Kratos Defense and Security Solutions Inc (KTOS) 2003 Q3 法說會逐字稿

Ladies and gentlemen thank you for standing by. Welcome to the Wireless Facilities Incorporated third-quarter 2003 earnings conference call. Or speakers for today are Dr. Masood Tayebi, Chairman and Chief Executive Officer; and Mr. Terry Ashwill, Executive Vice President and Chief Financial Officer. At this time, all participants are in a listen-only mode. After the speakers have concluded their prepared remarks, we will conduct a question-and-answer session. As a reminder, this call is being recorded today October 30, 2003. I will now turn the conference over to Ms. Gina Aven, who will read the Company's warnings regarding forward-looking statements. Go ahead Ms. Aven.

Thank you for joining WFI's third quarter 2003 conference call. A replay of the call will be available from a 3:30 PM Pacific time on October 30, 2003, through 3:30 PM Pacific, November 3rd 2003 by dialing 800-633-8284, using the reservation number 21160901.

Additionally, the conference call is being broadcast live on our website at www.WFInet.com. The call will be archived there for one year.

Our comments today contain certain forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those anticipated in such forward-looking statements. A description of those risks and uncertainties is available in our filings with the Securities and Exchange Commission including our annual report on Form 10-K filed on March 21, 2003. Copies of this report are available free of charge on our website.

In response to the SEC's regulation fair disclosure, any forecast of WFI's revenues and earnings will only be provided within quarterly earnings conference calls or press releases or through specific regulatory filings. These forecasts will be as of the date of the call the release or the filing and will include estimates based on factual information as well as certain assumptions which management believes to be reasonable at that time.

WFI assumes no obligation to update any such projections at any time. WFI will continue to provide additional company information on its website including press releases, conference calls, and other company information. This conference call will include a discussion of the non-GAAP financial measures as that term is defined in Regulation G. The most directly comparable GAAP financial measures and information reconciling the non-GAAP financial measures to the Company's financial results prepared in accordance with GAAP have been posted on the company's investors relations website at www.WFInet.com.

Our comments today will be delivered by Dr. Masood Tayebi, CEO, who will give an overview of our operating results and industry conditions. And Terry Ashwill, CFO, who will review the Company's financial performance. Now, I would like to turn the call over to Masood Tayebi.

Thank you Gina. We are very pleased to report the 6th consecutive quarterly increase in revenue on net income. We posted a 39.7 percent increase in revenue and 164 percent increase in net income compared to the third quarter of 2002. We ended the quarter with 116.1 million in cash and short-term investments. Our second-largest in the history of the Company.

Overall, our balance sheet and operating metrics continue to show improvements. During this quarter, 83.2 percent of our revenue came from our U.S. operations. Our international operations represented 16.8 percent of revenue up 4.1 percent sequentially. Both domestic and international operations showed strong growth during the third quarter.

Now, I would like to discuss each one of our revenue producing business groups. The Wireless Network Services group which represented 74.7 percent of total revenue. The outsourcing group which represents a 6.5 percent of the Wireless Network Services revenue; and the Enterprise Solution group which represented 23.6 percent of the total revenue.

Each one of these groups we will discuss in the following manner. I will first discuss customer concentration followed by the industry trends and finally the outlook for each of these groups.

First, Wireless Network Services Group. As I mentioned earlier this group represented 76.4 percent of the third-quarter revenue. During this quarter, revenue grew over 12 percent from the prior quarter. Also, during this quarter, our largest customer relationship was Cingular which represented 22.9 percent of total revenue. Other top customers in the quarter were AT&T Wireless, with 9.3 percent; Siemens, 11.7 percent; Western Wireless, 5.5 percent; and Sprint PCS with 4.7 percent of total revenue.

As you look at our business globally at the macrolevel, it is primarily driven by the following. First subscriber growth. The trend in carrier subscriber growth indicates a long-term substantial growth potential. It is estimated that less than 20 percent of the population of the world are using wireless as a means of communication. And a large percentage have yet to make a phone call and when they do, it will be wireless as it is cheaper and faster to implement. As a result, we feel this will continue to be one of our main business drivers.

Secondly, capacity growth. In the past few years, we have seen a significant ramp up in minutes of use. This increasing minutes of use has put a lot of strain on the wireless networks. In fact, the current annualized wireless minutes of use per base station in the U.S. is more than doubled the comparable European rates. This capacity pressure and its related impact on capital expenditures are and will remain a big focus for the wireless carriers.

Third, the data usage. Recently we have seen global carriers are starting to put a lot of emphasis on data services. The increase of data usage is forcing the carriers to optimize, expand and upgrade their networks.

And fourth, the quality. In the past several quarters this has become increasingly more important to the carriers. Quality is related to coverage, capacity, technology, integration, maintenance, optimization of this complex networks. All of which are directly related to WFI's service offerings.

On the microlevel, you see the following drivers all of which have been a potential beneficial impact on WFI. In the U.S., wireless network portability is now a major focus our carriers. It is anticipated that carriers which have less coverage capacity and/or quality will have a significant increase in channel (ph) rates. Capacity expansion which will increase call quality is a likely result of this.

Second, E-911 is also becoming a main focus. In South and Latin America marketplace competition is a main driver of business activity for WFI and in (indiscernible) finally 3-D (ph) is here and it is starting to have a meaningful impact. This is forcing other carriers who have yet to commit to 3-D to start making plans for technology conversion or lose market share.

These combined trends are all forcing the wireless carriers to dedicate a larger percentage of their CAPEX to improving capacity coverage and quality. At the same time, carriers are becoming more focused on key comparative differentiators such as sales, marketing, pricing etc. which is encouraging the carriers to outcast the coverage capacity and quality buildout of their networks to third-party companies. Our response to this trend is to continue our emphasis to deliver high-quality cost competitive turnkey network deployment services.

In the past two quarters, we have seen a significant shift from carriers towards turnkey network deployment services. In fact, during the third quarter, we have received several high-profile RFPs related to such services. Also during the third quarter we won a significant turnkey contract from Telefonica in Mexico. We're starting to see similar trends beginning to emerge in Europe. Currently we're focusing on establishing our turnkey network deployment capabilities within Europe.

We see these trends as a very positive for our Wireless Network Services division. We expect that these trend should continue for the foreseeable future. We remain optimistic about our strategy within this space.

Now, on our outsourcing grew. During the third quarter this group represented 6.5 percent of the Wireless Network Services revenue. This revenue was generated primarily by two key customers, Sprint PCS and Nokia (ph) . Although we have not seen a large outsourcing contract as yet, from any of the major domestic wireless carriers, we continue to see a growing number of inquiries and analysis done by a number of different carriers.

During the third quarter, we continued to strengthen our relationship in some of our existing outsourcing partners as well as potential new ones. We feel very optimistic that the service productline will grow significantly in future quarters and become an increasingly large potential source of new revenue for WFI.

Now on Enterprise Solutions group. I am very pleased to announce that during the third quarter our Enterprise Solutions group has grown to 23.6 percent of our consolidated total revenue. Some of the main services performed by this group are wireless LAN system integration, security system integration, voice and data system integration and building technologies.

Today most enterprise networks consist of five different technologies wireless, voice data, security and billing technologies, Often these technologies are over single service networks, have different vendors, varied clients, high CAPEX and operating costs and importantly the most management is not always possible.

As we look ahead, we see the following trends emerging. Wireless is becoming an integral part of enterprise networks. Security systems are becoming wireless, currently however, 30 percent of the cost of security system integration is wiring and cabling. Technology is also available today to integrate various enterprise networks into one integrated platform which allows for lower CAPEX, lower maintenance cost, (indiscernible) information exchange and many other advantages.

WFI has expertise in proven core competency of project management, IP engineering, RF engineering, integration and commissioning and well as network management. All of these skill sets are a necessity and are applicable to the future of enterprise networks.

In summary are and initiatives to diversify and grow our enterprise business which is built on our proven competencies in wireless as well as our strong balance sheet which allows us to potentially acquire companies in this space should prove to be a successful strategy. As a result of our focus on our core competencies and strategic initiatives, we expect to see the three primary source of the future revenue. Wireless Network Services, outsourcing which is part of Wireless Network Services and Enterprise Solutions Services.

Now on our strategy. Overall we feel very good about the Company's performance in the third quarter. We believe our results reflect many of the positive changes that the company has made to read as well as the continuous focus on our key strength over the coursed of the past few orders. These include strengthening our relationship with our top tier customers, retaining core talent operational skill ability which allows us to provide global quality solutions for our customers; the implementation of cost control structures which have improved our profit margins; the development on utilization of tools and processes which has resulted in better execution of our projects an hence a lower cost of sales; and the continuation of successful gain in market share.

Some of the key challenges however we're facing today are recruiting is becoming more challenging due to the rising demand for some of our specialized services. This (indiscernible) price pressure on our cost of sales. The delay in our ability to raise prices, we are experiencing stability with pricing however we do not expect to see any meaningful price increases over the next couple of quarters.

In the future, we expect to pass a portion of our planned price increases onto our hard-working employees as a form of additional compensation.

Finally, the industry is rapidly moving towards turnkey deployment services although this is a key of strength for WFI, the pace of this development remains a challenge.

Finally, as we take a look at our company today we feel good about the following facts. We have a very strong management team that is dedicated to the success of this company. We have a very capable, hard-working group of professional staff that is dedicated to the success of this company. And we have one of the best balance sheets in the entire telecom indications industry.

As we look to the future, our objective is to continue to improve shareholder value by continuing to retain and recruit the best talent in the industry. Both in executive management as well as in our professionals staff. Continuing to closely manage the remnants of our business, our control such as execution of projects, financial expenses and others. And continue to expand our business utilizing our skill set, financial capabilities and leveraging our expertise and continue to utilize our cash and balance sheet to expand our existing and future operations both organically and nonorganically.

So, I will look at the balance of this year and 2004. We are optimistic that our financial performance should continue to improve. We are financially healthy and our backlog of profitable projects with quality customers remain strong. We appreciate the support of our investors throughout the quarter. We are also very grateful to our remarkable group of employees who participate so enthusiastically in the performance and success of our business. Now I will turn the call over to Terry Ashwill, CFO who will review our financials.

Thank you Masood. WFI's financial results for the third quarter 2003 continued the strong performance over the last five quarters. Revenue increased 20.8 percent from the prior quarter. The sixth consecutive sequential quarterly increase.

Gross profit increased for the sixth consecutive quarter also. Both operating income and net income increased for the sixth consecutive quarter.

SG&A expense net of the provision for doubtful accounts as a percent of revenue was the lowest recorded in the last four years.

Diluted earnings per share was nine cents an increase of 28.6 percent from the previous quarter.

Cash and cash equivalents and short-term investments ended the quarter at 116.1 million, the second highest amount in WFI history. Excluding one million of dollars of capitalization obligations, WFI continues to have no debt.

Productivity as measured by annualized revenue for average employee improved 5.8 percent from the prior quarter. Equity increased to 221 million and now represents nearly 80 percent of WFI's total balance sheet.

Now turning to the income statement. Revenue. Revenue for the third quarter of 68.6 million was 11.8 million or 20.8 percent over the prior quarter and 19.5 million our 39.7 percent over the same quarter last year. With Wireless Network Services and Enterprise Solutions, the Company's two principal operating segments contributed to the improved performance.

Latin America Wireless revenue was 7.6 million, an increase of 280 percent from the 2 million last quarter.

The diversity and breadth of WFI's revenue base continues to widen. For the third quarter, the top five customers account for 50 percent, 50.1 percent of revenue versus 78.2 percent in the third quarter 2002 period and 61.6 percent for the previous quarter.

The top 10 customers account for 65.6 percent of revenue in the third quarter versus 93.7 percent in the prior year quarter. Also, our Enterprise Solutions business represented 23.6 percent of WFI's revenue for the third quarter.

Gross profit. Gross profit of 18.7 million was 6.8 million or 57.1 percent ahead of the third quarter of 2002. As a percent of revenue, gross profit was 27.3 percent or 3.1 percentage points over the 24.2 percent in the third quarter 2002 and 2.6 percentage points below the previous quarter. The sequential percentage decline in gross profit versus the prior quarter is principally attributable to unusually high one-time expenses a quarter in our Brazilian operation related to a new contract.

As we look to future quarters, our gross profit percentage on our services business should gradually benefit from a firming enterprising environment. Partially offsetting this trend, however, will possibly be lower margin percentage of business coming to WFI due to the increasing trend by carriers to request turnkey contracts which frequently require us to use third party vendors.

SG&A expense. SG&A expense netted a provision for doubtful accounts of $11 million was 16.0 percent of revenue. This compares very favorably to the 17.5 percent in the third quarter 2002, and the 18.1 percent of the previous quarter. Reductions as a percent of revenue in our basic expense category with domestic and international accounted for this improvement.

Productivity as measured by annualized revenue per average employee was $165,000 annualized this quarter versus 156,000 last quarter.

Depreciation and amortization. DNA for the third quarter was 1.6 million down 100,000 from the previous quarter.

Net after-tax and earnings per share. Net after-tax of 6.6 million was 4.1 million or 164 percent over the 2.5 million for the third quarter of 2002 and 1.8 million or 37.5 percent over the previous quarter.

Diluted earnings per share for the third quarter was nine cents an increase of five cents or 125 percent over the third quarter 2002 and two cents or 28.6 percent over the previous quarter.

Diluted weighted average shares increased to 75.7 million an increase of 10.3 million shares or 15.7 percent over the same quarter of the prior year and 3.4 million shares or 4.7 percent over the previous quarter of this year.

Now turning to the balance sheet. Total cash, cash equivalents and short-term investments at the end of the third quarter of 116.1 million was 33.1 million or 39.9 percent ahead of the 83 million for the comparable period one year ago and 1.1 million below the previous quarter. Excluding $1 million of capitalized lease obligations WFI continues to have no debt.

Accounts Receivable. Total net AR for the third quarter was 79.8 million an increase of 8.3 million over the 71.5 million of the third quarter last year. DSOs increased five days from the previous quarter to 106 as a result of the significant increase in revenue and related receivables from Latin America.

Equity. For the third quarter, shareholder's equity of 221 million was 79.9 percent of WFI's total balance sheet.

Enterprise Solutions. During the third quarter, Enterprise Solutions continued its aggressive growth as revenue increased 6.2 million, or 62 percent, from the previous quarter. Organic growth from the prior quarter amounted to 1.7 million or 17 percent. During the third quarter, WFI purchased a small systems integrator which concentrates on both security and in-building technologies based in Houston, Texas. Revenue from this acquisition accounted for the balance of the quarter-to-quarter revenue increase.

Outsourcing. Revenue from outsourcing for the third quarter of 3.4 million was 17.2 percent over the prior quarter. WFI now has four revenue-generating outsourcing projects underway. Proposal activity and development of alliance partners continued to show significant progress during the quarter.

Wireless trends. On balance, there are a number of favorable wireless industry developments that beneficially impact WFI. The third quarter year-over-year percentage change in revenue from the national carriers we have reported for the third quarter, as of this date, continue to compare favorably to last year. Data usage is growing rapidly due principally to text messaging, as well as the new generation of color camera phones.

Wireless number portability deadline of November 24 in the top 100 markets has reached a roughly 50 percent awareness level in business and high-end residential neighborhoods. Churn rates could rise 100 basis points from the mid-2003 level as a result of wireless number portability. Each of these trend changes could induce a significant increase in capital expenditure spending by the national U.S. carriers. With capacity and coverage limitations already negatively impacting quality of service, these additional trend changes could likely cause more pressure to build new cell sites and infrastructure.

Operating leverage. We continue to closely control and monitor our expense structure so that revenue growth is only burdened with related verbal expenses and not fixed expenses. This maximizes our profitability. As a result, operating leverage had a strong influence on earnings performance during the third quarter.

Revenue increased 20.8 percent sequentially while SG&A expense net of the provision for doubtful accounts decreased from 18.1 percent to 16 percent of revenue. In actual numbers, revenue grew 11.8 million while SG&A expense, net of the doubtful accounts, grew only $700,000. Accordingly, operating income of 6.1 million in the third quarter increased 281 percent from 1.6 million in the same quarter of the prior year and increased 22 percent from the 5 million in the previous quarter.

Telefonica contract. During the third quarter, WFI executed a master services agreement with Telefonica Moviles Mexico for the performance of GSM-related turnkey deployment work in Mexico. Revenue related to this contract will principally be recognized in the fourth quarter 2003. This revenue is likely to be material to the fourth quarter revenue, as well as calendar year 2003 revenue, for the company. Net profits related to this contract are currently estimated to be materially positive, but as a percentage of revenue, may be below the company's historical leverage due to third-party services. Also, if incurred and enforced, significant penalties related to completed milestones could possibly limit the contract's total profit potential.

Outlook. Our financial strategies and operational execution continue to deliver good performance. There are currently many positive factors benefiting WFI. Our Latin America operations are generating significant revenue increases from both Telefonica as well as American Mobile. Enterprise Solutions is developing a very powerful national footprint in the security integration business, which we expect will bode well for future marketing of our services for all forms of enterprise needs.

Current trends. Current trends in the wireless industry could materially affect positive changes in capital spending behavior for national U.S. carriers. WFI's increasing worldwide scale has nearly eliminated our dependence on work performed by WFI as a subcontractor to other larger companies. Rigorous monitoring and enforcement of our expense structure and cost containment programs should continue to minimize SG&A spending and further leverage profitability.

WFI's balance sheet and financial strength continue to attract marketplace opportunities for capital deployment and earnings accretion. Numerous such initiatives are currently underway. Finally, as we look ahead to the fourth quarter, and the year 2004, we're feeling increasingly optimistic about our ability to achieve improving financial performance. Now, we will begin the Q&A section of the call.

(OPERATOR INSTRUCTIONS) Seth Potter with Tom Siegel.

Very good quarter, congratulations. A couple of questions. First, Terry, can you go through again the organic growth scenario you spoke about? I missed some of it. That is the first question. The second question is, on your breakdown of international versus domestic, I don't know -- does that include your enterprise business also? Then finally, in terms of your Telefonica contract, you mentioned that would be material to the fourth quarter and possibly 2004. Is there anyway to quantify material, i.e. will it become possibly a top five client? Any detail on that would be appreciated. Thanks.

Well, I didn't -- on Telefonica, Telefonica we said fourth quarter in 2003, not 2004, will be material, so I just want to correct that. On organic growth, wireless, the subtotal for wireless category grew 12 percent organically quarter-to-quarter. Enterprise Solutions grew a total of 62 percent in total and roughly about 17 percent organic. So, we had very strong growth on organic basis from both of our principal operating segments. Looking at the domestic versus international piece, which was one of your questions, we had 83 percent of our total revenue from domestic and 17 percent of our total revenue was international. If you look at just wireless revenue alone, the domestic was 78 percent and the international was 22 percent. I think that answers your three questions.

Thanks again.

Thank you.

By the way, the other piece of that is yes, Telefonica would be in the top five for the fourth quarter.

Thanks.

Ned Zachar with Thomas Weisel Partners.

Good afternoon, everybody. I will echo what Seth said. There are good numbers. Congratulations. A couple of questions. A, could you talk a little bit about contract renewals? As I recall in the last call or two, there was some talk about some contract renewals or some contracts that were ending, I think in 2003. If I recall, I think it was AT&T Wireless. So, to the extent that there is discussions, or things you can talk about there, where we're seeing renewals, that would be terrific? Secondly, Terry, I think you mentioned that you thought there might be as much as 100 basis point increase in churn for the wireless industry. A, did I get that right and B, is that based on your own analysis or did you -- were referring to somebody else that put that kind of analysis together? Any color there would be great as well?

First of all, on the contract renewal, obviously every -- there is not a week that goes by that we do not get a new contract or we don't renew a new project. So, that is an ongoing process, globally. With respect to AT&T Wireless, no, actually we work directly with AT&T Wireless, and we are getting more direct work and I cannot go in more detail, as we have not announced anything specific, but our work is starting to expand more directly with AWS.

I guess my question, Masood, is just that there is not any kind of exposure where contracts would rolloff and you would see a drop -- a decrease as you look into 2004 because of a -- someone didn't renew a contract associated with their GSM conversion or something like that?

The only project that is tailing off is actually Cingular project. On the Cingular only project which are a little bit tailing off sometime next year. But that has been tailing off for the past three quarters and it is being replaced by additional direct work from Cingular as well as our other customers.

So we don't have any specific one that it worries me that is going to finish and its going to be a major one except obviously as we talked about Telefonica. Telefonica is a new contract is there is a -- we feel very good about it for the fourth quarter. It is material. So, that is the only one but that is on the positive side.

Great.

As a relates to churn, churn for the five carriers that have reported so far for the third quarter, churn is up 10.5 percent on an apples-to-apples basis for the five carriers. I you look at the churn rates that have occurred in Hong Kong and some of European countries when wireless number portability was installed, there were basically off the map, but the 100 basis point increase from mid 2003 level at our speech is basically kind of a consensus of what a number of outsiders in industry studies that we follow have registered. My own view based on what could happen with wireless number portability is that the 100 percent points is basically a median kind of a target point of what I personally expect.

Terrific. Thank you very much.

Erik Hellman with Piper Jaffray.

Hi. Congratulations on the fantastic quarter. My first question is, I guess early part of the week early last week you guys announced a deal with TruePosition. I wanted to find out could you give us any additional color into that agreement? I guess the length of the contract is a couple of years? Is it for a specific dollar amount? Any other help would be great?

Sure. As we have been talking about E-911 is becoming more and more a focus for wireless carriers obviously TruePosition provides equipment and solutions to wireless carriers on E-911.

And in this particular case, our deal with them allows us to work with them on the various wireless carriers to integrate the TruePosition equipment into their network. So, it depends on which carrier, it varies from market to market and from carrier to carrier. But it is a general agreement between us and TruePosition to help them across various different carriers. That is one aspect of it and the other aspect it is a we will be positioning to obviously provide that solution to (indiscernible) carriers that they don't have E-911 solution today.

So, we will be helping to position the solution with this third tier carriers. We don't have any specific dollar amounts attached to it because it varies from project to project and depending on which projects we are engaged (indiscernible) position on which carrier.

Have you displaced somebody? Were they using internal capabilities before, or were the operators themselves doing the work and just buying the equipment from TruePosition?

This is E-911 is a gaining momentum now. The operators to a large extent they have not been doing this internally. They don't have to a large extent they don't have a completed E-911 solution. They are putting that in place now.

And TruePosition has relationships with Cingular and T-Mobile? Is that correct?

That is correct.

My last question is on the gross margin. I think they were a little bit lighter than I was expecting. The contribution from the Enterprise segment, it that dilutive to the group margins during the quarter?

Basically the Enterprise Solutions group gross margins are very close to the composite margins for the company. So, they come in within 50, 100 basis points of the composite. So, they were not dilutive to the company on any material basis.

So this is the general the 26, 29 percent range --?

Right. Right.

Thank you so much and congratulations on a great quarter.

Thanks Erik.

(OPERATOR INSTRUCTIONS) Mr. Tayebi, there are no further questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

Thank you. Thank you for joining our conference call. We look forward to having you to attend our next conference call. Thank you.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.