001.
The decrease resulted from the Company's adoption on December 28, 2001, the
first day of fiscal year 2002, of the Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets". The
provisions of SFAS No. 142 eliminated amortization of goodwill, including
assembled workforce which is now considered goodwill, and accordingly, the
Company eliminated amortization of goodwill beginning December 28, 2001. The
provisions also require an impairment assessment at least annually by applying a
fair-value based test. See Note 8 to the Consolidated Condensed Financial
Statements included in this Quarterly Report on Form 10-Q to show what the
impact would have been on the second quarter and first half of 2001 financial
results if SFAS No. 142 had been adopted at the beginning of fiscal 2001.
Other Expense (Other Income)
- ----------------------------
Other expense (other income) was $18.1 million and $19.9 million for the three
and six months ended June 27, 2002 and consists mostly of the Company's share of
the estimated net losses of unconsolidated affiliates, and the write-off of an
investment in an unconsolidated affiliate.
The Company periodically evaluates the recoverability of its equity investments,
in accordance with Accounting Principles Board No. 18, "The Equity Method of
Accounting for Investments in Common Stock," and if circumstances arise where a
loss in value is considered to be other than temporary, the Company will record
a write-down of excess investment cost. The Company's recoverability analysis is
based on the projected undiscounted cash flows of the investments, which is the
lowest level of cash flow information available. During the second quarter of
2002, the Company recorded a non-recurring, write-off of approximately $15.8
million, which represented the net balance of a certain investment, which was
stated in excess of its net realizable value. The total charge was included in
Other Expense (Other Income) on the Consolidated Condensed Statement of
Operations at June 27, 2002.
Income Taxes
- ------------
The provisions for income taxes in 2002 and 2001 are based upon estimated
effective tax rates, including the impact of permanent differences between the
book bases of assets and liabilities recognized for financial reporting purposes
and the bases recognized for tax purposes. The provision for income taxes
decreased by $4.1 million and $2.9 million for the three and six months ended
June 27, 2002, respectively, from the comparable periods in 2001. The decreases
were due to lower pretax income in both the three and six months ended June 27,
2002 and a lower effective tax rate in the second quarter of 2002, and partially
offset by a slightly higher effective tax rate in the first six months of 2002,
compared to the same periods in 2001. The Company's effective tax rate
approximated 43.7% for the six months ended June 27, 2002, compared to 43.0% in
the comparable period in 2001, after taking into account the effect of minority
interests.
Backlog
- -------
The Company's backlog of business, which includes awards under both prime
contracts and subcontracts as well as the estimated value of option years on
government contracts, was $7.2 billion at June 27, 2002 compared to $6.8 billion
at December 27, 2001, a net increase of $0.4 billion. The backlog at June 27,
2002 consisted of $2.3 billion for DSS, $2.2 billion for DI, $2.6 billion for
DTS, and $0.1 billion for ADVMED compared to December 27, 2001 backlog of $2.4
billion for DSS, $2.2 billion for DI, $2.0 billion for DTS, and $0.2 billion for
ADVMED. A large part of the increase was attributable to the $0.5 billion win on
a fifteen - year DTS contract with the U.S. Air Force in the second quarter of
2002. This cost plus contract begins in October 2002 and will provide support to
the Air Force Command and Air Combat Command operations at the Nevada Test and
Training Range.
Working Capital
- ---------------
Working capital, defined as current assets less current liabilities, was $165.2
million at June 27, 2002 compared to $150.2 million at December 27, 2001, an
increase of $15.0 million, or 10.0%. The ratio of current assets to current
liabilities at June 27, 2002 and December 27, 2001 was 1.6. The increase in
working capital was primarily a result of strong customer collections, which
resulted in a higher cash and cash equivalents balance at June 27, 2002 compared
to December 27, 2001, and increases in the other current asset balance, which
was due to increased inventory on a FBI contract. Partially offsetting these
increases in cash and cash equivalents and other current assets was a larger
current portion of the Senior Secured Credit Agreement Term A debt as of June
27, 2001 and increases in certain accrued expenses.
Cash Flows from Operating Activities
- ------------------------------------
Cash provided by operations was $40.1 million in the first six months of 2002,
an increase of $46.1 million from the comparable period in 2001. The major
components of the increase were higher collections of receivables, higher
accounts payable, and higher operating profits, excluding non-cash net losses of
unconsolidated affiliates of $2.2 million and a non-cash reserve of an
investment in an unconsolidated affiliate of $15.8 million in the second quarter
of 2002. In the first six months of 2001, $6.0 million was used in operations.
The major components of the $6.0 million were a decrease in current liabilities
and certain other liabilities of $38.0 million, offset by net earnings of $8.3
million, and a decrease in current assets and certain other assets of $10.4
million.
Cash Flows from Investing Activities
- ------------------------------------
Investing activities used funds of $3.4 million in the six months ended June 27,
2002, as compared to cash used by investing activities of $0.9 million in the
six months ended June 28, 2001. The use of funds in the first half of 2002
resulted mostly from the purchase of property and equipment of $4.0 million,
compared to the purchase of property and equipment in the same period of 2001 of
$3.3 million.
Cash Flows from Financing Activities
- ------------------------------------
Financing activities used funds of $10.7 million during the six months ended
June 27, 2002 and included several short-term borrowings and subsequent payments
of a cumulated sum of $63.0 million under the Senior Secured Credit Agreement
Revolving Credit Facility, maturing December 9, 2004. In the second quarter
2002, the Company made installment payments of $1.3 million and $6.3 million on
the Senior Secured Credit Agreement Term A Loan, maturing December 9, 2004, in
February and May respectively, and prepaid $3.2 million on the Senior Secured
Credit Agreement Term B Loan, maturing December 9, 2006. During the first half
of 2001, financing activities provided funds of $0.1 million and included
several short-term borrowing and subsequent payments of a cumulated sum of
$159.3 million under the Senior Secured Credit Agreement Revolving Credit
Facility.
Earnings before Interest, Taxes, Depreciation, and Amortization
- ---------------------------------------------------------------
Earnings before Interest, Taxes, Depreciation, and Amortization ("EBITDA") as
defined by management, consists of net earnings before income tax provision
(benefit), net interest expense, and depreciation and amortization. EBITDA
represents a measure of the Company's ability to generate cash flow and does not
represent net income or cash flow from operating, investing and financing
activities as defined by generally accepted accounting principles ("GAAP").
EBITDA is not a measure of performance or financial condition under GAAP, but is
presented to provide additional information about the Company to the reader.
EBITDA should be considered in addition to, but not as a substitute for, or
superior to, measures of financial performance reported in accordance with GAAP.
EBITDA has been adjusted for the amortization of deferred debt expense and debt
issue discount which are included in "interest expense" in the Consolidated
Statements of Operations and included in "amortization and depreciation" in the
Consolidated Statements of Cash Flows. EBITDA has not been adjusted to give
affect to the depreciation and amortization attributable to minority interest
shareholders. Readers are cautioned that the Company's definition of EBITDA may
not necessarily be comparable to similarly titled captions used by other
companies due to the potential inconsistencies in the method of calculation.
The following represents the Company's computation of EBITDA (in thousands):
Three Months Ended Six Months Emded
------------------ ----------------
June 28, June 28,
June 27, 2001 (Revised June 27, 2001 (Revised
2002 - See Note 2) 2002 - See Note 2)
---- ------------- ---- -------------
Net (loss) earnings $(1,505) $ 5,411 $ 5,487 $ 9,460
Depreciation and amortization 2,874 5,536 7,757 10,325
Interest expense, net 6,791 7,873 13,916 15,956
(Benefit) provision for income taxes (38) 4,082 4,251 7,136
Amortization of deferred debt expense (525) (887) (1,047) (1,359)
Debt issue discount (135) (12) (291) (23)
------- -------- -------- --------
EBITDA $ 7,462 $ 22,003 $ 30,073 $41,495
======= ======== ======== =======
EBITDA (as defined above) decreased by $14.5 million, or 66.1%, to $7.5 million
for the second quarter of 2002 as compared to the comparable period in 2001. For
the first six months of 2002, EBITDA decreased by $11.4 million, or 27.4%, to
$30.1 million as compared to the first six months of 2001. The decreases in
EBITDA in the three and six month periods in 2002, as compared to the similar
periods in 2001, are primarily attributable to the non-recurring write-off of
the investment in an unconsolidated affiliate of $15.8 million in the second
quarter of 2002 and offset partially by the higher operating profits, as
discussed above.
Recent Developments
- -------------------
The Board of Directors authorized management in the fourth quarter of 2001 to
consider interests of third parties in a merger or sale of the Company. There is
the potential for a merger or sale of the Company in the short-term future, but
no formal agreement has been negotiated or executed at this time. The Company
has notified its stockholders and participants in its Savings and Retirement
Plan, Capital Accumulation and Retirement Plan, and former Employee Stock
Ownership Plan of this potential change in owners of the Company and merger or
sale of the Company.
Liquidity and Capital Resources
- -------------------------------
The carrying amounts reflected in the Consolidated Condensed Balance Sheets of
cash and cash equivalents, accounts receivable and contracts in process, and
accounts payable approximate fair value at June 27, 2002 due to the short
maturities of these instruments.
As of June 27, 2002 the Company's total debt was $274.1 million, a decrease of
$10.5 million from $284.6 million as of December 27, 2001, primarily due to the
February and May 2002 payments of $1.3 million and $6.3 million, respectively,
made on the Term A Loan and the April 2002 prepayment of $3.2 million on the
Term B Loan. These payments were partially offset by the amortization of the
discounts on the Subordinated Notes and the 9 1/2% Senior Subordinated Notes
discussed below.
The Company has a Senior Secured Credit Agreement (the "Credit Agreement") with
a group of financial institutions. Under the Credit Agreement, the Company has
outstanding borrowings of $62.5 million under Term A Loans maturing December 9,
2004, $73.7 million under Term B Loans maturing December 9, 2006, and has a
$90.0 million revolving line of credit, which, at June 27, 2002, had no
borrowings. Installment payments of $1.3 million and $6.3 million were paid on
the Term A Loans in February and May 2002, respectively. The Term A Loans are to
be repaid in eleven quarterly installments of $6.3 million, which began in May
2002. A prepayment of $3.2 million was paid on the Term B Loan in April 2002.
The Term B Loans are scheduled to be repaid in an installment of $5.7 million in
May 2005 and then six quarterly installments of $11.9 million beginning in
August 2005. The Company is charged a commitment fee of 0.5% per annum on unused
commitments under the revolving line of credit. Letters of credit outstanding
were $11.0 million and $11.1 million at June 27, 2002 and December 27, 2001,
respectively, under the line of credit. The amount available was $79.0 million
and $78.9 million, respectively, as of June 27, 2002 and December 27, 2001.
The Company has $99.7 million of 9 1/2% Senior Subordinated Notes ("Senior
Subordinated Notes") outstanding with a scheduled maturity in 2007. Interest is
payable semi-annually, in arrears, on March 1 and September 1 of each year. The
Company has outstanding $40.0 million face value of the Company's subordinated
pay-in-kind notes due 2007, with an estimated fair value of $38.2 million
("Subordinated Notes"). The Subordinated Notes bear interest at 15.0% per annum,
payable semi-annually. The Company may, at its option, prior to December 15,
2004, pay the interest in cash or in additional Subordinated Notes.
The Company is a guarantor on a fixed price services contract for non-emergency
transportation brokerage services. Management perceives the exposure of
financial losses on this guarantee could possibly be in the range of $4.0
million to $12.5 million over the next twelve months. At this time, management
does not believe a reserve is required because no claim has been asserted and
one is not considered probable.
Chart Outlining Future Financial Commitments
- --------------------------------------------
The following table sets forth the Company's total contractual cash obligations
for the remaining six months of 2002 and over the next four years and thereafter
(in thousands):
Cash Obligations Due by Year
----------------------------
July -
Contractual December
Cash Obligation Total 2002 2003 2004 2005 2006 Thereafter
- --------------- ----- ---- ---- ---- ---- ---- ----------
Long-term Debt $274,146 $12,547 $ 25,002 $28,083 $26,228 $47,500 $134,786
Operating Leases 227,468 24,649 42,968 36,790 27,600 25,643 69,818
Maximum Liability to
Repurchase ESOP
Shares 368,649 18,697 27,802 30,032 27,674 23,842 240,602
Liability to Repurchase
Other Redeemable
Common Stock 7,944 - 7,944 - - - -
-------- ------- -------- ------- -------- ------- --------
Total Contractual Cash
Obligations $878,207 $55,893 $103,716 $94,905 $81,502 $96,985 $445,206
======== ======= ======== ======= ======= ======= ========
The Company has contractual cash obligations under several of its long-term debt
provisions, as discussed above.
The Company has several significant operating leases for facilities, furniture
and equipment. Minimum lease payments over the next 11 years are estimated to be
$227.5 million, including $24.6 million for the remaining six months of 2002. Of
the $24.6 million 2002 minimum lease payments, $7.3 million related to DIS
leases, $5.2 million related to a U.S. Postal Service contract, and $3.5 million
related to the new corporate headquarters building.
The Company is obligated to repurchase certain of its former Employee Stock
Ownership Plan ("ESOP") vested common stock shares (under a "put option") from
former ESOP participants upon death, disability, retirement and termination at
the fair value (as determined by an independent appraiser) until such time as
the Company's common stock is publicly traded. Under the Subscription Agreement
dated September 9, 1988, the Company is permitted to defer put options if, under
Delaware law, the capital of the Company would be impaired as a result of such
repurchase. The Company's total contractual cash obligation to repurchase former
ESOP shares will fluctuate in the future as the independently determined fair
value fluctuates. The total obligation to repurchase former ESOP shares is
$368.6 million as of June 27, 2002, based on the independently determined fair
value as of May 24, 2002.
Under a registration rights agreement, the holders of the other redeemable
common stock will have a put right to the Company commencing on December 10,
2003, at a price of $40.53 per share, unless one of the following events has
occurred prior to such date or the exercise of the put right: (1) an initial
public offering of the Company's common stock has been consummated; (2) all the
Company's common stock has been sold; (3) all the Company's assets have been
sold in such a manner that the holders have received cash payments; or (4) the
Company's common stock has been listed on a national securities exchange or
authorized for quotation on the NASDAQ National Market System for which there is
a public market of at least $100 million for the Company's common stock. The
total obligation to repurchase other redeemable shares of the Company's stock is
$7.9 million as of June 27, 2002.
Critical Accounting Policies
- ----------------------------
The preparation of financial statements in conformity with U.S. Generally
Accepted Accounting Principles ("GAAP") requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Estimates include accrued liabilities such as contract losses,
litigation reserves, and incentive compensation awards, which are not paid out
until the following year. Actual results could differ from those estimates.
During the performance of long-term contracts, these estimates are periodically
reviewed and revisions are made as required. The impact on revenue and contract
profit as a result of these revisions is included in the periods in which the
revisions are made.
Revenues for cost-reimbursement contracts are recorded as reimbursable costs are
incurred, including a pro-rata share of the contractual fees. For
time-and-material contracts, revenue is recognized to the extent of billable
rates times hours delivered plus material and other reimbursable costs incurred.
For long-term fixed price production contracts, units-of-delivery is generally
used as the measurement basis for revenue recognition. Revenue from other
long-term fixed price contracts is recognized ratably over the contract period
or other appropriate methods to measure services provided. Because the Company
assumes the risk of performing a fixed price contract at a set price, the
failure to accurately estimate ultimate costs or to control costs during
performance of the work could result, and in some instances has resulted, in
reduced profits or losses for such contracts. Anticipated losses on contracts
are recognized when identified. Disputes arise in the normal course of the
Company's business on projects where the Company is contesting with customers
for collection of funds because of events such as delays, changes in contract
specifications and questions of cost allowability or collectibility. Such
disputes, whether claims or unapproved change orders in the process of
negotiation, are recorded at the lesser of their estimated net realizable value
or actual costs incurred, and only when realization is probable and can be
reliably estimated. Claims against the Company are recognized where loss is
considered probable and reasonably determinable in amount. Because there are
estimates and judgments involved, the actual results could be different from
those estimates.
Forward Looking Statements
- --------------------------
Certain matters discussed or incorporated by reference in this report are
forward-looking statements within the meaning of the federal securities laws.
Although the Company believes that the expectations reflected in such
forward-looking statements are based upon reasonable assumptions, there can be
no assurance that its expectations will be achieved. Factors that could cause
actual results to differ materially from the Company's current expectations
include the early termination of, or failure of a customer to exercise option
periods under, a significant contract; the inability of the Company to generate
actual customer orders under indefinite delivery, indefinite quantity contracts;
technological change; the inability of the Company to manage its growth or to
execute its internal performance plan; the inability of the Company to integrate
the operations of acquisitions; the inability of the Company to attract and
retain the technical and other personnel required to perform its various
contracts; general economic conditions; and other risks discussed elsewhere in
this report and in other filings of the Company with the Securities and Exchange
Commission.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risk from changes in interest rates and, to a
limited extent, foreign currency exchange rates that could affect its results of
operations and financial condition or cash flows. The Company manages its
exposure to these market risks through normal operating and financing activities
and, when deemed appropriate, hedges these risks through the use of derivative
financial instruments. The Company uses the term hedge to mean a strategy
designed to manage risks of volatility in rate movements on certain assets,
liabilities or anticipated transactions by creating a relationship in which
gains or losses on derivative instruments are expected to counterbalance the
losses or gains on the assets, liabilities or anticipated transactions exposed
to such market risks. The Company uses derivative financial instruments as a
risk management tool and not for trading or speculative purposes.
Interest Rate Risk
The Company has minimal exposure due to fluctuations in market interest rates.
Had market interest rates been 10% higher in the first half of 2002, the
Company's net earnings would have been approximately $119.1 thousand lower, or a
change of 2.2%. This is derived from a historical model that recalculates the
interest expense incurred by the Company assuming that the market interest rates
to which the Company's interest payments are indexed were, in all cases, 10.0%
higher, taking into consideration the effect of such higher interest rates on
the interest rate swap as noted below.
From time to time, the Company may enter into various derivative financial
instruments, including interest rate forwards, options and interest rate swaps,
to manage the exposure of portions of the Company's total debt portfolio and
related cash flows to fluctuations in market interest rates. In December 2000,
the Company entered into a two year and 28-day swap agreement, wherein the
Company pays approximately 6.2% annualized interest on a notional amount of
$35.0 million on a quarterly basis beginning on January 4, 2001 and ending on
January 6, 2003. The objective of this transaction is to neutralize the cash
flow variability on designated portions of the Company's Senior Secured Credit
Agreement Term A and Term B loans, which have a floating-rate, that may be
caused by fluctuations in market interest rates. The adjustments to fair value
of this derivative instrument during the six months ended June 27, 2002 resulted
in additional increases in accumulated other comprehensive income of $0.3
million. This swap is perfectly effective at its objective, and accordingly,
there are no existing gains or losses as of June 27, 2002 that are expected to
be reclassified into earnings within the next twelve months. The Company also
managed its exposure to changes in interest rates by effectively capping at 7.5%
the base interest rate on a notional amount of $100.0 million of its Senior
Secured Credit Agreement Term A and Term B loans until February 2002.
Foreign Currency Risk
The Company's cash flows are primarily denominated in U.S. dollars. With respect
to the limited cash flows that are denominated in foreign currency, the
Company's policy is to manage exposure to fluctuations in foreign exchange rates
by netting inflows of foreign exchange with outflows of foreign exchange. From
time to time the Company uses foreign exchange contracts to minimize exposure to
the risk that the eventual net cash inflows and outflows will be adversely
affected by changes in exchange rates. The Company's exposure to fluctuations in
foreign exchange risk is immaterial.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company and its subsidiaries and affiliates are involved in various claims
and lawsuits, including contract disputes and claims based on allegations of
negligence and other tortuous conduct. The Company is also potentially liable
for certain personal injury, tax, environmental, and contract dispute issues
related to the prior operations of divested businesses. In addition, certain
subsidiary companies are potentially liable for environmental, personal injury,
and contract and dispute claims. In most cases, the Company and its subsidiaries
have denied, or believe they have a basis to deny, liability, and in some cases
have offsetting claims against the plaintiffs, third parties, or insurance
carriers. The total amount of damages currently claimed by the plaintiffs in
these cases is estimated to be approximately $8.7 million (including
compensatory punitive damages and penalties). The Company believes that the
amount that will actually be recovered in these cases will be substantially less
than the amount claimed. After taking into account available insurance, the
Company believes it is adequately reserved with respect to the potential
liability for such claims. The estimates set forth above do not reflect claims
that may have been incurred but have not yet been filed. The Company has
recorded such damages and penalties that are considered to be probable
recoveries against the Company or its subsidiaries.
In September, 2000, the Company became aware of significant errors in
preacquisition estimates of the cost to complete a major ten-year federal
government telephone installation and operation contract that was undertaken in
1998 by a predecessor of GTE Information Systems, LLC, now known as DynCorp
Information Systems LLC, a wholly-owned subsidiary of the Company ("DIS"). The
Company acquired GTE Information Systems LLC from Contel Federal Systems, Inc.,
a subsidiary of GTE Corporation, in December 1999. See Note 2 for a discussion
of revisions concerning the accounting for such preacquisition estimates and the
impact of those revisions on the financial statements. Effective August 1, 2001,
DIS and the federal government customer entered into a bilateral modification of
the contract as a consequence of which the Company reduced the previously
recorded loss reserve by $42.7 million effective in the third quarter 2001. This
reduction resulted from the government's elimination of certain future
liabilities from the contract, an increase in future billing rates for calls,
and a decrease in future call revenue shared with the government agency. On
August 10, 2001, the Company instituted suit against GTE Corporation claiming
breaches of the acquisition agreement representations and warranties and for
other relief.
On September 11, 2001, DynCorp and three of its wholly-owned subsidiaries were
served with a civil action filed in the United States District Court for the
District of Columbia on behalf of certain Ecuadorian citizens and an alleged
class that could consist of at least 10,000 such unnamed citizens, alleging
personal injury, property damage and wrongful death as a consequence of the
spraying of narcotic crops along the Colombian border adjacent to Ecuador. The
action seeks a declaratory judgment as well as unspecified compensatory and
punitive damages. Spraying operations are conducted under a Company subsidiary
contract with the United States Department of State in cooperation with the
Colombian government. No spraying operations are conducted in Ecuador, although
the complaint alleges that sprayed material has drifted across the border into
Ecuador. All operations of the Company's subsidiary in Colombia are conducted in
accordance with specific instructions from the Department of State using
equipment and spray material provided by the United States government. The State
Department has publicly stated that the spray material has been demonstrated not
to be toxic to human beings. The Company and its subsidiaries intend to
vigorously defend against all allegations. The Company does not expect any
losses due to this litigation.
Regarding environmental issues, neither the Company, nor any of its
subsidiaries, is named a Potentially Responsible Party (as defined in the
Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"))
at any site. The Company, however, did undertake, as part of the 1988
divestiture of a petrochemical engineering subsidiary, an obligation to install
and operate a soil and water remediation system at a subsidiary research
facility site in New Jersey and also is required to pay the costs of continued
operation of the remediation system. In addition, the Company, pursuant to the
1995 sale of its commercial aviation business, is responsible for the costs of
clean-up of environmental conditions at certain designated sites. Such costs may
include the removal and subsequent replacement of contaminated soil, concrete,
and underground storage tanks that existed prior to the sale of the commercial
aviation business. The resolution of these matters is not expected to have a
material impact on the Company's results of operations or financial condition.
The Company believes it has adequate accruals for any liability it may incur
arising from the designated sites.
The Company has been advised by the purchasers of two former subsidiaries
(DynAir Tech of Florida, Inc. and DynAir Services, Inc.) of environmental claims
by Dade County, Florida, arising out of the former subsidiaries' conduct of
business at Miami International Airport ("MIA"). Claims for indemnification are
being asserted against the Company pursuant to divestiture agreements entered
into in 1995. The Company has assumed defense of these allegations with a full
reservation of rights. A lawsuit was filed in April 2001 by Dade County in
Florida State Court against DynAir Tech's successor-in-interest, Sabretech,
Inc., and 16 other defendants, but neither Sabretech nor any other named
defendant has been served. DynAir Services is not currently a named defendant,
although it is one of an additional 200 companies that the County has identified
as having possible responsibility for contamination at MIA. Under the terms of
the DynAir Tech divestiture agreement, the purchaser is responsible for the
first $125,000 of cost incurred as a result of such claims; however, the Company
is required to assume full responsibility for all costs to the extent claims
exceed $125,000 up to an aggregate maximum amount of $2.5 million. If the
Company is required to indemnify under the DynAir Services divestiture
agreement, it would be responsible for all related costs. The County's complaint
specifies $200.0 million of incurred and $250.0 million of future damages
against the named defendants. Defense has been tendered to certain of the
Company's insurance carriers, although no coverage determination has been made.
Both DynAir Services and Sabretech are represented by environmental defense
counsel and intend to vigorously defend against the allegations. At this time,
the Company cannot reasonably determine the exposure, if any, to possible losses
from these claims.
The Company is a party to other civil and contractual lawsuits that have arisen
in the normal course of business for which potential liability, including costs
of defense, constitutes the remainder of the $8.7 million discussed above. The
estimated probable liability (included in Other Liabilities and Deferred Credits
on the Consolidated Condensed Balance Sheet) for these issues is approximately
$5.8 million and is substantially covered by insurance at June 27, 2002. All of
the insured claims are within policy limits and have been tendered to and
accepted by the applicable carriers. The Company has recorded an offsetting
asset (included in Other Assets on the Consolidated Condensed Balance Sheet) of
$5.2 million at June 27, 2002 for these items.
The Company has recorded its best estimate of the aggregate liability that will
result from these matters. While it is not possible to predict with certainty
the outcome of litigation and other matters discussed above, it is the opinion
of the Company's management, based in part upon opinions of counsel, insurance
in force, and the facts currently known, that liabilities in excess of those
recorded, if any, arising from such matters would not have a material adverse
effect on the results of operations, consolidated financial condition or
liquidity of the Company over the long-term. However, it is possible that the
timing of the resolution of individual issues could result in a significant
impact on the operating results and/or liquidity for one or more future
reporting periods.
The major portion of the Company's business involves contracting with
departments and agencies of, and prime contractors to, the U.S. Government, and
such contracts are subject to possible termination for the convenience of the
government and to audit and possible adjustment to give effect to unallowable
costs under cost-type contracts or to other regulatory requirements affecting
both cost-type and fixed price contracts. Payments received by the Company for
allowable direct and indirect costs are subject to adjustment and repayment
after audit by government auditors if the payments exceed allowable costs. A
majority of the audits have been completed on the Company's incurred contract
costs through 1999. The Company has included an allowance for excess billings
and contract losses in its financial statements that it believes is adequate
based on its interpretation of contracting regulations and past experience.
There can be no assurance, however, that this allowance will be adequate. The
Company is aware of various costs questioned by the government, but cannot
determine the outcome of the audit findings at this time. In addition, the
Company is occasionally the subject of investigations by various investigative
organizations, resulting from employee and other allegations regarding business
practices. In management's opinion, there are no outstanding issues of this
nature at June 27, 2002 that will have a material adverse effect on the
Company's consolidated financial condition, results of operations, or liquidity.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Amendment on May 1, 2002 of Patrick C. FitzPatrick's November 1, 2001
Employment Agreement.
99.1 Certification by Chief Executive Officer Pursuant to 18 USC Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification by Chief Financial Officer Pursuant to 18 USC Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Form 8-K/A was filed on April 22, 2002 to amend the Company's Form 8-K filed on
December 27, 1999, to add as an Exhibit the unaudited financial statements of
Information Systems Division as of September 30, 1999.
Form 8-K was filed on May 31, 2002 to note the decision made on May 30, 2002, by
the Company's Board of Directors, upon the recommendation of its Audit
Committee, not to engage Arthur Andersen LLP as the Company's independent public
accountants for 2002 and authorized the engagement of Ernst & Young LLP to serve
as the Company's independent public accountants for the fiscal year ending
December 26, 2002. Form 8-K/A was filed on June 3, 2002 to amend the May 31,
2002 Form 8-K changing the date through which there were no disagreements
between the Company and Arthur Andersen LLP to May 30, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNCORP
Date: August 19, 2002 /S/ Patrick C. FitzPatrick
__________________________
Patrick C. FitzPatrick
Senior Vice President
and Chief Financial Officer
Date: August 19, 2002 /S/ John J. Fitzgerald
______________________
John J. Fitzgerald
Vice President and
Corporate Controller