UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

ý                  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JULY 2, 2004

 

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

 

Commission file number 0-27231

 

 

WIRELESS FACILITIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

4810 Eastgate Mall
San Diego, CA 92121
(858) 228-2000

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

 

 

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 ý No o

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes ý No o

 

As of September 14, 2004 there were 69,030,019 shares of the registrant’s common stock outstanding.

 

 

WIRELESS FACILITIES, INC.

 

FORM 10-Q

 

FOR THE QUARTERLY PERIOD ENDED JULY 2, 2004

 

INDEX

 

 

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets at December 31, 2003 (restated) and June 30, 2004 (unaudited)
	Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2003 (restated and unaudited) and 2004 (unaudited)
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2003 (restated and unaudited) and 2004 (unaudited)
	Notes to Consolidated Financial Statements (unaudited)
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings
Item 4.	Submission of Matters to a Vote of Security Holders
Item 6.	Exhibits and Reports on Form 8-K

 

2

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

WIRELESS FACILITIES, INC.
CONSOLIDATED BALANCE SHEETS
(in millions, except par value and number of shares)

 

		December 31, 2003			June 30, 2004
		(Restated)			(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	86.6		$	44.9
Restricted cash		—			1.0
Short-term investments		27.6			2.0
Accounts receivable, net		94.4			138.9
Accounts receivable - related party		0.2			—
Prepaid expenses		1.9			2.9
Employee loans and advances, net		0.1			0.4
Other current assets		4.3			2.0
Current assets of discontinued operations		1.0			0.2
Total current assets		216.1			192.3
Property and equipment, net		11.2			11.8
Goodwill		31.0			75.3
Other intangibles, net		1.9			5.6
Deferred tax assets, net		14.1			14.3
Investments in unconsolidated affiliates		4.0			2.0
Other assets		0.4			0.8
Non-current assets of discontinued operations		0.1			—
Total assets		$	278.8		$	302.1
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	13.5		$	23.5
Accrued expenses		42.0			42.0
Billings in excess of costs on completed contracts		6.9			6.5
Accrual for contingent acquisition consideration		3.8			—
Accrual for unused office space		1.5			1.0
Income taxes payable, net		1.3			3.3
Capital lease obligations		0.5			0.3
Current liabilities of discontinued operations		0.2			1.9
Total current liabilities		69.7			78.5
Capital lease obligations, net of current portion		0.2			0.1
Accrual for unused office space, net of current portion		2.0			2.1
Other liabilities		1.3			1.4
Total liabilities		73.2			82.1
Minority interest in subsidiary		0.3			0.3
Commitments and contingencies (Note 1)
Stockholders’ equity:
Preferred stock, 5,000,000 shares authorized
Series B Convertible Preferred Stock, $.001 par value, 90,000  shares outstanding at December 31, 2003 and June 30, 2004, respectively (liquidation preference $45.0)		—			—
Common Stock, $.001 par value, 195,000,000 shares authorized; 62,550,245 and 68,720,377 shares issued and outstanding at December 31, 2003 and June 30, 2004, respectively		0.1			—
Additional paid-in capital		309.6			317.2
Accumulated deficit		(100.4		)	(92.8		)
Accumulated other comprehensive loss		(4.0		)	(4.7		)
Total stockholders’ equity		205.3			219.7
Total liabilities and stockholders’ equity		$	278.8		$	302.1

 

See accompanying notes to unaudited consolidated financial statements.

 

3

 

WIRELESS FACILITIES, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in millions, except per share amounts)

 

		Three months ended June 30,						Six months ended June 30,
		2003			2004			2003			2004
		(Restated)						(Restated)			(Restated)
Revenues		$	58.3		$	102.7		$	109.9		$	199.8
Cost of revenues		39.0			78.8			77.8			154.2
Gross profit		19.3			23.9			32.1			45.6
Selling, general and administrative expenses		10.9			13.8			22.3			27.5
Credit for doubtful accounts		—			(0.4		)	—			(0.7		)
Depreciation and amortization		1.8			1.2			3.6			2.4
Operating income		6.6			9.3			6.2			16.4
Other income (expense), net:
Interest income, net		0.1			—			0.4			0.1
Foreign currency gain (loss)		(0.4		)	(0.4		)	0.1			(0.2		)
Impairment of investment in unconsolidated affiliate and other expenses, net		0.1			(3.0		)	0.1			(2.9		)
Other income (expense), net		(0.2		)	(3.4		)	0.6			(3.0		)
Income from continuing operations before income taxes		6.4			5.9			6.8			13.4
Provision for income taxes		—			1.7			—			3.2
Income from continuing operations		6.4			4.2			6.8			10.2
Loss from discontinued operations		(0.3		)	(2.5		)	(0.8		)	(2.7		)
Net income		$	6.1		$	1.7		$	6.0		$	7.5
Basic earnings (loss) per common share:
Income from continuing operations		$	0.13		$	0.06		$	0.14		$	0.15
Loss from discontinued operations		(0.01		)	(0.04		)	(0.02		)	(0.04		)
Net income		$	0.12		$	0.02		$	0.12		$	0.11
Diluted earnings (loss) per share:
Income from continuing operations		$	0.09		$	0.06		$	0.10		$	0.13
Loss from discontinued operations		(0.01		)	(0.04		)	(0.02		)	(0.03		)
Net income		$	0.08		$	0.02		$	0.08		$	0.10
Weighted average common shares outstanding:
Basic		51.1			68.3			50.2			66.2
Diluted		72.3			75.5			70.6			76.2

 

See accompanying notes to unaudited consolidated financial statements.

 

4

 

WIRELESS FACILITIES, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in millions)

 

		Six months ended June 30,
		2003			2004
		(Restated)
Operating activities:
Income from continuing operations		$	6.8		$	10.2
Adjustments to reconcile net income from continuing operations to net cash  provided by (used in) operating activities:
Depreciation and amortization		4.7			3.4
Deferred income taxes		—			3.2
Credit for doubtful accounts		(0.4		)	(0.7		)
Equity (earnings) loss in unconsolidated affiliates		0.1			3.2
Stock based compensation expense		1.0			—
Changes in assets and liabilities, net of acquisitions:
Accounts receivable		5.0			(36.8		)
Accounts receivable – related party		0.3			0.2
Income taxes receivable		0.4			—
Prepaid expenses		0.3			(0.7		)
Deferred tax asset		(1.6		)	(1.3		)
Other assets		0.6			2.0
Accounts payable and accrued expenses		1.6			7.0
Accounts payable – related party		(0.4		)	—
Billings in excess of costs on completed contracts		(3.1		)	(2.2		)
Accrual for unused office space		(0.6		)	(0.5		)
Other liabilities		1.8			1.7
Net cash provided by (used in) continuing operations		$	16.5		$	(11.3	)
Loss from discontinued operations		(0.8		)	(2.7		)
Changes in net assets and liabilities of discontinued operations		(0.7		)	2.6
Net cash used in discontinued operations		(1.5		)	(0.1		)
Net cash provided by (used in) operating activities		15.0			(11.4		)
Investing activities:
Capital expenditures		(2.2		)	(3.2		)
Purchase of short-term investments		(14.7		)	—
Proceeds from sale of short-term investments		1.5			26.3
Investment in unconsolidated subsidiary		—			(1.0		)
Cash paid for contingent earn-out consideration		—			(8.3		)
Cash paid for company acquisitions, net of cash received		(7.6		)	(47.4		)
Increase in restricted cash		—			(1.0		)
Net cash used in investing activities		(23.0		)	(34.6		)
Financing activities:
Proceeds from issuance of common stock		15.9			5.4
Repayment of notes payable		(0.5		)	—
Repayment of capital lease obligations		(1.5		)	(0.3		)
Net cash provided by financing activities		13.9			5.1
Effect of exchange rate on cash and cash equivalents		(0.8		)	(0.8		)
Net increase (decrease) in cash and cash equivalents		5.1			(41.7		)
Cash and cash equivalents at beginning of period		99.1			86.6
Cash and cash equivalents at end of period		$	104.2		$	44.9
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	0.2		$	0.1
Net cash refunded during the period for income taxes		$	0.6		$	0.5
Supplemental disclosures of non-cash transactions:
Fair value of assets acquired in acquisitions		$	8.8		$	—
Cash paid for acquisitions		(8.0		)	—
Liabilities assumed in acquisitions		$	0.8		$	—
Common stock issued pursuant to Employee Stock Purchase Plan		$	0.8		$	2.0

 

See accompanying notes to unaudited consolidated financial statements.

 

5

 

WIRELESS FACILITIES, INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

(1)               Organization and Summary of Significant Accounting Policies

 

(a) Description of Business

 

Wireless Facilities, Inc. (“WFI” or the “Company”) was initially incorporated in the state of New York on December 19, 1994, commenced operations in March 1995 and was reincorporated in Delaware in 1998. WFI is an independent, global provider of outsourced communications and security systems engineering and integration services for the wireless communications industry, the U.S. government, and enterprise customers. Such services include, but are not limited to, the design, deployment, integration, and the overall management of communications, information technology, and security networks. WFI’s work for the wireless communications industry primarily involves radio frequency engineering, site development, project management and the installation of radio equipment networks. WFI also provides network management services, which involve day-to-day optimization and maintenance of wireless networks. WFI’s work for the federal government primarily involves systems engineering, systems integration, and the outsourcing of technical services such as operational test and evaluation and program management.  WFI also provides services in the areas of mission assurance, product and process validation and verification, and software and applications development.  WFI’s work for enterprise customers primarily involves the design, deployment, and integration of security and other in-building systems including access control and intrusion detection and is focused on opportunities to integrate wireless technology into enterprise networks, especially physical and electronic security systems, and voice and data networks. WFI’s customers are primarily mature providers of wireless telecommunication services, wireless equipment vendors, a large range of customers from varied commercial and industry sectors that require security integration services, and the U.S. government. WFI’s engagements range from small and short in duration, to large multi-year contracts performed on a domestic and international level. WFI’s services are performed either on a time and materials basis, a cost plus fixed fee, or on a fixed price basis.

 

(b) Restatement of Prior Period Financial Statements

 

The Company recently determined that its previously filed financial statements for 2001, 2002 and 2003 required restatements.  The following discussion describes the nature and impact of the restatement items.  The primary reason for the restatement was a recent determination that the Company’s balance sheet did not properly reflect certain accruals which pertained primarily to foreign tax contingencies, and to a lesser degree, certain domestic sales and use tax contingencies.  Accordingly, the Company has restated its previously filed financial statements for the fiscal years 2001, 2002 and 2003 on its Form 10-K/A filed on September 20, 2004 (the “Form 10-K/A”).  The financial statements included in the Form 10-K/A for fiscal years 2001, 2002, 2003, and as of December 31, 2002 and 2003 reflect the appropriate accounting treatment for the tax related contingencies.

 

Additionally, as part of the restatement process, two other types of adjustments were recorded.  The first type of adjustment pertained to various items that had been previously identified in each of these prior periods, but were not recorded in the preceding periods because they were immaterial.  Certain of these previously unrecorded adjustments became material after they were subsequently refined or impacted by the restatement.  These adjustments were also reflected in the restated financial statements in the Form 10-K/A.  These adjustments related to a variety of topics including period cut-off errors, reclassifications, reconciling differences that impacted asset and liability carrying values, and the timing of revenue recognition.

 

The second type of adjustment pertained to the correction of the accounting for certain other prior year transactions.  These adjustments included the following: adjustments to reclassify bad debt expense as reductions to revenue, an impairment of the carrying value of a cost-method investment, recording stock compensation expense for changes in employment status which resulted in a modification of the terms of the employee stock options, the correction of an error in the measurement of progress toward contract completion, the correction of improper cost classifications and a contract billing error on a particular contract, a transitional impairment of goodwill of an acquired entity in connection with the adoption of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets", the identification of purchased intangible assets acquired which resulted in a reclassification from goodwill to other intangible assets and the associated amortization expense, and the correction to record certain earn-out consideration as compensation expense rather than additional purchase consideration.

 

Reliance should be placed solely on the financial statements in the Form 10-K/A and in this report on Form 10-Q and not on the previously published Form 10-K originally filed on March 8, 2004, or on any other previously reported financial statements for the periods identified above.  A complete discussion of the restated financial data is included in Note 1(b) to our consolidated financial statements included in the Form 10-K/A.

 

A summary of the adjustments impacting net income in the three and six months ended June 30, 2003 is as follows (in millions):

 

		Three months ended June 30, 2003			Six months ended June 30, 2003
Foreign tax contingencies		$	(0.3	)	$	(0.6	)
Prior year unrecorded entries		—			(0.8		)
Contract cost misclassifications and duplicate billings on a particular contract		—			0.1
Stock-based compensation expense		(0.2		)	(1.0		)
Adjust measurement of progress toward completion		1.9			(0.3		)
Reclassification of purchased intangibles and related amortization expense		(0.1		)	(0.2		)
		$	1.3		$	(2.8	)

 

6

 

In addition, the adjustments to present the Company’s network management business as discontinued operations has been reflected in the prior periods. (see Note 7)

 

The following tables (in millions) show the impact of the restatements on the relevant captions from the Company’s financial statements for the three and six months ended June 30, 2003.  These tables contain only the changed balances and do not represent the complete statements of operations.

 

		Three months ended June 30, 2003
		As Previously Reported			Adjustments			Discontinued Operations			As Restated
Revenues
Cost of revenues		$	56.8		$	2.8		$	(1.3	)	$	58.3
Gross profit		39.8			0.3			(1.1		)	39.0
		17.0			2.5			(0.2		)	19.3
Selling, general and administrative expenses		11.2			0.2			(0.5		)	10.9
Credit for doubtful accounts		(0.9		)	0.9			—			—
Depreciation and amortization		1.7			0.1			—			1.8
Operating income		5.0			1.3			0.3			6.6
Income from continuing operations before income taxes		4.8			1.3			0.3			6.4
Income from continuing operations		4.8			1.3			0.3			6.4
Loss from discontinued operations		—			—			(0.3		)	(0.3		)
Net income		$	4.8		$	1.3		—			$	6.1
Basic earnings per common share:
Income from continuing operations		$	0.09		0.03			0.01			$	0.13
Loss from discontinued operations		—			—			(0.01		)	(0.01		)
Net income		$	0.09		0.03			—			$	0.12
Diluted earnings per share:
Income from continuing operations		$	0.07		0.01			0.01			$	0.09
Loss from discontinued operations		—			—			(0.01		)	(0.01		)
Net income		$	0.07		0.01			—			$	0.08
Weighted average common shares outstanding:
Basic		51.1									51.1
Diluted		72.3									72.3

 

		Six months ended June 30, 2003
		As Previously Reported			Adjustments			Discontinued Operations			As Restated
Revenues		$	110.7		$	1.5		$	(2.3	)	$	109.9
Cost of revenues		78.8			0.9			(1.9		)	77.8
Gross profit		31.9			0.6			(0.4		)	32.1
Selling, general and administrative expenses		22.5			1.0			(1.2		)	22.3
Credit for doubtful accounts		(2.2		)	2.2			—			—
Depreciation and amortization		3.4			0.2			—			3.6
Operating income		8.2			(2.8		)	0.8			6.2
Income from continuing operations before income taxes		8.8			(2.8		)	0.8			6.8
Income from continuing operations		8.8			(2.8		)	0.8			6.8
Loss from discontinued operations		—			—			(0.8		)	(0.8		)
Net income		$	8.8		$	(2.8	)		—		$	6.0
Basic earnings per common share:
Income from continuing operations		$	0.18		$	(0.06	)	$	0.02		$	0.14
Loss from discontinued operations		—			—			(0.02		)	(0.02		)
Net income		$	0.18		$	(0.06	)	$	—		$	0.12
Diluted earnings per share:
Income from continuing operations		$	0.12		$	(0.03	)	$	0.01		$	0.10
Loss from discontinued operations		—			—			(0.01		)	(0.01		)
Net income		$	0.12		$	(0.03	)	$	—		$	0.09
Weighted average common shares outstanding:
Basic		50.2									50.2
Diluted		70.6									70.6

 

There was no change to the subtotals for cash flows from operating, investing and financing activities in the Statement of Cash Flows for the six months ended June 30, 2003.

 

7

 

(c) Fiscal Calendar and Basis of Presentation

 

The Company operates and reports using a 52-53 week fiscal year ending the last Friday in December. As a result, a fifty-third week is added every five or six years. Our 52 week fiscal year consists of four equal quarters of 13 weeks each, and our 53 week fiscal year consists of three 13 week quarters and one 14 week quarter. The financial results for our 53 week fiscal years and our 14 week fiscal quarters will not be exactly comparable to our 52 week fiscal years and our 13 week fiscal quarters. The quarters presented in this report on Form 10-Q are comparable.  For presentation purposes, all fiscal periods presented or discussed in this report have been presented as ending on the last day of the nearest calendar month. For example, our second quarter ended on July 2, 2004, but we present our quarter as ending on June 30, 2004.

 

8

 

The information as of June 30, 2004, and for the three and six month periods ended June 30, 2003 and 2004 is unaudited. In the opinion of management, these consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the results of operations for the interim periods presented. Interim operating results are not necessarily indicative of operating results expected in subsequent periods or for the year as a whole. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes included in WFI’s annual restated consolidated financial statements for the year ended December 26, 2003, filed on Form 10-K/A on September 20, 2004, with the United States Securities and Exchange Commission.

 

The unaudited consolidated financial statements include the accounts of WFI and its wholly-owned and majority-owned subsidiaries. WFI and its subsidiaries are collectively referred to herein as the “Company.”

 

(d) Use of Estimates

 

The preparation of financial statements in conformity with Generally Accepted Accounting Principles in the United States (US GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In the future, the Company may realize actual results that differ from the current reported estimates.

 

(e) Reclassifications

 

Certain prior period amounts have been reclassified to the extent deemed necessary in order to conform with the current period presentation.

 

(f) Cash and Cash Equivalents and Short-Term Investments

 

The Company’s cash equivalents consist of highly liquid investments with an original maturity of three months or less as of the date purchased by the Company.

 

9

 

The Company has evaluated its investment policies consistent with the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Based on such evaluation, the Company’s management has determined that all of its investment securities are properly classified as available-for-sale.  Based on the Company’s intent, investment policies and related ability to liquidate debt securities maturing after one year during the one-year operating cycle, the Company classifies such short-term investment securities within current assets.  Available-for-sale securities are carried at fair value, with unrealized gains and losses reported as a separate component of Stockholders’ Equity under the caption “Accumulated Other Comprehensive Income or Loss”.  The amortized cost basis of debt securities is periodically adjusted for amortization of premiums and accretion of discounts to maturity.  Such amortization is included as a component of interest income (expense). The amortized cost basis of securities sold is based on the specific identification method and all such realized gains and losses are recorded to other income (expense), net.  Interest and dividends on securities classified as available-for-sale are included in interest income.  The fair value of short-term investments at June 30, 2004 was as follows (in millions):

 

		June 30, 2004
		Amortized Cost Basis			Fair Value Basis
Cash and cash equivalents:
Cash		$	20.8		$	20.8
Money market		18.1			18.1
Corporate securities		6.0			6.0
Restricted cash		1.0			1.0
Cash and cash equivalents		44.9			44.9
Restricted cash		1.0			1.0
Short-term investments:
Corporate notes and bonds		0.7			0.7
U.S. government and agency securities		1.3			1.3
Short-term investments		2.0			2.0
Cash and cash equivalents, restricted cash and short-term investments		$	47.9		$	47.9
Debt securities recorded at fair value, maturing:
Within one year					$	7.3
After one year through five years					0.7
Debt securities recorded at fair value					$	8.0

 

The restricted cash is restricted to use and held in escrow to satisfy any indemnification obligations of the former stockholders of HTS.  The indemnification period ends in January 2005, at which time such restricted cash will either be paid to the former stockholders of HTS or become unrestricted as to use by the Company.

 

(g) Revenue Recognition

 

The Company provides services primarily under three types of contracts: fixed-price long-term turnkey contracts; time and materials engagements; and cost plus fixed fee.

 

The Company realizes a significant portion of its revenue from long-term contracts and accounts for these contracts under the provisions of Statement of Position (SOP) 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” Revenue on fixed-price contracts is recognized using the percentage-of-completion method based on the ratio of total costs incurred to date compared to estimated total costs to complete the contract. Estimates of costs to complete include materials, direct labor, overhead, and allowable general and administrative expenses for the Company’s government contracts. While the Company generally does not incur a material amount of set-up fees for its projects, such costs, if any, are excluded from the estimated total costs to complete the contract.  Cost estimates are reviewed monthly on a contract-by-contract basis, and are revised periodically throughout the life of the contract such that adjustments to profit resulting from revisions are made cumulative to the date of the revision. The full amount of an estimated loss associated with a contract is charged to operations in the period it is determined that it is probable a loss will be realized from the performance of the contract. Significant management judgments and estimates, including the estimated costs to complete projects, which determine the project’s percent complete,

 

10

 

must be made and used in connection with the revenue recognized in any accounting period. In the future, the Company may realize actual results that differ from current estimates.

 

Accordingly, the revenue we recognize in a given financial reporting period depends on (1) the costs we have incurred for individual projects, (2) our then current estimate of the total remaining costs to complete the individual projects and (3) current estimated contract value associated with the projects.  If, in any period, we significantly increase or decrease our estimate of the total costs to complete a project, and/or reduce or increase the associated contract value, revenue for that period would be impacted.  To the extent that our estimates fluctuate over time or differ from actual results, gross margins in subsequent periods may vary significantly from our estimates. Material differences may result in the amount and timing of our revenue for any period if management made different judgments or utilized different estimates.

 

Many of the Company’s contracts are master service agreements under which the Company is contracted to provide services to deploy a pre-determined and specific number of sites in specific geographic markets.  These contractual arrangements with the Company’s customers typically include billing milestones. The billing milestone clauses relate specifically to the timing of customer billings and payment schedules, and are independent of the Company’s right to payment and the timing of when revenue is recognized. If a contract is terminated without proper cause by the customer, if the customer creates unplanned / unreasonable time delays, or if the customer modifies the contract tasks / scope, the Company has contractual rights to reimbursement in accordance with the terms and conditions regarding payment for work performed, but not yet billed (i.e., unbilled trade accounts receivable) at a gross profit margin that is consistent with the overall project margin. Furthermore, certain additional provisions indemnify the Company for additional, or excess, costs incurred, whereby any scope reductions (i.e., reduction in original number of sites) or other modifications are subject to reimbursement of costs incurred to date with a reasonable profit margin based on the contract value and completed work at that time. The inherent aforementioned risks associated with the presence of potential “partial milestone billings” or “reductions in scope” are reflected in the Company’s ongoing periodic assessment of the “total contract value” and the associated revenue recognized and, hence, any allowance for unbilled trade accounts receivable. Total unbilled accounts receivable, net at June 30, 2004 was $57.6 million.

 

The Company’s government network services business with the U.S. government and prime contractors is generally performed under cost reimbursable plus fixed fee, fixed price or time and material contracts.  Cost reimbursable contracts for the government provide for reimbursement of costs plus the payment of a fee.  Under fixed-price contracts, the Company agrees to perform certain work for a fixed price.  Under time and materials contracts, the Company is reimbursed for labor hours at negotiated hourly billing rates and is reimbursed for travel and other direct expenses at actual costs plus applied general and administrative expenses.

 

Revenue from time and materials contracts is recognized when services are rendered at contracted labor rates, when materials are delivered and when direct costs are incurred.

 

Additionally, based on management’s periodic assessment of the collectibility of its accounts receivable, credit worthiness and financial condition of customers, the Company determines if collection is reasonably assured prior to the recognition of revenue.

 

(h) Stock-based Compensation

 

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations including Financial Accounting Standards Board (FASB) Interpretation No. 44, “Accounting for Certain Transactions involving Stock Compensation an interpretation of APB Opinion No. 25” to account for its stock option plans.  Under this method, compensation expense is measured on the date of grant by comparing the current market price of the underlying stock to the exercise price.  If the exercise price is less then the market price compensation expense is recorded on a straight-line basis over the applicable vesting period. SFAS No. 123, “Accounting for Stock-Based Compensation,” established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans.  As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.”

 

11

 

Under SFAS No. 123, the weighted average option price of stock options granted during the six months ended June 30, 2003 and 2004 were $5.53 and $10.41, respectively, on the date of grant.  Fair value under SFAS No. 123 is determined using the Black-Scholes option-pricing model with the following assumptions:

 

		Three months ended June 30,				Six months ended June 30,
		2003		2004		2003		2004
Expected term (Hold Period):
Stock Options		4 years		4 years		4 years		4 years
Purchase Plan		6 months		6 months		6 months		6 months
Interest Rate		2.96	%	3.14	%	2.96	%	3.14	%
Volatility		100	%	100	%	100	%	100	%
Dividends		—		—		—		—

 

The volatility factor is calculated based on the trailing historical volatility rates over the estimated hold period or, at the minimum, the standard 4-year vesting period.  The actual volatility factor used for the three and six months ended June 30, 2003 reflects a modification to the calculated historical volatility of 102%, based on management’s belief that recent experience indicates that the stock generally has become less volatile and is not indicative of expected future volatility.

 

Had compensation expense been recognized for stock-based compensation plans under the fair value method in accordance with SFAS No. 123, the Company would have recorded the following net income (loss) and net income (loss) per share amounts (in millions, except per share amounts):

 

		Three months ended June 30,						Six months ended June 30,
		2003			2004			2003			2004
		Restated						Restated
Net income – as reported		$	6.1		$	1.7		$	6.0		$	7.5
Add back : Actual stock - based compensation expense included in net earnings			—			—			0.8			—
Total stock-based employee compensation expense determined under fair value based method for all awards		(4.9		)	(4.0		)	(11.4		)	(9.8		)
Pro forma net income (loss)		$	1.2		$	(2.3	)	$	(4.6	)	$	(2.3	)
Earnings (loss) per common share:
Basic – as reported		$	0.12		$	0.02		$	0.12		$	0.11
Basic – pro forma		$	0.02		$	(0.03	)	$	(0.09	)	$	(0.03	)
Diluted – as reported		$	0.08		$	0.02		$	0.08		$	0.10
Diluted – pro forma		$	0.02		$	(0.03	)	$	(0.09	)	$	(0.03	)
Weighted average  shares:
Basic – as reported and pro forma		51.1			68.3			50.2			66.2
Diluted – as reported		72.3			75.5			70.6			76.2
Diluted – pro forma		72.3			68.3			50.2			66.2

 

(i) Accrual for Unused Office Space

 

Due to the downturn in the wireless telecommunications industry during 2001 through 2002, the Company recorded provisions for losses on unused office space under non-cancelable operating leases ranging in duration from 24 – 96 months.  The initial provision for loss on unused office space was determined based upon management’s analysis, review and assessment of the expected realization of projected sublease income associated with the expected excess facility capacity, compared to the aggregate scheduled lease payments through the remainder of the lease terms. The initial determination and computation of previous provision for loss were performed in accordance with FASB Technical Bulletin (FTB) 79-15, “Accounting for Loss on a Sublease Not Involving the Disposal of a Segment”.

 

12

 

During 2003, the Company reevaluated its accrual for unused office space. As a result, the Company recorded a $3.2 million reversal of the accrual for unused office space during the fourth quarter of 2003.  The remaining accrual for unused office space as of June 30, 2004 was $3.1 million.  The remaining accrual balance is primarily comprised of amounts payable under certain non-cancelable operating leases requiring payment for certain lease cancellation fees and other lease costs, net of assumed sublease income, with the remainder expected to be paid over the remaining lease terms, which expire in 2010.

 

(j) Commitments and Contingencies

 

The Company periodically evaluates all pending or threatened contingencies or commitments, if any, that are reasonably likely to have a material adverse effect on its operations or financial position. The Company assesses the probability of an adverse outcome and determines if it is remote, reasonably possible or probable as defined in accordance with the provisions of SFAS No. 5, “Accounting for Contingencies.”  If information available prior to the issuance of the Company’s financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the Company’s financial statements, and the amount of the loss, or the range of probable loss can be reasonably estimated, then such loss is accrued and charged to operations.  If no accrual is made for a loss contingency because one or both of the conditions pursuant to SFAS No. 5 are not met, but the probability of an adverse outcome is at least reasonably possible, the Company will disclose the nature of the contingency and provide an estimate of the possible loss or range of loss, or state that such an estimate cannot be made.

 

The Company assesses tax uncertainties and exposure items after taking into consideration the probability of the tax contingencies being incurred.  Accordingly, based upon the Company’s assessment of the probability of these tax contingencies, it determined that an accrual of $12.9 million was required for foreign tax contingencies and $2.0 million was required for sales and use tax contingencies for those prior periods.

 

Refer to Note 5 for a discussion of contingent earn-out payments related to acquired businesses.

 

(k) Contingent Acquisition Consideration

 

From time to time, in connection with certain business acquisitions, the Company may agree to make additional future payments to sellers that are contingent upon the acquired entities’ achievement of specific performance-based milestones.  Pursuant to the provisions of SFAS No. 141, such contingent liabilities are accrued, and therefore, recorded by the Company when the contingency is determinable beyond a reasonable doubt and, hence, the additional consideration becomes payable.  During the restatement process, the Company determined that certain amounts of the earn-out consideration should be recorded as compensation expense in accordance with EITF 95-8 “Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination” as a result of continued employment provisions in the agreements.

 

Assuming the entities acquired in 2003 reach the minimum base performance targets in 2004 through 2006, the aggregate future contingent payments related to the measurement periods from 2003 through 2006, including the balance paid through June 30, 2004, would approximate a cumulative total of $11.9 million.  If the acquired entities exceed the defined annual performance targets through estimated annual growth of approximately 15% based on 2003 performance, the aggregate future contingent payments could likely range from $29.2 million to $31.0 million inclusive of the amounts paid through June 30, 2004 and the amounts earned from the achievement of the minimum base performance targets.  The contingent consideration is calculated based on a certain multiple of defined annual earnings targets as stated in the respective purchase agreements. A portion of the possible future contingent payments will be recorded as compensation expense, as reflected in the table below.

 

The following table summarizes management’s estimate of the potential range of future contingent consideration by year:

 

		(in millions)
		2004		2005		2006		2007		Total
Potential range of future contingent consideration		$8.1-$8.6	*	$9.4-$10.0	*	$10.3-$11.0	*	$1.4-$1.4	*	$29.2-$31.0	*
Potential portion to be recorded as compensation expense**		$3.6-$3.9		$4.1-$4.3		$1.4-$1.5		—		$9.1-$9.7

 

*Hypothetical range based on estimated annual growth of 15%.

**Potential expense is assumed to be accrued in the fiscal year earned.  The $2.9 million compensation expense in fiscal 2003 is related to payments made in 2004. The timing of recognizing the liabilities and associated expenses for future year contingent payments could be accelerated and subject to periodic re-estimation if the continuous employment clauses are rescinded from the earn-out arrangements.  The timing of cash payments would not be impacted by removing such requirements.

 

 

(2)               Recent Accounting Pronouncements

 

In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” which addresses consolidation by business enterprises of variable interest entities (VIEs) either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46R (Revised Interpretation) resulting in multiple effective dates based on the nature as well as the creation date of the VIE. VIEs created after January 31, 2003, but prior to January 1, 2004, may be accounted for either based on the original interpretation or the Revised Interpretation. However, the Revised Interpretation must be applied no later than the first quarter of fiscal year 2004. VIEs created after January 1, 2004 must be accounted for under the Revised Interpretation.  The Company evaluated a partnership arrangement that was entered in 2004, and determined that it met the characteristics of a VIE and the requirements for consolidation pursuant to the provisions FIN 46R.   Included in the Company’s consolidated financial results are $0.5 million total net liabilities which are eliminated at the consolidated level against a corresponding receivable as of June 30, 2004, $0 revenue and $0.5 million of net loss from this partnership for the six months ended June 30, 2004.  Refer to Note 8 Related Party Transactions for further discussion.

 

13

 

(3)            Net Income Per Common Share

 

The Company calculates net income per share in accordance with the provisions of SFAS No. 128, “Earnings Per Share”. Under SFAS No. 128, basic net income per common share is calculated by dividing net income by the weighted-average number of common shares outstanding during the reporting period. Diluted net income per common share reflects the effects of potentially dilutive securities. Weighted average shares used to compute basic and diluted net income per share are presented below (in millions):

 

		Three months ended June 30,				Six months ended June 30,
		2003		2004		2003		2004
Weighted average shares, basic		51.1		68.3		50.2		66.2
Dilutive effect of stock options		5.0		2.9		4.2		3.8
Dilutive effect of Series A Convertible Preferred Stock		7.0		—		7.0		—
Dilutive effect of Series B Convertible Preferred Stock		9.0		4.3		9.0		6.2
Dilutive effect of contingently issuable shares pursuant to Employee Stock Purchase Plan		0.2		—		0.2		—
Weighted average shares, diluted		72.3		75.5		70.6		76.2

 

The following instruments were not included in the calculation of diluted net income per share because the effect of these instruments was anti-dilutive (in millions):

 

		Three months ended June 30,						Six months ended June 30,
		2003			2004			2003			2004
Stock options		1.6			4.5			2.1			2.6
Average market value of stock per share		$	8.50		$	9.94		$	7.33		$	11.94
Average outstanding stock option price per share		$	9.29		$	9.82		$	9.28		$	9.82

 

On November 3, 2003, 63,637 shares of Series A Convertible Preferred Stock were converted into 7,000,000 shares of the Company’s Common Stock.  In February 2004, 7,742 shares of Series B Convertible Preferred Stock were converted into 774,200 shares of the Company’s Common Stock.  On March 5, 2004, 40,000 shares of Series B Convertible Preferred Stock converted into 4,000,000 shares of the Company’s Common Stock.  The converted shares are reflected in basic weighted shares outstanding based upon the date of conversion. Refer to Note 8 for further details regarding Series A and Series B Convertible Preferred Stock.

 

(4)               Investments in Unconsolidated Affiliates

 

Tactical Survey Group, Inc.

 

On February 23, 2004, the Company paid $1.0 million in cash to acquire an 11.4% interest in Tactical Survey Group, Inc. (TSG), a privately-held company that provides expertise in developing, deploying and integrating tactical survey systems for use in government and commercial applications. Pursuant to the provisions of APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock” (APB 18), this investment is accounted for under the equity method of accounting due to the presence of significant influence deemed to exist based on the significant number of contracts that the Company has entered into with TSG and the presence of a Company employee on TSG’s board of directors.  The equity in earnings from this investment is classified within Other income (expense) in the Company’s consolidated statements of operations.  The balance of the Company’s investment in TSG at June 30, 2004, totaled $1.1 million and has been classified on the consolidated balance sheet under the caption “investment in unconsolidated affiliates.”  On at least a quarterly basis, the Company will obtain and review the financial statements and most recent forecasts of TSG.  Based on that review and inquiries with TSG’s management, the Company determines whether there has been other than a “temporary” impairment of its investment. Based on the periodic evaluations, the Company has concluded that the carrying value of its investment in TSG has not been impaired as of June 30, 2004.

 

14

 

Diversified Networks, Inc.

 

During the quarter ended June 30, 2004, the Company determined, based upon events occurring in the second quarter of 2004 at Diversified Networks, Inc. (“DNI”), that there was an other than temporary impairment of its investment in DNI.  Specifically, DNI reported that it was losing a significant customer and that such loss would result in reduced gross margins and profitability.  Additionally, DNI reported that it would need a cash infusion before the end of the year to fund operations and working capital requirements.  Accordingly, the Company concluded that the full carrying value of $3.1 million was impaired.  The write-off of $3.1 million is reflected in impairment of investment in unconsolidated affiliate and other expenses, net in the accompanying consolidated statements of operations.

 

(5)               Acquisitions

 

On January 5, 2004, the Company completed its acquisition of all of the outstanding securities of High Technology Solutions, Inc. (HTS), for $48.5 million in cash.  HTS provides systems engineering, systems integration, and the outsourcing of technical services such as operational test and evaluation and program management to government agencies.

 

The acquisition was accounted for under the provisions of the purchase method of accounting in accordance with SFAS No. 141.  The excess purchase price paid over the fair value of tangible net assets acquired of $44.0 million was allocated to goodwill in the amount of $40.1 million, and to identifiable finite-life intangible assets in the amount of $3.9 million.  The identified intangible assets consist of $3.2 million allocated to contracts and backlog, $0.2 million for intellectual property and $0.5 million for a non-compete agreement.  The allocation of the purchase price is subject to adjustments within a one-year period of the acquisition date based on the resolution of pre-acquisition contingencies.  In connection with the Company’s acquisition of HTS and the determination of the fair value of assets acquired pursuant to the provisions of SFAS No. 141, the Company valued acquired contracts in process at contract price, minus the estimated costs to complete and an allowance for the normal industry profit on its effort to complete such contracts.  This adjustment totaling $1.5 million has been reflected in the accompanying consolidated balance sheet as an increase to goodwill and a corresponding increase to billings in excess of costs (deferred profit).  The Company recognized approximately $0.1 million and $0.2 million as a reduction of costs against the deferred profit during the three and six months ended June 30, 2004, respectively.  The remaining amount of $1.3 million at June 30, 2004 is estimated to reduce costs through 2008.  The results of operations of HTS since the acquisition date are included in the Company’s unaudited consolidated financial statements for the three and six months ended June 30, 2004 and are a component of the government network services operating segment.

 

The following summary presents pro forma consolidated results of operations for the three and six months ended June 30, 2003 as if the acquisitions described above had occurred at the beginning of the periods, and includes adjustments that were directly attributable to the transaction or were expected to have a continuing impact on the Company.

 

The pro forma results are unaudited and for illustrative purposes only for the applicable periods, and do not purport to be indicative of the actual results which would have occurred had the transactions been completed as of the beginning of the periods, nor are they indicative of results of operations which may occur in the future. The following is also a reconciliation of GAAP (as reported and restated) to pro forma financial results for the three and six months ended June 30, 2003 (all unaudited amounts except per share amounts are in millions):

 

		Three months ended June 30, 2003									Six months ended June 30, 2003
		As Restated			Pro forma Adjustments			Pro forma			As Restated			Pro forma Adjustments			Pro forma
Revenue		$	58.3		$	10.4		$	68.7		$	109.9		$	21.5		$	131.4
Operating income		$	6.6		$	1.1		$	7.7		$	6.2		$	2.0		$	8.2
Net income		$	6.1		$	1.0		$	7.1		$	6.0		$	1.7		$	7.7
Net income per common share:
Basic		$	0.12					$	0.14		$	0.12					$	0.15
Diluted		$	0.08					$	0.10		$	0.09					$	0.11
Weighted average shares outstanding:
Basic		51.1						51.1			50.2						50.2
Diluted		72.3						72.3			70.6						70.6

 

15

 

In connection with certain business acquisitions, the Company may agree to make additional future payments to sellers contingent upon achievement of specific performance-based milestones by the acquired entities.  Pursuant to the provisions of SFAS No. 141, such amounts are accrued, and therefore, recorded by the Company when the contingency is resolved beyond a reasonable doubt and, hence, the additional consideration becomes payable.  During the three and six months ended June 30, 2004, the Company paid $4.3 million and $8.3 million, respectively, of contingent consideration to the stockholders of three entities that were acquired in 2003 within the Enterprise Network Services segment.  The Company had estimated and accrued $3.8 million of this contingent consideration as of December 31, 2003.  The $4.3 million that was paid in April 2004 had been accrued as additional contingent consideration pursuant to these arrangements as of March 31, 2004.  In addition, the Company has agreed to pay additional consideration based upon the achievement of earnings targets for fiscal years 2004 through year 2006.  Future additional consideration, if any, will be recorded at the time the outcome is issued or issuable or the outcome is determinable beyond a reasonable doubt.  The timing of recognizing the liabilities and associated expenses for future year contingent payments could be accelerated and subject to periodic re-estimation if the continuous employment clauses are rescinded from the earn-out arrangements.  The timing of payments of earn-outs would not be impacted by removing such requirements.  As of June 30, 2004, there is $1.0 million accrued as contingent consideration due to the former stockholders of HTS, subject to the satisfaction of indemnification obligations through January 2005.

 

The following table summarizes the changes in the carrying amounts of goodwill and other indefinite and finite-life intangible assets for the three and six months ended June 30, 2004, (in millions) restated:

 

		Wireless Network Services			Enterprise Network Services			Government Network Services			Total
Goodwill, net
Balance as of March 31, 2004		$	25.5		$	9.9		$	40.2		$	75.6
Adjustment		—			(0.3		)	—			(0.3		)
Balance as of  June 30, 2004		25.5			9.6			40.2			75.3
Other intangibles, net
Balance as of  March 31, 2004		—			1.9			3.8			5.7
Amortization expense		—			—			(0.1		)	(0.1		)
Balance as of  June 30, 2004		—			1.9			3.7			5.6
Total goodwill and other intangibles, net		$	25.5		$	11.5		$	43.9		$	80.9

 

		Wireless Network Services			Enterprise Network Services			Government Network Services			Total
Goodwill, net
Balance as of December 31, 2003		$	25.5		$	5.5		$	—		$	31.0
Acquisition		—			—			40.2			40.2
Accrual for contingent consideration		—			4.3			—			4.3
Adjustment		—			(0.2		)	—			(0.2		)
Balance as of  June 30, 2004		25.5			9.6			40.2			75.3
Other intangibles, net
Balance as of  December 31, 2003		—			1.9			—			1.9
Acquisition		—			—			3.9			3.9
Amortization expense		—			—			(0.2		)	(0.2		)
Balance as of  June 30, 2004		—			1.9			3.7			5.6
Total goodwill and other intangibles, net		$	25.5		$	11.5		$	43.9		$	80.9

 

16

 

(6)               Segment Information

 

In 2004, the Company reorganized its operating segments to reflect its current operations and strategic direction.  Effective January 1, 2004, the Company reorganized its business along service lines including three reportable segments:  Wireless Network Services, Enterprise Network Services, and Government Network Services. Revenues and operating income generated by the Company’s reporting segments for the three and six months ended June 30, 2003 and 2004 are as follows (in millions).  All prior period amounts have been reclassified in order to conform with the current period presentation.

 

		Three months ended June 30,						Six months ended June 30,
		2003			2004			2003			2004
		Restated						Restated
Revenues:
Wireless Network Services		$	48.3		$	75.5		$	97.9		$	147.0
Enterprise Network Services		10.0			15.1			12.0			29.5
Government Network Services		—			12.1			—			23.3
Total revenues		$	58.3		$	102.7		$	109.9		$	199.8
Operating income:
Wireless Network Services		$	5.8		$	6.7		$	5.4		$	11.8
Enterprise Network Services		0.8			1.3			0.8			2.2
Government Network Services		—			1.3			—			2.4
Total operating income		$	6.6		$	9.3		$	6.2		$	16.4

 

Revenues derived by geographic region are as follows (in millions):

 

		Three months ended June 30,						Six months ended June 30,
		2003			2004			2003			2004
		Restated						Restated
Revenues:
U.S.		$	49.9		$	75.1		$	94.3		$	149.2
Central and South America		4.8			17.8			7.8			33.4
Europe, Middle East and Africa		3.6			9.8			7.8			17.2
Total revenues		$	58.3		$	102.7		$	109.9		$	199.8

 

The Company had sales to two separate customers which comprised $10.8 million (10.5%) and $9.4 million (9.2%) and $23.0 million (11.5%) and $17.0 million (8.5%) for the three and six months ended June 30, 2004, respectively. Revenues for these customers are recorded in the Wireless Network Services segment.

 

(7)               Discontinued Operations

 

During the second quarter of 2004, the Company made the decision to sell or otherwise divest its Network Management business in Scandinavia, which had previously been reported in its Wireless Network Services segment.  WFI determined that this entity met the criteria to classify it as held for sale.  Accordingly, WFI has reflected this operation as discontinued in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  For the three and six months ended June 30, 2004, respectively, the Network Management business in Scandinavia generated revenues of $0.9 million and $2.1 million, respectively and a net loss of $2.5 million and $2.7 million, respectively, for the same periods.  Included in the net loss for the three and six months ended June 30, 2004 is an asset impairment loss of $0.5 million and a $1.7 million accrual for estimated employee termination costs.  There was no tax benefit provided for these losses due to the uncertain future realizability of tax assets resulting from net operating losses in Scandinavia.  All prior period amounts have been restated to reflect these operations as discontinued.

 

17

 

(8)               Related Party Transactions

 

On May 30, 2002, the Company issued an aggregate of 90,000 shares of Series B Convertible Preferred Stock, with aggregate proceeds of $45.0 million, in a private placement to entities affiliated with one of the directors of the Company (40,000 shares), to a brother of the Chairman of the Company (10,000 shares) and to an unrelated third-party investor (40,000 shares). The Company received $44.9 million of net proceeds. Based upon a review by disinterested members of management and the board of directors of terms of comparable transactions available from involving third parties, the Company believes that all transactions with related parties described above were made on terms no less favorable to the Company than could have been obtained by affiliated third parties. Each share of Series B Convertible Preferred Stock is initially convertible into 100 shares of Common Stock for a common stock conversion price of $5.00 per share, which was the fair market value of the Common Stock at the closing, at the option of the holder at any time subject to certain provisions in the Series B Preferred Stock Purchase Agreement. The Series B Preferred Stock Purchase Agreement has a lock-up provision, which expires over time, such that at the end of each of the three-month periods that commence on the 18-month anniversary of the closing date, 20% of the shares are released from lock-up and available for resale upon conversion. On March 5, 2004, 40,000 shares of Series B Convertible Preferred Stock were converted into 4,000,000 shares of the Company’s Common Stock, of which 1,600,000 shares were transferred free of any lock-up restriction and 2,400,000 shares were transferred subject to the lock-up restriction which will lapse, along with the lock-up restriction on an additional 3,000,000 shares (on an as-converted basis), in three equal tranches of 1,800,000 shares each on May 30, 2004, August 30, 2004 and November 30, 2004.

 

In 2004, the Company entered into a partnership arrangement with an unrelated individual whereby the Company committed to fund a $1 million line of credit for working capital purposes of the newly created partnership, known as Mobilitie Partners, LLC (“Mobilitie”).  The terms of the line of credit agreement provide for repayment based upon the occurrence of certain future events, such as a monetizing event.  In addition, in the event the Company exits the partnership based upon its evaluation of the viability of the business, WFI is committed to fund approximately $0.4 million of future operating costs of its partner. For this consideration the Company received 15% equity interest in Mobilitie.  The Company reviewed the terms of the partnership agreement and determined that it met the characteristics of a variable interest entity and the requirements for consolidation under FASB Interpretation No. 46R (see Note 2) and, accordingly, Mobilitie is fully consolidated by WFI.  As of June 30, 2004, approximately $0.5 million had been advanced on the line of credit.  For the three and six months ended June 30, 2004, $0 revenue and $0.25 million of net loss and $0 revenue and $0.5 million of net loss, respectively, from this partnership were consolidated.  On June 24, 2004, the Company entered into an agreement with the individual partner for consulting services, whereby the Company will compensate the individual $500 for each cellular site assigned to the Company by a certain major wireless carrier, if such assignment is a direct result of the efforts of the Company’s partner, subject to the conditions of the agreement.  As of June 30, 2004, there have been no amounts earned under this agreement.  Future payments, if any, will be recorded as costs of revenues.

 

(9)               Legal Matters

 

In August 2004 and September 2004, as a result of the Company’s announcement on August 4, 2004 that it intended to restate its financial statements for the fiscal years ended December 31, 2001, 2002 and 2003, the Company and certain of its current and former officers and directors were named as defendants in several securities class action lawsuits filed in the United States District Court for the Southern District of California.  These actions were filed on behalf of those who purchased, or otherwise acquired, the Company’s common stock between April 26, 2000 and August 4, 2004.  The lawsuits generally allege that, during that time period, the defendants made false and misleading statements to the investing public about the Company’s business and financial results, causing its stock to trade at artificially inflated levels.  Based on these allegations, the lawsuits allege that defendants violated the Securities Exchange Act of 1934.  These actions seek unspecified damages.

 

Two derivative lawsuis have been filed in the Southern District of California against certain of the Company’s current and former officers and directors.  The factual allegations in these lawsuits are substantially similar to those in the class action lawsuits and the plaintiffs in these lawsuits assert claims for breach of fiduciary duty, unjust enrichment and violations of California’s insider trading laws.  One of the lawsuits also asserts claims for abuse of control, gross mismanagement, waste of corporate assets, and violations of the Sarbanes-Oxley Act of 2002.  The plaintiffs in these lawsuits seek unspecified damages and equitable and/or injunctive relief.

 

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In August 2004, two virtually identical derivative lawsuits were also filed in San Diego County Superior Court against certain of the Company’s current and former officers and directors.  These lawsuits contain factual allegations similar to those of the federal lawsuits, but plaintiffs in these cases assert claims for violations of California’s insider trading laws, breaches of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, and unjust enrichment.  The plaintiffs in these lawsuits seek unspecified damages, equitable and/or injunctive relief, and disgorgement of all profits, benefits and other compensation obtained by defendants.

 

The Company has retained counsel to defend these lawsuits.  While the litigation is in a preliminary stage, we believe that the plaintiffs’ claims lack merit, and we intend to vigorously defend these lawsuits.  We are unable, however, to predict the ultimate outcome of these lawsuits.  There can be no assurance we will be successful in defending the lawsuits, and, if we are unsuccessful, we may be subject to significant damages.  Even if we are successful, defending the lawsuits may be expensive and may divert management’s attention from other business concerns.

 

(10)        Subsequent Event

 

On August 4, 2004, the Company completed its acquisition of Defense Systems, Incorporated (DSI), for $6.6 million in cash, subject to certain post-closing adjustments.  Additional consideration of up to $3.2 million can be earned by the former major stockholders of DSI over an 18 month period based upon performance milestones related to certain specified contracts.  Headquartered in Manassas, Virginia, DSI provides a full range of information technology and logistics automation services to federal government and commercial clients, with a strategic focus on providing end-to-end total radio frequency identification (“RFID”) solutions.  The operating results of DSI will be reported in our Government Services Network segment.

 

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