Kratos Defense and Security Solutions Inc (KTOS) 2006 Q1 法說會逐字稿

Welcome to the Wireless Facilities, Inc. first quarter 2006 earnings conference call. Your speakers for today are Mr. Eric DeMarco, President and Chief Executive Officer; Deanna Lund, Senior Vice President and Chief Financial Officer; and Michael Baehr, Vice President Corporate Communications and Investor Relations. This call is being recorded today, May 9, 2006. I will now turn the conference over to Michael Baehr who will read the Company's warning regarding forward-looking statements. Go ahead, Mr. Baehr.

Thank you. Good afternoon and thank you for joining us. With me this afternoon are Eric DeMarco, our President and CEO; and Deanna Lund, our Chief Financial Officer. We will begin with Eric and Deanna providing an overview of WFI's results for the first quarter of fiscal 2006 and then we will open up the call to your questions. If anyone has not yet seen a copy of our earnings release it is available on WFI's corporate website at www.wfinet.com.

Before we begin the substance of the call I'd like to remind our listeners that this conference call is open to the media and we are providing a simultaneous webcast of the call for the public. A replay of this call will be available on the Company's website later this afternoon. I also want to remind you that today's comments include forward-looking statements about our plans and expectations of future performance. These plans and expectations are subject to risk and uncertainties which could cause actual results to differ materially from those suggested by our forward-looking statement.

We encourage all of our listeners to review our SEC filings including our most recent 10-Q and 10-K for a complete description of these risks. In addition, this conference call will include a discussion of non GAAP financial measures as that term is defined in Regulation G, the most directly comparable GAAP financial measures and information reconciling these non-GAAP financial measures to the Company's financial results prepared in accordance with GAAP are included in the earnings release which is posted on the Company's website. With that as an introduction, I will turn the call over to Eric and Deanna for a detailed review of our operational and financial results for the first quarter.

Thank you. Let me first begin with our carrier business. In our domestic carrier division, on the engineering side, and as we have discussed previously with you, we are focused on building practices in the land mobile radio area, or LMR, the IP fixed and Core Network area, and the in-building network area. We are diversifying into these areas as we believe that there is opportunity here for growth and potential for higher margins as compared to the highly competitive core RF staff augmentation business.

In Q1 of 2006, we successfully grew each of these new business areas sequentially quarter over quarter, with fixed net IP and Core Network revenues increasing over 50%, in-building revenues increasing more than four-fold, and our wireless division generating its first land mobile radio revenues in this new business area. Though the success of these new and growing opportunity areas for WFI were significant, they were not able to completely offset the quarter over quarter reduction of nearly 15% in the legacy WNS engineering staffing business which was greater than expected. Outside of our traditional RF engineering services, which have declined, we have grown the revenues in the domestic engineering portion of our RF business from approximately 16% to nearly 30%. This represents a directional shift that we believe will continue to increase as these new opportunity areas gain further traction. We are convinced that our strategy to build our lower risk/higher margin Fixed Network IP core in-building and LMR practices is correct as we believe there is growing industry momentum in each of these areas.

On the deployment side of the business, we continue to experience challenges as new site builds were delayed by our customers without any additional compensation provided to WFI. This resulted in reduced profit margins for certain of our deployment projects by reducing operation efficiencies and our ability to recover fixed overhead costs and by requiring us to absorb the costs of the staffing ramp up and ramp down required to meet our customers plans. Under the percentage of completion method of accounting, the entire estimated impact of the reduction in profits from the delayed site builds is required to be recorded in the quarter in which we first became aware of the delay. While the jobs are still profitable, the cumulative reduction in profits had a significantly adverse effect on first quarter results.

In the quarter, we also identified some substandard work performed by certain of our subcontractors. We are committed to delivering high quality services to our customers, and therefore we needed to remedy these issues at a significant additional cost to WFI. In aggregate, the cumulative costs related to these issues I just described resulted in a negative impact of approximately 1.9 million to our gross margin. In both cases since we have yet to resolve these issues with our customer or with the subcontractors, we have not assumed any cost recovery in our results for the quarter.

On the positive side of our deployment business, we continue to receive a significant number of new sites from a customer under a large national program announced a couple of months ago to provide network integration services as a result of merger and consolidation activities. This is a large scale multi disciplined network integration modification and expansion contract we believe will continue for the foreseeable future and will provide a stable revenue base for the deployment business. Our overall strategy in the deployment business is to continue to be more and more selective on what work we take and in what markets with the to focus on reducing risk. The vast majority of the deployment projects that we are working on are profitable. However, we clearly recognize that we need to continue to reduce the risk of cost overruns, site cancellations or delays, and margin degradation by being more selective in the opportunities that we pursue.

Internationally, our Brazil engineering business remains solid with better than expected revenue and gross margins. These resulted in part from the receipt of customer change orders for costs that were incurred in the third and fourth quarters of 2005 for which WFI previously did not have proper customer documentation, and therefore booked only costs and no corresponding revenue. In EMEA, we remain focused on diversifying the business moving into wireless enterprise broadband solutions and high-end consulting. In this area of our business, we have continued to see competitive pressures impact our European operations resulting in both reduced revenues and gross margins below what we expected, which is a primary driver of these diversification initiatives.

Strategically, for WFI's carrier business, in addition to diversifying our engineering service into IP, the core and Fixed Network and land mobile radio, we believe there is a significant opportunity to provide long-term value to our customers by leveraging our relationships, sales channels, wireless network domain expertise and our engineering expertise through partnering with smaller software product and tool companies which do not otherwise have access to these customers to provide complete end to end solutions. By cultivating these value-added partnerships and bundling products with our services WFI can offer a differentiated solution to the customer. This total delivery of a solution set to the carrier customer is a clear differentiator from what the small and mid-size engineering firms offer via straight staff augmentation services. Accordingly, we will continue to seek to partner with software or tool companies similar to our partnership with Connectiv Solutions for Route Watch, where WFI brings these attributes for a combined overall solution.

If you recall, the Route Watch delivery is a hosted call routing management solution that provides ongoing comprehensive analysis of a carrier's switch, routing and translations, including tools and metrics to reduce long distance variable expenses. We have started to gain momentum with the Route Watch offering with contracts from two major carriers to date. We believe there's significant demand for these types of end-to-end solutions from the carriers, and that these types of partnerships can provide WFI with the opportunity to further diversify our carrier business into higher margin and lower risk areas.

In our enterprise division, some of the significant projects we are performing on are as follows. In Tucson, Arizona, we continue to work on what we believe to be a very exciting program called ER Link, or Emergency Room Link. ER Link is a wireless mesh network that will deliver real-time video and patient data from ambulances to hospitals in more than 90% of the City's populated areas. The ER Link program is another example of where WFI as the prime contractor, is delivering a complete solution with bundled products, software, video elements, and other components for an integrated mesh network solution.

In Mountain View, California, WFI has partnered with Google, and we have been working on one of the largest municipal wireless networks being deployed to date in the United States. And even though we encountered an unexpected project delay in Q1 which impacted our revenue and profit, we are continuing to also work on a large security enterprise system integration program for one of the largest shopping mall chains.

During the quarter in ENS we encountered some issues related to the completion of the earnout of two of the enterprise companies WFI acquired in 2003 which affected our first quarter results. The former owner and employee of one of the acquired companies left WFI with several members of that entities management team and set up a competing business. We recently obtained a restraining order against these individuals to stop them from contacting our customers. We hope to have this issue resolved permanently in our favor in the near future. We have also hired new general managers at these two enterprise companies and we are in the process of hiring new sales and other key management personnel for these locations. We are already seeing the positive impacts of these moves with increased bookings and backlog at these businesses, though it will take us some time to regain momentum in this area of our business. With these earnouts completely behind us we can now truly focus on transitioning these businesses with management teams motivated and focused on the strategy of delivering higher margin system integration, wireless infrastructure, security, building optical network, and network management offerings to our customers.

In the municipal wireless business, we are currently working on five municipal wireless related projects including the opportunity I just mentioned in Mountain View with Google. We currently see quite a bit of opportunity in this area with many municipalities across the United States considering deploying wireless mesh broadband networks. Our strategy in this area is to serve as the complete turn-key network solutions provider and systems integrator which partners with equipment vendors, wireless Internet service providers, and other network providers. Additionally, on each of the municipal projects which we are currently involved, we are focused on becoming the operations and maintenance provider for the customer once the network is deployed, performing the O&M via managed services type of offering.

In our Federal Government division we continue to be proud of the momentum we are building. Solid execution led to higher than expected margins, and we continue to win numerous new contracts which should provide a solid base of work in the coming months and years. Significant successes during the first quarter included global combat support system, a contract awarded to WFI from a major defense contractor valued at approximately 10 million. A multimillion dollar contract award as part of the technical and engineering team supporting the United States Navy surface fleet, overall, approximately 29 million in new contracts and ceiling increases on existing contracts from civil agencies and various agencies of the United States Department of Defense. These first quarter awards also include two previously unannounced contract ceiling increases totaling more than 22 million, for continued support for aerial and surface targets for the naval air weapons station at Pt. Mugu and for continued engineering services at the pacific missile range facility in Hawaii.

Finally, we have the successful completion of a command and control installations aboard a number of Pacific fleet submarines. Overall, our bid and proposal pipeline and our government business remains strong at nearly 600 million, and we continue to aggressively submit proposals for new federal work. Our strategy of building a highly profitable and growing Federal Government information technology business continues to be successfully executed. As we have discussed with you previously, this business unit of WFI has high barriers to entry, long-term contracts, and significant realizable backlog, each of which we believe to be very favorable attributes to building a consistent and predictable business. As we have previously stated, we are going to continue to focus on trying to grow this business as a larger and larger part of WFI both internally and through acquisition. Let me now turn the call over to Deanna to talk more about the financial results, then I will wrap up with some concluding remarks.

Thank you, Eric. Good afternoon. This afternoon we reported revenues for the first quarter of 83.9 million compared to 90.7 million for the first quarter of last year. Sequentially revenues were down from fourth quarter 2005 revenues of 94.8 million. Our first quarter revenues were impacted by our customers' delayed site builds in our domestic business and continued competitive pressures in our EMEA operations that Eric mentioned, as well as reduced ENS revenues resulting from customer delays, personnel turnover, and other issues related to the completion of the earnout period.

In addition, as a result of the manner in which we are awarded new sites and phases under the large national program that Eric mentioned earlier, we have not received purchase orders for all of the phases of the work that we will complete. Therefore, we are currently recording the profit on a conservative basis of a 0 margin or at revenue equal to cost, since we have not yet been awarded all phases of the project. As we receive more purchase orders for additional phases we will record the estimated margin on the project at that time. As a reminder, our operating results of our discontinued operations are all current year and prior year result have been reclassified as discontinued operations, and therefore any revenues, gross margin, and operating income generated from those operations is now reflected in the single caption, income loss from discontinued operations.

Our international operations in Europe and our remaining engineering operations in Brazil contributed 9% of our revenues while our domestic operations comprised the remaining 91% of our revenues. Some of our significant customers in the first quarter included Cingular at 26.1 million, or 31.1% of our revenues, the U.S. Navy at 7.4 million, or 8.8% of our revenues, Sprint Nextel at 4.4 million, or 5.2 of our revenues, and Verizon and 02 at 3 million each. Gross margin for the quarter was approximately 16.9%, down from first quarter 2005 gross margin of 22.8%. Reduction in gross margin is primarily a result of the subcontract rework, cost overruns, and the impact of site build delays mentioned previously and to a lesser degree due to the 400,000 of stock compensation expense in the first quarter of 2006.

Operating expenses were approximately 15.7 million which includes depreciation and amortization of 1 million, stock compensation of 500,000, and 100,000 of contingent acquisition consideration. Since the company adopted FAS 123R on January 1, 2006, this is the first quarter that the Company has recorded stock compensation expense which aggregated 900,000 comprised of 400,000 in cost of sales and 500,000 in SG&A. The reduction in gross margin was offset partially by cost containment efforts resulting in a reduction of SG&A which excludes stock compensation expense which decreased from 16.4 million in Q1 of '05 to 15.1 million in Q4 -- I'm sorry, Q1 of '06, and down sequentially from 18.1 million in the fourth quarter of 2005.

Operating loss for the quarter was approximately 1.5 million compared to operating profit of 4.3 million in the first quarter of fiscal 2005, reflecting the reduction in gross margin and the impact of the reduced revenues and which includes the 900,000 stock compensation expense in Q1 of '06. Loss from continuing operations was 1 million, or $0.01 per share, compared to income from continuing operations of 2.7 million, or $0.04 per share for the first quarter of 2005. Excluding the impact of the stock compensation expense in 2006, loss from continuing operations would have been approximately 350,000 or break-even earnings per share. Net loss for the quarter was 800,000, or $0.01 per share compared to net income of 3.6 million or $0.05 per share in the first quarter of 2005. Included in the net loss for the quarter was income from discontinued operations of 200,000 for the first quarter compared to net income from discontinued operations of 900,000 in the first quarter of 2005.

The sale of our operations in Mexico was completed in February, which we sold at the net carrying value of this business. As a result of the closing balance sheet adjustment, the total aggregate cash consideration for our Mexico operations is now at 19 million with 1.5 million that has already been received in February and a note receivable now adjusted to approximately 17.5 million which is due in installments through December 31, of this year. In April of 2006 we presented the closing net asset calculation to the buyer and the buyer is still in the review process of the computation as provided in the equity agreement between the parties. We expect that we will reach final resolution of the total net asset computation in the second quarter of 2006. Our next scheduled payment of 3.25 million is due on the note receivable from the buyer on May 17.

Turning to the balance sheet, total cash, cash equivalents, and short-term investments at the end of the first quarter were approximately 10 million. Cash balance is down from approximately 12.9 million from the end of the fourth quarter primarily resulting from working capital requirements in the first quarter. As of March 31, we had approximately 7 million drawn on our credit facility which was drawn primarily to fund acquisition earn-out payments that we made in March related to our enterprise acquisitions. We have one remaining payment that was recently determined following arbitration to be $900,000, including various fees and expenses with this final payment. At that point the earnout payments we had been making since 2004 related to the acquisitions that we made in our enterprise segment will be complete.

As expected, our DSOs increased from 105 days at the end of the fourth quarter to 116 days. This was expected as we were in the construction phase on some of our larger turn key deployment projects for which we have not yet achieved certain of the contractual milestones and therefore have not yet been able to invoice our customers on these projects. We expect that we will be able to invoice and collect certain of these amounts in the second quarter which should result in a reduction to our DSOs. We expect that the cash flows that we would generate in the next few quarters along with the payments from the sale of our Mexico operations will be utilized to pay down the amounts drawn on the credit facility. Let me now turn the call back over to Eric for some final comments.

Thank you, Deanna. Before we conclude, I'd like to mention an additional update relating to the Securities Class Action lawsuits filed against WFI in 2004. On March 14, we announced that the Class Action suit had been dismissed with leave to amend. As expected, the plaintiffs in the case have recently amended and refiled their complaint in United States District Court for the southern district of California. We anticipated this action by the plaintiffs and we continue to believe that the plaintiff's case lacks merit. We will keep you updated as we learn more about the proceedings.

In summary, WFI is successfully executing its stated strategy of building a profitable and growing Federal Government information technology business focused on networking, building engineering practices, and land mobile radio, and public safety, IP, and Core Net working, and backhaul and transport and building on our solutions delivery offerings as we have successfully demonstrated with Route Watch and the city of Tucson. All areas we believe will ultimately correspond to higher margins for the Company. However, the bottom line is that WFI must execute and execute well quarter to quarter consistently as we transition the business. This is an area where I personally, along with the entire management team will be focused over the next several months, on execution. We will update you on our progress in these areas in our next quarterly call. Thank you. Let me now turn the call back over to the moderator for any questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question from Bob Lee with Sidoti & Company.

I was just wondering if you can discuss the gross margins for each of the business units? I'm just trying to get my arms around what each of the business units contributed to the bottom line? How should I look at if going forward?

Hi, Bob this is Deanna. The gross margin for each of the business units, let me just give that to you, for our wireless business was just under 16%, in the high 15s. ENS was the high 16s, about 16.7. And our government business was at 20.7%.

Now, looking at the WNS and some of the delays from one of your contracts, is there any kind of horizon on when that's going to alleviate, or is that a on hold project?

It's on hold right now and we have not been given a date when it will be turned back on.

I think that's it for now. I might go back in later, in the queue later.

Next from Credit Suisse, we'll hear from Mike Ounjian.

Eric, could you talk a little bit about -- I know you're not giving guidance for the second quarter, but what visibility looks like in each of the segments. Just in the near term how has the quarter gone so far? And should we expect to see the business on the carrier side and the enterprise side pick up right away, or is this going to be a slower process?

Right. Visibility on the government side, as we sit here today, appears to be very, very good. And very, very sharp. We have a significant backlog that's multiquarter out that is funded, and that we -- we're fully staffed and we're working on. On the enterprise side, as I noted, we had a delay on one project that has been lifted now that we are starting to work on. We've already commenced working on again. And we had some issues with the management teams at some of the earnout companies, the previous owners. Those have been back-filled with new people, and that has turned around now. So on the enterprise side, it's clearly not as good as it is on the government side, but it's trending back to normalcy.

On the carrier side, as Deanna mentioned, on a very large piece of work, that we're under a master service agreement, we have taken a very conservative approach on booking profits, and we're going to wait until we get actual POs or work orders under that to do it. Those are in the hands of the customers after we achieve certain milestones, so our clarity in our carrier business, because of that, is not so clear, even as we sit here now, because many of those purchase orders are scheduled to come in later this month and in June and maybe in July.

Great. Thanks. And Deanna, you gave gross margins by segment. What were the operating margins by segment?

Sure, Mike. Operating income by segment on our wireless business was a negative 3.9%. Enterprise was a negative 13.5%. And our government business was a positive 10.8%.

Okay. Great. And did you -- I apologize if I missed this, but the cash flow from operations from the quarter, and CapEx?

CapEx was about 1.5 million, and the cash flow from operations was a use as we had expected of a couple million dollars.

Okay. Great. Thank you.

Thanks, Mike.

[OPERATOR INSTRUCTIONS] Next we'll hear from Frank Marsala with First Albany.

Just a couple of questions. Just as far as thinking about gross margins as we look forward, would it be fair to think that you're targeting just a removal of those sort of special items, and getting back to a number that we would to get to if we were to do that?

That's, Frank, on a normalized basis, if you look at the numbers that we briefed on the 1.7 million that was related to the cost overruns and the schedule delays including the compensation and expense of 400,000 that would lead to about a pro forma gross margin of right around 19%. That would be what -- that would be a reasonable range to expect going forward.

Yes. And how much of the -- your revenues right now are -- how much of the revenue decline came from just strictly eliminating pass through, because I know that that was a initiative that you had been going forward with before?

We don't have that exact number, but, Frank, they have continued to come down on the pass through side, they've continued to drop because that's been a concerted effort of the Company. A pretty good piece of the revenues coming down also were back to the conservatism on how we are booking profit or lack thereof. We're booking break even right now on this very large build until we get the POs, and then we'll catch up, then we'll book the normal profit on top of that which obviously impacts revenue.

Thanks. I appreciate that.

[OPERATOR INSTRUCTIONS] And at this time it appears we have no further questions. I'll hand the conference back to management for any final or closing remarks.

Very good. Thank you very much, and we will be back at the end of the second quarter.

And that does conclude our conference. Thank you all for your participation. We hope you enjoy the rest of your day.