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Executives

Cindy Roberts - Director of Investor Relations

William L. Ballhaus - President, Chief Executive Officer

Michael J. Thorne - Chief Financial Officer

Analysts

Erik Olbeter - Pacific Crest Securities

Myles Walton - Oppenheimer & Co.

James Harlow - Stifel Nicolaus & Company, Inc.

Richard Safran - Goldman Sachs

Joseph Vafi - Jefferies & Co.

Matt Vittorioso - Barclays Capital

DynCorp International Inc. (DCP) F4Q08 Earnings Call May 29, 2008 8:30 AM ET

Operator

At this time I would like to welcome everyone to the DynCorp International fourth quarter and fiscal 2008 year end earnings conference call. (Operator Instructions) Now I would like to turn the call over to Cindy Roberts, Director of Investor Relations. Ms. Roberts, you may begin.

Cindy Roberts

Thank you, Angela, and good morning, everyone. I would like to welcome everyone to our conference call today. This morning we are here to discuss the company's fiscal 2008 fourth quarter and full fiscal year financial results, which were released last night.

With me today are DynCorp International's President and Chief Executive Officer, Bill Ballhaus, and Chief Financial Officer, Mike Thorne. After management has made their formal remarks we will take your questions, but before we get started I would like to take care of a few housekeeping items.

In our remarks today we will include statements that are considered forward looking within the meaning of federal securities laws. The forward-looking statements are based on management's current knowledge and expectations and are subject to certain risks and uncertainties that may cause actual results to differ materially from the forward-looking statements. A description of the risk factors can be found in our earnings release issued last night and in our SEC filings. The company undertakes no obligation to update any forward-looking statements.

Before I turn the call over to management, I would like to introduce our new CEO, Bill Ballhaus. Bill started his career with Hughes Space and Communications and subsequently became part of Boeing due to the acquisition of Hughes. In 2003 Bill left Boeing and joined BAE as President of their Mission Solutions division and then Systems' National Security Solutions. Recently he served as President of its Network Systems division prior to joining DynCorp International. We are delighted to have Bill on board.

And now, with those formalities out of the way, it is my pleasure to turn the call over to Bill. Bill?

William L. Ballhaus

Thank you, Cindy, and good morning everyone. I'm glad you could be with us. In this morning's call I'll provide an overview of our performance for the fourth quarter and the full fiscal year 2008, hand it over to Mike to talk about the 2008 financials in greater detail, and then I'll complete our prepared remarks with a look ahead to our guidance for fiscal 2009.

But before I do so, I have three introductory comments related to my transition into the CEO position, announced just over two weeks ago.

First, let me start by saying that I'm absolutely honored to be part of the DynCorp International team, and I'm proud to have the opportunity to lead this great company. As many of you know, I've worked my entire career in the defense and aerospace industry. In that time, I've never worked for a company whose employees make such a direct, firsthand contribution as our employees do at DI. Every day our 15,000 men and women stand shoulder to shoulder with our customers, supporting and sharing their critical missions and enhancing security around the world. I can't imagine a more noble cause or a team that I could be more proud to be a part of.

Second, from my perspective as the new CEO, this is an exciting time to be at DynCorp. While this past fiscal year we've had our share of challenges in the marketplace, mostly driven by timing and program delays, we currently have all the portfolio programs, contract vehicles and market positions, including new contract wins, that will fuel significant year-over-year growth in fiscal 2009 and provide momentum going forward.

And third, with respect to transitioning into the CEO role, I can't imagine better timing for the transition, primarily because our business success drivers or what we need to do to be successful are pretty clear from both a tactical perspective to deliver on our FY2009 guidance and strategically to deliver continued profitable growth over the long term. And I look forward to sharing my thoughts on our go forward priorities while discussing guidance for 2009 later on in the call.

Now let's talk about fiscal 2008 results. From an operational results standpoint, we had a good fourth quarter and full year fiscal 2008. Our Q4 revenue was $572.9 million, an increase of $20.6 million or 3.7% over Q4 of fiscal 2007.

Our EBITDA was $39.6 million or 6.9% of revenue. Q4 EBITDA was negatively impacted by $15.9 million due to two onetime events that were mentioned in last night's press release and which Mike will cover in more detail shortly.

Our cash flow from operations for the quarter was $91.6 million, and we finished the year with days sales outstanding of 73 days. Both of those metrics reflect a significant improvement in Department of State receivables, which you may remember adversely impacted cash flow and DSS during our fiscal third quarter.

Before I turn the call over to Mike for his part of our discussion this morning I'd like to spend a few minutes talking about two topics - first, contract wins since our last call, both recompetes and new contract wins, and second, provide background on our recently announced reorganization.

First in terms of task orders on existing contracts and recompetes, our most significant win was the Iraq task order under Civ Pol. We've been performing this training mission in Iraq under Civ Pol and predecessor contracts since April 2003, and this task order win extends our performance until February 2010, or a total period of almost seven years.

Turning to new contract wins, the U.S. Army awarded a contract for management of translation and interpretation services in support of Operation Iraqi Freedom to Global Linguist Solutions, a joint venture formed by DynCorp International and McNeil Technologies. The five-year contract with a ceiling value of $4.6 billion was awarded by the U.S. Intelligence and Security Command, INSCOM.

Under the contract, GLS provides foreign language interpretation and translation services to the U.S. Army and other U.S. government agencies supporting OIF, including embedded Iraqi translators who operate with U.S. forces. This contract was originally awarded to GLS in December 2006 and was subject to a series of protests, proposal resubmissions and customer reorg decisions that are now favorably resolved. GLS assumed full operational responsibility for the program on May 1 and is currently completing the final stages of the successful transition.

Another important win for DynCorp was LOGCAP 4. The U.S. Army selected DynCorp International as one of three providers of logistics support to the U.S. Army under the LOGCAP 4 contract. The LOGCAP 4 contract has a term of up to 10 years and a ceiling of $5 billion per year for contractors. Under this multiple award, IDIQ contract, DI will support U.S. forces worldwide with immediate focus on those deployed in the Middle East.

This contract award was initially protested and following a further round of proposal submissions and customer reevaluation, we were again awarded the contract. We expect the customer next month to clarify the timeline for task orders under LOGCAP and do not expect any significant revenue contribution until late in the fiscal year. However, we expect the potential impact of LOGCAP in our fiscal 2010 to be significant.

In addition to the INSCOM and LOGCAP contracts, the U.S. Army Corps of Engineers awarded DynCorp International a $30.3 million construction contract in Konduz, Afghanistan. We also received our first task order under the Army Corps of Engineers multiple award task order contract for a construction project in Bermel, Afghanistan. These are the second and third projects for the Army Corps of Engineers awarded to DynCorp International in recent months for construction in Afghanistan. We expect construction projects in Afghanistan and other conflict areas to be a growth area for fiscal 2009 and beyond.

Other new wins include a director of logistics task order under the Field and Installation Readiness Support Team first contract to provide services at Fort Campbell, Kentucky. This contract is for base year and four option years, with an estimated value of $114 million if all options are exercised.

Another win is an award by the U.S. Navy to provide support services to the Joint Task Force in the Philippines. This contract is valued at $16.3 million for a seven-month base and contains four 12-month options which, if exercised, will bring the estimated award value to more than $164 million.

Finally, as described in an earlier press release, based on the growth of the business and these new contract awards we realigned our business from two to three reporting segments beginning in FY 2009. The Maintenance and Technical Support Services or MTSS unit is largely unchanged. The former Government Services unit has been divided into International Security Services, or ISS, which includes Civ Pol, the INL AirWing drug eradication work, and the GLS joint venture as its principal business areas. The other new segment is Logistics and Construction Management, which includes the LOGCAP contract, construction work primarily in Afghanistan, and contingency on logistics efforts in Africa for the Department of State and international organizations.

We believe this alignment strengthens our management of existing programs and better positions us to grow the company going forward.

Now I'll turn the call over to Mike for a more detailed discussion of our financial results and then come back to provide some color on the guidance that was included in our press release yesterday. Mike?

Michael J. Thorne

Thank you, Bill, and welcome aboard. We are certainly excited to have Bill as part of our leadership team.

As Bill mentioned, our press release was issued last night, and I hope everyone has had a chance to review the information. The press release contains a lot of detail, and I will try to address the highlights in my prepared remarks.

For our fourth quarter of fiscal 2008, revenue increased by $20.6 million to $572.9 million from $552.3 million during our fiscal 2007 fourth quarter. Both operating segments contributed to this 3.7% revenue increase, with Government Services growing by 4.9% and Maintenance and Technical Support Services revenue increasing 1.4%.

The primary driver for the growth for Government Services was additional construction work for projects in Africa and Afghanistan. For MTSS, we had added revenue for the MRAP program and continued increases in service support levels caused by high demand for equipment overhaul services, primarily for deployments in Iraq and Afghanistan.

Operating income for the fourth quarter was $23 million versus $42.9 million in Q4 of fiscal 2007.

Our EBITDA in the recent quarter was $39.6 million or 6.9% of revenue as compared to $55.8 million or 10.1% of revenue for the same quarter last year.

Both operating income and EBITDA were down for three primary reasons. First, in Q4 of fiscal 2007 we recognized $10.4 million of operating income and EBITDA related to two claims on two aviation contracts. The second fact was a recent adverse decision in a lawsuit brought by a former subcontractor which we plan to appeal and other unrelated legal costs that resulted in a total reduction to both operating income and EBITDA of $12.5 million.

Lastly, the company operationally supported the rapid startup of transition activities under the linguist and translation services contracts awarded to the company's majority owned joint venture, GLS. During the fourth quarter, our support of the transition activities did not result in corresponding revenue due to the protest filed by the incumbent contractor and an associated stop work order issued by the customer. As a result, our Q4 operating income was negatively impacted by GLS losses totaling $6.7 million, including $3.3 million of minority interest related losses.

Now turning to the full 2008 fiscal year results as compared to fiscal 2007, revenue for the full year of 2008 was $2.14 billion or an increase of 2.8% over fiscal 2007. Key items driving the revenue growth under the Government Services segment were increases in construction in Africa and Afghanistan in addition to increases in our drug eradication services. These increases were partially offset by a decrease in our law enforcement and security services due to the transition of our operations in Iraq from leased facilities to customer-provided facilities and the conclusion of contingency and logistics services provided after Hurricane Katrina in 2007.

The MTSS revenue growth was driven by increases in support requirements associated with our life cycle contractor support program primarily for deployment in Iraq and Afghanistan and increased work associated with MRAP, and also the new threat management systems within our aviation and maintenance services. These increases were partially offset by a temporary decline in personnel and services provided in association with our field service operations, which was a result of longer deployment cycles of equipment in Iraq and Afghanistan.

Operating income for the recently completed year was $120 million as compared to $113.5 million during fiscal 2007 or an increase of 5.7%.

Earnings per share was $0.84 per share for fiscal 2008 as compared to $0.49 last year. EPS was favorably impacted by the improved operating income that reflects year-over-year revenue growth and improved cost of operations primarily resulting from strong contract performance combined with the elimination of nonrecurring write-offs from contract losses occurring in fiscal year 2007 in our law enforcement and security services unit, nonrecurring costs associated with severance expenses for certain former executives and bonus compensation associated with the company's IPO from fiscal 2007 and year-over-year depreciation and amortization. These items were partially offset by the legal costs and GLS transition costs previously discussed.

EBITDA in fiscal 2008 increased 7% to $174.8 million or 8.2% of revenue compared to EBITDA of $163.4 million or 7.8% of revenue in fiscal year 2007. EBITDA growth was primarily driven by our improved operating income, which I just described. These operating income improvements were partially offset by nonrecurring legal expenses and GLS transition costs totaling $15.9 million of EBITDA. Without these two nonrecurring items, EBITDA would have been $190.7 million or 8.9% of revenue.

Our operating cash flow for the year decreased 51.2% to $42.4 million as compared to $86.8 million in fiscal 2007. The decrease was driven by increases in working capital, primarily increased accounts receivable offset by higher net income.

Looking at the balance sheet, we finished the year with net receivables of $513.3 million, which resulted in days sales outstanding or DSO of 73 days. This was a net increase of 6 days from fiscal 2007 year end and was primarily a result of the timing of certain collections.

Our net debt at year end was $507.8 million, a reduction of $20.7 million year-over-year. Our current credit agreement was put in place over three years ago, and given our expected growth in 2009, we are promptly exploring alternatives to revive or replace our current credit agreement to provide adequate liquidity to support our growth going forward.

The next topic I would like to cover for fiscal 2008 is a quick discussion of two key non-financial metrics  backlog and estimated remaining contract value.

Our backlog as of March 28, 2008 was $6 billion in total of which $1.2 billion is funded. The decrease in backlog is primarily due to the general shift to IDIQ contracts, which generally consist of short-term task orders that do not have a significant impact on backlog.

The last topic I will discuss before turning the call back to Bill is the contract type and financial arrangements for our two large recently awarded contracts, INSCOM and LOGCAP 4, and how these contracts will be reflected in our financial statements going forward.

As we have discussed, the INSCOM contract was awarded to a joint venture called GLS in which DynCorp International owns 51%. This JV will be consolidated in our financial statements, and minority interests will be deducted after the tax provision to arrive at net income available to common shareholders. A reconciliation to arrive at EBITDA will only include our portion of the GLS earnings.

In terms of LOGCAP, DynCorp International is the prime contractor so, of course, all the revenue will be included in our financial statements. In addition, we have two key subcontractors who are also teaming partners. Based on our agreement with these two teaming partners, they will get 60% or 30% each of the earnings on the contract and also provide 60% of the working capital required to support the contract. Therefore, we will recognize 40% of the total contract earnings in our financial statements and also only be required to provide 40% of the working capital.

In summary, fiscal 2008 was our strongest financial year ever, and with the recent contract wins, I believe we are well positioned for excellent growth in fiscal 2009.

And with that, I'll turn the call back over to Bill to provide some insight into what we are expecting for the coming year and a few closing remarks. Bill?

William L. Ballhaus

Thanks, Mike.

Despite the effect of a few one-time events in Q4, fiscal 2008 was a record year in terms of revenue, EBITDA and EBITDA margin. Let me now spend a minute talking about the business going forward.

From a strategic perspective, we're focused on continued profitable growth with two primary objectives - first, in the near term, maximizing the value of our current portfolio of programs, contract vehicles and market position, and second, continuing over the longer term to broaden our service offerings and diversify our customer base.

We've made good progress organically in our diversification in areas like translation services through GLS and in our Afghan construction work for the Army Corps of Engineers, which leverages our security services, logistics and construction management capabilities.

Going forward, we'll look to continue to move into adjacent customer spaces and offer new complementary services through both organic growth and through appropriately sized bolt-on acquisitions.

Specifically with respect to fiscal 2009, our focus for the year will be on relentless execution in three primary areas  first, completing our successful transition on GLS and continued strong performance, second, positioning to win and perform LOGCAP task orders late in the year, and third, winning new contracts and task orders for construction in Afghanistan and [inaudible] on Civ Pol and CFT.

In fiscal 2009, we expect significant revenue and EBITDA growth. In terms of revenue we expect our fiscal 2009 results to be between $2.825 and $2.925 billion. We expect GLS to contribute approximately $600 million in revenue for the fiscal year. In addition to the positive effect of GLS, we expect fiscal 2009 to benefit from a modest contribution from LOGCAP late in the year, growth in our Afghanistan construction work, and maintaining our base on Civ Pol and contract field teams.

We expect our adjusted EBITDA for fiscal 2009 to be between $205 and $215 million, which results in lower margins than fiscal 2008. This is driven mainly by the contract type, cost-plus award fee, and our sharing of profit in GLS.

We've experienced strong margin growth for the last several years, and a primary contributor to this growth has been a decline in the percentage of cost-type contracts and the increased in our fixed-price or time and material contracts, which typically have both higher risk and higher margins. Since the INSCOM contract is a cost-plus award fee contract and a major contributor to our expected fiscal 2009 results, our margins will decline in fiscal 2009. The INSCOM contract is still a positive contributor to both EPS and overall value and is a great addition to our diverse mix of contracts. In addition, we will recognize 51% of the earnings, consistent with our ownership in GLS.

Our earnings per share will be between $1.25 and $1.35 per share.

So with that, I'd like to turn this over to our operator to manage a question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Erik Olbeter - Pacific Crest Securities.

Erik Olbeter - Pacific Crest Securities

When you think about what you want to do in terms of [inaudible], I know you've only been there for a couple weeks but are there things you see right now that you think can make the company perform a little bit better, run a little bit more smoothly, changes that you want to make sort of in the short term?

William L. Ballhaus

As I said in the prepared remarks, what we need to do to be successful in 2009 is pretty clear, and the first thing that as a new CEO coming in I want to make sure is in place is that we have an absolutely relentless focus on performing, an absolutely relentless focus on performing, and that's on the key drivers with respect to our plan in 2009.

And I mentioned what those are. They're GLS in the near term, making sure that we successfully complete the transition, which we will at the end of this week. We'll be at, I think the number's 8,350 total staff, 8,200 linguists.

Secondly, making sure that we're very proactive with respect to LOGCAP, and as we said in the script, that won't be a major contributor to 2009 but it'll give us great momentum going into 2010, and we expect it to be a significant contributor in 2010.

And then third, with respect to new business and recompetes, having an absolutely intense winning mindset with respect to winning those new business opportunities that largely are right in front of us. And we're waiting to hear on a number of task orders now; we have a handful that are coming up.

So I'd say, Erik, first and foremost what I'll be looking for is to ensure that, from a leadership perspective, a team perspective and a mindset perspective, we have a culture here in this company that is absolutely relentless on meeting our commitments to our customers and, in turn, to our shareholders.

Erik Olbeter - Pacific Crest Securities

Going back to the press release announcing your arrival at the company, there was discussion by the chairman talking about the possibility of driving DynCorp, if you will, sort of up the value chain, sort of taking advantage more of your IT background in getting more involved in some areas that right now the company isn't involved with. How much of that is a focus of the chairman and of yourself as you transition?

William L. Ballhaus

Well, as I said earlier, there are really two areas that we're focused on. One is that relentless performance and execution in 2009, and then secondly, from a strategic perspective, to continue the diversification of our portfolio of services that we bring to the marketplace and customers that we serve. And over time we're going to continue to look hard at and work on that diversification.

And I think at this point, being two weeks into it, it would be premature for me to offer any specifics in that regard other than to say those expansions or those moves in the marketplace will look like one of three types of moves. The first would be leveraging the synergy that we have in our existing portfolio, and I think the Afghan construction work is a great example of how we've been to do that, leveraging our security work, our logistics work, and our construction management work.

I think the second are that we'll continue to look to make progress in is through partnerships, like we did with McNeil on GLS.

And then the third is through acquisitions. And we're always in the mode of evaluating acquisition opportunities that create value for our shareholders. We will continue to do that.

But now that I've mentioned acquisitions twice in this call, I want to come back and say our primary focus right now in the near term as a leadership team is on executing on our plan and delivering the organic growth that's right in front of us.

But clearly, the move towards diversification into new areas, leveraging our core business as a foundation, is a top strategic priority for the chairman, for myself and for the DynCorp leadership team.

Operator

And your next question comes from Myles Walton - Oppenheimer & Co.

Myles Walton - Oppenheimer & Co.

Mike, you actually mentioned looking at liquidity for 2009's growth and beyond. Could you just talk about some of the options that you're considering as you look to change your credit facility structure?

Michael J. Thorne

Yes, I can, Myles. I won't get into a lot of detail, but I do want to make it clear the options we're considering are strictly on the debt side. We're not looking at anything that would involve equity, which I know is possibly a concern to some folks. So they're strictly limited to the debt side of things.

But we're just looking, like I said, to increase our liquidity to support these programs. And as I mentioned, that could take many forms. We could amend our current credit agreement. We could put a new credit agreement in place. We're exploring all of our options at the moment, but limiting it to debt options.

Myles Walton - Oppenheimer & Co.

And with respect to cash, you had a nice rebound in the quarter on the receivables side. Is that a permanent fix you've put in place by now or is it still kind of a stop gap measure? And also, what is the outlook for fiscal 2009's cash flow?

Michael J. Thorne

I guess I would classify where we are at the moment as part way there to the permanent fix. We've done some things manually, both with us and the customer, to help keep invoices processing and getting paid, but there are some system changes that the customer's putting in that are supposed to be done towards the end of June. So from that perspective, I'd say we're not all the way there yet. We also are renewing the emphasis internally to make sure we're doing all we can internally to get invoices submitted timely and accurately.

Looking at FY '09, our estimate for operational cash flow I think is fairly minimal, somewhere between breakeven and $25 million. And that's because obviously with the large ramp up in revenue it's going to drive a working capital requirement, so that's where a lot of the cash will go next year as we build up the business.

Myles Walton - Oppenheimer & Co.

So it looks like working capital growth of $120 million, something like that?

Michael J. Thorne

Right.

Myles Walton - Oppenheimer & Co.

I'll add, Myles, we think we're maybe a little conservative on that but until we get the process rolling on INSCOM  it's a new contract with a new customer and a very large contract - so until we get a track record of invoicing and getting paid with them, we're being a little conservative.

On the positive side, obviously the INSCOM contract is with the Department of Defense, which historically has had a much better process, a much more defined process and few payment problems than we've seen with some of our other customers. So I think that's on the positive side.

Myles Walton - Oppenheimer & Co.

And the $6.5, $6.7 million cost on the startup for Linguist, is that a forward billable, a recoverable expense at some point or was that work that you did with the stop work order in place that you can't bill back at a later date?

Michael J. Thorne

Right. It's work we did when the stop work order was in place. Whether there's any potential to get that in the future, we may explore that. But we made the decision - and I think it was probably the right decision in hindsight  but the customer wanted the transition to go very quickly. And as it turned out, it did.

But with the stop work order we made the decision to keep plowing ahead, believing that would be a short-term event. It went on a little longer than we anticipated, but it did achieve the end result in that the transition, we took over full performance on May 1, which was very quick after all the issues were resolved, and as Bill said, we'll complete the transition in another week or so.

So it did accelerate the transition. I think it did help get the contract moving forward, but at the moment that was costs we incurred during the stop work order so it's not recoverable.

Myles Walton - Oppenheimer & Co.

And then, Bill, I guess lastly for you, you mentioned the LOGCAP 4 expectations for late in '09, and I think KBR's LOGCAP 3 effort actually expires the end of August. And so I guess are you expecting that that will extend for KBR and the task orders won't come out as quickly or are you just being conservative? And also, it looks like maybe it's $100 million or so of revenue that you're assuming for LOGCAP. Is that about right, in the 2009 guidance?

William L. Ballhaus

Yes, well, first, to answer the last part of the question, without being specific on it, it is in that range.

We are deliberately being conservative on LOGCAP, and the reason for that is we want to understand over the next few months how the transition actually will unfold. And we're actively in discussions with the customer, as are the other two contractors on that, on LOGCAP 4, in understanding that transition. We had a real good meeting yesterday. There's actually a draft RFP out right now on the first task order. We've got another session, in I think it's four or five weeks, with the customer, and we're starting to get some clarity on the transition plan. It will involve first work in Kuwait and Afghanistan, then Iraq.

That all said, I'll reemphasize we're taking a pretty conservative deliberate view on LOGCAP this year until we really understand the specifics of the timing with respect to task orders. We have some certainty around when they're coming out and what they are because there are two drivers here - one is the task orders that are released, and then the second is the scope and content of those task orders and how competitively we're positioned to win that work. So until we get a better handle on how that will unfold, probably over the summer and into the fall we're going to maintain a conservative posture on LOGCAP for 2009.

That said, we're really pleased that we're prime, one of three on that contract, and we expect LOGCAP 4 to be a source of our continued growth going into fiscal year 2010 and beyond.

Myles Walton - Oppenheimer & Co.

If you conceptually looked at the KBR $4 billion annual sole source revenue on that, about how much of that would you say is addressable market that DynCorp would consider competing on task orders for? Is it all of it, is it [half] of it?

William L. Ballhaus

Well, Myles, I think what's really relevant is how it unfolds over time and how the work gets transitioned. And as I said, I think personally I'll have a much clearer picture of that over the summer, but I think we believe that a pretty good percentage of that work is work that we can compete on. And that was fundamentally the intent of putting the LOGCAP 4 contract in place. It was to increase the competitive landscape and offer the customer best value through a competitive process.

So we expect to be on the playing field competing for a good portion of the work that's coming down the pipe.

Michael J. Thorne

Just, Myles, I would just add to that, I mean, between us and our two key teaming partners, we're not at the moment aware of any piece of LOGCAP we can't compete on. Conversely, I think Bill's point, until we see how they slice and dice the task orders, there may be some kind of one-off ones that are structured that aren't a very good fit. But in general we're not aware of any work scope under the LOGCAP contract that we won't be able to compete for.

Operator

Your next question comes from James Harlow - Stifel Nicolaus & Company, Inc.

James Harlow - Stifel Nicolaus & Company, Inc.

I just have two quick questions. One is can you talk a little bit about the pop in MRAP revenues this quarter, how that unfolded?

Michael J. Thorne

Yes, I can do that James. It's Mike. It's just the continued ramp up of the program. We're supporting the NAVSTAR vehicles in Iraq, and as they manufacture and deliver more and more vehicles and deploy more and more vehicles, it drives more requirement on our side for support personnel moving into Iraq with those vehicles.

We've had a good ramp up on that, and we expect that to continue to grow into our fiscal '09.

James Harlow - Stifel Nicolaus & Company, Inc.

I know you had talked in the past about possibly doing work for other producers of MRAPs. Has that unfolded at all?

Michael J. Thorne

There are some discussions going on, but nothing is materializing at this point on that, nothing that I would call near term.

I will add, James, we're expecting a couple RFPs to come out, one from the Army and one from the Marine Corps, to provide CLS or contractor logistic support for all the MRAP vehicles of those two services. So we're expecting those to come out. We will anxiously look for those to bid them, but they're not out yet.

James Harlow - Stifel Nicolaus & Company, Inc.

And lastly, what was the reason for booking the lawsuit reserve in the fourth quarter when it was more of a first quarter event?

Michael J. Thorne

It goes to being what they call a Type 1 subsequent event. But basically, because the lawsuits were already out there and sort of an ongoing activity, the fact that the jury decision occurred prior to filing our financials in essence drives the requirement that we reflect that in our FY '08 results.

Operator

Your next question comes from Richard Safran - Goldman Sachs.

Richard Safran - Goldman Sachs

First is I think it was pointed to previously that you thought that GLS was running about $700 to $800 million for L3, and I think that you're now saying you expect it to be about $600 million so I was just wondering if this is indicating a decline in the demand for the translator services, and should we be thinking that the contract has peaked in revenue?

William L. Ballhaus

Again, I think this is an area where, because the contract is new, we're ramping up and transitioning, I think we're taking a deliberate and conservative view here. We, at the end of this week, as I said earlier, we will have effectively transitioned 8,200 linguists, the total program staff of I think 8,350 when you include other management, etc., and we'll now begin the process of ramping up to the approved rate, which is 9,200.

So if you just do the math based on where we currently sit, the revenue potential for GLS this year is higher than the $600 million that we mentioned. We just want to make sure that we keep the team focused, we continue to execute and we keep overdriving the fill rate targets that we've established.

So I would characterize our position as the potential not being capped but us taking a fairly deliberate view at this point in time. A quarter from now we'll have a couple months of performance under our belt. We'll get to assess how we're performing on the fill rate and overdriving the current level of 8,200 towards the 9,200 that are approved, and we'll be able to reassess our position at that point in time.

I hope that provides a little clarity on not only where we are but how we're viewing GLS relative to our guidance.

Richard Safran - Goldman Sachs

And assuming I did the math here correctly, ex Linguist and ex LOGCAP it looks like the rest of your business is growing about 5%. So assuming you agree with that number, is that lower than you actually had originally expected? And that's 5% year-over-year of fiscal '09.

Michael J. Thorne

I think you did your math correctly, Richard. What we've seen in the past year or two, we've seen continued delays in government awards and/or awards being made and delays in funding or delays in task orders. So I think we're taking hopefully a fairly conservative view on things early in the year.

We have a lot of key awards coming up in the next 90 days. We'll know about the contractor field teams recompete; we'll know about the war reserve material recompete. We've got several other bids in on Afghan construction work, which we've had some success on.

So kind of to follow up on Bill's point, I think basically we're taking a somewhat conservative view of things with the expectation that we'll have a lot more clarity on what the year's going to look like in 60 to 90 days.

William L. Ballhaus

Yes, I'd just like to reinforce what Mike said. From my perspective, in the next 60 to 90 days we'll understand where we are on Civ Pol and Afghan task order recompete. As you know, we were successful in winning the recompete in Iraq, and we're going through the process now of - and we turned in the proposal last week; oral's this week, we're going through Q&A  and so we'll find out fairly shortly on Civ Pol Afghanistan; CFT, as Mike mentioned.

And also Afghan construction, which has the potential to be a growth driver of this business substantially higher than the 5% number that you mentioned, we currently have, I believe the number is 10, task orders that are outstanding just in Afghanistan construction. We'll know where we sit on those in the next 30 to 45 days, and again, I think we'll be in a much better position to reassess where we think we'll end up in '09 and our position based on our success in the marketplace in the very near term.

Richard Safran - Goldman Sachs

And just lastly, CFT, is the Air Force looking like, based on what you know, is the Air Force looking like it's going to hold to June?

Michael J. Thorne

I think the last date I heard, Richard, was the first week of July. So close, yes, that's our indications.

Operator

Your next question comes from Joseph Vafi - Jefferies & Co.

Joseph Vafi - Jefferies & Co.

I thought we'd maybe first start and talk a little bit about Civ Pol if, Mike, you've got an idea of how big that was as a percent of the overall business in fiscal 2008, and do you expect it to be flat in '09 or up or down?

Michael J. Thorne

I don't have the percentage off the top of my head for '08, Joe, as obviously that's our largest program in '08.

But yes, we think it'll be fairly flat in '09. We're at about 750 trainers and mentors on the Iraq program and about 550 on Afghanistan right now. And current projections, we expect those to hold steady. We don't [inaudible] anything that would indicate they're going to increase something, though there's always that possibility.

The other thing is, as we mentioned, we recently re-won the Iraq task order, so we know that one's solid through February of 2010. But the main part of Afghanistan task order is being recompeted right now, so that brings a little uncertainty into it.

So I guess in summary we're projecting Civ Pol to be kind of flat from '08 to '09.

Joseph Vafi - Jefferies & Co.

And then just looking at Linguist here, obviously, you've got a big team that you're taking on here, and they're all in place. Should we be looking at the first fiscal quarter here in '09 on Linguist to kind of just be almost at full run rate relative to that $600 million number you threw out for the full year?

Michael J. Thorne

Yes, it won't be at full run rate because basically April was only transition, May we took over full operational performance on May 1 but transition continues and will complete next week, so it's kind of like April was full transition, May's a mix, June will be full performance.

So in terms of where we finish the quarter, yes, we'll be at run rate for the year for what we expect. But in terms of total revenue for the quarter, no. It will be lower in Q1 than the balance of the year.

Joseph Vafi - Jefferies & Co.

And then on INSCOM, that's a cost plus award fee contract, are the award fees material enough there that they would kind of move margins around? I guess the question is timing on award fees and would those actually move margins around by any material level?

Michael J. Thorne

Yes, I think that's a very good question, Joe, and I think they will. The base fee is 1.5% and the award fee is 6% on INSCOM, so obviously the majority of the profit is going to come from the award fee.

Your question of timing is a good one, though, because under the accounting rules on recognizing award fee, the first couple award fee periods until we get the customer to have his award fee [board] and make his decision, we won't be able to recognize any award fee. Once we have a couple quarters under our belt we'll be able to accrue that on an ongoing basis based on the history.

So there'll be kind of a low profit on INSCOM for the first couple award fee periods, a bit of a spike, if you will, as you catch up for those two periods, and then it'll level off from there. But that will affect the timing from a fee point of view as we go through fiscal '09.

Operator

Your last question comes from Matt Vittorioso - Barclays Capital.

Matt Vittorioso - Barclays Capital

I was hoping to just get a little more detail on that $10.4 million. What did you mean by claims on contracts?

Michael J. Thorne

We had, in the fourth quarter of fiscal 2007, Matt, we had claims against two of our aviation contracts related to the cost of fringe benefits under the Service Contract Act. One of those, we've successfully resolved it, collected the cash during fiscal '08; the other one is still ongoing discussions with the customer.

I mean, I could give you, if you're familiar with the Service Contract Act, I could give you more detail, but hopefully that answers your question.

Matt Vittorioso - Barclays Capital

So this is money that you're trying to get from your customer, and it's reducing your operating income because you're taking a reserve against the probability of collecting?

Michael J. Thorne

No, no. We recognized the income in '07 and on a comparison basis we didn't have a similar $10 million in '08, so comparing the two quarters it was a reduction. But no, there's been no reserve or anything like that.

Matt Vittorioso - Barclays Capital

Oh, I see. I see. This is just a comparison. Okay, I see. And lastly from me, just given that you did mention acquisitions a couple times and you're looking for an increase in liquidity, is there anything out there in the acquisition front that looks attractive or are the two things related, increasing liquidity and talking about acquisitions?

William L. Ballhaus

I'd say at this point we're continuing to look at opportunities for - and again, I want to reemphasize - appropriately sized bolt-on acquisition targets. And one of the nice characteristics of this space is there are a number that are out there. So we're continuing to evaluate properties as they come up, looking for opportunities to create value and where we think there's synergy between the targets and the organic services that we have in place.

Yes, I think it would be premature to comment on anything specific at this point. And while we will be looking for, continuing to look for acquisitions, I want to reemphasize that in the immediate term, the focus of myself and this leadership team is absolutely on executing the organic growth opportunities that we have, delivering every quarter, delivering this fiscal year on the guidance that we've laid out today.

So I don't want at all anybody to leave this call thinking that acquisitions will be a distraction for this team. We will be relentless in our execution focus this year in hitting the guidance that we laid out.

Operator

This concludes the question-and-answer session. I will now turn the call over to Mr. Ballhaus for closing remarks.

William L. Ballhaus

Angela, thank you very much for your help today, and we'd like to thank everyone on the call, those that participated with your questions and your interest. We certainly appreciate it, and I want to thank you on behalf of DynCorp International and its employees worldwide for joining us this morning. And this concludes our fourth quarter conference call. Thank you.

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Source: DynCorp International Inc. F4Q08 (Qtr End 3/28/08) Earnings Call Transcript
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