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Executives

Cindy Roberts - Director of Investor Relations

Herbert J. Lanese - Chief Executive Officer, President

Michael J. Thorne - Chief Financial Officer, Principal Accounting Officer, Sr. VP, Treasurer, Sr. VP of DynCorp International LLC and Chief Financial Officer of DynCorp International LLC

Analysts

Lionel Jolivot - Bank of America

Myles Walton - Oppenheimer & Co.

James Harlow - Stifel Nicolaus & Company, Inc.

Louise Wager - Commerce Bank

Mike [Marionacci] - [inaudible] Rock Capital

Matt Vittorioso - Barclays Capital

DynCorp International Inc (DCP) F3Q08 Earnings Call January 31, 2008 8:30 AM ET

Operator

Welcome to DynCorp International’s fiscal year 2008 third quarter conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question and answer session. (Operator Instructions) Now I would like to turn the call over to Cindy Roberts, Director of Investor Relations. Miss Roberts, you may begin.

Cindy Roberts

Thank you Angeline. Good morning everyone. Welcome to DynCorp International’s conference call. This morning we are here to discuss the company’s fiscal 2008 third quarter financial results which were released last night. With me today are DynCorp International’s President and Chief Executive Officer Herb Lanese and Chief Financial Officer Mike Thorne. After management has made their formal remarks we will take your questions. Before we get started I would like to remind our listeners that our comments today will contain forward looking statements including those contained in yesterday’s press release. In accordance with the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 I would like to call your attention to the risks related to these statements which are more fully described in the press release and in the company’s filings with the Securities and Exchange Commission. Now with those formalities out of the way, it is my pleasure to turn the call over to Herb.

Herbert J. Lanese

Okay, Cindy, thanks. I would like to welcome everyone to our call as I always do on these calls. Thank you for your continued interest in DynCorp. By now everyone should have had an opportunity to read our press release. As with our past investor calls I plan to provide a high level overview of the quarter and that will be followed by a more detailed discussion of our financial results by Mike Thorne, our Chief Financial Officer. That will follow again my prepared remarks. After Mike completes his comments I would like to make some closing remarks before we open the call for questions.

In summary, we had another solid quarter. Revenue was $523 million which was a slight increase over last quarter and our third quarter from fiscal 2007. EBITDA was $44.3 million, which equates to an 8.5% margin. Our EBITDA in terms of both dollars and margins is both down slightly from both the third quarter of last year and last quarter. Mike will discuss this in greater detail during his remarks. Our days sales outstanding in cash flow for the quarter were well below our expectations and I am very disappointed. Our DSOs a year ago were 77 days and we finished our second quarter this year much the same at 76 days. During this last quarter our days sales outstanding increased to 92 days and that is due to significant payment problems within the Department of State, our largest customer. It is not a problem on what we have submitted in invoices or the work we have done. It is a problem with their payment system. As you recall on a previous investor call we mentioned that in the spring of 2007 the Department of State implemented a new payment system and that payment system is still causing major payment delays. It has adversely affected all contractors providing services to the Department of State but it has an especially strident effect on DynCorp because of the large relative number of work we do for government in the civilian police programs. The Department of State is working with us in this regard. They recognize the hardship it is causing for all contractors and they are working diligently to correct these matters before the end of this quarter.

Being at a normalized outstanding rate of roughly 75 days would have added approximately $100 million to our cash balances. While today we have no borrowings outstanding on our revolving credit facility, at the end of the third quarter we had a need to borrow just over $13 million in that same facility. Even though we had a solid quarter our revenue came below where we thought it would. We also believe that softness will carry over into our fourth quarter as well. Accordingly we have lowered our revenue guidance for the year and narrowed our earning guidance toward the lower end of the range we discussed at the beginning of our fiscal year. That is something that I will talk about more at the end of our prepared remarks today and certainly during our question session. This condition is almost entirely the result of funding delays of one kind or another in programs that we won throughout the year. It is not based on things we lost. It is based on things we won but did not come to fruition for one reason or another most of which was politically driven at this point in time. The encouraging side of this is that we should realize this revenue in future periods especially in our 2009 fiscal year. It is not something that is gone forever; it is gone in the near term.

Before I turn to Mike for his part of the brief this morning and his part of the remarks, I would like to spend a few minutes talking about LogCap 4 and INSCOM. As most of you know both of those awards are mired in protests by the parties who are unsuccessful in winning these awards. We really don’t have anything new to report on the LogCap front as it works its way though this protest process. I will tell you that I hear periodically unofficial rumors that this will be addressed shortly within the next 2 months but again that is unofficially. We don’t have any official word at this point in time. On INSCOM, however, the Department of the Army has responded the second protest filed by L3 by asking both L3 and GLS, Global Lingual Solutions, that is DynCorps partnership with McNeil Technologies that won this contract, to provide additional updated information on both program costs and related past performance. That updated information was submitted yesterday and we anticipate a fast turn around by INSCOM in reevaluating and once again making an award. With that what I would like to do is turn the call over to Mike for his formal remarks and then I will get back to you when he has completed his part of this presentation this morning. Mike.

Michael J. Thorne

Thanks Herb and good morning everyone. As Herb mentioned our press release was issued last night and I hope everyone has had a chance to review the information. The press release does contain a lot of detail and I will try to address the highlights during my prepared remarks. For our third quarter of fiscal 2008 revenue increased to $523.1 million from $517.5 during our fiscal 2007 third quarter. Both operating segments contributed to this 1.1% revenue increase with government services growing by 0.4% and maintenance and technical support services revenue increasing 2.4 %. The drivers for this growth for government services were additional work supporting the international Airway Program in both Columbia and Afghanistan as well as added peacekeeping work in Africa. These increases were partially offset by reduced construction and camp support revenue in Iraq.

For MTSS we had added revenue for the LCCS program and new business growth in the aviation and maintenance service line. These increases were partially offset by temporary reductions in manning under the contract field team program. Operating income for the third quarter was $30.8 million versus $32.3 million in Q3 of fiscal 2007. Our EBITDA in the recent quarter was $44.3 million or 8.5% of revenue as compared to $44.9 million or 8.7% of revenue for the same quarter last year. Both operating income and EBITDA margins were down slightly due to increased SG&A costs related to two primary things. One was our Sarbanes Oxley implementation and the other was increased business development costs generated from all the proposal activity we have had recently, both new proposals and recompletes in terms of INSCOM and LogCap which were previously mentioned. Overall our contract performance remains very solid.

Now looking at our results on a year to date basis it is a similar story to what I have just discussed for the quarter with revenues for the first 9 months of fiscal 2008 increasing to $1.5669 billion from $1.5299 billion at the same time last year. Again, both segments showed revenue increases year to date compared to last year as government services up 0.8% and MTFS up 5.5%. GS revenue grew principally as a result of increased work supporting the international Narcotics Air Wing Program. For our MTFS the revenue drivers on a year to date basis are similar as for the quarter and include increases from LCCFs, additional support provided to the US Air Force C21 fleet which was partially offset by reduced manning under the contract field teams program.

Our operating income for the first 9 months was $97 million or 6.2% which both compare favorably to the $70.6 million or 4.6% we reported for the first 9 months of fiscal 2007. The improvement is due to solid contract performance and the elimination of $17.9 million in one-time charges that occurred last year. On a year to date basis our improved operating income lead to EPS of $0.67 per share as compared to $0.15 per share for the same period last year. The EPS for the first 9 months of fiscal 2007 was also impacted by one-time charges related to the completion of our initial public offering during May 2006.

Due to the large amortization expenses associated with our customer related intangibles that significantly reduces both our operating income and EPS we view EBITDA as the key metric of our financial performance. On a year to date basis our EBITDA is $135.3 million or 8.6% of revenue. Both of these numbers are improvements over the $107.7 million or 7% of revenue we reported for EBITDA in the first 9 months of fiscal 2007. As Herb discussed our DSO increased to 92 days from 77 days at the end our third quarter last year due to significant payment issues thins the Department of State. To provide more insight into this issue our DSO for all other customers which is primarily the Department of Defense was 75 days at the end of Q3 and 54 days for the most recently completed third quarter. As a point of comparison our Department of State DSO was 79 days as of Q3 last year and has now increased to 125 days. We are working diligently with the Department of State to correct this problem but many of the actions required to correct this issue are internal for the customer.

As Herb discussed every point along the process from initial contract funding, issuing contract modification, budget line items, invoice approval, and payment processing are done at a very detailed level that must match exactly in their new system. Prior to the implementation of this system last spring, the entire payment process was accomplished at a higher level with significantly less granularity. The customer has committed to get these issues resolved by the end of March and we are working closely with them to do anything we can to assist in this process. This DOS payment issue which has caused a significant increase in our DSO has also had a negative impact on working capital which has increased to $351 million for Q3 of fiscal 2008 from $283 million at the comparable point a year ago. As you would expect our cash and cash equivalents have similarly reduced from $102.5 million at the beginning of fiscal 2008 to $13.6 million at the end of our recently completed quarter. In addition at the end of Q3 we had $13.5 million outstanding under our revolving line of credit which has subsequently been repaid and as I think Herb mentioned we currently have no outstanding borrowings against the revolver. Our backlog remains strong at $6.3 billion as compared to $6.1 billion at the beginning of the fiscal year. Both of these numbers include INSCOM at $3.5 billion and $3.3 billion respectively. As mentioned the Army is currently reevaluating past performance and cost data in order to make a new award decision. With that I would like to turn the call back over to Herb for some closing comments. Herb.

Herbert J. Lanese

Thanks. As noted in our press release we revised revenue guidance for fiscal 2008 from $2.3 billion to $2.4 billion down to $2.5 billion to $2.75 billion. We have also narrowed the range for fiscal 2008 on EBITDA from $190 million to $200 million formerly to $190 million to $195 million now. Consequently our earnings per share also narrow from $1.00 to $1.10 as they were previously to $1.00 to $1.05. In spite of the many successes we have had in winning new work this last year contract funding delays affected our work in Afghanistan, Iraq, and Africa. They have resulted in delaying over $400 million of revenue into future periods. This is revenue that we fully anticipated that we would receive this year; item issues that are outside our control because of timing. Fortunately it is work we did win that we will see again. Fortunately, this doesn't impact the overall growth opportunities that we see ahead of us. Although we will present official guidance for 2009 fiscal year at our next earnings call, we believe that fiscal 2009 should again demonstrate significant improvement over fiscal 2008.

Before I open the call up to questions I would like to deviate a bit from the formal remarks this morning and talk about a few things that I think add some color to what I just said. I would like to expand on what we see going forward into 2009 without getting into guidance at this point in time. For example in Iraq and Afghanistan we have 750 and 550 trainers respectively in both countries. I think it is pretty widely understood that police trainers in Iraq needs to go to roughly 3000 and in Afghanistan to 2000 in order to enable the change that needs to take place in both countries from a security standpoint and to alleviate the dependence on foreign troops, largely American troops. We have heard that for a while. It is a timing issue and strangely enough it is bi-partisan supported as well too. That I think bodes for a very bright future for us, especially given the fact that we continue to get very strong reviews on our performance both in the training arena in both places as well as in security. If you remember earlier in the year there were a number of concerns raised about contracts in Iraq, especially Iraq but possibly in Afghanistan too in the personal security work. Those concerns were mostly highlighted by the issue regarding Blackwater and since September the killing of a number of citizens in Kabul. We have gotten rave reviews for our security work from both Minister of the Interior as well as from our US forces on the ground. Comments like best of breed, outstanding work. This is an area that we are very sensitive to and the fact that our performance has been strong I think bodes well for future work in this environment. In both countries we are really going beyond just dealing with the training aspects and US State Department supported work. We are working very diligently to build relationships in both countries with the governments to deal with both border security in both countries as well as to build on the military capability that need to be rebuilt if these are going to be independent sovereignties.

For example, in Iraq most of the Iraqi ground forces were destroyed during the last conflict. If they are going to be an independent nation again they need to have an independent military. They can't rely on foreign forces. It is more than the boots on the ground. We are working with a number of agencies to rebuild the ground forces there on future contracts. The same is true in Afghanistan, but Afghanistan its air related. It is not so much ground support. It is building if you will an Afghanistan air force. If you look at the capabilities DynCorp has, it fits our skill set extremely well. We have opened offices in Islamabad, Pakistan and Abydos, Ethiopia. That obviously is not something that is cheap to do and it has affected our short term profitability but the fact of the matter is we don't build cars or trucks or ships, we provide services and services means people. If we are going to expand in regions we have to do it though people. We have to have offices, we have to have presence. If you look at Pakistan, there is a tremendous need in Pakistan for improving capability if we are going to fight the war on terror, both for the Western world, but also in Afghanistan and Pakistan. The opportunities in Africa at this point in time are well recorded. The issue in Africa is when the timing will break to where we are able to do both peacekeeping work and humanitarian support work across a broad framework within the African continent. Again, for us to do that we need a presence. We are building that presence now.

If you look at the peacekeeping side one disappointment that we had that really affected the second half of the year dealt with a contract that we won in Sudan to do humanitarian work. We had 300 people prepared to go in on this contract and 1000 local people, that’s 1300 people, in Sudan to do humanitarian work on a contract that we won which is our first real if you will breakthrough into the whole humanitarian effort in Africa. Because of the conflict in the Sudan and specifically Darfur region that contract was put on the shelf. As a result 1300 folks from our standpoint were basically set aside until that contract is able to resurface. The resurfacing part I think occurs once we get a little more stability in the region. Still active peacekeeping in Somalia which is where we have a presence now is going to come up for competition again very soon as well as the whole humanitarian effort in Sudan and Darfur.

Lastly on the GLS and LogCap front. Even thought these contracts are currently in protest we have continued to spend money on these contracts to keep our presence, our team in place. I think it would be disastrous for us to break our LogCap and GLS teams apart and try to reconstitute them once we again are awarded these contracts which I believe very strongly we will be. We can talk about that more in the question period. Right now GLS and LogCap have absorbed $5 million to $6 million of expenses for us this last year with no revenue. Again that is an investment for us. These are long term contracts. As you know GLS is $4.5 billion approximately over the next 4 to 5 years. LogCap is $150 billion contract in a total ceiling over 10 years. These are awards that we have to invest in in terms of people and capability so that when the time comes that we are able to compete and perform we have the team in place to do that. One other minor point that is important for a company of our size, Sarbanes Oxley has taken up a big chunk of dollars for us in the past year and a half. In fact this year there is at least $3 million to $4 million that will not be recurring expenses going forward into 2009 as we qualify on April 1st for Sarbanes Oxley. That again, if you add all those up that is roughly $10 million of expenses that have affected us this year that are important expenses that won't be there in periods going forward. We will still have obviously Sarbanes Oxley expense but not the development costs that go with it. In most companies $3 million to $4 million of added expense isn't a big deal but we are a small company and to us that is important. With that what I would like to do is turn this over to our operator to go into the question session. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Lionel Jolivot.

Lionel Jolivot - Bank of America

Good morning. First on the linguist contract can you just provide a little bit more detail. You submitted a proposal. Did you make any changes and do you know why the Army came back and decided to actually grant an appeal to [inaudible] Communications?

Herbert J. Lanese

Sure, Lionel, I’ll tell you what I can. The Army was responding to the second protest that was filed by L3 and frankly I don't know the details of that protest but what I do know is what the Army decided to do was request clarification on two items. One was past performance and the other was cost data. They sent inquiries out to both subcontractors L3 and ourselves to respond to that. We did that the other day. In responding what we really did was give history more clarification on past performance on similar work that we have done both at DynCorp and McNeil Technologies who were the two partners and GLS and the second was cost data. We relooked at our cost data and made some changes in that. The purpose in this is to clear up the confusion or possibly failings in the evaluation process that lead to the second protests by L3. In doing that the Army requested that the GAO disregard the protests at this point in time, that they would address it through these two new items. We have basically done that and I'll tell you, I feel as good about our proposal today as I did when it was first submitted. If there is anything positive that’s come out of this, and there is not much by the way from our standpoint, it is the fact that each time there has been a resubmission, and there have been two now, and this now is the third, we continue to improve our proposal. We find things that we can do better and smarter because we have had our team in place. It has been expensive to have this team in place throughout the course of the year but at he fact is in having a team in place, they continue to question and challenge a number of the things we had in previous proposals and we are finding better and smarter ways to do things. Overall I still feel like this contract is ours. I think we will re-win it. I am very confident of that, but unfortunately I can't call the timing peace line.

Lionel Jolivot - Bank of America

On the working capital on the receivables front it seems that you have paid for your revolver in the first quarter since the end of December. Have you seen an improvement in the terms or in the day of retrievable with the DOS and you mentioned that they have committed to solve the problem by the end of March? Do you think this is a reasonable time frame for these guys? Should we expect a lot of the cash to come back by the end of your fourth quarter?

Herbert J. Lanese

On the first part of your question, Lionel, we have seen improvement. We were at roughly 92 days but our days outstanding with the State Department were much higher than that. The whole company was at 92 days but the State Department piece was much, much higher. This new system they put in place has been a disaster. It is not because they intended it to be so, but the overall coordination of putting in a new payment system for the whole department has run into all kinds of difficulties. We have seen improvement, they’re working with us, they are very sympathetic to this problem and they are working diligently to try to get this resolved. We are working also on our end to try to provide data in a format that makes it easier for them to pay our bills. In the meetings that we have had, we have had a lot of discussion with our customer in the State Department as well as with the payment office. This payment office by the way is in Charleston, South Carolina. The payment office again very sensitive, they are working with us closely. They have told us that they expect most of their problems to be cleaned up in mid February and that we will see this system correct itself by the end of the quarter. I hope that is the case but frankly I don't control that. From their standpoint when they pay us late, they pay us interest. So we get interest on this in terms of at least getting some compensation but it is very, very modest and it costs us much more to borrow money than it does relative to the interest that they pay us which is probably just over 4% I would guess. That is hardly anything at all.

Michael J. Thorne

Right, it is based on some treasury rate but it is pretty low.

Herbert J. Lanese

We have to take them at their word. It is good faith. They are doing the best they can I think, and I really do believe that. I think they are really working diligently to get this fixed but it's taking a real turn for us and we worked so hard on this I can't even begin to tell you with virtually no results. By the way, the fourth quarter also has the month of December in it. It is our third quarter but the fourth quarter of the year. On the fourth quarter of the year there are not a whole lot of folks working in government in the fourth quarter of the year. Even though we work during that time, there are a lot of vacations and things just did not get done. They didn't have the sense of urgency that we have.

Lionel Jolivot - Bank of America

Lastly for me I think you had a meeting yesterday with [Gold & England] to talk about the new legal framework in Iraq for private security companies. Are you in a position to talk a little bit about some of the changes in terms of this legal framework?

Herbert J. Lanese

Yes. I can tell you some of the things that we are doing and by the way, we fully support this. We have talked with the State Department, the Department of Defense and we had senior people at the meeting yesterday. I couldn't be there but we had some of the senior people in the company there. If you look at what they are doing, there are two things that are happening. One is better documentation which means cameras in all the vehicles. By the way, we went a head and did this a few months back so wee have cameras in our vehicles. We can record events as they occur. What they have also done is that they have included having a representative of either the State Department or the Department of Defense in these vehicles as well. We basically have an observer if you will. On top of that there is better record keeping that is part of this whole process as well. By the way something that I have said before is that I absolutely support applying US law to anyone in country who does anything that is untoward. I would not support having American citizens under Iraqi law but I would support American citizens under American law. We have never been opposed to that. Contractors shouldn't have immunity for doing things that they shouldn't have done. That is all our people. We spend a tremendous time on the front end educating our people as to the rules of the use of force and the rules of engagement. That is another thing that has been cleaned up because what was in Iraq before, I will just talk about Iraq now; there were the different rules for the use of force. There was the State Department rule for the use of force, there was the Department of Defense and the Provisional Coalition Authority rule for the use of force. Those are three rules that are similar in many respects but technically different. What we did as a company is look at all three and came up with our own rules for the use of force that used the most conservative aspects of all of them. We used rules in country that meet all 3. Not all the other contractors did that. From our standpoint, we really applaud this, we think it is the right thing to do and I think it will clean up a lot of the errant work that is being done now by people who are less than qualified I think. I don't think we fall into that category at all, quite the contrary.

Lionel Jolivot - Bank of America

Great, thank you very much.

Hal Lanese

You are very welcome.

Operator

Your next question comes from the line of Myles Walton with Oppenheimer Company

Myles Walton - Oppenheimer & Co.

Thank you good morning. Mike the guidance is suggesting a bit of a healthy rebound in margins in the fourth quarter. I am just wondering what programs in particular are driving that rebound or is it just the absence of this SG&A that you might have realized here in the third quarter. I think [SIV poll] is kind of working against you on a margin basis as it moves towards cost plus. If you could just walk through what is driving the rebound there.

Michael J. Thorne

It is a combination of things, Myles. Part of it is we don't expect to have quite the level of SG&A expenses we had in Q3. Also some of the new programs that we have ramping up are some higher margin programs. Included in that is that we have talked for several quarters now about this new program we have in the UAE called GMD where we maintain their vehicles. We have been doing that for about a year now but due to the structure of the contract we haven't been recognizing revenue on it. We will start doing that in January because the final deliverable has been made that allows us to start recognizing revenue. That will contribute to both revenue growth in the fourth quarter and it is a higher margin program. EMRAMP continues to ramp up so we will have increased revenue from EMRAMP and that is a higher margin program. The third one is that we have one construction program in Afghanistan and, I guess, a lot of potential there. As you remember awhile back we won a multiple award contract for construction in Afghanistan through the Corp of Engineers that is up to $1.8 billion over 3 years. That contract is limited to construction projects between $5 million and $25 million dollars. We don't have any work under that yet but we have won to build a garrison in Julalabad which was done by the same customer but it is outside that contract because the value is greater than $25 million that we started in December and a lot of that work will get done during our fourth quarter and again that is a higher margin program than some of our historical work. The other point I would make and I am sure you are aware of this is that typically if you look at the last couple years, our fourth quarter has been our strongest quarter also. I think that some of that is timing of things, there is a variety of reasons for that but we believe we will achieve what we put out there for the fourth quarter.

Myles Walton - Oppenheimer & Co.

Can you remind me at last year’s fourth quarter, was there a cost adjustment that drove up margins and what was the size of that?

Michael J. Thorne

I don't have any specifics on that Myles. I know last 4th quarter our EBITDA was $55.8 million. I don't remember anything specific that was out of the ordinary there but there is always some plusses and minuses every quarter

Myles Walton - Oppenheimer & Co.

Okay, that is fair. On the first program it seemed some of the contract awards start to come out on that. Have you seen stats this quarter that are of interest to you? I know that you were down selected last year and there hadn't been really a presence of new task orders on that program. Are you starting to see some flow there?

Michael J. Thorne

We are seeing a flow of task orders and the ones that we are bidding on, we have bid 3 or 4 fairly large ones that are what they call DOL programs. I think the one we are waiting to hear on Herb is Fort Benning?

Herbert J. Lanese

Benning is one.

Michael J. Thorne

Fort Benning and Fort Campbell are the two. I think we are waiting to hear on Fort Benning and Fort Campbell is trailing that a little bit but those are the ones we have been focused on at the moment under first.

Herbert J. Lanese

Myles if I remember correctly, first I think there were 15 awards, somebody protested.... 1 company our of 15 was not awarded. That company protested and they said, yes throw them in too. So it is this 15 companies that compete for these task orders. What we don't want to do is get into price shoot outs. We don't want to be pursuing low margin, low skill work so we have been very selective on the stuff that we go after because in that group of 15 there are a number of companies in there that really do commodity work. We do some of that but it has to have a strategic basis for us and so we are being a little more selective in that regard. With 15 companies a lot of the contracts being awarded task orders being awarded are being done on cost and that means low margin work that is not quality work. We really don't want to pursue that.

Myles Walton - Oppenheimer & Co.

That is fair. I just knew that the program was in and of itself in a bit of a holding pattern. I did start to see some task order flow. That was more the point of the question. Here is the last one for me directed to Herb. Could you get a little more specific on the funding timing and what is driving it? Is it different than funding timing issues you have seen in the past? Is it budget driven, is it policy driven? I guess it would be tied to [SIV poll] the Africa Sudan contract you talked about and maybe the WPPS. Does that compromise the bulk of where the delays are?

Herbert J. Lanese

In fact it is in three places, Myles. It is in Afghanistan, Iraq and Africa. Africa is obviously a continent. In the continent of Africa it is Sudan driven. We made a major breakthrough in winning a peacekeeping contract in Sudan, Darfur in the second quarter of the year. That required us to ramp up quickly with 1300 people which we did. We found 300 ex-pats if you will, not just US but from other western countries, 1,000 local people to go in and manage half of the 50 camp structure in Darfur which is a humanitarian disaster obviously. What happened shortly after we won the contract and we started to mobilize the conflict between Darfur, Somalia, and Chad began to escalate. It became very unsafe. As a result because of the security aspects of it, the State Department and rightly so, put that on hold. We are not going to send people into dangerous areas unless we are sure that they are safe. Even though we made this break though, and this is again1300 people, this is a big contract for us, that had been put in advance. What is going to happen now in the next few months is that there are three major contracts coming out in Africa. One is this multitask logistics contract in Africa that is going to be UN sponsored. A second is what is called Africa Peacekeeping which is a follow on to the work we are doing in Somalia. We are in Somalia right now with the presence coordinating the activities there on the ground between the government and the militaries that are in place, largely Ugandan and Ethiopian, also providing logistical support for them. The third is humanitarian. The logistics contract is $1.8 million over 6 years. The humanitarian contract again back in Sudan and Darfur is roughly $600 million over I think it is 3 years, Myles, 2.5 to 3 years. We are going to be back in the fray with that again fairly soon. They truly are delays. In Afghanistan and Iraq what is disappointing about that is that we actually won contracts and were given task orders to increase our presence both in trainers doing civilian police work in Afghanistan and Iraq and in border security personnel. That included building camps. In the case of Afghanistan it was building two new training facilities to train Afghan female police if you will. There are cultural reasons why you need to keep them separate as well as why you need female police in place in Afghanistan and probably Iraq as well too. If you have an issue like domestic violence a male police officer cannot talk to someone's wife when it comes to a domestic violence issue. Only a female can talk to a female if she is married. Those programs were all put in advance. I don't know if that is because of political infighting between the governments. Whether it was because of the slow process of getting the supplemental approved I am really not sure. I just know that they are real programs, we still have them but we haven't been given the green light to go ahead and begin work on them. We’re told that this is forthcoming. Those are the delays primarily. Those account for over $400 million in work that we thought we had this year, that we haven't lost but we just don't have it in this period and hence that is why we have revised down the revenue site.

Myles Walton - Oppenheimer & Co.

That is helpful. My last question; on the Iraq [SIV poll] I know that the task orders have been extended through February of ‘08. What is the update there and the latest update there and the expectations for how the DOS is going to handle that re-compete?

Herbert J. Lanese

We submitted probably a week and a half ago our latest submission on that task order, Myles. Afghanistan occurs later on in 2008 I believe in the summer of 2008. That may be re-competed at that time or extended. We just send our new proposal in. It is a much broader proposal because they include justice department training as well as police training there. Something called [inaudible] I think Mike. That has been submitted. We have orals which they have never had before. Not only do we have formal submission which was a 100 page submission but on top of that we have orals that we will be presenting as will the other competitors in the next week and a half. We are looking forward to that process and we feel pretty good about the work that we have done there. Obviously our performance has been quite good so from a past performance stand point it is going to be very helpful for us. Also we have a very good proposal in hand.

Myles Walton - Oppenheimer & Co.

You don't sense that there is any desire to break up the work you are doing in there.

Herbert J. Lanese

In fact that is a good question. They started doing that. They took the work that we did and they broke it into 5 pieces. They were going to have contractors compete for each of those pieces. It just didn't make any sense. You can't break up the stuff that we do. A logistics communication, security. This stuff really goes together. As they rethought that they basically reached the same point that we did. Now it is in two pieces I guess.

Michael J. Thorne

The training and all their support is 1 piece and then construction is the second piece.

Herbert J. Lanese

Exactly.

Myles Walton - Oppenheimer & Co.

Thank you again.

Michael J. Thorne

Myles could I just add one thing to what Herb has just said to be clear, our current task order there has been extended through the end of May.

Myles Walton - Oppenheimer & Co.

Thank you.

Operator

Your next question comes from the line of James Harlow with Stifel Nicolaus.

James Harlow - Stifel Nicolaus & Company, Inc.

Thanks for taking my call. As far as the contact field teams, it looks like the last two quarters or so there has been a reduced manpower on that contract. Can you tell us what I going on there?

Herbert J. Lanese

Right, James. As a matter of fact, that is another item area I didn't address. That has softened for us as well. We expected that to increase in terms of manning because again it is very people driven. What has happened is that there's been less of what I call reset work, that is the terminology. What that means is bringing equipment out of Iraq and Afghanistan to be refurbished. That has especially affected us in Germany where we have a large presence, Mike. In general we are seeing that build up again toward the end of our fourth quarter which is the first quarter of the calendar year. James that has been a soft area as well for us. It has fallen off a bit. We expect that to strengthen again. Mike, beyond that do you have any other color you can add to that?

Michael J. Thorne

That is right. It's ramping up now so we do think our fourth quarter will be stronger than either the second or the third quarter in terms of contract field teams.

Herbert J. Lanese

That James has been soft as well but not nearly as soft as my examples with Afghanistan, Iraq and Africa where we actually won pretty large contracts and after winning the contracts we are put on hold waiting for whatever to be resolved. In the case of this we are not really put on hold, these things go up and down on the CF key side of things fairly often but just not as dramatically as they have. We have lost roughly 10% of our work force there in the last 2 to 3 months again because of timing.

James Harlow - Stifel Nicolaus & Company, Inc.

Thank you. When is the re-compete for contract field teams?

Michael J. Thorne

The current contracts have been extended thought September of ‘08, September of this year. The RP is out, the proposals were submitted in December. They are currently being evaluated by the Air Force. I believe their schedule is to make the new awards about the June time frame. I believe that is correct.

Herbert J. Lanese

My understanding is summer as well, too. New awards will be made in summer. As Mike indicates we have been extended though September of next year.

James Harlow - Stifel Nicolaus & Company, Inc.

Thank you.

Herbert J. Lanese

You are welcome.

Operator

Your next question comes from the line of Joseph Vafi with Jefferies & Co.

Joseph Vafi - Jefferies & Co.

Hi gentlemen, good morning. All my questions have been answered, thanks.

Michael J. Thorne

Thank you Joe.

Operator

Your next question comes from the line of Louise Wager with Commerce Bank.

Louise Wager - Commerce Bank

Hi gentlemen. I just had a quick question to follow about the INSCOM contract. The protest I think the original contract was awarded in December of ‘06 and it was protested by L3. That took an exceedingly long time for the Army to decide what to do and when they did they re-competed it and you won it again. I am sure it is very frustrating for you that it was protested again but you seem very confident that this is different this time and that it is going to be resolved very quickly because it was focused on those two issues that you responded to. When you build your guidance for 2009 I am thinking that in 2008 you didn’t have that contract in there because of the protest. I think you had it in and you took it our of your guidance. Do you have any thoughts about what you are going to do for 2009 given a higher level of confidence for winning the INSCOM contract this year and the significance of the amount of revenues and the amount of impact that is on the company?

Herbert J. Lanese

Sure Louise. As a matter of fact, I agree with all your points. They’re right on. We won this contract. Our partnership, McNeil and DynCorp, won this contract in December and over a year went by before a re-award was made to us. Promptly after the re-award it was protested again, which by the way was L3's right. They have a right to protest which they did and I understand that. Unfortunately it has taken the Army a very long period of time to decide what to do about it. Hopefully, this will be a faster process. We did win the first time, we won again the second time. We have a better proposal the third time. I think we will win again. I don't see this going against us. I am very confident about this.

Louise Wager - Commerce Bank

Do you think they will protest… it is really impossible to say that they … Obviously this is a really important contract for them. I also heard that the employees that are on this contract… You said that you have the teams already lined up. If you win this contract will you be required to…. Will you need to take some of their people because I had heard that they said they were going to deploy their people in other areas if they did not win this contract? Those people would no longer be available.

Herbert J. Lanese

The answer is yes. We are going to use people that are already on the program. We are going to be selective who we use, but people who already have clearances, who are already in country. If obviously makes sense to try and use some of those people providing that they haven't been part of the performance problems that L3 has suffered. We certainly don't want to be hiring leadership that hasn't performed. They just got another cure notice about 1.5 months ago. When I get a cure notice anywhere in this company, it attracts my attention I have to tell you. That means that you have a black mark. They just got another cure notice. Now, if this is re-awarded to us for the third time, to answer your question can they protest? Yes, they can. Sure, it is their right. They have a right to protest as much as they like. I guess up to a point and even if they did protest and the GEO ruled against them, they could take it a step further and take it into federal court. That gets to be pretty foolish after a while. You have to realize in the business that we are all in; relationships are an important part of this. It is not good for our country or for the people on the ground, our troops who are at risk. To continue protesting a contract that the government doesn't want to award to you. It is pretty clear that they don't want to award this contract to L3 in my mind. It is pretty clear that they like our team, they like our work. Going back to your other question Louise, when we look at 2009, what we will do is break out the GLS, the INSCOM piece of this. We will talk about DynCorp without GLS. We will talk about DynCorp with GLS because it is consolidated. We own 51% of the partnership so we are consolidated in our books. We will tell you what that is and what that means. Again just for clarity, so we don't muddy things up, because it is a very large contract. Right now it is running between $700 million and $800 million a year for the incumbent. It is pretty significant. We are a small company. We are only $2.4 billion in size. For us that is a big deal.

Louise Wager - Commerce Bank

Great, good luck.

Herb Lanese

Thank you very much

Operator

Your next question comes from the line of Mike [Marionacci] with [inaudible] Rock Capital.

Mike [Marionacci] - [inaudible] Rock Capital

Hi, Mike, just a couple quick balance sheet things. Prepaid expensed have doubled year over year. It is getting to be a pretty big number. Can you just sort of break down what that is and why that is?

Michael J. Thorne

Yes I can Mike. A lot of that is related to the airport we are building in Nigeria and the structure of that contract. We are getting from a cash point of view we get all the money in advance from Nigeria. Based on customer approval we make certain advances to the subcontractors. Until they complete work it shows up as prepaid expenses on the balance sheet. That is the driving item there.

Mike [Marionacci] - [inaudible] Rock Capital

When might that number start heading in the other direction?

Michael J. Thorne

That number will head in the other direction during our fiscal ‘09. It probably won't move much during fourth quarter but it will start to drop during fiscal ‘09.

Mike [Marionacci] - [inaudible] Rock Capital

Given the problems with the accounts receivable at least from a collections stand point, can you just explain the rationale for the allowance having dropped so dramatically year over year or historically? You are allowing for essentially nothing.

Herbert J. Lanese

Pretty much all of our business currently is obviously with the US government. They are a very low credit risk and good paying customer, sometimes the timing is a problem. Even all these issues that we are dealing with at the Department of State currently they are not questioning our invoices in terms of, oh we don't owe you the money. They agree that they owe us the money. It is more the administrative and bureaucratic process of getting us paid. We don't think that there is any impact there. A couple years ago our allowance for bad debts was higher because we ha a brief period where we were doing some work in Iraq for some construction companies, providing security, life support services. We had a lot of trouble getting paid on. We have subsequently worked thought that and we are not doing that kind of work anymore. That is why you saw that higher in the past and why it is lower today.

Mike [Marionacci] - [inaudible] Rock Capital

All right. Thank you very much

Operator

Your final question comes from the line of Matt Vittorioso with Barclays Capital.

Matt Vittorioso - Barclays Capital

Good morning. I know that this has been talked about. I just want to rehash this for a second. Looking at your fourth quarter guidance we are looking at north of $60 million in EBITDA and better than 10% margin. I know that we are early on in the quarter, but how comfortable are you with that guidance and are we on our way to those numbers already?

Herbert J. Lanese

I feel comfortable Matt. We have spent a lot of time talking about this. There are some things that could go our way and improve that number. Obviously there is always timing that could go against you. At this point in time we think that is a great balanced number and something that we can achieve.

Michael J. Thorne

I agree with Herb. We are very comfortable with it. I am not sure about your comment north of $60 million. I think it is between about $55 million and $60 million if you do the math. The real point is that yes we are very comfortable with that.

Matt Vittorioso - Barclays Capital

As you collect this cash that is coming in from the DOS what is the priority there with the cash? Are you going to continue to pay down bank debt?

Herbert J. Lanese

Matt, we really need this for growth. If you look at our capital structure, and by the way that is something we have to address and we will. We need a better capital structure probably for supporting the growth that we see ahead of us in the company. Not only because of the GLS INSCOM contract but also because of the natural growth in the areas that I have talked about, we need to do a much better job in managing our receivables, our working capital. We also will need to deploy our cash to support working capital needs as we grow the company. Ideally we are going to use this in the company to invest in growth. We do have some requirements. Mike you know more specifics than I do on this. If we generate more cash over a certain amount that is required to be repaid in some form against our revolving term credit line.

Michael J. Thorne

Last year that payment was about $34 million or $35 million. I don't expect it to be anywhere near that large this year. That was a payment that occurred in the June time frame.

Matt Vittorioso - Barclays Capital

Then have you guys thought about addressing your capital structure in fiscal ‘09 then?

Herbert J. Lanese

Yes we have.

Michael J. Thorne

We are looking at a large variety of alternatives at the moment.

Herbert J. Lanese

As a matter of fact, Mike has been working on this for the last months. We would have probably moved a little more quickly had the credit markets not collapsed. There is a lot of credit worries and a lot of anguish in the market place right now. It is not a good time to be refinancing any company. In our case it is something that we need to go ahead with. We have a solid base at this point and we have a very bright future I think. I think we are in easy credit to finance given where we are going. It is just a matter of getting through the hurdles that exist in the market place today.

Matt Vittorioso - Barclays Capital

Terrific, thank you

Herbert J. Lanese

You’re welcome

Operator

This concludes the question and answer session. Mr. Lanese, do you have any closing remarks?

Herbert J. Lanese

Again thank you everyone for being on the call and for your support and participation. I am disappointed that we have needed to lower guidance here in the third quarter but I really believe as you can see it is on the revenue side. Our profitability continues to be good. We are really building solid fundamentals with the company. If there is one thing I have learned about this business and others I have been in the defense arena, fundamentals are everything. You have to have solid performance. You need a solid balance sheet. You need to be winning programs that are profitable. You just don’t win programs to get revenue, you need to get quality revenue. We are doing all the right things and we are investing in all the right places. Some of that investment has caused some short term expenses to affect our bottom line in this last year, but they are things that are going to pay big dividends for us going forward. I feel really good about that. I think you will continue to see very solid growth in fundamentals in this company. That is what I am here to do. I am here to build long term value. Unfortunately, this quarter was a little bit weaker than we had anticipated it would be, but if you look at this year versus last year, we are having a very good year overall. It is going to be a strong year performance wise and next year is going to be better yet. Next time I talk to you we will get into some specifics on that and we will tell you why. Hopefully some things will be cleaned up by then. Hopefully GLS will be cleaned up by then and we will be able to move forward with the INSCOM contract and hopefully some of these other contracts that we are working on that I really can't talk about will be finalized too and that will bring some positive news as well. With that, thank you very much for your time today.

Operator

This concludes the DynCorp International fiscal year 2008 third quarter conference call. You may now disconnect.

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Source: DynCorp International Inc F3Q08 (Qtr End 12/28/07) Earnings Call Transcript
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