The following discussion and analysis of our financial condition and results of operations should be read together with the consolidated financial statements and the notes to those statements that appear elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K filed with the Securities Exchange Commission on March 13, 2012.

Some of the statements in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations", and elsewhere in this Quarterly Report on Form 10-Q, contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, regarding future events and the future results of DRC that are based on our current expectations, estimates, forecasts, and projections about the industries in which DRC operates and the beliefs and assumptions of the management of DRC. Words such as "anticipates", "believes", "estimates", "expects", "intends", "plans", "projects", "may", "will", "should", and other similar expressions are intended to identify these forward-looking statements. Such statements are subject to factors that could cause actual results to differ materially from anticipated results. Such factors include but are not limited to, the following:

· Our dependency on the Federal government and changes in federal spending priorities;

· A shift in pricing structure for government contracts;

· Risks associated with actual and potential goodwill impairment;

· An increased focus on the elimination of overhead within the Department of Defense;

· Failure to obtain new government contracts or retain existing contracts;

· The effect of Federal government in-sourcing on our business;

· The loss of skilled personnel;

· The risk of security breaches in systems we develop, install, or maintain;

· Failure by Congress to timely approve budgets governing spending by Federal agencies;

· Risks due to government contract provisions providing for rights unfavorable to us, including the ability to terminate contracts at any time for convenience;

· Potential systems or service failures that could result in liability to our company;

· Competition with competitors who may have advantages due to having greater resources or qualifying for special statuses;

· Failure to obtain or maintain necessary security clearances;

· Risks associated with various, complex Federal government procurement laws and regulations;

· Adverse effects in the event of an unfavorable Federal audit of our contracts;

· Failure to adequately safeguard confidential information;

· An adverse outcome related to ongoing legal proceedings;

· Incurrence of expenditures prior to final receipt of contracts;

· Competitive conditions in current markets and difficulties in entering new markets; and

· Our ability to maintain sufficient sources of financing and the risk that our financing requirements should increase.

These and other risk factors are more fully described in our Annual Report on Form 10-K for the year ended December 31, 2011 under the section entitled "Risk Factors", and from time to time, in other filings with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document. Actual results may differ materially and adversely from those expressed in any forward-looking statements. Except to the extent required by applicable law or regulation, DRC undertakes no obligation to revise or update publicly any forward-looking statements for any reason.

Unless the context otherwise requires, references in this Form 10-Q to "DRC", "we", "us", or "our" refer to Dynamics Research Corporation and its subsidiaries.

OVERVIEW

Business

Dynamics Research Corporation, headquartered in Andover, Massachusetts, is a leading provider of innovative management consulting, engineering, and information technology services and solutions to federal and state governments.

Our go-to-market strategy is sharply focused within each of four dimensions:

· Solutions. We deliver five high-value, differentiated solutions to our clients: business transformation, information technology, training and performance support, management services, and science and engineering services. We believe our solutions align well with the needs of our government customers today who require improved efficiencies and effectiveness, and face procurement reform, transformational and technology based changes, and ongoing, changing security threats.

· Markets and Customers. We target markets which are based on long-term market force drivers that have sustained demand for our services. We select specific customers from government agencies in our target growth markets with needs that well match the solutions we provide. Currently our target growth markets include homeland security, healthcare, cyber security, intelligence, and financial/regulatory reform.

· Prime Government and Agency-Wide Contracts. We hold a portfolio of government and agency-wide multiple award schedule ID/IQ task order contracts. Today, these types of contracts are the federal government's preferred means of procurement for services.

· Acquisitions. We use acquisitions, funded through both operationally generated cash and leverage, to strengthen our position in our target growth markets.

On June 30, 2011, we completed the merger of High Performance Technologies, Inc. ("HPTi") for $143 million in cash plus net working capital of $3.4 million. HPTi is a leading provider of high-end technology services to the federal healthcare and military technology markets. The merger strengthens and expands the Company's market presence as a provider of high-end services and solutions in the federal market.

Market

In the first half of 2012 as well as in 2011, we generated 95% of our revenue from contracts with the United States government, either as a prime contractor or as a subcontractor. As a result we are significantly impacted by trends and changes in federal expenditures and procurement policies. The U.S. government deficit, budgetary challenges, and efforts to curtail expenditures are on-going and reflected in (i) the Budget Control Act of 2011, which increased the debt ceiling and enacted 10-year discretionary spending caps and automatic spending cuts, referred to as sequestration, which will require $1.2 trillion of spending cuts over 10 years, if not amended by Congress and the President, (ii) the Defense Strategic Guidance, issued on January 5, 2012, which outlines fundamental changes in the strategy of United States armed forces, which is smaller and leaner but agile, flexible, and technologically advanced, and (iii) the President's budget submission for the fiscal year beginning October 1, 2012. Additionally, sizeable mandatory outlays for social security and medical programs in the face of large budget deficits indicate that federal discretionary spending will remain under pressure.

Overall, the President's information technology budget request of $78.9 billion for fiscal year 2013 is down slightly from the fiscal year 2012 enacted budget, reflecting reductions in defense and intelligence budgets and increases in civilian agencies such as the Departments of Treasury, Veterans Affairs, and Education.

We have seen and anticipate continued impacts from government budget management initiatives, the specific timing and effects of which may not be predictable, such as:

· Program delays, cuts, and terminations,

· fewer new program starts,

· intensified price competition for new business and re-competes of current business, and

· pressure to reduce dependency on service contractors and set more work aside for small and socially disadvantaged businesses.

These events may result in (i) new business contract wins being lower than expected or needed to sustain growth, (ii) ending of or reductions to current programs and contracts, and (iii) lower profit margins as a result of pricing pressure and the need to invest in winning new and retaining existing business - all of which may adversely affect our results of operations and financial condition.

NON-GAAP FINANCIAL MEASURES

In evaluating our operating performance, management uses certain non-GAAP financial measures to supplement the consolidated financial statements prepared under generally accepted accounting principles in the United States ("GAAP").

Management believes these non-GAAP measures help indicate our operating performance before charges that are considered by management to be outside our ongoing operating results. Accordingly, management uses these non-GAAP measures to gain a better understanding of our comparative operating performance from period-to-period and as a basis for planning and forecasting future periods. Management believes these non-GAAP measures, when read in conjunction with our GAAP financials, provide useful information to investors by offering:

· the ability to make more meaningful period-to-period comparisons of our ongoing operating results, net of the effect of goodwill impairment;

· the ability to better identify trends in our underlying business and perform related trend analysis;

· a higher degree of transparency for certain expenses (particularly when a specific charge impacts multiple line items);

· a better understanding of how management plans and measures our underlying business; and

· an easier way to compare our most recent results of operations against investor and analyst financial models.

The non-GAAP measures we use exclude the estimated preliminary goodwill impairment charge incurred in the second quarter of 2012 and its related tax effect that management believes is outside of our ongoing operations for the periods presented.

These non-GAAP measures have limitations; however, because they do not include all items of expense that impact our operations. Management compensates for these limitations by also considering our GAAP results. The non-GAAP financial measures we use are not prepared in accordance with, and should not be considered an alternative to, measurements required by GAAP, such as operating loss, net loss and loss per share, and should not be considered measures of our liquidity. The presentation of this additional information is not meant to be considered in isolation or as a substitute for the most directly comparable GAAP measures. In addition, these non-GAAP financial measures may not be comparable to similar measures reported by other companies.

Non-GAAP financial measures, together with a reconciliation with the most direct comparable financial measures under GAAP for the three and six months ended June 30, 2012 were as follows:

                                                                 Three Months Ended          Six Months Ended
 (in thousands)                                                    June 30, 2012               June 30, 2012
Operating loss                                                 $     (6,914 )    (8.6 )%   $     (1,240 )   (0.7 )%
Impairment of goodwill                                               12,000      14.8 %          12,000      7.2 %
Non-GAAP operating income                                      $      5,086       6.3 %    $     10,760      6.5 %

Loss before benefit for income taxes                           $     (9,606 )   (11.9 )%   $     (6,576 )   (3.9 )%
Impairment of goodwill                                               12,000      14.8 %          12,000      7.2 %
Non-GAAP income before provision for income taxes              $      2,394       3.0 %    $      5,424      3.3 %

Benefit for income taxes                                       $     (3,527 )    36.7 %    $     (2,288 )   34.8 %
Tax benefit for impairment of goodwill                                4,500      37.5 %           4,500     37.5 %
Non-GAAP provision for income taxes                            $        973      40.6 %    $      2,212     40.8 %

Net loss                                                       $     (6,079 )    (7.5 )%   $     (4,288 )   (2.6 )%
Impairment of goodwill, net of tax benefit                            7,500       9.3 %           7,500      4.5 %
Non-GAAP net income                                            $      1,421       1.8 %    $      3,212      1.9 %

Earnings (loss) per common share
Basic                                                          $      (0.59 )              $      (0.42 )
Per share effect of impairment of goodwill                             0.73                        0.73
Non-GAAP Basic                                                 $       0.14                $       0.31

Diluted                                                        $      (0.59 )              $      (0.42 )
Per share effect of impairment of goodwill                             0.72                        0.72
Non-GAAP Diluted (1)                                           $       0.14                $       0.31

Weighted average shares outstanding
Basic (GAAP diluted)                                             10,319,901                  10,330,851
Diluted (Non-GAAP)                                               10,352,869                  10,372,116

(1) May not add due to rounding.

RESULTS OF OPERATIONS

Operating results expressed as a percentage of total revenue are as follows:

                                                Three Months Ended June 30,
(in millions)                                    2012                  2011
 Revenue                                   $   80.8               $ 68.5

 Gross profit                              $   12.5     15.5 %    $ 10.4     15.2 %
 Selling, general and administrative            6.4      7.9 %       6.8      9.9 %
 Amortization of intangible assets              1.0      1.3 %       0.4      0.5 %
 Impairment of goodwill                        12.0     14.8 %         -        0 %
 Operating income (loss)                       (6.9 )   (8.6 )%      3.2      4.7 %
 Interest expense, net                         (2.6 )   (3.2 )%     (0.8 )   (1.1 )%
 Other income (expense), net                   (0.1 )   (0.1 )%      0.1      0.1 %
 Provision (benefit) for income taxes(1)       (3.5 )   36.7 %       1.1     43.5 %
 Net income (loss)(2)                      $   (6.1 )   (7.5 )%   $  1.4      2.1 %



                                                 Six Months Ended June 30,
(in millions)                                    2012                  2011
 Revenue                                   $ 166.7               $ 138.0

 Gross profit                              $  26.1     15.7 %    $  21.2     15.4 %
 Selling, general and administrative          13.3      8.0 %       12.5      9.0 %
 Amortization of intangible assets             2.1      1.2 %        0.7      0.5 %
 Impairment of goodwill                       12.0      7.2 %          -        0 %
 Operating income (loss)                      (1.2 )   (0.7 )%       8.0      5.8 %
 Interest expense, net                        (5.4 )   (3.2 )%      (1.0 )   (0.7 )%
 Other income, net                             0.1      0.0 %        0.2      0.1 %
 Provision (benefit) for income taxes(1)      (2.3 )   34.8 %        3.0     41.7 %
 Net income (loss)(2)                      $  (4.3 )   (2.6 )%   $   4.1      3.0 %

(1) The percentage of provision for income taxes relates to a percentage of income
(loss) before income taxes.

(2) Net income (loss) may not add due to rounding.

Revenues

Revenues were earned from the following sectors:

                                                  Three Months Ended June 30,
                                                   2012                  2011
(in millions)
National defense and intelligence agencies   $  46.5      57.6 %   $ 47.5      69.3 %
Homeland security                               11.1      13.7       11.3      16.5
Federal civilian agencies                       19.2      23.8        5.8       8.4
Total revenue from federal agencies(1)          76.8      95.0       64.6      94.3
State and local government agencies              4.0       5.0        3.9       5.7
Total revenue                                $  80.8     100.0 %   $ 68.5     100.0 %



                                                    Six Months Ended June 30,
                                                   2012                  2011
(in millions)
National defense and intelligence agencies   $  97.1      58.2 %   $  95.3      69.0 %
Homeland security                               22.5      13.5        23.6      17.1
Federal civilian agencies                       39.2      23.5        11.6       8.4
Total revenue from federal agencies(1)         158.8      95.2       130.5      94.6
State and local government agencies              7.9       4.7         7.5       5.4
Total revenue                                $ 166.7     100.0 %   $ 138.0     100.0 %

(1) Totals may not add due to rounding.

We reported total revenue of $80.8 million and $68.5 million in the second quarter of 2012 and 2011, respectively, and $166.7 million and $138.0 million in the first half of 2012 and 2011, respectively. Total revenues for the second quarter of 2012 and the first half of 2012 represent an increase of 18.1% and 20.8%, respectively, from the same period in 2011. The increase in revenue for both periods of 2012 compared with the same periods in 2011 resulted from the inclusion of HPTi in current year results, partially offset by approximately $15 million in contract erosion. For the second quarter and first half of 2011, HPTi revenues were $27.6 million and $53.6 million, respectively. We calculate organic revenue growth by adding revenue of the acquired operations prior to the acquisition date to the Company's reported revenue for the period. Accordingly, pro-forma revenue for the second quarter and first half of 2011 was $96.1 million and $191.6 million, respectively, and organic revenue declined 15.9% and 13.0% for the second quarter and first half of 2012, respectively.

During the fourth quarter of 2011, we saw evidence of aggressive government cost-cutting initiatives that impacted several successful programs, which were completed in the fourth quarter of 2011, where clients deferred or cancelled follow-on awards due to cost-cutting efforts. The reduction in annual revenue from these completed programs totaled approximately $30 million, which has impacted the first half of 2012 and our outlook for the remainder of 2012.

In the first half of 2012 we continued to see a shortage of new business awards, as well as adverse contract actions. The total contract value of our new business wins in the first half of 2012 totaled $29.4 million. Regarding competitions to re-win existing business we won $100.3 million, or 83%, of the award decisions made in the first half of 2012, down from a re-win rate of 98% for the 2011 fiscal year.

In the second quarter of 2012, we were adversely impacted by two contracts which were subject to re-compete or extension. One of the contracts was not extended or re-competed due to a lack of funds, and the other, which was scheduled for a competitive procurement, was awarded on a sole source basis to a small, socially disadvantaged business. The contracts generated approximately $11 million in annual revenue with 75 employees.

Revenues by contract type as a percentage of revenues were as follows:

                                                                  Three Months Ended           Six Months Ended
                                                                       June 30,                    June 30,
                                                                 2012            2011          2012          2011
 Fixed price, including service type contracts                        47 %            51 %         46 %         50 %
 Time and materials                                                   33              30           34           30
 Cost reimbursable                                                    20              19           20           20
                                                                     100 %           100 %        100 %        100 %

 Prime contract                                                       85 %            76 %         85 %         75 %
 Sub-contract                                                         15              24           15           25
                                                                     100 %           100 %        100 %        100 %

Backlog and Bookings

Our backlog position was as follows:

                 June 30,
(in millions)      2012         December 31, 2011
Backlog:
Funded          $    150.6     $             183.3
Unfunded             519.3                   618.6
Total backlog   $    669.9     $             801.9

During the second quarter we received funding for option year 2, which runs from May 2012 through May 2013 on the Veterans Relationship Management contract of $22.6 million. This contract runs through May 2015.

We expect that substantially all of our funded backlog at June 30, 2012 will generate revenue during the subsequent twelve month period. The funded backlog generally is subject to possible termination at the convenience of the contracting party. Contracts are typically funded on an annual basis or incrementally for shorter time periods. The funded backlog as of June 30, 2012 and December 31, 2011 covered approximately 5.6 months and 6.2 months of revenue, respectively. Funded bookings were $85.3 million and $61.5 million in the three months ended June 30, 2012 and December 31, 2011, respectively, and generated a book-to-bill ratio of approximately 1.1 to 1.0 and 1.0 to 1.0 for each respective period.

Gross Profit

Gross profit was $12.5 million and $10.4 million for the second quarter of 2012 and 2011, respectively, resulting in a gross margin of 15.5% and 15.2%, respectively. For the first half of 2012 and 2011, gross profit was $26.1 million and $21.2 million, respectively, resulting in a gross margin of 15.7% and 15.4%, respectively. The increase in gross profit margin was composed of a one point increase from direct margin on billed services and 7 tenths of a point decrease from higher overhead costs as a percentage of revenue.

Direct margin on billed services was 39.2% of revenue for the second quarter of 2012 compared with 38.2% for the same period of 2011, respectively, and 38.6% and 38.3% for the first half of 2012 and 2011, respectively. The change in direct margin as a percentage of revenue was composed of a 2.3 point increase as a result of the inclusion of higher margin HPTi services in results for the most recent quarter, and a decline of 1.3 points resulting from lower margins on legacy DRC business in the most recent quarter compared with the same period in 2011.

Selling, general and administrative expenses

Selling, general and administrative expenses were $6.4 million and $6.8 million in the three months ended June 30, 2012 and 2011, respectively, and $13.3 million and $12.5 million, respectively, in the first half then ended. Selling, general and administrative expenses as a percent of total revenue in the second quarter of 2012 and 2011 were 7.9% and 9.9%, respectively, and 8.0% and 9.0% in the first half of 2012 and 2011, respectively. The decrease in selling, general and administrative expenses in the first half of 2012 was due to transaction-related costs of $1.7 million recorded in the second quarter of 2011, partially offset by added costs from the merger, and the second quarter decrease as a percent of total revenue was attributable to an increase in administrative efficiencies driven by higher levels of revenue.

Intangible assets

Amortization expense was $1.0 million and $0.4 million in the second quarter of 2012 and 2011, respectively, and $2.1 million and $0.7 million in the first half of 2012 and 2011, respectively. The increase in amortization expense was due to $20 million of acquired intangible assets from the HPTi merger. The remaining amortization expense for the current fiscal year is expected to be approximately $2.1 million.

Impairment of goodwill

The Company's market capitalization continued to be below book value at June 30, 2012. Accordingly, management updated its fair value assessment as of June 30, 2012. Based on the step 1 analysis performed, management, with the assistance of a third party valuation specialist, determined on August 2, 2012 that the Company's fair value was below the carrying value of its equity as of June 30, 2012. As a result, the Company estimated the range of impairment to be between $12.0 million and $212.0 million and has recorded in the second quarter of 2012 an estimated preliminary impairment charge of $12.0 million. Due to the timing and complexity of step 2 of the impairment test, which is required to determine the actual impairment, we were unable to finalize the amount of impairment prior to filing form 10-Q for the quarter ended June 30, 2012. Step 2 of the impairment test will be completed in the third quarter of 2012. Any adjustment to the estimated impairment charge made in the second quarter of 2012 will be recorded in the third quarter of 2012.

The determination of valuation for goodwill impairment testing is sensitive to
(i) changes in the market price of DRC's stock, (ii) changes in premiums paid in excess of market price for public companies in our industry sector which are acquired, (iii) estimated future cash flows, (iv) weighted average cost of capital, and (v) market multiples. A significant decrease in any of these assumptions would cause a decline in valuation and increase the risk of impairment. At June 29, 2012 and December 30, 2011, the price of our common stock was $5.81 per share and $11.34 per share, respectively.

Interest expense, net

Net interest expense was $2.6 million and $0.8 million in the second quarter of 2012 and 2011, respectively, and $5.4 million and $1.0 million in the first half of 2012 and 2011, respectively. The increase in interest expense was due to the higher outstanding debt borrowings incurred in connection with the HPTi merger and higher interest rates in 2012. During the second quarter of 2011, interest expense included a charge of $0.5 million due to the payoff of the interest rate swap and the write-off of deferred financing cost associated with our previous credit facility.

Other income (expense), net

Other income (expense) consists of our portion of earnings and losses in HMRTech, gains and losses realized from our deferred compensation plan and results from other non-operating transactions, all of which were immaterial to our results.

Income tax provision (benefit)

We recorded income tax benefits of $3.5 million and $2.3 million in the second quarter and first half of 2012, respectively, and income tax provisions of $1.1 million and $3.0 million in the second quarter and first half of 2011, respectively. The effective income tax rate was 34.8% and 41.7% in the first half of 2012 and 2011, respectively. Excluding the goodwill impairment charge, the effective income tax rate for the first half of 2012 was 40.8%.

Net Income (Loss)

The net loss for the three and six month periods ended June 30, 2012 was $6.1 and $4.3 million, or $0.59 and $0.42 per diluted share, respectively. Results for the second quarter of 2012 included an impairment charge of $12.0 million, or $7.5 million net of income tax benefits. Excluding the impairment charge net income for the quarter ended June 30, 2012 was $1.4 million or $0.14 per diluted . . .