Kratos Defense and Security Solutions Inc (KTOS) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Wireless Facilities Incorporated fourth quarter and full year 2006 earnings conference call. Your speakers for today are Mr. Eric Marco, President and Chief Executive Officer, Deanna Lund, Senior Vice President and Chief Financial Officer and Michael Baehr, Vice President of Corporate Communications.

At this time, all participants are in a listen-only mode. [OPERATOR INSTRUCTIONS] As a reminder, this call is being recorded today, March 12, 2007. I will now turn the conference over to Mr. Michael Baehr who will read the Company's warning regarding forward-looking statements. Please go ahead, sir.

Thank you. Good afternoon. Thank you, everyone, for joining us for WFI's conference call. I want to start off by first, apologizing for the delay today. We were experiencing technical difficulties related to our news release crossing the wire. With me today are Eric DeMarco and Deanna Lund WFI's President and CEO and Deanna Lund WFI's Chief Financial Officer.

Before we begin the substance of today's call, I would like to make some brief introductory comment. Earlier this afternoon, we issued two press releases which outlined the topics we plan to discuss today. If anyone has not yet seen a copy of these press releases, they are available at WFI's corporate website at www.wfinet.com.

Additionally, I would 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 the call will be available on the Company's, later this afternoon. During the call we will discuss some factors that are likely to influence our business going forward. These forward-looking statements may include comments about our plans and expectations of future performance.

These plans and expectation are subject to risks and uncertainties which could cause actual results to differ materially from those suggested by our forward-looking statements. We encourage all of our listeners to review our SEC filings including our most recent 10-Q, 10-K and other documents and other related SEC filings for a more complete description of these risks. A partial list of these important risk factors is set forth at the end of today's release.

As always, we undertake no obligation to revise or update publicly any forward-looking statement for any reason. In today's call, Eric DeMarco, WFI's CEO will discuss business highlights and significant activity for the fourth quarter and full year of 2006 while Deanna Lund, WFI's CFO,will provide a financial update. Eric will also elaborate on the announcement we made earlier today regarding an ongoing review related to past stock option grants.

As a result of these ongoing activities, we will be unable to report full financial results for the fourth quarter and full year of 2006. Because of the ongoing review under way at this time, all financial numbers for the fourth quarter and full year of 2006 discussed on this call are unaudited. I will now turn the call over the Eric.

Thank you, Michael. Good afternoon. WFI announced today that this management team as a result of the recent high level of scrutiny related to stock option granting and pricing practice with public companies and the relatively large numbers of stock options that WFI had granted in prior years made a decision after conferring with outside council to conduct a review of WFI stock option grants.

Executive management determined at the outset of the review that the Company and our shareholders would be best served by WFI proactively initiating its own internal review of the Company's past practices. Though the review, which is being performed by outside legal council, is not yet complete, today there is absolutely no indication of stock option issues involving the current management team, nor are any anticipated. As of today, the review has identified grants issued between 1998 and 2003 that require further review in which the historical measurement dates appear incorrect and could result in adjustments affecting all previously issued WFI financial statements. Due the related vesting schedules for these grants through 2005.

Therefore, we are unable at this time to present complete fourth quarter 2006 financial results, full year 2006 financial results, or comparative complete prior period financial results. The Company, along with the team of outside advisors is working hard to complete the review so that we can report and file our financial results as quickly as possible. An unfortunate potential collateral issue resulting from WFI's delay in timely filing of our financial statements is that our credit facility with KeyBanc does require such timely financial statement filing.

So, even though we are confident that WFI is in complete compliance with the credit facility's financial and other related covenants, a late filing of our audited December 31, 2006 financial statement could put us in technical noncompliance.

Accordingly, we are discussing the situation and working the issue with KeyBanc at this time and keeping them apprised of the status of the stock option review and estimated filings of WFI's 2006 financial statements. Deanna will speak to all of this in greater detail in her prepared remarks. As we discussed with you in our last conference call, on January 3, we stated that we would be taking certain actions in the fourth quarter of 2006, which would result in a series of one-time financial non cash and non operational related costs and charges in the fourth quarter.

In order to better position the Company for the future and refine the WFI's focus and resources on business areas where we believe we can achieve sustained profitability, improve overall future operating results including profitability, cash flow and overall liquidity, eliminating or minimizing under performing or nonprofitable businesses or where WFI did not have critical mass, restructure and eliminate duplicative excess or non value adding infrastructure and costs, consolidate facilities and operations where practical and accelerate vesting on certain stock options which were under water and which we believe to be both non-incentivising to personnel and non-retentive in nature, in order to eliminate future cost or expense related to such options.

As we stated we would in our last conference call, we have instituted these actions in Q4 which I will briefly summarize. Last week we announced that we have completed a definitive agreement for the sale of our business in Europe, the Middle East, and Africa for an aggregate purchase price of 4 million in cash consideration, subject to customary hold back of approximately 700K.

Plus, the receipt from the EMEA operation of approximately 1.5 million in additional cash from the pay down of intercompany debt just prior to the close of the transaction. WFI had been focusing on expanding the breadth and scale of the EMEA business over the past several years, both geographically and through customer expansion in an attempt to achieve acceptable profitability. However, we just could not achieve the critical mass and acceptable business terms in a very competitive EMEA marketplace, where we believe that we could ultimately achieve adequate sustained profitability.

As we have stated previously, we are actively assessing and prioritizing our various domestic opportunities and the sale of EMEA will allow WFI management team to focus even more of its time and resources in the areas where we believe that WFI has critical mass, larger market opportunities and the ability for long-term sustained and predictable profitability.

These areas include the federal, state and local government information technology, communication and operations and maintenance outsourcing, the Department of Defense, Homeland and other security areas, the wireless networks in the United States, with opportunities being driven by ever increasing numbers of subscribers, higher speed data requirements, greater demand for content and wireless communications, the necessity for increased back haul and transport capabilities and new technologies, including WiMAX, EVDOMA and UMTSHSVPA.

Additionally, we have substantially completed the facility consolidation within our San Diego headquarters which has enabled us to move out of and an attempt to sublease extra space and space which as a result of our restructuring efforts was not being used efficiently. The facility consolidation is consistent with our actions of refining focus in our core strategic business areas, eliminating inefficiencies, reducing costs and improving cash flow. The facility consolidation has effectively reduced WFI's facility cost going forward by approximately 300 to 400K annually and if we are successful in our subleasing efforts, which we have moved out very aggressively on, with further increase WFI's cash flow.

Part of our restructuring assessments also included a critical review of our Enterprise business or ENF. The ENF division, businesses strategy and direction, investments required by WFI to execute the existing ENF business plan and what is occuring in the overall Enterprise related industry and market from an opportunity standpoint.

The assessment's we made of our Enterprise business, was performing conjunction with assessing the value of other opportunities that WFI currently have and the wireless carrier business or WNS and WGS for the Federal Government business area which included the following thinking. That WFI currently has opportunity in the wireless carrier area which has been increased as a result of the recently completed AWS auction, and may further increase as a result of the upcoming 700 megahertz auction. That recent contract wins by WNS, particularly in the WiMAX and other 4G areas which I will discuss later, will require a significant amount of resources and focus as we move forward in 2007 and into 2008. But our plan to continue to build and grow WGS including through acquisition, will require a significant amount of resources and management attention.

Accordingly, as a result, we have made the decision to change our strategy related to ENF, focusing greater investment in the wireless carrier, WNS and Federal Government, WGS business areas and focusing ENS primarily in areas where we have significant existing expertise, qualifications and relationships. For example, currently an increasing number of projects that ENS is working on and which ENS has been focused on is work related to physical and other types of security system integration at Department of Defense Military Bases, DOD Production Facilities, and other state, local and municipal government locations. This is an area where we believe that WFI's expertise and overall qualifications as an organization provide a clear, competitive differentiator and is an area where we intend to increase our enterprise focus and expertise.

We are confident this change in overall strategy related to ENF though in part resulting in the good will impairment, which we announced today, is the right decision and completely consistent with our actions to improve financial reporting predictability, improve overall WFI profitability, improve overall WFI cash flow and accordingly, enhancing WFI's focus in areas where WFI believes we have either critical mass, competitive advantages or other differentiators, which includes ENS's expertise in security, access control, fire and life safety, these are areas which WFI will continue to aggressively pursue.

Moving along, the previously announced planned sale of WFI's Brazilian operations has continued to move forward and we are hopeful of completing the transaction before the end of Q1 2007 or shortly thereafter.

Brazil is another WFI legacy area, where although WFI has had some success in customer and services expansion, we continue to experience extreme cost competition and we have been unable to achieve the adequate size, along with adequate gross margin generation necessary for sustained and consistent profitability. The planned disposition of Brazil, we believe is absolutely consistent with WFI's previously stated plan of action of eliminates risk, eliminating non value adding businesses and improving the overall financial performance of the Company.

In summary, management team has been saying for over a year now that we are focused on transitioning this business to eliminate and or reduce risk, expand our industry verticals and to streamline the business in response to industry consolidation and very competitive market forces. Over the last three years the strategy has allowed us to balance business risks and affords WFI the ability to continually adjust our business approach, to take advantage of key emerging opportunity areas. As a result, we are doing what we said we would do and we are successfully transitioning away the businesses where we do not already have sustainable critical mass and redirecting WFI's focus of certain domestic opportunities.

Now for an operational overview. In WNF as we have stated before, we are currently transitioning the business to be more focused on newer technology areas like WiMAX, EVDO including EVDO REV-A, UMTSHSVPA, spectrum clearing, both on the commercial and federal government side, which is a direct result of the AWS auction and IP fixed networking and back haul. And less focused on the more legacy, more competitive and commoditizing RF engineering areas which remain challenging. We are doing this while also attempting to expand our customer base and reduce recurrent customer concentration of risk issues.

WFI has continued to make strides with these higher technologies. With greater than 50% of WNS's business currently in these newer, more technical and growing areas and we are continuing to expand and and, diversify our major customer. Which up until just recently were the vast majority of the WNS business base, are areas that remain challenging for WFI, which we are in a transition away from and which we expect to continue this transition throughout 2007.

Specifically, in the fourth quarter WiMAX related work was a significant contributor to WNS. WNS today we firmly believe that WFI is one of the largest independent WiMAX service providers currently in the United States. We have been very successful in securing a number of contracts in the WiMAX area and although we cannot announce them but customer name, we are very encouraged by the opportunities here. For example, we are currently under contract for two national WiMAX carriers here in the United States performing a wide variety of services and work in numerous major market areas throughout the U.S.

Additionally, WFI continues to provide Engineering Services to a major international OEM for a large national WiMAX engagement. The scope of our work with this OEM involved WiMAX design, field verifications, drive testing and model calibration related to the WiMAX service roll-outs in the U.S.

As we have stated in the past, a key element of WFI's strategy is to position the Company as one of the premier go-to service providers or system integrators in the domestic WiMAX eco system. Overall today, WFI has approximately 200 of our personnel working on WiMAX or WiMAX related engagements, tens of millions of dollars of WiMAX related work under contract or MSA and we are anticipating this area to continue to grow for us in the future. We are hopeful that the WiMAX industry here in the United States will continue to gain traction and grow in the future and we believe that we have positioned the Company's wireless business to be part of this industry growth area.

In the fourth quarter, WFI continued to be under contract and performing work in numerous markets with one of the largest wireless back haul providers here in the United States. As we have discussed with you in the past, increased back haul requirements go hand in hand with increased bandwidth going to the cell sites from the 4G technologies, such as WiMAX, EVDO and UMTS.

Additionally, wireless back haul is arguably faster and less costly to deploy than traditional wired back haul solutions, intentionally offering a competitive advantage to those choosing this technology path. Similar to our WiMAX strategy, WFI's strategy here is to be one of the premier players in the wireless back haul, fixed net and transport areas and we intend on continuing to maintain our focus here. The wireless back haul industry, we believe can offer WFI potential growth opportunity if the rollout of both second generation 3G and 4G services continues, along with the increased demand for high speed data offerings and content by wireless subscribers. Today, WFI has several millions of dollars of wireless back haul, fixed net and IP related work under contract for MSA.

In the fourth quarter, WFI continued to perform EVDO network optimization services for a large national CDMA technology based carrier here in the U.S. EVDO networks are another strategic focus area for WFI and we believe that we continue to be one of the largest independent providers of such services to CDMA based carriers in the U.S.

In the spectrum clearing area, which we are hopeful will ultimately be one of the brightest areas for WFI coming out of the AWS auction, we have had some early successes including just recently being awarded a contract by a national carrier to clear 100% of their links across the United States. This contract is intended to be multi-year in nature and is expected to be multi million dollars in value and includes approximately 500 links to be addressed if all phases are executed. We have just recently commenced work with this very key customer of WFI's.

During the fourth quarter, we also continued to work with virtually every large winner of the AWS spectrum with our strategy being to position the Company, to be one of the largest independent providers of spectrum clearing and relocation services in the United States. If a winner of AWS spectrum intends on using the spectrum that they purchased, more likely than not, the winner of the spectrum will need assistance in clearing any incumbents currently using spectrum, including potential Federal Government and Department of Defense legacy users. If the majority of the spectrum acquired in the AWS auction is ultimately utilized by the acquires, we believe that the opportunity for a service provider like WFI to clear out legacy users from the purchase spectrum could be significant.

So WFI is aggressively positioning our wireless business areas as a premier spectrum clearing provider with AWS auction winners and utilizing our Federal Government expertise as a clear WFI differentiator when presenting our qualifications as once again a large number of the legacy users of the purchased AWS spectrum are DOD and other Federal Government agencies and these are customers where WFI already has relationships and is a key strategic focus for the Company.

Moving on operationally to the Enterprise business or ENS. ENS continues to be very project based were the timing of either completion or starting particular large ENS project potentially having a significant impact on any one fiscal quarter which is what occurred in Q4 of '06. This is one of the primary reasons why we have implemented the ENS strategy change I previously discussed. Although as I mentioned before, a key focus area for ENS and an area where we believe that we have made progress is focusing on federal, state, local and municipal government opportunities in both the prime and subcontractor role that have a security element and that are in our core geographic expertise and relationship areas.

Once again, we believe that the recent ENS restructuring which significantly reducing the recurring investment and cost base will yield more predictable overall forecasting and profitability going forward. Some of the key programs that ENS is currently working on include a range of network services for a facility which is part of the production of one of the most advanced stealth Military aircraft in the world. A multi-location security system including a significant wireless element for an agency of one of the largest municipalities in the United States. Ace wide CCTV surveillance and recording of buildings, common areas and gates for a major U.S. Army base. A fire and life safety network, at one of the largest airports in the United States. And a facility security, safety and access control system for a large correctional institution for a government agency.

Recently, one area where we have changed our business approach involves the area of municipal wireless networks. It has been our experience to date, that the most successful municipal wireless networks and those networks with the greatest likelihood of actually being deployed are those where a specific public utility is involved such as the Houston Metro Security Surveillance Network and the quadruple play ER Linked Mesh Network in Tucson.

Other municipal networks where cities are offering or planning on offering free or significantly subsidized broadband wireless of the public are slow to deploy and carry terms and conditions that are not acceptable to WFI. We have made the decision not to pursue the free municipal wireless opportunity as thus far we have not been able to routinely receive terms of payment or other conditions that are acceptable to WFI. We assessed the unacceptable terms that we routinely see against the sales and business development effort, resources, extremely long bid, proposal and decision making process and costs required to pursue such opportunities and continuing to pursue business in the generic muni wireless space, where services offered for free simply does not outweigh other potentially more lucrative opportunities where WFI could otherwise be focused. This is another key reason and driver of our recent decision to revise the ENS strategy which once again we are comfortable was the right decision.

Moving on to our Federal Government business or WGS, at the beginning of the fourth quarter we closed WFI's fourth acquisition of the Federal Government Space, Madison Research Corporation or MRC. The integration of Madison is going extremely well and we are approximately 80 to 90% complete with integrating that business in the WFI's overall government business. With the Madison acquisition, WGS now has a significant presence in key strategic Military locations including Northern Virginia, Washington, D.C. area, where we specialize in information technology services for the Department of Defense and various federal agencies, Southern California, including support to Spay War and the Naval Air Warfare Centerpoint Magoo, Huntsville, Alabama a key benefactor of the recent base relocation and closure initiative and also including Army and NASA support functions. White Sands, New Mexico, with where we provide target operations and missile system test and evaluation for the Department of Defense, Hawaii and the Pacific missile range, Florida and the Southern Command, KeyPort, Washington where we are involved in undersea warfare support services and foreign Military services currently focused on the Middle East. From a service offerings and capability standpoint, WGS is focused on weapon systems, operations and maintenance including surface to air missiles and the Egyptian Chapparell OPS and maintenance contract and approximately $36 million award we received in '06, performance on this contract has commenced and is going well and this was a key driver in the fourth quarter.

Operations and maintenance of ranges including the operations and maintenance of aerial and surface targets. Our range work was also a key contributor to revenue in the fourth quarter and we see this operational tempo increasing in the first quarter.

Technical resources, including command, control, communications and computing for Spay War, another key contribution area in the fourth quarter. Network design, installation, operations and maintenance, including network engineering for various Federal Government agencies, also a key fourth quarter contributor. Information technology and communication systems work on nuclear submarines. This is an area where we are looking for increased contribution in the future. Overall, we believe that WGS is achieving the capabilities necessary for sustained, long-term growth and continued profitability. We also believe we have positioned this business well from a refined service and capabilities offerings standpoint, we are positioned in areas where moneys will continue to flow. From a critical mass standpoint in terms not only of revenue, but also from the overall number of WGS personnel, allowing us to scale creditably. Our overall number of cleared personnel or personnel with government issued security clearances, our ongoing performance on current contracts is very good as evidenced by recent large ceiling increases on major contracts such as Spay War C4ISR and Point Magoo Targets Operations and Maintenance. And our sales and business development resources continue to scale.

From a strategic location standpoint, we still believe that we need a major presence in Colorado Springs in order to increase our reach primarily in Air Force Engineering and IT services. As you know, to date, WGS has been a significant profit and cash flow generator for WFI and as I have said before, WGS's EBITDA profit margins are some of the highest in its industry peer group. EBIT margins; however, are currently somewhat lower than the peer group as a result of the amortization of purchased intangibles, which results from the acquisitions we have made and as we have had an acquisition strategy with WGS, our amortization on a relative basis is higher than most of our peers.

This is basically an amortization of the purchase price or a form of good will amortization if you will. In any event, as I have said before, WGS we are going to focus more resources and make greater investment than we historically have on sales, business development and contract capture for as we continue to transition the overall WFI business, it is key to us that WGS internal growth occur.

In summary, for WGS we are very comfortable with how the business is positioned and performing. I will now turn the call over to Deanna for her prepared remarks.

Thank you, Eric, good afternoon. Today we reported that we have conducting an voluntary internal review of past practices for stock option granting and pricing. This voluntary review was initiated by the current executive management team in light of recent media and Wall Street reports regarding the option granting practices at numerous publicly traded companies.

The current executive management team which has has been in place since 2004 is conducting the review with the assistance of outside legal council and with oversight from a special committing of the board of directors and its special council. We are reviewing all option grants since 1998. To date the review has identified stock option grants issued during the years from 1998 through 2003 for further review in which the historical measurement date appears incorrect and could result in adjustments affecting all previously issued financial statements. The impact of these option grants and the associated compensation expense due to the option vesting period through 2005 could result in adjustments affecting all previously issued financial statements.

A conclusion of whether a restatement is required of the Company's previously issued financial statement will not be made until the internal review is complete. Once we have completed this review we will be able to provide information regarding the financial impact related to this issue. Until that time we are unable to comment further on the review or the potential financial impact.

In light of this ongoing view, the Company is not in a position to announce full financial results for the fourth quarter and fiscal 2006. All financial data included in the earnings release today and during this call are unaudited. However, we have provided an update to the previously announced action that we have taken in the fourth quarter. Our results from continuing operations will be impacted by the following non cash charges.

A good will impairment charge of 18.3 million related to acquisitions made in the Company's Enterprise network services segment in 2003. This charge was a result of the annual impairment task that we perform at the end of each year to determine if the forecasted operating performance of the acquired business is sufficient to cover the carrying value of the good will acquired. Due in part to changes in the industry, due to certain strategic focus change that's we have made in our ENS business that Eric outlined previously and due to certain of the operational challenges which occurred after the completion of the earn out periods and the resulting significant employee turnover we experienced throughout 2006, our forecasted operating performance was impacted and therefore impacted our good will impairment analysis.

Secondly, a 9.2 million charge related to stock compensation expense as a result of the Company's action to accelerate vesting on substantially all outstanding employee stock options in December 2006, and lastly, a restructuring and other asset impairment charge of 3.4 million primarily reflecting an excess facility accrual for the consolidation of the Company San Diego Headquarters facility, the impairment of asset and certain employee termination costs.

The results from discontinued operations will include losses generated from the operating performance of the Company's European and South American operations of approximately 3.2 million as well as the estimated loss on disposal of the South American business of approximately 5.2 million based upon indications of interest. Impact of the recent sale of the European operations which resulted in a net gain from disposal will not be recorded until the first quarter of 2007, which is the period the transaction was consummated.

As discussed previously, the Company's plan to dispose of the European and South American operation is a result of the Company's ongoing plan to continually evolve strategic focus, profitability, and free cash flow by divesting or exiting portions of its business where critical mass and profitability has not been achieved.

Also as we announced on January 3rd, we received the final payment totaling 9.5 million outstanding balance of the approximately 19 million purchase price from [Sakeio] LLC which acquired WFI's Mexico's wireless network deployment business at the end of last year. We utilize these payments to pay down 12 million of debt associated with our acquisition of Madison Research Corporation at year-end.

As of December 31, 2006, our debt balance is approximately 51 million with approximately 5 million in cash on hand. DSO or days sales outstanding for the Company decreased from 116 days at the end of the third quarter to 112 days at the end of the fourth quarter. This was in line with what we were planning based upon where we believe we would be on certain of our large turn key deployment projects which we were able to bill and collect in the fourth quarter.

Let me now turn the call back over the Eric for some final comments.

Thank you, Deanna. In closing, obviously, though we are clearly disappointed with any related adverse impact from the stock option review that is under way, we as a management team with complete support of the board remain completely focused on getting WFI's financial statements filed as expeditiously as possible. Working the timely file audited financial statement requirement with the bank which once we are filed we expect will be resolved. Completing the sale of our South American operations, executing on our respective strategy, WNS, WGS, and ENS, transitioning WFI to a profitable, predictable, growing financial performer and continuing reviewing respective business unit strategies and WFI's overall direction and strategy in order to deliver value to our shareholders. In closing, I want to apologize for the PR news wire issues resulting in the delay in our release this afternoon. Let me convey our sincere thanks to our shareholders and employees. We are concluding this call today without taking questions because as we have indicated, we have not yet completed the audit procedures for our Q4 or full year 2006 financial results and therefore we cannot comment in a meaningful way on the financials of our business until this process has been completed. We will certainly update you on any developments we hear. Thank you for joining us today.

Thank you, ladies and gentlemen. This does conclude today's conference, and we thank you for your participation, and you may disconnect at this time.