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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED MARCH 31, 2017

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

Commission File Number 000-51579

LOGO

NCI, Inc.

(Exact name of registrant as specified in its charter)

Delaware

20-3211574

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)



11730 Plaza America Drive Reston, Virginia		20190-4764
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (703) 707-6900

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 ☐ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes ☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (§230.405 of this chapter) or Rule 12b-2 of the Securities Exchange Act of 1934 (§240.12b-2 of this chapter).

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

As of May 3, 2017, there were 9,051,817 shares outstanding of the registrant’s Class A common stock. In addition, there were 4,500,000 shares outstanding of the registrant’s Class B common stock, which are convertible on a one-for-one basis into shares of Class A common stock.

NCI, INC.


		PAGE
PART I:	UNAUDITED FINANCIAL INFORMATION		1

Item 1.	Condensed Consolidated Financial Statements		1

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		9

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		14

Item 4.	Controls and Procedures		15

PART II:	OTHER INFORMATION		16

Item 1.	Legal Proceedings		16

Item 1A.	Risk Factors		16

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		16

Item 3.	Defaults Upon Senior Securities		16

Item 4.	Mine Safety Disclosures		17

Item 5.	Other Information		17

Item 6.	Exhibits		18

	Signatures		19

PART 1

FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

NCI, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(in thousands, except per share data)


	Three months ended March 31,
	2017			2016
Revenue	$	78,751		$	83,655
Operating expenses:
Cost of revenue		64,696			69,693
General and administrative expenses		6,690			6,107
Depreciation and amortization		1,788			1,792
Misappropriation loss and related expenses		6,617			1,541

Total operating expenses		79,791			79,133

Operating (loss) income		(1,040	)		4,522
Interest expense, net		208			190

(Loss) income before income taxes		(1,248	)		4,332
(Benefit) provision for income taxes		(441	)		1,743

Net (loss) income	$	(807	)	$	2,589

(Loss) earnings per common and common equivalent share:
Basic:
Weighted average shares outstanding		13,277			13,153
Net (loss) income per share	$	(0.06	)	$	0.20

Diluted:
Weighted average shares outstanding		13,277			13,867
Net (loss) income per share	$	(0.06	)	$	0.19

Cash dividend declared and paid per share	$	—		$	0.15

The accompanying notes are an integral

part of these condensed consolidated financial statements

NCI, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(in thousands, except par value)


	As of March 31, 2017			As of December 31, 2016
Assets:
Current assets:
Cash and cash equivalents	$	1,851		$	1,014
Accounts receivable, net		53,857			51,112
Prepaid expenses and other current assets		5,915			4,062

Total current assets		61,623			56,188
Property and equipment, net		5,591			6,332
Other assets		1,520			1,526
Deferred tax assets, net		41,833			41,912
Intangible assets, net		14,678			15,586
Goodwill		33,878			33,878

Total assets	$	159,123		$	155,422

Liabilities and stockholders’ equity:
Current liabilities:
Current portion of long-term debt	$	2,000		$	—
Accounts payable		10,934			9,995
Accrued salaries and benefits		17,748			17,665
Deferred revenue		4,689			4,571
Other accrued expenses		9,468			6,306

Total current liabilities		44,839			38,537

Other long-term liabilities		2,555			2,545

Total liabilities		47,394			41,082

Stockholders’ equity:
Class A common stock, $0.019 par value—37,500 shares authorized; 9,944 shares issued and 9,027 shares outstanding as of March 31, 2017, and 10,002 shares issued and 9,085 shares outstanding as of December 31, 2016		189			189
Class B common stock, $0.019 par value—12,500 shares authorized; 4,500 shares issued and outstanding as of March 31, 2017 and December 31, 2016		86			86
Additional paid-in capital		75,082			76,886
Treasury stock at cost—917 shares of Class A common stock as of March 31, 2017 and December 31, 2016		(8,331	)		(8,331	)
Retained earnings		44,703			45,510

Total stockholders’ equity		111,729			114,340

Total liabilities and stockholders’ equity	$	159,123		$	155,422

The accompanying notes are an integral

part of these condensed consolidated financial statements

NCI, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)


	Three months ended March 31,
	2017			2016
Cash flows from operating activities:
Net (loss) income	$	(807	)	$	2,589
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,788			1,792
Share-based compensation		361			329
Deferred income taxes		80			67
Changes in operating assets and liabilities:
Accounts receivable, net		(2,745	)		(8,892	)
Prepaid expenses and other assets		(1,847	)		(1,233	)
Accounts payable		939			(1,738	)
Accrued expenses and other liabilities		3,372			(1,072	)

Net cash provided by (used in) operating activities		1,141			(8,158	)

Cash flows from investing activities:
Purchases of property and equipment		(140	)		(339	)

Net cash used in investing activities		(140	)		(339	)

Cash flows from financing activities:
Borrowings under credit facility		23,194			47,233
Repayments on credit facility		(21,194	)		(36,733	)
Proceeds from exercise of stock options		127			172
Purchase of equity awards		(2,291	)		—
Dividends paid		—			(2,020	)

Net cash (used in) provided by financing activities		(164	)		8,652

Net change in cash and cash equivalents		837			155
Cash and cash equivalents, beginning of period		1,014			233

Cash and cash equivalents, end of period	$	1,851		$	388

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	190		$	104

Income taxes	$	—		$	327

The accompanying notes are an integral

part of these condensed consolidated financial statements

NCI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of NCI, Inc. and its subsidiaries (“NCI” or “the Company”) have been prepared in accordance with generally accepted accounting principles in the U. S. (“GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). As a result, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments necessary to fairly present the Company’s financial position as of March 31, 2017 and its results of operations and cash flows for the three months ended March 31, 2017 and 2016, which consist of normal and recurring adjustments. The information disclosed in the notes to the financial statements for these periods is unaudited. The current period’s results of operations are not necessarily indicative of results that may be achieved for any future period. All numbers in tables are presented in thousands except share and per share numbers. For further information, refer to the financial statements and footnotes included in NCI’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC .

Recently Issued Accounting Pronouncements

In March 2016, the FASB issued ASU 2016-09, which simplifies several aspects of the accounting for share-based payments, including immediate recognition of all excess tax benefits and deficiencies in the income statement, changing the threshold to qualify for equity classification up to the employees’ maximum statutory tax rates, allowing an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures as they occur, and clarifying the classification on the statement of cash flows for the excess tax benefit and employee taxes paid when an employer withholds shares for tax-withholding purposes. The Company adopted ASU 2016-09 effective January 1, 2017 on a prospective basis. The Company elected to continue to estimate the number of awards that are expected to vest.

2. Business Overview

NCI is a leading provider of enterprise solutions and services to U.S. defense, intelligence, health care and civilian government agencies. We have the expertise and proven track record to solve our customers’ most important and complex mission challenges through technology and innovation. Our team of highly skilled professionals focuses on delivering cost-effective solutions and services in the areas of agile software application and systems development/integration; cybersecurity and information assurance; engineering and logistics support; enterprise information management and advanced analytics; cloud computing and IT infrastructure optimization; health IT and medical support; IT service management; and modeling, simulation and training. Headquartered in Reston, Virginia, we have approximately 2,000 employees operating at more than 100 locations worldwide. The majority of the Company’s revenue was derived from contracts with the U.S. Federal Government, directly as a prime contractor or as a subcontractor. NCI primarily conducts business throughout the U. S. The Company reports operating results and financial data as one reportable segment.

For the three months ended March 31, 2017, the Company generated approximately 61% of revenue from the Department of Defense, including agencies within the intelligence community, and approximately 39% of revenue from federal civilian agencies. For the three months ended March 31, 2016, the Company generated approximately 63% of revenue from the Department of Defense, including agencies within the intelligence community, and approximately 37% of revenue from federal civilian agencies.

NCI’s Program Executive Office Soldier (“PEO Soldier”) contract is the Company’s largest revenue-generating contract and accounted for approximately 16% of revenue for the three months ended March 31, 2017 and 2016, respectively. The Company’s PEO Soldier program is a cost-plus fee contract consisting of a base period and four option periods for a total term of five years, which commenced in October 1, 2015. NCI’s Cyber Network Operations and Security Support (“CNOSS”) program, supporting the U.S. Army Network Enterprise Technology Command accounted for approximately 12% and 10% of revenue for the three months ended March 31, 2017 and 2016, respectively. This cost-plus-fixed-fee, single award indefinite delivery indefinite quantity contract consists of a 12-month base period with two one-year option periods and one six-month option period, and commenced in October 2014.

3. Misappropriation Loss and Related Expenses

As previously disclosed, in January 2017, the Company identified a misappropriation of Company funds by its former controller. An internal investigation of the matter was completed in March 2017, and revealed that the former controller had embezzled $19.4 million through a circumvention of controls, which included transfers from the payroll account to his personal account, creating fictitious invoices, and altering bank account statements to conceal the misappropriations. Misappropriation loss and related expenses totaled approximately $6.6 million and $1.5 million for the quarter ended March 31, 2017 and 2016, respectively. Misappropriation loss and related expenses includes the loss due to embezzled funds as well as external professional service fees including legal, forensic accounting, audit and other consulting fees.


	Three months ended March 31,
	2017		2016
Misappropriation loss	$	380	$	1,541
Expenses related to the misappropriation loss		6,237		—

	$	6,617	$	1,541

4. (Loss) Earnings Per Share

Basic (loss) earnings per share exclude dilution and are computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted (loss) earnings per share reflect potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted (loss) earnings per share include the incremental effect of stock options calculated using the treasury stock method. Shares that are anti-dilutive are not included in the computation of diluted (loss) earnings per share. For the three months ended March 31, 2017 and 2016, approximately 820,000 and 30,000 shares, respectively, were not included in the computation of diluted (loss) earnings per share, because to do so would have been anti-dilutive. The following details the computation of basic and diluted (loss) earnings per common share (Class A and Class B) for the three months ended March 31, 2017 and 2016.


	Three months ended March 31,
	2017			2016
Net (loss) income	$	(807	)	$	2,589

Weighted average number of basic shares outstanding during the period		13,277			13,153
Effect of dilutive potential common shares		—			714

Weighted average number of diluted shares outstanding during the period		13,277			13,867

Basic (loss) earnings per share	$	(0.06	)	$	0.20

Diluted (loss) earnings per share	$	(0.06	)	$	0.19

5. Accounts Receivable

Accounts receivable consists of billed and unbilled amounts. The following table details accounts receivable at the end of each period:


	As of
	March 31, 2017		December 31, 2016
Billed receivables	$	24,827	$	19,367
Unbilled receivables:
Amounts billable at end of period		24,541		25,484
Other		5,231		7,003

Total unbilled receivables		29,772		32,487

Total accounts receivable		54,599		51,854
Less: Allowance for doubtful accounts		742		742

Total accounts receivable, net	$	53,857	$	51,112

Other unbilled receivables primarily consist of amounts that will be billed upon milestone completions and other accrued amounts that cannot be billed as of the end of the period. Substantially all unbilled receivables are expected to be billed and collected within the next 12 months.

6. Property and Equipment

The following table details property and equipment at the end of each period:


	As of
	March 31, 2017		December 31, 2016
Property and equipment
Furniture and equipment	$	21,939	$	21,799
Leasehold improvements		7,450		7,450
Real property		549		549

		29,938		29,798
Less: Accumulated depreciation and amortization		24,347		23,466

Property and equipment, net	$	5,591	$	6,332

Depreciation and amortization expense for the three months ended March 31, 2017 and 2016 was $0.9 million.

7. Intangible Assets

The following table details intangible assets at the end of each period:


	As of
	March 31, 2017			December 31, 2016
Contract and customer relationships	$	33,284		$	33,284
Developed software		1,113			1,113
Less: Accumulated amortization		(19,719	)		(18,811	)

Intangible assets, net	$	14,678		$	15,586

Amortization expense of intangible assets for the three months ended March 31, 2017 and 2016 was $0.9 million. Intangible assets are primarily amortized on a straight line basis over periods ranging from seven to 11 years. Expected amortization expense for the remainder of the fiscal year ending December 31, 2017, and for each of the fiscal years thereafter, is as follows:


For the year ending December 31,
2017 (remaining nine months)		2,724
2018		3,150
2019		3,049
2020		3,027
2021		2,728

	$	14,678

8. Share-Based Payments

During the three months ended March 31, 2017, the Company did not grant any stock options to purchase shares of common stock. During the three months ended March 31, 2017, 12,500 stock options were exercised at a weighted-average price of $10.13. As of March 31, 2017, there were approximately 1,000,000 stock options outstanding. During the three months ended March 31, 2017, no restricted shares were granted, and 21,253 restricted shares vested. As of March 31, 2017, there were 236,167 shares of restricted stock outstanding.

The following table summarizes stock compensation expense allocated to cost of revenue and general and administrative costs for the three months ended March 31, 2017 and 2016:


	Three months ended March 31,
	2017		2016
Cost of revenue	$	36	$	79
General and administrative		325		250

	$	361	$	329

As of March 31, 2017, there was approximately $3.0 million of total unrecognized compensation cost related to unvested stock compensation arrangements. This cost is expected to be fully amortized over the next five years, with approximately $0.8 million, $0.9 million, $0.6 million, $0.5 million and $0.2 million amortized during the remainder of 2017, and the full years of 2018, 2019, 2020, and 2021, respectively. The cost of stock compensation is included in the Company’s Condensed Consolidated Statements of Operations and expensed over the service period of the equity awards.

On January 6, 2017, pursuant to the terms of the Separation Agreement entered into on November 29, 2016 between the Company and Marco de Vito, our former Chief Operating Officer, the Company paid Mr. de Vito $2.1 million for the repurchase of 272,000 vested stock options, which repurchase represents the difference between the closing price on the date of the agreement and the exercise price of the vested options. The Company recorded the payment as a reduction to additional paid-in capital in the Condensed Consolidated Balance Sheet.

9. Debt

On January 31, 2017, the Company entered into the Fourth Amendment (the “Amendment”) to the Amended and Restated Loan and Security Agreement, dated December 13, 2010, as amended by and among the Company and its subsidiaries, SunTrust Bank, which acted as administrative agent for the lenders, the lenders named therein and the other parties thereto (the “Credit Agreement”). The Amendment modifies certain provisions of the Credit Agreement to, among other things:

•

decrease the Borrowing capacity under the revolving line of credit from $80.0 million to $50.0 million;

•

extend the commitment termination date from January 31, 2017 to May 31, 2017;

•

amend the definition of “Required Lenders” to include all lenders which means, among other things, that amendments to and waivers of the terms of the Credit Agreement, as amended, will require the consent and approval of all lenders; and

•

include additional restrictions with respect to certain acquisitions and restricted payments, including certain acquisitions, dividends, and repurchase or redemption of our capital stock.

The outstanding borrowings are collateralized by a security interest in substantially all of the Company’s assets. The lenders also require a direct assignment of all contracts at the lenders’ discretion. The outstanding balance under the Credit Agreement accrues interest based on one-month LIBOR plus an applicable margin, ranging from 210 to 310 basis points, based on the ratio of our outstanding senior funded debt to Earnings before Interest, Taxes, Depreciation, and Amortization (“EBITDA”) as defined in the Credit Agreement.

Our Credit Agreement (i) restricts our ability to repurchase or redeem our capital stock, or merge or consolidate with another entity; (ii) limits our ability to borrow additional funds or to obtain other financing in the future for working capital, capital expenditures, acquisitions, investments and general corporate purposes; and (iii) limits our ability to dispose of our assets, to create liens on our assets, to extend credit or to issue dividends to our stockholders.

For the first quarter of 2017 and 2016, the Company had a weighted average outstanding loan balance of $2.9 million and $16.5 million, respectively, and a weighted average borrowing rate of 2.9% and 2.5%, respectively.

As of March 31, 2017, the outstanding balance under the credit facility was $2.0 million and interest accrued at a rate of one-month LIBOR plus 210 basis points, or 2.9%.

As of March 31, 2017, the Company was in compliance with all our loan covenants.

10. Income Taxes

As of March 31, 2017, the Company accrued interest expense related to uncertain tax positions totaling $0.7 million. During the three months ended March 31, 2017, the Company recorded $0.1 million in interest expense related to its uncertain tax positions in Interest Expense in the Consolidated Statements of Operations.

11. Leases

In March 2017, the Company executed the sixth amendment to the corporate office lease agreement (“the Lease Amendment”). The Lease Amendment extended the termination date to October 31, 2027 and provided certain rent abatement, tenant allowances, and adjustments to base rent. Minimum lease payments under the Lease Amendment are as follows:


	(in thousands)
For the year ending December 31,
2017 (remaining nine months)		$	1,671
2018			1,967
2019			2,022
2020			2,077
2021			2,135
Thereafter			13,674

Total minimum lease payments		$	23,546

12. Dividends

The Company’s Board of Directors declared and the Company paid the following dividends during the periods presented:

Declaration Date

Dividend
Per Share

Record Date

Total Amount

Payment Date

February 8, 2016

0.15

February 26, 2016

2,020

March 18, 2016

13. Related Party Transactions

The Company purchased services under a subcontract from Renegade Technology Systems, Inc., which is a government contractor wholly-owned by Rajiv Narang, the son of Charles K. Narang, Chairman of the Board of Directors. For the three months ended March 31, 2017 and 2016, the expense incurred under this agreement was approximately $0.4 million and $0.2 million, respectively. As of March 31, 2017 and 2016, outstanding amounts due to Renegade Technology Systems, Inc. under this agreement were $0.3 million and $0.1 million, respectively.

14. Contingencies

Government Audits

Payments to the Company on U.S. Federal Government contracts are subject to adjustment upon audit by various agencies of the U.S. Federal Government. Audits of costs and the related payments have been performed through 2009 for NCI Information Systems, Inc., the Company’s primary corporate vehicle for government contracting. In the opinion of management, the final determination of costs and related payments for unaudited years will not have a material effect on the Company’s financial position, results of operations, or liquidity.

Litigation

Civil Suit Against Former Controller

As previously disclosed on January 23, 2017, the Company commenced an internal investigation upon discovering that its former controller, Jon Frank, had been embezzling money from the Company. Upon completion of the internal investigation, the Company determined that the actual amount of the embezzlement by Mr. Frank during the period from January 2010 through 2017 was approximately $19.4 million. The Company believes that Mr. Frank acted alone and found no evidence that any other NCI employee was aware of or colluded in the embezzlement of Company funds and found no evidence of any unlawful activity apart from that associated with Mr. Frank’s embezzlement of Company funds.

On January 23, 2017, the Company filed a lawsuit against Mr. Frank in the Circuit Court of Fairfax County in the State of Virginia to recover the embezzled funds.

On February 2, 2017, the Honorable Chief Judge White entered an Order for Preliminary Injunction and Asset Freeze (the “Preliminary Injunction”) against Mr. Frank. Among other things, the Preliminary Injunction placed an immediate freeze on all monies and assets of Mr. Frank and ordered Mr. Frank to prepare and deliver to the Company an accounting of his personal assets. In addition, pursuant to the Preliminary Injunction, Mr. Frank agreed to cooperate with the Company to identify, recover and return to the Company all assets that he obtained wrongfully or acquired with wrongfully-obtained funds.

Government Agency Investigations

In connection with the discovery of Mr. Frank’s embezzlement of money from the Company, the Company self-reported such matter to the U.S. Securities and Exchange Commission (“SEC”) and the civil and criminal divisions of the U.S. Department of Justice (“DOJ”).

By letter to the Company dated February 1, 2017, the DOJ has identified the Company as a possible victim of Mr. Frank’s conduct. On February 8, 2017, the SEC commenced a formal investigation and has served the Company with a subpoena requesting certain documents and information relevant to the embezzlement of Company funds by Mr. Frank. The Company is cooperating fully with the DOJ and the SEC in connection with their respective investigations, which are ongoing.

The United States Attorney’s Office for the Eastern District of Virginia (“USAO EDVA”) has opened a civil fraud investigation into the impact of Mr. Frank’s conduct on the Company’s government contracts. The Company is cooperating fully with the USAO EDVA and the Inspectors General of relevant government agencies in connection with this investigation, which is ongoing. At this time, we do not have an estimate of the financial impact on the Company, if any, of the investigation being conducted by the USAO EDVA.

Other Legal Proceedings

The Company is party to various legal actions, claims, government inquiries, and audits resulting from the normal course of business. The Company believes that the probability is remote that any resulting liability will have a material effect on the Company’s financial position, results of operations, or liquidity.

Item 2. Management’s Dis cussion 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; delays performing work under 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

•

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; U.S. Federal Governmental shutdowns (such as the shutdown that occurred during the U.S. Federal Government’s 1996 and 2013 fiscal years); and other potential delays in the U.S. Federal Government appropriations process

•

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

•

the outcome of legal proceedings, investigations and other contingencies, as well as our ability to recover funds embezzled by our former controller

•

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

•

failure to identify and successfully integrate 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 (“GWAC”), agency-specific Indefinite Delivery/Indefinite Quantity (“IDIQ”) contracts and/or schedule contracts with the General Services Administration

•

the 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, and the ability to realize benefits from future deferred tax assets; and

•

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, 2016, as filed with the Securities and Exchange Commission (“SEC”), and from time to time in other filings with the SEC, such as our Current Reports on Forms 8-K and Quarterly Reports on Form 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 services and solutions primarily to U.S. Federal Government agencies. Our technology and industry expertise enables us to provide a wide spectrum of services and solutions that assist our customers in achieving their program goals. We deliver these complex services and solutions by leveraging our skills across six core capabilities:

•

Agile Development and Lean Software O&M

•

Big Data and Data Analytics

•

Cybersecurity and Information Assurance

•

Engineering and Logistics

•

IT Infrastructure Optimization and Service Management

•

Health and Program Integrity

Our team of highly skilled professionals is committed to service excellence and delivers innovative, cost-effective enterprise services and solutions on time and within budget. We are focused on reshaping the way services and solutions are delivered to our customers in order to proactively understand and meet their mission needs and enable them to rapidly adapt to dynamic environments. Headquartered in Reston, Virginia, the Company currently operates in more than 100 locations around the globe.

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 March 31,
	2017			2016
Revenue derived from prime contracts		91	%		94	%

Customer Group Revenue

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


	Three months ended March 31,
	2017			2016
Department of Defense and intelligence agencies		61	%		63	%
U.S. Federal civilian agencies		39	%		37	%

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 March 31,
	2017			2016
Time-and-materials		18	%		17	%
Cost-plus fee		53	%		59	%
Firm fixed-price		29	%		24	%

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. For cost-plus fee contracts, there is limited financial risk, because we are reimbursed all our allowable costs, 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 increase in the percentage of revenue generated on our firm fixed-price contracts is primarily the result of new firm fixed-price contracts awarded in 2016.

Contract Backlog


	As of
	March 31, 2017		December 31, 2016
	(in millions)
Funded backlog	$	139	$	139
Total backlog	$	590	$	625

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 that we believe are more likely than not to be exercised. Our backlog does not include any estimate of future potential delivery orders that might be awarded under our GWAC, agency-specific IDIQ, or other multiple-award contract vehicles. 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 funded backlog does not represent the full potential value of our contracts, as Congress often appropriates funds for a particular program or agency on a quarterly or yearly basis, even though the contract may provide for the provision of services over a number of years. We define unfunded backlog, not included above, as the total backlog less the funded backlog. Unfunded backlog includes values for contract options that have been priced but not yet funded. Additional information on how we determine backlog is included in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC.

Results of Operations

Three Months Ended March 31, 2017 Compared to Three Months Ended March 31, 2016

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


	Three months ended March 31,
	2017			2016		2017			2016
	(in thousands)					(as a percentage of revenue)
Revenue	$	78,751		$	83,655		100.0	%		100.0	%
Operating expenses:
Cost of revenue		64,696			69,693		82.2			83.3
General and administrative expenses		6,690			6,107		8.5			7.3
Depreciation and amortization		1,788			1,792		2.3			2.1
Misappropriation loss and related expenses		6,617			1,541		8.3			1.8

Total operating expenses		79,791			79,133		101.3			94.5

Operating (loss) income		(1,040	)		4,522		(1.3	)		5.5
Interest expense, net		208			190		0.3			0.2

(Loss) income before income taxes		(1,248	)		4,332		(1.6	)		5.3
(Benefit) provision for income taxes		(441	)		1,743		(0.6	)		2.1

Net (loss) income	$	(807	)	$	2,589		(1.0	)%		3.2	%

Revenue

For the three months ended March 31, 2017, revenue decreased by 5.9%, or $4.9 million, over the same period a year ago. This decrease is principally due contracts completed in 2016 and reductions in staffing and scope of work on certain other contracts, offset by increased revenues from additional task orders on the expanded CNOSS program, and revenue derived from new contract awards.

NCI’s PEO Soldier program accounted for $12.5 million, or 15.9% of revenue, in the first quarter of 2017, down $0.7 million from $13.2 million, or 15.8% of revenue, in the first quarter of 2016. NCI’s CNOSS program accounted for $9.4 million, or 11.9% of revenue, in the first quarter of 2017, up $0.9 million from $8.5 million, or 10.1% of revenue, in the first quarter of 2016.

Cost of revenue

Cost of revenue for the three months ended March 31, 2017 was $64.7 million, or 82.2% of revenue, compared to $69.7 million, or 83.3% of revenue, for the three months ended March 31, 2016. The decrease in cost of revenue as a percentage of revenue was primarily the result of improved gross margin realized from the increased portion of revenue derived from fixed price contracts.

General and administrative expenses

General and administrative expense increased $0.6 million, or 9.5%, to $6.7 million for the three months ended March 31, 2017, as compared to $6.1 million in the same period a year ago. General and administrative costs as a percentage of revenue increased from 7.3% in the three months ended March 31, 2016 to 8.5% in the three months ended March 31, 2017. The increase was primarily due to higher recruiting and business development costs.

Depreciation and amortization

Depreciation and amortization expense was approximately $1.8 million for the quarters ended March 31, 2017 and 2016, respectively.

Misappropriation loss and related expenses

Misappropriation loss and related expenses totaled approximately $6.6 million and $1.5 million for the quarter ended March 31, 2017 and 2016, respectively. Misappropriation loss and related expenses includes the loss due to embezzled funds as well as external professional service fees including legal, forensic accounting, audit and other consulting fees. We incurred approximately $0.4 million and $1.5 million of loss related to the embezzlement of funds from our former corporate controller for the quarters ended March 31, 2017 and 2016, respectively.

Interest expense, net

Interest expense, net, was $0.2 million for the quarters ended March 31, 2017 and 2016, respectively. Interest expense for the quarter ended March 31, 2017 included approximately $0.1 million of interest related to uncertain tax position related to the misappropriation loss. During the first fiscal quarter of 2017, we had a weighted average outstanding loan balance of $2.9 million which accrued interest at a weighted average borrowing rate of 2.9%. During the first fiscal quarter of 2016, we had a weighted average outstanding loan balance of $16.5 million which accrued interest at a weighted average borrowing rate of 2.5%.

(Benefit) provision for income taxes

For the three months ended March 31, 2017, our benefit for income taxes was 35.3% of our loss before tax. This represents a decrease from 40.3% of our income before tax for the three months ended March 31, 2016. The decrease was primarily attributable to a change in certain state tax rates during the three months ended March 31, 2017, offset by a tax benefit associated with certain stock transactions.

Misappropriation Loss—Costs and Recovery

As discussed in Note 14 to our financial statements, the Company initiated civil legal proceedings against our former controller seeking to recover assets acquired by him with funds wrongfully obtained by him through his embezzlement of Company funds and that litigation is ongoing. The court has frozen all of our former controller’s assets.

In its Annual Report on Form 10-K for the year ended December 31, 2016 and its Quarterly Reports on Form 10-Q/A for the periods ended March 31, June 30 and September 30, 2016, the Company disclosed such misappropriation losses and indicated that it carried an insurance policy that could cover up to $5 million dollars of the misappropriation losses. The Company was recently notified by letter from its insurance carrier, Berkley Regional Insurance Company (“Berkley”), that the applicable insurance policy that could cover a portion of the misappropriation losses was terminated due to misrepresentations made by the Company’s controller in applying for and obtaining such policy. The Company rejects Berkeley’s position and intends to enforce the applicable policy to seek to recover the maximum possible insurance proceeds with respect to the misappropriation losses. The timing and amount of final recoveries (if any), net of expenses of recovery, is uncertain. The Company has not yet recognized an estimated value of the potential recovery due to the limited amount of information available to it at this time. The Company expects that it will incur additional costs during fiscal 2017 related to the embezzlement, including legal, audit and other consulting fees.

Liquidity and Capital Resources

Our primary liquidity needs are for financing working capital, capital expenditures, stock repurchases, 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 cash, cash flow from operations, and the available borrowing capacity under our credit facility to continue to meet our normal working capital, capital expenditures and other cash requirements.

During the three months ended March 31, 2017, the balance of accounts receivable increased by $2.7 million to $53.9 million at the end of the quarter. Days sales outstanding of accounts receivable (DSO) increased one day to 62 days at March 31, 2017 as compared to 61 days at December 31, 2016. As of March 31, 2017, $2.0 million was due under the credit facility, as compared to no balance outstanding as of December 31, 2016, reflecting $2.0 million of net borrowings during the first three months of 2017. Net cash provided by operating activities was $1.1 million for the three months ended March 31, 2017.

On January 31, 2017, NCI, entered into the Fourth Amendment (the “Amendment”) to the Credit Agreement.

The Amendment modifies certain provisions of the Credit Agreement to, among other things:

•

decrease the Company’s borrowing capacity under the revolving line of credit from $80.0 million to $50.0 million;

•

extend the commitment termination date from January 31, 2017 to May 31, 2017;

•

include additional restrictions with respect to certain acquisitions and restricted payments, including certain acquisitions, dividends, and repurchase or redemption of our capital stock.

We intend to amend and extend our credit facility before the current facility expires on May 31, 2017. Our goal is to reestablish a credit agreement that will support our stated goals for financing working capital, capital expenditures, stock repurchases, and making selective strategic acquisitions.

As of March 31, 2017, we were in compliance with all our loan covenants.

Off-Balance Sheet Arrangements

We do not have any material off-balance sheet arrangements.

Critical Accounting Policies

There have been no significant changes to our Critical Accounting Policies during the first quarter of 2017. Refer to the Critical Accounting Policies section in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company’s exposure to market risk relates to changes in interest rates for borrowings under its credit facility. For the quarter ended March 31, 2017, a change of one percentage point in interest rates would have changed NCI’s interest expense or cash flows by less than $0.1 million. This estimate is based on our average balances for the period.

Additionally, the Company is subject to credit risks associated with our cash, cash equivalents, and accounts receivable. NCI believes that the concentration of credit risk with respect to cash equivalents is limited due to the high credit quality of these investments. NCI’s investment policy requires that the Company invest excess cash in high-quality investments, which preserve principal, provide liquidity, and minimize investment risk. NCI also believes that its credit risk associated with accounts receivable is limited as they are primarily with the U.S. Federal Government or prime contractors working for the U.S. Federal Government.

Item 4. Controls and Procedures

Evaluation of the Effectiveness of Disclosure Controls and Procedures

The Company, under the direction of the Chief Executive Officer and the Chief Financial Officer, has established disclosure controls and procedures as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

An evaluation was performed under the supervision and with the participation of NCI’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act. Based upon their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that as of March 31, 2017, the Company’s disclosure controls and procedures are not effective because of the material weakness in our internal control over financial reporting identified in our Annual Report on Form 10-K for the year ended December 31, 2016, as described below.

Remediation Plan

As noted in Item 9.A in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed on with the SEC, management’s evaluation of our internal control over financial reporting identified material weaknesses resulting from several control deficiencies in the internal control system that allowed the misappropriation of funds by the Company’s former corporate controller and the failure to detect them for an extended period of time. Management is committed to remediating each of the material weaknesses identified by implementing changes to the Company’s internal control over financial reporting. Management has implemented, or is in the process of implementing, the following changes to the Company’s internal control systems and procedures:

•

We have completed the initial assessment of the most critical material weaknesses and implemented procedures with improved segregation of duties and a more diligent review of supporting documentation.

•

We have met with our banking treasury support team to review alternative account structures and more robust reporting tools to better streamline processes and improve controls over electronic payments.

•

We engaged a contract recruiter to support the identification of a candidate for the corporate controller position. While the search is underway, we have hired a qualified individual to fill the role on a temporary basis.

•

We continue to review alternatives within the treasury function for a more efficient long-term solution.

•

The Audit Committee of the Board of Directors has decided to seek a new outside accounting consultant to assist in the evaluation and testing of the Company’s internal controls over financial reporting and we intend to conduct a more expansive risk assessment, with additional oversight by the Audit Committee.

•

Pending other planned personnel changes in the accounting department, we have engaged additional qualified consultants to provide temporary accounting support.

•

We implemented a new account structure to better monitor and track expenses across all employee benefit plans and have begun the effort to establish a systematic process to ensure the actual expenses are consistent with the terms of each benefit plan.

Management intends to finalize its efforts around implementing effective internal controls and closely test and monitor the operating effectiveness of these controls throughout 2017 to ensure they meet their designed control objectives and, where necessary, take additional corrective measures to ensure that deficiencies are remediated.

Changes in Internal Control over Financial Reporting

Except as described above, there have been no changes to the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2017, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The remediation plan noted above was initiated in the first quarter of 2017 and we expect that our remediation efforts, including design, implementation and testing, will continue throughout 2017.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

Civil Suit Against Former Controller

On January 23, 2017, we filed a lawsuit against Mr. Frank in the Circuit Court of Fairfax County in the State of Virginia to recover the embezzled funds.

Government Agency Investigations

In connection with the discovery of Mr. Frank’s embezzlement of money from the Company, we self-reported such matter to the U.S. Securities and Exchange Commission (“SEC”) and the civil and criminal divisions of the U.S. Department of Justice (“DOJ”).

Other Legal Proceedings

Item 1A. Risk Factors

There have been no significant changes in our risk factors from those discussed in Item 1A. “Risk Factors” included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

None

Item 6. Exhibits


Number		Description

2.1		Stock Purchase Agreement among NCI Information Systems, Inc. (“NCIIS”), a wholly owned subsidiary of NCI, Inc., and stockholders of AdvanceMed Corporation dated as of February 24, 2011 (incorporated herein by reference from Exhibit 2.1 to registrant’s Current Report on Form 8-K, as filed with the Commission on April 4, 2011)

3.1		Amended and Restated Certificate of Incorporation of the Registrant (incorporated herein by reference from Exhibit 3.1 to registrant’s Registration Statement on Form S-1 (File No. 333-127006), as filed with the Commission on October 4, 2005, as amended).

3.2		Bylaws of the Registrant (incorporated herein by reference from Exhibit 3.2 to registrant’s Registration Statement on Form S-1 (File No. 333-127006), as filed with the Commission on July 29, 2005).

4.1		Specimen Class A Common Stock Certificate (incorporated herein by reference from Exhibit 4.1 to registrant’s Registration Statement on Form S-1 (File No. 333-127006), as filed with the Commission on October 20, 2005, as amended).

4.2*		NCI, Inc. Amended and Restated 2005 Performance Incentive Plan (incorporated herein by reference from Appendix A to registrant’s Definitive Proxy Statement on Schedule 14A, as filed with the Commission on April 30, 2009).

4.3*		Form of Amended and Restated 2005 Performance Incentive Plan Notice of Stock Option Grant and Stock Option Agreement (incorporated herein by reference from Exhibit 4.2 to registrant’s Current Report on Form 8-K, as filed with the Commission on March 12, 2009).

31.1‡		Certification of the Chief Executive Officer pursuant to rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

31.2‡		Certification of the Chief Financial Officer pursuant to rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

32.1‡		Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS		XBRL Instance Document

101.SCH		XBRL Extension Schema

101.CAL		XBRL Extension Calculation Linkbase

101.DEF		XBRL Extension Definition Linkbase

101.LAB		XBRL Extension Label Linkbase

101.PRE		XBRL Extension Presentation Linkbase

‡	Included with this filing.

*	Management Contract or Compensatory Plan or Arrangement.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.


		NCI, Inc.
		Registrant

Date: May 9, 2017	By:	/s/ LUCAS J. NAREL
		Lucas J. Narel
		Executive Vice President, Chief Financial Officer and Treasurer
		(Principal Financial Officer)
		(Principal Accounting Officer)

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