FORM 10-Q/A, Amendment No. 1
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 September 26, 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 November 8, 2002
----- ----------------------------------
Common Stock, $0.10 par value 10,695,324
This amendment for Form 10-Q is being filed to expand the Company's disclosures,
at the request of the Staff of the Securities and Exchange Commission, regarding
investment recoverability as discussed in Notes 1, 8, 9 and 10 to the
Consolidated Condensed Financial Statements.
DYNCORP AND SUBSIDIARIES
FORM 10-Q/A, Amendment No. 1
FOR THE QUARTER ENDED SEPTEMBER 26, 2002
INDEX
Page
----
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements
Consolidated Condensed Balance Sheets at
September 26, 2002 and December 27, 2001 3-4
Consolidated Condensed Statements of Operations for
Three and Nine Months Ended September 26, 2002 and
September 27, 2001 5
Consolidated Condensed Statements of Cash Flows for
Nine Months Ended September 26, 2002 and
September 27, 2001 6
Consolidated Statement of Stockholders' Equity for
Nine Months Ended September 26, 2002 7
Notes to Consolidated Condensed Financial Statements 8-15
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16-25
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25-26
Item 4. Controls and Procedures 26-27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 27-29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 6. Exhibits and Reports on Form 8-K 29-30
Signatures 31
Certification of the Chief Executive Officer 32
Certification of the Chief Financial Officer 33
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
DYNCORP AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
SEPTEMBER 26, 2002 AND DECEMBER 27, 2001
(In thousands)
September 26,
2002 December 27,
(Unaudited) 2001
----------- ----
Assets
- ------
Current Assets:
Cash and cash equivalents $ 32,441 $ 15,078
Accounts receivable (net of allowance for doubtful accounts
of $8,133 in 2002 and $6,637 in 2001) 353,975 345,358
Other current assets 44,218 37,933
--------- ---------
Total current assets 430,634 398,369
Property and Equipment (net of accumulated depreciation
and amortization of $28,866 in 2002 and $26,599 in 2001) 20,857 20,959
Goodwill 107,814 103,185
Intangible Assets (net of accumulated amortization of
$24,900 in 2002 and $24,454 in 2001) 20,244 27,240
Other Assets 26,203 48,687
--------- ---------
Total Assets $ 605,752 $ 598,440
========= =========
The accompanying notes are an integral part of these consolidated condensed
financial statements.
DYNCORP AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
SEPTEMBER 26, 2002 AND DECEMBER 27, 2001
(In thousands, except share amounts)
September 26,
2002 December 27,
(Unaudited) 2001
----------- ----
Liabilities and Stockholders' Equity
- ------------------------------------
Current Liabilities:
Notes payable and current portion of long-term debt $ 25,027 $ 20,123
Accounts payable 27,197 19,420
Deferred revenue and customer advances 6,225 6,195
Accrued liabilities 208,245 207,961
---------- ----------
Total current liabilities 266,694 253,699
Long-Term Debt 243,012 264,482
Other Liabilities and Deferred Credits 47,578 44,768
Contingencies and Litigation - -
Temporary Equity:
Redeemable common stock at redemption value -
ESOP shares, 6,967,946 and 7,142,510
shares issued and outstanding in 2002 and 2001,
respectively, subject to restrictions 373,002 326,368
Other redeemable common stock, 286,217 shares issued
and outstanding in 2002 and 2001 8,492 6,967
Stockholders' Equity:
Common stock, par value ten cents per share, authorized
20,000,000 shares; issued 5,474,136 and 5,296,146 shares
in 2002 and 2001, respectively 547 530
Paid-in surplus 139,271 138,542
Accumulated other comprehensive loss (617) (1,081)
Reclassification to temporary equity for redemption value
greater than par value (380,767) (332,596)
Deficit (48,360) (59,681)
Common stock held in treasury, at cost; 2,159,758 and
2,196,853 shares in 2002 and 2001, respectively (43,100) (43,558)
---------- ----------
Total Liabilities and Stockholders' Equity $ 605,752 $ 598,440
========== ==========
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 Nine Months Ended
------------------ -----------------
September 27, September 27,
September 26, 2001 (Restated - September 26, 2001 (Restated -
2002 See Note 2) 2002 See Note 2)
---- ----------- ---- -----------
Revenues $ 607,539 $ 502,856 $ 1,744,276 $ 1,418,446
Costs and expenses:
Costs of services 564,967 429,000 1,640,974 1,293,920
Corporate general and administrative 8,337 7,297 23,171 21,326
Interest income (179) (105) (420) (558)
Interest expense 7,021 7,805 21,177 24,215
Amortization of intangibles of acquired companies 519 801 1,556 4,451
Losses on equity investment in DynTek 5,202 - 25,070 -
Other expense (other income) 7,008 (152) 8,707 (213)
---------- ---------- ------------ ------------
Total costs and expenses 592,875 444,646 1,720,235 1,343,141
Earnings before income taxes and minority interest 14,664 58,210 24,041 75,305
Provision for income taxes 3,871 20,060 6,738 26,933
---------- ---------- ------------ ------------
Earnings before minority interest 10,793 38,150 17,303 48,372
Minority interest 871 532 4,456 1,643
---------- ---------- ------------ ------------
Net earnings $ 9,922 $ 37,618 $ 12,847 $ 46,729
========== ========== ============ ============
Accretion of other redeemable common stock to
redemption value 549 628 1,526 1,748
Common stockholders' share of net earnings $ 9,373 $ 36,990 $ 11,321 $ 44,981
========== ========== ============ ============
Basic earnings per share $ 0.88 $ 3.50 $ 1.06 $ 4.26
Diluted earnings per share $ 0.80 $ 3.33 $ 0.98 $ 4.06
Weighted average number of shares
outstanding for basic earnings per share 10,677 10,555 10,661 10,552
Weighted average number of shares
outstanding for diluted earnings per share 11,683 11,110 11,601 11,075
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
Nine Months Ended
-----------------
September 27,
September 26, 2001 (Restated -
2002 See Note 2)
---- -----------
Cash Flows from Operating Activities:
Common stockholders' share of net earnings $ 11,321 $ 44,981
Adjustments to reconcile common stockholders' share of net earnings to
net cash provided by operating activities:
Depreciation and amortization 11,850 13,913
Accretion of other redeemable common stock to redemption value 1,526 1,748
Gain on sale of assets of DynServices.com (130) -
Deferred income taxes 581 121
Reversal of preacquistion contingency reserves - (42,744)
Non-cash net losses of unconsolidated affiliates 3,670 -
Change in minority interest 4,456 1,643
Changes in pension asset and other postretirement benefit obligations 3,881 2,340
Non-cash write-off of investment in unconsolidated affiliate 15,812 -
Other (633) 215
Changes in current assets and liabilities, net of acquisitions and
dispositions:
Increase in current assets and certain other assets except cash and cash
equivalents (17,361) (16,468)
Increase in current liabilities and certain other liabilities
excluding notes payable and current portion of long-term debt 7,151 2,209
---------- ----------
Cash provided by operating activities 42,124 7,958
---------- ----------
Cash Flows from Investing Activities:
Proceeds from sale of property and equipment 253 3,028
Purchases of property and equipment (5,373) (4,945)
Proceeds from investments in unconsolidated affiliates 307 563
Dividends paid to joint venture partners (1,115) (1,205)
Proceeds from the sale of assets of DynServices.com 400 -
Capitalized software costs (2,667) (2,997)
---------- ----------
Cash used in investing activities (8,195) (5,556)
---------- ----------
Cash Flows from Financing Activities:
Payments on indebtedness (88,292) (200,800)
Proceeds from debt issuance 71,250 200,800
Other 476 (841)
---------- ----------
Cash used in financing activities (16,566) (841)
---------- ----------
Net Increase in Cash and Cash Equivalents 17,363 1,561
Cash and Cash Equivalents at Beginning of the Period 15,078 12,954
---------- ----------
Cash and Cash Equivalents at End of the Period $ 32,441 $ 14,515
========== ==========
Supplemental Cash Flow Information:
Cash paid for income taxes $ 10,038 $ 8,028
========== ==========
Cash paid for interest $ 20,069 $ 25,523
========== ==========
The accompanying notes are an integral part of these consolidated condensed
financial statements.
DYNCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands)
UNAUDITED
Reclassification for Accumulated
Redemption Value Other
Common Paid-in Greater than Par Treasury Comprehensive
Stock Surplus Value Deficit Stock Income (Loss)
----- ------- ----- ------- ----- -------------
Balance, December 27, 2001 $ 530 $ 138,542 $(332,596) $(59,681) $(43,558) $ (1,081)
Employee compensation plans
(option exercises, restricted
stock plan, incentive bonus) 3 (797) 458
Reclassification to redeemable
common stock 14 (46,645)
Accretion of other redeemable
common stock to redemption
value 1,526 (1,526) (1,526)
Adjustment to fair value of
derivative financial instrument 531
Translation adjustment and other (67)
Net earnings 12,847
-----------------------------------------------------------------------------------------
Balance, September 26, 2002 $ 547 $ 139,271 $(380,767) $(48,360) $(43,100) $ (617)
===== ========= ========== ========= ========= =========
The accompanying notes are an integral part of these consolidated condensed
financial statements.
DYNCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 26, 2002
(Dollars in thousands, except per share amounts or where otherwise noted)
UNAUDITED
Note 1. Basis of Presentation
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 annual report on Form 10-K/A,
Amendment No. 2 for the fiscal year ended December 27, 2001. In the opinion of
the Company, the unaudited consolidated condensed financial statements included
herein reflect all adjustments (consisting of normal recurring adjustments and
some non-recurring adjustments discussed elsewhere in this Form 10-Q/A)
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, revenue is recognized at a rate
per unit as the units are delivered. Revenue from other long-term fixed price
contracts is recognized ratably over the contract period or by other appropriate
methods to measure services provided. Contract costs are expensed as incurred
except for certain limited long-term contracts noted below. For long-term
contracts which are specifically described in the scope section of American
Institute of Certified Public Accountants ("AICPA") Statement of Position
("SOP") No. 81-1, "Accounting for Performance of Construction Type and Certain
Production-Type Contracts," or other appropriate accounting literature, the
Company applies the percentage of completion method. Under the percentage of
completion method, income is recognized at a consistent profit margin over the
period of performance based on estimated profit margins at completion of the
contract. This method of accounting requires estimating the total revenues and
total contract cost at completion of the contract. 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. This
method can result in the deferral of costs, including start-up costs, or the
deferral of profit on these contracts. 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. Estimated losses on contracts at completion 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 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 when a 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. Accounts receivable
balances related to such disputed items were immaterial at September 26, 2002
and December 27, 2001.
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 in which
a loss in value is considered to be other than temporary, the Company will
record a write-down of the investment to its estimated fair value. The Company's
recoverability analysis is based on cash flow analyses of the investments, or
other appropriate methods. At June 27, 2002, the Company owned 18.3 million
shares of DynTek, representing 43.8% of the ownership of DynTek. During the
second quarter of 2002, the Company recorded a write-off of approximately $15.8
million, which represented the net balance of the Company's December 2001
investment in DynTek, Inc., which was stated in excess of its net realizable
value. This adjustment resulted from an analysis of DynTek's public filings
(which showed substantial negative working capital, contract losses and ongoing
operating and cash flow losses. DynTek also received a "going concern" opinion
from its independent auditors on its audited financial statements for the year
ended June 30, 2002.) as well as detailed cash flow analysis that the Company
was able to develop concerning DynTek's operations. The Company's decision was
also influenced by the inability of DynTek to attract additional debt or equity
working capital (as required under the terms of the December 2001 merger
agreement (Merger Agreement) between the Company and TekInsight, the predecessor
to DynTek), and the Company's inability to sell its investment in DynTek in
block transactions. The company concluded that the write-off was appropriate
notwithstanding reported closing prices for DynTek common stock on the NASDAQ
exchange during the period June 1, 2002 through August 31, 2002 in the range of
$1.31 to $1.86 based on average daily trading volume during such period of
approximately 57,000 shares. This conclusion was based on the observations that
the DynTek shares held by the Company were not registered for sale (even though
the Company had a demand registration right), and that notwithstanding
registration, there would be inadequate liquidity in the market to liquidate a
block the size of that held by the Company. The total charge was included in
Losses on Equity Investment in DynTek on the Consolidated Condensed Statement of
Operations. Also refer to Notes 8, 9 and 10 for further discussion of the
investment and the Company's contingent financial exposures.
Comprehensive Income
For the three and nine months ended September 26, 2002, total comprehensive
income was $10.0 million and $13.3 million, respectively. The $10.0 million for
the three months ended September 26, 2002 includes net earnings of $9.9 million,
translation adjustment and other of ($0.1) million, and the adjustment to fair
value of derivative financial instruments of $0.2 million. The $13.3 million for
the nine months ended September 26, 2002 includes, in addition to net earnings
of $12.8 million, translation adjustment and other of ($0.1) million and the
adjustment to fair value of derivative financial instruments of $0.5 million.
The components of accumulated other comprehensive loss as of September 26, 2002
consist of translation adjustment and other of ($0.1) million, an adjustment to
fair value of derivative financial instruments of ($0.4) million, and the
cumulative effect of a change in accounting principle of ($0.1) million for the
adoption of the Financial Accounting Standards Board ("FASB") Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities."
Note 2. Restatement of Financial Statements
As reported in the previously filed 2001 Form 10-K/A, Amendment No. 2, the
Company has restated certain information in the Consolidated Condensed Financial
Statements for the three and nine months ended September 27, 2001 and changed
previously reported financial results following discussions with the staff of
the SEC regarding accounting principles articulated in Statement of Financial
Accounting Standards ("SFAS") No. 38, "Accounting for Preacquisition
Contingencies of Purchased Enterprises" and Accounting Principles Board Opinion
("APB") No. 16, "Business Combinations" as they related to the Company's
acquisition of DynCorp Information Systems LLC ("DIS") from GTE Corporation in
December 1999 and also regarding its method of accounting on certain long-term
service contracts and the related applicability of the percentage of completion
method on these contracts. See the 2001 Form 10-K/A, Amendment No. 2 filed on
November 1, 2002 for further information on these restatements.
The impact on the Statement of Operations data for the nine months ended
September 27, 2001 for the restatements discussed above are presented in the
table below. The "As Reported" numbers are taken from the previously filed Form
10-Q for the quarterly period ended September 27, 2001. The financial data for
the quarter ended September 27, 2001 was previously reported in Note 2 to the
2001 Form 10-K/A, Amendment No. 2.
Nine Months Ended (Unaudited)
-----------------------------
September 27, September 27,
2001 2001
Statement of Operations Data: As Reported As Restated
- ----------------------------- ----------- ----------
Revenues $1,421,085 $1,418,446
Cost of services 1,339,406 1,293,920
Earnings before income taxes and
minority interest 31,288 75,305
Provision for income taxes 11,527 26,933
Minority interest 2,470 1,643
Net earnings 17,291 46,729
Common stockholders' share of net
earnings 15,543 44,981
Common stockholders' share of net
earnings per common share:
Basic earnings per share $ 1.47 $ 4.26
Diluted earnings per share $ 1.40 $ 4.06
Note 3. Other Current Assets
Other current assets as of September 26, 2002 and December 27, 2001 included
$18.2 million and $8.8 million of inventories on long-term contracts,
respectively.
Note 4. 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 remain intact in the new plans. In accordance with the
Employee Retirement 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 September 26, Redeemable December 27,
Shares Value 2002 Shares Value 2001
------ ----- ---- ------ ----- ----
ESOP Shares 2,873,969 $55.00 $158,068 2,995,783 $47.00 $140,802
4,093,977 $52.50 214,934 4,146,727 $44.75 185,566
--------- ------ -------- --------- ------ --------
6,967,946 $373,002 7,142,510 $326,368
========= ======== ========= ========
Other Shares 286,217 $29.67 $ 8,492 286,217 $24.34 $ 6,967
========= ======== ========= ========
Note 5. 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 6. 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.
Three Months Ended Nine Months Ended
------------------ -----------------
September 26, September 27, September 26, September 27,
2002 2001 2002 2001
---- ---- ---- ----
Weighted average shares outstanding for basic EPS 10,677 10,555 10,661 10,552
Effect of dilutive securities:
Stock options 1,006 555 940 523
------ ------ ------ ------
Weighted average shares outstanding for diluted EPS 11,683 11,110 11,601 11,075
====== ====== ====== ======
Note 7. 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 September 26, 2002, previously
classified as an intangible asset as of December 27, 2001. The
total carrying amount for goodwill is $107.8 million and $103.2 million as of
September 26, 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 and core development intangible assets are still
subject to amortization under SFAS No. 142. Amortization for the first nine
months of 2002 for these intangible assets totaled $1.6 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 September 26, 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 $ 1,572
Core and developed technology 14,800 6,289
-------- -------
$ 16,503 $ 7,861
======== =======
The following table presents adjusted net income and earnings per share for the
three and nine months ended September 27, 2001, in comparison to the results for
the three and nine months ended September 26, 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 Nine Months Ended
------------------ -----------------
September 27, September 27,
2001 2001
September 26, (Restated - September 26, (Restated -
2002 See Note 2) 2002 See Note 2)
---- ----------- ---- -----------
Common stockholders' share of net earnings $ 9,373 $ 36,990 $11,321 $ 44,981
Add back: Goodwill amortization, net of tax - 14 - 1,200
Add back: Assembled workforce
amortization, net of tax - 153 - 450
------- -------- ------- --------
Adjusted common stockholders' share of net
earnings $ 9,373 $ 37,157 $11,321 $ 46,631
======= ======== ======= ========
Basic earnings per share:
Common stockholders' share of net earnings $ 0.88 $ 3.50 $ 1.06 $ 4.26
Goodwill amortization, net of tax - - - 0.11
Assembled workforce amortization, net of
tax - 0.02 - 0.05
------- -------- ------- --------
Adjusted common stockholders' share of net
earnings $ 0.88 $ 3.52 $ 1.06 $ 4.42
======= ======== ======= ========
Diluted earnings per share:
Common stockholders' share of net earnings $ 0.80 $ 3.33 $ 0.98 $ 4.06
Goodwill amortization, net of tax - - - 0.11
Assembled workforce amortization, net of
tax - 0.01 - 0.04
------- -------- ------- --------
Adjusted common stockholders' share of net
earnings $ 0.80 $ 3.34 $ 0.98 $ 4.21
======= ======== ======= ========
The tables above excludes capitalized software that is not covered by SFAS No.
142. Capitalized software, net of accumulated amortization, totals $12.0 million
and $12.4 million as of September 26, 2002 and December 2001, respectively. The
balance at September 26, 2002 reflects a third quarter 2002 adjustment of $0.5
million to write-down to the net realizable value the capitalized software
balance related to a software product being sold by the AdvanceMed business
segment.
Note 8. Business Segments
Effective January 2002, the Company realigned its five strategic business
segments into four segments. DynCorp Information and Enterprise Technology
("DI&ET") (except for a contract which provides maintenance and operations
support to the Strategic Petroleum Reserve ("SPR Contract")) and 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. The SPR Contract was
incorporated into DynCorp Technical Services ("DTS"), which 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 Nine Months Ended
------------------ -----------------
September 27, September 27,
September 26, 2001 (Restated - September 26, 2001 (Restated -
2002 See Note 2) (e) 2002 See Note 2) (e)
---- --------------- ---- ---------------
Revenues
- --------
DSS $245,855 $216,784 $ 713,055 $ 608,050
DI 176,235 136,736 519,370 386,821
DTS 173,503 134,592 472,759 377,882
ADVMED 11,946 14,744 39,092 45,693
--------- -------- ----------- ----------
$607,539 $502,856 $1,744,276 $1,418,446
========= ======== =========== ==========
Operating Profit (Loss) (a)
- ---------------------------
DSS (b) $ 21,581 $ 58,355 $ 54,239 $ 81,924
DI 11,673 9,876 29,688 26,940
DTS 9,019 5,436 17,685 12,636
ADVMED (1,394) 515 (2,014) 2,209
--------- -------- ----------- ----------
40,879 74,182 99,598 123,709
Corporate general and administrative 8,337 7,297 23,171 21,326
Interest income (179) (105) (420) (558)
Interest expense 7,021 7,805 21,177 24,215
Goodwill amortization - 22 - 1,872
Amortization of other intangibles of acquired
companies 519 779 1,556 2,579
Losses on equity investment in DynTek (c) 5,202 - 25,070 -
Other miscellaneous (d) 6,186 706 9,459 613
--------- -------- ----------- ----------
Subtotal 27,086 16,504 80,013 50,047
--------- -------- ----------- ----------
Earnings before income taxes 13,793 57,678 19,585 73,662
Add back minority interest deducted from
operating profit 871 532 4,456 1,643
--------- -------- ----------- ----------
Earnings before income taxes and minority
interest $ 14,664 $ 58,210 $ 24,041 $ 75,305
========= ======== =========== ==========
September 26, December 27,
2002 2001 (d)
---- --------
Identifiable Assets
-------------------
DSS $289,317 $ 290,733
DI 96,039 94,464
DTS 115,175 100,573
ADVMED 22,855 26,880
Corporate 82,366 85,790
-------- ----------
$605,752 $ 598,440
======== ==========
(a) Defined as the excess of revenues over operating expenses and certain
non-operating expenses.
(b) Third quarter 2001 includes $42.7 million of income (a reduction of cost of
services) primarily from revised loss estimates due to contract
modifications in 2001 on a contract acquired with the purchase of DIS in
December 1999.
(c) Losses on equity investment in DynTek includes $15.8 million for the
write-off of an investment in an unconsolidated affiliate in the second
quarter of 2002 (see Note 1) and $3.6 million for the Company's share of
DynTek operating losses in the first and second quarters of 2002. Also
regarding the same investment that was written off, the Company, in the
third quarter of 2002, entered into an agreement with DynTek, Inc. pursuant
to which the Company and DynTek agreed to settle and release each other
from various disputes related to certain contracts of the Company's former
subsidiary, DynCorp Management Services, Inc (DMR)
that were assumed by DynTek as part of the Merger Agreement and disputes
concerning the adequacy of the working capital transferred to DynTek as
part of the DMR/DynTek merger. (However, see Notes 9 and 10 concerning
certain matters related to DMR and DynTek for which the Company continues
to have contingent liability) As part of the settlement agreement, the
Company sold back to DynTek 8 million shares of DynTek's Class B common
stock in exchange for a $5.0 million note (which was fully reserved) and
also agreed to exchange 10,336,664 shares of DynTek Class B shares for a
like number of Class A shares (representing approximately 29.2% of the
ownership of DynTek) thereby extinguishing the Company's right to vote such
shares as a separate class. In addition, the Company paid $4.0 million of
DynTek's operating expenses during the third quarter of 2002 and forgave a
$1.0 million loan, which was made and fully reserved during the second
quarter of 2002. In partial consideration of these undertakings, DynTek
also agreed to issue the Company warrants to purchase up to 7.5 million
Class A DynTek shares at a price of $4.00 which are carried on the
Company's books at $0. At September 26, 2002, the market value of DynTek
Class A common stock was approximately $30.8 million.
(d) Other miscellaneous includes $6.0 million in the third quarter of 2002 for
the reimbursement of out-of -pocket due diligence expenses that were
incurred by an unrelated party that had expressed an interest in the
possible acquisition of the Company. The $6.0 million was paid to the
unrelated party in the fourth quarter of 2002.
(e) Data has been restated to give recognition to the current reportable
segment structure.
Note 9. Contingencies and Litigation
The Company is a guarantor on a fixed price services contract for non-emergency
transportation brokerage services that was scheduled to end in June 2003. At the
end of the third quarter 2002, management perceived the exposure to financial
losses on this guarantee could possibly be up to $12.5 million over the
following nine months, but did not believe a reserve was required because no
claim had been asserted and one was not considered probable. See Note 10 for
further discussion.
Note 10. Subsequent Events
Prior to the consummation of the DMR DynTek merger, the Company issued a
performance guarantee to a state government and agreed to act as an indemnitor
under a $2.5 million payment bond in connection with a DMR fixed price services
contract for non-emergency transportation brokerage services with a completion
date in June 2003 (Brokerage Contract). Whereas management perceived at the end
of the 3rd quarter that potential exposure to financial losses under the
guarantee and bond could aggregate as much as $12.5 million over the nine month
period ending in June of 2003, the state customer and DynTek entered into a
settlement and termination of the Brokerage Contract effective December 15, 2002
under which DynTek will have no further obligation to perform the Brokerage
Contract after that date. No claim has been asserted against the Company
pursuant to the performance guarantee or under the bond. At this time, although
claims have been submitted by subcontractors on the Brokerage Contract against
DynTek and the bond, no claim has been asserted against the Company and the
Company has not established a reserve. The Company's maximum exposure as
ultimate indemnitor under the bond is $2.5 million and the Company believes no
claim is probable under the performance guarantee.
On December 13, 2002 the Company entered into an Agreement and Plan of Merger
with Computer Sciences Corporation ("CSC"), and Garden Acquisition LLC, a wholly
owned subsidiary of CSC ("Acquisition"). The Agreement and Plan of Merger
provides for the merger of Acquisition with and into the Company (the "Merger").
Upon consummation of the Merger (i) the Company will become a wholly owned
subsidiary of CSC, and (ii) each outstanding share of common stock of the
Company will be converted into, subject to adjustment as provided in the
Agreement and Plan of Merger, $15 cash plus shares of CSC's common stock having
a market value of $43. A Form 8-K filed on December 13, 2002 disclosed this
Merger and also included as exhibits, the Agreement and Plan of Merger and a
joint press release of the Company and CSC dated December 13, 2002 describing
the Merger.
Item 2.
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, Amendment No. 2 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 (as restated - see "Restatement of Financial Statements"
discussion) for the three and nine months ended September 26, 2002 and the
comparable periods for 2001.
Restatement of Financial Statements
- -----------------------------------
As reported in the previously filed 2001 Form 10-K/A, Amendment No. 2, the
Company has restated certain information in the Consolidated Condensed Financial
Statements for the three and nine months ended September 27, 2001 and changed
previously reported financial results following discussions with the staff of
the Securities and Exchange Commission ("SEC") regarding accounting principles
articulated in Statement of Financial Accounting Standards ("SFAS") No. 38,
"Accounting for Preacquisition Contingencies of Purchased Enterprises" and
Accounting Principles Board Opinion ("APB") No. 16, "Business Combinations" as
they related to the Company's acquisition of DynCorp Information Systems LLC
("DIS") from GTE Corporation in December 1999 and also regarding its method of
accounting on certain long-term service contracts and the related applicability
of the percentage of completion method on these contracts. See the 2001 Form
10-K/A, Amendment No. 2 filed on November 1, 2002 for further information on
these restatements.
Revenues and Operating Profit
- -----------------------------
For the three and nine months ended September 26, 2002, revenue increased 20.8%
and 23.0% to $607.5 million and $1.7 billion, respectively, compared to $502.9
million and $1.4 billion for the comparable periods in 2001. Operating profit
decreased 44.9% and 19.5% to $40.9 million and $99.6 million, respectively,
compared to $74.2 million and $123.7 million for the comparable 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. Exclusive
of the DIS revised loss estimates which were part of the restatements discussed
in the "Restatement of Financial Statements" discussion above, operating profit
increased for the three and nine months ended September 26, 2002, as compared to
the respective prior periods. The increase in both revenues and operating profit
(exclusive of the DIS revised loss estimates) was attributable primarily to
several new contract wins and increased tasking on existing contracts. The
overall decrease in operating profit was due to a revised loss estimate on a DIS
contract that added $42.7 million to operating profit in the third quarter of
2001.
DynCorp Systems and Solutions ("DSS") had revenues of $245.9 million and $713.1
million in the three and nine months ended September 26, 2002, compared to
revenues of $216.8 million and $608.1 million in the same periods in 2001. The
increases in revenue in the third quarter and first nine months of 2002 of $29.1
million, or 13.4%, and $105.0 million, or 17.3%, 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 the implementation of a nationwide network, including
desktop computers and other peripherals 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 at the SEC. Also contributing to the
revenue growth was the program expansion of the government emergency telecom
services contract. These three contracts provided combined revenues of $57.3
million and $153.9 million in the three and nine months ended September 26,
2002. Other contracts contributing to the revenue growth were the expansion of a
Department of Defense ("DoD") program for vaccine production and growth in a
contract that provides battlefield simulation and virtual training system
support services and maintenance for the U.S. Army. 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 nine months ended September 27, 2001 for this subcontract were
$26.5 million and $74.9 million, respectively. Also offsetting these increases
in revenues for DSS was the divesture of DynCorp Management Resources, Inc.
("DMR") in December 2001, which provided $13.9 million and $28.3 million for the
three and nine months ended September 27, 2001. (See notes 1 and 8(c) to the
consolidated condensed financial statements for additional information regarding
the Company's investment in DynTek.)
For the third quarter and nine months ended September 26, 2002, operating profit
for DSS decreased by $36.8 million, or 63.0%, and $27.7 million, or 33.8%,
respectively, to $21.6 million and $54.2 million, respectively. Exclusive of the
revised loss estimates discussed above for DIS, the operating profit increases
for DSS resulted primarily from the new FBI contract and, to a lesser extent,
the new SEC contract and the government emergency telecom services contract
noted above. These three contracts provided combined operating profits of $1.6
million and $6.9 million for the three and nine months ended September 26, 2002.
In addition, operating profit increased due to increased tasking and a larger
award fee pool on the vaccine production and battlefield simulation contracts
that are noted above. Also contributing to the increase in operating profits
were the losses on several contracts in the three and nine months ended
September 27, 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 nine months ended September 27, 2001 was $0.8
million and $2.2 million, respectively.
DynCorp International's ("DI") third quarter and nine-month 2002 revenues grew
by 28.9% and 34.3% to $176.2 million and $519.4 million, respectively, as
compared to the same prior year periods of $136.7 million and $386.8 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 2000 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 $6.6
million and $18.7 million in the three and nine months ended September 26, 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 includes providing base operations support for
personnel and aircraft. This contract provided revenues of $8.7 million in the
first nine months of 2002. Partially offsetting the increases in revenues was
the decreased manning requirements on the DoS international police task force
contract in the second and third quarters of 2002.
DI's third quarter and nine-month 2002 operating profits grew by 18.2% and 10.2%
to $11.7 million and $29.7 million, respectively, as compared to the same prior
year periods of $9.9 million and $26.9 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 and third quarters 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
$6.9 million and $29.0 million and operating profits of $0.8 million and $1.9
million, respectively, in the three and nine months ended September 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 nine months
ended September 26, 2002, grew 28.9% and 25.1%, respectively, to $173.5 million
and $472.8 million, respectively, compared to $134.6 million and $377.9 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 $18.7 million in
revenues in the first nine months 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 $10.4 million in
revenues in the first nine months 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 $16.8 million and $18.7 million for the third
quarter and nine-month revenue increases in 2002. Management expects further
revenue growth on a U.S. Air Force contract that provides base operations and
support services at Maxwell AFB, which will became fully operational in the
third quarter of 2002. This contract provided $4.1 million in revenues for the
nine months ended September 26, 2002.
DTS operating profits for the three and nine months ended September 26, 2002,
grew 65.9% and 40.0%, respectively, to $9.0 million and $17.7 million,
respectively, compared to $5.4 million and $12.6 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 $11.9 million and $39.1 million in
the three and nine months ended September 26, 2002, respectively, as compared to
$14.7 million and $45.7 million in the same prior year periods. ADVMED's
reported operating losses of ($1.4) million and ($2.0) million in the three and
nine months ended September 26, 2002, respectively, as compared to operating
profits of $0.5 million and $2.2 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 one task award to provide help desk support to the center for Medicaid and
Medicare services. The two task awards that provide support services to Medicaid
and Medicare began operations in the third quarter of 2002 and the task award to
provide help desk support will begin operations in the fourth 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, neither of which occurred in the prior year. Also contributing to the
decrease in operating profit and the loss for the three and nine months ended
September 26, 2002 was the write-down of $0.5 million of capitalized software
costs to the net realizable value and increases to allowances for doubtful
accounts receivable of $0.8 million.
Cost of Services
- ----------------
Cost of services as a percentage of revenue remained relatively consistent in
the three and nine months ended September 26, 2002 and was lower in the
comparable periods in 2001 due to the revised loss estimates of $42.7 million
for DIS as discussed above. Cost of services was 93.0% and 94.1% of revenue for
the three and nine months ended September 26, 2002, respectively, as compared to
85.3% and 91.2%, respectively, for the comparable periods in 2001. Cost of
services was $565.0 million and $1.6 billion, respectively, compared to $429.0
million and $1.3 billion for the comparable periods in 2001, increases of $136.0
million and $347.1 million, respectively. 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 $8.3 million and $23.2 million
for the third quarter and nine months ended September 26, 2002, as compared to
$7.3 million and $21.3 million in the same periods of 2001. Corporate general
and administrative expense as a percentage of revenue was 1.4% and 1.3% for the
three and nine months ended September 26, 2002 and 1.5% for the same periods in
2001. The increases in corporate general and administrative expenses in the
three and nine months ended September 26, 2002 are primarily attributable to the
audit fees related to the re-audit of the Company's financial statements for the
three fiscal years ended December 27, 2001, which were expensed in the third
quarter of 2002.
Interest Expense
- ----------------
Interest expense was $7.0 million and $21.2 million, respectively, for the three
and nine months ended September 26, 2002, compared to $7.8 million and $24.2
million for the comparable periods in 2001. Interest expense as a percentage of
revenue was 1.2% for the three and nine months ended September 26, 2002, as
compared to 1.6% and 1.7% 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 nine months of 2002 as compared to the same
periods in 2001. The average levels of indebtedness were approximately $277.7
million and $285.3 million in the nine months ended September 26, 2002 and
September 27, 2001, respectively.
Amortization of Intangibles of Acquired Companies
- -------------------------------------------------
Amortization of intangibles of acquired companies was $0.5 million and $1.6
million for the third quarter and first nine months of 2002, respectively, as
compared to $0.8 million and $4.5 million for the comparable periods of 2001.
The decrease in 2002 as compared to 2001 resulted from the Company's adoption on
December 28, 2001, the first day of fiscal year 2002, of 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 7 to
the Consolidated Condensed Financial Statements included in this Quarterly
Report on Form 10-Q/A to show what the impact would have been on the third
quarter and first nine months of 2001 financial results if SFAS No. 142 had been
adopted at the beginning of fiscal 2001.
Losses on Equity Investment in DynTek
- -------------------------------------
Losses on Equity Investment in DynTek was $5.2 million and $25.1 million for the
three and nine months ended September 26, 2002. Included in the losses was $15.8
million in the second quarter of 2002 for the write-off of the Company's
investment in DynTek, an unconsolidated affiliate, as well as $3.6 million in
the first six months of 2002 for the Company's share of DynTek operating losses,
$5 million related to a settlement with DynTek and $0.7 million in other
expenses. 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 in which a loss in value is considered
to be other than temporary, the Company will record a write-down of the
investment to its estimated fair value. The Company's recoverability analysis is
based on cash flow analyses of the investments or other appropriate methods. At
June 27, 2002, the Company owned 18.3 million shares of DynTek, representing
43.8% of the ownership of DynTek. During the second quarter of 2002, the Company
recorded a write-off of approximately $15.8 million, which represented the net
balance of the Company's December 2001 investment in DynTek, Inc., which was
stated in excess of its net realizable value. This adjustment resulted from an
analysis of DynTek's public filings (which showed substantial negative working
capital, contract losses and ongoing operating and cash flow losses. DynTek also
received a "going concern" opinion from its independent auditors on its audited
financial statements for the year ended June 30, 2002.) as well as detailed cash
flow analyses that the Company was able to develop concerning DynTek's
operations. The Company's decision was also influenced by the inability of
DynTek to attract additional debt or equity working capital (as required under
the terms of the December 2001 merger agreement (Merger Agreement) between the
Company and TekInsight, the predecessor to DynTek), and the Company's inability
to sell its investment in DynTek in block transactions. The Company concluded
that the write-off was appropriate notwithstanding reported closing prices for
DynTek common stock on the NASDAQ exchange during the period June 1, 2002
through August 31, 2002 in the range of $1.31 to $1.86 based on average daily
trading volume during such period of approximately 57,000 shares. This
conclusion was based on the observations that the DynTek shares held by the
Company were not registered for sale (even though the Company had a demand
registration right), and that notwithstanding registration, there would be
inadequate liquidity in the market to liquidate a block the size of that held by
the Company.
Also regarding the same investment that was written off, the Company, in the
third quarter of 2002, entered into an agreement with DynTek, Inc. pursuant to
which the Company and DynTek agreed to settle and release each other from
various disputes related to certain contracts of the Company's former
subsidiary, DynCorp Management Services, Inc (DMR) that were assumed by DynTek
as part of the Merger Agreement and disputes concerning the adequacy of the
working capital transferred to DynTek as part of the DMR/DynTek merger.
(However, see Notes 9 and 10 to the condensed consolidated financial statements
and the Liquidity and Capital Resources discussion below concerning certain
matters related to DMR and DynTek for which the Company continues to have
contingent liability) As part of the settlement agreement, the Company sold back
to DynTek 8 million shares of DynTek's Class B common stock in exchange for a
$5.0 million note (which was fully reserved) and also agreed to exchange
10,336,664 shares of DynTek Class B shares for a like number of Class A shares
(representing approximately 29.2% of the ownership of DynTek) thereby
extinguishing the Company's right to vote such shares as a separate class. In
addition, the Company paid $4.0 million of DynTek's operating expenses during
the third quarter of 2002 and forgave a $1.0 million loan, which was made and
fully reserved during the second quarter of 2002. In partial consideration of
these undertakings, DynTek also agreed to issue the Company warrants to purchase
up to 7.5 million Class A DynTek shares at a price of $4.00 which are carried on
the Company's books at $0. At September 26, 2002, the market value of DynTek
Class A common stock was approximately $30.8 million.
Other Expense (Other Income)
- ----------------------------
Other expense (other income) was $7.0 million and $8.7 million for the three and
nine months ended September 26, 2002, and includes $6.9 million and $8.6 million
for the three and nine months ended September 26, 2002, respectively, of 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 (see "Recent Developments" discussion below).
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 $16.2 million and $20.2 million for the three and nine months ended
September 26, 2002, respectively, from the
comparable periods in 2001. The decreases were due primarily to lower pretax
income in both the three and nine months ended September 26, 2002 and lower
effective tax rates in the three and nine months ended September 26, 2002,
compared to the same periods in 2001. The Company's effective tax rates
approximated 28.1% and 34.4% for the three and nine months ended September 26,
2002, respectively, compared to 34.8% and 36.6% in the comparable periods 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 $8.5 billion at September 26, 2002 compared to $6.8
billion at December 27, 2001, a net increase of $1.7 billion. The backlog at
September 26, 2002 consisted of $3.0 billion for DSS, $2.3 billion for DI, $3.1
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
$1.1 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 the fourth quarter of
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 $163.9
million at September 26, 2002 compared to $144.7 million at December 27, 2001,
an increase of $19.3 million, or 13.3%. The ratio of current assets to current
liabilities at September 26, 2002 and December 27, 2001 was 1.6. The increase in
working capital was primarily a result of higher revenues, which resulted in a
higher accounts receivable balance at September 26, 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 September 26, 2002 and
increases in accounts payable on a contract with the government for emergency
telecom service.
Cash Flows from Operating Activities
- ------------------------------------
Cash provided by operations was $42.1 million in the first nine months of 2002,
an increase of $34.2 million from the comparable period in 2001. The increase in
cash provided by operations compared to the same period a year ago resulted from
lower outflows for accounts payable in the nine months ended 2002 compared to
the first nine months of 2001. Also contributing to the increase were higher
collections of accounts receivable, and higher operating profits, excluding
non-cash net losses of unconsolidated affiliates of $3.7 million and a non-cash
write-off of an investment in an unconsolidated affiliate of $15.8 million in
the second quarter of 2002.
Cash Flows from Investing Activities
- ------------------------------------
Investing activities used funds of $8.2 million in the nine months ended
September 26, 2002, as compared to cash used by investing activities of $5.6
million in the nine months ended September 27, 2001. The use of funds in the
first nine months of 2002 resulted mostly from the purchase of property and
equipment of $5.4 million, purchases of software of $2.7 million, and dividends
paid to joint venture partners of $1.1 million compared to the purchase of
property and equipment of $4.9 million, purchases of software of $3.0 million,
and dividends paid to joint venture partners of $1.2 million in the same period
of 2001.
Cash Flows from Financing Activities
- ------------------------------------
Financing activities used funds of $16.6 million during the nine months ended
September 26, 2002 and included several short-term borrowings and subsequent
payments of a cumulated sum of $71.3 million under the Senior Secured Credit
Agreement Revolving Credit Facility, maturing December 9, 2004. In the first
half of 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. In August 2002, the Company made an additional
installment payment of $6.3 million on the Term A Loan. During the first nine
months of 2001, financing activities used funds of $0.8 million and included
several short-term borrowing and subsequent payments of a cumulated sum of
$200.8 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
effect 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 Nine Months Ended
------------------ -----------------
September 27, September 27,
September 26, 2001 (Restated - September 26, 2001 (Restated
2002 See Note 2) 2002 - See Note 2)
---- ----------- ---- -------------
Net earnings $ 9,922 $ 37,618 $12,847 $ 46,729
Depreciation and amortization 4,094 3,590 11,850 13,913
Interest expense, net 6,842 7,700 20,757 23,657
Provision for income taxes 3,871 20,060 6,738 26,933
Amortization of deferred debt expense (506) (621) (1,554) (1,985)
Debt issue discount (147) (13) (439) (35)
-------- --------- -------- ---------
EBITDA $24,076 $ 68,334 $50,199 $109,212
======= ======== ======= ========
EBITDA (as defined above) decreased by $44.3 million, or 64.8%, to $24.1 million
for the third quarter of 2002 as compared to the comparable period in 2001. For
the first nine months of 2002, EBITDA decreased by $59.0 million, or 54.0%, to
$50.2 million as compared to the first nine months of 2001. The decreases in
EBITDA in the three and nine 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 also the revised loss estimates in 2001 for DIS as discussed
above, offset partially by the higher operating profits in 2002, also discussed
above.
Recent Developments
- -------------------
The Board of Directors authorized management in the first quarter of 2002 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 September 26, 2002 due to the short
maturities of these instruments.
As of September 26, 2002 the Company's total debt was $268.0 million, a decrease
of $16.6 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 $56.3 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 September 26, 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 $13.9 million and $11.1 million at September 26, 2002 and December 27,
2001, respectively, under the line of credit. The amount available was $76.1
million and $78.9 million, respectively, as of September 26, 2002 and December
27, 2001.
The Company has $99.7 million of 9 1/2% Senior Subordinated Notes ("Senior
Subordinated Notes") outstanding as of September 26, 2002 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 $38.3 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.
Prior to the consummation of the DMR DynTek merger, the Company issued a
performance guarantee to a state government and agreed to act as an indemnitor
under a $2.5 million payment bond in connection with a DMR fixed price services
contract for non-emergency transportation brokerage services with a completion
date in June 2003 (Brokerage Contract). Whereas management perceived at the end
of the 3rd quarter that potential exposure to financial losses under the
guarantee and bond could aggregate as much as $12.5 million over the nine month
period ending in June of 2003, the state customer and DynTek entered into a
settlement and termination of the Brokerage Contract effective December 15, 2002
under which DynTek will have no further obligation to perform the Brokerage
Contract after that date. No claim has been asserted against the Company
pursuant to the performance guarantee or under the bond. At this time, although
claims have been submitted by subcontractors on the Brokerage Contract against
DynTek and the bond, no claim has been asserted against the Company and the
Company has not established a reserve. The Company's maximum exposure as
ultimate indemnitor under the bond is $2.5 million and the Company believes no
claim is probable under the performance guarantee.
Chart Outlining Future Financial Commitments
- --------------------------------------------
The following table sets forth the Company's total contractual cash obligations
for the remaining three months of 2002 and over the next four years and
thereafter (in thousands):
Cash Obligations Due by Year
----------------------------
October -
Contractual December
Cash Obligation Total 2002 2003 2004 2005 2006 Thereafter
- --------------- ----- ---- ---- ---- ---- ---- ----------
Long-term Debt $268,039 $ 6,277 $ 25,001 $28,083 $26,228 $47,500 $134,950
Operating Leases 217,517 14,698 42,968 36,790 27,600 25,643 69,818
Payment to Unrelated
Party 6,000 6,000 - - - - -
Maximum Liability to
Repurchase ESOP
Shares 373,002 12,514 28,639 30,936 28,508 24,560 247,845
Liability to Repurchase
Other Redeemable
Common Stock 11,600 - 11,600 - - - -
-------- ------- -------- ------- ------- ------ --------
Total Contractual Cash
Obligations $876,158 $39,489 $108,208 $95,809 $82,336 $97,703 $452,613
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
$217.5 million, including approximately $14.7 million for the remaining three
months of 2002. Of the $14.7 million 2002 minimum lease payments, approximately
$3.6 million relates to DIS leases, $2.6 million relates to a U.S. Postal
Service contract, and $1.7 million relates to the corporate headquarters
building.
The Company is obligated to reimburse up to $6.0 million of out-of-pocket due
diligence expenses that were incurred by an unrelated party that has expressed
an interest in the possible acquisition of the Company (see "Recent
Developments" discussion). This payment was made to the unrelated party during
the fourth quarter of 2002. This amount has been recorded as an expense in the
third quarter of 2002 and is included in the Other Expense (Other Income) on the
Consolidated Condensed Statement of Operations.
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
$373.0 million as of September 26, 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 $11.6 million.
Critical Accounting Policies
- ----------------------------
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, revenue is recognized at a rate
per unit as the units are delivered. Revenue from other long-term fixed price
contracts is recognized ratably over the contract period or by other appropriate
methods to measure services provided. Contract costs are expensed as incurred
except for certain limited long-term contracts noted below. For long-term
contracts, which are specifically described in the scope section of AICPA SOP
No. 81-1, "Accounting for Performance of Construction Type and Certain
Production-Type Contracts," or other appropriate accounting literature, the
Company applies the percentage of completion method. Under the percentage of
completion method, income is recognized at a consistent profit margin over the
period of performance based on estimated profit margins at completion of the
contract. This method of accounting requires estimating the total revenues and
total contract cost at completion of the contract. 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. This
method can result in the deferral of costs including start-up costs, or the
deferral of profit on these contracts. 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. Estimated losses on contracts at completion 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 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 when a 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. Accounts receivable
balances related to such disputed items were immaterial at September 26, 2002
and December 27, 2001.
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 nine months of 2002, the
Company's net earnings would have been approximately $173.2 thousand lower, or a
change of 1.4%. 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 nine months ended September 26, 2002
resulted in additional increases in accumulated other comprehensive income of
$0.5 million. This swap is perfectly effective at its objective, and
accordingly, there are no existing gains or losses as of September 26, 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.
Item 4. Controls and Procedures
- --------------------------------
Evaluation of Controls and Procedures:
- --------------------------------------
Within the 90 days prior to the date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's chief executive officer and chief financial
officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based
upon that evaluation, the chief executive officer and chief financial officer
concluded, as of the evaluation date, that the Company's disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) and ensuring
that such material information required to be included in the Company's SEC
filings under the Securities Exchange Act of 1934 is reported within the time
periods specified by SEC rules and regulations.
Change in Internal Controls:
- -----------------------------
There have been no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of this report.
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 $5.7 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 restatements concerning the accounting for such preacquisition estimates and
the impact of those restatements 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 $5.7 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
$4.6 million and is substantially covered by insurance at September 26, 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
$4.1 million at September 26, 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 September 26, 2002 that will
have a material adverse effect on the Company's consolidated financial
condition, results of operations, or liquidity.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
At the annual meeting of stockholders, held on July 10, 2002, at the Company's
headquarters in Reston, Virginia, the stockholders of the Company:
Elected the following individuals as Class II directors to the Board of
Directors for the terms set forth:
Director Term Votes Cast For Votes Withheld/Against
- ------- ---- -------------- ----------------------
Michael P. Carns Three Years 9,779,145 357,691
H. Brian Thompson Three Years 9,759,684 377,152
Herbert S. Winokur, Jr. Three Years 9,409,333 727,503
Item 6. Exhibits and Reports on Form 8-K
- -----------------------------------------
(a) Exhibits
3.2 Registrant's By-laws as amended through September 4, 2002 (previously
filed).
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 (previously
filed).
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 (previously
filed).
(b) Reports on Form 8-K
Form 8-K was filed on August 6, 2002 to note the decision made on May 30, 2002,
by the DynCorp Savings and Retirement Plan and DynCorp Capital Accumulation and
Retirement Plan (collectively, the "Plans"), to not engage Arthur Andersen LLP
as the Plans' auditor for the plan year ending December 31, 2001 and to engage
Ernst & Young LLP to serve as the auditor for such plan year.
Form 8-K was filed on September 23, 2002 to note the decision made on September
18, 2002, by the Audit Committee, to engage Deloitte & Touche LLP as the
Company's independent public accountant. D&T has been engaged to audit the
Company's financial statements for the fiscal years ended December 30, 1999,
December 28, 2000, and December 27, 2001 and to audit the Company's financial
statements for the fiscal year ending December 26, 2002.
Form 8-K was filed on December 13, 2002 to note that the Company had entered
into an Agreement and Plan of Merger with Computer Sciences Corporation ("CSC"),
and Garden Acquisition LLC, a wholly owned subsidiary of CSC ("Acquisition"), on
December 13, 2002. The Agreement and Plan of Merger provides for the merger of
Acquisition with and into the Company (the "Merger"). Upon consummation of the
Merger (i) the Company will become a wholly owned subsidiary of CSC, and (ii)
each outstanding share of common stock of the Company will be converted into,
subject to adjustment as provided in the Agreement and Plan of Merger, $15 cash
plus shares of CSC's common stock having a market value of $43. This Form 8-K
also included as exhibits, the Agreement and Plan of Merger and a joint press
release of the Company and CSC dated December 13, 2002 describing the Merger.
On January 1, 2002, the Company realigned its strategic business segments from
five to four segments. Footnote 21 to the Company's financial statements as set
forth in Item 8 of its Form 10-K/A, Amendment No. 2 has been revised accordingly
and filed as an exhibit in the Form 8-K filed on November 12, 2002.
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this amended report to be signed on its behalf by the
undersigned thereunto duly authorized.
DYNCORP
Date: December 23, 2002 /s/ Patrick C. FitzPatrick
--------------------------
Patrick C. FitzPatrick
Senior Vice President
and Chief Financial Officer
Date: December 23, 2002 /s/ John J. Fitzgerald
----------------------
John J. Fitzgerald
Vice President
and Corporate Controller
CEO/CFO Certifications under Section 302 for Quarterly Reports
Certificate of Chief Executive Officer
I, Paul V. Lombardi, hereby certify that:
1. I have reviewed this quarterly report on Form 10-Q, of DynCorp;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as such term is
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the Company, including its
consolidated subsidiaries, is made known to them by others within
those entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the Company's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the Company's auditors and the audit committee of the
Company's board of directors:
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Company's ability
to record, process, summarize and report financial data and have
identified for the Company's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the Company's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of their most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: December 23, 2002 /s/ Paul V. Lombardi
--------------------
Paul V. Lombardi
President & Chief Executive Officer
Certificate of Chief Financial Officer
I, Patrick C. FitzPatrick, hereby certify that:
1. I have reviewed this quarterly report on Form 10-Q, of DynCorp;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as such term is
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the Company, including its
consolidated subsidiaries, is made known to them by others within
those entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the Company's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the Company's auditors and the audit committee of the
Company's board of directors:
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Company's ability
to record, process, summarize and report financial data and have
identified for the Company's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the Company's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of their most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: December 23, 2002 /s/ Patrick C. FitzPatrick
--------------------------
Patrick C. FitzPatrick
Senior Vice President &
Chief Financial Officer