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NCI Inc. (NASDAQ:NCIT)

Q4 2007 Earnings Call

February 20, 2008 5 pm ET

Executives

Maureen Crystal - Vice President of Investor Relations

Charles Narang – Chairman and Chief Executive Officer

Terry Glasgow - President and Chief Operating Officer

Judy Bjornaas - Senior Vice President, Chief Financial Officer

Analysts

William Loomis - Stifel Nicolaus

Alex Hamilton - Jesup & Lamont

Michael Lewis - BB&T Capital Market

Brian Kinstlinger - Sidoti & Company

Chris Donahue - SunTrust Robinson Humphrey

Tim Quillen - Stephens Incorporated

Gautam Khanna - Cowen

Operator

Good day ladies and gentlemen and welcome to the NCI Incorporated Fourth Quarter and Full Year 2007 Financial Result Conference Call. My name is Gwen and, I will be your conference coordinator for today. Today’s conference is being recorded.

I would like to turn the presentation over to your host for today’s call, Maureen Crystal, Vice President of Investor Relations for NCI. Please go ahead.

Maureen Crystal - Vice President of Investor Relations

Good evening and welcome to NCI’s fourth quarter and year-end 2007 financial result conference call.

Here is our agenda for today. Charles Narang, NCI’s Chairman and CEO will provide a high level overview of our accomplishments during 2007. Terry Glasgow our President and Chief Operating Officer will then provide some comments on our current market condition, as well as provide more granularity on our operational and business development accomplishments during the fourth quarter and full year 2007. Next, Judy Bjornaas our Chief Financial Officer will discuss our fourth quarter financial and year-end results and operating metric. She will also review the first quarter and full year 2008 guidance initiated in today’s earnings press release. We will then open up the call for your questions.

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 our forward-looking statements may 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 certainties identified in our earnings press release under the caption, Forward-Looking Information. For a full discussion of these factors and other risks 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 Narang - Chairman and Chief Executive Officer

Thank you, Maureen. Good afternoon everyone and thank you for joining us today. I am very pleased to report another tremendous year for NCI. During 2007, we continue to drive our business forward to excellent operational progress, strong financial results, and the execution of all our major strategic initiatives.

Let me briefly touch on these achievements that you know. We acquired two first grade companies in 2007 that are fully integrated into our operations. Our acquisition of our Operational Technologies Services in January of 2007 provided NCI with the expansion of our customer base into the Federal Aviation Administration and our June acquisition of Karta Technologies opened new and expanded geographical markets for NCI especially in the San Antonio area.

In particular, Karta enjoyed a strong reputation and is recognized as one of top 10 best places to work in San Antonio area. Karta brings new and expanded service offerings especially within the professional services area and fresh fields as medical and healthcare transformation, engineering, and logistics and training solutions. And while Karta brings a number of new customers, we now have a tremendous ability to leverage with companies’ offerings or greatly expanded customer base.

So from a strategic perspective, we have got all that we have been looking. We added new customers, new capabilities, new locations, and new sources, which substantially have broaden our business base and positions us well for the future.

We are very proud of our proven track that goes to growing our business organically. As we have consistently stated, we will continue to augment organic growth with the strategic acquisitions like OTS and Karta to strengthen our foundation for future continued growth. And we have the ample financial resources to continue with money in pursuit, we will consider these if that will bring long-term value to NCI and its shareholders.

On the business development front, we booked $311 million in new orders and increased total backlog for record $756 million. We worked hard to have won a prime position on the $50 billion GSA Alliant contract. We see this as an important contract to hold a prime position for opportunities in the federal market place, especially if much begin to flow for much needed refresher of this market place.

With the addition of GSA Alliant contract, we now hold prime position on 16 key GWAC of Multiple Award Vehicles that have total program selling value of $86 billion. As a result of these new awarding contracts, we continue to believe that our pipeline adequately scores with long-term organic growth target of 10% to 15%.

Finally, on the financial front, we reported there were top on revenue growth 39% in 2007 with revenues over $304.4 million. Our organic growth of 19% for the full year of 2007 was well beyond of our targeted goal. We also made great strides in proving our profitability. In fact, our operating income for 2007 was at 59% to $22.3 million. This reflected a full year operating margin of 7.3%, or 90-basis point improvement over last year as we continued to leverage our in-debt cost or expanded in web position business base. Finally, our earnings per share grew 35% to record $0.93 per share.

In closing, we once again head into a new year the goal the key elements in place, which is to acquire relationships, the GWAC contract vehicles, the management team, the skilled employees, and the financial resources needed to deliver on our promises to our shareholders.

With that, I will turn the call over to Terry to provide an operational update.

Terry Glasgow - President and Chief Operating Officer

Thank you, Charles and good evening. 2007 was an outstanding year for NCI, as we achieved excellent results in our core business areas.

To summarize Charles earlier comments, full year revenue of $304 million was 39% better than 2006. We delivered an organic growth rate of 19% for the year and operating income growth at an even higher rate than the revenue growth for the year. The year-over-year improvement in our key financial metrics demonstrates our total commitment to our stockholders to consistently meet or exceed expectations and deliver outstanding business results.

New business awards for the fourth quarter with $122 million, $45 million or 59% higher than the same period in 2006, and $22 million better than the third quarter of 2007. Awards for the full year 2007, totaled $311 million, $60 million better than 2006. The fourth quarter and full year award figures, we have record levels for NCI and continues our drive to deliver excellent future organic growth.

Our book-to-bill ratio for the fourth quarter was 1.4 times revenue. I would like to point out that 2007 new awards showed a repeat of our 2006 experience. In both cases, the first two quarters of the year showed relatively modest new business awards followed with each case by impressive awards in both Q3 and Q4. To some extent that pattern was a reflection of customer funding pressures brought on by 2006 and 2007 continuing resolutions, as well as incremental funding of more supplemental request.

Another positive and recurring thing for NCI is that in both 2006 and 2007, we won important new awards late in the year that generated a year end exit momentum they carry forward into the next year’s performance. You may recall that late in the fourth quarter of 2006, we won the USNORTHCOM program as well as some important Air National programs. Those awards gave NCI great revenue on earnings momentum as we went into 2007 and contribute significantly to the 2007 financial results being highlighted today.

Now, fast forward to December 2007, NCI was selected as the winner of a highly visible and highly contested $97.2 million Army ITES-2S Netcom Enterprise Mission Support or Netcom EMS contract. Like the NORTHCOM award in December of 2006, the win of Netcom EMS program provides excellent momentum as we drive forward into 2008. The Netcom EMS contract is an important program for NCI and provides substantial energy into our 2008 organic growth model.

Under the EMS contract, NCI will support Netcom in planning, coordinating, integrating, and implementing solutions necessary to develop and deploy the army’s enterprise-wide IT infrastructure. Netcom has a critical mission in the army’s important infrastructure and transformation initiative and we are obviously thrilled to have been chosen as the superior solution provider in a competition that featured virtually all of the major DoD information solution providers.

Winning these new ITES-2S task order not only provides great business momentum going into 2008, but also further substantiates NCI as a top tier competitor on an important ITES-2S (light shift) GWAC contract vehicle. Clearly, we have demonstrated our ability to compete and win high-end, high-visibility engagements competing against the best in the business.

The Netcom EMS is a single award IDIQ 3-year task order with selling price of approximately $100 million. The work included under this contract has previously been performed by other contractors under a variety of different contracts and task orders, each having periods of performance that will end over the next 12 months.

We have good visibility into the previous contracts and an understanding of Windows contracts were merged into our Netcom EMS task order. The ramp up of work has already begun starting in January of this year. The majority of the staff decisions will be filled with NCI personnel with a balance being provided by high-end subject matter and functionality experts from our partner team. The guidance for 2008 that Judy will provide later in this call reflects our best judgment on the task order ramp up.

Consistent with our state of practice on backlog editions, we only include in backlog, the new business award values that we have high confidence of conversion into revenue over the life of the contract or task order. Accordingly, we have not included the full EMS task order value in backlog nor have we included the full $97.2 million customer stated award value in our awards in book-to-bill metrics.

Based on our understanding with the task order ramp up and the insight we have into the running rates of the program’s being consolidated, we have included only $75 million into our awards and backlog calculations. If the run rates improve in the future, as we will obviously work very hard to make happen or if the ramp rate is accelerated by the customer, we will at that time adjust our awards in backlog accordingly.

We believe that the $75 million award and backlog edition value was reasonable in light of the importance of the program, the high likely ahead of the work being funded and our knowledge of the run rate of the task orders included in our contract statement of work.

Examples of other awards of the fourth quarter included the NETCENTS $6 million Rome Air Force Research Lab task order and the $5 million NETCENTS USA Force Airborne Secure Communications task order. Both of these NETCENTS task orders were for new work for NCI. In addition, we awarded the 2-year $5 million NETCENTS USSTRATCOM Global Command and Control Program which was a re-compute award. Other new business was generated by the expansion of our existing business space across all of our business units using our progressive engagement business model.

I would like to highlight an example of our progress engagement model by focusing on the Air National Guard. Recall that progress engagement is the process we used to expand our business involvement with our existing customers. It is an excellent way to achieve organic growth with a very attractive return of investment.

In early 2007, NCI was awarded a task order to develop a technology implementation for the Air National Guard, Microsoft Exchange 2007 Messaging Solution. During 2007, NCI’s Air National Guard team developed the engineering design and performed detailed planning and analysis.

In late December, the Air National Guard customer authorized NCI to proceed with the exchange 2007 implementation and sealing. This $13 million effort will be performed over a 12-month period time commencing in January 2008. In addition to solidifying our strong position with this important customer, NCI will also gain unique status as being one of the first federal IT providers to implement a large scale exchange 2007 solution. This distinction will further support progress engagement and growth opportunities in other NCI customer areas. Similar to the Netcom EMS, the Air National Guard Exchange 2000 work will provide nice momentum as we drive forward into 2008.

In last conference call, I mentioned that we had entered into a contract effort with USSTRATCOM and a partnership with Google to deliver cutting edge search and do a special visualization capabilities using Google Earth and Google Enterprise search appliances. The technology demonstrations are proceeding as planned and the partnership with Google has expanded. Recently Google and NCI entered into teaming relationships on several of our key GWAC contract vehicles, the Alliant, ITES-2S and NETCENTS, GWAC further cementing our partnership and supporting strategy in our federal markets.

On the last conference call, I provided information on NETCENTS product orders and compared 2006 to 2007. Let me now update you on our full year product orders and revenue. For the full year 2007, awards for the NETCENTS product orders were $10 million as compared to $28 million for 2006. Similarly, full year 2007 NETCENTS product revenue was $16 million as compared to $25 million for 2006 or a year-over-year reduction of $9 million dollars.

As we have mentioned in previous calls, product orders, yield marginal turns and are not part of our business growth focus. While the reduction of revenues from NETCENTS product sales negatively impacts our yearoveryear metrics, we believe that the quality of our backlog in revenue has been improved.

For instance, excluding NETCENTS product revenues from our fourth quarter and full year 2006 and 2007 amounts would result in a 57% quarter-over-quarter revenue improvement or 49% full year 2006 versus 2007 improvement and a corresponding improvement in our organic growth rate. Again, this reduction in our low margin product revenues and awards highlights the improved quality of our revenues stream and backlog.

Our strategy with respect to NETCENTS product is to support our customer needs and requirements but to do so at pricing levels that minimizes the impact to our margin expansion strategy.

Let me now make a couple of comments about the overall business environment for 2008. On the positive side, we do have signed under the spending bills for the Civilian Agencies and for DoD and we have partial, we are supplemental. This is clearly an improvement over the same situation last year at this time. There does remain however, and then certainly enough way of spending given the large war supplemental funding that has not been approved and that will undoubtedly become a political issue in this election year.

The piecemeal approval of the war supplemental may delay some of the business activity in the sector and produce marked uncertainty. On a positive note, the President’s FY '08 budget request shows a 3.8 expansion of spending in the federal IT space with civilian agencies tapped to grow by over 5%. It is too soon to predict the faith of that request as it goes to Congress. However, a reasonable assumption is that civilian agencies will be the benefactor of increased spending as we enter 2009 and beyond and the DoD will continue to have lower year-over-year spending increases.

We are encouraged by those requests and believe that our market area will continue to offer NCI good opportunity for market share expansion consistent with out stated goal of 10% to 15% long-term sustained organic growth. We also believe that market areas we are in and the customer sets we support will continue to be well funded throughout 2008 and 2009. Our 2007 acquisitions of Karta and OTS strengthen our position with their service offerings and customer position.

New business development is a primary focus within the company. We continue to invest aggressively and improve our new business development and capture team resources to help us pursue our army, air force, intelligence and civilian agency customer areas.

During 2007, we are a significant leadership without standing business capture credentials. In addition, the acquisition of Karta Technologies provides NCI highly talented and customer knowledgeable new business resources. We have already seen results from those investments as we build a strong and qualified set of new business opportunities in our target markers.

Our pipeline reflects this focus, as shown in the following metrics. A totally business pipeline have identified opportunities in our qualification and pursuit process exceeds $8 billion, up over a billion compared to Q3 of 2007 and almost $3 billion higher than a year ago. About 25% or 2 billion of the pipeline is for opportunities in 2008 with a balance for opportunities in '09 and beyond.

We have 13 programs in our pipeline with values of greater than $100 million. We have 21 programs in our pipeline, with values of between $50 million and $100 million, and we have 22 programs in our pipelines with values of 25$ million to $50 million. We have today, approximately $130 million of new business proposals that are currently in evaluation.

In the first quarter, we are planning on submitting proposals in excess of $400 million. This assumes of course the government procurement schedules remained on track. Unlike last year, we are seeing a first and second quarter wrap up of new business proposal activities. Many of the opportunities we are looking at for the first half of 2008 will be adjudicated in the third and fourth quarters. Given the sluggish first half activity in 2006 and 2007, we are obviously encouraged by this current uptake and new business activity in our targeted customer areas.

In summary, we believe we have a very strong new business development and capture teams and our pipeline is sufficiently robust to support us in our stated goal of delivering 10% to 15% long-term organic growth.

Now, basing on our staffing, we continue to show improvement in these metrics, our total staff is approximately 2000 employees, an increase of more than 600 people or 43% over a year ago. Turnover for the fourth quarter was slightly higher than the third quarter but remains moderate for us in the mid to teen levels and is lower than it was for the same period in 2006. This is an encouraging result given the competition on labor markets especially in Northern Virginia.

I will now turn the time over to Judy who will present the financial results and guidance for the balance of 2007. Judy.

Judy Bjornaas - Senior Vice President, Chief Financial Officer

Thank you Terry and good afternoon everyone. For the year ending 2007, NCI reported revenue of $304.4 million, which represents a year-over-year growth rate of 39%. This increase was due to our acquisitions, new contract awards and growth on existing contracts. Our acquisition of Karta added approximately $29 million in revenue and our OTS acquisition added about $9 million to our 2007 revenue.

New contract awards consist of primarily of numerous new task orders under our NETCENTS, (CESPQ), ITES2S contracts. Additionally, we saw significant revenue growth on a contract within the intelligence community, as well as many numbers of contracts with the Army and National Guard. The additional revenue on these and other contracts was partially offset by decrease in revenue of approximately $9 million due to lower product sales under our NETCENTS contracts, as well as a reduction in the revenue permits spared contracts or funding reductions under existing contracts particularly with some of our civilian agency customers.

Our organic growth rate for the full year 2007 was a strong 19%. Operating income for 2007 was up 59% to $22.3 million reflecting a full year operating margin of 7.3%. This compares to a operating income of $14 million in 2006 and an operating margin of 6.4%. This 90-basis point increase was a result of a higher volume of revenue on a year-over-year basis and the leveraging of our indirect costs of our larger revenue base.

For the full year of 2007, our income tax rate was 40.1% compared to 37.2% for 2006.

Net income for the full year 2007 was $12.6 million compared to $9.3 million for the same period last year. We reported diluted earnings per share for the full year of 93 cents per share compared to 59 cents per share for the comparable period in 2006. Diluted shares outstanding for both 2007 and 2006 were approximately $13.5 million.

In the fourth quarter of 2007, revenue was up approximately 37% to $88.2 million. This compares to $64.6 million for the fourth quarter of 2006. Our fourth quarter organic revenue growth rate was 11.5%.

Operating income for the fourth quarter was $6.5 million compared to $4.5 million for the fourth quarter of 2006. Our operating margin of 7.4% for the fourth quarter compares with that operating margin of 7% for the same period in 2006.

Net income for the fourth quarter was $3.3 million compared to $3.1 million for the same period of 2006, and our diluted earnings per share for the fourth quarter was 25 cents per share compared to 23 cents per share for the comparable period in 2006.

The effective tax rate for the fourth quarter of 2007 was 41.7% higher than the expected 39.5% due to the provision to return throughout for the 2006 tax returns, which resulted in an additional $128,000 in tax expense for the quarter. This compares to fourth quarter 2006 tax rate of 33.7%, which was lower than normal due to the 2005 provision to return adjustment, which reduced income tax expense by approximately $270,000.

The net change in taxes between fourth quarter of 2007 and fourth quarter of 2006 was also approximately at $0.03 swing in EPS. Without these tax adjustments, our fourth quarter 2007 EPS would have been $0.26 compared to fourth quarter of 2006, which would have been $0.21.

Diluted shares outstanding for the fourth quarter of 2007 was 13.6 million shares compared to 13.5 million shares for the fourth quarter of 2006. Stock compensation expense for the fourth quarter was approximately $493,000 compared to approximately $59,000 in the fourth quarter of 2006.

You may recall that we mentioned on our last quarter conference call that we were possibly expecting an acceleration of investing of a portion of outstanding stock options based on NCI hitting certain performance targets by the end of 2007. We did hit those performance targets so we had an extra $305,000 in stock compensation expense in the fourth quarter of 2007 or approximately $0.02 impact on EPS.

Moving on to our fourth quarter 2007 metrics, approximately 84% of our revenue was performed as the prime contractor compared to 80% for the fourth quarter of 2006. This increase is due in large part from the continued expansion of our GWAC contract base with new contract win and growth under our existing contracts.

The fourth quarter of 2007, 82% of our revenue came from the Department of Defense and Intelligence Agency and approximately 17% from Federal Civilian Agency. Our contract mix for the fourth quarter was approximately 37% from the time of maturity of contracts, 29% from cost of those contracts and 34% from fixed-price contracts.

Now, for a brief summary of the balance sheet and cash flow statement, cash flow provided by operations for the year 2007 was approximately $18 million. Our strong cash flow over the last 6 months enabled us to pay down the debt associated with the Karta acquisition by $12 million and at the end of the year, our outstanding debt was $43 million.

At the end of the fourth quarter, our DSO was 92 days. We clearly remained disappointed that this metric has not improved and has remained flat over the past two quarters. Unfortunately, while we were hoping for improvement this quarter, we were working against the fact that our DSO are typically the highest in the fourth quarter due to the seasonal holidays and paperwork delays from new funding by the government.

As we previously mentioned, a few of our payment offices have undergone system upgrades over the last six months, which has resulted in continued delays in payment processing on some contracts. Additionally, where we are a subcontractor to small businesses, our payment terms were typically we get paid after our prime gets paid and they have been experiencing payment delays. Though not visible in our metrics yet, we have revamped the entire AR and collections process to improve efficiency and we remain committed to get our DSOs down into the low limits of 70 during 2008.

Our backlog was $756 million at the end of the fourth quarter with $180 million of this funded. This compares to $612 million of total backlog at the end of the fourth quarter 2006, at which $123 million was funded. We believe that our backlog adequately supports our current revenue base and gives us clear insight into our forecasted revenues.

Now, I am going to spend my remaining time on the call, giving you a view of the guidance for the first quarter for the year 2008 that we initiated today as published in our earnings press release. For the first quarter of 2008, we expect the revenues to be on the range of $86 to $90 million and diluted EPS to be in the range of $0.24 to $0.26 per share. This guidance is based on weighted average shares of approximately $13.6 million shares for the first quarter of 2008.

For the full year of 2008, we expect revenue to be in the range of $365 to $375 million with diluted EPS to be in the range of $1.09 to $1.15 per share. This guidance is based on shares outstanding of approximately $13.7 million for 2008. The midpoint of this revenue range represents about an 11% organic growth rate over 2007.

The first quarter and full year guidance includes the 39.5% estimated tax rate and has assumes net interest expense for the first quarter of approximately $650,000 and $2.3 million for the full year. Depreciation and amortization is expected to be $660,000 for the first quarter and $2.7 million for the full year.

Finally, stock option expense is expected to be approximately $165,000 in the first quarter and about $900,000 for the full year of 2008. This guidance does not reflect the impact of any potential future acquisitions.

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

Question-and-Answer Session

Operator

(Operator Instructions). We will go first to William Loomis with Stifel Nicolaus.

William Loomis

History, thanks. Great quarter. Just looking at the first development side, I think one of the more impressive things just have the pipelines growing and then all the metrics, as far as what's admitted and evaluates is going up. Can you just detail as far as what areas are you, is this deeper penetration in the same markets or you adding or looking into some new markets, looking from new service types? Can you just expand on that, please?

Terry Glasgow

Sure. This is Terry. As you know, when we acquired Karta, one of the great advantages there was that they broaden out our service offerings into the professional services area, something that we have been looking to do anyway with some of our previous wins. And so as we now look at what Karta have and as we look at what NCI had in terms of customer present, there is a great intersection of capabilities and interest, we can now go out and pursue work in some of our traditional customer sets with some new services. So, basically, this is up selling to adjusting clients in many places.

We are also looking at expanding into our new client sets as well, where Karta was cross selling IT up through them. So, it kind of goes both ways right there. I think the third point I would like to make is that a lot of these really has to do with the focus that our business, development team, and capture teams are really putting in into the market area. As you know, we have invested in some really top notched people with great experience in the market place. And we are focusing on those kinds of business engagements that we have to have, especially in the '09, '010, '011 timeframe that could really help us get through to our long-term objectives.

Charles Narang

Now, this is Charles. We are looking at about adding new customer set, that’s really is the focus for 2008 and beyond then especially the selling side for this that we are looking at. And Karta thus offer some of the opportunities for the new customers that have been are looking at. It is just not the penetration of existing customer set, by just adding new customer sets.

William Loomis

Thank you.

Operator

We will go next to Alex Hamilton with Jesup & Lamont.

Alex Hamilton

Hi. Good evening.

Terry Glasgow

Hi, Alex.

Alex Hamilton

A few basic questions, the first one if you mentioned, did I apologize? In terms of your booking, how much of that represents new business?

Terry Glasgow

You know, I did not mention it, but obviously the EMS contract is all new business to us as well as there is two other pieces that we have there. So, in the fourth quarter significant amount of that, I am not going to give you the exact number because I have to wind up and I do not want it right now but a significant amount of $122 million or so was a new business to us.

Alex Hamilton

And you know, I know it has been part of your business mantra going forward allowed you to kind of avoid the adds and flows of the funding environment. Not to put words in your mouth, but from what you are seeing it, it sounds like there is an acceleration given the recent funding environment. Can you talk about that? And I guess, really, where the challenges going forward given the current funding environment?

Terry Glasgow

Let me just start it off and if Charles and Judy want to jump in, it will be fine. First of all, what we are saying, and I think a lot of people in the industry are saying, given that this year unlike the last two, we are not operating under continuing resolutions. I think there has been some things that have been delayed and are now going to move forward and move forward fairly smartly. So, I think people are coming out in Q1 and Q2 where in prior years some of these things had made to right compounding that obviously is the fact we still have a big war supplemental overhang there and how that is going to affect this as we go downstream if that gets delayed or this will be even further that could create a problem. I do believe that the places that we are in, that the customers that we are involved in really are well funded and most of these new things that we are doing are well funded and funding does not appear to be an issue.

Alex Hamilton

Great. Thank you.

Operator

We will go next to Michael Lewis with BB&T Capital Market.

Michael Lewis

Hello.

Terry Glasgow

Hi, Mike.

Michael Lewis

Very impressive internal growth. Congratulations. Terry, I just want to ask the question about infrastructure, one of your competitors, I think surprised the Street yesterday talking about how they had to invest more heavily into infrastructure and sales and marketing. So, I want to kind of get a feel for where NCI is right now? With regards to the infrastructure, do you anticipate that you will need to invest any additional resources in 2008 above what you have in the plan? And I guess that’s about it. You know, we are about, how is your capacity?

Terry Glasgow

Well, looking back, you know, investment in business development and capture proposal activities, key personnel, key subject matter experts have been a focus for us and we believe that it is instrumental to our long-term strategies. So, we will continue to invest in people that will help us to achieve organic growth. And in '08, we will have additional investments and those are already imbedded within our forecast and guidance. It gets something in this market place, I think it is a very wise investment to make, and I think we have done it very well. Now, at the same time, as we make those investments it is incumbent upon the management team to look very closely at the other cost that we have to make sure that we are setting all of our indirect resources in the most positive and effective ways. So, clearly it adds something that Judy, Charles, and I look at every single month that the management team is very much aware of and we are willing to invest obviously. We are going to invest to around our high priority investment kinds and new business activities.

Judy Bjornaas

I think Mike, if I can just add to that a little bit, you know, Terry did say that those investments are kind of delved in, they are definitely working into our guidance. We started making some investments in Q4 of 2007 and have additional business plan in 2008 and I think, you know, when you start working your motto, you will see, we had a 90-basis point of progress near margin from 2006 to 2007 some of that was due to the mix of revenue changing to more deals focused from the product sales and leverage in infrastructure that was in place and we are forecasting about a 20% to 30% basis point margin improvement in 2008 because we will be making some additional investments that will ease up some of that leveraging.

Charles Narang

Mike, this is Charles. As Judy said that we are already built into the models that some of them are must have been expecting in '08 but business development and captured management proposal of such an area that you always look for the good people. And the best they do in the companies are built upon. If we find some experts, some of those people that they can build up the business and can help us out in our organic growth on the road, we will definitely go and spend more money, but we will not do it simply for sake of just doing it.

Michael Lewis

That is very helpful. Just a quick followup to that, what can your current infrastructure support with regard to a sales level, is it a few hundred million more and then we will have to see a step up and more money coming out?

Charles Narang

We have consistently stated in the past and the one-to-one discussion on the conference calls that we are pretty much in a good at $12,500 million of revenues, with exception of what we said about the business growth when the proposal is in captured management. I do not think so we need to spend a whole lot more money until we get to $500 million in revenue. There will be some incremental calls and that is what we plan to do and this all was built over numbers.

Michael Lewis

That’s great. And then just one more quick question for Judy, I will get out of the way. Judy with regards to a debt payoff schedule in 2008, how should we assume that you will be paying all debts, should we take a portion of the free cash flow and just apply it or should we keep it kind of straight lined?

Judy Bjornaas

We will definitely be using our cash flow to pay down the debt and that is factored into, you know, the interest for the year, drop in overtime over the course of 2008.

Michael Lewis

Okay. Thanks. Keep up the good work.

Judy Bjornaas

Thanks.

Operator

We will go next to Brian Kinstlinger with Sidoti & Company.

Brian Kinstlinger

Hi, thanks for taking my questions. The first one I have, Terry you mentioned $130 million in award, they were going into evaluation, are any of those or how many of those are the $20 to $50 or $50 to $100 million contracts, are any of those taken?

Terry Glasgow

I have not brokered it out that way and do not have that out in my fingertips.

Brian Kinstlinger

When you take a look at the organic growth of the company in 2008, about 11%, how would you characterize DoD versus Civilian, in terms of those growth rate?

Judy Bjornaas

We say its consistent with our current revenue nets.

Brian Kinstlinger

So, roughly, they will grow inline with each other?

Judy Bjornaas

Yes.

Brian Kinstlinger

Thanks. As I look at, you know, you grew 19% this year, which by industry standards is very strong, you were on a CR throughout the entire year and now funding is better and it sounds like bookings are getting better in the pipeline, what's happened in 2007 that won't happen in 2008? What I mean by that is organic growth seems to be slowing and I know 19% is a lot and hard to duplicate, but what is the dynamic that change that while the environment is getting better?

Terry Glasgow

I will start off with that. First of all, growth is driven not on a smooth 12 month or four quarter basis. It is driven around specific events and things occurring obviously. While we are entering 2008 with good momentum and we are starting to build up a very strong pipeline of bidding evaluation plus things we are going to bid. That does not mean that they will be adjudicated at the same rate such that we will have that growth. Obviously, you know, right now, because we are very early in the year, we are looking at a reasonable growth rate of about 11% there and it seems really very appropriate at this point in time. There is still and off a lot of things that have to happen in the market place and this is where I think it is reasonable guidance level at this point.

Charles Narang

We are bidding right now, I would just like Terry said that we are bidding in the first quarter for $4 million worth of programs and they also will be moving to the right. And what you do not know at this point in time or they will be coming out in time as we expect them to or they would be moving to the right and that delayed at some point that’s going to affect the organic growth.

Brian Kinstlinger

Thank you. I kind of appreciate that. Two quick questions and the first one is, related to the acquisitions you are talked about. First of all, where would you look to acquire and what kind of services or what kind segment civilian defense and how feasible are you right now with your tech capacity? Would you be aggressive or a little less aggressive right now?

Charles Narang

While we you know, we believe in organic growth really that there is a lot more determined investment, but we certainly look for candidates all the time, we look at thesis all the time. And our intention is to look at the existing customer set that we have whether we have new technology that they offer. And if they have the new customer sets with old technology so we look at everything with technologies, the customer side, the geographical region where they are, and what they are doing. We do not want to duplicate what we already have. That does not help us at all. So anything that is described to give us some different advantage in building up the business, going to business, we will look at it.

Terry Glasgow

For instance, as was mentioned earlier, I think to Bill's question, we are very interested in growing some of our professional services business base because that gives us ways in which we can expand and cross sell and up sell that we do not have right now. So, two ways to do that in one way obviously is to go out and bid jobs and win it and that is our first focus. But second focus, if we do find something that fits the formula of having really good customer relations, good contract base, good prime contract and things like that we would certainly look at that as a way of augmenting our fundamental organic gross strategy.

Judy Bjornaas

I think and just to kind of add on to that, you know with your earlier question on the civilian market place and the expectations that they are going to see increased funding going forward, obviously that would be an area that we would focus on as well.

Brian Kinstlinger

Thank you. Last question I have, I just want to make sure I get it right, you know, asking question that I think you said $10 million of NETCENTS products in '07 and '06 was that the yearly number and the 16 and the 25 was the quarterly number?

Judy Bjornaas

The 3 and the 10 were new orders and the 16 and 25 were revenue.

Charles Narang

So that is how you get to a $9 million year-over-year reduction, 16 versus 25.

Brian Kinstlinger

And when you are talking about orders, are you telling me that is for next year?

Judy Bjornaas

Yes, I mean basically we ended 2007 with lower back NETCENTS product and backlog than we ended in 2006.

Brian Kinstlinger

Got it. I think my question would have been would you expect as a percentage of the dollar value these next 10 orders were down, even additional (inaudible), I guess that would be or should I guess the answer would be yes?

Judy Bjornaas

From what we would expect we are targeting right now kind of a similar level as 2007.

Terry Glasgow

If it were to go down, it would not hurt our feelings at all but if something fundamentally and I want to make sure you guys understand this, is that it is really important to take care of our customers and so we do this and we try to balance it out but there is a big difference from supporting customers and I do not know, yes giving the product away.

Brian Kinstlinger

So I can appreciate that. I was just trying to get the underlying growth of the good business that we talked about or the business that is profitable that is growing faster and it seems like it is and that was the point.

Terry Glasgow

Yeah.

Brian Kinstlinger

Great. Thank you.

Judy Bjornaas

Operator

We will go next to Chris Donaghey with SunTrust Robinson Humphrey.

Rob Takas

Hi guys. This is actually Rob Takas for Chris.

Judy Bjornaas

Hello.

Rob Takas

Hey guys. Judy, what was the impact of product sales on organic growth in the fourth quarter and for the year if you have that?

Judy Bjornaas

Terry has the full year number.

Terry Glasgow

It would have been higher proportionately but we did not calculate that. I mean the organic growth of 19% would have grown obviously and then an 11% would have been higher as well.

Rob Takas

Okay.

Terry Glasgow

You know that is some issue that we need to look at but we did not calculate that.

Rob Takas

Okay and then a second question for Terry. Can you provide a little color on what initiatives you continue to follow and what the impact that these will have on operating margin in 2008? And that is it, thank you.

Terry Glasgow

Okay. Totally different pieces were margin expansion to date. First of all, obviously the more work that we get with significant NCI labor content, the stronger the leverage story that we have. So, obviously as a prime contractor the focus we have positioning ourselves to have good deal based contribution and along we both have margins on that work that they delete us. So, partly we are doing is our obtaining process. Another part of what we are doing is just going out and weighing the business, which gives us a natural leverage effect. And then the third part is the management of our workforce, our base, and you know, the T&M contract so as that you are maximizing the build and cost towards it. Okay?

Rob Takas

Thank you.

Operator

We will go next to Tim Quillen with Stephens Incorporated.

Tim Quillen

Hey, good afternoon.

Terry Glasgow

Hi Tim.

Judy Bjornaas

Hi Tim.

Tim Quillen

Judy, I just want to make sure I understand the D&A number of, I think you have said 660, 000 in the first quarter. Is that apples to apples with 900, 000 reported in the fourth quarter?

Judy Bjornaas

Yes.

Tim Quillen

So, that is a step down in the amortization line. Is that correct?

Judy Bjornaas

Correct.

Tim Quillen

And I think that is roughly it, a 20-30 basis points peaked up in EBIT margin there. Does that imply that the EBITDA margins will be flat or slightly down?

Judy Bjornaas

From Q4 to Q1, yeah, that will be flat and slightly down, but over the course of the year, you know, most of 2007, amortization came in the second, you know, second half of the year from Karta. So, it will be pretty flat over '08.

Tim Quillen

Okay. So, in terms, I just want to make sure I understand this. So, in terms of EBIT margins, you are projecting an increase of 20 to 30 basis points but in terms of EBITDA margins, you are projecting relatively flat. Is that correct?

Judy Bjornaas

Correct.

Tim Quillen

Okay. Brilliant, nice quarter. Thank you.

Judy Bjornaas

Thanks.

Operator

We will go next to Gautam Khanna with Cowen.

Gautam Khanna

Can you hear me?

Charles Narang

Yes.

Judy Bjornaas

Yes.

Gautam Khanna

Okay. I am sorry. Can you walk me through your reach and peaks in 2008? And also, if you could talk about the NETCENTS, how big is NETCENTS in terms of sales? And are we are going to see accelerate in bookings over the course of 2008 as they approaches in '09?

Judy Bjornaas

I will take the first question, the thing we have said about last quarter. We are looking about a 15% to 18% of our '07 revenue is up for re-compete in 2008, but the timing of when those re-competes happen is clearly back-end loaded in the year and it is a little less than 5% of our guidance is related to winning re-compete revenue.

Gautam Khanna

Okay.

Judy Bjornaas

I will let Terry answer the question about in NETCENTS, re-compete and how important it is, as far as accelerating bookings on NETCENTS, we are seeing costumers actually shying away from NETCENTS right now, because there is a little life left on it.

Gautam Khanna

Exactly. What I was trying to ask, are we going to see decelerated one that and how it is today as a percentage of sales?

Terry Glasgow

Yeah, I am not sure of what they are going to do there. Let me say, first of all that the customer recognizing that as made extended life available under that contract vehicle they have. Statistically though that the customers using that if they want to go for more than two years or say three years, they have to co-commit with dollars to the longer time period. So, they are doing that. As you reach the end of any of the multiple award or GWAC contract vehicle, this is a natural phenomenon. Customers are going to go to a contract vehicle that will allow them to acquire the services that they need for the time period they need. So, there could be some of that going on. Clearly, the NETCENTS program office is well aware of this and they are looking at it. And so, there may be some people that may take work elsewhere and there are other contract vehicles. We are monitoring that.

Gautam Khanna

Okay. I appreciate it.

Terry Glasgow

Okay.

Judy Bjornaas

Thanks.

Operator

And we'll take a followup from Brian Kinstlinger with Sidoti & Company.

Brian Kinstlinger

I had a followup on the amortization question. Judy, can you just walk us through why amortization and depreciation come down from quarter to quarter?

Judy Bjornaas

Because SES acquisition amortization drops off going into and then, our contracts and customer relationship intangible, we amortized over the acquired backlog and that drops off over time as well.

Brian Kinstlinger

Great. Thank you.

Operator

(Operator Instructions). Thank you. It appears there are no further questions at this time. You may hear a replay of today’s call through March 5th by calling 1-888-203-1112 or 1-719-457-0820 pass code 4805708. Again, the numbers are 1-888-203-1112 or 1-719-457-0820 pass code 480-5708.

This concludes today’s conference. You may now disconnect.

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Source: NCI Inc. Q4 2007 Earnings Call Transcript
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