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Wireless Facilities Learns a Hard Lesson

The tech outsourcer discovers continually missing guidance won't please the Street.

'Taint what you do, it's the way that you do it.

That old jazz standard should have been playing Monday when

Wireless Facilities


posted its third-quarter earnings and began mourning over what is already shaping up to be a dismal fourth quarter.

WFI manages outsourced wireless engineering and network projects, and it's clearly choosing to do the right projects. Just look at some of its recent contracts: supplying RFID technology to the Department of Defense and wireless services to Madison, Wis. It also is partnering with


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in a bid to make San Francisco a 49-square-mile wireless zone.

But these are fixed-price contracts, so they're only as valuable as WFI's ability to keep costs down. That, as the song goes, is what gets results. But when investors took a look at WFI's results Monday morning, they quickly drove its stock down 23%. WFI's third-quarter EPS was in line with analysts' forecasts, but only because of a $1.9 million benefit for income taxes.

In the fourth quarter, the performance is expected to be worse: CEO Eric DeMarco said EPS could fall to 5 cents, or half what analysts had been expecting. Fourth-quarter revenue will be "roughly flat" with the third, the company said.

After a daylong tug-of-war between bulls who held faith in WFI's long-term opportunities and bears who question its ability to get there, the stock had drifted back up to $5.95 by Monday's close, a moderate recovery from the morning carnage but still a 13% drop. Volume was nine times heavier than normal.

That ambivalence is also reflected in the reaction of analysts to WFI's report. "I'm bullish on the industry in general," said Seth Potter of Punk Ziegel, which has no underwriting relationship with the company. "And the company itself is diversified. But there's always something like this coming up. This is not an unusual situation this quarter." Potter is maintaining a market perform rating on WFI.

In the second quarter, for example, WFI missed revenue estimates because of contract delays and took a $1 million charge related to unexpected fees. The company has missed its own guidance figures for three quarters running.

WFI cited out-of-control costs on key contracts near the Gulf Coast and in Latin America. Labor and material costs are ballooning in the hurricane-battered southeastern U.S., where WFI has 60% of its enterprise business; and in Latin America, where managers apparently let project costs spiral out of control.

DeMarco said the hurricanes battering the Gulf Coast had driven up the cost of raw materials and subcontracting labor. What's more, the need to rebuild is so much stronger in other areas that the work on these contracts is likely to be delayed. CFO Deanna Lund said the heaviest hurricane-related costs would take one to two percentage points out of fourth-quarter gross margin.

The problems in WFI's Latin America division, which appeared to be centered on work for Spanish carrier


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, resulted in adjustments of $3 million, caused by "cost overruns" that occurred when "out of scope and additional work had been performed without formal documentation and formal pricing increases."

Although the spendthrifts in charge of those projects have been shown the door, WFI will lose $15 million in the next couple of quarters as the new managers get up to speed. Reorganization costs will likely reach $1 million in the fourth quarter.

DeMarco said it was "fortunate" the mishap happened in the latter months of the year, as "new contracts in Latin America don't happen until January and February and our backlog is intact contractually." Revenue from the region is likely to see year-on-year growth in the first half of 2006, he said.

In the conference call, DeMarco did his best to address the problems head on and highlight potential growth areas in 2006. In addition, the company can continue leverage growth in operating income by keeping selling, general and administrative costs down.

"Theoretically, if revenue grew 10% next year, EPS could grow 15%," said DeMarco. "If we made an acquisition or two, 20% EPS growth is doable for us. That's very achievable."

That bullish comment seemed to strike a nerve with some on the conference call. "You've missed earnings and revenue projections for three quarters now," said Tim Hasara, a portfolio manager at Kennedy Capital. "Can't you refrain from optimistic forecasts you can't meet?"

"Being 14 months out from the end of 2006," DeMarco replied, "it's hard to give guidance."

"But you did," Hasara shot back. "Saying 15% growth -- that's guidance."

And therein lies a lesson that many tech companies, not just WFI, have had to learn the hard way. Investors can forgive an earnings miss if a series of devastating storms drive up costs. They'll even cut some slack as you find your footing in a foreign market. But if, after hitting a bunch of speed bumps, you don't have the sense to hit the brakes on your guidance, heaven help you.

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long ago learned this trick: In growing but uncertain markets, conservative estimates are safest. With tech stocks in particular, that's the way that you do it.