NCI Inc. Q3 2008 Earnings Call Transcript

Nov. 4.08 | About: NCI, Inc. (NCIT)

NCI Inc. (NASDAQ:NCIT)

Q3 2008 Earnings Call

November 3, 2008 5:00 pm ET

Executives

Maureen Crystal – Vice President, Investor Relations

Charles K. Narang - Chairman of the Board & Chief Executive Officer

Terry W. Glasgow – President & Director

Judith L. Bjornaas - Chief Financial Officer

William M. Parker - Chief Operating Officer

Analysts

William Loomis – Stifel Nicolaus & Company, Inc.

Brian Gesuale – Raymond James

Timothy Quillin – Stephens Inc.

Michael Lewis – BB&T Capital Markets

Brian Kintslinger – Sidoti and Company

Erik Olbeter – Pacific Crest Securities 

Operator

Welcome to the NCI Incorporated third quarter 2008 financial results conference call. (Operator Instructions). At this time I'd like to turn the presentation over to Maureen Crystal, Vice President of Investor Relations for NCI.

Maureen Crystal

Welcome to NCI's third quarter 2008 financial results conference call. Here's our agenda for today. Charles Narang, NCI's Chairman and CEO, will provide a high-level overview of our accomplishments during the third quarter of 2008. Terry Glasgow, our President, will then provide some comments on our current market conditions as well as provide more granularity on our operational and business development accomplishments during the quarter.

Next, Judy Bjornaas, our Chief Financial Officer, will discuss our third quarter financial results and operating metrics. She will also review the fourth quarter and full year 2008 guidance published in today's earnings press release. We will then open up the call for your questions and we have Bill Parker, NCI's Chief Operating Officer, joining us today during the question and answer session.

Before we begin our discussion, it is important that we remind you that on this call we will make statements that do not address historical facts and thus are forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to factors that could cause actual results to differ materially from the anticipated results and include the risk and uncertainties identified in our earnings press release under the caption forward-looking information.

For a full discussion of these factors and other risk and uncertainties, please refer to the section entitled risk factors in NCI's Form 10-K filed with the Securities and Exchange Commission. Also, we undertake no obligation to update any of the forward-looking statements made on this call.

I will now turn the call over to Charles Narang.

Charles K. Narang

Good afternoon everyone and thank you for joining us today. We are pleased to announce that on all fronts we had an excellent quarter. During this period of uncertainty and turmoil in the markets our momentum remains strong. We continue to deliver solid operating results and we are on target with those stated objectives.

We have the following achievements in the third quarter of 2008. Our top line revenue grew 19% to a record $101 million. Our organic growth rate was 10%. Operating margin increased to 7.7%, another record achievement. Earnings per share increased 30% to $0.32 per share. New bookings for the third quarter were approximately $202 million reflecting a two times book-to-bill ratio for the quarter. Backlog hit a record $1.1 billion which continues to reflect our solid base of book business in the Federal IT marketplace and we reduced our DSO by 12 days to 76 days.

We continue to drive forward and execute our business strategy. Since our IPO in 2005 we have continued to grow our core business as is reflected by the fact that we have reported double digit organic growth for the past nine consecutive quarters. Since this time we have augmented a strong organic growth with three strategic acquisitions that have allowed us to expand into new markets with new complementary capabilities and service offerings.

We believe that today's results reflect our determination at building a bigger platform to grow NCI into a $500 million company by 2010 through this combination of organic growth and acquisitions.

Based on visibility into a market remains very high and a number of the issues we discussed on our second quarter call have now been resolved. Specifically on September 30th the President signed into law the 2009 budget appropriations for the Department of Defense, Homeland Security and [inaudible]. In addition, he signed into law a continued resolution for the remaining nine agencies to provide funding until March of 2009. You may also recall that this past June 30 the legislature passed into law a supplemental spending bill.

With approximately 80% of revenue from defense income, funding levels for the near-term appear to be secured for the vast majority of the customer we serve. We are obviously talking to you on the eve of a critically important presidential election.

There are many who debate the vast differences within the two candidates and the approach each will take in running our country including the candidates' response to dealing with the current crisis and its affect on the global economy, the timetable for phasing down the troops in Iraq, strategies for global war on terror efforts around the world, as well as domestic security, healthcare and education.

While the approach the newly elected president will take to resolve these issues may not be clear, it will take a substantial amount of time to put in place a new administration and work through the serious issues facing our nation. Even with these important issues, we remain confident in our strategy to deliver 10 to 15% organic growth as we move forward.

While we cannot control the issues affecting the broader market we have keenly focused on the methodical and diligent execution of our own business strategy and we're proud to be one of the leading providers of IT and professional services to the federal government. We continue to have great expectations for NCI and our ability to build a company with a superior platform.

In just a moment I will turn the call over to Terry Glasgow who will review our professional highlights. I think you will see that our results position us nicely for 2009 and beyond. Moreover, we hope that you get a sense of true quality of our backlog and pipeline.

As many of the new awards today we will be discussing the way NCI has rooted itself deeply within our customer's sight. More importantly, many areas of non-discretional initiative are more likely to prevail under critical environments and pressures.

As for the global credit crisis, NCI's balance sheet remains solid with a relatively low risk profile. During this past quarter our cash flow was exceptional given the tremendous progress we made to bring down our DSOs to 76 days.

Our long-term debt as of September 30th was $36.5 million. Our strong balance sheet and financial provision can provide us with ample ability to make an acquisition should we find a desirable candidate. While our main focus is on organic growth, we will continue to augment our organic growth with strategic acquisitions that will enhance the value of NCI for our stockholders.

Though I have closed to these comments, it was made before, that they remain the foundation of NCI and are worth repeating. We have all the key elements in place which is the client's relationships, the GWAC contract vehicles, the management team, the skilled employees and the financial resources to deliver on our promises to our stockholders.

With that I will now turn the call over to Terry to provide our official update.

Terry W. Glasgow

We are proud of the record results delivered in the third quarter. These outstanding business results provide us with a great platform for continued growth. During the third quarter we received contract awards with a total potential value of $283 million.

Consistent with our established practice we have included in our backlog only that portion of new business awards that we have high competence in executing. Consequently, we have not included some portions of the award were specific implementation plans are not defined fully. The result is in addition to our backlog of $202 million of bookings.

Our trailing 12 months awards of $528 million represent a 99% year-over-year increase in our bookings. These awards produce a book-to-bill ratio for the third quarter of two times and a trailing 12-month book-to-bill ratio of 1.4 times. Approximately 75% of the $202 million of awards represent new work to NCI in many cases with new customers and new geographic locations.

The balance of the awards represents progressive engagement growth with existing customers. There were no significant re-competes either won or lost during the quarter. The majority of the awards were made under one or more of our 20 prime GWAC contract vehicles including our NETCENTS, ITES I, ITES-2S, TEIS, dLETP, DESP II and GSA Schedule 70 contract vehicles.

We are all too keenly aware of the domestic and global economic climate. Succeeding in this market environment will require a tight focus on the right customer and technology areas combined with excellent business execution. With that context, I want to spotlight several emerging areas that offer strong potential growth and expansion.

First, cyber security and information assurance are national imperatives. Cyber security and information assurance are important elements of the government war on terrorism and bipartisan support and will be a priority for all Federal agencies and services throughout the foreseeable future.

Second healthcare, including related IT healthcare services, will see increased bipartisan support. Opportunities will be seen with a variety of customers including the Department of Health and Human Services, the VA and DoD services and agencies.

Our third area for potential growth is with IT consolidation in enterprise system management. We anticipate continued consolidation of IT services into more efficient and more secure IT enterprises that leverages resources, reduce costs, while at the same time improving services.

And fourth is the BRAC Realignment and Closure Act or BRAC that requires the Secretary of Defense to implement BRAC recommendations not later than September 15th, 2011. It is generally understood that many of the actions necessary to effect the BRAC recommendations have been delayed or pushed to the right in lieu of other budget requirements and constraints. Given the hard deadline in less than 36 months this area will likely received renewed emphasis.

Our final comment on the environment is the acknowledgement that price will be increasingly more important. It is essential for us to maintain our lean, agile and aggressive infrastructure and to provide solutions that reduce our customer's total cost of ownership.

With this economic and emerging customer priorities, I want to provide some insight into some of our new contract awards. In the third quarter we won six task orders under our Army TEIS GWAC contract with a combined potential value of over $125 million. The largest piece task order was the BRAC information assurance task order with a potential value of $90 million.

Under this competitive task order NCI will provide information assurance services for installation relocations and modernizations in support or the U.S. Army Information Systems Command located at Fort Huachuca, Arizona. This task embraces two of the previously mentioned emerging growth areas; information assurance and BRAC.

Another important aspect of this work is the types of services offered and the broad base of customers that will be served. Information assurance support and services under this task order may be provided to DoD organizations identified under BRAC, DoD organizations not indentified under BRAC but which will be relocating, upgrading or renovating, non-DoD Federal Agencies and organizations who will be relocating, upgrading or renovating, and finally new operational IT requirements for Army Directors of Information Management or DOIMs.

Specific IA services under this task order include security engineering, services to current information systems operations, networks, enclaves and installations which may connect to the LandWarNet or to the global information grid and oversight of users transitioning to the DIACAP or NIACAP certification and accreditation processes consistent with DoD and Federal regulations and guidelines.

Army and DoD organizations and BRAC sites specified in our statement of work include, [inaudible] move from Arlington to Fort Meade, the [USSOCOM] relocation, Army Materiel Command's move from Fort Belvoir to the Redstone Arsenal, FORSCOM and the Army Reserve Command's move from Fort McPherson to Fort Bragg, Trade Ops move from Fort Monroe to Fort Eustis, the First Army move from Fort Gillem to Rock Island Arsenal. The Third Army move from Fort McPherson to Shaw Air Force Base and the 4th Infantry Division from Fort Hood to Fort Carson.

The IE BRAC task order is a milestone win for NCI and places us in an ideal position to leverage our well known and respected information assurance capabilities. The task order is set up with 15 priced options for work spanning the analysis, design, implementation and close out phases.

The maximum potential price of $90 million, of approximately $90 million, reflects the total that could be ordered under the contract if all options for all locations were exercised. While we expect a significant portion of this work will be accomplished under the NCI task order, the exact amount will be driven by customer and timing direction.

As a consequence we have included only a third of the total potential value or $30 million in our backlog at this time. We are confident that we will be successful in receiving a significant portion of the $90 million award value. As we gain further insight into the timing and customer plans we will adjust our awards and backlog accordingly.

Other Army awards in the quarter included new ITES work at Fort Carson, where we now provide all IT services to the DOIM. And new work at Fort Belvoir where we have also taken over DOIM work previously provided by another incumbent. These new contracts, along with others that I’ll be discussing shortly, reinforce our position in enterprise systems management and consolidation.

In the third quarter we were awarded a $31 million competitive task order by the Air Force's 375th Communications Support Squadron. This competitively awarded contract represents new work for NCI and it is an expansion of our activities at Scott Air force Base.

Also in the third quarter we received four task orders on our DESP II contract with a total value of approximately $18 million and seven distance learning task orders under our dLETP and other contract vehicles with a total value of approximately $10 million.

Another example of a new customer and a new location is the $10 million headquarters Marine Corps information management branch contract. This work started up in October. Most of the awards mentioned were awarded in late September and we are still awaiting customer approval to publish press releases on these program wins. Upon approval we will release additional information about these and other recently awarded programs.

In summary the third quarter represented record new business results for NCI. We received awards across all business units, using our major GWAC contract vehicles and had substantial awards from new customers and at new locations.

More importantly, the work we are pursuing and winning are in areas that have substantial growth over the next 12 to 24 months. A key element of our business strategy is to pursue new business as a prime contractor and to target opportunities that will allow NCI to expand our professional workforce in important technical and management functions.

The majority of the contract wins in the third quarter are for work where NCI has substantial direct billable labor. Expansion of our professional staff supports our margin expansion strategy while at the same time creating and enduring value added relationship with our customers.

With these new wins our total staff at the end of the September was approximately 2,400 employees, a net increase of 500 people as compared to the same time last year. On the subject of staffing let me quickly update you on a NETCOM EMS contract which was awarded in December of 2007.

As planned the majority of the staffing for the program occurred in September and there is some work that will transition to NCI in the fourth quarter. By the end of the fourth quarter we will have over 180 billable staff on the program, more than 75% of which are NCI employees. Today we are performing 42 separate task orders in support of the Army NETCOM mission including information assurance, net worthiness, network architecture, strategic planning, and enterprise operations.

Strategically this work ties in nicely with our targeted market strategy in both the information assurance and enterprise management areas. For those of you who may not be aware of NETCOM’s mission, they are the army’s cyber force. Their mission is to operate and defend the Army’s network enterprise. I am sure you can see why we’re so pleased at having both the NETCOM EMS and the TEIS IA BRAC programs and the strong business position we have developed.

With the exceptions of the recently awarded IA BRAC and the 375th Scott Air force program staffing on all our recently awarded programs is well under way. Due to an initial protest from the Scott 375th award staffing was delayed. But that protest has now been dismissed and we will begin staffing in November. Staffing on the TEIS IA BRAC job has begun but our expectation is that most of the work will ramp in 2009 and into 2010 as BRAC initiatives become more focused.

We continue to place significant emphasis on our new business development activities. We are aggressively attacking our market areas and focusing on major new business opportunities. In the last 18 months we have made a number of key new hires, bringing in people possessing strong government and industry experience and technical expertise. Also our acquisitions of Carter and PEO Soldier have opened new targets of opportunity in the professional services, engineering, acquisition management, training, healthcare, and logistics service areas.

With these investments and expanded service offerings our pipeline has grown substantially, and the last quarter we have added over $3 billion of new opportunities, many of which are in the 2010 and 2011 time period. A fundamental tenet of our new business model lies in the early identification of new business opportunities coupled with aggressive opportunity qualification's position.

The following metrics characterize our new business pipeline. Our total pipeline now exceeds $13 billion, more than double the pipeline we had a year ago. Approximately $3.4 billion of the pipeline is for opportunities to be awarded in 2009 with a balance for opportunities in 2010 and beyond.

We have 88 programs with values of $25 million or more in the pipeline broken down as follows. There are 26 programs with values greater than $100 million, another 25 programs with values between $50 million and $100 million and 37 programs with values $25 million to $50 million. These 88 programs represent approximately 84% of the total pipeline dollar value. In addition to the above programs, we have identified a number of large and important GWAC programs with targeted DoD and civilian agency customers.

These programs are carried in our pipeline statistics at $0 values; nevertheless, these programs are treated as top priority opportunities in that they provide access to both important customers and support our long-term growth strategies.

During the third quarter we prepared and submitted in excess of $300 million of proposals that are awaiting award. It is our expectation that the majority of these awards will be adjudicated in the fourth quarter. For the fourth quarter we anticipate preparing and submitting an additional $250 million of proposals.

In summary, through the first nine months of the year we delivered 34% revenue growth, including 12% from organic growth, have won over $400 million of awards, or 115% year-over-year growth, achieved a book-to-bill of 1.4 and expanded our backlog to a record $1.1 billion. We are pleased with our progress and are committed to drive forward and continue our pursuit of our business goals. As I have said before, the best is yet to come.

I will now turn the time over to Judy who will present the financial results and guidance for the balance of 2008, Judy.

Judith L. Bjornaas

Thank you, Terry, and good afternoon everyone. For the third quarter of 2008 revenue was up approximately 19% to $101.1 million. This compares to $85.2 million for the third quarter of 2007. Our third quarter organic revenue growth rate was 10%. The increase in revenue resulted from activity under our new list GWAC contract vehicles, growth from progressive engagement on existing contracts, as well as from revenue from our acquisitions.

We did also see an acceleration of some revenue we had anticipated to hit in Q4 into Q3, which accounts for revenue being slightly higher than we had expected in the quarter. Operating income for the third quarter was $7.8 million compared to $6.3 million for the third quarter of 2007. Operating margin for the third quarter was 7.7% compared to 7.4% for the third quarter of 2007. This year-over-year 30 basis point improvement in operating margin is due to an increase in our direct labor base revenue, which typically carries our highest margin.

Net income for the third quarter was $4.4 million compared to $3.3 million for the same period in 2007. Diluted earnings per share for the third quarter were $0.32 per share compared to $0.25 per share for the comparable period in 2007. The effective tax rate for the third quarter of 2008 was 39.7%. Diluted shares outstanding for the third quarter of 2008 was approximately 13.7 million shares compared to approximately 13.5 million shares for the third quarter of 2007. [DOT] compensation expense for the third quarter was approximately $225,000 compared to approximately $127,000 in the third quarter of 2007.

I would like to briefly discuss our operating margin improvements, both this quarter and on a year-to-date basis compared to last year. Our operating margin is up 30 basis points quarter-over-quarter, and 20 basis points on a year-to-date basis, well in line with the projected margin expansion of 20 to 30 basis points for 2008 that we have been guiding all year.

We are very pleased by this margin improvement, and I would like to point out that we have achieved this improvement while continuing to increase our investments in bidding proposals, business development and capture resources. During the third quarter we spent approximately $700,000 more than we did in Q3 2007 for these types of activities. And on a year-to-date basis this investment totaled slightly over $3.9 million than in the same period in 2007.

We have been able to make these investments while still improving our margins because we have been able to offset these increases by leveraging our infrastructure and gaining efficiency from our acquisitions. You can see the benefits of these investments through our record backlog and award figures and our increasing pipeline statistics. As we continue to grow, we will be able to again leverage these infrastructure investments over our increasing revenue base, and we'll continue to show margin expansion going forward.

Moving on to our third quarter 2008 metrics, approximately 84% of our revenue was performed as a prime contractor. For the third quarter, 80% of our revenue came from the Department of Defense and Intelligence Agencies, approximately 17% from federal civilian agencies, and approximately 3% from other sources, primarily training services provided to commercial customers. Our contract mix for the third quarter was approximately 44% from time and materials contracts, 20% from cost plus contracts and 36% from fixed price contracts.

Now for a brief summary of the balance sheet and cash flow statements. Cash flow provided by operations for the first nine months of 2008 was approximately $25.2 million. This is over two times our net income for the period. Over $21 million in operating cash flow came during the third quarter where we have made outstanding progress in reducing our accounts receivables.

As you may recall from discussions on our past conference calls, we have been diligently working to streamline our billings and collections processes, and work through some customer payment office issues. We are pleased to announce that these efforts have resulted in tremendous success at lowering our days sales outstanding, or DSO.

At the end of the third quarter, our DSO was 76 days, a reduction of 12 days for the quarter and 16 days since the end of last year. While we remain committed to continuing to improve DSOs with a long-term target near the low to mid 70s, I would like to caution that we typically see DSOs go up in the fourth quarter due to delays in paperwork processing at the start of the government fiscal year.

Certainly the recent global credit crisis and the extreme market volatility has focused attention on the debt loads of publically traded companies and their associated risk profile. Again we're pleased to announce that our exceptionally strong cash flow for the quarter provided ample funds to pay down a large portion of our debt. Our outstanding baked debt at end of the third quarter was $36.5 million, a reduction of $20.5 million from the $57 million outstanding at the end of second quarter.

Our total backlog was $1 billion 96 million at the end of third quarter, with $233 million of that funded. This compares to $722 million of total backlog at the end of third quarter 2007, of which $157 million was funded. As Terry stated, this represents a record level of backlog for NCI, and reflects the strong position we are in as we close out 2008 and enter 2009. I'm going to spend my remaining time on the call giving you an overview of the guidance for the fourth quarter and full year 2008 that we published in our earnings press release today.

For the fourth quarter of 2008 we expect revenues to be in the range of $101 million to $106 million, and diluted EPS to be in the range of $0.32 to $0.35 per share. This guidance is based on weighted average shares of approximate 13.7 million for the fourth quarter. For the full year of 2008 we are increasing the lower end of our guidance range and now expect revenue to be between $390 million and $395 million, and we are increasing both the lower and upper end of the EPS range with diluted EPS now expected to be in the range of $1.21 to $1.24 per share.

This guidance is based on weighted average shares of approximately 13.7 million for 2008. The fourth quarter and full year guidance includes a 39.8% estimated tax rate for the balance of the year. We are estimating net interest expense for the fourth quarter of approximately $600,000 and $2.2 million for the full year. Depreciation and amortization is expected to be $1 million for the fourth quarter and $3.7 million for the full year.

Finally, stock option expense is expected to be approximately $250,000 for the forth quarter and about $830,000 for the full year 2008. This guidance does not reflect the impact of any potential future acquisitions.

As you have just heard from both Charles and Terry, we had an outstanding quarter and are exceptionally well positioned for the future. During this past quarter we set new records for the majority of our operating metrics. Specifically, we achieved record revenue, operating income and margin, and EPS. We had tremendous cash collections that reduced our DSO by 12 days. Terry clearly highlighted that we also achieved record backlog and grew our price line to its highest level yet.

More importantly, he highlighted the quality that our recent contract wins and how we intend to translate those awards in sustainable organic growth. We’re proud of these accomplishments the NCI team has delivered this quarter and are optimistically looking forward to 2009 and beyond.

With that operator, we are now ready to begin the Q & A session.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is from William Loomis – Stifel Nicolaus & Company, Inc.

William Loomis – Stifel Nicolaus & Company

Just looking at the days sales, Terry, let me get this straight. The BRAC bid is only $30 million in that $202 million? Did I hear that right?

Terry W. Glasgow

That is correct.

William Loomis – Stifel Nicolaus & Company

Is there any, you said most of it had high direct labor content. Was there any significant ones that were at low direct labor or significantly below average margins in that 202 mix?

Terry W. Glasgow

No.

Judith L. Bjornaas

Nothing significant. Clearly there was some teammate revenue and a little bit of product on that side, but nothing significant.

William Loomis – Stifel Nicolaus & Company

Okay, and then on the NET contract that you won last December finally starting to ramp up. Can you just remind us what the staffing of that was, like say at the end of the second quarter, and third quarter and you already talked about the forth quarter.

Terry W. Glasgow

Yes it started out relatively low in the first quarter. We had levels 20 people or so. End of the second quarter it had ramped up more but the vast majority of the staffing was taking place late in September. By late, I mean the last three or four or five days of September, so most of that has come up. There is a little bit that yet to be staffed out of about 480 people in the fourth quarter. But the majority of that is already staffed and on working for us right now.

William Loomis – Stifel Nicolaus & Company

And then finally on the BRAC program you said not a lot of contributions, it sounds like in ’09 just because it’s not – BRAC doesn’t appear to be a near term priority. Is that true or when do you expect to really see that impact, by the second quarter or third quarter of next year?

Terry W. Glasgow

Well, I’m not going into 2009 yet because we haven’t said anything there. But just to say that as we look at less than 36 months to go and the kinds of activities that have to be done in order to support these BRAC moves, and IA being a critical feature of that, I would expect to see the work load ramp up. We’re already seeing it. We already have work underway. We already have staffing underway. So I didn’t want to lead you to believe that there was nothing there.

But if you look at the total program and the potential that it has, and as I mentioned, there are so many different customers that can use it. Not only DoD BRAC but non-BRAC organizations and so on, that I believe that this will receive and awful lot of attention, especially given the kind of work that we’re doing. So I’m hopeful and going to work hard to bring as much as we can in 2009. I'm just not prepared right now to say how much.

Operator

Our next question is from Brian Gesuale – Raymond James

Brian Gesuale – Raymond James

It looked like the G&A line that you guys were very disciplined there. We saw nice revenue growth as we’ve seen in the past. But, really, actually a decline in the absolute dollar amount there. Can you tell us a little bit of detail of what you’re doing there and what we should expect from that line or any targets you might have going forward longer term?

Judith L. Bjornaas

I think long term it will be about 5% of revenue within a 10 to 20 basis points, give or take any particular quarter is probably where we’re going to be. I think the sequential decrease that you’re seeing was due to that huge amount of [BMP] that we had in Q2 as well as continuing to kind of leverage the efficiencies from the acquisitions.

Brian Gesuale – Raymond James

I'm wondering if you can give us a little bit of detail on NETCENTS, maybe contribution in the quarter, and a little bit of an update on the re-compete situation there, and any other re-competes as well?

Thomas L. Glasgow

Bill, why don't you talk a little bit about the NETCENTS to re-compete, and what's going on there okay?

William M. Parker

In terms of NETCENTS to re compete, there are, as you are probably aware, they've divided into eight separate contracts, two of which are product, six relate to different categories of services.

In terms of timing, we expect the two draft RFPs for products have been released and those do not represent interest areas for us. We're not really focused on product revenues. Our focus is on services. In that regard there are four draft RFPs we expect out in December of '08 and then two – the guidance that we've been given is spring of '09 for those two draft RFPs.

And in general, the acquisition approach of the Air Force has been slipping. They're certainly trying to adhere to this schedule and they have indicated that they intend to do NETCENTS One extensions in six month increments, based on whatever success they have in pursuing the NETCENTS Two procurement.

Brian Gesuale – Raymond James

Any thoughts on the size in the quarter? And then any other significant re-competes over the next 12 months you want to talk about?

Judith L. Bjornaas

I think we said at the last call, looking into '09, in '08 we had about 10 to 15% of our revenue up for re-compete. I think going into '09 it's a little higher than that, probably right at about the 15% number, but the majority of that back end fourth quarter starts at the end of the year. But no one significant – we don't have any material contracts.

Charles K. Narang

Most of our contracts have 5% of the revenues, so it's not a material number where it comes in with income fee, Brian, but definitely she is right, it's coming somewhere 15 to 20% income feed just like everything else. We have 50 of the contracts get re-competed, so close to 15 to 20%, and they are all at the later part of '09.

Brian Gesuale – Raymond James

That's helpful. Thanks for the color there. And then a final question, looks like PEO Soldier contract's doing exceptionally well. Can you maybe just talk about some of the activities there and what the outlook is over the next year or so?

Thomas L. Glasgow

I'll talk about the contract. I'll let Judy talk about the outlook later. PEO Soldier is just really well run. We're very fortunate to have picked that up. The leadership down there has a great reputation. They've been working that contract for years. They create great value for our customers down there and are essential to the mission.

So that has been a very good acquisition for us. They continue to do well. There have been some ups and downs, and they will be subject to budget pressures and things like anyone else. But it continues to meet all of our expectations and be consistent with all that we said when we acquired them.

Brian Gesuale – Raymond James

How does that contract do in the fourth quarter per your guidance, relative to the third?

Judith L. Bjornaas

We see it coming down a couple million dollars actually, from Q3 to Q4. They've been ramped up a little bit heavier.

William M. Parker

And a lot of what happens there, there's a lot of travel in the theater now and so on, and there's usually less travel in that fourth quarter.

Operator

Your next question is from Tim Quillin – Stephens.

Timothy Quillin – Stephens Inc.

Nice quarter. I may have missed it, but what's the term of the IA BRAC Task?

Thomas L. Glasgow

It goes through the life of the TEIS contract, plus it has the ability to extend at least one year beyond there. So it'll go through 2011 plus another year, so putting us to 2012 or more.

Timothy Quillin – Stephens Inc.

And it sounds like the composition of your 202 million that went into backlog is pretty diverse, but was there anything else that contributed meaningfully to that, besides the IA BRAC task?

Thomas L. Glasgow

Well every one is meaningful to us of course. Every one is hard fought and won The IA, the 375th I mentioned was $31 million. There was some great things going on with our training group. Virtually every group won things, bid things and there's still things outstanding, so all were very meaningful. What I was trying to express to everyone was, I think the quality of these wins were very, very good, and it put us in the right place to do the right things.

And given that all these win, and basically the vast majority of our year-to-date awards have been for non-re-compete types of things. It all speaks well for our backlog.

Timothy Quillin – Stephens Inc.

Absolutely, and is there any large contracts on the cyber side or, not that these weren't large, but does this lead to other things that you're targeting right now, other cyber opportunities?

Thomas L. Glasgow

First of all, most often we find our engineering, security – our cyber IA kinds of things are embedded within our enterprise management engagements, like at US TRANSCOM, NORTHCOM, NORAD, throughout – PEO Soldier, [Stride Ruther], and all these. They are quite often embedded there.

We haven't seen a lot of stand alone opportunities, like if that's why this one looks so good to us and gives us an awful lot of opportunity. If you think of it this way, if you're going in and doing the front end engineering and if you're involved with doing the IA work, it really gives you an awful lot of insight into the new BRAC locations, and gives us I think some very good visibility into the follow on O&M there.

So I like the business position that it provides us; I also like the content. I'm not aware of a lot of other jobs like this; however, obviously IA is a priority with every federal agency out there. So having done this, I think it should help us, but there's also an awful lot of BRAC work going on with Air Force and other DoD agencies, which we might be able to leverage as well.

Timothy Quillin – Stephens Inc.

And Judy, did you say how much revenue PEO Soldier contributed, or at least where that was relative to 2Q?

Judith L. Bjornaas

I didn't. But it was up slightly from Q2, I think it kind of peaked in Q3, I think it was $1 million, $1.5 million maybe more than Q2. And then again, we expect it to drop back in Q4 a little bit.

Operator

Your next question is from Michael Lewis – BB&T Capital Markets

Michael Lewis – BB&T Capital Markets

Was wondering if you could help me reconcile something here, based on the numbers that we have it looks like as of the fourth quarter '07 you had about 247 million on NETCENTS since its inception. Can you tell us where you are in the third quarter on NETCENTS, with regard to total business there? And what was the split of products and services?

Terry W. Glasgow

I don't have those numbers. I'm not sure what it is. But I will say with respect to products for the last year we have been de-emphasizing that and products is increasingly a smaller percentage of our business base. But it's very, very small.

Judith L. Bjornaas

NETCENTS product was about 3% of our revenue in Q3.

Michael Lewis – BB&T Capital Markets

And then, just if I could follow up on a few other questions here. Are my numbers correct with regard to the NETCOM EMS contract? Last quarter did you say you anticipated putting 150 people on that? And now is that 180 or was it always 180?

William M. Parker

If you recall in that contract, this is a consolidation of many other contracts coming in. And there was always a question of which things were going to be brought in and when. Matter of fact when we booked that job, it was a $97 million award, and we only booked a portion of it as well. And we did it because we weren't sure of the timing and when things were going to come in. So some things could come in that we were not expecting.

It's good, which we're looking at. It has grown a bit, and again it's still fairly consistent though with what we thought. I'd say it's just marginally higher right now.

Michael Lewis – BB&T Capital Markets

So I'm assuming that it looks like you could continue to be surprised with increased scale or scope on that contract going forward, or do you think you're going to top out at that 180 employees with 75% of them are NCI employees.

Terry W. Glasgow

And the supply chain is to say that we're working very hard to create more value for our customers and have our customers see value in us so I wouldn't want to be surprised per se. We have a great team working out in Sierra Vista, Arizona on this and I think that they've captured the interest of our customer and we've staffed it up very nicely, so I think that's a result of a lot of work.

Clearly, as we told you before, here was a great opportunity with a flagship contract to be able to grow it and do so by expanding the services that we offer there. And they're doing all the right kinds of things, so Mike, my bottom line is that I think there is opportunity there and we'll continue to explore that consistent with the customer's missions and priorities.

Brian Gesuale – Raymond James

Just one more question and I'll get out of the way here. Last quarter, Terry, I think you said you had about $450 million in proposals awaiting adjudication. How much came through because you only had, well, you had $200 million in bookings which is very strong, but I'm trying to reconcile this on what's currently still out there?

Terry W. Glasgow

First of all, if you're going to try to reconcile with the 450 I'd like to have you use the $283 million number since that's the amount – those were the total value of those awards. The fact that we've only elected to put a portion of that in the backlog is our conservatism right now.

It's kind of hard to say because you have things that were in the 450 that got adjudicated. There's some of it that has not; that it's still pending. There's other things that we bid during the quarter and won during the quarter and so I'm not sure really how to do that now. The numbers I gave you showed that there's about $283 million of awards during the quarter. We put in another $300 million roughly of awards and we'll probably do another $250 million this quarter, so it fits in there but there's a lot of ins and outs.

Operator

Your next question is from Brian Kintslinger – Sidoti & Company

Brian Kintslinger – Sidoti & Company

I want to talk a little bit about cyber security. I think, Terry, you mentioned there's no stand-alones which I think the industry is seeing. When you take a look at your pipeline over the next two years do you see stand-alone programs inside your '09 or even 2010 pipeline which you discuss? And if so, what guidance do you think that you have where you'll be seeing these programs come under?

Terry W. Glasgow

That's just a long question. There's clearly going to be a lot of emphasis here, whether they come out under some agency as stand-alones or as part of others is kind of their call. But as we look at our government wide acquisition vehicles there's a number – obviously ITES is a very strong one; it's got plenty of ceiling. NETCENTS will continue to do some things as we look forward.

There will be other civil agency kinds of vehicles and I'm not going to go through them now, but obviously there's some very important ones coming up over the next 12 to 18 months that will be used as well. I also think Alliant, once it gets resolved, will be another vehicle that will be used. Clearly the scope of work is covered there but even more importantly, given the acquisition environment where most of the customers have really reduced acquisition staff, I just believe that eventually people will be turning to Alliant and to GSA as a great source of help.

Brian Kintslinger – Sidoti & Company

And just to clarify and try to understand, not that it's a bad thing, the programs in your pipeline that have IA and cyber in them, like you mentioned before mostly are embedded within other contracts.

Terry W. Glasgow

Generally speaking, yes.

Brian Kintslinger – Sidoti & Company

And when you talk about cyber security is information assurance where it's built around for you guys or are there other services and do you need to go through any kind of training to perform or offer any other services? What needs to be done there to prepare for some of the other services involved?

Terry W. Glasgow

Bill, you want to jump on that one?

William M. Parker

Well, we feel like that our staff is – we have the right staff with the right kind of credentials to pursue the opportunities that are in our pipeline today and there are certain certifications that can be helpful in that regard and generally speaking our staff has the certifications that we need to pursue the business that's in the pipeline.

Brian Kintslinger – Sidoti & Company

Great, and the programs you're looking at, is most of that on the DHS side or the Intel side as ordering, as both are obviously spending on this?

Terry W. Glasgow

Well, I would say it's DHS and Intelligence, all the – virtually everyone out there. It is not unique to one of them.

Charles K. Narang

Both DoD and Homeland within all sectors; it's in almost every sector.

Brian Kintslinger – Sidoti & Company

And in terms of the CR for many of the agencies, other than the three you mentioned, when you take a look at your pipeline does this suggest that DoD in the next couple of quarters will be going faster or should we not look at it that way?

Charles K. Narang

I think you can't make a judgment like that, that they're going to go faster, but I think on the pace that they've been keeping in the past, that pace, they will at least stay at the same pace. Will it get faster than that? I doubt it very much because change of administration, everything else, there might be some go around, especially with references from the platform systems. We will not be impacted however it is mostly non-discretion spending and at least six months out it will stay the same pace that we have led.

Brian Kintslinger – Sidoti & Company

And the $2.4 billion of opportunities that you expect to be awarded in '09 that Terry mentioned, is there a split maybe? Is it split much more heavily towards DoD?

Terry W. Glasgow

It's split about the same way our mix is in our execution. It follows fairly closely there.

Brian Kintslinger – Sidoti & Company

And when you look at your proposal expenses and big spike in quarters when you obviously proposed a lot more and they come back down, but when you take a look at your total pipeline which is growing so quick, do you expect next year to maybe see significant increases in expenses or, Judy, you mentioned long-term 5% as a percentage of sales for SG&A? Does that take into account seeing these increases in proposals I take it?

Judith L. Bjornaas

Yes. I think it does because the revenue base will be growing along with that and like I said plus or minus 10 to 20 basis points around that 5% number.

Brian Kintslinger – Sidoti & Company

The last question that I have relates to the BRAC. You mentioned $30 million of the $90 million is in backlog. I take it most quarters you put in a fraction, a large fraction, but a fraction of what you booked. Over time – this is a rough question, I'm sure, but can you sort of tell us how much of that generally you picked back up of that difference? Does it take couple of quarters but generally you get most of it or can you just give us a little bit of explanation on the past? How that's worked for you?

Judith L. Bjornaas

There's really only been a few contracts that have come in that are like this, the NETCOM EMS and this where really there is some uncertainty as to what the total volume will be over the life of the contract so I don't know that we have enough experience with just a couple in the last year or so to come back and say we end up getting – if we had that experience then we'd be putting that in the backlog right now.

If we knew we were going to get 90% of it then we'd the 90% in backlog.

Terry W. Glasgow

Matter of fact, when I look at the more traditional awards that we get, usually what happens is that the values go up because of progressive engagement and we see that quite often and we start with something and expand beyond what was really there. It's just that in these cases it could distort it if we weren't a little bit cautious here. We just want to make sure what it is an we adjust it such that the backlog always represents a very good look at what we think is in fact executable.

Brian Kintslinger – Sidoti & Company

And actually the last one, sorry, interest expense, Judy, you've paid down about 40% of your debt. Is the increase in interest expense just because of the rate movements? Or how should – how do we explain an increase in interest expense when otherwise with the rates, with the debt level coming down so much?

Judith L. Bjornaas

It's primarily rate-driven and a little bit, yes, I did say that we're expecting DSOs to go back up a little bit by the end of the year and so that implies that we probably won't be staying at that $36.5 million.

Operator

(Operator Instructions). We'll next go to Erik Olbeter – Pacific Crest Securities.

Erik Olbeter – Pacific Crest Securities 

Real quick just two things, one is that it looks like the percent of contracts coming from cost plus went down to sort of 20%. It's the lowest number we've see in a couple of years. What are you finding? Is that just NETCENTS products rolling of or is there something more fundamental going on there?

Judith L. Bjornaas

I think the biggest driver there is I think we talked about the White Sands Missile Range contract that we were a prime on and at the end of Q1 the re-compete with a small business team and so now we're a subcontractor. So a lot of the revenue, there was a lot of ODCs and things like that on that contract that now aren't ours any more. But we did see kind of a run out in Q2 so in Q3 that's basically now kind of its run rate.

Erik Olbeter – Pacific Crest Securities 

And just real quick, what you said about the sort of turn over rate?

Terry L. Glasgow

Yes, turnover rate actually dropped down slightly. It's still in the upper teens but it got marginally better; still a lot of competition in the capital region.

Operator

And we do have a follow-up from Michael Lewis – BB&T Capital.

Michael Lewis – BB&T Capital Markets

I’m sorry. Judy, a few housekeeping questions here. You made a statement that some revenue shifted from the fourth quarter to the third. How much was that?

Judith L. Bjornaas

It was, I mean, it was probably about a couple million. I mean when we give out the guidance there's always things that could be a little bit higher, a little bit lower than we expect but that's the primary driver of why we were a little bit higher in Q3 than we guided but we're still looking at the same full year 395 top end number for '08.

Michael Lewis – BB&T Capital Markets

When you say a couple million, is that $2 million, $4 million?

Judith L. Bjornaas

$2 million.

Michael Lewis – BB&T Capital Markets

And then your – I do understand that the DSOs will go up a little bit in the December quarter, but have you – will you discuss with us what your expectation is for the DSO in the fourth quarter? Are you looking for a five day increase or two day increase? What specifically – how should we be modeling to that?

Judith L. Bjornaas

I would say a five day wouldn't be out of line but I don't – I wish I had a crystal ball and I knew where it was going to go. It's just so much of it is out of our control.

Michael Lewis – BB&T Capital Markets

And then two more quick questions, free cash flow expectations for this year. What do you think you will come in as a percent net income?

Judith L. Bjornaas

I don't have that exact number. I mean, we're sitting at two right now. I would imagine the fourth quarter will bring that down a little bit, but definitely going to be 150%.

Michael Lewis – BB&T Capital Markets

And then finally, debt payoff, what's your assumption for next year, should we be assuming continued payoff but at not as high of a level as we witnessed this quarter?

Judith L. Bjornaas

Yes. I mean clearly it's to our benefit I think to pay down the debt with the revolver so it's – there's no penalties for paying down. There's no advantage to keeping a lot of cash on the balance sheet so as the cash flow allows we'll pay down.

Operator

And with that there are no further questions in the queue. That will conclude today's conference call. A replay of the call is available through November 17th by dialing 888-203-1112. Alternatively, 719-457-0820, entering a pass code of 1996154. Again that number is 888-203-1112 or 719-457-0820 with a pass code of 1996154. This does conclude today's conference call. We'd like to thank everyone for your participation and wish you a good day.

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