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NCIT > SEC Filings for NCIT > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for NCI, INC.


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q, including the section titled "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. There are statements made herein, which may not address historical facts and, therefore, could be interpreted to be forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Such statements are subject to factors that could cause actual results to differ materially from anticipated results. The factors that could cause actual results to differ materially from those anticipated include, but are not limited to, the following:

Our dependence on our contracts with U.S. Federal Government agencies, particularly within the U.S. Department of Defense, for the majority our revenue; a change in funding of our contracts due to bid protests; changes in U.S. Federal Government spending priorities; changes in contract type, particularly changes from cost-plus fee or time-and-material type contracts to firm fixed-price type contracts

A reduction in the overall U.S. Defense budget, volatility in spending authorizations for Defense and Intelligence-related programs by the U.S. Federal Government or a shift in spending to programs in areas where we do not currently provide services

U.S. Federal Governmental shutdowns (such as the shutdown that occurred during the U.S. Federal Government's 1996 fiscal year) and other potential delays in the U.S. Federal Government appropriations process, or budgetary cuts resulting from Congressional committee recommendations or automatic sequestration under the Budget Control Act of 2011)

Changes in U.S. Federal Government programs or requirements, including the increased use of small business providers

Failure to achieve contract awards in connection with recompetes for present business and/or competition for new business

U.S. Federal Government agencies more frequently awarding contracts on a technically acceptable/lowest cost basis in order to reduce expenditures

Adverse results of U.S. Federal Government audits of our government contracts

Competitive factors, such as pricing pressures and competition to hire and retain employees (particularly those with security clearances)

Failure to identify and successfully integrate future acquired companies or businesses into our operations or to realize any accretive or synergistic effects from such acquisitions, or effectively integrate acquisitions appropriate to the achievement of our strategic plans

Economic conditions in the United States, including conditions that result from terrorist activities or war

Material changes in policies, laws, or regulations applicable to our businesses, particularly legislation affecting (i) U.S. Federal Government contracts for services, (ii) outsourcing of activities that have been performed by the U.S. Federal Government, (iii) U.S. Federal Government contracts containing organizational conflict of interest clauses,
(iv) delays related to agency specific funding freezes, and
(v) competition for task orders under Government Wide Acquisition Contracts, agency-specific Indefinite Delivery/Indefinite Quantity contracts and/or schedule contracts with the General Services Administration

U.S. Federal Government's "insourcing" of previously contracted support services and the realignment of funds to non-defense related programs

Our ability to achieve the objectives of near-term or long-range business plans, particularly revenue growth

Risk of contract non-performance or termination

Some of these important factors are outlined under Item 1A. Risk Factors and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC, and from time to time, in other filings with the SEC, such as our Forms 8-K and 10-Q. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee our future results, level of activity, or performance. We undertake no obligation to update publicly or revise any forward-looking statements. You should not place undue reliance on any forward-looking statements.

In this document, unless the context indicates otherwise, the terms "Company," "NCI," "we," "us," and "our" refer to NCI, Inc., a Delaware corporation, and, where appropriate, its subsidiaries.


Overview

We are a provider of information technology (IT) and professional engineering services and solutions to U.S. Federal Government agencies. Our technology and industry expertise enables us to provide a full spectrum of services and solutions that assist our customers in achieving their program goals. We deliver a wide range of complex services and solutions by leveraging our skills across eight core competencies.

Enterprise systems management

Network engineering

Cybersecurity and information assurance

Software development and systems engineering

Program management and lifecycle support

Engineering and logistics

Health IT and informatics

Training and simulation

We generate the majority of our revenue from U.S. Federal Government contracts. We report operating results and financial data as one operating segment. Revenue from our contracts and task orders is generally linked to trends in U.S. Federal Government spending by defense, intelligence, and U.S. Federal civilian agencies.

Key Financial Metrics

Prime Contractor Revenue

The following table shows our revenue derived from contracts on which we serve
as a prime contractor.



                                       Three months ended September 30,                   Nine months ended September 30,
                                      2012                         2011                   2012                       2011
Revenue derived from prime
contracts                                    87 %                         89 %                  87 %                       90 %

Customer Group Revenue

The following table shows our revenue from the client groups listed as a
percentage of total revenue for the period shown.



                                         Three months ended September 30,                   Nine months ended September 30,
                                        2012                         2011                   2012                       2011
Department of Defense and
intelligence agencies                          75 %                         82 %                  76 %                       87 %
U.S. Federal civilian
agencies                                       25 %                         18 %                  24 %                       13 %

The increase in the percentage of total revenue earned on work for Federal civilian agencies was primarily due to our revenue earned on work for U.S Federal civilian agencies remaining fairly constant in absolute dollars combined with lower revenue earned on work for Federal Department of Defense and intelligence agencies.

Contract Type Revenue

Our services and solutions are provided under three types of contracts:
time-and-materials; cost-plus fee; and firm fixed-price. Our contract mix varies from year to year due to numerous factors including our business strategies and U.S. Federal Government procurement objectives.

The following table shows our revenue from each of these types of contracts as a percentage of our total revenue for the periods shown.

--------------------------------------------------------------------------------
                         Three months ended September 30,              Nine months ended September 30,
                         2012                        2011               2012                      2011
Time-and-materials              24 %                        30 %              25 %                      44 %
Cost-plus fee                   49 %                        43 %              51 %                      29 %
Firm fixed-price                27 %                        27 %              24 %                      27 %

The increase in our revenue under cost-plus fee type contracts primarily resulted from the transition of our U.S. Army Program Executive Office (PEO) Soldier contract from a time-and-materials type contract to a cost-plus fee type contract during the second quarter of 2011.

The amount of risk and potential reward varies under each type of contract. Under time-and-materials contracts, we are paid a fixed hourly rate by labor category. To the extent that our actual labor costs vary significantly from the negotiated hourly rates, we may generate more or less than the targeted amount of profit. We are typically reimbursed for other contract direct costs and expenses at our cost, and typically receive no fee on those costs. Under cost-plus fee contracts, there is limited financial risk, because we are reimbursed all our allowable costs, and therefore the profit margins tend to be lower on cost-plus fee contracts. Under firm fixed-price contracts, we perform specific tasks or provide specified goods for a predetermined price. Compared to time-and-materials and cost-plus fee contracts, firm fixed-price service contracts generally offer higher profit margin opportunities but involve greater financial risk because we would bear the impact of potential cost overruns in return for the full benefit of any cost savings. The majority of the services work we do under firm fixed-price service contracts is firm fixed-price level-of-effort work, which has a lower risk than firm fixed-price completion or deliverable contracts.

Contract Backlog



              As of                 Funded backlog       Total backlog
                                              (in millions)
              September 30, 2012   $            249     $           910
              December 31, 2011                 220               1,001

We define backlog as our estimate of the remaining future revenue from existing signed contracts over the remaining base contract performance period and from the option periods of those contracts, assuming the exercise of all related options. We define funded backlog as the portion of backlog for which funding currently is appropriated and obligated to us under a contract or other authorization for payment signed by an authorized purchasing agency, less the amount of revenue we have previously recognized. Our backlog does not include any estimate of future potential delivery orders that might be awarded under our Government Wide Acquisition Contract (GWAC) or other multiple-award contract vehicles. Additional information on how we determine backlog is included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC.

Other Significant Financial Events

AdvanceMed Acquisition

On April 1, 2011, pursuant to the terms of a Securities Purchase Agreement (the "Purchase Agreement") dated February 24, 2011, we completed our purchase of 100% of the stock of AdvanceMed from an affiliate of Computer Sciences Corporation. NCI acquired AdvanceMed to enhance the scope of our information technology and professional services in general and to develop our data analytics and informatics practice.

Under the terms of the Purchase Agreement, we acquired AdvanceMed for $63.3 million in cash. The transaction was funded through cash on hand and borrowings under our existing credit facility.

The acquisition has been accounted for under the Purchase method of accounting which requires the total purchase consideration to be allocated to the assets acquired and liabilities assumed based on estimates of fair value. The excess of the purchase consideration over the amounts assigned to tangible or intangible assets acquired and liabilities assumed is recognized as goodwill.


Results of Operations

Three Months Ended September 30, 2012 Compared to Three Months Ended
September 30, 2011

The following table sets forth certain items from our consolidated statements of
income and expresses each item in dollars and as a percentage of revenue for the
periods indicated:



                                                          Three months ended September 30,
                                           2012            2011             2012                   2011
                                              (in thousands)               (as a percentage of revenue)
Revenue                                  $  88,467       $ 132,004              100.0 %               100.0 %

Operating expenses:
Cost of revenue                             77,147         116,855               87.2                  88.5
General and administrative expenses          6,251           6,768                7.1                   5.2
Depreciation and amortization                1,681           1,870                1.9                   1.4
Stock option purchase                        2,311              -                 2.6                   0.0
Acquisition and integration related
expenses                                        -               54                0.0                   0.0
Goodwill impairment                         92,793              -               104.9                   0.0

Total operating expenses                   180,184         125,547              203.7                  95.1

Operating income (loss)                    (91,717 )         6,457             (103.7 )                 4.9
Interest expense, net                          266             503                0.3                   0.4

Income (loss) before income taxes          (91,983 )         5,954             (104.0 )                 4.5
Provision (benefit) for income taxes       (36,788 )         2,472               41.6                   1.9

Net income (loss)                        $ (55,195 )     $   3,482              (62.4 )%                2.6 %

Revenue

For the three months ended September 30, 2012, total revenue decreased by 33.0%, or $43.5 million, over the same period a year ago. This decrease in revenue was primarily due to a net decrease of approximately $22.5 million as a result of reductions of scope of work, the expiration of task orders and contracts, and certain lost contract recompetes, and the ending of our Base Realignment and Closure (BRAC) related and other non-core programs, which collectively accounted for $16.3 million of the decline in revenue year-over-year. Our PEO Soldier program decreased $4.7 million year-over-year mostly due to a reduced scope of work. During the third quarter of 2012, our PEO Soldier program accounted for 16.3% of our revenue as compared with 14.5% of our revenue for the same period during 2011.

Cost of revenue

Cost of revenue decreased 34.0%, or $39.7 million, for the three months ended September 30, 2012, as compared to the same period a year ago. The decrease was attributable to decreases in direct labor and associated indirect costs and hardware and product related expenses associated with the ending of our BRAC related and other non-core programs. As a percentage of revenue, cost of revenue was 87.2% and 88.5% for the quarters ended September 30, 2012 and 2011, respectively. The 1.3% decrease in cost of revenue as a percentage of revenue resulted from a decrease in lower-margin BRAC related and other non-core material costs and direct labor costs for the quarter ended September 30, 2012, compared to the quarter ended September 30, 2011, and from losses incurred on two unrelated fixed-price contracts that contributed to the cost of revenue for the quarter ended September 30, 2011.

General and administrative expenses

General and administrative expenses decreased 7.6%, or $0.5 million, for the three months ended September 30, 2012 as compared to the same period a year ago. The decrease was primarily due to lower compensation expense and to a lesser extent the timing of certain accrued expenses.

Depreciation and amortization

Depreciation and amortization expense was approximately $1.7 and $1.9 million for the quarters ended September 30, 2012 and 2011, respectively. The decrease was primarily due to reduced amortization expense of intangible assets associated with prior acquisitions.

Stock option purchase

In September 2012, we completed a cash tender offer for certain out-of-the-money stock options held by current and former employees, officers, and directors of NCI that were granted prior to January 1, 2012, provided that such stock options had not expired or terminated prior to the


expiration of the offering period on September 19, 2012. For the three months ended September 30, 2012, costs associated with the stock option purchase were approximately $2.3 principally consisting of $2.2 million related to the remaining unamortized stock based compensation expense associated with the unvested portion of the options tendered in the offer, plus $0.1 million related to associated payroll taxes, professional fees and other costs.

Acquisition and integration related expenses

On April 1, 2011, we completed the acquisition of AdvanceMed. For the three months ended September 30, 2011, acquisition expenses were $0.1 million principally consisting of accounting, legal and investment banking fees. There were no acquisition related costs for the three months ended September 30, 2012.

Goodwill impairment

On September 30, 2012, we completed a test for goodwill impairment due to certain triggering events and determined a goodwill impairment existed. For the three months ended September 30, 2012, we took a $92.8 million goodwill impairment. No goodwill impairment existed for the three months ended September 30, 2011.

Operating income

For the three months ended September 30, 2012, net operating loss was $91.7 million, or 103.7% of revenue, as compared to $6.5 million, or 4.9% of revenue, for the three months ended September 30, 2011. Operating income was lower for the three months ended September 30, 2012 due to costs associated with the impairment charge and the stock option tender offer.

Interest Expense, net

Net interest expense was approximately $0.3 million for the quarter ended September 30, 2012 as compared to net interest expense of $0.5 million for the corresponding quarter during 2011. The decrease was primarily attributed to a lower overall weighted average loan balance, offset slightly by a higher weighted average borrowing rate.

Income taxes

For the three months ended September 30, 2012, the decrease in income taxes of $39.3 million was the result of the decrease in pretax income due to the goodwill impairment, partially offset by a slightly lower effective income tax rate. The effective income tax rate was approximately 40.0% and 41.5% for the quarters ended September 30, 2012 and 2011, respectively. The lower effective income tax rate for the three months ended September 30, 2012 was the result of an increase in the permanent differences as a percent of lower book income due to the goodwill impairment.


Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

The following table sets forth certain items from our consolidated statements of income and expresses each item in dollars and as a percentage of revenue for the periods indicated:

                                                           Nine months ended September 30,
                                          2012             2011              2012                    2011
                                              (in thousands)                 (as a percentage of revenue)
Revenue                                 $ 278,729        $ 443,432              100.0 %                 100.0 %

Operating expenses:
Cost of revenue                           244,855          395,781               87.9                    89.3
General and administrative expenses        19,377           18,612                7.0                     4.2
Depreciation and amortization               5,145            4,995                1.8                     1.1
Stock option tender offer                   2,311               -                 0.8                     0.0
Acquisition and integration related
expenses                                       -             1,003                0.0                     0.2
Goodwill impairment                        92,793               -                33.3                     0.0

Total operating expenses                  364,481          420,391              130.8                    94.8

Operating income (loss)                   (85,752 )         23,041              (30.8 )                   5.2
Interest expense, net                       1,077            1,183                0.4                     0.3

Income (loss) before income taxes         (86,829 )         21,858              (31.2 )                   4.9
Provision (benefit) for income
taxes                                     (34,698 )          8,825               12.5                     2.0

Net income (loss)                       $ (52,131 )      $  13,033              (18.7 )%                  2.9 %

Revenue

For the nine months ended September 30, 2012, total revenue decreased 37.1%, or $164.7 million, over the same period a year ago. This decrease in revenue was primarily due to the ending of our BRAC related and other non-core programs in 2011 which collectively accounted for $79.9 million of the decrease in revenue year-over-year, and a net decrease of approximately $65.4 million in revenue as a result of reductions of scope of work, the expiration of task orders and contracts, and certain lost contract recompetes. Our PEO Soldier program decreased $19.4 million in revenue year-over-year. These decreases were partially offset by revenue from our acquisition of AdvanceMed in 2011. During the first nine months of 2012, our PEO Soldier program accounted for 17.2% of our revenue as compared with 15.2% of our revenue for the same period during 2011. The increase was due to our top line revenue year over year decreasing more than the dollar decrease in the PEO Soldier program year over year.

Cost of revenue

Cost of revenue decreased 38.1%, or $150.9 million, for the nine months ended September 30, 2012, as compared to the same period a year ago. The decrease was attributable to decreases in direct labor and associated indirect costs, subcontractor labor costs, and hardware and product related costs due to the decrease in revenue primarily associated with the ending of our BRAC related and other non-core programs in 2011. As a percentage of revenue, cost of revenue was 87.9% and 89.3% for the nine months ended September 30, 2012 and 2011, respectively. The 1.6% decrease in cost of revenue as a percentage of revenue is due to decreases in lower-margin BRAC related and other non-core material costs, subcontractor labor costs and direct labor costs, and from losses incurred on two unrelated fixed-price contracts that contributed to the cost of revenue for the nine months ended September 30, 2011.

General and administrative expenses

General and administrative expenses increased 4.1%, or $0.8 million, for the nine months ended September 30, 2012, as compared to the same period a year ago. The increase was primarily due to general and administrative expenses associated with programs resulting from the acquisition of AdvanceMed, and higher stock compensation expense.

Depreciation and amortization

Depreciation and amortization expense was approximately $5.1 and $5.0 million for the nine months ended September 30, 2012 and 2011, respectively. The increase was primarily associated with the AdvanceMed acquisition which included significant property and equipment and purchased identified intangible assets.

Stock option tender offer

In September 2012, we completed a cash tender offer for certain out-of-the-money stock options held by current and former employees, officers, and directors of NCI that were granted prior to January 1, 2012, provided that such stock options had not expired or terminated prior to the


expiration of the offering period on September 19, 2012. For the nine months ended September 30, 2012, costs associated with the stock option purchase were approximately $2.3 million principally consisting of $2.2 million related to the remaining unamortized stock based compensation expense associated with the unvested portion of the options tendered in the offer, plus $0.1 million related to associated payroll taxes, professional fees and other costs.

Goodwill impairment

On September 30, 2012, we completed a test for goodwill impairment due to certain triggering events and determined a goodwill impairment existed. For the nine months ended September 30, 2012, we took a $92.8 million goodwill impairment. No goodwill impairment existed for the nine months ended September 30, 2011.

Acquisition and integration related expenses

On April 1, 2011, we completed the acquisition of AdvanceMed. For the nine months ended September 30, 2011, acquisition expenses were $0.1 million, principally consisting of accounting, legal and investment banking fees. There were no acquisition-related costs for the nine months ended September 30, 2012.

Operating income

For the nine months ended September 30, 2012, net operating loss was $85.8 million, or 30.8% of revenue, as compared to $23.0 million, or 5.2% of revenue, for the nine months ended September 30, 2011. Operating income was lower for the nine months ended September 30, 2012 due to costs associated with the impairment charge and the stock option tender offer, lower labor-related profit margin on the PEO Soldier program, and higher indirect costs as a percentage of revenue.

Interest expense, net

Net interest expense was approximately $1.1 million for the nine months ended September 30, 2012 and approximately $1.2 million for the nine months ended September 30, 2011. The decrease was primarily attributed to a higher weighted average borrowing rate on a lower weighted average loan and an increase in the interest expense related to the unutilized portion of NCI's credit facility.

Income taxes

For the nine months ended September 30, 2012, income taxes decreased by $43.5 million from $8.8 million for the nine months ended September 30, 2011, on a lower pretax income and a slightly lower effective tax rate. The effective income tax rate for the nine months ended September 30, 2012 was approximately 40.0% as compared to an effective income tax rate of 40.4% for the nine months ended September 30, 2011. The lower effective income tax rate for the nine months ended September 30, 2012 was the result of lower permanent difference amounts as a percent of lower book income due to the goodwill impairment.

Liquidity and Capital Resources

Our primary liquidity needs are for financing working capital, capital expenditures, and making selective strategic acquisitions. Historically, we have relied primarily on our cash flow from operations and borrowings under our credit facility to provide the capital for our liquidity needs. As part of our growth strategy, we may pursue acquisitions that could require us to incur additional debt or issue new equity. We expect the combination of our current . . .

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