NCI, Inc. - FORM 10-Q/A - April 21, 2017

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EX-32.1 - EX-32.1 - NCI, Inc.	d277963dex321.htm
EX-31.2 - EX-31.2 - NCI, Inc.	d277963dex312.htm
EX-31.1 - EX-31.1 - NCI, Inc.	d277963dex311.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

Amendment No. 1

(Mark One)

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

FOR THE QUARTER ENDED JUNE 30, 2016

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

Commission File Number 000-51579

LOGO

NCI, Inc.

(Exact name of registrant as specified in its charter)


Delaware		20-3211574
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No

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

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

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

As of April 10, 2017, there were 9,038,897 shares outstanding of the registrant’s Class A common stock and 4,500,000 shares outstanding of the registrant’s Class B common stock. Shares of the Class B common stock are convertible on a one-for-one basis into shares of Class A common stock.

EXPLANATORY NOTE

This Amendment No. 1 to the NCI, Inc. (the “Company”) Quarterly Report on Form 10-Q (the “Form 10-Q/A”) amends our Quarterly Report on Form 10-Q for the quarter ended June 30, 2016 previously filed on July 29, 2016 (the “Original Filing”). The Company is filing this Form 10-Q/A to restate its unaudited consolidated financial statements, financial data and related disclosures as of and for the three- and six-month periods ended June 30, 2016 and 2015 to give effect to the embezzlement of Company funds by the Company’s former controller, as discussed below, and the reclassification of related cost of revenues and general and administrative expenses to misappropriation loss in connection therewith.

Restatement of Previously Issued Unaudited Consolidated Financial Statements

On January 23, 2017, the Company announced that it had discovered, based on preliminary findings of an internal investigation, that its controller had been embezzling Company funds.

On March 31, 2017, the Company announced that it had completed its internal investigation into the facts and circumstances surrounding the embezzlement by its former controller. The internal investigation revealed that the Company’s former controller had embezzled approximately $19.4 million during the period from January 1, 2010 through January 10, 2017. The embezzlement was accomplished by the former controller’s unauthorized transfers of Company funds to the controller’s personal bank accounts using his authority as controller to approve automated clearinghouse (“ACH”) payments from the Company’s payroll account. The former controller was able to conceal the unauthorized transfers by falsifying certain corporate records and Company bank statements, using fictitious balance sheet accruals and lying to other NCI employees and to the Company’s independent registered public accountants when questioned about the suspicious payments. The Company was unable to confirm any unauthorized transfers of Company funds by the former controller prior to 2010, as the Company’s bank no longer maintains the records necessary to identify the specific beneficiaries of any such remittances. The Company believes that the former controller acted alone and found no evidence that any other NCI employee was aware of or colluded in the embezzlement of Company funds or that there was any unlawful activity apart from that associated with the former controller’s embezzlement of Company funds.

The embezzled funds were primarily disguised as payments to the administrator of the Company’s self-insured employee medical benefits plan that led to an overstatement of fringe benefit costs. Such costs were included in the Company’s cost of revenues and general and administrative expenses in its financial statements for the fiscal years ended December 31, 2010 through 2015 and were originally allocated to contracts as allowable costs. The Company has reclassified such costs to misappropriation loss for the years 2010 through 2016, with appropriate reductions in cost of revenues and general and administrative expenses, and such costs are now treated as unallowable costs. The Company had sufficient allowable but previously unbilled costs allocated to its contracts during the period from 2010 through 2015 to offset the unallowable costs related to the embezzlement, such that there was no material change in revenue recognized on its cost reimbursable contracts for the fiscal years ended December 31, 2010 through 2015.

As discussed in Note 3 to the financial statements included in this Form 10-Q/A, we have restated our previously issued unaudited consolidated financial statements for the three- and six-month periods ended June 30, 2016 and 2015 to give effect to the embezzlement and reclassification of related cost of revenues and general and administrative expenses to misappropriation loss.

The effects of the restatement of the unaudited consolidated financial statements as of and for the three- and six-month periods ended June 30, 2016 and 2015 are as follows (the “Restatement”):


	Three Months Ended,				Three Months Ended,				Six Months Ended,						Six Months Ended,
	June 30, 2016				June 30, 2015				June 30, 2016						June 30, 2015
	As Reported		As Restated		As Reported		As Restated		As Reported			As Restated			As Reported		As Restated
Statements of Income
Costs of revenue	$	67,921	$	67,682	$	71,553	$	70,898	$	137,908		$	137,376		$	139,155		137,889
General and administrative expenses		6,812		6,793		6,866		6,807		12,941			12,900			13,495		13,382
Misappropriation loss		—		1,369		—		714		—			2,909			—		1,379
Provision for income taxes		2,100		1,666						4,324			3,410
Net income	$	3,230	$	2,553					$	6,563		$	5,141
Earnings per share
Basic EPS	$	0.25	$	0.19					$	0.50		$	0.39
Diluted EPS	$	0.23	$	0.18					$	0.47		$	0.37

Statements of Cash Flows
Net income									$	6,563		$	5,141
Prepaid expenses and other assets										(1,462	)		790
Accrued expenses and other liabilities										(1,779	)		(2,609	)

	As of June 30, 2016
	As Reported		As Restated
Balance Sheet
Prepaid expenses and other current assets	$	4,932	$	2,682
Accrued salaries and benefits		15,928		16,015
Other accrued expenses		4,985		4,070
Retained Earnings		42,592		41,170

This Form 10-Q/A amends and restates Items 1, 2, and 4 of Part I and Item 6 of Part II of the Original Filing and no other information included in the Original Filing is amended hereby. Generally, no attempt has been made in this Form 10-Q/A to modify or update the foregoing items, except as required to reflect the effects of the Restatement. Information not affected by the Restatement is unchanged and reflects the disclosures made at the time of the Original Filing. Accordingly, this Form 10-Q/A should be read in conjunction with the Company’s filings made with the SEC subsequent to the Original Filing.

In accordance with applicable SEC rules, this Form 10-Q/A includes updated certifications from our Chief Executive Officer and Chief Financial Officer as Exhibits 31.1, 31.2 and 32.1.

NCI, INC.


		PAGE
PART I: UNAUDITED FINANCIAL INFORMATION			1
Item 1.	Condensed Consolidated Financial Statements		1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		10
Item 4.	Controls and Procedures		17

PART II: OTHER INFORMATION			20
Item 6.	Exhibits		20
	Signatures		21

PART 1

UNAUDITED FINANCIAL INFORMATION

Item 1.

Condensed Consolidated Financial Statements

NCI, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(in thousands, except per share data)


	Three months ended June 30,				Six months ended June 30,
	2016 (Restated)		2015 (Restated)		2016 (Restated)		2015 (Restated)
Revenue	$	81,900	$	85,799	$	165,555	$	166,767

Operating expenses:
Cost of revenue		67,682		70,898		137,376		137,889
General and administrative expenses		6,793		6,807		12,900		13,382
Depreciation and amortization		1,684		1,892		3,476		3,981
Acquisition and integration related expenses		—		192		—		422
Misappropriation loss		1,369		714		2,909		1,379

Total operating expenses		77,528		80,503		156,661		157,053

Operating income		4,372		5,296		8,894		9,714
Interest expense, net		153		221		343		459

Income before income taxes		4,219		5,075		8,551		9,255
Provision for income taxes		1,666		2,029		3,410		3,804

Net income	$	2,553	$	3,046	$	5,141	$	5,451

Earnings per common and common equivalent share:
Basic:
Weighted average shares outstanding		13,184		13,013		13,169		12,991
Net income per share	$	0.19	$	0.23	$	0.39	$	0.42

Diluted:
Weighted average shares outstanding		13,858		13,603		13,847		13,604

Net income per share	$	0.18	$	0.22	$	0.37	$	0.40

Cash dividend declared and paid per share		—		—	$	0.15	$	0.12

The accompanying notes are an integral

part of these condensed consolidated financial statements

NCI, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(in thousands, except par value)


	As of June 30, 2016 (Restated)			As of December 31, 2015
Assets:
Current assets:
Cash and cash equivalents	$	138		$	233
Accounts receivable, net		54,398			60,044
Prepaid expenses and other current assets		2,682			3,447

Total current assets		57,218			63,724
Property and equipment, net		5,870			6,698
Other assets		1,523			1,548
Deferred tax assets, net		38,722			38,789
Intangible assets, net		17,410			19,231
Goodwill		33,878			33,878

Total assets	$	154,621		$	163,868

Liabilities and stockholders’ equity:
Current liabilities:
Current portion of long-term debt	$	7,107		$	—
Accounts payable		12,112			19,693
Accrued salaries and benefits		16,015			18,977
Deferred revenue		2,285			2,217
Other accrued expenses		4,070			3,843

Total current liabilities		41,589			44,730

Long-term debt		—			10,000
Other long-term liabilities		2,636			2,578

Total liabilities		44,225			57,308

Stockholders’ equity:
Class A common stock, $0.019 par value—37,500 shares authorized; 9,921 shares issued and 9,004 shares outstanding as of June 30, 2016, and 9,843 shares issued and 8,961 shares outstanding as of December 31, 2015		188			187
Class B common stock, $0.019 par value—12,500 shares authorized; 4,500 shares issued and outstanding as of June 30, 2016 and December 31, 2015		86			86
Additional paid-in capital		77,283			76,569
Treasury stock at cost—917 shares of Class A common stock as of June 30, 2016 and December 31, 2015		(8,331	)		(8,331	)
Retained earnings		41,170			38,049

Total stockholders’ equity		110,396			106,560

Total liabilities and stockholders’ equity	$	154,621		$	163,868

The accompanying notes are an integral

part of these condensed consolidated financial statements

NCI, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)


	Six months ended June 30,
	2016 (Restated)			2015
Cash flows from operating activities:
Net income	$	5,141		$	5,451
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,476			3,981
Share-based compensation		543			696
Deferred income taxes		67			73
Changes in operating assets and liabilities:
Accounts receivable, net		5,646			1,254
Prepaid expenses and other assets		790			2,682
Accounts payable		(7,581	)		2,386
Accrued expenses and other liabilities		(2,609	)		(2,546	)

Net cash provided by operating activities		5,473			13,977

Cash flows from investing activities:
Purchases of property and equipment		(827	)		(849	)
Cash paid for acquisition, net of cash acquired		—			(56,657	)

Net cash used in investing activities		(827	)		(57,506	)

Cash flows from financing activities:
Borrowings under credit facility		91,636			106,975
Repayments on credit facility		(94,529	)		(87,475	)
Proceeds from exercise of stock options		172			217
Repurchase of stock awards		—			(39	)
Dividends paid		(2,020	)		(1,561	)

Net cash (used in) provided by financing activities		(4,741	)		18,117

Net change in cash and cash equivalents		(95	)		(25,412	)
Cash and cash equivalents, beginning of period		233			25,819

Cash and cash equivalents, end of period	$	138		$	407

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	263		$	414

Income taxes	$	3,010		$	2,333

The accompanying notes are an integral

part of these condensed consolidated financial statements

NCI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of NCI, Inc. and its subsidiaries (“NCI” or “the Company”) have been prepared in accordance with generally accepted accounting principles in the U. S. (“GAAP”) for interim financial information and pursuant to the rules and regulations of the U. S. Securities and Exchange Commission (“SEC”). As a result, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted. In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments necessary to fairly present the Company’s financial position as of June 30, 2016, and its results of operations for the three and six months ended June 30, 2016 and 2015, and cash flows for the six months ended June 30, 2016 and 2015, which consists of normal and recurring adjustments. The information disclosed in the notes to the financial statements for these periods is unaudited. The current period’s results of operations are not necessarily indicative of results that may be achieved for any future period. All numbers in tables are presented in thousands except per share numbers. For further information, refer to the financial statements and footnotes included in NCI’s Annual Report on Form 10-K for the year ended December 31, 2015 and NCI’s Annual Report on Form 10-K for the year ended December 31, 2016.

Recently Issued Accounting Pronouncements

On November 20, 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes. To simplify the presentation of deferred income taxes, the amendments in this ASU require that deferred tax assets and liabilities be classified as non-current in a classified balance sheet. As permitted, the Company elected to early adopt this ASU using the retrospective approach, effective with its Form 10-Q filing for March 31, 2016. As a result of adopting this ASU, current net deferred taxes of $4.0 million were reclassified to net non-current deferred taxes as of December 31, 2015. The adoption of ASU 2015-17 had no impact on the Company’s consolidated statements of income or cash flows for year ended December 31, 2015 or the condensed consolidated statements of income or cash flows three and six month periods ended June 30, 2016.

In February 2016, the FASB issued ASU 2016-02, which requires the recognition of right-to-use assets and lease liabilities arising from capital leases and operating leases in the statement of comprehensive income and the statement of financial position, respectively. The Company will adopt the standard effective January 1, 2019. The Company has not yet completed its evaluation of the impact that the standard may have on its consolidated balance sheet. The actual impact will depend on the Company’s lease portfolio at the time of adoption.

In March 2016, the FASB issued ASU 2016-08, which clarifies the implementation guidance with respect to principal versus agent considerations under the new revenue recognition standard, ASU 2014-09, Revenue from Contracts with Customers. In April 2016, the FASB issued ASU 2016-10, which clarifies the implementation guidance with respect to identifying promised goods or services from a principal and agent perspective under ASU 2014-09. The Company will adopt the standard effective January 1, 2018 and is continuing to evaluate the full effect that ASU 2014-09 and related subsequent updates will have on its consolidated financial statements and related disclosures.

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

2. Business Overview

NCI is a leading provider of enterprise solutions and services to U.S. defense, intelligence, health care and civilian government agencies. The Company has the expertise and proven track record to solve its customers’ most important and complex mission challenges through technology and innovation. The Company’s team of highly skilled professionals focuses on delivering cost-effective solutions and services in the areas of agile software application and systems development/integration; cybersecurity and information assurance; engineering and logistics support; enterprise information management and advanced analytics; cloud computing and IT infrastructure optimization; health IT and medical support; IT service management; and modeling, simulation and training. Headquartered in Reston, Virginia, the Company has approximately 2,000 employees operating at more than 100 locations worldwide.

The majority of the Company’s revenue was derived from contracts with the U.S. Federal Government, directly as a prime contractor or as a subcontractor. NCI primarily conducts business throughout the U. S. The Company reports operating results and financial data as one reportable segment.

For the three and six months ended June 30, 2016, the Company generated approximately 64% of revenue from the Department of Defense, including agencies within the intelligence community, and approximately 36% of revenue from federal civilian agencies. For the three and six months ended June 30, 2015, the Company generated approximately 60% of revenue from the Department of Defense, including agencies within the intelligence community, and approximately 40% of revenue from federal civilian agencies.

NCI’s Program Executive Office Soldier (“PEO Soldier”) contract is the Company’s largest revenue-generating contract and accounted for approximately 17% and 10% of revenue for the three months ended June 30, 2016 and 2015, respectively. The Company’s PEO Soldier program is a cost-plus fee contract consisting of a base period and four option periods for a total term of five years, which commenced in October 2015. NCI’s Cyber Network Operations and Security Support (CNOSS) program, supporting the U.S. Army Network Enterprise Technology Command accounted for approximately 11% and 7% of revenue for the three months ended June 30, 2016 and 2015, respectively. This cost-plus-fixed-fee, single-award indefinite delivery indefinite quantity contract consists of a 12-month base period with two one-year option periods and one six-month option period, and commenced in October 2014.

3. Embezzlement and Restatement

In January 2017, the Company identified a misappropriation of Company funds by its former controller. The Audit Committee engaged independent legal counsel and forensic consultants to investigate the fraud. The internal investigation was completed in March 2017, and revealed that the former controller had embezzled $19.4 million through a circumvention of controls, which included transfers from the payroll account to his personal account, creating fictitious invoices, and altering bank account statements to conceal the misappropriations. The Company believes that the former controller acted alone and found no evidence that any other NCI employee was aware of, or colluded in, the embezzlement of Company funds or that there was any unlawful activity apart from that associated with the former controller’s embezzlement of Company funds. The amounts embezzled were primarily classified as expenses and were included as fringe benefits costs in costs of revenue and selling, general and administrative expenses and was originally allocated to contracts as allowable costs. After discovery of the embezzlement these costs were restated as misappropriation loss, which is an unallowable cost. The Company had sufficient allowable, but previously unbilled costs allocated to its contracts in fiscal years 2010 through 2015 to offset the unallowable costs related to the embezzlement, such that there was no material change in revenue recognized on its cost reimbursable contracts during such periods. During 2016, a portion of the amounts embezzled were recorded on the balance sheet. Accordingly, the Company has restated the Condensed Consolidated Statements of Income for the three-and six-month periods ended June 30, 2016 and 2015, Condensed Consolidated Statements of Cash Flows for the six-month period ended June 30, 2016 and the Condensed Consolidated Balance Sheet as of June 30, 2016, as follows:


	Three Months Ended,				Three Months Ended,				Six Months Ended,						Six Months Ended,
	June 30, 2016				June 30, 2015				June 30, 2016						June 30, 2015
	As Reported		As Restated		As Reported		As Restated		As Reported			As Restated			As Reported		As Restated
Statements of Income
Costs of revenue	$	67,921	$	67,682	$	71,553	$	70,898	$	137,908		$	137,376		$	139,155	$	137,889
General and administrative expenses		6,812		6,793		6,866		6,807		12,941			12,900			13,495		13,382
Misappropriation loss		—		1,369		—		714		—			2,909			—		1,379
Provision for income taxes		2,100		1,666						4,324			3,410
Net income	$	3,230	$	2,553					$	6,563		$	5,141

Earnings per share
Basic EPS	$	0.25	$	0.19					$	0.50		$	0.39
Diluted EPS	$	0.23	$	0.18					$	0.47		$	0.37

Statements of Cash Flows
Net income									$	6,563		$	5,141
Prepaid expenses and other assets										(1,462	)		790
Accrued expenses and other liabilities										(1,779	)		(2,609	)

	As of June 30, 2016
	As Reported		As Restated
Balance Sheet
Prepaid expenses and other current assets	$	4,932	$	2,682
Accrued salaries and benefits		15,928		16,015
Other accrued expenses		4,985		4,070
Retained Earnings		42,592		41,170

4. Earnings Per Share

Basic earnings per share exclude dilution and are computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted earnings per share include the incremental effect of stock options calculated using the treasury stock method. Shares that are anti-dilutive are not included in the computation of diluted earnings per share. For the three months ended June 30, 2016 and 2015, approximately 8,000 and 131,000 shares, respectively, were not included in the computation of diluted earnings per share, because to do so would have been anti-dilutive. For the six months ended June 30, 2016 and 2015, approximately 4,000 and 115,000 shares, respectively, were not included in the computation of diluted earnings per share, because to do so would have been anti-dilutive. The following table details the computation of basic and diluted earnings per common share (Class A and Class B) for the three and six months ended June 30, 2016 and 2015.


	Three months ended June 30,				Six months ended June 30,
	2016 (Restated)		2015		2016 (Restated)		2015
Net income	$	2,553	$	3,046	$	5,141	$	5,451

Weighted average number of basic shares outstanding during the period		13,184		13,013		13,169		12,991
Dilutive effect of stock options and restricted stock after application of treasury stock method		674		591		678		614

Weighted average number of diluted shares outstanding during the period		13,858		13,603		13,847		13,604

Basic earnings per share	$	0.19	$	0.23	$	0.39	$	0.42

Diluted earnings per share	$	0.18	$	0.22	$	0.37	$	0.40

5. Accounts Receivable

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


	As of
	June 30, 2016		December 31, 2015
Billed receivables	$	21,499	$	23,621
Unbilled receivables:
Amounts billable at end of period		26,480		27,185
Other		7,161		9,980

Total unbilled receivables		33,641		37,165

Total accounts receivable		55,140		60,786
Less: Allowance for doubtful accounts		742		742

Total accounts receivable, net	$	54,398	$	60,044

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

6. Property and Equipment

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


	As of
	June 30, 2016		December 31, 2015
Property and equipment
Furniture and equipment	$	24,502	$	26,573
Leasehold improvements		9,388		9,323
Real property		549		549

		34,519		36,444
Less: Accumulated depreciation and amortization		28,649		29,746

Property and equipment, net	$	5,870	$	6,698

Depreciation and amortization expense for the three months ended June 30, 2016 and 2015 was $0.8 million. Depreciation expense for the six months ended June 30, 2016 and 2015 was $1.7 million and $1.8 million, respectively.

7. Intangible Assets

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


	As of
	June 30, 2016			December 31, 2015
Contract and customer relationships	$	39,594		$	39,594
Developed software		1,113			1,113
Less: Accumulated amortization		(23,297	)		(21,476	)

Intangible assets, net	$	17,410		$	19,231

Amortization expense of intangible assets for the three months ended June 30, 2016 and 2015 was $0.9 million and $1.1 million, respectively. Amortization expense of intangible assets for the six months ended June 30, 2016 and 2015 was $1.8 million and $2.2 million, respectively. Intangible assets are primarily amortized on a straight line basis over periods ranging from three to 11 years. Expected amortization expense for the remainder of the fiscal year ending December 31, 2016, and for each of the fiscal years thereafter, is as follows:


For the year ending December 31,
2016 (remaining six months)	$	1,823
2017		3,632
2018		3,149
2019		3,049
2020		3,027
Thereafter		2,730

	$	17,410

8. Share-Based Payments

During the three and six months ended June 30, 2016, the Company granted 25,000 stock options to purchase shares of Class A common stock with a weighted-average exercise price of $13.29, which represents the fair market value at the date of grant. During the three months ended June 30, 2016, no stock options were exercised. During the six months ended June 30, 2016, 38,332 stock options were exercised at a weighted-average exercise price of $4.48. As of June 30, 2016, there were 1,534,500 stock options outstanding.

During the three months ended June 30, 2016, 20,000 restricted shares were granted and 20,000 restricted shares were cancelled. During the six months ended June 30, 2016, 25,000 restricted shares were granted and 20,000 restricted shares were cancelled. As of June 30, 2016, there were 320,000 shares of restricted stock outstanding.

The following table summarizes stock compensation expense allocated to cost of revenue and general and administrative costs for the three and six months ended June 30, 2016 and 2015:


	Three months ended June 30,				Six months ended June 30,
	2016		2015		2016		2015
Cost of revenue	$	36	$	59	$	115	$	122
General and administrative		178		267		428		574

	$	214	$	326	$	543	$	696

As of June 30, 2016, there was approximately $3.6 million of total unrecognized compensation cost related to unvested stock compensation arrangements. This cost is expected to be fully amortized over the next five years, with approximately $0.5 million, $0.9 million, $0.9 million, $0.7 million and $0.6 million amortized during the remainder of 2016, and the full years of 2017, 2018, 2019, and 2020, respectively. The cost of stock compensation is included in the Company’s Condensed Consolidated Statements of Income and expensed over the service period of the options.

9. Debt

NCI’s senior credit facility, amended in December 2014, and referred to herein as the “credit facility,” consists of a revolving line of credit with a borrowing capacity of up to an $80.0 million principal amount and a $45.0 million accordion feature allowing the Company to increase its borrowing capacity to up to a $125.0 million principal amount, subject to obtaining commitments for the incremental capacity from existing or new lenders. The outstanding borrowings are collateralized by a security interest in substantially all of the Company’s assets. The lenders also require a direct assignment of all contracts at the lenders’ discretion. The outstanding balance under the credit facility accrues interest based on one-month LIBOR plus an applicable margin, ranging from 210 to 310 basis points, based on the ratio of the Company’s outstanding senior funded debt to Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA) as defined in the credit facility. The credit facility expires on January 31, 2017. Accordingly all borrowings are classified as current liabilities as they are due and payable within the next 12 months.

The credit facility contains various covenants that limit, among other things, the Company’s ability to incur or guarantee additional debt; make certain distributions, investments and other restricted payments, including limits on cash dividends on the Company’s outstanding common stock or equivalent equity interests; enter into transactions with certain affiliates; create or permit certain liens; and consolidate, merge, or sell assets. In addition, the credit facility contains certain financial covenants that require the Company to maintain a minimum fixed charge coverage ratio, maintain a minimum funded debt to earnings ratio; and limit capital expenditures below certain thresholds. As of June 30, 2016, the Company was in compliance with all of its loan covenants.

The credit facility allows the Company to use borrowings thereunder of up to $17.5 million to repurchase outstanding shares of Class A common stock. No stock repurchases took place in the three or six months ended June 30, 2016. At June 30, 2016, $16.7 million was remaining under the board of directors’ authorization for share repurchases.

During the second quarter of 2016, NCI had a weighted average outstanding loan balance of $16.4 million which accrued interest at a weighted average borrowing rate of 2.5%. During the second quarter of 2015, NCI had a weighted average outstanding loan balance of $24.7 million which accrued interest at a weighted average borrowing rate of 2.3%.

As of June 30, 2016, the outstanding balance under the credit facility was $7.1 million and interest accrued at a rate of one-month LIBOR plus 210 basis points, or 2.5%.

10. Computech Acquisition

On January 1, 2015, the Company completed its purchase of 100% of the outstanding stock of Computech, Inc. (“Computech”), a leader in agile and lean application software development and IT operations and maintenance, for approximately $56.7 million, net of cash acquired. The acquisition has been accounted for under the acquisition method of accounting, which requires the total purchase consideration to be allocated to the assets acquired and liabilities assumed based on estimates of fair value. The excess of the purchase consideration over the amounts assigned to tangible or intangible assets acquired and liabilities assumed is recognized as goodwill.

Allocation of Purchase Price

NCI has completed the valuation of the assets acquired and liabilities assumed of Computech. The fair values assigned to the intangible assets acquired were based on estimates, assumptions, and other information compiled by management, including independent valuations that utilized established valuation techniques. Based on the Company’s valuation, the total consideration of approximately $56.7 million, net of $3.3 million of cash acquired, has been allocated to assets acquired (including identifiable intangible assets and goodwill) and liabilities assumed, as follows:


Accounts receivable and other assets		8,407
Goodwill		33,878
Definite-life intangible assets		19,720
Accrued salary and benefits		(4,112	)
Other accrued expenses		(1,236	)

	$	56,657

The definite life intangibles recognized in the allocation of the Computech purchase price consists of $18.6 million in contracts and customer relationships and $1.1 million in developed software. The fair value of the definite-lived intangible asset for contracts and customer relationships is based on existing customer contracts and anticipated follow-on contracts with existing customers and will be amortized on a straight-line basis over its expected life of seven years. The fair value of the definite-lived intangible asset for developed software will be amortized on a straight-line basis over its expected useful life of three years.

All goodwill and intangible asset amortization related to the acquisition of Computech is expected to be deductible for income tax purposes.

11. Dividends

Our board of directors declared and the Company paid the following dividends during the periods presented:


Declaration Date	Dividend Per Share		Record Date	Total Amount		Payment Date
February 10, 2015	$	0.12	February 25, 2015	$	1,561	March 13, 2015
February 8, 2016	$	0.15	February 26, 2016	$	2,020	March 18, 2016

12. Related Party Transactions

The Company purchases services under a subcontract from Renegade Technology Systems, Inc., which is a government contractor wholly-owned by Rajiv Narang, the son of Charles K. Narang, Chairman of the Board. For the three months ended June 30, 2016 and 2015, the expense incurred under this agreement was approximately $201,000 and $182,000, respectively. For the six months ended June 30, 2016 and 2015, the expense incurred under this agreement was approximately $358,000 and $348,000, respectively. As of June 30, 2016 and 2015, outstanding amounts due to Renegade Technology Systems, Inc. under this agreement were $65,566 and $60,378, respectively.

13. Contingencies

Government Audits

Payments to the Company on U.S. Federal Government contracts are subject to adjustment upon audit by various agencies of the U.S. Federal Government. Audits of costs and the related payments have been performed by the various agencies through 2007 for NCI Information Systems, Inc., our primary corporate vehicle for Government contracting. In the opinion of management, the final determination of costs and related payments for unaudited years will not have a material effect on the Company’s financial position, results of operations, or liquidity.

Litigation

Civil Suit Against Former Controller

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

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

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

Government Agency Investigations

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

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

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

Other Legal Proceedings

From time to time, we are involved in legal proceedings arising in the ordinary course of business. At this time, the probability is remote that the outcome of any such ordinary course litigation matters currently pending will have a material adverse effect on our financial condition and results of operations.

Misappropriation loss—Costs and Recovery

As discussed above, the Company initiated civil legal proceedings against our former controller seeking to recover assets acquired by him with funds wrongfully obtained by him through his embezzlement of Company funds and that litigation is ongoing. The court has frozen all of our former controller’s assets. The Company carries insurance that could cover up to $5 million of the misappropriation loss. The timing and amount of final recoveries, net of expenses of recovery, is uncertain. The Company has not yet recognized an estimated value of the potential recovery due to the limited amount of information available to it at this time. The Company estimates that it incurred approximately $5 million in costs during the first quarter of 2017 related to the embezzlement, including legal, auditing and forensic accounting fees.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q/A, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements regarding our business, financial condition, results of operations, and prospects. There are statements made herein, which may not address historical facts and, therefore, could be interpreted to be forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Such statements are subject to factors that could cause actual results to differ materially from anticipated results. The factors that could cause actual results to differ materially from those anticipated include, but are not limited to, the following:

•

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

•

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

•

delays in the U.S. Federal Government appropriations process, or budgetary cuts resulting from Congressional committee recommendations or automatic sequestration under the Budget Control Act of 2011; U.S. Federal Governmental shutdowns (such as the shutdowns that occurred during the U.S. Federal Government’s 1996 and 2013 fiscal years); and other potential delays in the U.S. Federal Government appropriations process;

•

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

•

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

•

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

•

adverse results of U.S. Federal Government audits of our government contracts;

•

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

•

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

•

economic conditions in the U.S., including conditions that result from terrorist activities or war;

•

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

•

the U.S. Federal Government’s “insourcing” of previously contracted support services and the realignment of funds to non-defense related programs;

•

our ability to achieve the objectives of near-term or long-range business plans, particularly revenue growth, and the ability to realize benefits from future deferred tax assets; and

•

risk of contract non-performance or termination.

Some of these important factors are outlined under Item 1A. Risk Factors and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the U.S. Securities and Exchange Commission (“SEC”), and from time to time in other filings with the SEC, such as our Current Reports on Forms 8-K and Quarterly Reports on Form 10-Q. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee our future results, level of activity, or performance. We undertake no obligation to update publicly or revise any forward-looking statements. You should not place undue reliance on any forward-looking statements.

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

EMBEZZLEMENT AND RESTATEMENT

In this Form 10-Q/A, we have restated our unaudited condensed consolidated financial statements for the three- and six-month periods ended June 30, 2016 and 2015. Like the other updated sections of this Form 10-Q/A, where specifically stated, the information in this section is reflective of the Restatement, but no attempt has been made to modify this Item 2 of the Form 10-Q/A, except as required to reflect the effects of the Restatement. Information not affected by the Restatement is unchanged and reflects the disclosures made at the time of the Original Filing.

OVERVIEW

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

•

Cloud Computing and IT Infrastructure Optimization

•

Cybersecurity and Information Assurance

•

Engineering and Logistics Support

•

Enterprise Information Management and Advanced Analytics

•

Health IT and Medical Support

•

IT Service Management

•

Modeling, Training and Simulation

•

Agile Development and Integration

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

Key Financial Metrics

Prime Contractor Revenue

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


	Three months ended June 30,						Six months ended June 30,
	2016			2015			2016			2015
Revenue derived from prime contracts		94	%		91	%		94	%		91	%

Customer Group Revenue

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


	Three months ended June 30,						Six months ended June 30,
	2016			2015			2016			2015
Department of Defense and intelligence agencies		64	%		60	%		64	%		60	%
U.S. Federal civilian agencies		36	%		40	%		36	%		40	%

Contract Type Revenue

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

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


	Three months ended June 30,						Six months ended June 30,
	2016			2015			2016			2015
Time-and-materials		17	%		22	%		17	%		23	%
Cost-plus fee		61	%		49	%		60	%		47	%
Firm fixed-price		22	%		29	%		23	%		30	%

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

Contract Backlog


	As of
	June 30, 2016		December 31, 2015
	(in millions)
Funded backlog	$	120	$	147
Total backlog	$	507	$	552

We define backlog as our estimate of the remaining future revenue from existing signed contracts over the remaining base contract performance period and from the option periods of those contracts that we believe are more likely than not to be exercised. Our backlog does not include any estimate of future potential delivery orders that might be awarded under our GWAC, agency-specific IDIQ, or other multiple-award contract vehicles. We define funded backlog as the portion of backlog for which funding currently is appropriated and obligated to us under a contract or other authorization for payment signed by an authorized purchasing agency, less the amount of revenue we have previously recognized. Our funded backlog does not represent the full potential value of our contracts, as Congress often appropriates funds for a particular program or agency on a quarterly or yearly basis, even though the contract may provide for the provision of services over a number of years. We define unfunded backlog, not included above, as the total backlog less the funded backlog. Unfunded backlog includes values for contract options that have been priced but not yet funded. Additional information on how we determine backlog is included in our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC.

Results of Operations

Three Months Ended June 30, 2016 Compared to Three Months Ended June 30, 2015

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


	Three months ended June 30,
	2016 (Restated)		2015 (Restated)		2016 (Restated)			2015 (Restated)
	(in thousands)				(as a percentage of revenue)
Revenue	$	81,900	$	85,799		100.0	%		100.0	%
Operating expenses:
Cost of revenue		67,682		70,898		82.6			82.6
General and administrative expenses		6,793		6,807		8.3			7.9
Depreciation and amortization		1,684		1,892		2.0			2.2
Acquisition and integration related expenses		—		192		—			0.2
Misappropriation loss		1,369		714		1.7			0.8

Total operating expenses		77,528		80,503		94.6			93.8

Operating income		4,372		5,296		5.4			6.2
Interest expense, net		153		221		0.2			0.3

Income before income taxes		4,219		5,075		5.2			5.9
Provision for income taxes		1,666		2,029		2.0			2.4

Net income	$	2,553	$	3,046		3.2	%		3.5	%

Revenue

For the three months ended June 30, 2016, revenue decreased by 4.5%, or $3.9 million, over the same period a year ago. The decrease was due mostly to completed contracts, work that was set aside for small businesses, and reductions in staffing and scope of work on certain contracts, partially offset by revenues derived under the expanded PEO Soldier program, CNOSS program, and other new awards.

NCI’s PEO Soldier program accounted for $13.6 million, or 16.6% of revenue, in the second quarter of 2016, up $5.4 million from $8.2 million, or 9.6% of revenue, in the second quarter of 2015. NCI’s CNOSS program accounted for $9.3 million, or 11.4% of revenue, in the second quarter of 2016, up $3.6 million from $5.6 million, or 6.6% of revenue, in the second quarter of 2015.

Cost of revenue

Cost of revenue for the three months ended June 30, 2016 was $67.7 million, or 82.6% of revenue, compared to $70.9 million, or 82.6% of revenue, for the three months ended June 30, 2015. The decrease in cost of revenue was primarily the result of the greater contribution of direct labor and more efficient absorption of indirect costs for the period.

General and administrative expenses

General and administrative expenses decreased 0.2%, or $0.01 million, for the three months ended June 30, 2016, as compared to the same period a year ago. The decrease was primarily due to lower indirect labor costs, more efficient allocation of business development expenses, lower executive compensation costs, and decreased stock compensation expense, partially offset by an increase in external strategic consulting costs.

Depreciation and amortization

Depreciation and amortization expense was approximately $1.7 million and $1.9 million for the three months ended June 30, 2016 and 2015, respectively. The decrease was primarily due to certain fixed assets becoming fully depreciated in the beginning of the second quarter of 2016.

Misappropriation loss

Misappropriation loss for the three months ended June 30, 2016 was $1.4 million compared to $0.7 million for the three months ended June 30, 2015.

These expenses are the result of the embezzlement of Company funds by our former controller. As more fully described in the Explanatory Note to this Form 10-Q/A and Note 3 to the financial statements included in this Form 10-Q/A, a recent internal investigation revealed that the Company’s former controller had embezzled approximately $19.4 million from the Company during the period from January 1, 2010 through January 10, 2017. Prior to discovery, the embezzled funds were primarily disguised as payments to the administrator of the Company’s self-insured employee medical benefits plan and were included in the Company’s cost of revenues and general and administrative expenses in its financial statements for the fiscal years ended December 31, 2010 through 2015 and treated as allowable costs allocated to the Company’s federal government contracts during such period. The Company has reclassified such costs for the 2010 through 2016 period to misappropriation loss with appropriate reductions in cost of revenues and general and administrative expenses, and such costs are now treated as unallowable costs for contract revenue recognition. The Company had sufficient allowable, but previously unbilled costs on its contracts during the period from 2010 through 2015 to offset the unallowable costs related to the embezzlement. However, during 2016, a portion of the amounts embezzled were recorded on the balance sheet, and subsequent to discovery of the embezzlement were restated as misappropriation loss.

Interest expense, net

Interest expense, net, was $0.2 million and $0.2 million for the quarters ended June 30, 2016 and 2015, respectively. During the second quarter of 2016, we had a weighted average outstanding loan balance of $16.4 million which accrued interest at a weighted average borrowing rate of 2.5%. During the second quarter of 2015, we had a weighted average outstanding loan balance of $24.7 million which accrued interest at a weighted average borrowing rate of 2.3%.

Provision for income taxes

Provision for income taxes decreased by $0.4 million in the three months ended June 30, 2016, as compared to the three months ended June 30, 2015. This decrease was due to a decrease in operating income for the period ended June 30, 2016 and a slightly lower effective income tax rate. The effective income tax rate for the quarters ended June 30, 2016 and 2015 was approximately 39.5% and 40.0%, respectively. The decrease in the effective income tax rate is due to changes in the blended state income tax rate and state apportionment factors.

Six Months Ended June 30, 2016 Compared to Six Months Ended June 30, 2015

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


	Six months ended June 30,
	2016		2015		2016			2015
	(Restated)		(Restated)		(Restated)			(Restated)
	(in thousands)				(as a percentage of revenue)
Revenue	$	165,555	$	166,767		100.0	%		100.0	%

Operating expenses:
Cost of revenue		137,376		137,889		83.0			82.7
General and administrative expenses		12,900		13,882		7.8			8.0
Depreciation and amortization		3,476		3,981		2.1			2.4
Acquisition and integration related expenses		—		422		0.0			0.3
Misappropriation loss		2,909		1,379		1.8			0.8

Total operating expenses		156,661		157,053		94.6			94.2

Operating income		8,894		9,714		5.4			5.8
Interest expense, net		343		459		0.2			0.3

Income before income taxes		8,551		9,255		5.2			5.5
Provision for income taxes		3,410		3,804		2.1			2.3

Net income	$	5,141	$	5,451		3.1	%		3.2	%

Revenue

For the six months ended June 30, 2016, total revenue decreased 0.7%, or $1.2 million from $166.8 million to $165.6 million, over the same period a year ago. The decrease was primarily due to lower pass-through revenue, reductions in scope of work, and the expiration of task orders and contracts, offset by revenues derived under our PEO Soldier and CNOSS programs and, to a lesser extent, from new awards.

Cost of revenue

Cost of revenue decreased 0.4% or $0.5 million from $137.9 million to $137.4 million, for the six months ended June 30, 2016, as compared to the same period a year ago. This decrease was primarily the result of reduced hardware, software and subcontractor costs, offset by an increase in direct labor costs. Cost of revenue represented 83.0% of revenue for the six months ended June 30, 2016, as compared to 82.7% for the six months ended June 30, 2015. This decrease was primarily the result of the greater contribution of direct labor and more efficient absorption of indirect costs.

General and administrative expenses

General and administrative expenses decreased 7.1%, or $1.0 million, for the six months ended June 30, 2016, as compared to the same period a year ago. The decrease was primarily due to lower indirect labor costs, more efficient allocation of business development expenses, lower executive compensation costs, and decreased stock compensation expense, partially offset by an increase in external strategic consulting costs.

Depreciation and amortization

Depreciation and amortization expense was approximately $3.5 and $4.0 million for the six months ended June 30, 2016 and 2015, respectively. The decrease was primarily due to certain intangible assets becoming fully amortized in the second quarter of 2015 and due to certain fixed assets becoming fully depreciated in the beginning of the second quarter of 2016.

Misappropriation loss

Misappropriation loss for the six months ended June 30, 2016 was $2.9 million compared to $1.4 million for the six months ended June 30, 2015.

Interest expense, net

Interest expense, net, was approximately $0.3 million and $0.5 million for the six months ended June 30, 2016 and 2015, respectively. The decrease was primarily attributed to a lower weighted average loan balance.

Provision for income taxes

For the six months ended June 30, 2016, the provision for income taxes decreased to $3.4 million from $3.8 million in the same period a year ago, due to decreased pretax income on a lower effective tax rate. The effective income tax rate for the six months ended June 30, 2016 was approximately 39.9% as compared to an effective income tax rate of 41.1% for the six months ended June 30, 2015. The lower effective income tax rate for the six months ended June 30, 2016 was the result of a decrease in the blended state income tax rate from our current state revenue allocation for the six months ended June 30, 2016 and 2015.

Liquidity and Capital Resources

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

During the six months ended June 30, 2016, the balance of accounts receivable decreased by $5.6 million to $54.4 million at the end of the quarter. Days sales outstanding of accounts receivable (DSO) decreased 6 days to 60 days at June 30, 2016 as compared to 66 days at December 31, 2015. The decrease in DSO was mostly attributable to the resolution and payment of invoices related to certain contracts. As of June 30, 2016, $7.1 million was due under the credit facility, as compared to $10.0 million outstanding as of December 31, 2015, reflecting $2.9 million of net pay downs during the first six months of 2016. Net cash provided by operating activities was $5.5 million at June 30, 2016 and was used to pay down debt and meet working capital requirements.

Our board of directors authorized management to repurchase up to $25.0 million of our Class A common stock pursuant to a stock repurchase program. If shares are repurchased, the shares will be repurchased pursuant to open market purchases, privately negotiated

transactions, or block transactions. We have no obligation to repurchase shares under the authorization, and the timing, actual number and value of the shares which are repurchased (and the manner of any such repurchase) will be at the discretion of management and will depend on a number of factors, including the price of our common stock, our Company’s cash needs, borrowing capacity under our credit facility, interest rates, and our financial performance and position. We may suspend or discontinue repurchases at any time.

During 2015 and the three and six months ended June 30, 2016, we did not repurchase any shares. At June 30, 2016, we had $16.7 million remaining under the board of directors’ authorization for share repurchases.

Credit Facility: Our senior credit facility, amended in December 2014, and referred to herein as the “credit facility,” consists of a revolving line of credit with a borrowing capacity of up to an $80.0 million principal amount, and a $45.0 million accordion feature allowing us to increase our borrowing capacity to up to a $125.0 million principal amount, subject to obtaining commitments for the incremental capacity from existing or new lenders. The outstanding borrowings are collateralized by a security interest in substantially all of the Company’s assets. The lenders also require a direct assignment of all contracts at the lenders’ discretion. The outstanding balance under the credit facility accrues interest based on one-month LIBOR plus an applicable margin, ranging from 210 to 310 basis points, based on the ratio of our outstanding senior funded debt to Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA) as defined in the credit facility.

The credit facility allows us to use borrowings thereunder of up to $17.5 million to repurchase shares of our common stock. Funds borrowed under the credit facility may be used to finance possible future acquisitions, for working capital requirements, for stock repurchases, for cash dividends or for general corporate uses.

The loan interest accrual rate is set monthly at one-month LIBOR plus a set amount per the credit facility.

The credit facility contains various restrictive covenants that restrict, among other things, our ability to incur or guarantee additional debt; make certain distributions, investments and other restricted payments such as dividends; enter into transactions with certain affiliates; create or permit certain liens; and consolidate, merge, or sell assets. In addition, the credit facility contains certain financial covenants that require us to maintain a minimum tangible net worth; maintain a minimum fixed charge coverage ratio; maintain a minimum funded debt to earnings ratio; and limit capital expenditures below certain thresholds. There are no restrictions on our retained earnings in the credit facility.

We intend to amend and extend our credit facility before the current facility expires in January 2017. As of June 30, 2016, we were in compliance with all our loan covenants.

Off-Balance Sheet Arrangements

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

Critical Accounting Policies

There have been no significant changes to our Critical Accounting Policies during the second quarter of 2016. Refer to the Critical Accounting Policies section in our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the SEC.

Item 4.

Controls and Procedures

Background to Embezzlement and Misappropriation Loss

On January 23, 2017, the Company announced that it had discovered, based on preliminary findings of an internal investigation, that its controller had been embezzling Company funds.

On the same date, the Company announced the Board of Directors’ conclusion that, as a result of the preliminary information obtained to date in connection with such internal investigation: (i) the unaudited interim financial statements included in the Company’s Quarterly Report on Form 10-Q for the three-months ending March 31, 2016, filed on April 29, 2016; (ii) the unaudited interim financial statements included in the Company’s Quarterly Report on Form 10-Q for the three- and six-months ending June 30, 2016, filed on August 1, 2016; and (iii) the unaudited interim financial statements included in the Company’s Quarterly Report on Form 10-Q for the three- and nine-months ending September 30, 2016, filed on November 7, 2016, should no longer be relied upon. In addition, the Board of Directors also determined that investors, analysts and other persons should not rely upon management’s report on internal control over financial reporting or the Company’s independent registered public accounting firm’s report on the effectiveness of the Company’s internal control over financial reporting filed with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

The internal investigation revealed that the Company’s former controller had embezzled approximately $19.4 million from the Company from January 1, 2010 through January 10, 2017. The embezzlement was accomplished by the former controller’s unauthorized transfers of Company funds to the controller’s personal bank accounts using his authority as controller to approve ACH payments from the Company’s payroll account. The former controller was able to conceal the unauthorized transfers by falsifying certain corporate records and Company bank statements and lying to other NCI employees and to the Company’s independent registered public accountants when questioned about the suspicious payments. The Company was unable to confirm any unauthorized transfers of Company funds by the former controller prior to 2010, as the Company’s bank no longer maintains the records necessary to identify the specific beneficiaries of any such remittances. The Company believes that the former controller acted alone and found no evidence that any other NCI employee was aware of or colluded in the embezzlement of Company funds or that there was any unlawful activity apart from that associated with the former controller’s embezzlement of Company funds.

This Form 10-Q/A reflects the Restatement to reflect the effects of the embezzlement and reclassification of related cost of revenues of general and administrative expenses to misappropriation loss. Additionally, this Form 10-Q/A reflects related restatements of the June 30, 2016 balance sheet and statement of cash flows for the period ended June 30, 2016.

Disclosure Controls and Procedures

We maintain disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that are intended to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to our management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our system contains control-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.

In the course of preparing the Original Filing, the Company carried out an evaluation, under the supervision and with the participation of the Audit Committee of the Company’s Board of Directors (“Audit Committee”) and the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to the Exchange Act Rules 13a-15(e) and 15d-15(e). Our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective, as of June 30, 2016, because the material weaknesses described below existed as of June 30, 2016.

Changes in Internal Control Over Financial Reporting

There were no changes to the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2016, that have materially affected, or are reasonably likely to affect, the Company’s internal control over financial reporting. After the date of the Original Filing, our management concluded that the material weaknesses described below existed as of June 30, 2016. The remediation plan noted below was initiated in the first quarter of 2017 and we expect that our remediation efforts, including design, implementation and testing, will continue throughout 2017.

Material Weaknesses

Following the Company’s discovery of the embezzlement of Company funds, as discussed elsewhere in this Form 10-Q/A, in accordance with the internal control reporting requirements of the SEC, our management completed an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2016. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework (2013). The COSO framework summarizes each of the components of a company’s internal control system, including the: (i) control environment; (ii) control activities (process-level controls); (iii) risk assessment; (iv) information and communication; and (v) monitoring activities. The COSO framework defines a “material weakness” as a deficiency, or combination of deficiencies, that results in a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. Management’s evaluation of our internal control over financial reporting identified material weaknesses resulting from several control deficiencies in the internal control system that allowed the misappropriation of funds and the failure to detect them for an extended period of time.

Management identified the following material weaknesses:

Control Environment. We did not maintain an effective control environment that fully emphasized the establishment of adherence to effective internal controls over financial reporting throughout the Company’s management. We did not give sufficient consideration to the risk of management override of internal controls. The Company had not ensured that certain of the accounting personnel were adequately trained to properly execute critical internal controls.

Control Activities. We did not have control activities that were designed and operating effectively. The Company did not establish adequate controls over its banking relationship and the use of the electronic payment system provided by our bank. The Company did not maintain sufficient segregation of duties with respect to certain activities of its former controller, the Human Resources Department, and the Payroll Department. The Company did not maintain adequate monitoring and oversight of the work performed by the former controller, specifically in performing balance sheet reconciliations and reviews in order to prevent or detect management override of controls and the resulting misappropriation of assets by the former controller. The Company’s Financial Planning and Analysis and Human Resources Departments failed to coordinate their activities with respect to monitoring the expense of the self-insured employee medical benefits plan until the fraudulent payments were identified in January 2017.

Risk Assessment. We did not have an effective risk assessment process. Our former controller managed the activity of documenting our processes and the related internal controls, the fraud risk assessments and scoping of management’s testing of the internal control over financial reporting. The resulting documentation of our processes and internal control was incomplete and contributed to failures in evaluating and testing the effectiveness of the Company’s internal controls over financial reporting.

Information and Communication. We did not adequately communicate to all employees of the organization information regarding the importance of internal controls over financial reporting and employees’ duties and responsibilities, including segregation of duties.

Monitoring Activities. We did not maintain effective monitoring controls related to the evaluation and testing of our internal controls over financial reporting. The external accounting consultants engaged by the Audit Committee failed to identify the material weaknesses in the Company’s internal controls over financial reporting.

Remediation Plan

Immediately upon learning of the embezzlement, the Audit Committee engaged a team of investigators and forensic accountants to fully investigate such matter to confirm the extent of the fraudulent actions. As stated elsewhere in this Form 10-Q/A, based on its internal investigation, the Company believes that the former controller acted alone and found no evidence that any other NCI employee was aware of or colluded in the embezzlement of Company funds and the Company found no evidence of any unlawful activity apart from that associated with the former controller’s embezzlement of Company funds.

Management is committed to remediating each of the material weaknesses identified above by implementing changes to the Company’s internal control over financial reporting. Management has implemented, or is in the process of implementing, the following changes to the Company’s internal control systems and procedures:

•

We have initiated a project led by a senior executive independent of the Finance and Accounting organization, and aided by outside consultants, to fully document our processes to serve as the basis for activities during 2017 to assess our fraud risks and evaluate and test our internal controls over financial reporting.

•

We have updated our delegation of authority over our banking activities, and are establishing a treasury function that will improve the segregation of duties surrounding the controller to better safeguard cash.

•

The Audit Committee of the Board of Directors will re-assess its past practice of engaging an outside accounting consultant to assist in the evaluation and testing of the Company’s internal controls over financial reporting and we intend to conduct a more expansive risk assessment, with additional oversight by the Audit Committee.

•

We will require that the Financial Planning and Analysis and Human Resources Departments perform regular joint reviews of expenses associated with our employee benefit plans to ensure the actual expenses are consistent with the terms of the plans.

We immediately terminated the former controller upon discovering the fraudulent payments by him. We have initiated a search for a new controller and are considering other personnel actions to improve the overall level of competence in the accounting department.

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

We believe the remediation measures described above will strengthen our internal control over financial reporting and remediate the material weaknesses we have identified.

PART II

OTHER INFORMATION

Item 6.

Exhibits


Number		Description

2.1		Stock Purchase Agreement among NCIIS, the Sellers named therein, the Phantom Stock Holders named therein and Computech, Inc., dated as of December 24, 2014, (incorporated herein by reference from Exhibit 2.1 to registrant’s Current Report on Form 8-K, as filed with the Commission on December 29, 2014).

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

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

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

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

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

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

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

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

101.INS		XBRL Instance Document

101.SCH		XBRL Extension Schema

101.CAL		XBRL Extension Calculation Linkbase

101.DEF		XBRL Extension Definition Linkbase

101.LAB		XBRL Extension Label Linkbase

101.PRE		XBRL Extension Presentation Linkbase

‡	Included with this filing.

*	Management Contract or Compensatory Plan or Arrangement.

SIGNATURES

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


		NCI, Inc.
		Registrant

Date: April 21, 2017	By:	/s/ LUCAS J. NAREL
		Lucas J. Narel
		Executive Vice President, Chief Financial Officer and Treasurer
		(Principal Financial Officer)
		(Principal Accounting Officer)

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