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NCI (NASDAQ:NCIT)

Q1 2013 Earnings Call

May 01, 2013 4:30 pm ET

Executives

Ali Ferguson

Charles K. Narang - Founder, Chairman, Chief Executive Officer, Chairman of NCI Information Systems Inc, Chief Executive Officer of NCI Information Systems Inc and President of NCI Information Systems Inc

Brian J. Clark - President and Director

Lucas J. Narel - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Edward S. Caso - Wells Fargo Securities, LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to NCI, Inc. First Quarter 2013 Financial Results Conference Call. My name is Keith, and I'll be your conference operator today. This call is being recorded. I would now like to turn the presentation over to your host for today's call, Ali Ferguson, Corporate Communications Manager for NCI. Please proceed, Ms. Ferguson.

Ali Ferguson

Good afternoon, and thank you for participating in NCI's conference call today. By now, you should have a copy of the press release we issued a short time ago. If not, it is available on our website at www.nciinc.com.

With us are our Chairman and CEO, Charles Narang; our President, Brian Clark; and our Chief Financial Officer, Lucas Narel, all of whom will deliver prepared remarks. Our Chief Operating Officer, Marco de Vito, is also here to participate on the Q&A portion of the call.

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 are thus 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 anticipated results and include the risks and uncertainties identified in our earnings press release under the caption Forward-looking Statements.

For a full discussion of these factors and other risks and uncertainties, please refer to the section titled Risk Factors in NCI's Form 10-K and Form 10-Q 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

Thank you, Ali, and good evening, everyone. This is a busy week for earnings and like at social sector. Since several of our peers are reporting results this evening, our remarks will be shorter than usual to allow more time for questioning.

So in the interest of time, I'm skipping my usual remarks and turning the call over to Brian. Of course, I will be available for questions and answers.

Brian?

Brian J. Clark

Okay. Thanks, Charles. Good afternoon. I want to start by reviewing our performance for the first quarter and let Lucas follow with a more in-depth discussion. I'll then come back on with an update on progress we made thus far for the year and our business development efforts and NCI's pipeline in particular.

With that said, first quarter revenue came in at $91.5 million, well above the guidance range we gave on last quarter's call. And earnings per share was $0.15, which exceeded the top end of our range by $0.05. As we told you to expect, net bookings in the first quarter were low at approximately $10 million, revenue came in at above our guidance due to onetime gains and earnings beats results from the additional revenue, as well as the impact of additional cost controls we have implemented.

So although revenue, margin and earnings per share were solid in the first quarter, we're less pleased with cash flow and bookings metrics. We believe that some of the factors that affected DSO and resulting cash flow will be resolved before the end of next quarter. Most importantly, we believe the issues involving delays in receipt of payments on certain contracts are customer-specific, they're not part of any larger trends, real or forecasted, in our industry.

Lucas will now explain the numbers in greater detail and give our guidance including underlying assumptions for the second quarter and full fiscal year 2013.

I'll then come back online to give additional color around the outlook, bid activity and pipeline statistics, along with some final comments.

Lucas?

Lucas J. Narel

Thanks, Brian. Good afternoon. For the first quarter ended March 31, 2013, revenue decreased by 7.6% or $7.5 million over the same period a year ago. The decrease was primarily due to approximately $5.8 million of lower revenue from our PEO Soldier contract.

During the first quarter of 2013, PEO Soldier accounted for 13.7% or $12.5 million of revenue, compared with 18.6% or $18.4 million of revenue for the same period last year. The primary reasons for this decrease were reductions in volume of work and the in-sourcing of certain tasks under the contract. Projected troop drawdowns will continue to reduce the staffing levels and required support on this program.

We expect PEO Soldier to contribute approximately $30 million of revenue for the remainder of 2013.

Revenue exceeded the top end of our guidance for the first quarter ended March 31, 2013, by $5.5 million. Revenue is higher than forecast primarily due to more direct labor on certain contracts to support onetime customer requirements and additional hardware purchases among other factors.

Contracts where NCI is a prime contractor accounted for 90% of revenue for the quarter compared with 89% last quarter and 87% in the first quarter of 2012.

DoD and intelligence contracts made up 76% of total revenues, while federal civilian contracts comprised 24%. The portion of civilian contracts was up 1 percentage point sequentially and year-over-year.

Fixed price contracts accounted for 28% of revenue, down 1 percentage point from the fourth quarter of 2012, and up 4 percentage points year-over-year. However, materials contracts were 21% of revenue, down 2 percentage points sequentially and down 5 percentage points from the first quarter of 2012.

Cost-plus fee contracts accounted for 51% of revenue, which is up 3 percentage points sequentially and up 1 percentage point year-over-year.

General and administrative expenses decreased 13.1% or $0.9 million for the 3 months ended March 31, 2013, compared with the same period a year ago. This decrease was due to lower stock comp expense, lower consulting fees and facilities costs, among other factors.

Operating income for the first quarter of 2013 was $3.6 million, up from $3.1 million from the first quarter of 2012. Operating margin for this quarter was 3.9% compared with 3.1% for the first quarter of 2012.

Operating margin increased due to improved margins on certain time material contracts to receive a past due award fees on certain cost-plus contracts, lower G&A expenses, as well as lower depreciation and amortization.

Net interest expense was $0.3 million for the quarter, down from $0.5 million for the first quarter of last year. This decrease is primarily due to our lower average loan balance in the quarter ended March 31, 2013, compared with the same period last year.

Net income for the quarter increased to $2 million from $1.6 million in the first quarter 2012. The increase in net income year-over-year is attributable to the factors affecting operating income and lower interest expense, offset by an increase in income taxes and a higher effective income tax rate.

Diluted earnings per share for the first quarter was $0.15 compared with $0.12 in the first quarter of last year.

First quarter 2013 EPS exceeded the top end of our guidance by $0.05. Diluted EPS was higher than previously forecasted, primarily due to the additional income generated on the revenue that exceeded the high end of the guidance, including the receipt of past due award fees and lower G&A expenses than forecasted.

Days sales outstanding, or DSO, was 78 days for the quarter ended March 31, 2013, up 14 days from the 64 days reported for the fourth quarter ended December 31, 2012. The increase in DSO is primarily associated with delays in receipt of payments from several large contracts, due to the change in payment offers for a significant customer, as well as the allocation of funding within certain other contracts. As a result, net cash used in our operating activities for the first quarter of 2013 was $8.3 million.

Contract backlog at March 31, 2013 was $623 million, of which, $162 million was funded. This compares with total backlog at December 31, 2012, of $706 million, of which, $212 million was funded.

Now moving on to guidance. For the second quarter of 2013, we expect revenues to be $76 million to $84 million, and diluted earnings per share to be $0.10 to $0.12 on a weighted average diluted share count of 12.8 million shares. We are raising our full year 2013 revenue forecast to $290 million to $320 million, and diluted earnings per share to $0.27 to $0.37 on a weighted average diluted share count of 12.8 million shares.

Our assumptions of the number of diluted shares outstanding for the second quarter and full year assumes that all outstanding reshipment stock and options are anti-dilutive. We estimate interest expense will be approximately $250,000 for the second quarter of 2013 and $1 million for the full year.

Depreciation and amortization is expected to be $1.5 million for the second quarter and $6 million for the full year.

The stock comp expense is expected to be approximately $300,000 in the second quarter and about $1.4 million for the full year.

And with that, I'll turn the call back over to Brian.

Brian J. Clark

Okay. As we said before, without significant revenue from new awards in the remaining quarters in 2013, NCI will post fairly ratable revenue declines with a sharper reduction in earnings per share in the second half of the year.

Our guidance continues to factor in the impact of federal budget constraints being the norm going forward, as we still do not have a clear indication from our customers regarding the effects of sequestration on our programs. Nonetheless, one quarter into the year, we determined that we could raise the low-end of our revenue guidance to $290 million, based on the higher revenue that came in, in the first quarter and some additional throughput anticipated on existing contracts later in the year.

Midpoint of our new revenue guidance range is $5 million higher and earnings per share at the midpoint is $0.12 higher than what we had forecasted on our 2012 yearend call. So I want to share with you how our underlying assumptions changed in the couple of months since the last call.

The top line increase is a bit more straightforward with the higher revenue midpoint, including additional mostly onetime revenue gains from the first quarter assumes minimal revenue -- new -- minimal revenue from new wins and does not factor in material impacts from sequestration.

New earnings per share midpoint bears further clarification. Clearly, we're pleased that higher than expected revenue, including onetime award fees, added meaningfully to the bottom line. Also contributing to the higher EPS in the first quarter was lower-than-forecasted spends in G&A, generally related to the timing of business development hires and other business proposal costs.

The cost containment measures we took in the first quarter will carry through the year and improve profitability, as reflected in our EPS guidance uptick. At the same time, as we've said before, we're committed to continuing to invest in new business development efforts in highly targeted and efficient ways. We expect that this strategy will allow us to remain profitable in the second half of the year when the effects of sequestration might be more pronounced and the impact of reduced absorption of indirect costs on the lower revenue base will definitely be more pronounced.

We've already provided substantial detail on how we're working to transform NCI's business development culture and disciplines. We also told you that our targeted 12-month bookings number was $360 million or better, which would represent a book-to-bill well above 1x our new revenue guidance midpoint of $305 million.

Today, I want to reiterate that we still see several possible scenarios for arriving at our bookings goal or greater, but I have to caution that our targets assume that there will not be continued material delays in the procurement process or cancellations of entire programs.

When we last spoke with you, we had approximately $650 million in bids submitted and awaiting award. As of today, that number remains relatively unchanged. During the first quarter of 2013, we won approximately $10 million of new business, which will contribute modestly to 2013 revenue. While it is certainly possible that we could see higher award activity in the current quarter, we continue to expect that the majority of 2013 bookings will come in the second half of the year. However, any significant new bookings in the next couple of months would move NCI's revenue number toward the top half of the full year guidance range.

We continue to qualify more of NCI's pipeline in the first quarter. As of today, our pipeline stands at approximately $8 million -- $8 billion and both the qualified portion and the average bid size of opportunities showed increases from last quarter.

Of this approximately $8 billion pipeline, we expect to bid $1.5 billion over the remainder of this year, including 15 having individual bid values of $50 million or more. Again, however, these numbers are dependent on our fees actually hitting the street, some of which have already been delayed by 9 to 12 months from their originally advertised dates.

The good news is that we're qualifying new business opportunities earlier in the pipeline cascade, focusing our efforts on opportunities and high-priority funding streams, targeting vulnerable incumbents and mining our high-value GWACs and IDIQs for near-term winnable task quarters. As a result of these efforts, our new business pursuits have increased significantly since the last call.

In closing, I can assure you that our management team is more focused than ever on winning new awards and rebuilding NCI to meet the challenges we're facing while, at the same time, keeping costs in line with reduced revenue base to protect profitability.

With that, operator, we'll be happy to open the call up to questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Bill Loomis with Stifel, Nicolaus.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Brian, the one thing I was surprised to hear and hopefully good news is the improved margins on time and material contracts. If you could just go into that a little more. What's happening there? Is it a bid strategy or just more of a onetime event? And then, the award fees, it sounds like -- are you just assuming it will come later in the year on other contracts? Is it a timing? Or why you seem to be focused on that onetime award fees, but yet, normal course of business, we tend to see them through the year. What -- if you can comment on that, too?

Brian J. Clark

Bill, let me get the award fee piece first and I'll let Lucas chime in on the T&M margins. The award fees that we're talking about relate to -- specifically to AdvanceMed. And those have been -- one of the things that we've been dealing with since that acquisition is getting award fees through the pipeline to be paid. And those -- that actually related to a period that was pre-acquisition, to give you an idea of how far some of these things are behind. So we are starting to see these things break free because it's been something we've been working on with that customer for the better part of the last couple of years. So that was something where, as you put it, yes, they would be recurring, the timing moves around a little and shifts up and down a quarter, generally speaking, when you're dealing with those things. But in this case, because of the level of delay that we were dealing with there, we've really not forecasted a whole lot of that into the plan. So when they do come in, they present some level side when those things come in like that. Well, on the T&M, Lucas?

Lucas J. Narel

Yes, so on the T&M contract, obviously, the reference to the improved margins relates to the year-over-year comparison. One of the things that we've really been focusing on over the last year, 1.5 years, is to control and improve the contracts that we do have in hand in addition to winning new business. So what that really represents is that coming to fruition with really a hard look at the staffing levels we have, the requirements under the contract and making improvements as we can for those contracts to improve profitability. So we have managed to do that on several contracts and we've seen the fruits of that labor here in the current quarters.

Brian J. Clark

And the amount, what -- would you classify as onetime, like the AdvanceMed fees, what would you total that to be in the quarter?

Lucas J. Narel

Yes, I mean, really, for the award fees, as Brian indicated, it's kind of this release of the backlog of award fees. So I'd say it relates to the beat on the bottom line guidance, I'd say it's probably a couple of pennies or so.

Brian J. Clark

Bill, about $0.5 million in revenue is your question, right? $0.5 million impact, yes.

Operator

We'll take our first question from Tobey Sommer with SunTrust.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

I was wondering if you could give us a little bit of color on the 2 significant bids that you've already submitted and a couple others that you're seeing as opportunities throughout the year and how they dovetail into the revised strategy. Any kind of color and explanation would be helpful?

Brian J. Clark

Yes, Tobey, on those, those are the things we've really talked about the last several quarters in terms of how we look at the pipeline of opportunities, we've really tried to increase the personnel and the attention we have from a pure capability standpoint and the resources we have to go after things. We've talked about moving the needle in terms of moving the average size of the bids up, all those things are happening. And then I think we have talked about this as well before, that the way we talk about it internally anyway, is we classify certain bids as what we call corporate bids. And I would say those are the kinds -- those are ones that, as we put it, ones that we go all-in on. So we use all resources from across the company, it goes all the way up to Charles as a matter of fact. And that's generally going to be somewhere 10, 12, 15 or so of those is the way I would think about it. And there's going to be those larger needle-moving opportunities that I would say, in all cases, will be at least $50 million in value. But we're trying to push those to be more like things that would be more like $100 million or better. And so we have submitted 2 of those so far this year-to-date. As I said earlier, we expect things come out as advertised and we expect to take shots at another 15 during the course of this year. And I think the other thing that's really important about that is in addition to size and attention is really, again, this all comes back to what we've really been giving a lot of insight to everyone on is this rebuilding effort and really putting very significant levels of resources against these things and doing it in a much earlier fashion than had been the practice in the past. Really, to boil it all down, truly giving ourselves the best possible chance to win.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Brian, as a follow-up, just curious if you could describe what -- the 2 bids that you've already submitted, what was the original timeline for those bids versus when you actually submitted them? Thought that may give us kind of tangible examples of how things have been moving to the right, if indeed these 2 did that.

Brian J. Clark

I want to say on these, the 2 that we're talking about, I would say, yes, I'd say they're 4 to 6 months was about the slide on those from when we had originally anticipated them hitting. And that's pretty typical. I think, if you talk to other folks around the industry as we certainly do, it's not something that's unique that we're seeing. I think, everybody is kind of saying about generally 6 months seems to be kind of a good guideline. If you're thinking you're going to bid something a year from now, it's probably going to be more like 18 months or so, that's kind of the way it's been playing out. But as we said, some things are taking -- we certainly have a couple of them in our pipeline that we expected to go bid last September timeframe and we're probably not going to see those, at least what they're saying right now, is going to be sometime this fall. So they're going to be at least 12 months out.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

And do you -- are the big bids that you have submitted and planned this year, are they from new work or are those attempted takeaways?

Brian J. Clark

Are you saying -- well, they would be new work for NCI. But I think, in almost all cases, they would be existing work for somebody else today, if that's answering your question.

Operator

[Operator Instructions] We'll take our next question from Edward Caso with Wells Fargo.

Edward S. Caso - Wells Fargo Securities, LLC, Research Division

The tax rate guidance for this year, can you offer that?

Lucas J. Narel

Yes, this is Lucas. Right now, we're expecting about 40.9%, is what we've got for effective tax rate annually.

Edward S. Caso - Wells Fargo Securities, LLC, Research Division

Okay. My memory of NCI historically is that they where IT-focused, value-add and leveraging off IDIQ contracts. Can you -- I mean, you've talked about stepping up your new business efforts. But I'm really curious to see what the -- if the focus -- or where the focus is today within the market, both in type of work and maybe end clients?

Brian J. Clark

That's a great question. We were talking about that earlier today because we figured somebody would ask that question. And I think I'd tell you the -- we can give you all kinds of answers, but I'll tell you the very honest answer is that we're going to go after anything that looks -- anything that we can do that looks real and that has a funding stream associated with it. Hopefully, it's either right in our strike zone or something that's tangential to it so that we can be credible in the ability to bid those things. And as you said, I mean, I think that's a good way to look at it. We have tried to do those, really look at things that are not necessarily just strictly in the IT services market. We're trying to broaden that, looking at things, particularly logistics is something that's of interest and things that can be differentiators. As you mentioned, the suite of IDIQ and GWAC contracts, that is absolutely an important part of our strategy to be able to really -- not only to have them, but to better leverage our success by using them. And we've restructured the way that we -- our business development functions around those, how those vehicles are operated to allow us to go after the opportunities we may not have gone after in the past. So to kind of be poised for those things that may present more incremental upsides, probably things that are smaller in nature, but that we can be positioned to be able to be responsive to the things we may not see coming. But in terms of other areas, I mean, generally, I'd say directionally more in the civilian market would be something I'd tell you. And more specifically within that, health care, of course, that represents over -- about 25% of our business today and we'd certainly like to see that -- continue to see that number move upward. Do you want to add anything?

Lucas J. Narel

Yes, I guess, I would point out that when we acquired AdvanceMed, that was a big step away from just IT work. But there are a lot of things that we do and that we're looking at that go outside of that. Brian mentioned logistics. But a lot of analytical work exists and there are some other areas that really broaden beyond straight IT work, which is more and more commoditized, as you know.

Edward S. Caso - Wells Fargo Securities, LLC, Research Division

Is acquisitions part of the strategy or potentially part of the strategy?

Brian J. Clark

Yes, that's starting to come back more into play at this point. And by that, I mean, we're now at a point where, I think, things are -- we haven't hit the bounce point yet, but we feel a lot better about having gotten, really, at this point, gotten all the internal structurings and restructurings behind us for the most part, so we can turn more attention in that regard. We also have paid down debt significantly in the past year. Obviously, this quarter, we have a little bit of a blip from a cash flow standpoint. But that's tied to some specific customer issues that were going on, they're not problems with the receivables or anything like that. So we're getting to a position where we're more comfortable with starting to take on some more leverage. Obviously, we're not going to be able to do anything that's going to be transformational at this point, nor I think in this environment would we want to do that. I don't think -- I'm not expecting we're going to see anybody doing that right now. But if we can see something that -- in that $20 million to $30 million range, it would certainly help. And we can be opportunistic, we're definitely going to be looking for those things as we look forward here.

Edward S. Caso - Wells Fargo Securities, LLC, Research Division

And last question. If Lucas could run through the quarter and full year expense assumptions? I think he listed 3 items. My fingers didn't type quite fast enough.

Lucas J. Narel

I'm sorry, what are you looking for exactly?

Edward S. Caso - Wells Fargo Securities, LLC, Research Division

Guidance. You listed, I think, 3 different items, like depreciation, amortization, interest. Can you just run through that set of your script again?

Lucas J. Narel

Sure, yes, no problem. Interest expense, we're looking at about $250,000 for Q2, and $1 million for the full year. Depreciation and amortization, we're looking for $1.5 million for the second quarter, and $6 million for the full year. And stock comp expense, $300k for the second quarter and $1.4 million for the full year.

Operator

Ladies and gentlemen, this does conclude today's question-and-answer session. At this time, I'd like to turn the conference back your speakers for any additional or closing remarks.

Brian J. Clark

No, we have nothing further. Thanks, everybody, for taking time to join us on the call. And if anybody has any questions to follow, certainly, feel free to give myself or Lucas or Larry Delaney a call, we'll be happy to help. Thanks.

Operator

Ladies and gentlemen, this does conclude today's conference. We appreciate your participation.

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