UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

(Mark One)

 

 

x

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended March 31, 2006

or

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to            

Commission File Number: 001-32869

DYNCORP INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)

Delaware

 

01-0824791

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

8445 Freeport Parkway, Suite 400, Irving, Texas 75063
(817) 302-1460

(Address, including zip code, and telephone number, including area code,
 of registrant’s principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

 

Name of Exchange on Which Registered

Class A common stock, par value $0.01 per share

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Act.       Yes o     No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.      Yes o     No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.       Yes o     No x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filer  o

 

Accelerated filer  o

 

Non-accelerated filer x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).     Yes  o     No x

The aggregate market value of the registrant’s voting and non-voting common stock held by non-affiliates of the registrant at June 5, 2006, based on the $12.49 per share closing price for the registrant’s common stock on the New York Stock Exchange on June 5, 2006, was approximately $312.3 million.

As of June 5, 2006, the registrant had 57,000,000 shares of its Class A common stock outstanding.

Documents Incorporated by Reference

None.

 




DYNCORP INTERNATIONAL INC.
TABLE OF CONTENTS

 

 

 

 

Page

PART I.

 

 

 

 

 

 

Item 1.

 

Business

 

 

1

 

Item 1A.

 

Risk Factors

 

 

12

 

Item 1B.

 

Unresolved Staff Comments

 

 

25

 

Item 2.

 

Properties

 

 

25

 

Item 3.

 

Legal Proceedings

 

 

25

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

 

26

 

PART II.

 

 

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

 

27

 

Item 6.

 

Selected Financial Data

 

 

28

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

30

 

Item 7A.

 

Quantitative and Qualitative Disclosure About Market Risk

 

 

53

 

Item 8.

 

Financial Statements and Supplementary Data

 

 

55

 

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

 

95

 

Item 9A.

 

Controls and Procedures

 

 

95

 

Item 9B.

 

Other Information

 

 

95

 

PART III.

 

 

 

 

 

 

Item 10.

 

Directors and Executive Officers of the Registrant

 

 

96

 

Item 11.

 

Executive Compensation

 

 

102

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

 

105

 

Item 13.

 

Certain Relationships and Related Transactions

 

 

107

 

Item 14.

 

Principal Accounting Fees and Services

 

 

110

 

PART IV.

 

 

 

 

 

 

Item 15.

 

Exhibits and Financial Statement Schedules

 

 

111

 

 




PART I

ITEM 1. BUSINESS.

Our Company

In this Annual Report, unless the context requires otherwise, references to “we,” “our,” “the Company,” “us” or “DynCorp International” refer to DynCorp International Inc. and its consolidated subsidiaries. We refer to our subsidiary, DynCorp International LLC and its subsidiaries, as our “operating company.” All references in this Annual Report to fiscal years made in connection with our financial statements or operating results refer to the fiscal year ended on the Friday closest to March 31st of such year. For example, “fiscal 2004” refers to our fiscal year ended April 2, 2004.

We provide specialized mission-critical outsourced technical services to civilian and military government agencies. Our specific global expertise is in law enforcement training and support, security services, base operations, and aviation services and operations. We also provide logistics support for all our services. Our predecessors have provided services to numerous U.S. government departments and agencies since 1951. Our operating company was a separate subsidiary of Computer Sciences Corporation from March 2003 until February 2005. On February 11, 2005, Computer Sciences Corporation and DynCorp (a wholly owned subsidiary of Computer Sciences Corporation) sold DynCorp International LLC (a wholly owned subsidiary of DynCorp) to DynCorp International Inc., a newly formed entity controlled by The Veritas Capital Fund II, L.P. and its affiliates. We refer to The Veritas Capital Fund II, L.P. and its affiliates in this Annual Report as “Veritas Capital.” The Company has no operations independent of DynCorp International LLC.

On May 9, 2006, we consummated an Equity Offering of 25,000,000 shares of our Class A common stock, par value $0.01 per share, at a price of $15.00 per share (the “Equity Offering”). The gross proceeds from the Equity Offering of $375.0 million, together with cash on hand, were used: (i) to redeem all of our outstanding preferred stock, of which $222.8 million in stated amount, including accrued and unpaid dividends thereon, was outstanding as of May 9, 2006; (ii) to pay a special Class B distribution in the amount of $100.0 million to the holder of the Company’s common stock, DIV Holding LLC; (iii) to redeem $28.0 million of our senior subordinated notes on June 8, 2006; (iv) to pay prepayment penalties of $8.4 million as of May 9, 2006, $5.7 million of which represented prepayment penalties on our preferred stock and $2.7 million of which represented prepayment penalties on our senior subordinated notes; and (v) to pay transaction expenses of approximately $35.0 million, including an underwriters’ commission of $22.5 million, a fee of $5.0 million to Veritas Capital Management II, L.L.C. and $7.5 million of miscellaneous fees and expenses related to the Equity Offering.

Our Services

We provide government technical services and outsourced solutions to our customers. Our primary services are provided through our two core operating segments, International Technical Services and Field Technical Services.

Our International Technical Services operating segment offers the following services:

·        Law Enforcement Training. Our services in this area include international policing and police training, judicial support, immigration support and base operations.

·        International Narcotics Eradication. Our services include drug eradication and interdiction, host nation pilot and crew training.

·        Contingency Services. We provide peace-keeping support, humanitarian relief, de-mining, worldwide contingency planning, warehousing and heavy equipment inspections. We believe we have the ability to provide these services on a rapid response basis.

1




·        Logistics Support Services. We offer procurement, parts tracking, inventory and equipment maintenance, property control, data entry and mobile repair services. We believe that we are able to support the deployment of personnel and equipment on short notice.

·        Security Services. Our services include security for diplomats, personal protection, security system design, installation and operations and cultural training. Using a database of approximately 3,000 qualified individuals, as of March 31, 2006, we have the ability to recruit and assemble large security contingents on short notice.

·        Military Facility Operations. We provide facility and equipment maintenance and control, civil, electrical, environmental and mechanical engineering, custodial and administrative services.

·        Infrastructure Development. Our services include infrastructure engineering and construction management.

·        Marine Services. Our services include ship logistics, range ship maintenance, communications services and oil spill response fleet operations. We provide these services for both government agencies and commercial customers.

·        Security Technology. Our services include installation, maintenance and upgrades of physical and software access control points and servers and development of security software, smart cards and biometrics for use by government agencies and commercial customers.

Our Field Technical Services operating segment offers the following services:

·        Aviation Services and Operations. Our aviation services and operations include aircraft fleet maintenance, depot augmentation, aftermarket logistics support, aircrew services and training, ground equipment maintenance and modifications, quality control, Federal Aviation Administration certification, facilities and operations support, aircraft scheduling and flight planning and the provisioning of pilots, test pilots and flight crews. Services are provided from both main base locations and forward operating locations.

·        Aviation Engineering. Our technicians design, manufacture and install aircraft modification programs for a broad range of weapons systems and, as of March 31, 2006, more than 70 engine types, updating entire fleets to mission-readiness status. We provide services such as engineering design, kit manufacturing and installation, field installations, configuration management, avionics upgrades, cockpit and fuselage redesign and technical data, drawings and manual revisions.

·        Aviation Ground Equipment Support. Our services in this area include ground equipment support, maintenance and overhaul, modifications and upgrades, corrosion control, engine rebuilding, hydraulic and load testing and serviceability inspections. We provide these services worldwide and offer both short- and long-duration field teams. As of March 31, 2006, we employed over 850 mechanics, technicians and support personnel who perform depot level overhaul of ground support equipment for U.S. Navy and U.S. Coast Guard programs and provide depot level ground support equipment support at 20 worldwide locations.

·        Ground Vehicle Maintenance. Our ground vehicle maintenance services include vehicle maintenance, overhaul and corrosion control and scheduling and work flow management. We perform maintenance and overhaul on wheeled and tracked vehicles for the U.S. Army and U.S. Marine Corps, in support of their pre-positioning programs. We also provide overall program management, logistics support, tear down and inspection of equipment cycled off of prepositioned ships.

2




The 2005 Acquisition

On December 12, 2004, together with The Veritas Capital Fund II, L.P., we entered into a purchase agreement with Computer Sciences Corporation and DynCorp whereby we agreed to acquire DynCorp International LLC, then a wholly owned subsidiary of DynCorp and Computer Sciences Corporation (the “2005 Acquisition”). We assigned our rights to acquire DynCorp International LLC to a subsidiary we formed, DI Finance LLC. Immediately after the consummation of the 2005 Acquisition on February 11, 2005, DI Finance LLC was merged with and into DynCorp International LLC. DynCorp International LLC survived the merger and is now our wholly owned subsidiary. We changed our name from DI Acquisition Corp. to DynCorp International Inc. on February 11, 2005, the day we acquired DynCorp International LLC. In this section, Computer Sciences Corporation and DynCorp are referred to as the “sellers.”

Closing Price and Purchase Price Adjustments

The purchase price for the 2005 Acquisition was $937.0 million after giving effect to a net working capital adjustment in favor of Computer Sciences Corporation in the amount of $65.55 million and $6.1 million of accumulated dividends in connection with the preferred stock issued for satisfaction of the working capital adjustment. Of the $937.0 million purchase price, $775.0 million was paid in cash, $140.6 million was paid to Computer Sciences Corporation in the form of our preferred equity, $6.1 million represented accumulated dividends on the preferred stock issued in connection with the working capital adjustment and the remaining amounts were attributable to transaction expenses.

In addition to the issuance of preferred stock to Computer Sciences Corporation and the additional preferred stock equity investment discussed above, the 2005 Acquisition was funded by:

·       borrowings under our senior secured credit facility, consisting of a $345.0 million term loan, and a $90.0 million revolving credit facility, as amended, which was drawn down $20.0 million at closing;

·       the senior subordinated notes of $320.0 million offered by our operating company; and

·       a common equity investment in our Company of $86.0 million by Veritas Capital and $14.0 million by The Northwestern Mutual Life Insurance Company.

See notes to the consolidated financial statements elsewhere in this Annual Report for a discussion of the senior secured credit facility and the senior subordinated notes.

Purchase Agreement

General.   The purchase agreement contained customary representations, warranties, covenants and indemnities by, and for the benefit of, The Veritas Capital Fund II, L.P. and the sellers.

Indemnification.   Sellers’ obligation, which is joint and several, to indemnify the Company and The Veritas Capital Fund II, L.P. for breaches of representations and warranties generally survived until 180 days after the closing of the 2005 Acquisition, except for representations and warranties relating to certain corporate representations and broker representations, which will survive until the applicable statute of limitations, and tax representations that did not survive closing except for the representation relating to our Company’s status as a disregarded entity, which will survive for three years following the closing of the 2005 Acquisition. The sellers’ obligations to indemnify DynCorp International and its affiliates (including after the closing of the 2005 Acquisition) and our obligation, subject to certain exceptions, to indemnify the sellers are subject to a $5.0 million deductible, and each individual claim must be at least $50,000 per individual claim. The aggregate indemnification obligations are generally threshold capped at $50.0 million in the aggregate, subject to certain exceptions.

3




The purchase agreement also provides that the sellers will indemnify us without regard to any time limitation, but subject to the above cap, for any losses incurred in connection with the Arias litigation, a class action lawsuit seeking $100.0 million filed on September 11, 2001. Upon closing of the 2005 Acquisition, the sellers and our Company entered into a joint defense agreement pursuant to which both parties will assume joint defense of the litigation. See “Legal Proceedings—Pending Litigation and Claims” for additional information regarding the Arias litigation.

Under the purchase agreement, the sellers agreed to remit to the Company any amounts actually received by sellers (less related fees) with respect to potential Texas sales tax refunds relating to any contracts that have been assigned by the sellers to our Company or any subsidiaries thereof.

Additional Covenants.   The purchase agreement includes customary covenants by the sellers to maintain certain proprietary information about the buyer and its affiliates confidential, by the sellers and certain of their affiliates not to compete with our Company and our affiliates with respect to any of our existing contracts for a period of two years, and both parties not to solicit for employment or hire certain of our employees for a period of three years after the closing of the 2005 Acquisition.

Under the purchase agreement, the sellers granted to our Company an exclusive, perpetual, irrevocable, worldwide, royalty-free and fully paid-up license to use the “Dyn International” and “DynCorp International” names in connection with aviation services, security services, technical services and marine services.

Contract Types

Our contracts typically have a term of three to ten years consisting of a base period of one year with multiple one-year options. Our contracts typically are awarded for an estimated dollar value based on the forecast of the work to be performed under the contract over its maximum life. In addition, we have historically received additional revenues through increases in program scope beyond that of the original contract. These contract modifications typically consist of “over and above” requests derived from changing customer requirements. The government is not obligated to exercise options under a contract after the base period. At the time of completion of the contract term of a government contract, the contract is recompeted to the extent that the service is still required.

Contracts between our operating company and the U.S. government or the government’s prime contractor (to the extent that we are a subcontractor) generally contain standard provisions for termination at the convenience of the government or the prime contractor or for default. Government contracts generally also contain provisions that allow the U.S. government to unilaterally suspend us from receiving new contracts pending resolution of alleged violations of procurement laws or regulations, reduce the value of existing contracts, issue modifications to a contract and control and potentially prohibit the export of our services and associated materials.

Many government contracts are indefinite delivery, indefinite quantity contracts, which are often awarded to multiple contractors. An indefinite delivery, indefinite quantity contract does not represent a firm order for services. Our Civilian Police and Contract Field Teams programs are examples of indefinite delivery, indefinite quantity contracts. In fiscal 2005 and 2006, 56.3% and 58.9% of our revenues, respectively, were attributable to indefinite delivery, indefinite quantity contracts. When a customer wishes to order services under an indefinite delivery, indefinite quantity contract, the customer issues a task order. Requests for proposal are often submitted to all of the contract awardees, and task orders are typically awarded under a best-value approach. However, many indefinite delivery, indefinite quantity contracts permit the customer to direct work to a particular contractor. In some instances, the contractor may identify specific projects and propose to perform the service for a customer covered by the indefinite delivery, indefinite quantity contract, although the customer is not obligated to order the services. See

4




“Management’s Discussion and Analysis of Financial Condition and Results of Operations—Explanation of Reporting Periods and Basis of Presentation.”

Our business generally is performed under fixed-price, time-and-materials or cost-reimbursement contracts. Each of these is described generally below.

·       Fixed-Price Contracts. In a fixed-price contract, the price is not subject to adjustment based on costs incurred, which can favorably or adversely impact our profitability depending upon our execution in performing the contracted service. Fixed-price contracts can include a firm fixed price covering multiple service elements and/or a fixed-price covering individual service elements.

·       Time-and-Materials Contracts. In a time-and-materials contract, we operate under fixed per-hour or per-day labor rates and receive reimbursement for allowable direct and indirect costs. Time-and-materials contracts generally have shorter billing and collection terms than other contract types.

·       Cost-Reimbursement Contracts. We are reimbursed for allowable incurred costs, plus a fixed fee or an award fee. In addition, under some cost-reimbursement contracts, we may receive additional award fees or incentive fees based upon various objective and subjective criteria, such as aircraft mission capability rates and meeting cost targets.

We believe that our profitability will continue to improve as we anticipate that our customers will continue to shift away from cost-reimbursement to time-and-materials contracts and fixed-price contracts. We base our belief on recent trends in our revenues, the nature of the contracts on which we are bidding and the pricing structure in fixed-price and time-and-materials contracts.

Our historical contract mix by type for the last three fiscal years, as a percentage of revenue, is indicated in the table below.

 

 

Fiscal Year

 

Contract Type

 

2004

 

2005

 

2006

 

Fixed-Price

 

24

%

27

%

34

%

Time-and-Materials

 

32

 

39

 

38

 

Cost-Reimbursement

 

44

 

34

 

28

 

 

 

100

%

100

%

100

%

 

Many of our contracts involve subcontracts with other companies, which we rely upon to perform all or a portion of the services we are required to provide to our customers. Often we enter into subcontract arrangements in order to meet government requirements that certain categories of services be awarded to small businesses. We use subcontractors primarily for non-core functions such as construction and catering. For fiscal 2004, 2005 and 2006, we paid our subcontractors approximately $95.4 million, $174.9 million and $229.0 million, respectively.

Principal Customers and Contracts

Our principal customers are U.S. government agencies, including the Department of Defense and Department of State. Over the last decade, we have expanded our customer base to include foreign governments and commercial customers, such as EarthTech, Fluor, the Kuwaiti Air Force, Lucent, Parsons, the Royal Saudi Air Force and Washington Group International. During fiscal 2004, 2005 and 2006, we derived substantially all of our revenues from contracts and subcontracts with the U.S. government and its agencies, Department of Defense and Department of State and their respective agencies. Contracts with agencies of the Department of Defense represented approximately 63%, 49% and 44% of our revenues for fiscal 2004, 2005 and 2006, respectively, and contracts with agencies of the Department of State represented approximately 29%, 49% and 53%, respectively, of our revenues over the same period. For fiscal 2006, we derived 3% of our revenue from contracts directly with foreign

5




governments or with commercial customers. For fiscal 2005 and 2006, Contract Field Teams, Civilian Police and International Narcotics and Law Enforcement contracts accounted for 18.0%, 27.4% and 8.1% and 17.2%, 32.1% and 11.9% of our revenues, respectively. For a discussion of the risk of government contracts, see “Risk Factors—We rely on sales to U.S. government entities. A loss of contracts with the U.S. government, a failure to obtain new contracts or a reduction of sales under existing contracts could adversely affect our operating performance and our ability to generate cash flow to fund our operations.”

For fiscal 2005 and 2006, approximately 5.9% and 1.9% of our revenues, respectively, were derived from services that we provided as a subcontractor.

Key International Technical Services Contracts

Civilian Police.   The most significant contract of our International Technical Services operating segment is our Civilian Police contract, awarded to us by the Department of State in February 2004. Our Civilian Police contract has an estimated value of $1.75 billion over the five-year term of this program, through February 2009. Through the Civilian Police program, we have deployed civilian police officers from the United States to 12 countries to train and offer logistics support to the local police and assist them with infrastructure reconstruction. Our first significant deployment of civilian police personnel began in the Balkans in 1996, where our predecessors helped train local police and provided support during the height of the conflict. We remained in the region through 2004. In addition, we have been awarded multiple task orders under the Civilian Police program, including assignments in Iraq, Afghanistan and Haiti.

International Narcotics Eradication and Law Enforcement.   In May of 2005, the Department of State awarded us a new contract in support of the International Narcotics and Law Enforcement Air-Wing program to aid in the eradication of illegal drug operations. We are the sole awardee of this contract, which has an estimated value of $643 million for the first three years of this ten-year contract through May 2015. This program has been ongoing since 1991 in cooperation with multiple Latin American countries, and we recently commenced a similar program in Afghanistan.

War Reserve Material.   Through our War Reserve Material program, we provide management of the U.S. Air Force Southwest Asia War Reserve Material Prepositioning program, which includes operations in Oman, Bahrain, Qatar, Kuwait and two locations in the United States, Albany, Georgia and Shaw Air Force base, South Carolina. We store, maintain and deploy assets such as tents, generators, vehicles, kitchens and medical supplies to deployed forces in the Global War on Terror. During Operation Enduring Freedom and Operation Iraqi Freedom, we sent teams into the field to assist in the setup of tent cities prior to the arrival of the deployed forces. The War Reserve Material program continues to partner with the United States Central Command Air Force in the development of new and innovative approaches to asset management.

6




The following table sets forth certain information for our principal International Technical Services contracts, including the respective estimated values of the current contracts as of March 31, 2006:

Contract

 

 

 

Principal Customer

 

Initial/Current Award Date

 

Recompete
Date

 

Estimated
Contract Value
(1)

 

Civilian Police Program

 

Department of State

 

 

Feb. 1994/Feb. 2004

 

 

February 2009

 

 

$

1.75 billion

(2)

 

International Narcotics and Law Enforcement

 

Department of State

 

 

Jan. 1991/May 2005

 

 

October 2015

 

 

$

643 million

(3)

 

War Reserve Material

 

U.S. Air Force

 

 

May 2000

 

 

December 2006

 

 

$

493 million

 

 

Forward Operating
Locations

 

U.S. Air Force

 

 

March 2002

 

 

December 2006

 

 

$

141 million

 

 

Qatar Security

 

U.S. Army

 

 

Aug. 1997/Feb. 2003

 

 

September 2007

 

 

$

92 million

 

 

Sudan

 

Department of State

 

 

May 2001

 

 

Not Applicable

 

 

$

27 million

(2)

 

Worldwide Personal Protective Services

 

Department of State

 

 

April 1998/June 2005

 

 

June 2010

 

 

$

2 million

(4)(2)

 


(1)             For more information on estimated contract value, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Estimated Contract Value.”

(2)             These contracts are indefinite delivery, indefinite quantity contracts. For more information about indefinite delivery, indefinite quantity contracts, see “—Contract Types.” Also, for a discussion of how we define estimated remaining contract value for indefinite delivery, indefinite quantity contracts, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Estimated Remaining Contract Value.”

(3)             Estimated contract value is for the first three years of this ten-year contract through May 2015.

(4)             Estimated contract value is for the priced, program management portion of the contract only. Potential task orders are not included in this estimated contract value.

Key Field Technical Services Contracts

Contract Field Teams.   Contract Field Teams is the most significant program in our Field Technical Services operating segment. Our Company and its predecessors have provided this service for over 54 consecutive years. This program deploys highly mobile, quick-response field teams to customer locations to supplement a customer’s workforce. Services under a Contract Field Teams contract generally include providing mission support to aircraft and weapons systems in addition to depot-level repair. The principal customer for our Contract Field Teams program is the Department of Defense. Our Contract Field Teams contract is up for recompetition in September 2007. This contract has a $2.09 billion estimated value over a ten-year term through September 2007.

Life Cycle Contractor Support.   This Field Technical Services program consists of contracts with both the U.S. Army and the U.S. Navy. Under the Life Cycle Contractor Support-Army contracts, our Company provides aircraft maintenance and logistics for 165 C-12/RC-12 and 27 UC-35 aircraft, as well as services for a major avionics suite upgrade of 39 aircraft for Global Air Traffic Management compliance. Under our Life Cycle Contractor Support-Navy contracts, our Company and its predecessors provide aircraft maintenance and logistics for the U.S. Navy’s 6 UC-35 aircraft. We entered into the Life Cycle Contractor Support-Army and Life Cycle Contractor Support-Navy contracts in August 2000 and the Global Air Traffic Management portion of our Army contract in March 2003. The Life Cycle Contractor Support-Army and Life Cycle Contractor Support-Navy contracts are up for recompetition in January 2010. These contracts have estimated values of $911 million and $33 million for Life Cycle Contractor Support-Army and Life Cycle Contractor Support-Navy, respectively.

7




Attack Helicopter-1/Utility Helicopter-1 (“AH-1/UH-1”).   The AH-1/UH-1 program provides worldwide helicopter support to foreign governments that have acquired AH-1 and UH-1 helicopters. Services include program management, sustaining engineering, training, maintenance and refurbishment, logistics and material management. The U.S. Army is our principal customer for this program. We entered into our AH-1/UH-1 contract in March 2004 and the contract is up for recompetition in March 2014. This contract has a $406 million estimated value.

Andrews Air Force Base.   Under the Andrews Air Force Base contract, our Company performs aircraft maintenance and base supply functions, including full backshop support, organizational level maintenance, fleet fuel services and supply, launch and recovery and FAA repair services. Our principal customer under this contract is the U.S. Air Force. We entered into this contract in January 2001 and it is up for recompetition in December 2011. This contract has a $324 million estimated value.

The following table sets forth certain information for our principal Field Technical Services contracts, including the respective estimated values of the current contracts as of March 31, 2006:

Contract

 

Principal Customer

 

Initial/Current
Award Date

 

Recompete
Date

 

Estimated
Contract Value
(1)

 

Contract Field Teams

 

Department of Defense

 

Oct. 1951/Oct. 1997

 

September 2007

 

 

$

2.09 billion

(2)

 

Life Cycle Contractor Support 

 

U.S. Army and U.S. Navy

 

August 2000

 

January 2010

 

 

$

944 million

 

 

AH-1/UH-1

 

U.S. Army/FMS

 

March 2004

 

March 2014

 

 

$

406 million

(2)

 

Andrews Air Force Base

 

U.S. Air Force

 

January 2001

 

December 2011

 

 

$

324 million

 

 

Columbus Air Force Base

 

U.S. Air Force

 

Oct. 1998/July 2005

 

September 2012

 

 

$

245 million

 

 

Army Prepositioned Stocks Afloat

 

U.S. Army

 

February 1999

 

February 2009

 

 

$

217 million

 

 

Holloman Air Force Base

 

U.S. Air Force

 

September 1999

 

September 2006

 

 

$

101 million

 

 

Eglin Air Force Base

 

U.S. Air Force

 

November 2002

 

November 2010

 

 

$

77 million

 

 

F/A-18

 

Kuwaiti Air Force(3)

 

Sept. 1997/Dec. 2005

 

December 2010

 

 

$

70 million

 

 

California Department of Forestry

 

State of California

 

January 2002

 

June 2007

 

 

$

65 million

 

 


(1)    For more information on estimated contract value, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Estimated Contract Value.”

(2)    These contracts are indefinite delivery, indefinite quantity contracts. For more information about indefinite delivery, indefinite quantity contracts, see “—Contract Types.”  Also, for a discussion of how we define estimated remaining contract value for indefinite delivery, indefinite quantity contracts, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Estimated Remaining Contract Value.”

(3)    Reflects end users under the contract rather than the contract party.

Backlog

Backlog consists of orders and options under our contracts. We define backlog as the estimated value of contract modifications received from customers that have not been recognized as revenue. Our backlog consists of funded and unfunded backlog. Funded backlog is based upon amounts actually appropriated by a customer for payment of goods and services less actual revenue recorded as of the measurement date under that appropriation. Unfunded backlog is the actual dollar value of unexercised contract options. Anticipated revenues from indefinite delivery, indefinite quantity contracts are not included in unfunded backlog. Backlog is only a measure of funded contract values and unfunded contract options, less any revenue recognized to that point. Backlog does not take into account any expenses associated with contractual performance and converting backlog into revenue would not reflect net income associated with the contracts. Most of our U.S. government contracts allow the customer, in its sole discretion, the option to extend the period of performance of a contract for a period of one or more years. Historically, it has been our experience that the customer has exercised contract options. See “Risk Factors—Our U.S. government contracts may be terminated by the U.S. government at any time prior to their completion and

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contain other unfavorable provisions, which could lead to unexpected loss of revenues and reduction in backlog.”

Our backlog is spread over a diverse mix of activities, services and platforms. In addition, contracts and task orders awarded thereunder are with different agencies within the U.S. government.

The following table sets forth our approximate contracted backlog (dollars in millions) as of the dates indicated:

 

 

April 2,
2004

 

April 1,
2005

 

March 31,
2006

 

Funded Backlog

 

$

991

 

$

1,140

 

 

$

1,024

 

 

Unfunded Backlog

 

1,173

 

900

 

 

1,617

 

 

Total Backlog

 

$

2,164

 

$

2,040

 

 

$

2,641

 

 

 

Regulatory Matters

Contracts with the U.S. government are subject to certain regulatory requirements. Under U.S. government regulations, certain costs, including certain financing costs, portions of research and development costs, lobbying expenses, certain types of legal expenses and certain marketing expenses related to the preparation of bids and proposals, are not allowed for pricing purposes and calculation of contract reimbursement rates under cost-reimbursement contracts. The U.S. government also regulates the methods by which allowable costs may be allocated under U.S. government contracts.

Our government contracts are subject to audits at various points in the contracting process. Pre-award audits are performed at the time a proposal is submitted to the U.S. government for cost-reimbursement contracts. The purpose of a pre-award audit is to determine the basis of the bid and provide the information required for the U.S. government to negotiate the contract effectively. In addition, the U.S. government may perform a pre-award audit to determine our capability to perform under a contract. During the performance of a contract, the U.S. government may have the right to examine our costs incurred in the contract, including any labor charges, material purchases and overhead charges. Upon a contract’s completion, the U.S. government performs an incurred cost audit of all aspects of contract performance for cost-reimbursement contracts to ensure that we have performed the contract in a manner consistent with our proposal. The government also may perform a post-award audit for proposals that are subject to the Truth in Negotiations Act, which are proposals in excess of $550,000, to determine if the cost proposed and negotiated was accurate, current and complete as of the time of negotiations.

The Defense Contract Audit Agency performs these audits on behalf of the U.S. government. The Defense Contract Audit Agency also reviews the adequacy of, and our compliance with, our internal control systems and policies, including our purchasing, property, estimating, compensation and management information systems. The Defense Contract Audit Agency has the right to perform audits on our incurred costs on all contracts on a yearly basis. We have Defense Contract Audit Agency auditors on site to monitor our billing and back office operations. An adverse finding under a Defense Contract Audit Agency audit could result in the disallowance of our costs under a U.S. government contract, termination of U.S. government contracts, forfeiture of profits, suspension of payments, fines and suspension and prohibition from doing business with the U.S. government. In the event that an audit by the Defense Contract Audit Agency results in disallowance of our costs under a contract, we have the right to appeal the findings of the audit under applicable dispute resolution provisions. Approval of submitted yearly contract incurred costs can take from one to three years from the date of submission of the contract costs. All of our contract incurred costs for U.S. government contracts completed through March 28, 2003 have been audited and approved by the Defense Contract Audit Agency, and audits are continuing on such costs for subsequent periods. See “Risk Factors—A negative audit or other actions by the U.S. government could adversely affect our operating performance.”

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At any given time, many of our contracts are under review by the Defense Contract Audit Agency and other government agencies. We cannot predict the outcome of such ongoing audits and what, if any, impact such audits may have on our future operating performance. An audit report we received in August 2005 issued by the Defense Contract Audit Agency on our Air-Wing Contract to the Department of State in June 2005 reached the conclusion that we had incorrectly included certain cost elements in base pay for purposes of calculating hazard and post-differential pay, resulting in overbilling of $1.8 million. To the extent this matter is decided against us, we will need to refund the disputed amount, and our revenues will be adversely affected.

Sales and Marketing

As of March 31, 2006, we had marketing offices in the following 8 countries: the United Kingdom, Germany, Australia, Afghanistan, Iraq, the United Arab Emirates, Kenya and Italy. We also market through relationships with military and government officials, joint ventures and international trade shows. Personnel profiles range from employees with marketing degrees to retired senior officers from the various U.S. and foreign military branches. Most senior personnel engaged in sales and marketing have long-term operations experience.

Our approach is to establish marketing activities in the area or region that we believe presents the greatest opportunity to grow and develop our business. As of March 31, 2006, we had an organization and presence in Dubai, UAE which we believe, together with our Company and its predecessors’ long-standing presence in the Middle East well-positions us to pursue additional opportunities in that region. We also have an office in Canberra, Australia from which we pursue opportunities in Australia and the Asia-Pacific region, and we have offices in both the United Kingdom and Germany to develop business with the U.K. Ministry of Defense, United States, national and NATO military commands as well as to promote commercial business opportunities. In addition, we have frontline sales and marketing personnel in the United States, Europe-Africa and Asia-Pacific. In each office, to assist us in the regions we serve, we employ personnel who are fluent in both English and the local language, and who are familiar with local culture. We also utilize focus groups to target our services to geographic markets and provide local training to our sales force. In addition, we  market through international trade shows and relationships with senior military and government officials.

Competition

We compete with various entities across geographic and business lines based on a number of factors, including services offered, experience, price, geographic reach and mobility. Some of our competitors have greater financial and other resources than we do or are better positioned than we are to compete for certain contract opportunities. For example, original equipment manufacturers who also provide aftermarket support services have an advantage in obtaining service contracts for aircraft that they have manufactured, as they frequently have better access to replacement and service parts as well as an existing technical understanding of the platform they have manufactured. In addition, we are at a disadvantage when bidding for contracts put up for recompetition for which we are not the incumbent provider, because incumbent providers frequently are able to capitalize on customer relationships, technical knowledge and pricing experience gained from their prior service.

Competitors of our International Technical Services operating segment include solutions providers who typically compete in one of our International Technical Services business segments. Our three largest competitors for international law enforcement services are Civilian Police International, PAE Government Services, Inc. and Science Applications International Corporation. Our three largest competitors for international logistics and base operations services are ITT Industries, Halliburton and IAP Worldwide Services, Inc. Our two largest competitors in the personnel and physical security business are Blackwater and Triple Canopy.

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Competitors of our Field Technical Services operating segment typically are large defense services contractors, who offer services associated with maintenance, training and other activities. The three largest domestic competitors of Field Technical Services are Lockheed Martin Corporation, Sikorsky United Technologies and L-3. The three largest international competitors of Field Technical Services are Aerospace Industrial Development Corporation, Al Salam Aircraft Company Ltd. and Serco Group Plc.

Intellectual Property

We hold an exclusive, perpetual, irrevocable, worldwide, royalty-free and fully paid up license to use the “Dyn International” and “DynCorp International” names in connection with aviation services, security services, technical services and marine services. We do not own any trademarks or patents and do not believe our business is dependent on trademarks or patents.

Environmental Matters

Our operations include the use, generation and disposal of petroleum products and other hazardous materials. We are subject to various U.S. federal, state, local and foreign laws and regulations relating to the protection of the environment, including those governing the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites and the maintenance of a safe workplace. We believe that we have been and are in substantial compliance with environmental laws and regulations and that we have no liabilities under environmental requirements that would have a material adverse effect on our business, results of operations or financial condition. We have not incurred, nor do we expect to incur, material costs relating to environmental compliance.

Employees

As of March 31, 2006, we had over 14,400 employees in 33 countries, of which approximately 1,490 were represented by labor unions.

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FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements, written, oral or otherwise made, represent the Company’s expectation or belief concerning future events. Forward-looking statements involve risks and uncertainties. Without limiting the foregoing, the words “believes,” “thinks,” “anticipates,” “plans,” “expects” and similar expressions are intended to identify forward-looking statements. The Company cautions that these statements are further qualified by important economic, competitive, governmental and technological factors that could cause our business, strategy or actual results or events to differ materially, or otherwise, from those in the forward-looking statements, including, without limitation, changes in the demand for services that the Company provides; additional work awarded under the Civilian Police and International Narcotics and Law Enforcement contracts; pursuit of new commercial business in the United States and abroad;  activities of competitors; changes in significant operating expenses; changes in availability of capital; general economic and business conditions in the United States; acts of war or terrorist activities; variations in performance of financial markets; estimates of contract values; anticipated revenues from indefinite delivery, indefinite quantity contracts; expected percentages of future revenues represented by fixed-price and time-and-materials contracts; and statements covering our business strategy, those described in “Risk Factors” and other risks detailed from time to time in the Company’s reports filed with the Securities and Exchange Commission. Accordingly, such forward-looking statements do not purport to be predictions of future events or circumstances and therefore there can be no assurance that any forward-looking statement contained herein will prove to be accurate. The Company assumes no obligation to update the forward-looking statements.

ITEM 1A. RISK FACTORS.

You should carefully consider the risks described below, together with all of the other information contained in this Form 10-K. The risks described below are not the only ones we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our financial condition, results of operations or cash flow. Any of the following risks could materially and adversely affect our financial condition or results of operations.

We rely on sales to U.S. government entities. A loss of contracts with the U.S. government, a failure to obtain new contracts or a reduction of sales under existing contracts could adversely affect our operating performance and our ability to generate cash flow to fund our operations.

For fiscal 2005 and 2006, the Contract Field Teams, Civilian Police and International Narcotics and Law Enforcement contracts accounted for 18.0%, 27.4% and 8.1%, and 17.2%, 32.1% and 11.9% of our revenues, respectively. The loss of any one of these contracts would significantly and adversely affect our future revenues and earnings. We derived substantially all of our revenues from contracts and subcontracts with the U.S. government and its agencies, primarily the Department of Defense and the Department of State. Contracts with agencies of the Department of Defense represented 63%, 49% and 44% of our revenues for fiscal 2004, 2005 and 2006, respectively, and contracts with agencies of the Department of State represented 29%, 49% and 53% of our revenues over the same respective periods. The remainder of our revenues represent commercial contracts and direct contracts with foreign governments. We expect that U.S. government contracts, particularly with the Department of Defense and the Department of State, will continue to be our primary source of revenue for the foreseeable future. Continuation and renewal of our existing government contracts and new government contracts are, among other things, contingent upon the availability of adequate funding for various U.S. government agencies, including the Department of Defense and the Department of State. Changes in U.S. government spending could directly affect our

12




operating performance and lead to an unexpected loss of revenue. Among the factors that could impact U.S. government spending and that would reduce our federal government contracting business are:

·       a significant decline in, or reapportioning of, spending by the U.S. government, in general, or by the Department of Defense or the Department of State, in particular;

·       changes, delays or cancellations of U.S. government programs or requirements;

·       the adoption of new laws or regulations that affect companies that provide services to the U.S. government;

·       U.S. government shutdowns or other delays in the government appropriations process;

·       curtailment of the U.S. government’s outsourcing of services to private contractors;

·       changes in the political climate, including with regard to the funding or operation of the services we provide; and

·       general economic conditions.

These or other factors could cause U.S. government agencies to reduce their purchases under our contracts, to exercise their right to terminate our contracts in whole or in part, to issue temporary stop-work orders under, or decline to exercise options to renew, our contracts. The loss or significant curtailment of our material government contracts, or our failure to renew or enter into new contracts could adversely affect our operating performance and lead to an unexpected loss of revenue.

Our U.S. government contracts may be terminated by the U.S. government at any time prior to their completion and contain other unfavorable provisions, which could lead to unexpected loss of revenues and reduction in backlog.

Under the terms of our contracts, the U.S. government may unilaterally:

·       terminate or modify existing contracts;

·       reduce the value of existing contracts through partial termination;

·       delay the payment of our invoices by government payment offices;

·       audit our contract-related costs and fees; and

·       suspend us from receiving new contracts pending resolution of alleged violations of procurement laws or regulations.

The U.S. government can terminate or modify any of its contracts with us either for its convenience or if we default by failing to perform under the terms of the applicable contract. A termination arising out of our default could expose us to liability and adversely affect our operating performance and lead to an unexpected loss of revenue.

Our government contracts typically have an initial term of one year with multiple option periods, exercisable at the discretion of the government at previously negotiated prices. The government is not obligated to exercise any option under a contract. Furthermore, the government is required to compete all programs and, therefore, may not automatically renew a contract. In addition, at the time of completion of any of our government contracts, the contract is required to be recompeted if the government still requires the services covered by the contract.

If the U.S. government terminates and/or materially modifies any of our contracts or if option periods are not exercised, our failure to replace revenue generated from such contracts would result in lower

13




revenues and would likely adversely affect our earnings, which would have a material adverse effect on our financial condition and results of operations.

Our U.S. government contracts are subject to competitive bidding, both upon initial issuance and recompetition. If we are unable to successfully compete in the bidding process or if we fail to receive renewal, it could adversely affect our operating performance and lead to an unexpected loss of revenue.

Substantially all of our U.S. government contracts are awarded through a competitive bidding process, including upon renewal, and we expect that this will continue to be the case. There often is significant competition and pricing pressure as a result of this process. The competitive bidding process presents a number of risks, including the following:

·       we must expend substantial funds and time to prepare bids and proposals for contracts;

·       we may be unable to estimate accurately the resources and costs that will be required to fund any contract we win, which could result in substantial cost overruns; and

·       we may encounter expense and delay if our competitors protest or challenge awards of contracts to us, and any such protest or challenge could result in a requirement to resubmit bids on modified specifications or in termination, reduction or modification of the awarded contract.

The government contracts for which we compete typically have multiple option periods, and if we fail to win a contract or a task order, we generally will be unable to compete again for that contract for several years. For example, we recently lost four task orders for which we competed under our Worldwide Personal Protective Services program in Israel, Haiti, Afghanistan and Baghdad. If we fail to win new contracts or to receive renewal contracts upon recompetition, it may result in additional costs and expenses and possible loss of revenue, and we will not have an opportunity to compete for these opportunities again until the current task orders expire.

Political destabilization or insurgency in the regions in which we operate may have a material adverse effect on our operating performance.

Certain regions in which we operate are highly unstable. Insurgency activities in the areas in which we operate may cause further destabilization in these regions. There can be no assurance that the regions in which we operate will continue to be stable enough to allow us to operate profitably or at all. For fiscal 2005 and 2006, respectively, revenues generated on a combined basis from our operations in Iraq and Afghanistan contributed 36.9% and 38.5% of our revenues. Insurgents in Iraq and Afghanistan have targeted installations where we have personnel and have contributed to instability in these countries. This could impair our ability to attract and deploy personnel to perform services in either or both locations. In addition, we have been required to increase compensation to our personnel as an incentive to deploy them to these regions. To date, we have been able to recover this added cost under the contracts, but there is no guarantee that future increases, if required, will be able to be passed onto our customers through our contracts. To the extent that we are unable to pass through such increased compensation costs to our customers, our operating margins would be adversely impacted, which could adversely affect our operating performance. We also may have difficulty obtaining insurance to cover our liabilities in these regions and for third-party general liability. We have been able to obtain insurance to cover our liabilities; however, this could change or premiums may become prohibitively expensive. In addition, increased insurgency activities or destabilization, including civil unrest or a civil war in Iraq or Afghanistan, may lead to a determination by the U.S. government to halt our operations in a particular location, country or region and to perform the services using military personnel. Furthermore, in extreme circumstances, the U.S. government may decide to terminate all U.S. government activities including our operations under U.S. government contracts in a particular location, country or region and to withdraw all military personnel.

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This could adversely affect our operating performance and may result in additional costs and expenses and loss of revenue.

Our indefinite delivery, indefinite quantity contracts are not firm orders for services, and we may never receive revenues from these contracts, which could adversely affect our operating performance.

Many of our government contracts are indefinite delivery, indefinite quantity contracts, which are often awarded to multiple contractors. Award of an indefinite delivery, indefinite quantity contract does not represent firm orders for services. Generally, under an indefinite delivery, indefinite quantity contract, the government is not obligated to order a minimum of services or supplies from its contractor, irrespective of the total estimated contract value. Furthermore, under an indefinite delivery, indefinite quantity contract, the customer develops requirements for task orders that are competitively bid against all of the contract awardees, usually under a best-value approach. However, many contracts also permit the government customer to direct work to a specific contractor. Our Civilian Police and Contract Field Team programs are performed under indefinite delivery, indefinite quantity contracts. We may not win new task orders under these contracts for various reasons such as failing to rapidly deploy personnel or high prices, which would have an adverse effect on our operating performance and may result in additional expenses and loss of revenue. In fiscal 2005 and 2006, 56.3% and 58.9% of our revenues, respectively, were attributable to indefinite delivery, indefinite quantity contracts.

Our cost of performing under time-and-materials and fixed-price contracts may exceed our revenues which would result in a recorded loss on the contracts.

Our government contract services have three distinct pricing structures: cost-reimbursement, time-and-materials and fixed-price levels of effort, representing approximately 34%, 39% and 27% of our revenues, respectively, for fiscal 2005, and approximately 28%, 38% and 34% of our revenues, respectively, for fiscal 2006. With cost-reimbursement contracts, so long as actual costs incurred are within the contract ceiling and allowable under the terms of the contract, we are entitled to reimbursement of the costs plus a stipulated fixed fee and, in some cases, an incentive-based award fee. We assume financial risk on time-and-materials and fixed-price contracts, because we assume the risk of performing those contracts at the stipulated prices or negotiated hourly/daily rates. If we do not accurately estimate ultimate costs and control costs during performance of the work, we could lose money on a particular contract or have lower than anticipated margins. Also, we assume the risk of damage or loss to government property and we are responsible for third-party claims under fixed-price contracts. We believe that our profitability will continue to improve as we anticipate that our customers will continue to shift away from cost- reimbursement to time-and-materials contracts and fixed-price contracts. We base our belief on recent trends in our revenues, the nature of the contracts on which we are bidding and the pricing structure in fixed-price and time-and-materials contracts. As of March 31, 2006, seven of our 44 active contracts contained incentive-based pricing terms. These contracts comprised 19.7% and 15.3% of our revenues, respectively, for fiscal 2005 and 2006. The failure to meet contractually defined performance standards may result in a loss of a particular contract or lower-than-anticipated margins. This could adversely affect our operating performance and may result in additional costs and expenses and possible loss of revenue.

15




A negative audit or other actions by the U.S. government could adversely affect our operating performance.

At any given time, many of our contracts are under review by the Defense Contract Audit Agency and other government agencies. These agencies review our contract performance, cost structure and compliance with applicable laws, regulations and standards. The Defense Contract Audit Agency also reviews the adequacy of, and our compliance with, its internal control systems and policies, including our purchasing, property, estimating, compensation and management information systems. Any costs found to be improperly allocated to a specific contract will not be reimbursed. In addition, government contract payments received by us for allowable direct and indirect costs are subject to adjustment after audit by government auditors and repayment to the government if the payments exceed allowable costs as defined in the government contracts. For example, an audit report issued by the Defense Contract Audit Agency on our Air-Wing Contract to the Department of State in June 2005 that we received in August 2005 reached the conclusion that we had incorrectly included certain cost elements in base pay for purposes of calculating hazard and post-differential pay, resulting in overbilling of $1.8 million. To the extent this matter is decided against us, we will need to refund the disputed amount and our revenues will be adversely affected.

Audits have been completed on our incurred contract costs through March 28, 2003 and are continuing for subsequent periods. We cannot predict the outcome of such audits and what, if any, impact such audits may have on our future operating performance.

We are subject to investigation by the U.S. government, which could result in our inability to receive government contracts and could adversely affect our future operating performance.

As a U.S. government contractor, we must comply with laws and regulations relating to U.S. government contracts that do not apply to a commercial company. From time to time, we are investigated by government agencies with respect to our compliance with these laws and regulations. If we are found to be in violation of the law, we may be subject to civil or criminal penalties or administrative sanctions, including contract termination, the assessment of penalties and suspension or debarment from doing business with U.S. government agencies. For example, many of the contracts we perform in the United States are subject to the Service Contract Act, which requires hourly employees to be paid certain specified wages and benefits. If the Department of Labor determines that we violated the Service Contract Act or its implementing regulations, we could be suspended from winning new government contracts or renewals of existing contracts for a period of time, which could adversely affect our future operating performance.

We are subject to an increased risk of investigations, criminal prosecution, civil fraud, whistleblower lawsuits and other legal actions and liabilities to which companies with solely commercial customers are not subject. In addition, if an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the U.S. government. Furthermore, our reputation could suffer serious harm if allegations of impropriety were made against us. If we were suspended or prohibited from contracting with the U.S. government, or any significant U.S. government agency, if our reputation or relationship with U.S. government agencies was impaired or if the U.S. government otherwise ceased doing business with us or significantly decreased the amount of business it does with us, it could adversely affect our operating performance and may result in additional expenses and possible loss of revenue.

An accident or incident involving our employees or third parties could harm our reputation and adversely affect our ability to compete for business and, as a result, adversely affect our operating performance.

We are exposed to liabilities arising out of the services we provide. Such liabilities may relate to an accident or incident involving our employees or third parties, particularly where we are deployed on-site at

16




active military installations or in locations experiencing political or civil unrest, or they may relate to an accident or incident involving aircraft or other equipment we have serviced or used in the course of our business. Any of these types of accidents or incidents could involve significant potential claims of injured employees and other third parties, and claims relating to loss of or damage to government or third-party property. The amount of our insurance coverage may not be adequate to cover those claims or liabilities and we may be forced to bear substantial costs from an accident or incident. Substantial claims in excess of our related insurance coverage could adversely affect our operating performance and may result in additional expenses and possible loss of revenue. Moreover, any accident or incident for which we are liable, even if fully insured, may result in negative publicity which could adversely affect our reputation among our customers, including our government customers, and the public, which could result in us losing existing and future contracts or make it more difficult for us to compete effectively, which could adversely affect our operating performance and may result in additional expenses and possible loss of revenue.

The expiration of our collective bargaining agreements could result in increased operating costs or work disruptions, which could potentially affect our operating performance.

As of March 31, 2006, we had over 14,400 employees located in 33 countries around the world, approximately 7,400 of whom are located inside the United States. Of these employees, approximately 1,490 are represented by labor unions. As of March 31, 2006, we had approximately 62 collective bargaining agreements. These agreements either expired or will expire between March 2006 and December 2008. Although we believe that our relationships with these unions and our employees are satisfactory, there can be no assurance that we will not experience labor disruptions associated with the expiration or renegotiation of collective bargaining agreements or otherwise. We could experience a significant disruption of operations and increased operating costs as a result of higher wages or benefits paid to union members, which could adversely affect our operating performance and may result in additional expenses and possible loss of revenue.

Our employees in Bahrain working on the War Reserve Material contract are also represented by a labor union. We have been notified by our work force that they are dissatisfied with their compensation and benefits and that they have voted to strike. We have a strike contingency plan in place that should avoid disruption to our performance of the contract; however, if our plan does not work to our expectations, we would experience a disruption of operations which could adversely affect our operating performance and may result in additional expenses and possible loss of revenue.

Proceedings against us in domestic and foreign courts could result in legal costs and adversely affect our operating performance.

At any given time, we are involved in various claims and lawsuits arising in the ordinary course of business. Actions involving third-party liability claims generally are covered by insurance; however, in the event our insurance coverage is inadequate to cover such claims, we will be forced to bear the costs arising from a judgment. We do not have insurance coverage for adverse employment and breach of contract actions, and we bear all costs associated with such litigation and claims.

As required by generally accepted accounting principles, we estimate material loss contingencies and establish reserves when we assess that liability is deemed probable and reasonably estimable based on the facts and circumstances known to us at a particular point in time, as adjusted by subsequent developments in a particular matter. For a description of our current material legal proceedings, see “Legal Proceedings.”

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Competition in our industry could limit our ability to attract and retain customers or employees, which could result in a loss of revenue and/or a reduction in margins, which could adversely affect our operating performance.

We compete with various entities across geographic and business lines. Competitors of our Field Technical Services operating segment are typically large defense services contractors, who offer services associated with maintenance, training and other activities. Competitors of our International Technical Services operating segment are various solution providers who typically compete in any one of our key business segments. We compete on a number of factors, including our broad range of services, geographic reach, mobility and response time.

Some of our competitors have greater financial and other resources than we do or are better positioned than we are to compete for contract opportunities. For example, original equipment manufacturers who also provide aftermarket support services have a distinct advantage in obtaining service contracts for aircraft that they have manufactured, as they frequently have better access to replacement and service parts as well as an existing technical understanding of the platform they have manufactured. In addition, we are at a disadvantage when bidding for contracts put up for recompetition for which we are not the incumbent provider, because incumbent providers are frequently able to capitalize on customer relationships, technical knowledge and pricing experience gained from their prior service.

In addition to the competition we face in bidding for contracts and task orders, we must also compete to attract the skilled and experienced personnel integral to our continued operation. We hire from a limited pool of potential employees, with military and law enforcement experience, specialized technical skill sets and security clearances as prerequisites for many positions. Our failure to compete effectively for employees or excessive attrition among our skilled personnel could reduce our ability to satisfy our customers’ needs, and increase the costs and time required to perform our contractual obligations. This could adversely affect our operating performance and may result in additional expenses and possible loss of revenue. For example, we recently lost four task orders for which we competed under our Worldwide Personal Protective Services program in Israel, Haiti, Afghanistan and Baghdad.

Loss of our skilled personnel, including members of senior management, may have an adverse effect on our operations and/or our operating performance until we find suitable replacements.

Our continued success depends in large part on our ability to recruit and retain the skilled personnel necessary to serve our customers effectively, including personnel with extensive military and law enforcement training and backgrounds. The proper execution of our contract objectives depends upon the availability of quality resources, especially qualified personnel. Given the nature of our business, we have substantial need for personnel who are willing to work overseas, frequently in locations experiencing political or civil unrest, for extended periods of time and often on short notice. We may not be able to meet the need for qualified personnel as such need arises.

In addition, we must comply with provisions in U.S. government contracts that require employment of persons with specified work experience and security clearances. An inability to maintain employees with the required security clearances could have a material adverse effect on our ability to win new business and satisfy our existing contractual obligations, and could adversely affect our operating performance and may result in additional expenses and possible loss of revenue.

The loss of services of any of the members of our senior management could adversely affect our business until a suitable replacement can be found. There may be a limited number of personnel with the requisite skills to serve in these positions, and we may be unable to locate or employ such qualified personnel on acceptable terms.

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If our subcontractors fail to perform their contractual obligations, our prime contract performance and our ability to obtain future business could be materially and adversely impacted.

Many of our contracts involve subcontracts with other companies upon which we rely to perform a portion of the services we must provide to our customers. In fiscal 2005 and 2006, we paid our subcontractors $174.9 million and $229.0 million, respectively. These subcontractors generally perform niche or specialty services for which they have more direct experience, such as construction or catering services, or they have local knowledge of the region in which we will be performing and the ability to communicate with local nationals and assist in making arrangements for commencement of performance. Often, we enter into subcontract arrangements in order to meet government requirements to award certain categories of services to small businesses. A failure by one or more of our subcontractors to satisfactorily provide on a timely basis the agreed-upon supplies or perform the agreed-upon services may materially and adversely impact our ability to perform our obligations as the prime contractor. Such subcontractor performance deficiencies could result in a customer terminating our contract for default. A default termination could expose us to liability and adversely affect our operating performance and may result in additional expenses and possible loss of revenue.

Environmental laws and regulations may subject us to significant costs and liabilities that could adversely affect our operating performance.

We are subject to numerous environmental, legal and regulatory requirements related to our operations worldwide. In the United States, these laws and regulations include those governing the management and disposal of hazardous substances and wastes and the maintenance of a safe workplace, primarily associated with our aviation services activities, including painting aircraft and handling substances that may qualify as hazardous waste, such as used batteries and petroleum products. In addition to U.S. federal laws and regulations, states and other countries where we do business have numerous environmental, legal and regulatory requirements by which we must abide. We could incur substantial costs, including clean-up costs, as a result of violations of, or liabilities under, environmental laws. This could adversely affect our operating performance and may result in additional expenses and possible loss of revenue.

The requirements of complying with the Securities Exchange Act of 1934 and the Sarbanes-Oxley Act of 2002 may strain our resources and distract management.

We are subject to the Sarbanes-Oxley Act of 2002. These requirements may place a strain on our systems and resources. Section 404 of the Sarbanes-Oxley Act will require that we maintain, and certify that we have, effective disclosure controls and procedures and internal control over financial reporting. Pursuant to Section 404 of the Sarbanes-Oxley Act, our management will be required to deliver a report that assesses the effectiveness of our internal control over financial reporting and an attestation report of our auditors on our management’s assessment of such internal control. In order to maintain and improve the effectiveness of our disclosure controls and procedures and internal control over financial reporting, significant resources and management oversight will be required to devote additional time and personnel to legal, financial and accounting activities to ensure our ongoing compliance with these reporting requirements. We might not be able to complete the documentation and management assessment required by Section 404 of the Sarbanes-Oxley Act before it becomes applicable to us. In addition, the effort to prepare for these obligations may divert management’s attention from other business concerns, which could adversely affect our operating performance. In addition, we may need to hire additional accounting and financial staff, which we may not be able to do in a timely fashion and which would result in additional expense and distraction of our management’s time and resources.

19




Our substantial level of indebtedness may make it difficult for us to satisfy our debt obligations and may adversely affect our ability to obtain financing for working capital, capitalize on business opportunities or respond to adverse changes in our industry.

As of March 31, 2006, we had $661.6 million of total indebtedness and $82.5 million of additional borrowing capacity under our senior secured credit facility (which gives effect to the $7.5 million of outstanding letters of credit). Based on our indebtedness and other obligations as of March 31, 2006, we estimate that, for fiscal 2007, our remaining contractual commitments including interest associated with our indebtedness and other obligations (assuming that our revolving credit facility will be undrawn at the close of fiscal 2007) will be $216.0 million in the aggregate for the remaining period between April 1, 2006 through the end of fiscal 2010. This estimate gives effect to the use of a portion of the proceeds of the Equity Offering to redeem approximately $28.0 million of the senior subordinated notes on June 8, 2006, which does not include accrued and unpaid interest on such notes as of that date of $0.8 million. Even after the application of a portion of the proceeds of the Equity Offering to repay certain indebtedness, we still have substantial indebtedness. Such indebtedness could have important consequences for you, including the following:

·       it may be more difficult for us to satisfy our debt obligations;

·       our ability to obtain additional financing for working capital, debt service requirements, general corporate or other purposes may be impaired;

·       we must use a substantial portion of our cash flow to pay interest and principal on our indebtedness which will reduce the funds available for other purposes;

·       we are more vulnerable to economic downturns and adverse industry conditions;

·       our ability to capitalize on business opportunities and to react to competitive pressures and adverse changes in our industry as compared to our competitors may be compromised due to the high level of indebtedness; and

·       our ability to refinance indebtedness may be limited.

Our senior secured credit facility and the indenture governing our senior subordinated notes contain various covenants limiting the discretion of our management in operating our business.

Our indenture and senior secured credit facility contain various restrictive covenants that limit our management’s discretion in operating our business. These instruments limit our ability to engage in, among other things, the following activities:

·       the incurrence of additional indebtedness or guarantee obligations;

·       the repayment of indebtedness prior to stated maturities;

·       the payment of dividends or make certain other restricted payments;

·       making investments or acquisitions;

·       the creation of liens or other encumbrances; and

·       the ability to transfer or sell certain assets or merge or consolidate with another entity.

In addition, our senior secured credit facility also requires us to maintain certain financial ratios and limits our ability to make capital expenditures. Capital expenditures, as defined in the senior secured credit facility, are the purchases of property and equipment. These financial ratios include a minimum interest coverage ratio and a leverage ratio. The interest coverage ratio is the ratio of earnings before interest, taxes, depreciation and amortization (“EBITDA’’) (as defined in our senior secured credit facility) to cash

20




interest expense for the preceding four quarters. The leverage ratio is a ratio of our debt to our EBITDA for the preceding four quarters. The minimum interest coverage ratio increases from 2:1 to 3.2:1 during the term of the senior secured credit facility. The maximum leverage ratio decreases from 6:1 to 3:1 during the term of the senior secured credit facility. The senior secured credit facility also restricts the maximum amount of our capital expenditures during each year of the term of the senior secured credit facility. Our annual capital expenditures may not exceed $4.0 million during the term of our senior secured credit facility. Capital expenditures are expenditures that are required by generally accepted accounting principles to be included in the purchase of property and equipment.

If we fail to comply with the restrictions in the indenture or our senior secured credit facility or any other subsequent financing agreements, a default may allow the creditors under the relevant instruments, in certain circumstances, to accelerate the related debt and to exercise their remedies thereunder, which will typically include the right to declare the principal amount of such debt, together with accrued and unpaid interest and other related amounts immediately due and payable, to exercise any remedies such creditors may have to foreclose on any of our assets that are subject to liens securing such debt and to terminate any commitments they had made to supply us with further funds. Moreover, any of our other debt that has a cross-default or cross-acceleration provision that would be triggered by such default or acceleration would also be subject to acceleration upon the occurrence of such default or acceleration.

Our ability to comply with these covenants may be affected by events beyond our control, and an adverse development affecting our business could require us to seek waivers or amendments of covenants, alternative or additional sources of financing or reductions in expenditures. We cannot assure you that such waivers, amendments or alternative or additional financings could be obtained, or if obtained, would be on terms acceptable to us.

Servicing our indebtedness requires a significant amount of cash. Our ability to generate sufficient cash depends on numerous factors beyond our control, and we may be unable to generate sufficient cash flow to service our debt obligations, which could adversely affect our financial condition.

As of March 31, 2006, we had $661.6 million of total indebtedness and $82.5 million of additional borrowing capacity under our senior secured credit facility (which gives effect to the $7.5 million of outstanding letters of credit). Based on our indebtedness and other obligations as of March 31, 2006, we estimate that, for fiscal 2007, our remaining contractual commitments including interest associated with our indebtedness and other obligations (assuming that our revolving credit facility will be undrawn at the close of fiscal 2007) will be $216.0 million in the aggregate for the remaining period between April 1, 2006 through the end of fiscal 2010. This estimate gives effect to the use of a portion of the proceeds of the Equity Offering to redeem approximately $28.0 million of the senior subordinated notes on June 8, 2006, which includes accrued and unpaid interest on such notes as of that date of $0.8 million. Our ability to make payments on and to refinance our indebtedness depends on our ability to generate cash. This, to a certain extent, is subject to general economic, political, financial, competitive, legislative, regulatory and other factors that are beyond our control.

We cannot assure you, however, that our business will generate sufficient cash flow from operations, or that future borrowings will be available to us under our senior secured facility in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness. We cannot assure you that we will be able to refinance any of our indebtedness, including our senior secured credit facility, on commercially reasonable terms or at all. In addition, the terms of existing or future debt agreements, including our senior secured credit facility and the indenture governing our senior subordinated notes, may restrict us from carrying out any of these alternatives. If we are unable to generate sufficient cash flow or refinance our debt on favorable terms, it could significantly adversely affect our financial condition.

21




Despite our current indebtedness level, we and our subsidiaries may still be able to incur substantially more debt, which could exacerbate the risks associated with our substantial leverage.

As of March 31, 2006, we had up to $82.5 million of additional availability under our senior secured credit facility (which gives effect to $7.5 million of outstanding letters of credit). The terms of the senior secured credit facility and our senior subordinated notes do not fully prohibit us or our subsidiaries from incurring additional indebtedness. It is not possible to quantify the specific dollar amount of indebtedness we may incur because our senior secured credit facility does not provide for a specific dollar amount of indebtedness we may incur. Our senior secured credit facility and our senior subordinated notes allow us to incur only certain indebtedness that is expressly enumerated in our senior secured credit facility and the indenture governing our senior subordinated notes. The indebtedness permitted under our senior secured credit facility includes indebtedness that is customary for similar credit facilities. Specific examples of indebtedness permitted under our senior secured credit facility are described further under notes to the consolidated financial statements and include certain intercompany indebtedness, indebtedness under the senior secured credit facility, the senior subordinated notes, certain refinancing indebtedness and certain indebtedness with respect to capital leases in an amount that may not exceed $10.0 million. We believe that the comparable restrictions in the indenture governing our senior subordinated notes have restrictions that are generally no more restrictive in any material respect than the senior secured credit facility. If either we or our subsidiaries were to incur additional indebtedness, the related risks that we now face could intensify.

If our Class A common stock price fluctuates, you could lose a significant part of your investment.

The market price of our Class A common stock may be influenced by many factors, some of which are beyond our control, including:

·       the failure of securities analysts to cover our Class A common stock, or changes in financial estimates by analysts;

·       the activities of competitors;

·       future sales of our Class A common stock either by us or by our controlling stockholder;

·       future issuances by us of our Class A common stock to finance future acquisitions;

·       investor perceptions of us and the industry;

·       our quarterly or annual earnings or those of other companies in our industry;

·       the public’s reaction to our press releases, our other public announcements and our filings with the Securities and Exchange Commission;

·       general economic conditions; and

·       the other factors described elsewhere in these “Risk Factors.”

The stock market often experiences extreme price and volume fluctuations that are unrelated or disproportionate to the operating performance of a particular company. These broad market fluctuations and industry factors may materially reduce the market price of our Class A common stock, regardless of our operating performance.

We are controlled by Veritas Capital, whose interests may not be aligned with yours.

Veritas Capital Management II, L.L.C. and its affiliates, The Veritas Capital Fund II, L.P. and Veritas Capital II A, LLC, own 86% of the outstanding membership interest in our controlling stockholder, DIV Holding LLC. Veritas Capital indirectly controls approximately 56.1% of our Class A common stock. So long as Veritas Capital continues to own a significant amount of the outstanding shares of our Class A common stock, it will continue to be able to strongly influence or effectively control our decisions,

22




including potential mergers or acquisitions, asset sales and other significant corporate transactions. As a result, Veritas Capital is able to control the election of our directors, determine our corporate and management policies and determine without the consent of our other stockholders, the outcome of any corporate transaction or other matter submitted to our stockholders for approval, including potential mergers or acquisitions, asset sales and other significant corporate transactions. Three of our thirteen directors are either employees of, or advisors to, Veritas Capital, as described under “Directors and Executive Officers of the Registrant—Management.”  Veritas Capital has sufficient voting power to amend our organizational documents. The interests of Veritas Capital may not coincide with the interests of other holders of our Class A common stock. Additionally, Veritas Capital is in the business of making investments in companies and may, from time to time, acquire and hold interests in businesses that compete directly or indirectly with us. Veritas Capital may also pursue, for its own account, acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us. In addition, our Bylaws provide that so long as Veritas Capital beneficially owns a majority of our outstanding Class A common stock, the foregoing advance notice procedures for stockholder proposals will not apply to it. Amendment of the provisions described above in our Amended and Restated Certificate of Incorporation generally will require an affirmative vote of our directors, as well as the affirmative vote of at least a majority of our then outstanding voting stock if Veritas Capital beneficially owns a majority of our outstanding Class A common stock, or the affirmative vote of at least 80% of our then outstanding voting stock if Veritas Capital beneficially owns less than a majority of our then outstanding Class A common stock. Amendments to any other provisions of our Amended and Restated Certificate of Incorporation generally will require the affirmative vote of a majority of our outstanding voting stock. In addition, because we are a controlled company within the meaning of the New York Stock Exchange rules, we will be exempt from the New York Stock Exchange requirements that our board be composed of a majority of independent directors, and that our compensation and corporate governance committees be composed entirely of independent directors.

DIV Holding LLC is a party to a registration rights agreement, which grants it rights to require us to effect the registration of its shares of common stock. In addition, if we propose to register any of our common stock under the Securities Act of 1933, as amended, whether for our own account or otherwise, DIV Holding LLC is entitled to include its shares of common stock in that registration.

Prior to our Equity Offering, we and our existing holder of Class A common stock agreed with the underwriters to a “lock-up” period, meaning that our current stockholder may not, subject to certain other exceptions, sell any of its shares of our Class A common stock without the prior written consent of Credit Suisse Securities (USA) LLC and Goldman, Sachs & Co. until approximately 180 days after the effective date of the offering. Credit Suisse Securities (USA) LLC and Goldman, Sachs & Co., on behalf of the underwriters, may, in their sole discretion, at any time or from time to time and without notice, waive the terms and conditions of the lock-up agreement. In addition, our current stockholder will be subject to the Rule 144 holding period requirement. When the lock-up agreements expire, 32.0 million shares of our Class A common stock will become eligible for sale, in some cases subject to the requirements of Rule 144. The market price for shares of our Class A common stock may drop significantly when the restrictions on resale by our existing stockholder lapses. A decline in the price of shares of our Class A common stock might impede our ability to raise capital through the issuance of additional shares of our Class A common stock or other equity securities.

23




Even if Veritas Capital no longer controls us in the future, certain provisions of our charter documents and agreements, as well as Delaware law, could discourage, delay or prevent a merger or acquisition at a premium price.

Our Amended and Restated Certificate of Incorporation and Bylaws contain provisions that:

·       permit us to issue, without any further vote or action by our stockholders, 50,000,000 shares of preferred stock in one or more series and, with respect to each series, to fix the number of shares constituting the series and the designation of the series, the voting powers (if any) of the shares of such series, and the preferences and other special rights, if any, and any qualifications, limitations or restrictions, of the shares of the series;

·       provide for a classified board of directors serving staggered three-year terms; and

·       limit our stockholder’s ability to call special meetings.

In addition, we have a rights plan that grants stockholders the right to purchase from us additional shares at preferential prices in the event of a hostile attempt to acquire control of us.

All of the foregoing provisions may impose various impediments to the ability of a third party to acquire control of us, even if a change in control would be beneficial to our existing stockholders.

We do not intend to pay dividends on our Class A common stock for the foreseeable future, and the instruments governing our current indebtedness contain various covenants that may limit our ability to pay dividends.

We do not intend to pay dividends on our Class A common stock for the foreseeable future. Our board of directors may, in its discretion, modify or repeal our dividend policy. Future dividends, if any, with respect to shares of our Class A common stock will depend on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions, provisions of applicable law and other factors that our board of directors may deem relevant. Accordingly, we cannot assure you that we will pay dividends in the future or at all.

The instruments governing our current indebtedness contain covenants that place limitations on the amount of dividends we may pay. See the notes to the consolidated financial statements elsewhere in this Form 10-K. In addition, under Delaware law, our board of directors may declare dividends only to the extent of our “surplus” (which is defined as total assets at fair market value minus total liabilities, minus statutory capital), or if there is no surplus, out of net profits for the then current and/or immediately preceding fiscal year. For a discussion of our restrictions, see “Risk Factors.”

We are dependent upon cash flows from our operating activities and availability under our senior secured credit facility as our principal source of liquidity.

We are dependent upon the cash generated from operating activities and availability under our senior secured credit facility to be our principal sources of liquidity. Based on our current level of operations, we believe our cash flow from operations and available borrowings under our senior secured credit facility will be adequate to meet our liquidity needs for at least the next twelve months. We cannot assure you, however, that our business will generate sufficient cash flow from operations, or that future borrowings will be available to us under our senior secured credit facility in an amount sufficient to enable us to repay our indebtedness, including the notes, or to fund our other liquidity needs.

24




ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

ITEM 2. PROPERTIES.

Our principal executive office is located in, and a portion of our operations are conducted from, leased premises located at 8445 Freeport Parkway, Suite 400, Irving, Texas, 75254-8815. In addition, as of March 31, 2006, we leased 197 commercial facilities in 18 countries used in connection with the various services rendered to our customers. Upon expiration of our leases, we do not anticipate any difficulty in obtaining renewals or alternative space. We do not own any real property. Lease expirations range from month-to-month to ten years. Many of the current leases are non-cancelable.

We believe that substantially all of our property and equipment is in good condition, subject to normal wear and tear and that our facilities have sufficient capacity to meet the current and projected needs of our business.

The following table lists our U.S. leased properties, including the inside square footage of those properties as of May 31, 2006.

City, State

 

 

 

Size

 

 

 

(square feet)

 

Albany, Georgia

 

 

280,000

 

 

Fort Worth, Texas

 

 

119,001

 

 

Irving, Texas

 

 

52,421

 

 

Falls Church, Virginia

 

 

46,664

 

 

McClellan, California

 

 

18,837

 

 

Herndon, Virginia

 

 

10,063

 

 

Hampton, Virginia

 

 

3,437

 

 

Fredericksburg, Virginia

 

 

2,600

 

 

Huntsville, Alabama

 

 

1,200

 

 

Killeen, Texas

 

 

1,000

 

 

 

ITEM 3. LEGAL PROCEEDINGS.

Pending Litigation and Claims

On September 11, 2001, a class action lawsuit seeking $100.0 million on behalf of approximately 10,000 citizens of Ecuador was filed against DynCorp International and several of its former affiliates in the U.S. District Court for the District of Columbia. The action alleges personal injury, property damage and wrongful death as a consequence of the spraying of narcotic plant crops along the Colombian border adjacent to Ecuador. The spraying operations are conducted under a Department of State contract in cooperation with the Colombian government. The terms of the Department of State contract provide that the Department of State will indemnify DynCorp International against third-party liabilities arising out of the contract, subject to available funding. We are also entitled to indemnification by Computer Sciences Corporation in connection with this lawsuit, subject to certain limitations. Additionally, any damage award would have to be apportioned between the other defendants and our Company.

On May 29, 2003, Gloria Longest, a former accounting manager for the Company, filed suit against the Company under the False Claims Act and the Florida Whistleblower Statute, alleging that it submitted false claims to the government under the International Narcotics & Law Enforcement Affairs contract with the Department of State. The action, titled U.S. ex rel. Longest v. DynCorp and DynCorp International LLC, was filed in the U.S. District Court for the Middle District of Florida under seal. The case was unsealed in 2005, and we learned of its existence on August 15, 2005 when we were served with the complaint. After

25




conducting an investigation of the allegations made by the plaintiff, the U.S. government did not join the action. The complaint does not demand any specific monetary damages; however, in the event that a court decides against us in this lawsuit, it could have a material adverse effect on our operating performance.

General Legal Matters

The Company and its subsidiaries and affiliates are involved in various lawsuits and claims that have arisen in the normal course of business. In most cases, we have denied, or believe we have a basis to deny, liability. We have recorded, in the consolidated financial statements found elsewhere in this Form 10-K, our best estimate of the aggregate liability that will result from these matters and believe that these matters are adequately reserved. While it is not possible to predict with certainty the outcome of litigation and other matters discussed above, it is the opinion of the Company’s management, based in part upon opinions of counsel, insurance in force and the facts currently known, that liabilities in excess of those recorded, if any, arising from such matters would not have a material adverse effect on the results of operations, consolidated financial condition or liquidity of the Company over the long term.

In addition, the Company is occasionally the subject of investigations by various agencies of the U.S. government. Such investigations, whether related to our U.S. government contracts or conducted for other reasons, could result in administrative, civil or criminal liabilities, including repayments, fines or penalties being imposed upon us, or could lead to suspension or debarment from future U.S. government contracting. In management’s opinion, there are no outstanding issues of this nature at March 31, 2006 that will have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

26




PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

(a)          Market Information. Our equity securities consist of one class of common stock, Class A common stock. DIV Holding LLC held Class B common stock, which automatically converted on a one-for-one basis into Class A common stock once the underwriters’ over-allotment option expired on June 2, 2006. Our Class A common stock began trading on the New York Stock Exchange on May 4, 2006, subsequent to our fiscal year ended March 31, 2006, under the symbol “DCP.”  Therefore, we do not have any quarterly high and low sales prices of our Class A common stock for fiscal 2005 and 2006.

(b)         Holders of Record. As of June 1 2006, there were approximately 154 holders of record of our Class A common stock.

(c)          Dividends. Immediately prior to the consummation of our Equity Offering, we declared an initial special Class B distribution of $100.0 million, payable upon the consummation of the offering, and an additional special Class B distribution payable upon the exercise of the underwriters’ over-allotment option, representing 50% of the aggregate net proceeds that we would have received from the sale of up to 3,750,000 additional shares of our Class A common stock. The initial special Class B distribution was made on May 9, 2006 and since the underwriters failed to exercise their over-allotment option, the additional special Class B distribution is no longer payable.

We do not intend to pay cash dividends on our Class A common stock in the foreseeable future. We are a holding company that does not conduct any business operations of our own. As a result, we are dependent upon cash dividends and distributions and other transfers from our subsidiaries to make dividend payments on our Class A common stock. The amounts available to us to pay cash dividends are restricted by our subsidiaries’ debt agreements. The declaration and payment of dividends also are subject to the discretion of our board of directors and depend on various factors, including our net income, financial conditions, cash requirements, future prospects and other factors deemed relevant by our board of directors.

(d)         Securities Authorized for Issuance Under Equity Compensation Plans. None.

(e)          Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities. The following is a list of all securities sold or issued by us during the period covered by this Annual Report:

In October 2005, as payment for the working capital adjustment in the amount of $65.5 million, we issued 65,550 shares of our preferred stock to Computer Sciences Corporation. We redeemed all of our preferred stock using proceeds from the Equity Offering.

On May 9, 2006, we consummated an Equity Offering of 25,000,000 shares of our Class A common stock, par value $.01 per share, at a price of $15.00 per share. The gross proceeds from the Equity Offering of $375.0 million, together with cash on hand, were used: (i) to redeem all of our outstanding preferred stock, of which $222.8 million in stated amount, including accrued and unpaid dividends thereon, was outstanding as of May 9, 2006 (including preferred stock issued and accrued and unpaid dividends related to the working capital adjustment); (ii) to pay a special Class B distribution in the amount of $100.0 million to the holder of the Company’s common stock, DIV Holding LLC; (iii) to redeem $28.0 million of our senior subordinated notes on June 8, 2006; (iv) to pay prepayment penalties of $8.4 million as of May 9, 2006, $5.7 million of which represented prepayment penalties on our preferred stock and $2.7 million of which represented prepayment penalties on our senior subordinated notes; and (v) to pay transaction expenses of approximately $35.0 million, including an underwriters’ commission of $22.5 million, a fee of

27




$5.0 million to Veritas Capital and $7.5 million of miscellaneous fees and expenses related to the Equity Offering.

ITEM 6. SELECTED FINANCIAL DATA.

Set forth below are the five-year selected historical consolidated financial data. This information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes thereto included elsewhere in this Form 10-K. The selected consolidated financial information for fiscal 2002 has been derived from our unaudited consolidated financial statements. In our opinion, these unaudited consolidated financial statements have been prepared on the same basis as the audited financial statements and include all adjustments, consisting only of normal and recurring adjustments, necessary for a fair presentation of the information included therein. The selected consolidated financial information for the period from March 30, 2002 through March 7, 2003 has been derived from our consolidated financial statements, referred to as the “original predecessor period.”  The selected historical consolidated financial data for the period from March 8, 2003 through March 28, 2003, as of and for the fiscal year ended April 2, 2004 and for the period from April 3, 2004 through February 11, 2005 are derived from our consolidated financial statements, referred to as the “immediate predecessor period.”  The selected historical consolidated financial data as of April 1, 2005 and for the period from February 12, 2005 through April 1, 2005 and for the fiscal year ended March 31, 2006 are derived from our consolidated financial statements, referred to as the “successor period.”

We use a 52/53-week fiscal year ending on the closest Friday to March 31. The period from April 3, 2004 to February 11, 2005 was a 45-week period. The fiscal year ended April 2, 2004 was a 53-week year. The period from March 30, 2002 to March 7, 2003 included 49 weeks. During the original predecessor period, DynCorp used a calendar year. Accordingly, the financial statements covered by that period were restated to 52/53-week fiscal year ends.

28




 

 

Original Predecessor Period

 

 

 

Immediate Predecessor Period

 

 

 

Successor Period

 

 

 

Fiscal Year
Ended
March 29,
2002

 

March 30,
2002 –
March 7,
2003

 

 

 

21 Days
Ended
March 28,
2003

 

Fiscal Year
Ended
April 2,
2004

 

April 3,
2004 –
Feb. 11,
2005

 

 

 

49 Days
Ended
April 1,
2005

 

Fiscal Year
Ended
March 31,
2006

 

 

 

 

 

 

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

STATEMENT OF OPERATIONS DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

$

755,326

 

 

 

$

859,112

 

 

 

 

$

59,240

 

$

1,214,289

 

$

1,654,305

 

 

 

$

266,604

 

$

1,966,993

 

Costs of Services (excluding depreciation and amortization disclosed below)

 

 

687,088

 

 

 

787,649

 

 

 

 

53,482

 

1,106,571

 

1,496,109

 

 

 

245,406

 

1,722,089

 

Selling, General and Administrative

 

 

34,544

 

 

 

40,316

 

 

 

 

3,414

 

48,350

 

57,755

 

 

 

8,408

 

97,520

 

Depreciation and Amortization

 

 

1,462

 

 

 

351

 

 

 

 

265

 

8,148

 

5,922

 

 

 

5,605

 

46,147

 

Operating Income

 

 

32,232

 

 

 

30,796

 

 

 

 

2,079

 

51,220

 

94,519

 

 

 

7,185

 

101,237

 

Interest Expense

 

 

43

 

 

 

 

 

 

 

 

 

 

 

 

8,054

 

56,686

 

Interest on Mandatory Redeemable
Shares

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,182

 

21,142

 

Interest Income

 

 

(50

)

 

 

(43

)

 

 

 

(2

)

(64

)

(170

)

 

 

(7

)

(461

)

Net Income (Loss) Before Income
Taxes

 

 

32,239

 

 

 

30,839

 

 

 

 

2,081

 

51,284

 

94,689

 

 

 

(3,044

)

23,870

 

Provision for Income Taxes

 

 

11,525

 

 

 

11,973

 

 

 

 

852

 

19,924

 

34,956

 

 

 

60

 

16,627

 

Net Income (Loss)

 

 

$

20,714

 

 

 

$

18,866

 

 

 

 

$

1,229

 

$

31,360

 

$

59,733

 

 

 

$

(3,104

)

$

7,243

 

CASH FLOW DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Cash (Used in) Provided by Operating Activities

 

 

 

 

 

 

$

(10,331

)

 

 

 

$

12,542

 

$

(6,756

)

$

(2,092

)

 

 

$

(31,240

)

$

55,111

 

Net Cash Used in Investing Activities

 

 

 

 

 

 

(920

)

 

 

 

(360,961

)

(2,292

)

(10,707

)

 

 

(869,394

)

(6,231

)

Net Cash Provided by (Used in) Financing Activities

 

 

 

 

 

 

13,191

 

 

 

 

348,854

 

11,017

 

14,325

 

 

 

906,072

 

(41,781

)

OTHER FINANCIAL DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

EBITDA (1) (2)

 

 

$

33,744

 

 

 

$

31,781

 

 

 

 

$

2,382

 

$

60,072

 

$

101,326

 

 

 

$

12,896

 

$

148,718

 

Capital Expenditures

 

 

1,181

 

 

 

1,011

 

 

 

 

11

 

2,047

 

8,473

 

 

 

244

 

3,465

 

SELECTED OPERATING INFORMATION:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Backlog (3)

 

 

$

2,091

 

 

 

NA

 

 

 

 

$

2,028

 

$

2,164

 

NA

 

 

 

$

2,040

 

$

2,641

 

BALANCE SHEET DATA:(4)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and Cash Equivalents

 

 

$

2,166

 

 

 

NA

 

 

 

 

$

4,541

 

$

6,510

 

NA

 

 

 

$

13,474

 

$

20,573

 

Working Capital (5)

 

 

38,861

 

 

 

NA

 

 

 

 

58,295

 

104,335

 

NA

 

 

 

200,367

 

251,329

 

Total Assets

 

 

148,032

 

 

 

NA

 

 

 

 

481,097

 

579,829

 

NA

 

 

 

1,148,193

 

1,239,089

 

Total Debt

 

 

 

 

 

NA

 

 

 

 

 

 

NA

 

 

 

826,990

 

881,372

 

Shareholder’s Equity

 

 

 

 

 

NA

 

 

 

 

354,198

 

396,573

 

NA

 

 

 

96,918

 

106,338

 


(1)             EBITDA is a primary component of certain covenants under our senior secured credit facility and is defined as net income (loss) before interest expense, income taxes, depreciation and amortization. EBITDA does not represent net income or cash flows from operations, as these terms are defined under generally accepted accounting principles, or “GAAP,” and should not be considered as an alternative to net income, operating income or any other performance measures derived in accordance with GAAP. EBITDA as presented in this Form 10-K is not necessarily comparable to similarly titled measures reported by other companies.

(2)             The following table presents a reconciliation of income to EBITDA for the periods included below.

 

 

Original Predecessor Period

 

 

 

Immediate Predecessor Period

 

 

 

Successor Period

 

 

 

Fiscal Year
Ended
March 29,
2002

 

March 30,
2002 –
March 7,
2003

 

 

 

21 Days
Ended
March 28,
2003

 

Fiscal Year
Ended
April 2,
2004

 

April 3,
2004 –
Feb. 11,
2005

 

 

 

49 Days
Ended
April 1,
2005

 

Fiscal Year
Ended
March 31,
2006

 

 

 

 

 

 

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

RECONCILIATION OF NET INCOME TO EBITDA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income (loss)

 

 

$

20,714

 

 

 

$

18,866

 

 

 

 

 

$

1,229

 

 

 

$

31,360

 

 

$

59,733

 

 

 

 

$

(3,104

)

 

 

$

7,243

 

 

Income Taxes

 

 

11,525

 

 

 

11,973

 

 

 

 

 

852

 

 

 

19,924

 

 

34,956

 

 

 

 

60

 

 

 

16,627

 

 

Interest Expense

 

 

43

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10,236

 

 

 

77,828

 

 

Depreciation and Amortization

 

 

1,462

 

 

 

942

 

 

 

 

 

301

 

 

 

8,788

 

 

6,637

 

 

 

 

5,704

 

 

 

47,020

 

 

EBITDA

 

 

$

33,744

 

 

 

$

31,781

 

 

 

 

 

$

2,382

 

 

 

$

60,072

 

 

$

101,326

 

 

 

 

$

12,896

 

 

 

$

148,718

 

 


(3)             Backlog data is as of the end of the applicable period.

(4)             Balance sheet data is as of the end of the applicable period.

(5)             Working capital is defined as current assets, net of current liabilities.

29




ITEM 7.                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Overview

Company Background

We provide specialized mission-critical outsourced technical services to civilian and military government agencies. Our specific global expertise is in law enforcement training and support, security services, base operations and aviation services and operations. We also provide logistics support for all of our services. Our predecessors have provided services to numerous U.S. government departments and agencies since 1951. We operated as a separate subsidiary of Computer Sciences Corporation from March 2003 until February 2005. On February 11, 2005, Computer Sciences Corporation and DynCorp sold DynCorp International LLC to DynCorp International Inc., a newly formed entity controlled by Veritas Capital. The Company has no operations independent of DynCorp International LLC.

Equity Offering

On May 9, 2006, we consummated an Equity Offering of 25,000,000 shares of our Class A common stock, par value $0.01 per share, at a price of $15.00 per share (the “Equity Offering”). The gross proceeds from the Equity Offering of $375.0 million, together with cash on hand, were used: (i) to redeem all of our outstanding preferred stock, of which $222.8 million in stated amount, including accrued and unpaid dividends thereon, was outstanding as of May 9, 2006; (ii) to pay a special Class B distribution in the amount of $100.0 million to the holder of the Company’s common stock, DIV Holding LLC; (iii) to redeem $28.0 million of our senior subordinated notes on June 8, 2006; (iv) to pay prepayment penalties of $8.4 million as of May 9, 2006, $5.7 million of which represented prepayment penalties on our preferred stock and $2.7 million of which represented prepayment penalties on our senior subordinated notes; and (v) to pay transaction expenses of approximately $35.0 million, including an underwriters’ commission of $22.5 million, a fee of $5.0 million to Veritas Capital Management II, L.L.C. and $7.5 million of miscellaneous fees and expenses related to the Equity Offering.

Presentation of Financial Results

On December 12, 2004, The Veritas Capital Fund II, L.P. and its subsidiary, DI Acquisition Corp. (later renamed DynCorp International Inc.), entered into a purchase agreement with Computer Sciences Corporation and DynCorp whereby DynCorp International agreed to acquire our operating company, a wholly owned subsidiary of DynCorp. DynCorp International assigned its rights to acquire our operating company to DI Finance LLC, its wholly owned subsidiary. Immediately after the consummation of the 2005 Acquisition on February 11, 2005, DI Finance LLC was merged with and into our operating company. Our operating company survived the merger and is now a wholly owned subsidiary of DynCorp International. Accordingly, the discussion and analysis of historical operations during the period prior to the 2005 Acquisition do not reflect the significant impact that this transaction had on us. You should read the following discussion together with the sections entitled “Selected Financial Data,” “Risk Factors” and the consolidated financial statements included elsewhere in this Form 10-K. With respect to certain forward-looking statements contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, see “Business—Forward-Looking Statements.”

We are providing the following supplemental comparative financial information on a pro forma and combined basis for the immediate predecessor and successor for the full year of fiscal 2005. This pro forma and combined financial information is presented on a consolidated basis as if the acquisition was effective at the beginning of fiscal 2005. The usefulness of this information may be limited due to the aforementioned risk factors. Unless otherwise indicated, references in this Item 7 to results for the full year of fiscal 2005 reflect pro forma and combined results of the immediate predecessor and successor.

30




The following pro forma consolidated statement of operations for the fiscal year ended April 1, 2005, is derived from the application of pro forma adjustments to the historical statement of operations of the immediate predecessor for the period from April 3, 2004 to February 11, 2005 as if the 2005 Acquisition occurred on April 3, 2004. The statement of operations for the 49 days ended April 1, 2005 represents the historical results of the successor company. These pro forma results should be read in conjunction with the consolidated financial statements, related notes and other consolidated financial information included elsewhere in this Form 10-K.

The pro forma adjustments are described in the notes to the pro forma statement of operations and are based on available information and assumptions that management believes are reasonable. The pro forma statement of operations is not necessarily indicative of the future results of operations of the successor company or results of operations of the successor company that would have actually occurred had the 2005 Acquisition been consummated as of April 3, 2004.

Pro Forma Financial Information

 

 

Immediate
Predecessor
Period

 

Successor

 

 

 

 

 

 

 

Period from
April 3, 2004 to
Feb. 11, 2005

 

49 Days
Ended
April 1, 2005

 

Adjustments

 

Pro Forma
Combined
Fiscal Year
Ended
April 1, 2005

 

 

 

(dollars in thousands)

 

Revenues

 

 

$

1,654,305

 

 

 

$

266,604

 

 

 

$

 

 

 

$

1,920,909

 

 

Costs of Services

 

 

1,496,109

 

 

 

245,406

 

 

 

 

 

 

1,741,515

 

 

Selling, General and Administrative

 

 

57,755

 

 

 

8,408

 

 

 

(775

)(1)

 

 

65,388

 

 

Depreciation and Amortization

 

 

5,922

 

 

 

5,605

 

 

 

34,009

(2)

 

 

45,536

 

 

Total Costs and Expenses

 

 

1,559,786

 

 

 

259,419

 

 

 

33,234

 

 

 

1,852,439

 

 

Operating Income

 

 

94,519

 

 

 

7,185

 

 

 

(33,234

)

 

 

68,470

 

 

Interest Income

 

 

(170

)

 

 

(7

)

 

 

 

 

 

(177

)

 

Interest Expense

 

 

 

 

 

8,054

 

 

 

47,414

(3)

 

 

55,468

 

 

Interest on Mandatory Redeemable Shares

 

 

 

 

 

2,182

 

 

 

18,960

(4)

 

 

21,142

 

 

Income (loss) before Income Taxes

 

 

94,689

 

 

 

(3,044

)

 

 

(99,608

)

 

 

(7,963

)

 

Provision for Income Taxes

 

 

34,956

 

 

 

60

 

 

 

(30,153

)(5)

 

 

4,863

 

 

Net Income (loss)

 

 

$

59,733

 

 

 

$

(3,104

)

 

 

$

(69,455

)

 

 

$

(12,826

)

 

Segment information:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

International Technical Services

 

 

$

1,059,713

 

 

 

$

173,007

 

 

 

$

 

 

 

$

1,232,720

 

 

Field Technical Services

 

 

594,480

 

 

 

93,674

 

 

 

 

 

 

688,154

 

 

Other

 

 

112

 

 

 

(77

)

 

 

 

 

 

35

 

 

Consolidated

 

 

$

1,654,305

 

 

 

$

266,604

 

 

 

$

 

 

 

$

1,920,909

 

 

Earnings before Interest and Taxes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

International Technical Services

 

 

$

68,198

 

 

 

$

3,447

 

 

 

$

(24,821

)

 

 

$

46,824

 

 

Field Technical Services

 

 

27,755

 

 

 

3,662

 

 

 

(8,106

)

 

 

23,311

 

 

Other

 

 

(1,434

)

 

 

76

 

 

 

(307

)

 

 

(1,665

)

 

Consolidated

 

 

$

94,519

 

 

 

$

7,185

 

 

 

$

(33,234

)

 

 

$

68,470

 

 

Cash flow data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in operating activities

 

 

$

(2,092

)

 

 

$

(31,240

)

 

 

$

 

 

 

$

(33,332

)

 

Net cash used in investing activities

 

 

(10,707

)

 

 

(869,394

)

 

 

 

 

 

(880,101

)

 

Net cash provided by financing activities

 

 

14,325

 

 

 

906,072

 

 

 

 

 

 

920,397

 

 


(1)            The annual management fee is $300,000, $25,000 of which is reflected under selling, general and administrative for the successor period and which is offset by management retention bonuses expensed during the successor period of $1,050,000. See “Certain Relationships and Related Transactions.”

31




(2)            Reflects the change in intangible amortization related to the adjustment to estimated fair value of intangible assets and the change in estimated lives.

(3)            Represents the increase in interest expense to reflect the new capital structure and the amortization of financing costs over the terms of the corresponding debt. A summary follows (dollars in thousands):

 

 

Year Ended
April 1, 2005

 

Interest on Term Loan

 

 

$

21,735

 

 

Interest on Senior Subordinated Notes

 

 

30,400

 

 

Senior Administrative Agent Fee

 

 

100

 

 

Undrawn Facility Fee

 

 

375

 

 

Amortization of Deferred Financing Fees

 

 

2,858

 

 

Total Expense

 

 

$

55,468

 

 

 

(4)            Represents a full year of accreted value on our preferred stock.

(5)            Based on an effective tax rate of 36.9%, which is the historical rate for the period April 3, 2004 to February 11, 2005 and is the expected approximate effective tax rate for successor operations.

Operating Environment and Impact of Our Business

We are primarily a U.S. government contractor providing a broad range of critical technical services to civilian and military government agencies and to a lesser extent, commercial customers. As a result, our operating performance for any time period is impacted primarily by trends in U.S. government outsourcing, spending and the awarding of contracts and related payment terms and therefore trends they currently have in this market can have a significant effect on our business. The trends we monitor and the impact we believe they have on our business are discussed below.

Increased Outsourcing by U.S. and Foreign Governments.   We have seen and benefited from a continued trend toward outsourcing of services by the U.S. government, particularly within the Department of Defense and the Department of State. These outsourcing trends are seen both domestically and internationally and support the increased deployment of U.S. resources overseas. The increase in overseas deployment has been in both frequency and magnitude, and across multiple U.S. government agencies. For example, our International Technical Services segment has witnessed strong growth as a result of the U.S. government’s trend toward outsourcing critical functions. Outside of the U.S. government, we are seeing other countries, particularly the United Kingdom and Australia, follow the U.S. government trend to outsource services. We believe that this provides additional markets for our existing services. Our International Technical Services operating segment primarily provides outsourced law enforcement training, drug eradication, global logistics, base operations and personal physical security services to government and commercial customers in foreign jurisdictions. Since fiscal 2001, International Technical Services has grown revenues from $264.7 million to $1,264.6 million for fiscal 2006, or 64.3% of our total revenues. Although we expect to continue to see increases in government outsourcing for the foreseeable future, particularly in government technical support services and other non-combat related functions, the adoption of new laws or regulations that affect companies that provide services to the federal government or curtailment of the federal government’s outsourcing of services to private contractors would significantly alter this positive trend.

Increased Spending by Our Customers.   The Department of Defense budget for fiscal 2007, excluding supplemental funding relating to operations in Iraq and Afghanistan, has been proposed to Congress at $439.3 billion, representing a 48% increase over fiscal 2001. Fiscal 2005 Department of Defense actual spending, excluding supplemental funding relating to operations in Iraq and Afghanistan, was $400.1 billion. The U.S. government budget for international development and humanitarian and international security assistance coordinated by the Department of State has grown from approximately $15 billion in fiscal 2000 to a projected $25 billion in fiscal 2009 (a compound annual growth rate of 5.2%)

32




from fiscal 2000 to fiscal 2009. As a result of the U.S. military’s presence in the Middle East and abroad, we believe that this trend will continue for the foreseeable future and that we are well-positioned to benefit from this trend. Among the factors that could impact U.S. government spending and that would reduce our U.S. government contracting business are: a significant decline in, or reapportioning of, spending by the U.S. government, in general, or by the Department of Defense or the Department of State.

Shift to More Multiple Awards in Indefinite Delivery, Indefinite Quantity Contracts.   The trend in the service segment of the U.S. government has been to award more multiple award indefinite delivery, indefinite quantity contracts. We expect these trends to continue. Strong customer relationships combined with strong past performance will increase the probability of earning a customer’s business under multiple award indefinite delivery, indefinite quantity contracts, as well as winning new procurements. In fiscal 2005 and 2006, 56.3% and 58.9% of our revenues were attributable to indefinite delivery, indefinite quantity contracts, respectively. Traditional government contracts typically have a base year award plus four to nine option years, limiting the competition to the 5-10 year contract cycle. Under multiple award indefinite delivery, indefinite quantity contracts, the customer has the ability to compete for the work more frequently among the contract holders, or even move the work on a sole source basis to one of the other providers. This trend toward multiple award indefinite delivery, indefinite quantity contracts could increase the volatility in our revenue.

Shift from Cost Type Contracts to Time-and-Materials or Fixed-Price Contracts.   Our government contract services have three distinct pricing structures: cost-reimbursement, time-and-materials and fixed-price, representing approximately 34%, 39% and 27% of our revenues, respectively, for fiscal 2005, and approximately 28%, 38% and 34% of our revenues, respectively, for fiscal 2006. We believe that our profitability will continue to improve as we anticipate that our customers will continue to shift away from cost-reimbursement to time-and-materials contracts and fixed-price contracts. We base our belief on recent trends in our revenues, the nature of the contracts on which we are bidding and the pricing structure in fixed-price and time-and-materials contracts. We assume financial risk on time-and-materials and fixed-price contracts, because we assume the risk of performing those contracts at the stipulated prices or negotiated hourly rates. If we do not accurately estimate ultimate costs and control costs during performance of the work, we could lose money on a particular contract or have lower than anticipated margins. The movement from cost type contracts to time-and-materials or fixed-price contracts, while increasing our risks, allows us the opportunity to earn higher margins.

Increased Maintenance, Overhaul and Upgrades Needed to Support Aging Military Platforms.   Another trend we monitor to determine our future strategies is the age and use of weapon systems. The high visibility/high cost new weapons systems tend to be the target of budget reductions, while the O&M budget continues to grow as a percentage of the total budget. The O&M portion of the Department of Defense budget, which includes the majority of the services we provide, is the largest and fastest growing segment of Department of Defense military spending. Also, as the purchase of new weapons systems are delayed or cancelled, the current weapons systems continue to age and require increased maintenance. This aging, combined with the increased use of the equipment, often in harsh environments, provides opportunities for the services we offer.

Competition.   We believe that the favorable industry trends that we anticipate may also attract additional competition by certain existing and potential competitors. We compete with various entities across geographic and business lines. Some of our competitors have greater financial and other resources than we do or are better positioned than we are to compete for contract opportunities. In addition, we are at a disadvantage when bidding for contracts put up for recompetition for which we are not the incumbent provider, because incumbent providers are frequently able to capitalize on customer relationships, technical knowledge and pricing experience gained from their prior service.

33




Factors Affecting Our Results of Operations

Our future results of operations will be affected by the following factors, which may cause our results of operations to differ from those discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Debt Service.   During the predecessor periods, working capital was provided by our parent at the time, and therefore there was no debt and minimal interest expense on our financial statements. As of March 31, 2006, we had $661.6 million of outstanding debt, which generates significant interest expense. Approximately $216.0 million per year of our cash flow will be required for interest and principal payments annually for fiscal 2007 through 2010, giving effect to the application of the use of proceeds from our Equity Offering. This will limit the amount of cash that is available for working capital requirements, or other uses.

Stand-Alone Operating Costs.   During fiscal 2004, we paid Computer Sciences Corporation $12.7 million, and during the period from April 3, 2004 through February 11, 2005, we paid Computer Sciences Corporation $11.9 million for executive oversight and other services such as treasury, tax, insurance, legal, consolidation accounting, public affairs and information technology. In addition, under the transition services agreement, we incurred approximately $1.6 million of expenses during the fiscal year ended March 31, 2006. We have put in place people and/or other resources to provide the services previously provided by corporate resources from Computer Sciences Corporation (March 29, 2003 through February 11, 2005). On May 15, 2006, we terminated the transition services agreement with Computer Sciences Corporation. All services previously provided by Computer Sciences Corporation are now performed by our own employees.

Purchase Accounting Adjustments.   The 2005 Acquisition was accounted for under the purchase method and, accordingly, the purchase price of the 2005 Acquisition was allocated to the net assets acquired based on the fair values at the date of the 2005 Acquisition. We engaged a third party to provide an independent appraisal of the fair values of certain intangible assets.

2005 Working Capital Adjustment.   The purchase price for the 2005 Acquisition was $937.0 million after giving effect to a $65.55 million net working capital adjustment in favor of Computer Sciences Corporation and $6.1 million of accumulated dividends in connection with the preferred stock issued for satisfaction of the working capital adjustment. Of the $937.0 million purchase price, $775.0 million was paid in cash, $140.6 million was paid to Computer Sciences Corporation in the form of our preferred equity, $6.1 million in accumulated dividends on the preferred stock was issued in connection with the working capital adjustment and the remaining amounts were transaction expenses.

On May 9, 2006, we redeemed all of our outstanding preferred stock, of which $222.8 million in stated amount included accrued and unpaid dividends thereon as of May 9, 2006, with a portion of the proceeds from the Equity Offering.

Explanation of Reporting Periods and Basis of Presentation

On February 11, 2005, our Company was sold by Computer Sciences Corporation to an entity controlled by Veritas Capital. The financial statements from March 29, 2003 to February 11, 2005, the period of Computer Sciences Corporation ownership, are referred to as the “immediate predecessor period” statements. We refer to financial statements from and after February 12, 2005 as the “successor period” statements.

The historical financial statements and information included herein include the consolidated accounts of DynCorp International and its subsidiaries. This presentation is on the historical cost basis of accounting with the application of purchase accounting related to the 2005 Acquisition in the applicable period presented.

34




The Company’s financial statements for fiscal 2004 are based on the historical assets, liabilities, sales and expenses of our Company, including the allocation to our Company of a portion of our corporate expenses and income taxes. During fiscal 2004 and the period from April 3, 2004 to February 11, 2005, our Company’s predecessor parents allocated $12.7 million and $11.9 million, respectively, of expenses it incurred for providing executive oversight and corporate headquarter functions, consolidation accounting, treasury, tax, legal, public affairs, human resources, information technology and other services. Of the $12.7 million, $9.4 million and $3.3 million were allocated to selling, general and administrative and costs of services, respectively. Of the $11.9 million, $9.8 million and $2.1 million were allocated to selling, general and administrative and costs of services, respectively. These allocations are considered to be reasonable reflections of the utilization of services provided to, or the benefit received by, our Company. For a discussion of our transition services agreement, see “Certain Relationships and Related Transactions—Transition Services Agreement.”  On May 15, 2006, we terminated the transition services agreement with Computer Sciences Corporation. All services previously provided by Computer Sciences Corporation are now performed by our own employees.

The 2005 Acquisition

On December 12, 2004, The Veritas Capital Fund II, L.P. and its subsidiary, DynCorp International (formerly known as DI Acquisition Corp.), entered into a purchase agreement with Computer Sciences Corporation and DynCorp whereby DynCorp International agreed to acquire our operating company, a wholly owned subsidiary of DynCorp. DynCorp International assigned its rights to acquire our operating company to DI Finance LLC, its wholly owned subsidiary. Immediately after the consummation of the 2005 Acquisition on February 11, 2005, DI Finance LLC was merged with and into our operating company. Our operating company survived the merger and is now a wholly owned subsidiary of DynCorp International.

As a result of the 2005 Acquisition, our assets and liabilities have been adjusted to their estimated fair value as of the closing. The excess of the total purchase price over the value of our assets at the closing of the 2005 Acquisition has been allocated to goodwill and other intangible assets, some of which will be amortized, and will be subject to annual impairment review.

Backlog

We track contracted backlog in order to assess our current business development effectiveness and to assist us in forecasting our future business needs and financial performance. Backlog consists of orders and options under our contracts. We define contracted backlog as the estimated value of contract modifications received from customers that have not been recognized as revenue. Our backlog consists of funded and unfunded backlog. Funded backlog is based upon amounts actually appropriated by a customer for payment of goods and services less actual revenue recorded as of the measurement date under that appropriation. Unfunded backlog is the actual dollar value of unexercised contract options. Most of our U.S. government contracts allow the customer the option to extend the period of performance of a contract for a period of one or more years. These options may be exercised at the sole discretion of the customer. Historically, it has been our experience that the customer has exercised contract options.

Because of appropriation limitations in the federal budget process, firm funding for our contracts is usually made for only one year at a time, with the remainder of the years under the contract expressed as a series of one-year options. As is the case with the base period of our U.S. government contracts, option periods are subject to the availability of funding for contract performance. The U.S. government is legally prohibited from ordering work under a contract in the absence of funding. Our historical experience has been that the government generally has funded the option periods of our contracts.

35




The following table sets forth our contracted backlog (dollars in millions) as of the dates indicated:

 

 

April 2,
2004

 

April 1,
2005

 

March 31,
2006

 

Funded Backlog

 

$

991

 

$

1,140

 

 

$

1,024

 

 

Unfunded Backlog

 

1,173

 

900

 

 

1,617

 

 

Total Backlog

 

$

2,164

 

$

2,040

 

 

$

2,641

 

 

 

For additional information on backlog, see “Business—Backlog.”

Estimated Contract Value

Estimated contract value is calculated as the greater of the bid price we submitted or expect to submit for the applicable contract or the sum of our actual revenues under the contract plus our estimated revenues from future performance under priced options in the contract. For indefinite delivery, indefinite quantity contracts, the estimated contract value of such contracts is the greater of the sum of our actual revenues under the contract plus our estimated revenue from future performance under funded task orders or the bid price we submitted that was accepted by the customer.

Estimated Remaining Contract Value

The following table sets forth our estimated remaining contract value (dollars in millions) as of the dates indicated:

 

 

April 2,
2004

 

April 1,
2005

 

March 31,
2006

 

Estimated remaining contract value

 

$

2,812

 

$

4,413

 

 

$

5,727

 

 

 

Our estimated remaining contract value represents the backlog plus management’s estimate of future revenues under indefinite delivery, indefinite quantity contracts that have not been funded, or award term periods that have not yet been earned. These future revenues would be our estimate of revenue that would occur from the end of currently funded task orders until the end of the indefinite delivery, indefinite quantity contracts. Our estimated remaining contract value is based on our experience under contracts and we believe our estimates are reasonable. However, there can be no assurance that our existing contracts will result in actual revenues in any particular period or at all. These amounts could vary depending upon government budgets and appropriations.

36




Results of Operations

The following tables set forth, for the periods indicated, our historical and pro forma combined results of operations, both in dollars and as a percentage of revenues:

 

 

Immediate Predecessor
Period

 

 

 

 

 

Successor Period

 

 

 

For the Fiscal
Year Ended
April 2, 2004

 

Pro Forma Combined
Fiscal Year Ended
April 1, 2005
(1)

 

For the Fiscal
Year Ended
March 31, 2006

 

 

 

(dollars in thousands)

 

Revenues

 

 

$

1,214,289

 

 

100.0

%

$

1,920,909

 

100.0

%

$

1,966,993

 

100.0

%

Costs of Services (excluding depreciation and amortization disclosed below)

 

 

1,106,571

 

 

91.1

 

1,741,515

 

90.7

 

1,722,089

 

87.5

 

Selling, General and Administrative Expenses

 

 

48,350

 

 

4.0

 

65,388

 

3.4

 

97,520

 

5.0

 

Depreciation and Amortization

 

 

8,148

 

 

0.7

 

45,536

 

2.4

 

46,147

 

2.4

 

Total Costs and Expenses

 

 

1,163,069

 

 

95.8

%

1,852,439

 

96.5

%

1,865,756

 

94.9

%

Interest Income

 

 

(64

)

 

0.0

 

(177

)

0.0

 

(461

)

0.0

 

Interest Expense

 

 

 

 

 

55,468

 

2.9

 

56,686

 

2.9

 

Interest on Mandatory Redeemable Shares

 

 

 

 

 

21,142

 

1.1

 

21,142

 

1.1

 

Income (loss) Before Taxes

 

 

51,284

 

 

4.2

 

(7,963

)

(0.5

)

23,870

 

1.1

 

Provision for Income Taxes

 

 

19,924

 

 

1.6

 

4,863

 

0.3

 

16,627

 

0.8

 

Net Income (loss)

 

 

$

31,360

 

 

2.6

%

$

(12,826

)

(0.8

)%

$

7,243

 

0.3

%


(1)             This information was derived from, and should be read in conjunction with, the “Pro Forma Financial Information” and footnotes thereto included in Item 7 of this Form 10-K.

Fiscal Year Ended March 31, 2006 Compared to Fiscal Year Ended April 1, 2005 Pro Forma

The following discussion provides a comparison of the results of operations for the successor company for the fiscal year ended March 31, 2006 with the pro forma combined results of operations for the Company for the fiscal year ended April 1, 2005. The discussion is provided for comparative purposes only, but the value of such a comparison may be limited. The information in this section should be read in conjunction with the consolidated financial statements and the related notes contained elsewhere in this Form 10-K.

Consolidated

Revenues.   Total revenues increased from $1,920.9 million for the fiscal year ended April 1, 2005 pro forma to $1,967.0 million for the fiscal year ended March 31, 2006, an increase of $46.1 million or 2.4%.

Revenue from our International Technical Services segment increased from $1,232.7 million for the fiscal year ended April 1, 2005 pro forma to $1,264.6 million for the fiscal year ended March 31, 2006, an increase of $31.9 million or 2.6%. Increases in this segment include $79.0 million of revenue under the International Narcotics and Law Enforcement Air-Wing program as a result of a new contract that went into effect on November 1, 2005 for operations, and added work to provide helicopter support for ground eradication efforts in Afghanistan, $27.1 million of new work providing hurricane relief efforts along the Gulf Coast, $26.0 million due to added work under our Africa Peacekeeping contract with the Department of State and $12.8 million of additional construction work under the Worldwide Personal Protective Services program. These increases were partially offset by a reduction of $16.6 million under the Civilian Police program due to the timing of various construction efforts in the Middle East, and $67.5 million from

37




a series of contracts to provide security and logistics support to various U.S. government construction efforts in the Middle East as a subcontractor. This type of subcontract effort was typically short term with delayed payments, and therefore we decided to exit this line of business until it can be performed in a more stable environment with improved financial terms. Further offsetting the increases described above was a reduction in our Dyn Marine Services of Virginia LLC business of $32.0 million due to the discontinuance of our work under the Oceangraphics Ships contract.

Revenues from our Field Technical Service segment increased from $688.2 million for the fiscal year ended April 1, 2005 pro forma to $702.4 million for the fiscal year ended March 31, 2006, an increase of $14.2 million or 2.1%. The Field Technical Services increase of $14.7 million was primarily driven by the Life Cycle Contractor Support program increase of $8.5 million due to the addition of the Global Air Traffic Management avionics modification to the contract, an increase in the Army Pre-Positioned Stocks program of $7.8 million and the ramp-up of the AH-1/UH-1 program, which increased $16.9 million since the initial contract award during the first quarter of fiscal 2005. Partially offsetting this increase was the Contract Field Teams program, which decreased by $10.2 million mainly as a result of reduced workload for maintenance, repair and refurbishment of weapons systems, and the end of the Al Salam program, which reduced revenue by $12.4 million. We withdrew from the Al Salam program due to unfavorable contract terms offered by the customer. Consequently, the customer decided to self perform the maintenance we had been providing. In addition, the Holloman contract decreased by $5.1 million due to the removal of the German F-4s from the contract.

Costs of services.   Costs of services are comprised of direct labor, direct material, subcontractor costs, other direct costs and overhead. Other direct costs include travel, supplies and other miscellaneous costs. Costs of services decreased from $1,741.5 million for the fiscal year ended April 1, 2005 pro forma to $1,722.1 million for the fiscal year ended March 31, 2006, or a decrease of $19.4 million or 1.1%. As a percentage of revenue, costs of services dropped from 90.7% in the fiscal year ended April 1, 2005 pro forma to 87.5% for the fiscal year ended March 31, 2006. This reduction as a percentage of revenue was due to the following: (i) strong performance on fixed-price construction projects and on fixed-price task orders under the Civilian Police program; and (ii) improved contract mix resulting from a larger proportion of higher-margin fixed-price and time-and-materials contracts as opposed to lower-margin.

Selling, general and administrative expenses.   Selling, general and administrative expenses primarily relate to functions such as management, legal, financial accounting, contracts and administration, human resources, management information systems, purchasing and business development. Selling, general and administrative expenses for the fiscal year ended April 1, 2005 pro forma were $65.4 million and increased to $97.5 million for the fiscal year ended March 31, 2006, an increase of 49.1%. In addition, as a percentage of revenue, selling, general and administrative expenses increased from 3.4% for the fiscal year ended April 1, 2005 pro forma to 5.0% for the fiscal year ended March 31, 2006. This increase was primarily the result of developing our administrative functions as an independent company, which contributed approximately $15.0 million to the fiscal 2006 increase. Prior to the 2005 Acquisition, these services were provided by our predecessor parent, Computer Sciences Corporation. In addition to the development of administrative functions, we incurred a higher business development cost of approximately $10.0 million during fiscal 2006. Business development expenses represented $32.0 million or 33% of total selling, general and administrative expense. We expect business development expenses to level out and increase at a much lower rate, approximately 10%, in fiscal 2007. Other factors contributing to higher selling, general and administrative expenses in fiscal 2006 include:

·       Non-cash equity-based compensation expense was $2.4 million. During fiscal 2007, we expect to incur $2.6 million related to this equity compensation program.

·       Legal expense of approximately $1.6 million related to our current expected outcome of legal contingencies.

38




·       Certain incentive compensation payments related to retention bonuses associated with the 2005 Acquisition and incentive payments related to our Equity Offering were $2.7 million and $2.3 million, respectively. Pro forma fiscal 2005 included approximately $1.1 million of retention bonus expense.

Depreciation and amortization.   Depreciation and amortization increased from $45.5 million for the fiscal year ended April 1, 2005 pro forma to $46.1 million for the fiscal year ended March 31, 2006, or an increase of $0.6 million. This increase was primarily due to higher depreciation expense. Amortization in the fiscal year ended April 1, 2005 pro forma was based on an estimate of current year amortization. The amortization for the fiscal year ended March 31, 2006 was based on the 2005 Acquisition, which included a step-up in basis of our customer-related intangibles resulting in increased amortization. An independent valuation study was done to allocate the purchase price between goodwill and intangibles.

Interest Expense.   Interest expense increased from $55.5 million for the fiscal year ended April 1, 2005 pro forma to $56.7 million for the fiscal year ended March 31, 2006. The interest expense incurred related to our senior secured credit facility, the revolving credit facility and our senior subordinated notes. This interest expense includes interest costs applicable to the fiscal year as well as amortization of deferred financing fees. The increase was primarily due to the increasing interest rates during fiscal 2006.

Interest on mandatory redeemable shares.   Interest on the mandatory redeemable shares, or preferred stock, was $21.1 million for the fiscal year ended March 31, 2006 as compared to $21.1 million for the fiscal year ended April 1, 2005 pro forma, which gives effect to the net working capital settlement. The interest is accrued, but unpaid.

Income tax expense.   We had income tax expense for the fiscal year ended March 31, 2006 of $16.6 million, which is an increase of $11.7 million or 238.8% from income tax expense of $4.9 million for the fiscal year ended April 1, 2005 pro forma. The interest expense related to the preferred shares is nondeductible for tax purposes resulting in the taxable position for the fiscal year ended March 31, 2006.

Results by Segment

The following table sets forth the revenues and earnings before interest and taxes for our International Technical Services and Field Technical Services operating segments, both in dollars and as a percentage of our consolidated revenues for segment revenue and as a percentage of segment specific revenue for earnings before interest and taxes, for the fiscal year ended March 31, 2006 as compared to the fiscal year ended April 1, 2005 pro forma.

 

 

 

 

Successor Period

 

 

 

Pro Forma for
the Year Ended
April 1, 2005

 

For the Fiscal
Year Ended
March 31, 2006

 

 

 

 

(dollars in thousands)

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

International Technical Services

 

 

$

1,232,720

 

 

64.2

%

 

$

1,264,586

 

 

64.3

%

Field Technical Services

 

 

688,154

 

 

35.8

 

 

702,407

 

 

35.7

 

Other

 

 

35

 

 

0.0

 

 

 

 

 

Consolidated

 

 

$

1,920,909

 

 

100.0

%

 

$

1,966,993

 

 

100.0

%

Earnings before Interest and Taxes

 

 

 

 

 

 

 

 

 

 

 

 

 

International Technical Services

 

 

$

46,824

 

 

3.8

%

 

$

93,637

 

 

7.4

%

Field Technical Services

 

 

23,311

 

 

3.4

%

 

10,017

 

 

1.4

%

Other(1)

 

 

(1,665

)

 

NA

 

 

(2,417

)

 

NA

 

Consolidated

 

 

$

68,470

 

 

3.6

%

 

$

101,237

 

 

5.1

%


(1)             Amount represents amortization of Class B equity interests for fiscal year 2006.

39




International Technical Services

Revenues.   Revenues for the fiscal year ended March 31, 2006 were $1,264.6 million, an increase of $31.9 million, or 2.6%, from $1,232.7 million for the fiscal year ended April 1, 2005 pro forma. The revenue increase was due to additional revenue under the International Narcotics and Law Enforcement Air-Wing program as a result of a new contract that went into effect on November 1, 2005 for operation, added work to provide helicopter support for ground eradication efforts in Afghanistan, new work providing hurricane relief efforts along the Gulf Coast, added work under our Africa Peacekeeping contract with the Department of State and additional construction work under the Worldwide Personal Protective Services program. These increases were partially offset by a reduction of revenue under the Civilian Police program due to the timing of various construction efforts in the Middle East, and from a series of contracts to provide security and logistics support to various U.S. government construction efforts in the Middle East as a subcontractor. This type of subcontract effort was typically short term with delayed payments, and therefore we decided to exit this line of business until it can be performed in a more stable environment with improved financial terms. Further offsetting the increases described above was a reduction in our Dyn Marine Services of Virginia LLC business due to the discontinuance of our work under the Oceangraphics Ships contract.

Earnings before interest and taxes.   Earnings before interest and taxes for the fiscal year ended March 31, 2006 were $93.6 million, an increase of $46.8 million, or 100.0%, from $46.8 million for the fiscal year ended April 1, 2005. Earnings before interest and taxes as a percentage of revenue for the fiscal year ended March 31, 2006 and April 1, 2005 pro forma was 7.4% and 3.8%, respectively. The increase is due to the following: (i) strong performance on fixed-price construction projects and on fixed-price task orders under the Civilian Police program; and (ii) improved contract mix resulting from a larger proportion of higher-margin fixed-price and time-and-materials contracts as opposed to lower-margin. The Civilian Police contract changed from cost-reimbursement to a combination of fixed-price and time-and-materials in February 2004, and the International Narcotics and Law Enforcement Air-Wing contract had a similar change effective November 2005. The current year also includes the recognition of an equitable adjustment related to our Civilian Police program. The equitable adjustment has resulted in earnings of $5.5 million during the current year and has improved the margin on earnings before interest and taxes by 0.4% for the fiscal year ended March 31, 2006.

Field Technical Services

Revenues.   Revenues for the fiscal year ended March 31, 2006 were $702.4 million, an increase of $14.2 million, or 2.0%, from $688.2 million for the fiscal year ended April 1, 2005 pro forma. This revenue increase was primarily from the Global Air Traffic Management avionics modification under the Life Cycle Contractor Support program, increases on Army Prepositioned Stocks Afloat program workload and ramp-up of the AH-1/UH-1 program. These increases were partially offset by reduced workload under Contract Field Teams, and the withdrawal from the Al Salam contract due to unfavorable contract terms offered by the customer. Consequently, the customer decided to self perform the F-15 maintenance we had been providing.

Earnings before interest and taxes.   Earnings before interest and taxes for the fiscal year ended March 31, 2006 were $10.0 million, a decrease of $13.3 million, or 57.1%, from $23.3 million for the fiscal year ended April 1, 2005 pro forma. Earnings before interest and taxes as a percentage of revenue for the fiscal year ended March 31, 2006 was 1.4% compared to 3.4% for the fiscal year ended April 1, 2005 pro forma. The primary factors contributing to the decrease are as follows: (i) higher indirect allocations not recoverable under our fixed-price and time-and-materials contracts of $9.5 million; (ii) incurred operating losses of $3.2 million in delivering services to the U.S. Army under our Life Cycle Contractor Support program. We have experienced operational issues in executing to the cost structure outlined in the original proposal. As a result, we are in the process of seeking an equitable adjustment from our customer for this

40




program; and (iii) higher depreciation of $1.2 million due to our decision to exit a facility where we provided a portion of our AH-1/UH-1 services in Puerto Rico. As a result of this decision, we accelerated the amortization of leasehold improvements related to the facility.

Fiscal Year Ended April 1, 2005 Pro Forma Compared to the Fiscal Year Ended April 2, 2004

The following discussion provides a comparison of the pro forma results of operations for the successor company for the fiscal year ended April 1, 2005 with the historical results of the immediate predecessor company for the fiscal year ended April 2, 2004. The discussion is provided for comparative purposes only, but the value of such a comparison may be limited. The information in this section should be read in conjunction with the consolidated financial statements, summary consolidated historical and pro forma financial data, and the related notes contained elsewhere in this Form 10-K.

Consolidated

Revenues.   Revenues for the fiscal year ended April 1, 2005 pro forma were $1,920.9 million, an increase of $706.6 million, or 58.2%, from $1,214.3 million for the fiscal year ended April 2, 2004. The largest amount of this increase was $494.6 million under the Civilian Police program, which includes both the current Civilian Police contract that was awarded in February 2004 as well as predecessors’ contracts for similar police training activity in support of the Department of State. This increase was primarily due to additional and expanded task orders in the Middle East to provide police and other law enforcement training. Other revenue increases occurred on the Worldwide Personal Protective Services contract of $72.9 million as a result of additional work in the Middle East, and $72.8 million on the Contract Field Teams program due to higher manning requirements. These higher manning requirements were primarily due to increased equipment maintenance due to higher usage. These revenue increases were offset by decreases on Dyn Marine programs of $15.7 million and the Al Salam contract of $13.5 million. The decrease in Dyn Marine revenue was a result of the loss of the Oceangraphics Ship contract, and the decrease on the Al Salam contract was a result of the customer not extending the contract and performing the work itself.

Costs of services.   Costs of services for the fiscal year ended April 1, 2005 pro forma were $1,741.5 million, an increase of approximately $634.9 million, or 57.4%, from approximately $1,106.6 million for fiscal year ended April 2, 2004. For the fiscal year ended April 1, 2005, pro forma costs of services as a percentage of revenue decreased to 90.7% from 91.1% for the fiscal year ended April 2, 2004. This decrease was due to increased overhead absorption resulting from higher revenues and a change in the contract mix. The contract mix in the fiscal year ended April 2, 2004 was 44% cost-reimbursement, with the balance being either time-and-materials or fixed-price. The percentage of cost-reimbursement dropped to 34% for the entire fiscal year ended April 1, 2005 pro forma, with a resulting increase in the time-and-materials or fixed-price portion.

Selling, general and administrative.   Selling, general and administrative for the fiscal year ended April 1, 2005 pro forma were $65.4 million, an increase of $17.0 million, or 35.1%, from $48.4 million for the fiscal year ended April 2, 2004. For the fiscal year ended April 1, 2005, pro forma selling, general and administrative expense as a percentage of revenue decreased to 3.4% from 4.0% for the fiscal year ended April 2, 2004. This decrease was due to lower increases as a percentage of sales for business development spending as revenue growth accelerated.

Depreciation and amortization.   Depreciation and amortization expense for the fiscal year ended April 1, 2005 pro forma was $45.5 million, an increase of $37.4 million, or 461.7%, from $8.1 million for fiscal year ended April 2, 2004. This increase was primarily due to the amortization of intangible assets. Intangible assets valued in connection with the 2005 Acquisition were significantly higher than previous

41




values assigned in connection with the Computer Sciences Corporation acquisition. A third party assisted us in determining the amount for amortization of intangible assets.

Interest Expense.   Interest expense was $55.5 million for the fiscal year ended April 1, 2005 pro forma. The pro forma interest expense is related to our senior secured credit facility, the revolving credit facility and our senior subordinated notes. For fiscal 2004, we did not incur any interest expense because it was recorded at the Computer Sciences Corporation corporate level and not allocated to the operating entities.

Interest on mandatory redeemable shares.   Interest on the mandatory redeemable shares, or preferred stock, was $21.1 million for the fiscal year ended April 1, 2005 pro forma. These shares were not outstanding during fiscal 2004, so there was no interest during the comparable period. The interest is accrued, but unpaid.

Income tax expense.   Income tax expense for the fiscal year ended April 1, 2005 pro forma was $4.9 million, a decrease of $15.0 million from $19.9 million for the fiscal year ended April 2, 2004. This decrease is primarily the result of reduced income before tax as a result of the addition of interest expense, which was not pushed down to the operating units during the immediate predecessor period, and the increase in amortization discussed above, as the effective tax rates for the fiscal years ended April 1, 2005 and April 2, 2004 were 36.7% and 38.9%, respectively. The reduction in the overall effective tax rate is a result of a greater percentage of the income before tax being from outside the United States, so the overall state tax is reduced as a percentage of income before tax.

42




Results by Segment

The following table sets forth the revenues and earnings before interest and taxes for our International Technical Services and Field Technical Services operating segments, both in dollars and as a percentage of our consolidated revenues for segment revenue and as a percentage of segment specific revenue for earnings before interest and taxes, on a pro forma basis for the fiscal year ended April 1, 2005 as compared with the fiscal year ended April 2, 2004:

 

 

Immediate Predecessor
Period

 

 

 

 

 

 

 

For the Fiscal
Year Ended
April 2, 2004

 

Pro Forma for
the Year Ended
April 1, 2005

 

 

 

(dollars in thousands)

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

International Technical Services

 

 

$

631,672

 

 

 

52.0

%

 

$

1,232,720

 

64.2

%

Field Technical Services

 

 

582,476

 

 

 

48.0

 

 

688,154

 

35.8

 

Other

 

 

141

 

 

 

0.0

 

 

35

 

0.0

 

Consolidated

 

 

$

1,214,289

 

 

 

100.0

%

 

$

1,920,909

 

100.0

%

Earnings before Interest and Taxes

 

 

 

 

 

 

 

 

 

 

 

 

 

International Technical Services

 

 

$

26,189

 

 

 

4.1

%

 

$

46,824

 

3.8

%

Field Technical Services

 

 

25,144

 

 

 

4.3

%

 

23,311

 

3.4

%

Other

 

 

(113

)

 

 

NA

 

 

(1,665

)

NA

 

Consolidated

 

 

$

51,220

 

 

 

4.2

%

 

$

68,470

 

3.6

%

 

International Technical Services

Revenues.   Revenues for the fiscal year ended April 1, 2005 pro forma were $1,232.7 million, an increase of $601.0 million, or 95.1%, from $631.7 million for the fiscal year ended April 2, 2004. This increase was primarily due to an increase in revenues from our Civilian Police and Worldwide Personal Protective Services programs. The revenue increase under our Civilian Police program was due to our entering into a new Civilian Police contract in February 2004, reflecting initial stages of law enforcement training in the Middle East. The revenue increase under our Worldwide Personal Protective Services program was due to increased security contracts in Iraq. These increases were partially offset by a decrease in our War Reserve Materials program revenues as activity under this program has returned to historical levels after a short-term increase due to recent wartime activity.

Earnings before interest and taxes.   Earnings before interest and taxes for the fiscal year ended April 1, 2005 pro forma were $46.8 million, an increase of $20.6 million, or 78.6%, from $26.2 million for the fiscal year ended April 2, 2004. Earnings before interest and taxes as a percentage of revenue for the fiscal year ended April 1, 2005 pro forma and for the year ended April 2, 2004 was 3.8% and 4.1%, respectively. The earnings before interest and taxes as a percentage of revenue did not change; however, the increased amortization resulting from the transaction was offset by an improvement in contract margin due to the change in the mix of contracts types with a greater percentage of our programs performed under time-and-material or fixed-price contracts versus lower margin cost-reimbursement contracts.

Field Technical Services

Revenues.   Revenues for the fiscal year ended April 1, 2005 pro forma were $688.2 million, an increase of $105.7 million, or 18.1%, from $582.5 million for the fiscal year ended April 2, 2004. This increase was primarily due to increased revenues under our Contract Field Teams program and, to a lesser extent, our Army Prepositioned Stocks Afloat, or Army Pre-Positioned Stocks Afloat, program. This was offset by a reduction in revenue under the Al Salam contract, which was not extended.

43




Earnings before interest and taxes.   Earnings before interest and taxes for the fiscal year ended April 1, 2005 pro forma were $23.3 million, a decrease of $1.8 million, or 7.2%, from $25.1 million for the fiscal year ended April 2, 2004. Earnings before interest and taxes as a percentage of revenue for the fiscal year ended April 1, 2005 pro forma was 3.4% compared to 4.3% for the fiscal year ended April 2, 2004. This reduction was due to the increased amortization resulting from the 2005 Acquisition and offset by an improvement in contract performance on the Contract Field Teams contract due to increased absorption of fixed costs.

The Period April 3, 2004 to February 11, 2005 and the Period February 12, 2005 to April 1, 2005

Other items impacting the immediate predecessor period April 3, 2004 to February 11, 2005 or the successor period February 12, 2005 to April 1, 2005 are presented below:

Depreciation and Amortization.   During the immediate predecessor period, the amortization of intangibles was based on appraised values of the customer contracts and related customer relationships that were determined on a by-contract basis done at the time of the Computer Sciences Corporation purchase of DynCorp with the assistance of a third party.

Interest Expense.   During the immediate predecessor period, interest expense was recorded at the parent level and was not allocated down to the operating units. As a result of the 2005 Acquisition, significant long-term debt has been incurred.

Liquidity and Capital Resources

The following table sets forth cash flow data for the periods indicated therein (dollars in thousands):

 

 

Fiscal Year
Ended
April 2, 2004

 

Pro Forma
Combined
Fiscal Year Ended
April 1, 2005

 

Fiscal Year
 Ended
March 31, 2006

 

Net Cash (Used in) Provided by Operating Activities

 

 

$

(6,756

)

 

 

$

(33,332

)

 

 

$

55,111

 

 

Net Cash Used in Investing Activities

 

 

(2,292

)

 

 

(880,101

)

 

 

(6,231

)

 

Net Cash Provided by (Used in) Financing Activities

 

 

11,017

 

 

 

920,397

 

 

 

(41,781

)

 

 

Historically, we financed our capital and working capital requirements through a combination of cash flows from operating activities and transfers from the predecessor parent companies. We did not incur interest-bearing debt during the year ended April 2, 2004. In connection with the 2005 Acquisition, we entered into a $75.0 million revolving credit facility available to fund working capital and other cash requirements not funded from ongoing operations. Subsequently, in January 2006, this revolving credit facility was amended to $90.0 million. Leading up to the 2005 Acquisition, Computer Sciences Corporation accelerated collection of receivables where possible and delayed payments to vendors and subcontractors. As a result, we had to draw $20.0 million on the revolving credit facility shortly after the closing of the 2005 Acquisition, and as of April 1, 2005 the outstanding balance was $35.0 million. We repaid our revolving credit facility during the three months ended July 1, 2005.

Cash and cash equivalents as of March 31, 2006 were $20.6 million compared to $13.5 million as of April 1, 2005. Concurrently with, and as a condition to, the offering of our senior subordinated notes, we entered into a senior secured credit facility. Our senior secured credit facility provided us with a $345.0 million term loan, maturing in 2011, and up to $90.0 million in available revolving loan borrowings, maturing in 2010. As of March 31, 2006, our revolving credit facility was undrawn and we had $661.6 million of indebtedness, of which $341.6 million was secured, including the senior subordinated notes and excluding interest accrued thereon. The foregoing does not take into account the partial redemption of our senior subordinated notes with a portion of the proceeds that we received from our Equity Offering. On the same date, we had approximately $82.5 million available under our senior secured

44




credit facility (which gives effect to $7.5 million of outstanding letters of credit). For more information regarding our senior secured credit facility, see notes to the consolidated financial statements elsewhere in this Form 10-K.

During fiscal 2006, $77.8 million of interest expense was incurred, which included both the interest costs applicable to the fiscal year, as well as amortization of the deferred financing fees resulting from the 2005 Acquisition. This interest expense includes the interest on the senior secured credit facility, the revolving credit facility, the senior subordinated notes and the accrued and unpaid dividends for the preferred stock. On May 9, 2006, we redeemed all of our outstanding preferred stock, of which $222.8 million in stated amount included accrued and unpaid dividends thereon as of May 9, 2006, with a portion of the proceeds from the Equity Offering.

On May 9, 2006, we consummated an Equity Offering of 25,000,000 shares of our Class A common stock, par value $0.01 per share, at a price of $15.00 per share. The gross proceeds from the Equity Offering of $375.0 million, together with cash on hand, were used: (i) to redeem all of our outstanding preferred stock, of which $222.8 million in stated amount, including accrued and unpaid dividends thereon, was outstanding as of May 9, 2006; (ii) to pay a special Class B distribution in the amount of $100.0 million to the holder of the Company’s common stock, DIV Holding LLC; (iii) to redeem $28.0 million of our senior subordinated notes on June 8, 2006; (iv) to pay prepayment penalties of $8.4 million as of May 9, 2006, $5.7 million of which represented prepayment penalties on our preferred stock and $2.7 million of which represented prepayment penalties on our senior subordinated notes; and (v) to pay transaction expenses of approximately $35.0 million, including an underwriters’ commission of $22.5 million, a fee of $5.0 million to Veritas Capital and $7.5 million of miscellaneous fees and expenses related to the Equity Offering.

In addition, we used cash on hand to pay special cash bonuses subsequent to the Equity Offering of $3.125 million in the aggregate to our executive officers and certain other members of management. Of that amount, Messrs. Cannon, Gorman, Thorne and Rosenkranz and Ms. Morrel received $1,000,000, $750,000, $500,000, $100,000 and $100,000, respectively. These bonuses rewarded management for their efforts in connection with the successful consummation of our Equity Offering.

Cash Flows