UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

x                               ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

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)

Delaware

 

13-3818604

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

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)

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock, par value $0.001

Rights to Purchase Shares of Series C Preferred Stock


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

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

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act);

Large accelerated filer o

Accelerated Filer x

Non Accelerated Filer o

 

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

The aggregate market value of the voting and non-voting stock (Common Stock) held by non-affiliates as of the last business day of most recently completed second fiscal quarter (June 30, 2006) was approximately $135.0 million, based on the closing sale price on the NASDAQ market exchange on that date.*

The number of shares outstanding of the Registrant’s Common Stock was 74,061,650 as of July 31, 2007.

*Excludes the common stock held by executive officers, directors and stockholders whose individual ownership exceeds 5% of the Common Stock outstanding on June 30, 2006.

 




DOCUMENTS INCORPORATED BY REFERENCE

None

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WIRELESS FACILITIES, INC.

FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

TABLE OF CONTENTS

 

 

 

Page No.

PART I

 

 

 

 

 

Item 1.

 

Business

 

7

 

Item 1A.

 

Risk Factors

 

20

 

Item 1B.

 

Unresolved Staff Comments

 

38

 

Item 2.

 

Properties

 

38

 

Item 3.

 

Legal Proceedings

 

39

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

42

 

PART II

 

 

 

 

 

Item 5.

 

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

 

43

 

Item 6.

 

Selected Financial Data

 

46

 

Item 7.

 

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

 

50

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

91

 

Item 8.

 

Financial Statements and Supplementary Data

 

91

 

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

91

 

Item 9A.

 

Controls and Procedures

 

91

 

Item 9B.

 

Other Information

 

97

 

PART III

 

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

97

 

Item 11.

 

Executive Compensation

 

101

 

Item 12.

 

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

 

114

 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

116

 

Item 14.

 

Principal Accountant Fees and Services

 

118

 

PART IV

 

 

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

 

118

 

 

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All references to us, we, our, the Company and WFI refer to Wireless Facilities, Inc., a Delaware Corporation, and its subsidiaries.

EXPLANATORY NOTE

In this Annual Report on Form 10-K, we are restating our consolidated balance sheet as of December 31, 2005, and the related consolidated statements of income, stockholders’ equity, comprehensive income and cash flows for the years ended December 31, 2004 and 2005. This Report also includes restated unaudited quarterly financial information and financial statements for interim periods of 2005.

As a result of the findings of our Equity Award Review, our consolidated financial statements for the years ended December 31, 2004 and 2005 have been restated. The restated consolidated financial statements include unaudited financial information for interim periods of 2005 consistent with Article 10-01 of Regulation S-X. The Company also recorded additional stock-based compensation expense and associated tax adjustments affecting the Company’s previously reported financial statements for 1998 through 2003, the effects of which are summarized in cumulative adjustments to additional paid-in capital, deferred compensation and accumulated deficit accounts as of December 31, 2003 in the amounts of $56.1 million, $6.6 million and $62.9 million, respectively, all of which are recorded in the Consolidated Statements of Shareholders’ Equity.

Equity Award Review

Background and Scope of Review

Our current executive management team, which has been in place since 2004, initiated an internal review of our historical practices related to granting stock option awards and other equity awards (the “Equity Award Review”) in the summer of 2006 in reaction to media reports regarding stock option granting practices of public companies. The Equity Award Review was conducted with oversight from the Board of Directors (the “Board”), and assistance from our outside counsel, Morrison & Foerster LLP (“Morrison Foerster”). In February 2007, the Board appointed a Special Committee of the Board to review the adequacy of the Equity Award Review and the recommendations of management regarding historical option granting practices, and to make recommendations and findings regarding those practices and individual conduct. The Special Committee was not charged with making, and did not make, any evaluation of the accounting determinations and related tax adjustments. The accounting determinations and related tax adjustments were evaluated by management and the Audit Committee of the Board of Directors. The Special Committee was comprised of a non-employee director who had not served on our Compensation Committee before 2005.

The Equity Award Review encompassed all grants of options to purchase shares of our common stock and other equity awards made since two months prior to our initial public offering (our “IPO”) in November 1999 through December 2006. We also reviewed all option grants that were entered into our stock option database (Equity Edge) after our IPO with a grant date before November 1999, as well as other substantial grants issued prior to our IPO. The total number of grants reviewed in the Equity Award Review exceeded 14,000 individual grants. We further reviewed all option grants with a grant date that preceded an employee’s date of hire. As part of the review, interviews of 18 current and former officers, directors, employees and attorneys were conducted, and more than 40 million pages of electronic and hard copy documents were searched for relevant information. The Special Committee also conducted its own separate review of the option granting practices during the tenure of our current executive management team through additional interviews and document collection and review with the assistance of its own separate counsel, Pillsbury Winthrop Shaw Pittman LLP (“Pillsbury Winthrop”), and FTI Consulting Inc. (“FTI Consulting”), a forensic information technology consulting firm.

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The Special Committee completed its evaluation of the Equity Award Review in August 2007 after considering the information gathered by management and Morrison & Foerster, along with testing and data gathering by Pillsbury Winthrop and FTI Consulting. The Special Committee concluded that the Equity Award Review was complete and worthy of reliance. Our Board has also concluded that the scope and thoroughness of the Equity Award Review was complete and appropriate.

The Equity Award Review established the absence of contemporaneous evidence supporting a substantial number of the previously-recorded option grants, substantially all of which were made in the period from 1998 through late 2003. During this period of time, in some instances, documents, data and interviews suggest that option grants were prepared or finalized days or, in some cases, weeks or months after the option grant date recorded in our accounting records. The affected grants include options issued to certain newly-hired employees using measurement dates prior to their employment start dates and options issued to non-employees, including advisors to the Board, erroneously designated as employees. The Special Committee also concluded that certain former employees and former officers participated in making improper option grants, including the selection of grant dates with the benefit of hindsight and in the delay in dating of otherwise approved option grants.

Impact on Previously Issued Reports and Financial Statements

In light of the Equity Award Review and the Special Committee’s findings described herein, the Audit Committee of the Board concluded that our prior financial statements for periods from 1998 through our filing of interim financial statements for the period ended September 30, 2006, must be restated. Our management determined that, from fiscal year 1998 through fiscal year 2005, the Company did not properly recognize non-cash equity-based compensation charges. These charges are material to our financial statements for the years ended December 31, 1998 through 2005, the periods to which such charges would have related. Previously filed annual reports on Form 10-K and quarterly reports on Form 10-Q affected by the restatements have not been and will not be amended and should not be relied upon.

Consistent with the relevant accounting standards and recent guidance from the Securities and Exchange Commission (the “SEC”) as part of the Equity Award Review, the grants during the relevant period were organized into categories based on grant type and process by which the grant was finalized. We analyzed the evidence related to grants in each category as part of the Equity Award Review. This evidence included, but was not limited to, electronic and physical documents, document metadata, and witness interviews. The controlling accounting standards were applied to the relevant facts and circumstances, in a manner consistent with the recent guidance from the SEC, to determine the proper measurement date for every grant within each category. If the measurement date was not the same as the originally assigned grant date, accounting adjustments were made as required, resulting in stock-based compensation expense and related income tax effects, as detailed below.

Based on the results of the Equity Award Review, we concluded that, pursuant to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and relevant interpretations, revised accounting measurement dates should be applied to a substantial number of the stock option grants covering options for the purchase of 15.2 million shares of our common stock that were awarded primarily between March 1998 and December 2003. The use of the revised measurement dates for the affected option grants required us to record a total of $75.0 million in additional deferred compensation, with substantially all of the increase relating to option grants made before December 31, 2003. We have also recorded $58.2 million in additional stock-based compensation expense for the years 1998 through 2005, reflecting the amortization of deferred compensation over the relevant vesting periods, which was typically over four years. After aggregate other tax adjustments and income tax adjustments of $9.6 million, the restatement resulted in total net adjustments to net income (loss) of $48.6 million for the years 1998 through 2005. This amount is net of forfeitures related to employee terminations of

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approximately $16.8 million. These amounts do not include the unauthorized issuance of common stock charge of $0.6 million and $5.7 million in 2002 and 2003, respectively, related to misappropriated options by the Company’s former stock administrator described herein. The aggregate amount of the Equity Award Review including the misappropriated options is $64.5 million comprised of the $58.2 million in additional stock-based compensation expense and $6.3 million of a charge for unauthorized issuance of common stock. After aggregate other tax adjustments and income tax adjustments of $9.6 million, the restatement resulted in total net adjustments to net income (loss) of $54.9 million for the years 1998 through 2005. Approximately $26.6 million of the stock-based compensation expense was recorded in 2001, due to cancellations from our Stock Option Cancel/Re-grant Program, as described below, which resulted in the remaining unamortized deferred compensation being expensed upon the cancellation in March 2001 in accordance with Emerging Issues Task Force 00-23, “Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44.”

As a consequence of these adjustments, our audited consolidated financial statements and related disclosures for the years ended December 31, 2004 and 2005 and our consolidated statements of operations and consolidated balance sheet data for the four years ended December 31, 2005, included in “Selected Consolidated Financial Data” in Part II, Item 6 of this Report, have been restated. Additionally, the unaudited quarterly financial information for interim periods of 2005, as well as the unaudited balance sheet data for the interim periods of 2006, included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of this Report, have been amended. We have also restated the stock-based compensation expense footnote information calculated under Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation, or SFAS 123, and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, or SFAS 148, under the disclosure-only alternatives of those pronouncements for the years 2004 and 2005 and for interim periods of 2005. The restated footnote information has been included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as in the Consolidated Financial Statements in Part II, Item 15 of this Report.

None of the adjustments resulting from the Equity Award Review affected our previously reported revenue, cash, cash equivalents or marketable securities balances in any prior periods.

Former Stock Option Administrator

During the course of the Equity Award Review, we discovered that Vencent Donlan, a former stock option administrator, had engaged in a fraudulent scheme by which he misappropriated options to purchase more than 700,000 shares of stock. Ill-gotten gains from this scheme approximated $6.3 million. We have brought an action against Donlan seeking return of the fraudulently obtained stock option proceeds. We also promptly alerted the SEC of our discovery in March 2007. The SEC commenced an enforcement action against Donlan, and the U.S. Attorney’s Office forwarded a grand jury subpoena to us seeking records related to Donlan and our historical option granting practices. We have cooperated with, and intend to continue to cooperate with, both the SEC and the U.S. Attorney’s Office in their actions against Donlan and otherwise. Donlan has consented to an injunction brought by the SEC and has plead guilty to federal criminal charges brought against him by the U.S. Attorney’s Office. We have recorded an unauthorized issuance of common stock charge of $0.6 million and $5.7 million in 2002 and 2003, respectively, related to this theft.

Except as otherwise stated, all financial information contained in this Annual Report on Form 10-K gives effect to this restatement. Information regarding the effect of the restatement on our financial position and results of operations is provided in Note 2 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this Report. Financial information included in the previously filed reports on Form 10-K, Form 10-Q and Form 8-K, the related opinions of our independent registered public accounting firms, and all previously issued earnings press releases and similar communications, for all

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periods ended on or before December 31, 2005 should not be relied upon and are superseded in their entirety by the information in this Annual Report on Form 10-K.

In 2006 and 2007, we undertook a transformation strategy whereby we divested our wireless related businesses and chose to aggressively pursue business with the federal government. A more detailed description of our transformation strategy is included herein.

PART I

Item 1.                        Business

This Annual Report on Form 10-K (including the section regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations) contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this Annual Report on Form 10-K. Additionally, statements concerning future matters are forward-looking statements.

Although forward-looking statements in this Annual Report on Form 10-K reflect our good faith judgment, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed in Item 1A—“Risks Factors” below, as well as those discussed elsewhere in this Annual Report on Form 10-K. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. We file reports with the SEC. We make available on our website under “Investor Relations/SEC Filings,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file such materials with or furnish them to the SEC. Our website address is www.wfinet.com. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us.

We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this Annual Report on Form 10-K. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this Annual Report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

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On November 7, 2006, our Board approved a change in the fiscal year end from the last Friday in December to December 31. Concurrently, the Board approved a change in the interim fiscal periods to provide that the last day of the fiscal quarter shall be the last day of the calendar month of each quarter. As a result, the end of fiscal 2006, which would have ended on December 29, 2006, ended as of December 31, 2006. Prior to this change in fiscal year, the Company operated and reported using a 52-53 week fiscal year ending the last Friday in December. As a result, a fifty-third week was added every five or six years. Under the prior reporting system, each 52 week fiscal year consisted of four equal quarters of 13 weeks each, and each 53 week fiscal year consists of three 13 week quarters and one 14 week quarter. The change in fiscal year and interim fiscal periods will not be applied to periods prior to the quarter ended September 30, 2006, and, consistent with prior reports, all prior fiscal periods presented or discussed in this report have been presented as ending on the last day of the nearest calendar month. In reliance on Exchange Act Release No. 26589, the Company will not file a transition report covering the transition period from December 30, 2006 to December 31, 2006.

We were incorporated in the state of New York on December 19, 1994 and began operations in March 1995. We reincorporated in the state of Delaware in 1998. We consummated our IPO on November 5, 1999. Our principal executive office is located at 4810 Eastgate Mall, San Diego, California 92121. Our telephone number is (858) 228-2000.

Description of the Business

General

Historical Structure

In 2006, we were an independent provider of outsourced engineering and network deployment services, security systems engineering and integration services and other technical services for the wireless communications industry, the U.S. government, and enterprise customers.

Former Operating Segments

In 2006, we had three operating segments which consisted of our Wireless Network Services (“WNS”) segment, our Enterprise Network Services (“ENS”) segment, and our Government Network Services segment, also known as WFI Government Services, Inc. The financial statements in this Annual Report on Form 10-K are presented in a manner consistent with this former operating structure. For additional information regarding our operating segments, see Note 14 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this Report.

Wireless Network Services Segment

Our Wireless Network Services segment consisted of two primary services: Wireless Engineering Services and Wireless Network Deployment Services.

Wireless Engineering Services

Wireless Engineering Services provided network engineering and business consulting services for all pre-deployment planning for wireless carriers, including technology assessment, market analysis, and business plan development. This service area studied and analyzed the traffic patterns, population density, and topography and propagation environment in each market under consideration. It analyzed the financial, engineering, competitive and technology issues applicable to a proposed technology or network deployment project.

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Wireless Deployment Services

Wireless Deployment Services provided a range of services for the full design and deployment of wireless networks carrier customers. Such services included: Radio Frequency Engineering; Spectrum Relocation; Fixed Network Engineering; Site Development; and Installation and Optimization Services.

Enterprise Network Services Segment

Our ENS segment, which we now call our non-federal business, provides system design, deployment, integration, monitoring and support services for enterprise networks. Enterprise networks have been traditionally segregated into systems such as voice, data, access control, video surveillance, temperature control and fire alarm. We provide services that combine such systems and offer integrated solutions on an Ethernet-based platform. We also offer solutions that combine voice, data, electronic security and building automation systems with fixed or wireless connectivity solutions. We aim to meet the needs of any business enterprise by understanding the needs of the particular entity, sifting through the multiple solutions and complex technologies available in the marketplace and designing, deploying, managing and maintaining a cost-effective and integrated solution that is capable of evolving as the needs of the client change with time. Our target markets are retail, healthcare, education, municipal government and public facilities. Our commitment to these markets and our proven ability to provide feature-rich, cost-effective solutions has allowed us to become one of the larger independent integrators for these types of systems.

Government Network Services Segment

Our Government Network Services segment, which we now call our federal business, serves the federal engineering and information technology services market, which includes the design, development, deployment, integration and management of communications and information networks. This business is described in more detail below.

Corporate Transformation

In 2006 and 2007, we undertook a transformation strategy whereby we divested our wireless-related businesses and chose to aggressively pursue business with the federal government, primarily the U.S. Department of Defense, through strategic acquisitions. These divestitures and acquisitions are described in more detail below.

Sale and Discontinuance of Significant Subsidiaries

In December 2005, our Board made the decision to exit our Mexican operations and certain of our other deployment businesses in South America. Prior to this decision, these operations had been reported in our WNS segment. We determined that these operations met the criteria to be classified as held for sale. Accordingly, we reflected these operations as discontinued in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” in our financial statements as of and for the year ended 2005. The other South American operations were substantially shut down as of the end of December 2005.

On February 17, 2006, we entered into an Equity Purchase Agreement to sell all of the stock of our wholly owned subsidiaries (i) WFI de Mexico, S. de R.L. de C.V., (ii) WFI de Mexico, Servicios de Adminstracion, S. de R.L. de C.V., (iii) WFI de Mexico, Servicios de Ingenieria, S. de R.L. de C.V., (iv) WFI Services de Mexico S.A. de C.V., (v) WFI Asesoria en Adminstracion, S.C; and (vi) WFI Asesoria en Telecomunicaciones, S.C. (the “Mexico Operations”) to Sakoki LLC. The transaction closed on March 10, 2006. Refer to Note 14 Related Party Transactions for further discussion of the purchaser, Sakoki, LLC.

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The Equity Purchase Agreement provided that we would receive total approximate consideration of $18.9 million, with $1.5 million in cash and the balance by a secured promissory note. As of December 31, 2006 we had received all installment payments due under the promissory note.

The impact of the divestiture has been reflected in the consolidated balance sheets as of December 31, 2006. There was no gain or loss realized on the sale since the business was sold at its net carrying value.

On December 28, 2006, our Board approved a plan to divest portions of our business where critical mass had not been achieved. This plan involved the divestiture of our EMEA operations and remaining South American operations. We determined that these operations met the criteria to be classified as held for sale. Accordingly, we have reflected these operations as discontinued in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” in our financial statements as of and for the year ended December 31, 2006.

On March 9, 2007, we completed the sale of our EMEA operations to LCC Wireless Engineering Services Limited, a wholly-owned subsidiary of LCC International, Inc. (“LCC”) in a cash for stock transaction valued at $4 million. The sale of EMEA generated a gain of $3.3 million which was recorded in the first quarter of 2007.

On April 20, 2007, we completed the sale of all of the issued and outstanding equity interests of our wholly owned subsidiary WFI de Brazil Techlogia en Telecomunicaciones LTDA, to Strategic Project Services, LLC (SPS). The consideration included the assumption of substantially all outstanding liabilities of WFI Brazil, nominal cash consideration, and additional earn-out consideration based on 25% of net receivables collected subsequent to the closing date. We recorded an impairment charge in the fourth quarter of 2006 of approximately $5.2 million to reduce the current carrying value of the South American operations to their estimated fair value.

For the year ended December 31, 2006, our discontinued operations in Latin America and EMEA had revenues of $27.0 million and net loss of $11.2 million. The prior year’s activities have been reclassified as discontinued operations in the accompanying consolidated statements of operations.

On June 4, 2007, the Company completed the sale to LCC of the assets used in the conduct of the operation of the Company’s Wireless Engineering Services portion of the wireless network services segment that provides engineering services to the non-government wireless communications industry in the United States.

The aggregate consideration in connection with the sale was $46 million, subject to certain adjustments. LCC delivered a subordinated promissory note for the principal amount of $21.6 million subject to working capital adjustments, and paid $17 million in cash at the closing, and we have retained an estimated $7 million in net accounts receivable of the business, subject to working capital adjustments.

On July 5, 2007, we sold the $21.6 million subordinated promissory note taken in the sale of assets to LCC. We received approximately $19.6 million in net cash proceeds, reflecting a discount from par value of less than five percent and aggregate transaction fees of approximately $1 million. The note was acquired by a fund affiliated with Silver Point Capital, L.P. We are not providing any guaranty for LCC’s payment obligations. Certain post closing adjustments that, under the terms of the sale of our U.S. Wireless Engineering business are expected to be made to the principal amount of the Note, may instead be made by payments between WFI and LCC or between Silver Point and WFI, as applicable.

On August 10, 2007, in accordance with the terms of the agreement, we provided the closing balance sheet working capital calculation, which indicated a $2.6 million working capital adjustment was due to WFI as an increase to the balance of the Subordinated Promissory Note. LCC has 30 days to review the calculation and notify us of any dispute.

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On July 24, 2007, we completed the sale to an affiliate of Platinum Equity of our Wireless Deployment services portion of the wireless network services segment. The total consideration for the acquisition was $24 million including $18 million in cash at closing, subject to typical post closing working capital adjustments, and an aggregate $6 million in a three-year earn-out arrangement through 2010. The deal includes a Transition Services Agreement for the transition of certain services for a period of six months and the deployment business employees will remain our employees until October 1, 2007; under an employee leasing arrangement with Platinum. The assets sold to Platinum Equity include all of our Wireless Deployment business, and the Wireless Facilities name.

As a result of the Engineering and Deployment Services divestitures in 2007, the wireless network services segment will be classified as a discontinued operation in the second and third quarters of 2007, respectively.

Customers

A representative list of our customers in our WNS segment during 2006, consisting of both Engineering and Deployment services, included (in alphabetical order) Cingular (now AT&T), Clearwire, Fibertower, Huawei, Sprint, T-Mobile and Verizon Wireless and equipment vendors such as Motorola and Samsung. In our ENS segment, our customers in 2006 included General Electric, the Atlanta airport, Lockheed Martin, the City of Houston, Texas the Toyota Center, and Westfield Shopping Towns. Customers in our Government Network Services segment during 2006 included the U.S. Air Force, U.S. Army, U.S. Navy, Missile Defense Agency, the Department of Homeland Security, FMS and the U.S. Southern Command.

Employees

As of December 31, 2006, our then continuing operations employed approximately 2,180 full-time employees, consultants and contractors worldwide. None of our employees were represented by a labor union and we did not experience any work stoppage.

Transition to New Company Name

As noted above, the final wireless related divestiture of WFI’s Wireless Deployment business included the sale of the company’s name, Wireless Facilities, Inc. Accordingly, the Company announced that by December 31, 2007 it would change its corporate name and stock ticker symbol to reflect its new business focus.

Company Overview

The following discussion presents our current business following the transformation actions that we made in 2007.

We are an innovative provider of mission critical engineering, IT services and warfighter solutions. We work primarily for the U.S. federal government, but we also perform work for state and local agencies. Our principle services include, but are not limited to, Command, Control, Communications, Computing, Intelligence, Surveillance and Reconnaissance (C4ISR), weapon systems lifecycle support, military weapon range and technical services, network engineering services, advanced IT services, security and surveillance systems, and critical infrastructure design and integration services. We offer our customers solutions and expertise to support their mission-critical needs by leveraging the Company’s skills across our core service areas.

We derive a substantial portion of our revenue from contracts performed for federal government agencies, with the majority of our revenue currently generated from the delivery of mission-critical war

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fighter solutions, advanced engineering services, system integration and system sustainment services to defense and other government agencies. We believe our diversified and stable client base, strong client relationships, broad array of contracts, considerable employee base with possession of government security clearances, and significant management and operational capabilities position us for continued growth.

We have strong, long-term relationships with our clients, as evidenced by our record of retaining business. We have provided high-end engineering, weapons support and other solutions to customers within the U.S. Army, U.S. Air Force, U.S. Navy, National Aeronautics and Space Administration (NASA), Defense Logistics Agency (DLA), Defense Contract Management Agency (DCMA), U.S. Department of Homeland Security, and various strategic military bases and defense locations throughout the United States for more than twenty years.

We believe our strong relationships are the result of our in-depth understanding of our client’s missions, the strength of our technical solutions, and the co-location of a number of our employees with our clients.

We have made significant investments in our management, employees and infrastructure in support of our growth and profitability strategies. Our senior managers have more than 125 years of collective experience with federal government agencies, the U.S. military and federal government contractors. Members of our management team have extensive experience growing businesses organically, as well as through acquisitions.

Relevant Industry Terms

We generally perform our services for federal government agencies pursuant to both contracts and task orders. A contract may include specific work requirements for a particular job that is to be performed, or may instead provide a framework that defines the scope and terms under which work may be performed in the future, in which case any task orders that may be issued from time to time under the contract set forth the specific work assignments that are to be performed under the contract. In this document, references to any contract include the task orders, if any, issued under that contract. Accordingly, information in this document regarding our revenue under government contracts includes revenue we receive under both contracts and task orders. We perform services as a prime contractor under those contracts and task orders that are awarded to us directly by the federal government. We also perform services for the federal government as a subcontractor to other companies that are awarded prime contracts. References in this prospectus regarding our engagements mean specific work that we have contracted to perform as a prime contractor or subcontractor pursuant to both contracts and task orders for a particular client.

Some of our contracts are multiple award contracts (MACs). Multiple award contracts are vehicles pursuant to which the federal government may purchase goods or services from several different pre-qualified contractors. Such contracts include government-wide acquisition contracts (GWACs ), blanket purchase agreements ( BPAs ), GSA Schedule 70 and other Indefinite Delivery/Indefinite Quantity (ID/IQ) contracts. GWACs are task-order or delivery-order contracts for goods and services established by one agency for government-wide use. BPAs are a simplified method of filling repetitive needs or services by establishing “charge accounts” with qualified suppliers and eliminating the need for issuing individual purchase, invoice and payment documents. GSA Schedule 70 is a contracting vehicle sponsored by the General Services Administration that is available to all federal government agencies for procuring information technology services and products pursuant to contracts (GSA Schedule 70 Contracts) and task orders (GSA Schedule 70 Task Orders) awarded thereunder. Finally, ID/IQs are contracts for goods or services which do not specify a firm quantity and that provide for issuance of orders for the performance of tasks during the contract period. Multiple award contracts typically have a ceiling , which is the maximum amount the government is authorized to spend under the contract over the life of the contract. While the

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government is permitted to spend up to the ceiling amount, there is no guarantee that it will do so or that any particular pre-qualified contractor will receive awards under the vehicle.

Federal government contracts for our services include three types of pricing: time-and-materials; cost-plus; and fixed-price. Time-and-materials contracts are contracts under which we are reimbursed for labor at fixed hourly rates and generally reimbursed separately for allowable materials, other direct costs and out-of-pocket expenses. Cost-plus contracts are contracts under which we are reimbursed for costs that are determined to be allowable and allocable to the contract and receive a fee, which represents our profit. Cost-plus fixed fee contracts specify the contract fee in dollars. Cost-plus incentive fee and cost-plus award fee contracts provide for increases or decreases in the contract fee, within specified limits, based upon actual results as compared to contractual targets for factors such as cost, quality, schedule and performance. Fixed-price contracts are contracts under which we perform specific tasks for a predetermined price.

Market Opportunity

U.S. Department of Defense Drives Strategic Priorities for the Company

The delivery and execution of our mission-critical engineering and support services are driven by the priorities of the U.S. Federal government. According to the U.S. Department of Defense (DoD) 2007 Fiscal Budget Priorities, the world has changed dramatically since the end of the last century, and the DoD is changing with it—refocusing America’s forces and capabilities for the future.

The strategic priorities of the DoD are based in large part on the Quadrennial Defense Review, the first conducted in an era of global terrorism, which continues the shift in emphasis by identifying key strategic priorities. These priorities are currently focused on mission critical capabilities of our armed forces, and providing the support infrastructure necessary to sustain these forces in a time of heightened warfare readiness and deployment.

The 2007 Fiscal DoD Budget is $439.3 billion, an increase of $28.5 billion over Fiscal Year 2006. The budgetary increase is primarily a result of supporting Operation Iraqi Freedom with significant budgetary increases for the U.S. Army (+$12.7 billion), the U.S. Navy (+$4.1 billion) and the U.S. Marine Corps (+$0.8 billion), The U.S. Air Force (+$6.3 bilion), and Defense-wide increases of +$4.6 billion. The total budgetary increase of approximately 7% represents a significant opportunity to key federal government contractors in support of the DoD’s war fighter, information technology, and other operational priorities. We believe there will be significant market opportunities for providers of system sustainment, IT and engineering services and solutions to federal government agencies, particularly those in the defense and homeland security community, over the next several years.

Focus on Federal Government Transformation

The federal government, and the DoD in particular, is in the midst of a significant transformation that is driven by the federal government’s need to address the changing nature of global threats. A significant aspect of this transformation is the use of Command, Control, Communications, Computing, Intelligence, Surveillance and Reconnaissance (C4ISR), and information technology to increase the federal government’s effectiveness and efficiency. The result is increased federal government spending on information technology to upgrade networks and transform the federal government from separate, isolated organizations into larger, enterprise level, network-centric organizations capable of sharing information broadly and quickly. While the transformation initiative is driven by the need to prepare for new world threats, adopting these IT transformation initiatives will also improve efficiency and reduce infrastructure costs across all federal government agencies.

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Competitive Strengths

We believe we are well positioned to meet the rapidly evolving needs of federal government agencies for high-end engineering services and IT solutions because we possess the following key business strengths:

In-Depth Understanding of Client Missions

We have a long history of providing mission-critical services and solutions to our clients, enabling us to develop an in-depth understanding of their missions and technical needs. In addition, a significant number of our employees are located at client sites, giving us valuable strategic insights into clients’ ongoing and future program requirements. Our in-depth understanding of our client missions, in conjunction with the strategic location of our employees, enables us to offer technical solutions tailored to our clients’ specific requirements and consistent with their evolving mission objectives.

Diverse Base of Key Contract Vehicles

As a result of our business development focus on securing key contracts, we are a preferred contractor on numerous multi-year GWACs and MACs that provide us the opportunity to bid on hundreds of millions of dollars of business against a discrete number of other pre-qualified companies each year. These contracts include:

Seaport-e
GSA
Passive RFID EPC-1
PES
IT
LOG World
Mobis
Millennia Lite
AMCOM Express
Consolidated Acquisition of Professional Services (CAPS)
Support Services for Aviation, Air Defense & Missile Systems (NAVSURFWARCENDIV)
Systems Engineering and Technical Assistance Contract (SETAC)
Specialized Engineering, Development & Test Articles/Models

While the federal government is not obligated to make any awards under these vehicles, we believe that holding preferred positions on these contract vehicles provides us an advantage as we seek to expand the level of services we provide to our clients.

Highly Skilled Employees and an Experienced Management Team

We deliver our services through a highly skilled workforce of approximately 1,200 employees in our on-going business, as of August 1, 2007. Our senior managers have over 125 years of collective experience with federal government agencies, the U.S. military, and federal government contractors. Members of our management team have experience growing businesses organically, as well as through acquisitions.

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Strategy

Our objective is to aggressively grow our business as a leading provider of high-end engineering services and information technology solutions to federal government agencies while improving our profitability. To achieve our objective, we intend to:

Accelerate Internal Growth

We intend to accelerate our internal growth rate by capitalizing on our current contract base, expanding services provided to our existing clients, expanding our client base and offering new, complementary services.

Capitalize on Current Contract Base.   We intend to aggressively pursue task orders under existing contract vehicles to maximize our revenue and strengthen our client relationships, though there is no assurance that the federal government will make awards up to the ceiling amounts or that we will be awarded any task orders under these vehicles. We have developed several internal tools that facilitate our ability to track, prioritize and win task orders under these vehicles. Combining these tools with our technical expertise, our strong past performance record and our knowledge of our clients’ needs, should position us to win additional task orders.

Expand Services Provided to Existing Clients.   We intend to expand the services we provide to our current clients by leveraging our strong relationships, technical capabilities and past performance record. We believe our understanding of client missions, processes and needs, in conjunction with our full lifecycle IT offerings, positions us to capture new work from existing clients as the federal government continues to increase the volume of IT services contracted to professional services providers. Moreover, we believe our strong past performance record positions us to expand the level of services we provide to our clients as the federal government places greater emphasis on past performance as a criterion for awarding contracts.

Expand Client Base.   We also plan to expand our client base into areas with significant growth opportunities by leveraging our industry reputation, long-term client relationships and diverse contract base. We anticipate that this expansion will enable us both to pursue additional higher value work and to further diversify our revenue base across the federal government. Our long-term relationships with federal government agencies, together with our GWAC vehicles, give us opportunities to win contracts with new clients within these agencies.

Improve Operating Margins

We believe that we have significant opportunities to increase our operating margins and improve profitability by capitalizing on our corporate infrastructure investments and internally developed tools, and concentrating on high value-added prime contracts.

Capitalize on Corporate Infrastructure Investments.   In recent periods, we have made significant investments in our senior management and corporate infrastructure in anticipation of future revenue growth. These investments included hiring senior executives with significant experience with federal IT services companies, strengthening our internal controls over financial reporting and accounting staff in support of Sarbanes-Oxley compliance and public company reporting requirements and expanding our Sensitive Compartmented Information Facilities (SCIFs) and other corporate facilities. We believe our management experience and corporate infrastructure are more typical of a company with a much larger revenue base than ours. We therefore anticipate that as our revenue grows, we will be able to leverage this infrastructure base and increase our operating margins.

Concentrate on High Value-Added Prime Contracts.   We expect to improve our operating margins as we strive to increase the percentage of revenue we derive from our work as a prime contractor and from engagements where contracts are awarded on a best value, rather than on a low cost, basis. The federal

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government’s move toward performance-based contract awards to realize greater return on its investment has resulted in a shift to greater utilization of best value awards. We believe this shift will enable us to expand our operating margins as we are awarded more contracts of this nature.

Pursue Strategic Acquisitions

We intend to supplement our organic growth by identifying, acquiring and integrating acquisitions that complement and broaden our existing client base and expand our primary service offerings. Our senior management team brings significant acquisition experience.

In the fourth quarter of 2006, we acquired Madison Research Corporation (“MRC”), a Huntsville, Alabama based privately-held provider of high-end engineering, weapon systems support, and professional services to the U.S. Army, U.S. Air Force, and NASA. Through the MRC acquisition, we significantly expanded our customer footprint within the DoD, added an important new customer with the U.S. Army, and added a key service differentiator by including weapon systems life cycle sustainment operations and maintenance to our core competencies, which will help us achieve our long term growth objectives.

We intend to pursue additional acquisition opportunities to continue to expand our customer base and to added new areas of differentiation to our business model.

Growth Strategy

Our revenues have grown organically by establishing new business units with experienced senior executives who have the ability to grow these business units and expand our customer base. Our objective is to continue growing revenues organically and through strategic acquisitions. In order to assist in accomplishing this objective, we are focused on expanding new business development resources to build the necessary infrastructure to identify, bid on and win new business. Additionally, we plan to acquire businesses that meet our primary objective of providing us with enhanced capabilities in order to pursue a broader cross section of the DoD, DHS and other government markets, which at the same time, may enable us to achieve our secondary objective of broadening our customer base. We are currently evaluating potential targets. We anticipate that we will need to obtain additional financing through the sale of equity or debt securities to fund any such acquisitions. We also expect to re-compete on our existing engineering and management contracts. Our rate of revenue growth depends upon many factors, including, among others, our success in bidding on new contracts and re-competes of our existing contracts, the continuation of our existing programs, the funding levels for our contracts, our ability to meet demand for our services or products and our ability to make strategic acquisitions and to grow the businesses of our acquired companies.

Current Organization

We currently have two types of business operations: federal; and non-federal. We do not treat our on-going business operations as separate segments. Rather, we view our business as an integrated whole. Within our federal division, we have sectors of expertise: “Communications & Technology Sector (CTS),” “Technical Resources Sector (TRS),” and “Engineering Design and Solutions Sector (EDSS).” Within our non-federal division, we maintain regional office locations, comprised of the Mid Atlantic Regional Office, Southeast Regional Office, and the Southwest Regional Office, where we are focused on security integration services.

Federal Business

Our federal business serves the federal information technology services market, which includes the design, development, deployment, integration and management of communications and information networks.

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The fiscal year (FY) 2007 defense budget supports substantial investments in advanced technology to provide advantages over our enemies, particularly in remote sensing and high-performance computing. This includes investments in communications improving connectivity between troops and their commanders well beyond the field of battle. C4ISR capabilities, information communications and transformation are some of the key areas of focus for the DoD’s technology spending. We believe opportunities for growth can be found in the following areas:

Weapon Systems Lifecycle Support

C4ISR
Defense IT
Knowledge management
Systems integration
Outsourced engineering services

We have historically targeted these areas for growth with our engineering service solutions, and in the past two years, we have begun to further supplement this growth by expanding our customer footprint in these areas through continued strategic acquisition. In particular, through our acquisition of MRC, we have added both service and product capabilities in: weapon systems support and maintenance; space programs; software and IT solutions; and advanced telecommunications programs.

The growth in the government information technology market is being driven by a number of factors, including an overall desire on the part of the federal government to upgrade communication and information systems, the aging of the federal workforce, and an increase in the use of private sector outsourcing. In addition, market growth has been driven and will continue to be driven in large part by DoD information technology spending which has been increasing over the past two years at an even faster rate than the overall government information technology market.

Our federal government business segment also focuses on the homeland security market with products and services aimed at providing first responders to emergency situations with a real time 3D image of the incident site.

Non-Federal Business

Our non-federal business provides system design, deployment, integration, monitoring and support services for non-federal, state, local and municipal governments and civilian networks. Non-federal networks have been traditionally segregated into systems such as voice, data, access control, video surveillance, temperature control and fire alarm. We provide services that combine such systems and offer integrated solutions on Ethernet-based and IP based platforms. We also offer solutions that combine safety, voice, data, electronic security and building automation systems with fixed or wireless connectivity solutions.

We aim to meet the needs of any non-federal government customer by understanding the needs of the particular entity, sifting through the multiple solutions and complex technologies available in the marketplace and designing, deploying, managing and maintaining a cost-effective and integrated solution that is capable of evolving as the needs of the client change with time. Our target markets include opportunities at; military bases, retail, healthcare, education, and public facilities.

Our commitment to these markets and our proven ability to provide feature-rich, cost-effective solutions has allowed us to become one of the larger independent civilian integrators for these types of systems.

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Services and Solutions

We provide a range of integrated engineering, war fighter, security and information technology services and solutions by leveraging our five core service offerings: network engineering; engineering services; range and technical services; security systems integration; and IT services.

Weapons System Life Cycle Sustainment

We provide weapons systems life cycle sustainment services for the Department of Defense and foreign governments. These services focus on maintaining, testing and repairing certain weapons systems for the war fighter.

Engineering services

We have comprehensive experience providing engineering services at any phase of a project lifecycle including Program Management, Engineering Design, Systems Engineering, C4I System INCO, Operations & Maintenance, Integrated Logistics, Test & Evaluation, Security/Building Mapping, Propulsion R&D, Advanced Telecommunications, and Warfare Systems Training.

Range & Technical Services

A key area of differentiation for us is within the range and technical service areas we offer. We have resources stationed at virtually all major range locations throughout the United States, including NAWC Pt. Magu, Hawaii Pacific Missile Range, Fort Bliss, Texas, and White Sands Missile Range, New Mexico. Our services include, Aerial Targets Operations & Maintenance, Surface Targets Operations & Maintenance, Missile Systems Operations & Maintenance, Range Operations Planning & Support, HAZMAT Management, Supply & Logistics Support, and Manufacturing.

Security Systems Integration

We have broad experience integrating security services and solutions across a number of network and communications platforms. In particular, our non-federal business has long-standing experience and has developed vast customer relationships by providing best-in-class systems integration services on a variety of platforms including Digital (IP) Surveillance & Security, Building Automation Systems & Controls, Fire & Life Safety Systems, Access Control & Perimeter Protection, and Service & Maintenance.

Network Engineering

We offer a full lifecycle of network engineering services to our clients from the initial analysis of the requirements and design of the network through implementation and testing of the solution, including the design of disaster recovery contingency plans. Our network engineering capabilities include architecture development, design, implementation, configuration, and operation of Local Area Networks (LAN), Metropolitan Area Networks (MAN) and Wide Area Networks (WAN). Our extensive experience providing the following network engineering services for federal government clients allows us to rapidly identify potential bottlenecks, security threats and vulnerabilities, and address these potential issues with cost-effective solutions in Design, Architecture, Testing System, Integration, Deployment, Security Assessments, Recovery Plans, and Certification.

IT Services

We offer a range of IT services and solutions from conceptual network planning to system service and maintenance. We have extensive experience building complex and secure networks for the federal government, and we possess in-depth experience with network operations centers (NOCs). Our services

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include Network Operations Centers (NOCs), Help Desks, System Maintenance, System Upgrades, Configuration Management, Data Warehousing, COTS Selection and Integration, and High Performance Computing.

Customers

Our primary customers include the U.S. Department of Defense, and various federal, state and local government agencies. Representative customers include:

U.S. Department of Defense (DoD)
U.S. Army
U.S. Navy
Foreign Military Services (FMS)
U.S. Department of Energy (DOE)
Defense Logistics Agency (DLA)
Defense Contract Management Agency (DCMA)
Defense Commissary Agency (DeCA)
Defense Information Systems Agency (DISA)
Space and Naval Warfare (SPAWAR) Systems Center
Joint Interagency Task Force-South (JIATF-South)
National Aeronautics and Space Administration (NASA)

Competition

Our market is competitive, and includes the full range of federal and non-federal engineering and IT service providers. Many of the companies that we compete against have significantly greater financial, technical and marketing resources, and generate greater revenues than we do.

Competition in the federal business segment includes tier one, large federal government contractors, such as Northrop Grumman, SAIC, ITT Industries, Inc., Computer Sciences Corporation, ARINC, Raytheon Corporation, BAE, CACI. While we view government contractors as competitors, we often team with these companies in joint proposals or in the delivery of our services for customers. Tier two competitors include NCI, Inc., Stanley, Inc., MTC Technologies, SYS Technologies, and Dynamics Research Corp.

Competition in the non-federal business segment includes Siemens Building Technology, Johnson Controls, Ingersoll Rand and Convergent.

We believe that the principal competitive factors in our ability to win new business include past performance, qualifications, domain and technology expertise, the ability to replace contract vehicles, the ability to deliver results within budget (time and cost), reputation, accountability, staffing flexibility, and project management expertise. We believe our ability to compete also depends on a number of additional factors including the ability of our customers to perform the services themselves, and competitive pricing for similar services.

Employees

As of August 1, 2007 we employed in our on-going business approximately 1,200 full-time employees, consultants and contractors worldwide. As of the date of this report, approximately 25 employees are represented by a labor union, and we have not experienced any work stoppages. This employee count does not include the deployment business employees on our payroll until October 1, 2007, who are currently being leased by Platinum Equity.

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Item 1A.     Risk Factors

Risks Related to Our Business

You should carefully consider the following risk factors and all other information contained herein as well as the information included in this Annual Report, and other reports and filings made with the SEC in evaluating our business and prospects. Risks and uncertainties, in addition to those we describe below, that are not presently known to us or that we currently believe are immaterial may also impair our business operations. If any of the following risks occur, our business and financial results could be harmed and the price of our common stock could decline. You should also refer to the other information contained in this report, including our unaudited consolidated financial statements and related notes.

The matters relating to our internal review of our stock option granting practices and the restatement of our financial statements have exposed us to civil litigation claims, regulatory proceedings and government proceedings which could burden the Company and have a material adverse effect on us.

Our current executive management team, which has been in place since 2004, initiated the Equity Award Review in the summer of 2006 in reaction to media reports regarding stock option granting practices of public companies. The Equity Award Review was conducted with oversight from the Board and assistance from our outside counsel, Morrison & Foerster. In February 2007, the Board appointed a Special Committee of the Board to review the adequacy of the Equity Award Review and the recommendations of management regarding historical option granting practices, and to make recommendations and findings regarding those practices and individual conduct. The Special Committee was not charged with making, and did not make, any evaluation of the accounting determinations or tax adjustments. The Special Committee was comprised of a non-employee director who had not served on our Compensation Committee before 2005.

The Equity Award Review encompassed all grants of options to purchase shares of our common stock and other equity awards made since two months prior to our IPO in November 1999 through December 2006. We also reviewed all option grants that were entered into our stock option database (Equity Edge) after our IPO with a grant date before November 1999, as well as other substantial grants issued prior to our IPO, consisting of more than 14,000 grants. We further reviewed all option grants with a grant date that preceded an employee’s date of hire. As part of the review, interviews of 18 current and former officers, directors, employees and attorneys were conducted, and more than 40 million pages of electronic and hard copy documents were searched for relevant information. The Special Committee also conducted its own separate review of the option granting practices during the tenure of current executive management team through additional interviews and document collection and review with the assistance of its own separate counsel, Pillsbury Winthrop, and FTI Consulting.

The Equity Award Review established the absence of contemporaneous evidence supporting a substantial number of the previously-recorded option grants, substantially all of which were made in the period from 1998 through late 2003. During this period of time, in some instances, documents, data and interviews suggest that option grants were prepared or finalized days or, in some cases, weeks or months after the option grant date recorded in our books. The affected grants include options issued to certain newly-hired employees but dated prior to their employment start dates and options issued to non-employees, including advisors to the Board erroneously designated as employees. The Special Committee also concluded that certain former employees and former officers participated in making improper option grants, including the selection of grant dates with the benefit of hindsight and in the deferral of the recording of otherwise approved option grants.

In light of the Equity Award Review, the Audit Committee of our Board concluded that our prior financial statements for periods from 1998 through our filing of interim financial statements for the period ended September 30, 2006, can no longer be relied upon and must be restated. Our management

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determined that, from fiscal year 1998 through fiscal year 2005, we had unrecorded non-cash equity-based compensation charges associated with our equity incentive plans. These charges are material to our financial statements for the years ended December 31, 1998 through 2005, the periods to which such charges would have related. Previously filed annual reports on Form 10-K and quarterly reports on Form 10-Q affected by the restatements have not been and will not be amended and should not be relied upon.

Our past stock option granting practices and the restatement of our prior financial statements have exposed and may continue to expose us to greater risks associated with litigation, regulatory proceedings and government inquiries and enforcement actions. As described in Part I, Item 3, “Legal Proceedings,” several derivative complaints have been filed in state and federal courts against our current directors, some of our former directors and some of our current and former executive officers pertaining to allegations relating to stock option grants. The SEC has initiated an informal inquiry into our historical stock option granting practices and we received a subpoena from the United States Attorney’s Office for the Southern District of California for the production of documents relating to our historical stock option granting practices, which could result in civil and/or criminal actions seeking, among other things, injunctions against us and the payment of significant fines and penalties by us. We are cooperating with the SEC and the United States Attorney’s Office for the Southern District of California, and expect to continue to do so.

We have not been in compliance with The Nasdaq Stock Market’s continued listing requirements and remain subject to the risk of our stock being delisted from The Nasdaq Global Select Market, which would have a material adverse effect on us and our stockholders.

Due to the Equity Award Review and resulting restatements, we could not timely file with the SEC our Annual Report on Form 10-K for the year ended December 31, 2006 or our Quarterly Reports on Form 10-Q for the periods ended March 31, 2007 and June 30, 2007. As a result, and as described in Part I, Item 3, “Legal Proceedings,” we were not in compliance with the filing requirements for continued listing on The Nasdaq Global Select Market as set forth in Marketplace Rule 4310(c)(14) and were subject to delisting from The Nasdaq Global Select Market. Until we file our Quarterly Reports on Form 10-Q for the periods ended March 31, 2007, and June 30, 2007, we will continue to be in non-compliance with Marketplace Rule 4310(c)(14), and our common stock may be delisted from The Nasdaq Select Global Market. If our stock is delisted, it would be uncertain when, if ever, our common stock would be relisted. If a delisting did happen, the price of our stock and the ability of our stockholders to trade in our stock could be adversely affected and, depending on the duration of the delisting, some institutions whose charters disallow holding securities in unlisted companies might sell our shares, which could have a further adverse effect on the price of our stock.

The process of restating our financial statements, making the associated disclosures, and complying with SEC requirements are subject to uncertainty and evolving requirements.

We have worked with our outside legal counsel and our independent registered public accounting firms to make our filings comply with all related requirements. Nevertheless the issues surrounding our historical stock option grant practices are complex and the regulatory guidelines or requirements continue to evolve. There can be no assurance that further SEC and other requirements will not evolve and that we will not be required to further amend this and other filings. In addition to the cost and time to amend financial reports, such amendments may have a material adverse affect on investors and common stock price and could result in a delisting of our common stock from The Nasdaq Global Select Market.

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A number of our current and former executive officers and directors have been named as parties to several derivative action lawsuits arising from our internal option review, and there is a possibility of additional lawsuits, all of which could require significant management time and attention and result in significant legal expenses.

We are subject to a number of lawsuits purportedly on behalf of Wireless Facilities, Inc. against certain of our current and former executive officers and board members, and we may become the subject of additional private lawsuits. Subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees in connection with the investigation of our historical stock option practices and such lawsuits. The expenses associated with these lawsuits may be significant, the amount of time to resolve these lawsuits is unpredictable and defending these lawsuits may divert management’s attention from the day-to-day operations of our business, which could have a material adverse effect on our financial condition, business, results of operations and cash flows.

Ongoing government inquiries relating to our past stock option practices may be time consuming and expensive and could result in injunctions, fines and penalties that may have a material adverse effect on our financial condition and results of operations.

The inquiries by the Department of Justice (“DOJ”) and the SEC into our past stock option practices are ongoing. We have cooperated with the DOJ and the SEC and expect to continue to do so. The period of time necessary to resolve these inquiries is uncertain, and we cannot predict the outcome of these inquiries or whether we will face additional government inquiries, investigations or other actions related to our historical stock option grant practices. Subject to certain limitations, we are obligated to indemnify our current and former directors, officers and employees in connection with the investigation of our historical stock option practices, these DOJ and SEC inquiries and any future government inquiries, investigations or actions. These inquiries could require us to expend significant management time and incur significant legal and other expenses, and could result in civil and criminal actions seeking, among other things, injunctions against us and the payment of significant fines and penalties by us, which could have a material adverse effect on our financial condition, business, results of operations and cash flow.

We face intense competition from many competitors that have greater resources than we do, which could result in price reductions, reduced profitability or loss of market share.

We operate in highly competitive markets and generally encounter intense competition to win contracts from many other firms, including mid-tier federal contractors with specialized capabilities and large defense and IT services providers. Competition in our markets may increase as a result of a number of factors, such as the entrance of new or larger competitors, including those formed through alliances or consolidation. These competitors may have greater financial, technical, marketing and public relations resources, larger client bases and greater brand or name recognition than we do. These competitors could, among other things:

·       divert sales from us by winning very large-scale government contracts, a risk that is enhanced by the recent trend in government procurement practices to bundle services into larger contracts;

·       force us to charge lower prices; or

·       adversely affect our relationships with current clients, including our ability to continue to win competitively awarded engagements in which we are the incumbent.

If we lose business to our competitors or are forced to lower our prices, our revenue and our operating profits could decline. In addition, we may face competition from our subcontractors who, from time-to-time, seek to obtain prime contractor status on contracts for which they currently serve as a subcontractor to us. If one or more of our current subcontractors are awarded prime contractor status on such contracts in the future, it could divert sales from us or could force us to charge lower prices, which could cause our margins to suffer.

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Our quarterly operating results may fluctuate significantly as a result of factors outside of our control, which could cause the market price of our common stock to decline.

We expect our revenue and operating results to vary from quarter to quarter. As a result, our operating results may fall below the expectations of securities analysts and investors, which could cause the price of our common stock to decline. Factors that may affect our operating results include those listed in this “Risk Factors” section and others such as:

·       fluctuations in revenue recognized on contracts;

·       variability in demand for our services and solutions;

·       commencement, completion or termination of contracts during any particular quarter;

·       timing of award or performance incentive fee notices;

·       timing of significant bid and proposal costs;

·       variable purchasing patterns under the GSA Schedule 70 Contracts, government wide acquisition contracts (GWACs), blanket purchase agreements and other Indefinite Delivery/Indefinite Quantity (ID/IQ) contracts;

·       strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs and joint ventures;

·       strategic investments or changes in business strategy;

·       changes in the extent to which we use subcontractors;

·  seasonal fluctuations in our staff utilization rates;

·       federal government shutdowns or temporary facility closings;

·       fluctuations in demand for outsourced network services or engineering services;

·       changes in our effective tax rate including changes in our judgment as to the necessity of the valuation allowance recorded against our deferred tax assets, and

·       the length of sales cycles.

Reductions in revenue in a particular quarter could lead to lower profitability in that quarter because a relatively large amount of our expenses are fixed in the short-term. We may incur significant operating expenses during the start-up and early stages of large contracts and may not be able to recognize corresponding revenue in that same quarter. We may also incur additional expenses when contracts expire, are terminated or are not renewed.

In addition, payments due to us from federal government agencies may be delayed due to billing cycles or as a result of failures of government budgets to gain congressional and administration approval in a timely manner. The federal government’s fiscal year ends September 30. If a federal budget for the next federal fiscal year has not been approved by that date in each year, our clients may have to suspend engagements that we are working on until a budget has been approved. Any such suspensions may reduce our revenue in the fourth quarter of that year or the first quarter of the subsequent year. The federal government’s fiscal year end can also trigger increased purchase requests from clients for equipment and materials. Any increased purchase requests we receive as a result of the federal government’s fiscal year end would serve to increase our third or fourth quarter revenue, but will generally decrease profit margins for that quarter, as these activities generally are not as profitable as our typical offerings.

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Our business could be adversely affected by changes in budgetary priorities of the Federal Government.

Because we derive a significant portion of our revenue from contracts with the Federal Government, we believe that the success and development of our business will continue to depend on our successful participation in Federal Government contract programs. Changes in Federal Government budgetary priorities could directly affect our financial performance. A significant decline in government expenditures, a shift of expenditures away from programs that call for the types of services that we provide, or a change in Federal Government contracting policies could cause Federal Governmental agencies to reduce their expenditures under contracts, to exercise their right to terminate contracts at any time without penalty, not to exercise options to extend contracts, or to delay or not enter into new contracts. Any of those actions could seriously harm our business, prospects, financial condition or operating results. Moreover, although our contracts with governmental agencies often contemplate that our services will be performed over a period of several years, Congress usually must approve funds for a given program each government fiscal year and may significantly reduce or eliminate funding for a program. Significant reductions in these appropriations by Congress could have a material adverse effect on our business. Additional factors that could have a serious adverse effect on our Federal Government contracting business include:

·       changes in Federal Government programs or requirements;

·       budgetary priorities limiting or delaying Federal Government spending generally, or by specific departments or agencies in particular, and changes in fiscal policies or available funding, including potential governmental shutdowns;

·       reduction in the Federal Government’s use of technology and/or professional services & solutions firms; and

·       an increase in the number of contracts reserved for small businesses which could result in our inability to compete directly for these prime contracts.

Our contracts with the Federal Government may be terminated or adversely modified prior to completion, which could adversely affect our business.

Federal Government contracts generally contain provisions, and are subject to laws and regulations, that give the Federal Government rights and remedies not typically found in commercial contracts, including provisions permitting the Federal Government to:

·       terminate our existing contracts;

·       reduce potential future income from our existing contracts;

·       modify some of the terms and conditions in our existing contracts;

·       suspend or permanently prohibit us from doing business with the Federal Government or with any specific government agency;

·       impose fines and penalties;

·       subject us to criminal prosecution;

·       subject the award of some contracts to protest or challenge by competitors, which may require the contracting federal agency or department to suspend our performance pending the outcome of the protest or challenge and which may also require the government to solicit new proposals for the contract or result in the termination, reduction or modification of the awarded contract;

·       suspend work under existing multiple year contracts and related task orders if the necessary funds are not appropriated by Congress;

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·       decline to exercise an option to extend an existing multiple year contract; and

·       claim rights in technologies and systems invented, developed or produced by us.

The Federal Government may terminate a contract with us either “for convenience” (for instance, due to a change in its perceived needs or its desire to consolidate work under another contract) or if we default by failing to perform under the contract. If the Federal Government terminates a contract with us for convenience, we generally would be entitled to recover only our incurred or committed costs, settlement expenses and profit on the work completed prior to termination. If the Federal Government terminates a contract with us based upon our default, we generally would be denied any recovery for undelivered work, and instead may be liable for excess costs incurred by the Federal Government in procuring undelivered items from an alternative source and other damages as authorized by law. As is common with government contractors, we have experienced and continue to experience occasional performance issues under some of our contracts. We may in the future receive show-cause or cure notices under contracts that, if not addressed to the Federal Government’s satisfaction, could give the government the right to terminate those contracts for default or to cease procuring our services under those contracts.

Our Federal Government contracts typically have terms of one or more base years and one or more option years. Many of the option periods cover more than half of the contract’s potential term. Federal governmental agencies generally have the right not to exercise options to extend a contract. A decision to terminate or not to exercise options to extend our existing contracts could have a material adverse effect on our business, prospects, financial condition and results of operations.

Certain of our Federal Government contracts also contain “organizational conflict of interest” clauses that could limit our ability to compete for certain related follow-on contracts. For example, when we work on the design of a particular solution, we may be precluded from competing for the contract to install that solution. While we actively monitor our contracts to avoid these conflicts, we cannot guarantee that we will be able to avoid all organizational conflict of interest issues.

If we fail to establish and maintain important relationships with government entities and agencies, our ability to successfully bid for new business may be adversely affected.

To develop new business opportunities, we primarily rely on establishing and maintaining relationships with various government entities and agencies. We may be unable to successfully maintain our relationships with government entities and agencies, and any failure to do so could materially adversely affect our ability to compete successfully for new business.

Failure to maintain strong relationships with other government contractors could result in a decline in our revenue.

In our federal business we often act as a subcontractor or in “teaming” arrangements in which we and other contractors bid together on particular contracts or programs. As a subcontractor or team member, we often lack control over fulfillment of a contract, and poor performance on the contract could tarnish our reputation, even when we perform as required. We expect to continue to depend on relationships with other contractors for a portion of our revenue in the foreseeable future. Moreover, our revenue and operating results could be materially adversely affected if any prime contractor or teammate chooses to offer a client services of the type that we provide or if any prime contractor or teammate teams with other companies to independently provide those services.

We cannot guarantee that our contracts will result in actual revenue.

There can be no assurance that our contracts will result in actual revenue in any particular period, or at all, or that any contract will be profitable. The actual receipt and timing of any revenue is subject to

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various contingencies, many of which are beyond our control. The actual receipt of revenue on contracts may never occur or may change because a program schedule could change, the program could be canceled, a contract could be reduced, modified or terminated early, or an option that we had assumed would be exercised not being exercised. Further, while many of our federal government contracts require performance over a period of years, Congress often appropriates funds for these contracts for only one year at a time. Consequently, our contracts typically are only partially funded at any point during their term, and all or some of the work intended to be performed under the contracts will remain unfunded pending subsequent Congressional appropriations and the obligation of additional funds to the contract by the procuring agency. Our estimates of contract value are based on our experience under such contracts and similar contracts. However, there can be no assurances that all, or any, of such estimated contract value will be recognized as revenue.

Loss of our GSA contracts or GWACs would impair our ability to attract new business.

We are a prime contractor under several GSA contracts and GWAC schedule contracts. We believe that our ability to continue to provide services under these contracts will continue to be important to our business because of the multiple opportunities for new engagements each contract provides. If we were to lose our position as prime contractor on one or more of these contracts, we could lose substantial revenues and our operating results could suffer. GSA contracts and other GWACs typically have a one or two-year initial term with multiple options exercisable at the government client’s discretion to extend the contract for one or more years. We cannot be assured that our government clients will continue to exercise the options remaining on our current contracts, nor can we be assured that our future clients will exercise options on any contracts we may receive in the future.

If we fail to attract and retain skilled employees or employees with the necessary security clearances, we might not be able to perform under our contracts or win new business.

The growth of our business and revenue depends in large part upon our ability to attract and retain sufficient numbers of highly qualified individuals who have advanced information technology and/or engineering skills. These employees are in great demand and are likely to remain a limited resource in the foreseeable future. Further, obtaining and maintaining security clearances for employees involves a lengthy process, and it is difficult to identify, recruit and retain employees who already hold security clearances. If we are unable to recruit and retain a sufficient number of these employees, our ability to maintain and grow our business could be limited. In a tight labor market, our direct labor costs could increase or we may be required to engage large numbers of subcontractor personnel, which could cause our profit margins to suffer. In addition, some of our contracts contain provisions requiring us to staff an engagement with personnel that the client considers key to our successful performance under the contract. In the event we are unable to provide these key personnel or acceptable substitutions, the client may terminate the contract and we may lose revenue.

In addition, certain federal government contracts require us, and some of our employees, to maintain security clearances. If our employees lose or are unable to obtain security clearances, or if we are unable to hire employees with the appropriate security clearances, the client may terminate the contract or decide not to renew the contract upon its expiration. As a result, we may not derive the revenue anticipated from the contract, which, if not replaced with revenue from other contracts, could seriously harm our operating results.

Our failure to maintain appropriate staffing levels could adversely affect our business.

We can not be certain that we will be able to hire the requisite number of experienced and skilled personnel when necessary in order to service a major contract, particularly if the market for related personnel becomes competitive. Conversely, if we maintain or increase our staffing levels in anticipation of

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one or more projects and the projects are delayed, reduced or terminated, we may underutilize the additional personnel, which would increase our general and administrative expenses, reduce our earnings and possibly harm our results of operations. If we are unable to obtain major contracts or effectively complete such contracts due to staffing deficiencies, our revenues may decline and our business may be harmed.

If our subcontractors fail to perform their contractual obligations, our performance and reputation as a prime contractor and our ability to obtain future business could suffer.

As a prime contractor, we often rely significantly upon other companies as subcontractors to perform work we are obligated to perform for our clients. As we secure more work under our GWAC vehicles, we expect to require an increasing level of support from subcontractors that provide complementary and supplementary services to our offerings. Depending on labor market conditions, we may not be able to identify, hire and retain sufficient numbers of qualified employees to perform the task orders we expect to win. In such cases, we will need to rely on subcontracts with unrelated companies. Moreover, even in favorable labor market conditions, we anticipate entering into more subcontracts in the future as we expand our work under our GWACs. We are responsible for the work performed by our subcontractors, even though in some cases we have limited involvement in that work.

If one or more of our subcontractors fail to satisfactorily perform the agreed-upon services on a timely basis or violate federal government contracting policies, laws or regulations, our ability to perform our obligations as a prime contractor or meet our clients’ expectations may be compromised. In extreme cases, performance or other deficiencies on the part of our subcontractors could result in a client terminating our contract for default. A termination for default could expose us to liability, including liability for the agency’s costs of reprocurement, could damage our reputation and could hurt our ability to compete for future contracts.

If we experience systems or service failure, our reputation could be harmed and our clients could assert claims against us for damages or refunds.

We create, implement and maintain IT solutions that are often critical to our clients’ operations. We have experienced, and may in the future experience, some systems and service failures, schedule or delivery delays and other problems in connection with our work. If we experience these problems, we may:

·       lose revenue due to adverse client reaction;

·       be required to provide additional services to a client at no charge;

·       receive negative publicity, which could damage our reputation and adversely affect our ability to attract or retain clients; and

·       suffer claims for substantial damages.

In addition to any costs resulting from product or service warranties, contract performance or required corrective action, these failures may result in increased costs or loss of revenue if clients postpone subsequently scheduled work or cancel, or fail to renew, contracts.

While many of our contracts limit our liability for consequential damages that may arise from negligence in rendering services to our clients, we cannot assure you that these contractual provisions will be legally sufficient to protect us if we are sued.

In addition, our errors and omissions and product liability insurance coverage may not continue to be available on reasonable terms or in sufficient amounts to cover one or more large claims, or the insurer may disclaim coverage as to some types of future claims. As we continue to grow and expand our business into new areas, our insurance coverage may not be adequate. The successful assertion of any large claim

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against us could seriously harm our business. Even if not successful, these claims could result in significant legal and other costs, may be a distraction to our management and may harm our reputation.

Security breaches in sensitive federal government systems could result in the loss of clients and negative publicity.

Many of the systems we develop, install and maintain involve managing and protecting information involved in intelligence, national security and other sensitive or classified federal government functions. A security breach in one of these systems could cause serious harm to our business, damage our reputation and prevent us from being eligible for further work on sensitive or classified systems for federal government clients. We could incur losses from such a security breach that could exceed the policy limits under our errors and omissions and product liability insurance. Damage to our reputation or limitations on our eligibility for additional work resulting from a security breach in one of the systems we develop, install and maintain could materially reduce our revenue.

Our employees may engage in misconduct or other improper activities, which could cause us to lose contracts.

We are exposed to the risk that employee fraud or other misconduct could occur. Misconduct by employees could include intentional failures to comply with federal government procurement regulations, engaging in unauthorized activities or falsifying time records. Employee misconduct could also involve the improper use of our clients’ sensitive or classified information, which could result in regulatory sanctions against us and serious harm to our reputation and could result in a loss of contracts and a reduction in revenues. It is not always possible to deter employee misconduct, and the precautions we take to prevent and detect this activity may not be effective in controlling unknown or unmanaged risks or losses, which could cause us to lose contracts or cause a reduction in revenues.

We may not be successful in identifying acquisition candidates and if we undertake acquisitions, they could increase our costs or liabilities and impair our revenue and operating results.

One of our strategies is to pursue growth through acquisitions. We may not be able to identify suitable acquisition candidates at prices that we consider appropriate. If we do identify an appropriate acquisition candidate, we may not be able to successfully negotiate the terms of the acquisition or finance the acquisition on terms that are satisfactory to us. Negotiations of potential acquisitions and the integration of acquired business operations could disrupt our business by diverting management attention from day-to-day operations. Acquisitions of businesses or other material operations may require additional debt or equity financing, resulting in additional leverage or dilution of ownership. We may encounter increased competition for acquisitions, which may increase the price of our acquisitions.

We have completed several acquisitions of complementary businesses in recent years, and we continually evaluate opportunities to acquire new businesses as part of our ongoing strategy. On October 2, 2006, we acquired MRC as an expansion of our Government Network Services segment, and we cannot assure you that we will obtain the anticipated benefits of this acquisition. Further, our integration of historic and future acquisitions, including MRC, will require significant management time and financial resources because we will need to integrate dispersed operations with distinct corporate cultures. We also may continue to expand our operations through business acquisitions over time. Our failure to properly integrate businesses we acquire and to manage future acquisitions successfully could seriously harm our operating results. In addition, acquired companies may not perform as well as we expect, and we may fail to realize anticipated benefits. We may issue common stock that would dilute our current stockholders’ ownership and incur debt and other costs in connection with future acquisitions which may cause our quarterly operating results to vary significantly.

If we are unable to successfully integrate companies we may acquire in the future, our revenue and operating results could suffer. The integration of such businesses into our operations may result in

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unforeseen operating difficulties (including incompatible accounting and information management systems), may absorb significant management attention and may require significant financial resources that would otherwise be available for the ongoing development or expansion of our business. These difficulties of integration may require us to coordinate geographically dispersed organizations, integrate personnel with disparate business backgrounds and reconcile different corporate cultures. In certain acquisitions, federal acquisition regulations may require us to enter into government novation agreements, a potentially time-consuming process. In addition, we may not be successful in achieving the anticipated synergies from these acquisitions, including our strategy of offering our services to clients of acquired companies to increase our revenue. We may experience increased attrition, including, but not limited to, key employees of the acquired companies, during and following the integration of acquired companies that could reduce our future revenue.

In addition, we may need to record write-downs from future impairments of identified intangible assets and goodwill, which could reduce our future reported earnings. Acquired companies may have liabilities or adverse operating issues that we fail to discover through due diligence prior to the acquisition. In particular, to the extent that prior owners of any acquired businesses or properties failed to comply with or otherwise violated applicable laws or regulations, or failed to fulfill their contractual obligations to the federal government or other clients, we, as the successor owner, may be financially responsible for these violations and failures and may suffer reputational harm or otherwise be adversely affected. The discovery of any material liabilities associated with our acquisitions could cause us to incur additional expenses and cause a reduction in our operating profits.

Additionally, the Small Business Administration (SBA) is enacting new regulations which will require small businesses to recertify their size standard within thirty days of any sale or merger. It is highly likely that any company we may look to acquire will have some component of small business contracts. These new regulations may impact our ability to retain all of the contracts after the acquisition.

The loss of any member of our senior management could impair our relationships with federal government clients and disrupt the management of our business.

We believe that the success of our business and our ability to operate profitably depends on the continued contributions of the members of our senior management. We rely on our senior management to generate business and execute programs successfully. In addition, the relationships and reputation that many members of our senior management team have established and maintain with federal government personnel contribute to our ability to maintain strong client relationships and to identify new business opportunities. We do not have any employment agreements providing for a specific term of employment with any member of our senior management. The loss of any member of our senior management could impair our ability to identify and secure new contracts, to maintain good client relations and to otherwise manage our business.

If we are unable to manage our growth, our business could be adversely affected.

Sustaining our growth has placed significant demands on our management, as well as on our administrative, operational and financial resources. For us to continue to manage our growth, we must continue to improve our operational, financial and management information systems and expand, motivate and manage our workforce. If we are unable to manage our growth while maintaining our quality of service and profit margins, or if new systems that we implement to assist in managing our growth do not produce the expected benefits, our business, prospects, financial condition or operating results could be adversely affected.

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Our margins and operating results may suffer if we experience unfavorable changes in the proportion of cost-plus-fee or fixed-price contracts in our total contract mix.

Although fixed-price contracts entail a greater risk of a reduced profit or financial loss on a contract compared to other types of contracts we enter into, fixed-price contracts typically provide higher profit opportunities because we receive the benefit of cost savings. In contrast, cost-plus-fee contracts are subject to statutory limits on profit margins, and generally are the least profitable of our contract types. Our federal government customers typically determine what type of contract we enter into. Cost-plus-fee and fixed-price contracts in our federal business accounted for approximately 31% and 37%, respectively, of our federal business revenues for the fiscal year ended December 31, 2006. To the extent that we enter into more cost-plus-fee or less fixed-price contracts in proportion to our total contract mix in the future, our margins and operating results may suffer.

Our cash flow and profitability could be reduced if expenditures are incurred prior to the final receipt of a contract.

We provide various professional services and sometimes procure equipment and materials on behalf of our federal government customers under various contractual arrangements. From time to time, in order to ensure that we satisfy our customers’ delivery requirements and schedules, we may elect to initiate procurement in advance of receiving final authorization from the government customer or a prime contractor. If our government or prime contractor customers’ requirements should change or if the government or the prime contractor should direct the anticipated procurement to a contractor other than us or if the equipment or materials become obsolete or require modification before we are under contract for the procurement, our investment in the equipment or materials might be at risk if we cannot efficiently resell them. This could reduce anticipated earnings or result in a loss, negatively affecting our cash flow and profitability.

We may be harmed by intellectual property infringement claims and our failure to protect our intellectual property could enable competitors to market products and services with similar features.

We may become subject to claims from our employees or third parties who assert that software and other forms of intellectual property that we use in delivering services and solutions to our clients infringe upon intellectual property rights of such employees or third parties. Our employees develop some of the software and other forms of intellectual property that we use to provide our services and solutions to our clients, but we also license technology from other vendors. If our employees, vendors, or other third parties assert claims that we or our clients are infringing on their intellectual property rights, we could incur substantial costs to defend those claims. In addition, if any of these infringement claims are ultimately successful, we could be required to: cease selling or using products or services that incorporate the challenged software or technology; obtain a license or additional licenses from our employees, vendors, or other third parties; or redesign our products and services that rely on the challenged software or technology.

In addition, if we are unable to protect our intellectual property, our competitors could market services or products similar to our services and products, which could reduce demand for our offerings.

We may be unable to prevent unauthorized parties from attempting to copy or otherwise obtain and use our technology. Policing unauthorized use of our technology is difficult, and we may not be able to prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our intellectual property as fully as those in the United States. Others, including our employees, may circumvent the trade secrets and other intellectual property that we own. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets and to determine the validity and

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scope of the proprietary rights of others. Any litigation could result in substantial costs and diversion of resources, with no assurance of success.

A preference for minority-owned, small and small disadvantaged businesses could impact our ability to be a prime contractor on certain governmental procurements.

As a result of the SBA set-aside program, the federal government may decide to restrict certain procurements only to bidders that qualify as minority-owned, small or small disadvantaged businesses. As a result, we would not be eligible to perform as a prime contractor on those programs and would be restricted to a maximum of 49% of the work as a subcontractor on those programs. An increase in the amount of procurements under the SBA set-aside program may impact our ability to bid on new procurements as a prime contractor or restrict our ability to recompete on incumbent work that is placed in the set-aside program.

We derive a significant portion of our revenues from a limited number of customers.

We have derived, and believe that we will continue to derive, a significant portion of our revenues from a limited number of customers. To the extent that any significant customer uses less of our services or terminates its relationship with us, our revenues could decline significantly. As a result, the loss of any significant client could seriously harm our business. For the fiscal year ended December 31, 2006, in our federal business two customers comprised approximately 55% of our federal business revenues, and our five largest customers accounted for approximately 80% of our total federal business revenues. None of our customers are obligated to purchase additional services from us. As a result, the volume of work that we perform for a specific customer is likely to vary from period to period, and a significant client in one period may not use our services in a subsequent period.

If our customers do not receive sufficient financing or fail to pay us for services performed, our business may be harmed.

A few of our customers in our non-federal business rely upon outside financing to pay the costs of the services we provide. These customers may fail to obtain adequate financing or experience delays in receiving financing and they may choose the services of our competitors if our competitors are willing and able to provide project financing. In addition, we have historically taken significant write-offs of our accounts receivable. While the vast majority of our customers today are large federal customers and large enterprises, it is possible that in some instances we may not receive payment for services we have already performed. If our customers do not receive adequate financing or if we are required to write off significant amounts of our accounts receivables, then our net income will decline, and our business will be harmed.

Our business is dependent upon our ability to keep pace with the latest technological changes.

The market for our services is characterized by rapid change and technological improvements. Failure to respond in a timely and cost effective way to these technological developments will result in serious harm to our business and operating results. We have derived, and we expect to continue to derive, a substantial portion of our revenues from providing innovative engineering services and technical solutions that are based upon today’s leading technologies and that are capable of adapting to future technologies. As a result, our success will depend, in part, on our ability to develop and market service offerings that respond in a timely manner to the technological advances of our customers, evolving industry standards and changing client preferences.

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Failure to properly manage projects may result in costs or claims.

Our engagements often involve large scale, highly complex projects. The quality of our performance on such projects depends in large part upon our ability to manage the relationship with our customers, and to effectively manage the project and deploy appropriate resources, including third-party contractors, and our own personnel, in a timely manner. Any defects or errors or failure to meet clients’ expectations could result in claims for substantial damages against us. Our contracts generally limit our liability for damages that arise from negligent acts, error, mistakes or omissions in rendering services to our clients. However, we cannot be sure that these contractual provisions will protect us from liability for damages in the event we are sued. In addition, in certain instances, we guarantee customers that we will complete a project by a scheduled date. If the project experiences a performance problem, we may not be able to recover the additional costs we will incur, which could exceed revenues realized from a project. Finally, if we underestimate the resources or time we need to complete a project with capped or fixed fees, our operating results could be seriously harmed.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud.

As previously disclosed in the Explanatory Note preceding Part I and in Note 2 of our consolidated financial statements of this Form 10-K, in 2006 the Company commenced an internal review of the Company’s past practices for granting and pricing stock options and other equity awards. The findings of this review and a separate review of historical stock option practices and related matters performed by a Special Committee of our Board, required restatement of the Company’s previously issued financial statements for periods from 1998 through the Company’s last filing of interim financial statements for the period ended September 30, 2006. Due to the duration of the stock option review that precluded the Company from filing its financial information with the SEC in a timely manner, and after discussion with our external auditors regarding varying accounting positions resulting in the recording in 2001 of a material adjustment related to the cancellation of stock options, we determined that a material weakness in our internal controls and procedures (see Item 9A, “Controls and Procedures”) exists as of December 31, 2006. In addition, as of December 31, 2006 after consultation with our external auditors, we recorded a material adjustment to reduce the valuation of deferred tax assets to reflect the risks and uncertainties related to our future ability to realize and utilize our deferred tax assets.   A “material weakness”, by itself or in combination with other control deficiencies, results in a more than remote likelihood that a material misstatement in our financial statements will not be prevented or detected by our employees in the normal course of performing their assigned functions.

In addition, from time to time we acquire businesses which could have limited infrastructure and systems of internal controls. Performing assessments of internal controls, implementing necessary changes, and maintaining an effective internal controls process is costly and requires considerable management attention, particularly in the case of newly acquired entities. Internal control systems are designed in part upon assumptions about the likelihood of future events, and all such systems, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met.

Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. We also cannot assure you that we will implement and maintain adequate controls over our financial processes and reporting in the future or that additional material weaknesses or significant deficiencies in our internal controls will not be discovered in the future. Any failure to remediate any future material weaknesses or implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results, cause us to fail to meet our reporting obligations or result in material misstatements in our financial statements or other public disclosures. Inferior internal controls could also cause investors to

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lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.

We may need additional capital in the future to fund the growth of our business, and financing may not be available.

We currently anticipate that our available capital resources, including our line of credit, and operating cash flows will be sufficient to meet our expected working capital and capital expenditure requirements for at least the next 12 months. However, we cannot assure you that such resources will be sufficient to fund the long-term growth of our business. In particular, we may experience a negative operating cash flow due to billing milestones and project timelines in certain of our contracts.

We may raise additional funds through public or private debt or equity financings if such financings become available on favorable terms or we may expand the senior credit facility we entered into on October 2, 2006 to fund future acquisitions and for general corporate purposes. However, we have not been in compliance with the terms of that credit facility as a result of our failure to timely file our annual and quarterly financial statements, and we can provide no assurance that the lender would agree to extend additional or continuing credit under that facility. We believe that, with the filing of this Report and our Quarterly Reports on Form 10-Q for the periods ended March 31, 2007 and June 30, 2007, we are no longer in default under this facility.

Any new financing or offerings would likely dilute our stockholders’ equity ownership. In addition, we cannot assure you that any additional financing we may need will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of unanticipated opportunities, develop new products or otherwise respond to competitive pressures. In any such case, our business, operating results or financial condition could be materially adversely affected.

Litigation may harm our business or otherwise distract our management.

Substantial, complex or extended litigation could cause us to incur large expenditures and distract our management. For example, lawsuits by employees, stockholders or customers could be very costly and substantially disrupt our business. Disputes from time to time with such companies or individuals are not uncommon, and we cannot assure you that that we will always be able to resolve such disputes on terms favorable to us.

In addition, we and certain of our current and former officers and directors have been named defendants in class action and derivative lawsuits. While we believe that allegations lack merit and we intend to vigorously defend all claims asserted, we are unable to estimate what our liability in these matters may be. We may be required to pay judgments or settlements and incur expenses in connection with such matters in aggregate amounts that could have a material adverse effect on our business financial condition, results of operations and cash flows.

Disclosure of trade secrets could aid our competitors.

We attempt to protect our trade secrets by entering into confidentiality and intellectual property assignment agreements with third parties, our employees and consultants. However, these agreements can be breached and, if they are, there may not be an adequate remedy available to us. In addition, others may independently discover our trade secrets and proprietary information and in such cases we could not assert any trade secret rights against such party. Enforcing a claim that a party illegally obtained and is using our trade secret is difficult, expensive and time consuming, and the outcome is unpredictable. If our trade secrets become known we may lose our competitive position.

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Our stock price may be volatile, which may result in lawsuits against us and our officers and directors.

The stock market in general and the stock prices of government services companies in particular, have experienced volatility that has often been unrelated to or disproportionate to the operating performance of those companies. The market price of our common stock has fluctuated in the past and is likely to fluctuate in the future. Factors which could have a significant impact on the market price of our common stock include, but are not limited to, the following:

·       quarterly variations in operating results;

·       announcements of new services by us or our competitors;

·       the gain or loss of significant customers;

·       changes in analysts’ earnings estimates;

·       rumors or dissemination of false information;

·       pricing pressures;

·       short selling of our common stock;

·       impact of litigation;

·       general conditions in the market;

·       political and/or military events associated with current worldwide conflicts; and

·       events affecting other companies that investors deem comparable to us.

Companies that have experienced volatility in the market price of their stock have frequently been the object of securities class action litigation. We and certain of our current and former officers and directors have been named defendants in class action and derivative lawsuits. These matters and any other securities class action litigation, in which we may be involved, could result in substantial costs to us and a diversion of our management’s attention and resources, which could materially harm our financial condition and results of operations.

Our charter documents and Delaware law may deter potential acquirers and may depress our stock price.

Certain provisions of our charter documents and Delaware law, as well as certain agreements we have with our executives, could make it substantially more difficult for a third party to acquire control of us. These provisions include:

·       authorizing the board of directors to issue preferred stock;

·       prohibiting cumulative voting in the election of directors;

·       prohibiting stockholder action by written consent;

·       establishing advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by stockholders at meetings of our stockholders;

·       Section 203 of the Delaware General Corporation Law, which prohibits us from engaging in a business combination with an interested stockholder unless specific conditions are met; and

·       a number of our executives have agreements with us that entitle them to payments in certain circumstances following a change in control.

In addition, on December 16, 2004, we adopted a stockholder rights plan (“Rights Plan”). Pursuant to the Rights Plan, our Board declared a dividend distribution of one preferred share purchase right

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(“Right”) on each outstanding share of our common stock. Each Right will entitle stockholders to buy one one-hundredth of a share of newly created Series C Preferred Stock at an exercise price of $54, subject to adjustment, in the event that the Rights become exercisable. Subject to limited exceptions, the Rights will become exercisable if a person or group acquires 15% or more of our common stock or announces a tender offer for 15% or more of the common stock. If we are acquired in a merger or other business combination transaction which has not been approved by our Board, each Right will entitle its holder to purchase, at the Rights then-current exercise price, a number of the acquiring company’s common shares having a market value at the time of twice the Rights exercise price. These provisions may discourage certain types of transactions involving an actual or potential change in control and may limit our stockholders’ ability to approve transactions that they deem to be in their best interests. As a result, these provisions may depress our stock price.

The non-federal business arena in which we operate has relatively low barriers to entry and increased competition could result in margin erosion, which would make profitability even more difficult to sustain.

Other than the technical skills required in our non-federal business, the barriers to entry in our non-federal business are relatively low. We do not have any intellectual property rights in this segment of our business to protect our methods and business start-up costs do not pose a significant barrier to entry. The success of our non-federal business is dependent on our employees, customer relations and the successful performance of our services. If we face increased competition as a result of new entrants in our markets, we could experience reduced operating margins and loss of market share and brand recognition.

If our non-federal customers do not invest in security systems and other new in-building technologies such as wireless local area networks and/or IP-based networks, our business will suffer.

We intend to devote significant resources to developing our enterprise-based WLAN (Wireless Local Area Networks), but we cannot predict that we will achieve widespread market acceptance amongst the enterprises we identify as potential customers. It is possible that some enterprises will determine that capital constraints and other factors outweigh their need for WLAN systems. As a result, we may be affected by a significant delay in the adoption of WLAN by enterprises, which would harm our business.

We may incur goodwill impairment charges in our reporting entities which could harm our profitability.

In accordance with Statement of Financial Accounting Standards, or SFAS, No. 142, “Goodwill and Other Intangible Assets,” we periodically review the carrying values of our goodwill to determine whether such carrying values exceed the fair market value. Our acquired companies are subject to annual review for goodwill impairment. If impairment testing indicates that the carrying value of a reporting unit exceeds its fair value, the goodwill of the reporting unit is deemed impaired. Accordingly, an impairment charge would be recognized for that reporting unit in the period identified, which could reduce our profitability.

Risks Related to Our Industry

Our revenue and operating profits could be adversely affected by significant changes in the contracting or fiscal policies of the federal government.

We depend on continued federal government expenditures on intelligence, defense and other programs that we support. Accordingly, changes in federal government contracting policies could directly affect our financial performance. In addition, a change in presidential administrations, congressional majorities or in other senior federal government officials may negatively affect the rate at which the federal government purchases IT services. The overall U.S. defense budget declined from time-to-time in the late 1980s and the early 1990s. While spending authorizations for intelligence and defense-related programs by the federal government have increased in recent years, future levels of expenditures and authorizations for

35




those programs may decrease, remain constant or shift to programs in areas where we do not currently provide services. Among the factors that could materially adversely affect us are:

·       budgetary constraints affecting federal government spending generally, or specific departments or agencies in particular, and changes in fiscal policies or available funding;

·       changes in federal government programs or requirements, including the increased use of small business providers;

·       curtailment of the federal government’s use of professional services providers;

·       the adoption of new laws or regulations;

·       federal governmental shutdowns (such as that which occurred during the federal government’s 1996 fiscal year) and other potential delays in the government appropriations process;

·       delays in the payment of our invoices by federal government payment offices due to problems with, or upgrades to, federal government information systems, or for other reasons;

·       competition and consolidation in the IT industry;

·       general economic conditions; and

·       a reduction in spending or shift of expenditures from existing programs, and a failure of Congress to pass adequate supplemental appropriations to pay for an international conflict or related reconstruction efforts;

These or other factors could cause federal governmental agencies, or prime contractors for which we are acting as a subcontractor, to reduce their purchases under contracts, to exercise their right to terminate contracts or not to exercise options to renew contracts, any of which could cause our revenue and operating profits to decline.

Many of our federal government clients spend their procurement budgets through multiple award contracts under which we are required to compete for post-award orders or for which we may not be eligible to compete and could limit our ability to win new contracts and grow revenue.

Budgetary pressures and reforms in the procurement process have caused many federal government clients to increasingly purchase goods and services through ID/IQ contracts, the GSA Schedule 70 Contracts and other multiple award and/or GWAC vehicles. These contract vehicles have resulted in increased competition and pricing pressure, requiring us to make sustained post-award efforts to realize revenue under the relevant contract vehicle. The federal government’s ability to select multiple winners under multiple award schedule contracts, GWACs, blanket purchase agreements and other ID/IQ contracts, as well as its right to award subsequent task orders among such multiple winners, means that there is no assurance that these multiple award contracts will result in the actual orders equal to the ceiling value, or result in any actual orders. We are only eligible to compete for work (task orders and delivery orders) as a prime contractor pursuant to GWACs already awarded to us. Our failure to compete effectively in this procurement environment could reduce our revenue. If the federal government elects to use a contract vehicle that we do not hold we will not be able to compete as a prime contractor.

36




Our failure to comply with complex procurement laws and regulations could cause us to lose business and subject us to a variety of penalties.

We must comply with and are affected by laws and regulations relating to the formation, administration and performance of federal government contracts, which affect how we do business with our clients and may impose added costs on us. Among the most significant laws and regulations are:

·       the Federal Acquisition Regulations, and agency regulations supplemental to the Federal Acquisition Regulations, which comprehensively regulate the formation, administration and performance of federal government contracts;

·       the Truth in Negotiations Act, which requires certification and disclosure of all cost and pricing data in connection with contract negotiations;

·       the Cost Accounting Standards and Cost Principles, which impose accounting requirements that govern our right to reimbursement under certain cost-based federal government contracts; and

·       laws, regulations and executive orders restricting the use and dissemination of information classified for national security purposes and the export of certain products and technical data.

Moreover, we are subject to industrial security regulations of the DoD and other federal agencies that are designed to safeguard against foreigners’ access to classified information. If we were to come under foreign ownership, control or influence, our federal government clients could terminate or decide not to renew our contracts, and our ability to obtain new contracts could be impaired.

The federal government may revise its procurement or other practices in a manner adverse to us.

The federal government may revise its procurement practices or adopt new contracting rules and regulations, such as cost accounting standards. It could also adopt new contracting methods relating to GSA contracts, GWACs or other government-wide contracts, or adopt new standards for contract awards intended to achieve certain social or other policy objectives, such as establishing new set-aside programs for small or minority-owned businesses. In addition, the federal government may face restrictions from new legislation or regulations, as well as pressure from government employees and their unions, on the nature and amount of services the federal government may obtain from private contractors. These changes could impair our ability to obtain new contracts or contracts under which we currently perform when those contracts are put up for recompetition bids. Any new contracting methods could be costly or administratively difficult for us to implement, and, as a result, could harm our operating results.

We derive significant revenue from contracts awarded through a competitive procurement process, which may require significant upfront bid and proposal costs that could negatively affect our operating results.

We derive significant revenue from federal government contracts that are awarded through a competitive procurement process. We expect that most of the federal government business we seek in the foreseeable future will be awarded through competitive processes. Competitive procurements impose substantial costs and present a number of risks, including:

·       the substantial cost and managerial time and effort that we spend to prepare bids and proposals for contracts that may not be awarded to us and could reduce our profitability; and

·       the expense and delay that we may face if our competitors protest or challenge contract awards made to us pursuant to competitive procedures, and the risk that any such protest or challenge could result in the resubmission of offers, or in termination, reduction or modification of the awarded contract, which could result in increased cost and reduced profitability.

37




In addition, most federal government contract awards are subject to protest by competitors. If specified legal requirements are satisfied, these protests require the federal government agency to suspend the contractor’s performance of the newly awarded contract pending the outcome of the protest. These protests could also result in a requirement to resubmit bids for the contract or in the termination, reduction or modification of the awarded contract.

Unfavorable federal government audit results could subject us to a variety of penalties and sanctions, and could harm our reputation and relationships with our clients and impair our ability to win new contracts.

The federal government, including the Defense Contract Audit Agency (DCAA), audits and reviews our performance on contracts, pricing practices, cost structure and compliance with applicable laws, regulations and standards. The DCAA reviews a contractor’s internal control systems and policies, including the contractor’s purchasing, property, estimating, compensation and management information systems, and the contractor’s compliance with such policies. Any costs found to be improperly allocated to a specific contract will not be reimbursed, while such costs already reimbursed must be refunded. Adverse findings in a DCAA audit could materially affect our competitive position and result in a substantial adjustment to our revenue and profit.

If a federal government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or debarment from doing business with federal government agencies. In addition, we could suffer serious harm to our reputation and competitive position if allegations of impropriety were made against us, whether or not true. If our reputation or relationship with federal government agencies were impaired, or if the federal government otherwise ceased doing business with us or significantly decreased the amount of business it does with us, our revenue and operating profit would decline.

Changes in interest rates could adversely affect the profitability of the Company.

Our outstanding borrowings on our Credit Facility of $51.0 million as of December 31, 2006 are subject to changes in short-term interest rates. If interest rates increase in the future, there can be no assurance that future increases in interest expense will not reduce our overall profitability.

Item 1B.               Unresolved Staff Comments

None.

Item 2.                        Properties

Our principal executive offices for all business segments are located in approximately 93,000 square feet of office space in San Diego, California. The lease for such space expires in April 2010. Other corporate resource offices are located in the following locations: Marietta, Georgia; Newport, Delaware; Houston, Texas; Huntsville, Alabama, Reston, Virginia, Haryana, India and Beijing, China. The Company also leases office space to support engineering and design and deployment services in various regions throughout the United States. The leases on these spaces expire at various times through February 2015. We have leases on spaces related to discontinued operations in Sao Paulo, Brazil; Stockholm, Sweden; and London, U.K. that have been assigned to the buyers of the businesses or terminated with immaterial penalties. We continually evaluate our current and future space capacity in relation to current and projected future staffing levels. We believe that our existing facilities are suitable and adequate to meet our current business requirements.

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Item 3.                        Legal Proceedings

Contingencies

IPO Securities Litigation

Beginning in June 2001, WFI and certain of its officers and directors were named as defendants in several parallel class action shareholder complaints filed in the United States District Court for the Southern District of New York, now consolidated under the caption, In re Wireless Facilities, Inc. Initial Public Offering Securities Litigation, Case No. 01-CV-4779. In the amended complaint, the plaintiffs allege that WFI, certain of its officers and directors, and the underwriters of WFI’s IPO violated section 11 of the Securities Act of 1933 and section 10(b) of the Securities Exchange Act of 1934 based on allegations that WFI’s registration statement and prospectus failed to disclose material facts regarding the compensation to be received by, and the stock allocation practices of, the IPO underwriters. The plaintiffs seek unspecified monetary damages and other relief. Similar complaints were filed in the same court against hundreds of other public companies (“Issuers”) that conducted IPOs of their common stock in the late 1990s and 2000 (the “IPO Cases”).

In June 2004, the Issuers (including WFI) executed a settlement agreement with the plaintiffs that would, among other things, result in the dismissal with prejudice of all claims against the Issuers and their officers and directors and the assignment of certain potential Issuer claims to the plaintiffs. On February 15, 2005, the court issued a decision certifying a class action for settlement purposes and granting preliminary approval of the settlement subject to modification of certain bar orders contemplated by the settlement. On August 31, 2005, the court reaffirmed class certification and preliminary approval of the modified settlement in a comprehensive Order. On February 24, 2006, the court dismissed litigation filed against certain underwriters in connection with certain claims to be assigned under the settlement. On April 24, 2006, the court held a Final Fairness Hearing to determine whether to grant final approval of the settlement. On December 5, 2006, the Second Circuit Court of Appeals vacated the lower court’s earlier decision certifying as class actions the six IPO Cases designated as “focus cases.” Thereafter, the District Court ordered a stay of all proceedings in all of the IPO Cases pending the outcome of plaintiffs’ petition to the Second Circuit for rehearing en banc and resolution of the class certification issue. On April 6, 2007, the Second Circuit denied plaintiffs’ rehearing petition, but clarified that the plaintiffs may seek to certify a more limited class in the District Court. Accordingly, the stay remains in place and the plaintiffs and Issuers have stated that they are prepared to discuss how the settlement might be amended or renegotiated to comply with the Second Circuit’s decision. Plaintiffs filed amended complaints in the six focus cases on or about August 14, 2007. The court has not yet set a deadline for the plaintiffs to file amended complaints in the other IPO lawsuits. Due to the inherent uncertainties of litigation, and because the settlement may not receive final approval from the Court, the ultimate outcome of this matter cannot be predicted. In accordance with FASB No. 5, “Accounting for Contingencies” WFI believes any contingent liability related to this claim is not probable or estimable and therefore no amounts have been accrued in regards to this matter.

2004 Securities Litigation

In August 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, 2000, 2001, 2002 and 2003, the Company and certain of its current and former officers and directors were named as defendants (“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, 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

39




levels. Based on these allegations, the lawsuits allege that Defendants violated the Securities Exchange Act of 1934, and the plaintiffs seek unspecified damages. These actions have been consolidated into a single action—In re Wireless Facilities, Inc. Securities Litigation, Master File No. 04CV1589-JAH. Plaintiffs filed a First Amended Consolidated Class Action Complaint on April 1, 2005. Defendants filed their motion to dismiss this first amended complaint on April 14, 2005. The plaintiffs then requested leave to amend their first amended complaint. The plaintiffs filed their Second Amended Complaint on June 9, 2005, this time on behalf of those who purchased, or otherwise acquired, the Company’s common stock between May 5, 2003 and August 4, 2004. Defendants filed their motion to dismiss this Second Amended Complaint on July 14, 2005. The motion to dismiss was taken under submission on October 20, 2005 and on March 8, 2006, the court granted the Defendants’ motion. However, plaintiffs were granted the right to amend their complaint within 45 days and subsequently filed their Third Amended Consolidated Class Action Complaint on April 24, 2006. Defendants filed a motion to dismiss this complaint on June 8, 2006. On May 7, 2007, the court denied the Defendants’ motion to dismiss. Defendants’ filed their answer to the plaintiffs’ complaint on July 13, 2007. The Company believes that the allegations lack merit and intends to vigorously defend all claims asserted. It is impossible at this time to assess whether or not the outcome of these proceedings will or will not have a material adverse effect on the Company. We have not recorded any accrual for a contingent liability associated with this legal proceeding based on the Company’s belief that a liability, while possible, is not probable and any range of potential future charge cannot be reasonably estimated at this time.

In 2004, two derivative lawsuits were filed in the United States District Court for the Southern District of California against certain of the Company’s current and former officers and directors: Pedicini v. Wireless Facilities, Inc., Case No. 04CV1663; and Roth v. Wireless Facilities, Inc., Case No. 04CV1810. These actions were consolidated into a single action in In re Wireless Facilities, Inc. Derivative Litigation, Lead Case No 04CV1663-JAH. The factual allegations in these lawsuits are substantially similar to those in the class action lawsuits, but the plaintiffs in these lawsuits assert claims for breach of fiduciary duty, gross mismanagement, abuse of control, waste of corporate assets, violation of Sarbanes Oxley Act section 304, unjust enrichment and insider trading. The plaintiffs in these lawsuits seek unspecified damages and equitable and/or injunctive relief. The lead plaintiff filed a consolidated complaint on March 21, 2005. On May 3, 2005, the defendants filed motions to dismiss this action, to stay this action pending the resolution of the consolidated non-derivative securities case pending in the Southern District of California, and to dismiss the complaint against certain non-California resident defendants. Pursuant to a request by the Court, Defendants’ motions were withdrawn without prejudice pending a decision on defendants’ motion to dismiss the complaint against the non-California resident defendants. On March 20, 2007, the Court ruled that it lacked personal jurisdiction over five of the six non-California defendants and dismissed them from the federal derivative complaint. On March 27, 2007, plaintiffs filed an amended derivative complaint setting forth all of the same allegations from the original complaint and adding allegations regarding WFI’s stock option granting practices. Basically, plaintiffs allege that WFI “backdated” or “springloaded” employee stock option grants so that the options were granted at less than fair market value. The amended complaint names all of the original defendants (including those dismissed for lack of jurisdiction) as well as nine new defendants. On July 2, 2007, the non-California resident defendants moved to dismiss the complaint for lack of personal jurisdiction. That motion is set to be heard on November 5, 2007. Once the court has decided the issue of personal jurisdiction, WFI, along with any remaining individual defendant found subject to the court’s jurisdiction, may again move to dismiss the complaint as to them.

In April 2007, another derivative complaint was filed in the United States District Court for the Southern District of California, Hameed v. Tayebi, 07-CV-0680 BTM(RBB) (the “Hameed Action”), against several of WFI’s current and former officers and directors.  The allegations in this new derivative complaint mirror the amended allegations in the 2004 federal derivative action.  Pursuant to a Court order and agreement between the parties, the defendants need not respond to the complaint in the Hameed Action until the Court rules on the motion to dismiss for lack of personal jurisdiction currently pending in

40




the 2004 derivative litigation.  Once the court in that matter has decided the issue of personal jurisdiction, the parties will meet and confer regarding defendants’ response to the Hameed Action.  At this time, we are unable to form a professional judgment that an unfavorable outcome is either probable or remote.  Moreover, if an unfavorable outcome should eventually occur, we are not at this time able to estimate the amount or range of possible loss.”

In August and September 2004, two virtually identical derivative lawsuits were filed in California Superior Court for San Diego County against certain of the Company’s current and former officers and directors. These actions contain factual allegations similar to those of the federal lawsuits, but the 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 actions seek unspecified damages, equitable and/or injunctive relief and disgorgement of all profits, benefits and other compensation obtained by defendants. These lawsuits have been consolidated into one action—In re Wireless Facilities, Inc. Derivative Litigation, California Superior Court, San Diego County, Lead Case No. GIC 834253. The plaintiffs filed a Consolidated Shareholder Derivative Complaint on October 14, 2004. This action has been stayed pending a decision in federal court on a motion to dismiss the federal derivative lawsuits. The parties will appear before the judge in October 2007 to apprise the court of the status of the federal action. The Company believes that the allegations lack merit and intends to vigorously defend all claims asserted. It is impossible at this time to assess whether or not the outcome of these proceedings will or will not have a material adverse effect on the Company. We have not recorded any accrual for a contingent liability associated with this legal proceeding based on the Company’s belief that a liability, while possible, is not probable and any range of potential future charge cannot be reasonably estimated at this time.

2007 Securities Litigation

In March and April 2007, there were three federal class actions filed in the United States District Court for the Southern District of California against WFI and several of its current and former officers and directors.  These class action lawsuits followed WFI's March 12, 2007 public announcement that it is conducting a voluntary internal review of its stock option granting processes.  These actions have been consolidated into a single action, In re Wireless Facilities, Inc. Securities Litigation II, Master File No. 07-CV-0482-BTM-NLS.  A consolidated class action complaint has not been filed.  At this time, we are unable to form a professional judgment that an unfavorable outcome is either probable or remote.  Moreover, if an unfavorable outcome should eventually occur, we are not at this time able to estimate the amount or range of possible loss.

Other Litigation

In January 2005 a former independent contractor of the Company filed a lawsuit in Brazil against the Company’s subsidiary, WFI de Brazil, to which he had been assigned for a period of time. He sought to be designated an employee of WFI de Brazil and entitled to severance and related compensation pursuant to Brazilian labor law. The individual sought back wages, vacation pay, stock option compensation and related benefits in excess of $0.5 million. This matter was argued before the appropriate labor court in July 2005 and in July, 2006, the labor court awarded the individual the Brazilian currency equivalent of approximately $0.3 million for his back wages, vacation pay and certain other benefits. The Company filed an appeal in the matter on July 20, 2006 and challenged the basis for the award on several theories. The Company has accrued approximately $0.3 million as of December 31, 2006 related to this matter. On august 22, 2007, the appeals court partially upheld the Company’s appeal, although it upheld the individual’s designation as an employee. The court is reviewing possible damage calculations before publishing a final decision. The Company’s counsel is preparing a motion for clarification of the judgment due to omissions in the decision. The Company is unable to determine the ultimate outcome of this matter.

41




On March 28, 2007, three plaintiffs, on behalf of a purported class of similarly situated employees and contractors, filed a lawsuit against the Company in the Superior Court of the State of California, Alameda County. The suit alleges various violations of the California Labor Code and seeks payments for allegedly unpaid straight time and overtime, meal period pay and associated penalties. The Company and the plaintiffs have agreed to venue for the suit in San Diego County. Based on our research to date, the Company has not concluded that it has any liability in the case. The Company believes that the allegations lack merit and intends to vigorously defend all claims asserted. It is impossible at this time to assess whether or not the outcome of these proceedings will or will not have a material adverse effect on the Company. We have not recorded any accrual for a contingent liability associated with this legal proceeding based on our belief that a liability, while possible, is not probable and any range of potential future charge cannot be reasonably estimated at this time.

On May 3, 2007, the Company announced that it has a filed a lawsuit against a former employee, Vencent Donlan, who previously served as its stock option administrator and left the Company in mid-2004, and his spouse. The lawsuit seeks to recover damages resulting from the theft by Donlan of WFI stock options and common stock valued in excess of $6.3 million. The thefts, which appear to have taken place during 2002 and 2003, were discovered through the Company’s review of its past practices related to the granting and pricing of employee stock options with the assistance of its outside counsel and forensic computer consultants. The complaint also alleges that Donlan attempted to cover up the scheme by, among other things, deleting entries from the Company’s records. WFI had promptly reported this discovery to the SEC in March 2007 when the theft was discovered. The SEC commenced an enforcement action against Donlan, and the U.S. Attorney’s Office forwarded a grand jury subpoena to the company seeking records related to Donlan and our historical option granting practices. The SEC filed a federal lawsuit and obtained a temporary restraining order and asset freeze against Donlan and his spouse. The U.S. Attorney’s Office indicted Donlan for the theft and he plead guilty to the federal criminal charges. The Company has cooperated with, and intends to continue to cooperate with both the SEC and the U.S. Attorney’s Office on this matter and otherwise.

In addition to the foregoing matters, from time to time, the Company may become involved in various lawsuits and legal proceedings that arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm the Company’s business. The Company is currently not aware of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse affect on our business, financial condition or operating results.

Item 4.                        Submission of Matters to a Vote of Security Holders

None.

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PART II

Item 5.                        Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our Common Stock is listed on the Nasdaq Global Select Market, under the symbol “WFII” and has traded since November 5, 1999.

The following table sets forth the high and low sales prices for our Common Stock for the periods indicated, as reported by NASDAQ. Such quotation represents inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions.

 

 

High

 

Low

 

Year Ended December 31, 2006:

 

 

 

 

 

Fourth Quarter

 

$

2.88

 

$

2.00

 

Third Quarter

 

$

2.83

 

$

1.91

 

Second Quarter

 

$

4.53

 

$

2.85

 

First Quarter

 

$

5.52

 

$

3.88

 

Year Ended December 31, 2005:

 

 

 

 

 

Fourth Quarter

 

$

6.86

 

$

5.10

 

Third Quarter

 

$

6.67

 

$

4.95

 

Second Quarter

 

$

6.43

 

$

5.13

 

First Quarter

 

$

9.54

 

$

6.25

 

 

On September 6, 2007, the last sale price of our Common Stock as reported by NASDAQ was $2.74 per share. On September 6, 2007, there were 210 shareholders of record of our Common Stock.

We have not declared any cash dividends since becoming a public company. We currently intend to retain any future earnings to finance the growth and development of the business and, therefore, do not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our Board and will be dependent upon the future financial condition, results of operations, capital requirements, general business conditions and other relevant factors as determined by our Board.

On December 16, 2004, we adopted our Rights Plan. Pursuant to the Rights Plan, our Board declared a dividend distribution of one preferred share purchase right (“Right”) on each outstanding share of our common stock. Each Right will entitle stockholders to buy one one-hundredth of a share of newly created Series C Preferred Stock at an exercise price of $54, subject to adjustment, in the event that the Rights become exercisable. Subject to limited exceptions, the Rights will become exercisable if a person or group acquires 15% or more of our common stock or announces a tender offer for 15% or more of the common stock. If we are acquired in a merger or other business combination transaction which has not been approved by our Board, each Right will entitle its holder to purchase, at the Right’s then-current exercise price, a number of the acquiring company’s common shares having a market value at the time of twice the Right’s exercise price.

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Securities Authorized for Issuance Under Equity Compensation Plans

Information about our equity compensation plans as of December 31, 2006 was as follows (shares in thousands):

Plan Category

 

 

 

Number of
Securities
to be Issued
Upon
Exercise of
Outstanding
Options,
Warrants and
Rights

 

Weighted
Average
Exercise
Price of
Outstanding
Options,
Warrants and
Rights

 

Number of 
Securities
Remaining
Available for
Future
Issuance

 

Equity Compensation Plans Approved by Shareholders(1)

 

 

9,277

 

 

 

$

6.28

 

 

 

5,841

(3)

 

Equity Compensation Plans Not Approved by Shareholders(2)

 

 

2,357

 

 

 

$

5.30

 

 

 

1,071

 

 

Total

 

 

11,634

 

 

 

 

 

 

 

6,912

 

 

 


(1)          Includes 1997 Stock Option Plan, 1999 and 2005 Equity Incentive Plan and 1999 Employee Stock Purchase Plan

(2)          Includes 2000 Non-Statutory Stock Option Plan

(3)          Includes 352,000 shares reserved for issuance under the Employee Stock Purchase Plan which was suspended in 2006 but has been re-activated for 2007.

For more detailed information regarding our equity compensation plans, see Note 10 to our consolidated financial statements.

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Performance Graph

The following performance graph is a comparison of the five year cumulative stockholder return on our common stock against the cumulative total return of the NASDAQ Composite Index and the NASDAQ Telecommunications Index for the period commencing December 31, 2001 and ending December 31, 2006. The performance graph assumes an initial investment of $100 in our common stock and in each of the indices. The performance graph and related text are based on historical data and are not necessarily indicative of future performance.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Wireless Facilities, Inc., The NASDAQ Composite Index
And The NASDAQ Telecommunications Index

GRAPHIC


*                    $100 invested on 12/31/01 in stock of index-including reinvestment of dividends.

Fiscal year ending December 31.

The performance graph above and related text are being furnished solely to accompany this annual report on Form 10-K pursuant to Item 201(e) of Regulation S-K, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be incorporated by reference into any filing of ours, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

45




Item 6.                        Selected Financial Data

We recently completed a voluntary review of our equity award practices. The voluntary review, which covered all option grants and other equity awards made since two months prior to our IPO in November 1999, as well as other substantial grants issued prior to our IPO, was initiated by the current executive management team, which has been in place since 2004, under the direction of our Board, with the assistance of outside counsel and forensic accountants. We also reviewed all option grants input into our stock option database (Equity Edge) subsequent to our IPO date of November 1999 but with a grant date prior to November 1999 and all option grants that preceded an employee’s date of hire.

Based on the results of the review, the Audit Committee concluded that, pursuant to APB 25 and related interpretations, the accounting measurement dates for certain stock option grants awarded between March 1998 and December 2003, covering options to purchase 15.2 million shares of our common stock, differed from the measurement dates previously used for such awards. As a result, revised measurement dates were applied to the affected option grants and WFI has recorded a total of $75.0 million in additional deferred compensation, with substantially all of the increase relating to option grants issued prior to December 31, 2003. WFI has recorded $58.2 million in additional stock-based compensation for the years 1998 through 2005, reflecting the amortization of deferred compensation over the relevant vesting periods, which is typically over four years. After related tax adjustments of $9.6 million, the restatement resulted in total net adjustments of $48.6 million. This amount is net of forfeitures related to employee terminations. The additional stock-based compensation expense is being amortized over the service period relating to each option, typically four years, with approximately 92% of the expense being recorded in years prior to 2004.

During the course of the Equity Award Review, we discovered that a former stock option administrator had engaged in a fraudulent scheme by which he misappropriated options to purchase more than 700,000 shares of stock. Ill-gotten gains from this scheme exceeded $6.3 million, and we have recorded an unauthorized issuance of common stock charge of $0.6 million and $5.7 million in 2002 and 2003, respectively, related to this theft.

The aggregate financial impact of the Equity Award Review including the unauthorized issuance of common stock charge was $64.5 million. After aggregate other tax adjustments and income tax adjustments of $9.6 million, the restatement resulted in total net adjustments to net income (loss) of $54.9 million for the years 1998 through 2005.

The selected consolidated financial data has been restated as a result of the above matters. See the Explanatory Note included before Part I, Item 1 of this Report, the discussion included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Part II, Item 7 of this Report, and Note 2 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this Report.

The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes thereto and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which are incorporated in Item 7 or included elsewhere in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of operating results to be expected in the future.

46




In December 2005, our Board made the decision to exit our Mexican and South American deployment businesses. In December 2006, our Board made the decision to exit our EMEA and Brazilian businesses. Accordingly, all results of operations for these businesses have been reflected as discontinued operations for all years presented.

 

 

Year Ended December 31,

 

 

 

2002

 

2003

 

2004

 

2005

 

2006

 

 

 

(Restated)

 

(Restated)

 

(Restated)

 

(Restated)

 

 

 

 

 

(All amounts except per share data in millions)

 

Consolidated Statements of Operations Financial Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

$

155.7

 

 

 

$

205.1

 

 

 

$

296.2

 

 

 

$

337.7

 

 

$

327.8

 

Gross profit

 

 

47.5

 

 

 

61.1

 

 

 

69.4

 

 

 

76.3

 

 

53.5

 

Operating income (loss)

 

 

(11.3

)

 

 

7.8

 

 

 

5.6

 

 

 

16.9

 

 

(31.4

)

Provision (benefit) for income taxes

 

 

15.4

 

 

 

(1.6

)

 

 

(0.6

)

 

 

5.9

 

 

14.5

 

Income (loss) from continuing operations

 

 

(27.3

)

 

 

10.2

 

 

 

3.4

 

 

 

11.3

 

 

(46.7

)

Income (loss) from discontinued operations

 

 

(42.2

)

 

 

(8.3

)

 

 

11.6

 

 

 

(9.7

)

 

(11.2

)

Cumulative effect of change in accounting principle

 

 

(16.1

)

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

 

$

(85.6

)

 

 

$

1.9

 

 

 

$

15.0

 

 

 

$

1.6

 

 

$

(57.9

)

Income (loss) from continuing operations per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

$

(0.57

)

 

 

$

0.15

 

 

 

$

0.05

 

 

 

$

0.15

 

 

$

(0.64

)

Diluted

 

 

$

(0.57

)

 

 

$

0.14

 

 

 

$

0.05

 

 

 

$

0.15

 

 

$

(0.64

)

Income (loss) from discontinued operations per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

$

(0.88

)

 

 

$

(0.12

)

 

 

$

0.16

 

 

 

$

(0.13

)

 

$

(0.15

)

Diluted

 

 

$

(0.88

)

 

 

$

(0.11

)

 

 

$

0.15

 

 

 

$

(0.13

)

 

$

(0.15

)

Net income (loss) per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

$

(1.78

)

 

 

$

0.03

 

 

 

$

0.21

 

 

 

$

0.02

 

 

$

(0.79

)

Diluted

 

 

$

(1.78

)

 

 

$

0.03

 

 

 

$

0.20

 

 

 

$

0.02

 

 

$

(0.79

)

Weighted average shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

48.1

 

 

 

68.4

 

 

 

72.8

 

 

 

74.0

 

 

73.5

 

Diluted

 

 

48.1

 

 

 

73.5

 

 

 

75.3

 

 

 

75.0

 

 

73.5

 

 

 

 

As of December 31,

 

 

 

2002

 

2003

 

2004

 

2005

 

2006

 

 

 

(Restated)

 

(Restated)

 

(Restated)

 

(Restated)

 

 

 

 

 

(All amounts in millions)

 

Consolidated Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

97.0

 

 

 

$

75.8

 

 

 

$

50.4

 

 

 

$

7.7

 

 

$

5.4

 

Short-term investments

 

 

 

 

 

35.1

 

 

 

7.6

 

 

 

 

 

 

Working capital

 

 

101.4

 

 

 

132.5

 

 

 

98.6

 

 

 

67.4

 

 

(3.9

)

Total assets

 

 

221.3

 

 

 

279.3

 

 

 

330.7

 

 

 

342.0

 

 

335.9

 

Total debt

 

 

2.8

 

 

 

0.7

 

 

 

1.9

 

 

 

0.7

 

 

51.4

 

Total stockholders’ equity

 

 

140.0

 

 

 

191.9

 

 

 

219.6

 

 

 

229.7

 

 

187.1

 

 

47




The following table presents details of the total stock-based compensation expense resulting from our Equity Award Review as well as previously recorded stock-based compensation expense and unauthorized issuance of stock expense that is included within the functional line items in the consolidated statements of operations data above. The expense below does not include the related tax adjustments.

 

 

As of December 31,

 

 

 

2002

 

2003

 

2004

 

2005

 

2006

 

 

 

(Restated)

 

(Restated)

 

(Restated)

 

(Restated)

 

 

 

 

 

(All amounts in millions)

 

Supplemental Data on Stock-Based Compensation and Unauthorized Issuance of Stock Expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

 

$

2.9

 

 

 

$

1.8

 

 

 

$

1.5

 

 

 

$

1.7

 

 

$

4.1

 

Selling, general and administrative

 

 

2.6

 

 

 

7.7

 

 

 

0.9

 

 

 

1.1

 

 

7.5

 

Unauthorized issuance of stock

 

 

0.6

 

 

 

5.7

 

 

 

 

 

 

 

 

 

Discontinued operations

 

 

0.6

 

 

 

0.6

 

 

 

 

 

 

 

 

 

Total

 

 

$

6.7

 

 

 

$

15.8

 

 

 

$

2.4

 

 

 

$

2.8

 

 

$

11.6

 

 

The following table presents the detail of the non-income tax payroll related adjustments resulting from the Equity Award Review that is included within the functional line items in the consolidated statements of operations data above.

 

 

As of December 31,

 

 

 

2002

 

2003

 

2004

 

2005

 

2006

 

 

 

(Restated)

 

(Restated)

 

(Restated)

 

(Restated)

 

 

 

 

 

(All amounts in millions)

 

Supplemental Data on Non-Income Tax Payroll Related Expense (Credit)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

 

$

0.5

 

 

 

$

(0.2

)

 

 

$

(7.5

)

 

 

$

(0.4

)

 

 

$

 

 

Selling, general and administrative

 

 

  0.4

 

 

 

  (0.2

)

 

 

    (3.9

)

 

 

  (0.2

)

 

 

 

 

Income (loss) from discontinued operations

 

 

   —

 

 

 

 

 

 

(0.8

)

 

 

(0.0

)

 

 

 

 

 

 

 

$

0.9

 

 

 

$

(0.4

)

 

 

$

(12.2

)

 

 

$

(0.6

)

 

 

$

 

 

 

The consolidated statement of operations data set forth above for the years ended December 31, 2005 and 2004 and the consolidated balance sheet data as of December 31, 2005, are derived from, and qualified by reference to, the audited restated financial statements appearing elsewhere in this Report. The consolidated statement of operations data for the years ended December 31, 2003 and 2002, and the consolidated balance sheet data as of December 31, 2004, 2003, and 2002, are derived from unaudited financial statements not included herein and have also been restated to reflect the results of the Equity Award Review.

See “Impact of the Additional Stock-Based Compensation Expense-Related Adjustments on the Consolidated Financial Statements” included in, ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in Part II, Item 7 of this Report, for tables presenting the adjustments to our previously-reported consolidated statements of operations for the four years ended December 31, 2005.

The information that has been previously filed or otherwise reported in our Quarterly Reports on Form 10-Q or any of our Annual Reports on Form 10-K for the periods affected by the restatement is superseded by the information in this Report, and the previously filed financial statements and related financial information and opinions of our independent registered public accounting firm contained in such reports can no longer be relied upon. The restated consolidated financial statements include unaudited

48




financial information for interim periods of 2005 consistent with Article 10-01 of Regulation S-X. That information is presented in Note 2 to Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this Report.

Certain amounts in the selected consolidated financial data above have been reclassified to conform to the 2006 presentation. See Note 1 of Notes to Consolidated Financial Statements, included in Part IV, Item 15 of this Report.

You should read this selected consolidated financial data together with the Explanatory Note and Consolidated Financial Statements and related Notes contained in this Report and in our subsequent reports filed with the SEC, as well as the section of this Report and our other reports entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

49




Item 7.                        Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

This report contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. Factors that may cause our results to differ include, but are not limited to: changes in the scope or timing of our projects; changes or cutbacks in spending by the U.S. DoD which could cause delays or cancellations of key government contracts; slowdowns in telecommunications infrastructure spending in the United States and globally, which could delay network deployment and reduce demand for our services; the timing, rescheduling or cancellation of significant customer contracts and agreements, or consolidation by or the loss of key customers; failure to successfully consummate acquisitions or integrate acquired operations; the rate of adoption of telecom outsourcing by network carriers and equipment suppliers; the rate of growth of adoption of WLAN and wireless security systems by enterprises; and competition in the marketplace which could reduce revenues and profit margins.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we, nor any other person, assume responsibility for the accuracy and completeness of the forward-looking statements. We are under no obligation to update any of the forward-looking statements after the filing of this Annual Report on Form 10-K to conform such statements to actual results or to changes in our expectations.

Certain of the information set forth herein, including costs and expenses that exclude the impact of stock compensation expense in 2006, may be considered non-GAAP financial measures. We believe this information is useful to investors because it provides a basis for measuring the operating performance of our business and our cash flow, excluding the effect of stock compensation expense that would normally be included in the most directly comparable measures calculated and presented in accordance with Generally Accepted Accounting Principles. Our management uses these non-GAAP financial measures along with the most directly comparable GAAP financial measures in evaluating our operating performance, capital resources and cash flow. Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information presented in compliance with GAAP, and non-financial measures we report may not be comparable to similarly titled amounts reported by other companies.

The following discussion should be read in conjunction with our audited consolidated financial statements and the related notes and other financial information appearing elsewhere in this Form 10-K and other reports and filings made with the Securities and Exchange Commission. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation the disclosures made under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and And Item 1A—Risk Factors.

Equity Award Review

Background and Scope of Review

Our current executive management team, which has been in place since 2004, initiated an internal review of our historical practices related to granting stock option awards and other equity awards (the “Equity Award Review”) in the summer of 2006 in reaction to media reports regarding stock option granting practices of public companies. In February 2007, the Board appointed a Special Committee of the Board to review the adequacy of the Equity Award Review and the recommendations of management regarding historical option granting practices, and to make recommendations and findings regarding those practices and individual conduct. The Special Committee was not charged with making, and did not make, any evaluation of the accounting determinations and related tax adjustments. The accounting determinations and related tax adjustments were evaluated by Management and the Audit Committee of the Board of Directors. The Special Committee was comprised of a non-employee director who had not served on our Compensation Committee before 2005.

50




The Equity Award Review encompassed all grants of options to purchase shares of our common stock and other equity awards made since two months prior to our IPO in November 1999 through December 2006. We also reviewed all option grants that were entered into our stock option database (Equity Edge) after our IPO with a grant date before November 1999, as well as other substantial grants issued prior to our IPO. The total number of grants reviewed in the Equity Award Review exceeded 14,000 individual grants. We further reviewed all option grants with a grant date that preceded an employee’s date of hire. As part of the review, interviews of 18 current and former officers, directors, employees and attorneys were conducted, and more than 40 million pages of electronic and hard copy documents were searched for relevant information. The Special Committee also conducted its own separate review of the option granting practices during the tenure of current executive management team through additional interviews and document collection and review with the assistance of its own separate counsel, Pillsbury Winthrop Shaw Pittman and FTI Consulting.

The Special Committee completed its evaluation of the Equity Award Review in August 2007 after considering the information gathered by management and Morrison & Foerster, along with testing and data gathering by Pillsbury Winthrop and FTI Consulting. The Special Committee concluded that the Equity Award Review was complete and worthy of reliance. Our Board has also concluded that the scope and thoroughness of the Equity Award Review was complete and appropriate.

The Equity Award Review demonstrated the absence of contemporaneous evidence supporting a substantial number of the previously-recorded option grants, substantially all of which were made in the period from 1998 through late 2003. During this period of time, in some instances, documents, data and interviews suggest that option grants were prepared or finalized days or, in some cases, weeks or months after the option grant date recorded in our accounting records. The affected grants include options issued to certain newly-hired employees using measurement dates prior to their employment start dates and options issued to non-employees, including advisors to the Board of Directors, erroneously designated as employees. The Special Committee also concluded that certain former employees and former officers participated in making improper option grants, including the selection of grant dates with the benefit of hindsight and in the delay in dating of otherwise approved option grants.

Impact on Previously Issued Reports and Financial Statements

In light of the Equity Award Review and the Special Committee’s findings described below, the Audit Committee of our Board concluded that our prior financial statements for periods from 1998 through our filing of interim financial statements for the period ended September 30, 2006 must be restated. Our management determined that, from fiscal year 1998 through fiscal year 2005, the Company did not properly recognize non-cash equity-based compensation charges. These charges are material to our financial statements for the years ended December 31, 1998 through 2005, the periods to which such charges would have related. Previously filed annual reports on Form 10-K and quarterly reports on Form 10-Q affected by the restatements have not been and will not be amended and should not be relied upon.

Consistent with the relevant accounting standards and recent guidance from the SEC as part of the Equity Award Review, the grants during the relevant period were organized into categories based on grant type and process by which the grant was finalized. We analyzed the evidence related to grants in each category as part of the Equity Award Review. This evidence included, but was not limited to, electronic and physical documents, document metadata, and witness interviews. The controlling accounting standards were applied to the relevant facts and circumstances, in a manner consistent with recent guidance from the SEC, to determine the proper measurement date for every grant within each category. If the measurement date was not the same as the originally assigned grant date, accounting adjustments were made as required, resulting in stock-based compensation expense and related income tax effects, as detailed below.

Based on the results of the Equity Award Review, we concluded that, pursuant to Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and relevant

51




interpretations, revised accounting measurement dates should be applied to a substantial number of the stock option grants covering options for the purchase of 15.2 million shares of our common stock that were awarded primarily between March 1998 and December 2003. The use of the revised measurement dates for the affected option grants required us to record a total of $75.0 million in additional deferred compensation, with substantially all of the increase relating to option grants made before December 31, 2003. We have also recorded $58.2 million in additional deferred compensation for the years 1998 through 2005, reflecting the amortization of stock-based compensation expense over the relevant vesting periods, which was typically over four years. After aggregate payroll tax adjustments and income tax adjustments of $9.6 million, the restatement resulted in total net adjustments to net income (loss) of $48.6 million for the years 1998 through 2005. This amount is net of forfeitures related to employee terminations and cancellations of approximately $16.8 million. These amounts do not include the unauthorized issuance of common stock charge of $0.6 million and $5.7 million in 2002 and 2003 related to misappropriated options by the Company’s former stock administrator described herein. The aggregate amount of the Equity Award Review including the misappropriated options is $64.5 million comprised of the $58.2 million in additional stock-based compensation expense and $6.3 million of a charge for unauthorized issuance of common stock. After aggregate other tax adjustments and income tax adjustments of $9.6 million, the restatement resulted in total net adjustments to net income (loss) of $54.9 million for the years 1998 through 2005. Approximately $26.6 million of the stock-based compensation expense was recorded in 2001, which was primarily due to cancellations from our Stock Option Cancel/Re-grant Program, as described below, which resulted in the remaining unamortized deferred compensation being expensed upon the cancellation in March 2001.

As a consequence of these adjustments, our audited consolidated financial statements and related disclosures for the years ended December 31, 2004 and 2005 and our consolidated statements of operations and consolidated balance sheet data for the four years ended December 31, 2005, included in “Selected Consolidated Financial Data” in Part II, Item 6 of this Report, have been restated. Additionally, the unaudited quarterly financial information for interim periods of 2005, included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of this Report, have been amended. We have also restated the stock-based compensation expense footnote information calculated under Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation, or SFAS 123, and SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, or SFAS 148, under the disclosure-only alternatives of those pronouncements for the years 2004 and 2005 and for interim periods of 2005. The restated footnote information has been included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as in the Consolidated Financial Statements in Part II, Item 15 of this Report.

None of the adjustments resulting from the Equity Award Review affected our previously-reported revenue, cash, cash equivalents or marketable securities balances in any prior periods.

Former Stock Option Administrator

During the course of the Equity Award Review, we discovered that Vencent Donlan, a former stock option administrator, had engaged in a fraudulent scheme by which he misappropriated options to purchase more than 700,000 shares of stock. Ill-gotten gains from this scheme exceeded $6.3 million. We have brought an action against Donlan seeking return of the fraudulently obtained stock option proceeds. We also promptly alerted the SEC of our discovery in March 2007. The SEC commenced an enforcement action against Donlan, and the U.S. Attorney’s Office forwarded a grand jury subpoena to us seeking records related to Donlan and our historical option granting practices. We have cooperated with, and intend to continue to cooperate with, both the SEC and the U.S. Attorney’s Office in their actions against Donlan and otherwise. Donlan has consented to an injunction brought by the SEC and has plead guilty to federal criminal charges brought against him by the U.S. Attorney’s Office. We have recorded an

52




unauthorized issuance of common stock charge of $0.6 million and $5.7 million in 2002 and 2003, respectively, related to this theft.

Historical Option Grant Approval Processes

Before our IPO, there was no formal policy or process covering granting or approval of stock option grants. As of December 1999, the Compensation Committee, which was comprised of three non-employee members of our Board, delegated authority to our then chief executive officer (“CEO”) to grant options covering the purchase of up to 10,000 shares of our common stock per non-executive officer employee per year (“CEO Award Grants”). Since our IPO, our policies required Compensation Committee approval of option grants that exceeded the limits of the CEO Award Grants and all option grants to executive officers, as defined in Rule 16a-1(f) promulgated under the Securities Exchange Act of 1934, as amended (“Executive Officers”). As a result of the information considered in the Equity Award Review, we have concluded that, from our IPO in November 1999 through October 2003, our option grant processes and procedures were not consistently followed.

The Compensation Committee approved stock option grants using two different forms of authorizations. First, on occasion, the Compensation Committee approved stock option grants at formal meetings of the Compensation Committee. After our IPO, these meetings were typically held quarterly. Second and more often, the Compensation Committee members held informal discussions with our then CEO—typically telephonically or via email—to determine whether option grants should be approved. The approval of option grants determined by the Compensation Committee was documented through the use of unanimous written consent actions. The unanimous written consent actions granted the options “as of” the date the committee members informally approved the grant, which was almost always a date earlier than the date on which the formal unanimous written consent actions were prepared and signed.

In March 2001, our Board approved a voluntary stock option cancel and re-grant program for employees (the “Cancel/Re-grant Program”). The Cancel/Re-grant Program provided employees with the opportunity to cancel all of their existing and outstanding stock options granted to them on or after September 30, 2000 and before March 30, 2001, and some or all of their existing and outstanding stock options granted to them prior to September 30, 2000, in exchange for a new option grant for an equal number of shares granted at a future date. The new options were issued six months and one day after the cancellation date, March 30, 2001, and the exercise price of the new options was based on the trading price of our common stock on the date of the new option grants.

One of the objectives of the Equity Award Review was to verify whether the unanimous written consent actions accurately identified the dates on which the Compensation Committee informally approved the option awards. For a number of the unanimous written consent actions, we were able to verify that the date reflected in the document was the date on which the Compensation Committee members informally approved the option grant. However, as to some of the unanimous written consent actions, we were unable to verify that the grant dates reflected in the approval documentation was the date for which the approval had occurred. When we could not verify the grant date reflected in a unanimous written consent action was the date on which it was approved through contemporaneous documents, we made measurement date adjustments based on the best available evidence such as fax dates on unanimous written consents and e-mail correspondence that supported the proper measurement date. This resulted in measurement date changes to 17 grant dates.

In November 2003, our current CEO, Eric DeMarco, commenced employment as the President of WFI. Shortly thereafter, in December 2003, our former Chief Financial Officer, Terry Ashwill, left the Company. In April 2004, Mr. DeMarco became CEO and the prior CEO, Masood Tayebi, became the Executive Chairman of our Board of Directors. In April 2004, the additional members of our executive team were hired, which included a new Chief Financial Officer, Deanna Lund, and new General Counsel, James Edwards. Shortly thereafter, other positions such as Corporate Controller, Vice President of

53




Human Resources, and Stock Administrator were also hired, replacing the former employees in those positions.

The new executive management team engaged in an overall review of our processes and controls and made improvements where deemed necessary. Our stock option granting processes and procedures were among the areas to which the new management team made improvements. Thus, shortly after April 2004, the processes were formalized and a consistent procedure was implemented for the CEO Award Grants and grants made by the Compensation Committee.

We believe that the Equity Award Review has confirmed that our equity granting processes and practices in effect since April 2004 are sound and have been consistently followed. The Equity Award Review did not identify any measurement date adjustments required under APB 25 for grants made since November 2003, although it did find minor administrative errors that have resulted in immaterial adjustments aggregating approximately $50,000 for grants during the period from 2004 through 2006.

In January 2007, for various business reasons, we made the decision to discontinue the issuance of stock options as a broad-based form of incentive compensation. Instead, we have begun using other forms of equity-based incentives such as restricted stock or restricted stock units on a limited basis.

Adjustments to Measurement Dates

As a result of the Equity Award Review, we determined under the criteria set forth in APB 25 that option grants covering a total of 15.2 million of the shares of our common stock require measurement date adjustments. For reasons that fell into four categories, we concluded that the measurement dates originally used for those option grants did not meet the criteria to establish a measurement date, as set forth in APB 25. For some of those grants, more than one reason applied. The four categories are:

·  Lack of Contemporaneous Documentation.   The Equity Award Review identified a number of grants for which we have been unable to locate contemporaneous documentation confirming that either a Compensation Committee approval occurred or the CEO Award Grants occurred on the indicated grant date. We identified grants requiring measurement date adjustments under the criteria of APB 25 when we were unable to locate contemporaneous documentation confirming that (1) a meeting occurred on the grant date, (2) the CEO approved the grant on the grant date, (3) the Compensation Committee approved the grant on the grant date or (4) the identification of employee-recipients and grant amounts were finalized by the grant date. The affected grants involved options allowing the purchase of 3.7 million shares of our common stock. Of these options, options to purchase 0.5 million shares were granted to Executive Officers, options to purchase 60,000 shares were granted to three of our current Directors and options to purchase 3.1 million shares were granted to other employees. Adjustments to the APB 25 measurement dates for the grants covered by these grants resulted in the recording of additional deferred compensation of $25.9 million, and amortization of stock-based compensation expense of $22.4 million, with the remaining $3.5 million eliminated due to forfeitures and terminations.

·  Date Selection/Indications of Other Dates.   For twelve grant dates, the Equity Award Review identified documents that indicated that the grant date for some options was selected with the benefit of hindsight after the date indicated on the unanimous written consent or after the CEO authorization form documenting the approval of those options. The affected awards on these twelve grant dates involved option grants covering 7.0 million shares. Of these option grants, options to purchase 1.3 million shares were granted to Executive Officers and options to purchase 5.7 million shares were granted to other employees. Adjustments to the APB 25 measurement dates for these grants resulted in the recording of additional deferred compensation of $13.1 million and amortization of stock-based compensation expense of $9.9 million, with the remaining $3.2 million eliminated due to forfeitures and terminations. Each of the twelve grant dates were on dates when the closing price of our common stock was at or near the lowest price experienced during the previous 7 weeks or earlier.

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·  Subsequent Allocations.   In 1999, 2000, 2001, 2002 and 2003, we made large, broad-based grants of stock options covering a substantial percentage of our employees. With respect to seven of the broad-based grant dates, the Equity Award Review identified that we had not completed allocations of options to individual employees by the time the grant was approved by Compensation Committee. The affected awards on these seven grant dates involved option grants covering 4.2 million shares. Of these option awards, options to purchase 0.2 million shares were granted to Executive Officers and options to purchase 4.0 million shares were granted to other employees. Adjustments to the APB 25 measurement dates for these grants resulted in the recording of additional deferred compensation of $23.8 million and amortization of stock-based compensation expense of $17.5 million, with the remaining $6.3 million eliminated due to forfeitures and terminations.

·  Pre-Hire Grants.   We made certain grants in connection with offers of employment to new employees were made on grant dates that preceded the employee’s hire date. These grants involved options to purchase a total of 0.7 million shares. Of these option grants, options to purchase 0.2 million shares were granted to Executive Officers and options to purchase 0.5 million shares were granted to other employees. Adjustments to the APB 25 measurement dates for these grants resulted in the recording of additional deferred compensation of $7.9 million and amortization of stock-based compensation expense of $3.9 million, with the remaining $4.0 million eliminated due to forfeitures and terminations.

Other Adjustments

During the course of the Equity Award Review, we identified some instances in which adjustments to deferred compensation were required that were not related to changes in measurement dates for the following reasons:

·  Non-Employee Grants.   Certain grants made to consultants and board advisors under our incentive stock option plan, which allowed only grants to employees. These grants were accounted for under APB 25 as if they were proper incentive stock option awards. In some instances, individuals were added to our payroll, even though they were not employees. The affected awards involved options to purchase 0.3 million shares, of which options to purchase 75,000 shares were issued to one of our Directors prior to his joining our Board. To correctly account for these grants in accordance with SFAS 123 and EITF 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in conjunction with Selling, Goods or Services”, we recorded $3.6 million in additional deferred compensation during 1998 through 2003 and amortization of stock-based compensation expense of $3.6 million.

·  Modifications of Existing Grants.   With respect to 0.3 million option grants, modifications were made to employee stock options that were not accounted for in accordance with APB 25. The modifications included the extension of the post-service exercise period for vested stock options of terminated employees and the acceleration of vesting for an Executive Officer, which resulted in $0.1 million of additional deferred compensation and amortization of stock-based compensation expense. Adjustments to reflect the modification of terms in accordance with APB 25 resulted in the recording of $1.3 million in additional deferred compensation and amortization of stock-based compensation expense of $1.3 million, to properly account for these modifications.

We previously recorded stock-based compensation expenses in prior periods for certain former employees for whom, in connection with their terminations, the post-service exercise period for vested stock options was extended or of the vesting period of stock options was accelerated. Those charges were accounted for correctly pursuant to APB 25. However, as a result of adjustments made in the restatement, the previously-recorded deferred compensation charge was reduced by $0.4 million.

During the course of the Equity Award Review, we discovered that a former stock option administrator had engaged in a fraudulent scheme by which he misappropriated options to purchase more than 700,000 shares of stock. Ill-gotten gains from this scheme approximated $6.3 million, and we have

55




recorded an unauthorized issuance of common stock charge of $0.6 million and $5.7 million in 2002 and 2003, respectively, related to this theft.

Summary of Measurement Date Adjustments to Grants to Former Executive Officers and Related Party

The Equity Award Review identified option grants to former Executive Officers covering an aggregate of 2.2 million shares that required measurement date adjustments. The resulting aggregate gross increase in deferred compensation associated with these grants was $7.7 million, and the aggregate amortization of stock-based expense associated with these grants was $7.2 million, with the difference of $0.7 million eliminated due to forfeitures.

Neither of our co-founders, Dr. Massih Tayebi and Dr. Masood Tayebi, was awarded any grants of stock options. Throughout the periods covered by the Equity Award Review, the Tayebi family (including Massih and Masood Tayebi), owned between 30 percent to 40 percent of our outstanding capital stock. Thus, none of the grants requiring measurement date adjustments was made to our co-founders. However, there were grants requiring measurement date adjustments that were issued to the brother of our co-founders, Jay Tayebi, who was the former general manager of our Mexican operation. Options to purchase 530,597 shares that were granted to Jay Tayebi required measurement date adjustments, resulting in increased gross deferred compensation of $6.3 million and amortization of stock-based compensation expense of $5.4 million, with the difference of $0.9 million eliminated due to forfeitures. A total of 2,640 of the shares requiring measurement date adjustments were sold by Mr. Tayebi, of which $9,000 of the profit realized from the sale of those shares was related to the difference in the remeasured price compared to the original option grant price.

The financial statement impact of measurement date adjustments to grants to former Executive Officers is as follows:

·       Terry Ashwill, former Executive Vice President and Chief Financial Officer (September 2000 to December 2003)—grants that in the aggregate allowed the purchase of 562,330 shares were found to require measurement date adjustments resulting in increased gross deferred compensation of $1.0 million and amortization of stock-based compensation expense of $0.6 million, with the difference of $0.3 million eliminated due to forfeitures. A total of 404,448 of the shares requiring measurement date adjustments were sold by Mr. Ashwill, of which $0.7 million of the profit realized from the sale of those shares was related to the difference in the remeasured price compared to the original option grant price.

·       Frankie Farjood, former Senior Vice President Deployment (November 1999 to July 2004)—grants that in the aggregate allowed the purchase of 287,743 shares were found to require measurement date adjustments resulting in increased gross deferred compensation of $1.0 million and amortization of stock based compensation of $1.0 million. A total of 170,000 of the shares requiring measurement date adjustments were sold by Mr. Farjood, of which $0.5 million of the profit realized from the sale of those shares was related to the difference in the remeasured price compared to the original option grant price.

·       Scott Fox, former President Network Management and Operations (May 1999 to June 2002)—(part time employee June 2002—April 2005) grants that in the aggregate allowed the purchase of 55,014 shares were found to require measurement date adjustments resulting in increased gross deferred compensation of $0.1 million and amortization of stock based compensation of $0.1 million. A total of 53,621 of the shares requiring measurement date adjustments was sold by Mr. Fox, of which $40,000 of the profit realized from the sale of those shares was related to the difference in the remeasured price compared to the original option grant price.

·       Farzad Ghassemi, former President of Wireless Network Services (February 1998 to June 2007)—grants that in the aggregate allowed the purchase of 194,591 shares were found to require

56




measurement date adjustments resulting in increased gross deferred compensation of $0.3 million and amortization of stock based compensation of $0.3 million. A total of 117,000 of the shares requiring measurement date adjustments were sold by Mr. Ghassemi, of which $0.1 million of the profit realized from the sale of those shares was related to the difference in the remeasured price compared to the original option grant price.

·       Greg Jacobssen, former Executive Vice President of Wireless Network Services (July 2002 to January 2004)—grants that in the aggregate allowed the purchase of 60,000 shares were found to require measurement date adjustments resulting in increased gross deferred compensation of $40,000 and amortization of stock based compensation of $10,000, with the difference of $30,000 eliminated due to forefeitures. Mr. Jacobssen did not sell any of the options requiring measurement date adjustments.

·       David Knutson, former Executive Vice President of Wireless Network Services (July 2003 to February 2006)—grants that in the aggregate allowed the purchase of 300,000 shares were found to require measurement date adjustments resulting in increased gross deferred compensation of $1.3 million and amortization of stock based compensation of $1.3 million. Mr. Knutson did not sell any of the options requiring measurement date adjustments.

·       Thomas Munro, former Chief Financial Officer (July 1997 to September 2000) and former President (September 2000 to December 2002)—grants that in the aggregate allowed the purchase of 510,890 shares were found to require measurement date adjustments resulting in increased gross deferred compensation of $3.1 million and amortization of stock based compensation of $3.1 million. A total of 88,890 of the shares requiring measurement date adjustments were sold by Mr. Munro, of which $0.1 million of the profit realized from the sale of those shares was related to the difference in the remeasured price compared to the original option grant price.

·       William Brad Weller, former General Counsel and Vice President Legal Affairs (September 1999 to December 2002)—grants that in the aggregate allowed the purchase of 153,636 shares were found to require measurement date adjustments resulting in increased gross deferred compensation of $1.0 million and amortization of stock based compensation of $0.8 million, with the difference of $0.3 million eliminated due to forfeitures. A total of 60,865 of the shares requiring measurement date adjustments were sold by Mr. Weller, of which $0.1 million of the profit realized from the sale of those shares was related to the difference in the remeasured price compared to the original option grant price.

No Affected Grants to Current Executive Officers

The Equity Award Review examined all option grants to current Executive Officers and concluded that no measurement date adjustments related to those option grants was required.

Aggregate Financial Statement Impact of the Measurement Date and Other Adjustments Identified in the Equity Award Review

The aggregate gross additional deferred compensation that we recorded for the years 1998 through 2003 as a result of information identified in the Equity Award Review is $75.0 million. The aggregate gross additional deferred compensation that we recorded for the years 2004 through 2005 of approximately $0.5 million was primarily as a result of reductions in deferred compensation to reflect reductions in our stock price for option grants that were repriced and required variable accounting treatment for grants that were issued prior to 2004. The aggregate gross additional deferred compensation for the years 1998 through 2005 does not reflect the elimination of $16.8 million in deferred compensation due to subsequent forfeitures related to employee terminations. In addition, the remaining amount of deferred compensation totaling $0.1 million at December 31, 2005 was eliminated in accordance with the provisions of

57




SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS 123R, which we adopted effective January 1, 2006. After these reductions, we recorded net additional stock-based compensation expense of $58.2 million for the years 1998 through 2005 in connection with our Equity Award Review. After related tax adjustments of $9.6 million, the restatement resulted in total net adjustments to net income (loss) of $48.6 million for the years 1998 through 2005. These amounts do not include the unauthorized issuance of common stock charge of $0.6 million and $5.7 million in 2002 and 2003, respectively, related to misappropriated options by the Company’s former stock administrator described herein. The aggregate amount of the Equity Award Review including the misappropriated options is $64.5 million comprised of the $58.2 million in additional stock-based compensation expense and $6.3 million of a charge for unauthorized issuance of common stock. After aggregate other tax adjustments and income tax adjustments of $9.6 million, the restatement resulted in total net adjustments to net income (loss) of $54.9 million for the years 1998 through 2005. The adjustments did not affect our previously-reported revenue, cash, cash equivalents or marketable securities balances in any prior period.

As stated previously, we made measurement date adjustments based on the best available evidence such as fax dates on unanimous written consents and e-mail correspondence that supported what management believes to be the appropriate measurement date. However, we also prepared sensitivity analyses using alternative measurement dates for certain grants that had less certain evidence to support a measurement date. If the alternative measurement dates were used, an aggregate $47.7 million of additional stock-based compensation expense would have been recorded compared to the $58.2 million we recorded.

Related Tax Adjustments

In our restated financial statements for 1998, 1999, 2000 and 2001, we recorded income tax benefits of $0.5 million, $1.6 million, $3.5 million, and $7.3 million, respectively, with respect to additional stock-based compensation expense relating to U.S.-based income. At December 31, 2002, we had no additional net deferred tax assets for additional stock-based compensation expense as such amounts were offset by a valuation allowance. No tax benefits were recorded for additional stock-based compensation expense recorded during 2002 as such amounts were offset by a valuation allowance because we did not believe such additional deferred tax assets were more likely than not to be realized. At December 31, 2002, we concluded that a full valuation allowance against our deferred tax assets was appropriate as a result of our cumulative losses as of December 31, 2002, which caused a presumption that any deferred tax assets would be difficult to realize, and reversed the $4.2 million of deferred tax assets recognized in prior periods which were yet to be realized for tax purposes, thereby increasing tax expense by $4.2 million. We recorded an income tax benefit of $1.5 million in 2003 related to income tax benefits realized from employee stock option exercises in 2003 that reduced our tax liabilities. Prior to the restatement, such income tax benefits were credited to additional paid-in capital because there was no associated stock-based compensation expense related to such employee stock options. No income tax benefits were recorded for additional stock-based compensation in 2004 and 2005 because of our domestic tax losses prior to deductions related to employee stock options. As a result, the cumulative net income tax benefit we recorded through December 31, 2005 was $10.2 million. We also recorded net other non-income tax payroll adjustments of $0.6 million, resulting in total related tax adjustments of 9.6 million. The other non-income tax payroll expenses recorded were $1.0 million, $10.3 million, $1.6 million and $0.9 million for 1999, 2000, 2001, and 2002, respectively. As a result of the expiration of certain statutory periods, previously recorded non-income tax payroll expenses were reduced by $0.4 million, $12.2 million and $0.6 million in 2003, 2004, and 2005, respectively.

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The Conduct Review

Background and Scope of Review

As described above, in February 2007, the Board appointed a Special Committee of the Board (the “Committee”) to review the adequacy of the Equity Award Review and the recommendations of management regarding historical option granting practices, and to make recommendations and findings regarding those practices and individual conduct. The Committee was not charged with making, and did not make, any evaluation of the accounting determinations or tax adjustments. The accounting determinations and related tax adjustments were evaluated by management and the Audit Committee of the Board of Directors. The Committee was comprised of a non-employee director who had not served on our Compensation Committee before 2005.

In connection with its review of the individual conduct of persons involved in the historical option granting practices (the “Conduct Review”), the Committee’s counsel considered information developed in the Equity Award Review, which it reviewed and tested. In addition, the Committee conducted its own separate review of the option granting practices during the tenure of current executive management team through additional interviews and document collection and review. The Committee also reported on other matters, including areas for further improvements in the stock option granting process and the controls surrounding that process. The Conduct Review was accomplished with the full support and cooperation of our Board, management and employees.

Conduct of Certain Former Executive Officers and Former Employees

Upon completion of the Conduct Review, the Committee concluded that certain former Executive Officers and other former employees participated in making improper option grants, including the selection of grant dates with the benefit of hindsight and in the delay in dating of otherwise approved option grants. The Committee concluded that certain of the former Executive Officers and other former employees appreciated the legal and accounting consequences of their actions. The Committee further recommended that we consider pursuing available remedies against the former Executive Officers, including potentially seeking disgorgement of option exercise proceeds related to options with adjusted measurement dates from certain former Executive Officers. None of the former Executive Officers or former employees identified by the Committee as having participated in grant date selection were employed by us at the time of the Committee’s findings, as all of them had previously resigned for reasons unrelated to the Equity Award Review or the Conduct Review.

Conduct of Current Executive Officers and Employees

Upon completion of the Conduct Review, the Committee concluded that none of the current Executive Officers or other current employees had participated in making improper option grants. To the contrary, the Special Committee concluded that current management proactively improved the processes of approving and granting stock options on its own initiative from the beginning of its tenure in 2004, and that the Committee has confidence in the integrity of current management. The Committee concluded that, although at times there were minor administrative errors and delays in option grants from 2004 through 2006 resulting in cumulative immaterial adjustments of approximately $50,000, there was no evidence that any members of current management had engaged in or benefited from any inappropriate option granting practices.

Conduct of the Compensation Committee

Since our IPO, the Compensation Committee has consisted at various times of two or three non-employee members of the Board. The members of the Compensation Committee with their respective periods of service were: Scott Anderson (August 1999—February 2002); Scot Jarvis (August 1999 to present); David Lee (June 2001 to February 2002); Bandal Carano (August 1999 to June 2001,

59




September 2001 to present); William Hoglund (May 2005 to present). Messrs. Anderson, Jarvis, Carano and Hoglund continue to serve on our Board.

As described above, the Compensation Committee approved stock option grants using two  forms of authorization. First, on occasion, the Committee approved stock option grants at formal Committee meetings which typically were held quarterly. Second and more often, the Compensation Committee members held informal discussions with our then CEO—usually telephonically or via email—to determine whether option grants should be approved. Approval was documented through the use of unanimous written consent action forms which were prepared by management and transmitted to the Committee members, who signed them and returned them to then management. The unanimous written consent actions granted the options “as of” the date the Committee members informally approved the grants, which almost always was a date earlier than the date on which the  forms were prepared and signed.  Before November 2003, as demonstrated by a comparison of the “as of dates” on the unanimous written consent action forms and the fax header lines reflecting the dates on which the signed forms were returned: (1) the consent forms generally were sent to the Compensation Committee members for signature within days or, in some cases, weeks or months after the option grant date recorded in our books; (2) the consent forms occasionally were sent to and returned by the Committee members out of sequence; and (3) in 2001, grants reflecting an “as of” date that resulted in option awards priced at the lowest price in our history up to that point were approved in three separate unanimous written consent actions awarding grants to different individuals that followed the “as of” date of the grant by two weeks to three months. On one occasion this included a consent action form signed by an individual who was not a Compensation Committee member on the “as of” date of the grant. From November 2003 through 2006, the Compensation Committee continued to approve option grants informally and, later, document that approval in a unanimous written consent action, but the time lag between the date of the approval—the “as of date”—and the execution of the unanimous written consent actions was reduced to days rather than weeks or months. After considering all of the information presented to the Special Committee, the Committee concluded that the members of the Compensation Committee were entitled to rely upon our option granting processes and that the Committee has confidence in their ability to continue to serve on our Board and any committees thereof.

Conclusion

With the completion of the review by the Committee, we are evaluating our available remedies arising from the inappropriate granting practices, but we have not yet made any decisions in that regard.

Restatement of Our Consolidated Financial Statements

As a result of the findings of Equity Award Review, our consolidated financial statements for the years ended December 31, 2004 and 2005 have been restated. The restated consolidated financial statements include unaudited financial information for interim periods of 2005 consistent with Article 10-01 of Regulation S-X. We also recorded additional stock-based compensation expense and associated tax adjustments affecting our previously-reported financial statements for 1998 through 2003, the effects of which are summarized in cumulative adjustments to our additional paid-in capital, deferred compensation and accumulated deficit accounts as of December 31, 2003, in the amounts of $56.1 million, $6.6 million and $62.9 million, respectively, all of which are recorded in the Consolidated Statements of Shareholders’ Equity, included in Part IV, Item 15 of this Report.

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The following table summarizes the additional deferred compensation recorded on an annual basis as a result of the equity award review, categorized by each of the three reasons that led to the determination that particular option grants failed to meet the measurement date criteria of APB 25, together with the other adjustments made that were not related to changes in measurement dates:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative

 

 

 

 

 

Cumulative

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount

 

Years ended

 

Amount

 

 

 

Years Ended December 31,

 

December 31,

 

December 31,

 

December 31,

 

 

 

1998

 

1999

 

2000

 

2001

 

2002

 

2003

 

2003

 

 2004 

 

 2005 

 

2005

 

 

(in millions)

 

Deferred Compensation Adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

No contemporaneous
documentation

 

 

$ 3.2

 

 

$ 4.6

 

$ 17.4

 

$ 0.0

 

 

$ —

 

 

$ 0.7

 

 

$ 25.9

 

 

 

$ 0.0

 

 

 

$ 0.0

 

 

 

$ 25.9

 

 

Date selection/Indication of other
date

 

 

 

 

 

5.2

 

4.3

 

 

3.1

 

 

1.0

 

 

13.6

 

 

 

(0.2

)

 

 

(0.3

)

 

 

13.1

 

 

Subsequent allocation

 

 

 

 

1.2

 

16.8

 

 

 

 

 

5.8

 

 

23.8

 

 

 

 

 

 

 

 

 

23.8

 

 

Start date issues

 

 

0.2

 

 

4.3

 

2.2

 

0.1

 

 

0.3

 

 

0.4

 

 

7.5

 

 

 

0.1

 

 

 

0.4

 

 

 

8.0

 

 

Other adjustments(a)

 

 

0.1

 

 

2.8

 

1.7

 

(1.3

)

 

0.1

 

 

0.3

 

 

3.7

 

 

 

0.5

 

 

 

0.0

 

 

 

4.2

 

 

Subtotal

 

 

$ 3.5

 

 

$ 12.9

 

$ 43.3

 

$ 3.1

 

 

$ 3.5

 

 

$ 8.2

 

 

$ 74.5

 

 

 

$ 0.4

 

 

 

$ 0.1

 

 

 

$ 75.0

 

 

Unauthorized issuance of stock by administrator

 

 

$ —

 

 

$ —

 

$ —

 

$ —

 

 

$ 0.6

 

 

$ 5.7

 

 

$ 6.3

 

 

 

$ —

 

 

 

$ —

 

 

 

$ 6.3

 

 

Total

 

 

$ 3.5

 

 

$ 12.9

 

$ 43.3

 

$ 3.1

 

 

$ 4.1

 

 

$ 13.9

 

 

$ 80.8

 

 

 

$ 0.4

 

 

 

$ 0.1

 

 

 

$ 81.3

 

 


(a)              Represents adjustments related to modifications that were made to employee stock options which included the extension of the post-service exercise period for vested stock options of terminated employees and the acceleration of vesting.

The following table summarizes the activity in additional deferred compensation as well as additional stock-based compensation expense and related tax adjustments on an annual basis. This table does not include previously-recorded activity in deferred compensation or stock-based compensation expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative

 

 

 

 

 

Cumulative

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Amount

 

Years Ended

 

Amount

 

 

 

Years Ended December 31,

 

December 31,

 

December 31,

 

December 31,

 

 

 

1998

 

1999

 

2000

 

2001

 

2002

 

2003

 

2003

 

2004

 

2005

 

2005

 

 

 

(in millions)

 

Activity in Deferred Compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred compensation
adjustment—beginning balance

 

$ —

 

$ 2.2

 

$ 10.2

 

$ 38.3

 

$ 7.0

 

$ 2.9

 

 

$   —

 

 

$ 6.6

 

$ 3.2

 

 

$   —

 

 

 

Additional deferred compensation recorded

 

3.5

 

12.9

 

43.3

 

3.1

 

3.5

 

8.2

 

 

74.5

 

 

0.4

 

0.1

 

 

75.0

 

 

 

Additional stock-based
compensation expense amortization(a)

 

(1.3

)

(4.4

)

(11.3

)

(26.6

)

(6.1

)

(3.7

)

 

(53.4

)

 

(2.2

)

(2.6

)

 

(58.2

)

 

 

Elimination due to employee terminations

 

 

(0.5

)

(3.9

)

(7.8

)

(1.5

)

(0.8

)

 

(14.5

)

 

(1.6

)

(0.7

)

 

(16.8

)

 

 

Additional deferred
compensation—ending balance

 

$ 2.2

 

$ 10.2

 

$ 38.3

 

$ 7.0

 

$ 2.9

 

$ 6.6

 

 

$ 6.6

 

 

$ 3.2

 

$ (0.0

)

 

$ (0.0

)

 

 

Additional Stock-Based Compensation Expense and Related Tax Adjustments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional stock-based
compensation expense

 

$ 1.3

 

$ 4.4

 

$ 11.3

 

$ 26.6

 

$ 6.1

 

$ 3.7

 

 

$ 53.4

 

 

$ 2.2

 

$ 2.6

 

 

58.2

 

 

 

Other tax adjustments(b)

 

 

1.0

 

10.3

 

1.6

 

0.9

 

(0.4

)

 

13.4

 

 

(12.2

)

(0.6

)

 

0.6

 

 

 

Additional operating expenses

 

1.3

 

5.4

 

21.6

 

28.2

 

7.0

 

3.3

 

 

66.8

 

 

(10.0

)

2.0

 

 

58.8

 

 

 

Income tax expense (benefit)

 

(0.5

)

(1.6

)

(3.5

)

(7.3

)

4.2

 

(1.5

)

 

(10.2

)

 

 

 

 

(10.2

)

 

 

Net adjustment

 

$ 0.8

 

$ 3.8

 

$ 18.1

 

$ 20.9

 

$ 11.2

 

$ 1.8

 

 

$ 56.6

 

 

$ (10.0

)

$ 2.0

 

 

$ 48.6

 

 

 


(a)              The increase in stock-based compensation expense in 2001 primarily reflects the cancellations from our Stock Option Cancel/Regrant Program in March 2001 which resulted in the remaining unamortized deferred compensation being expensed upon cancellation. In addition, the remaining amount of deferred compensation totaling $0.1 million at December 31, 2005 was

61




eliminated in accordance with the provisions of SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS 123R, which we adopted effective January 1, 2006.

(b)    Reflects the accrual of payroll related tax adjustments in 1999 through 2002, and a reduction of such accruals due to the expiration of statutory requirements in 2003 through 2005.

The following table summarizes the impact of the additional stock-based compensation expense resulting from the review of our equity award practices on our previously-reported stock-based compensation expense on an annual basis, excluding the impact of an additional $0.6 million and $5.7 million in 2002 and 2003, respectively, related to the theft of shares by the Company’s former stock administrator:

 

 

Stock-Based Compensation Expense

 

 

 

As Reported

 

Adjustments

 

As Restated

 

 

 

(in millions)

 

Year ended December 31, 2005

 

 

$ 0.1

 

 

 

$ 2.6

 

 

 

$ 2.7

 

 

Year ended December 31, 2004

 

 

0.2

 

 

 

2.2

 

 

 

2.4

 

 

Year ended December 31, 2003

 

 

6.3

 

 

 

3.7

 

 

 

10.0

 

 

Year ended December 31, 2002

 

 

 

 

 

6.1

 

 

 

6.1

 

 

Year ended December 31, 2001

 

 

 

 

 

26.6

 

 

 

26.6

 

 

Year ended December 31, 2000

 

 

 

 

 

11.3

 

 

 

11.3

 

 

Year ended December 31, 1999

 

 

 

 

 

4.4

 

 

 

4.4

 

 

Year ended December 31, 1998

 

 

 

 

 

1.3

 

 

 

1.3

 

 

 

 

 

$ 6.6

 

 

 

$ 58.2

 

 

 

$ 64.8

 

 

 

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The following table presents the impact of the additional stock-based compensation expense-related adjustments and the discontinuance of our international businesses on our consolidated balance sheet as of December 31, 2002:

RECONCILIATION OF CONSOLIDATED BALANCE SHEET FOR 2002
(in millions)

 

 

 

 

Adjustment for

 

 

 

 

 

 

 

 

 

 

 

International

 

As Restated for

 

Adjustment for

 

 

 

 

 

 

 

Discontinued

 

Discontinued

 

Stock Based

 

 

 

 

 

As Reported

 

Operations

 

Operations

 

Expenses

 

As Restated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

98.1

 

 

 

$

(1.1

)

 

 

$

97.0

 

 

 

$

 

 

 

$

97.0

 

 

Accounts receivable, net

 

 

50.9

 

 

 

(4.7

)

 

 

46.2

 

 

 

 

 

 

46.2

 

 

Accounts receivable—related party

 

 

0.4

 

 

 

(0.4

)

 

 

0.0

 

 

 

 

 

 

 

 

Prepaid expenses

 

 

1.6

 

 

 

(0.1

)

 

 

1.5

 

 

 

 

 

 

1.5

 

 

Employee loans and advances

 

 

0.2

 

 

 

(0.1

)

 

 

0.1

 

 

 

 

 

 

0.1

 

 

Other current assets

 

 

2.1

 

 

 

(0.8

)

 

 

1.3

 

 

 

 

 

 

1.3

 

 

Current assets of discontinued operations

 

 

18.7

 

 

 

8.2

 

 

 

26.9

 

 

 

 

 

 

26.9

 

 

Total current assets

 

 

172.0

 

 

 

1.0

 

 

 

173.0

 

 

 

 

 

 

173.0

 

 

Property and equipment, net

 

 

11.7

 

 

 

(1.1

)

 

 

10.6

 

 

 

 

 

 

10.6

 

 

Goodwill

 

 

25.5

 

 

 

 

 

 

25.5

 

 

 

 

 

 

25.5

 

 

Deferred tax assets, net

 

 

5.4

 

 

 

 

 

 

5.4

 

 

 

 

 

 

5.4

 

 

Investments in unconsolidated affiliates

 

 

4.1

 

 

 

 

 

 

4.1

 

 

 

 

 

 

4.1

 

 

Other assets

 

 

0.3

 

 

 

 

 

 

0.3

 

 

 

 

 

 

0.3

 

 

Other assets of discontinued operations

 

 

1.3

 

 

 

1.1

 

 

 

2.4

 

 

 

 

 

 

2.4

 

 

Total assets

 

 

$

220.3

 

 

 

$

1.0

 

 

 

$

221.3

 

 

 

$

 

 

 

$

221.3

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities: