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America’s Best Cyber Thug Defense System

In Monday’s issue, I warned that the world is on high alert from an increasing form of cyber terrorism – ransomware.

Criminals are hijacking computers and networks – and then holding them for ransom until a payment is made.

It’s just one of the many crippling ways that cyber thugs are hacking into systems, violating our privacy, and stealing critical data.

Obviously, companies that focus exclusively on solving these problems are crucial in our data-dependent society.

Especially those that work closely with government agencies and are charged with protecting the country.

That’s exactly what this company does. And I’m running it through my C.H.A.O.S. stock screener to gauge its investment merit…

The Government’s Go-To Security Service

“Trust. Integrity. Performance.”

That’s the slogan for NCI, Inc. (NCIT), which provides technology and security services to a host of critical global government agencies.

And in the world of cyber security, those three words have never been more important.

Defense, healthcare, intelligence, and civilian agencies all benefit from NCI’s leading cyber security technology, as well as cloud-computing, IT infrastructure, and networking solutions. It also provides information management and analysis services. This includes supporting Department of Defense weapons systems and, in the healthcare sector, safeguarding patients’ medical records and benefit programs.

~Cash

If you don’t know this simple mantra by now, let me hammer it into your skull:

Share prices follow earnings.

That logic applies perfectly to NCI.

Over the past year, NCI has demonstrated a consistent pattern of earnings-per-share (EPS) growth. In fact, the most recent quarter saw NCI’s EPS shoot 34% higher when compared to the same period in 2013.

That kind of growth can only mean one thing: Business is booming.

And the stock has reflected that, soaring around 70% over the past 12 months.

This speaks to the successful restructuring project that NCI’s management started back in 2011. Recall that this came at a time of widespread corporate cost-cutting… including serious government sequestration.

As a result, NCI revenue has trended down… matched by an even steeper decline in spending. But despite the revenue drop, effective restructuring has made the company leaner – and more profitable.

Plus, with no debt, $12.6 million in cash, and some robust valuation ratios over the past five years, it’s obvious that the company’s strategy is working.

C.H.A.O.S. Meter: 15/20

~High Impact

NCI’s technology falls within eight categories. The most impactful are:

Cloud Computing And IT Infrastructure Optimization: The world is using an increasing amount of digital data. And the federal government is one of the biggest gluttons. From cyber security agencies, to medical records, military surveillance, logistics, networking… the list goes on. It can’t get enough data.

This poses a number of issues. Data storage, data analysis, and data protection are the biggest. But NCI doesn’t just throw more servers at the problem. It offers “surge capacity” as a part of its cloud system – a storage-as-a-service framework that includes real-time and near-real-time monitoring tools.

Information Management And Advanced Analytics: In partnership with NDI SiteWare, the company offers data analytics much like Splunk (SPLK) or Tableau Software (DATA) do – but on a larger scale.

We’re talking dynamic, real-time data analysis for government agencies. For example, if you’ve ever watched the TV show, “24,” imagine the data center that Jack Bauer reports back to.

Software And Systems Development/Integration: This segment helps agencies build customized, proprietary software platforms. This could be for business efficiency optimization, security, or infrastructure development.

And because of its close work with the government, NCI provides top-level cyber security for various agencies, which makes employees’ data much safer than the Jennifer Lawrences of the world. And since NCI acquired AdvanceMed in 2011, those solutions now apply to government healthcare agencies’ need to store, manage and protect patient information.

Needless to say, NCI doesn’t exactly reveal the specifics behind its technology. If it did, critical U.S. defense agencies – like the Air Force, Special Ops, National Guard, and Strategic Command Operations – wouldn’t exactly be pleased!

But the fact that these agencies enlist NCI as one of their primary contractors to provide such services (and consistently re-sign contracts, too) is proof that the company’s technology impacts its industry on a higher level than its peers.

C.H.A.O.S. Meter: 17/20

~Acceleration

For the positive, moneymaking aspects of doing business with the government, there’s a downside, too.

The government can be a fickle partner. One minute it loves you, the next minute… you’re out.

NCI knows this better than most. Its heavy ties to government agencies have proven to be both positive and negative catalysts for the firm. While new contract wins and extensions can fuel the share price, losing contracts has the opposite effect.

This is the nature of NCI’s government business.

It can largely control the factors that comprise a successful contract signing. It’s done so for over a decade now.

But the factors that cause NCI to lose contracts are often out of its hands. We’re talking about things like a change of presidents, new policies enacted, old policies scrapped, budget cuts, protests… you name it.

So keep in mind that NCI’s acceleration (or decline) does depend on government conditions. That unpredictability creates volatility and risk – and investors are forced to ride along with it.

C.H.A.O.S. Meter: 5/20

~Orders

One hundred percent of NCI’s business comes from government contract work. That’s the bad news.

The good?

Ninety-one percent of that business comes from primary government contracts. That means NCI works for the government – and answers to the government.

NCI’s sub-contractors work for the company. Which is fine when things are going well… but if someone screws up, guess who pays the price?

Yep… the primary contractor – NCI.

On the bright side, when agencies need cyber security work, they turn to NCI – and rarely leave.

All of NCI’s sales come from government bodies like the Department of Defense and various other federal civilian agencies.

Breaking it down further, 68% of NCI’s government revenue comes from “cost-plus fee” contracts and “time-and-material” contracts.

Translation: “We bill the government for more if we take longer or use more resources than expected.”

The biggest problem occurs when the government changes the billing structure to “fixed-price.” As the name suggests, this sets the price to pay, without the chance to bill for added costs, or overtime. So if there are overages on a project, it can impact NCI’s bottom line.

Unfortunately, this happens more often than not.

However, as part of its successful restructuring, NCI has done an incredible job of lowering the number of days it takes to collect receivables.

For example, in 2007, it took NCI 106.1 days to collect payments. Today, it only takes 63.2 days.

And getting cash on the books faster is crucial when you consider the company’s backlog orders. It explains NCI’s ability to shrink its backlog from $488 million at the end of 2013 to $362 million by the end of June. Back in the slower collection days, the backlog used to be in the billions.

This quicker income stream isn’t just crucial for NCI. It’s much better for investors, too.

C.H.A.O.S. Meter: 15/20

~Scalability

As I mentioned above, NCI’s revenue is trending down. But the company is still outperforming its industry. How?

By growing and remaining competitive.

NCI has three main objectives here…

  1. Deploy More Investment Into Higher-Growth Federal Agencies: It stands to reason that winning contracts from more lucrative areas will positively affect NCI’s business.
  1. Improve Business Infrastructure For Greater Efficiency: Improving operating margins is a key area for NCI, as they’re low and lag the company’s peers.
  1. Growth Through Acquisitions: Following the acquisition of AdvanceMed in 2011, NCI can use its competitive advantages to buy other companies, too.

While NCI is capable of achieving all three, the strategic acquisition part concerns me the most. You see, the AdvanceMed takeover wasn’t pretty, and harmed NCI’s goodwill after a 2012 review.

Essentially, “goodwill” accounts for a company’s intangible assets. It counts factors like brand recognition, company reputation, and intellectual property. It’s the “intrinsic value” behind the numbers – and explains why companies like WhatsApp get bought for staggering, “I-can’t-believe-they-paid-that” amounts ($19 billion, to be exact).

After its review, it turned out that AdvanceMed’s goodwill wasn’t as valuable as originally projected at the time of purchase. It contributed to goodwill impairment and intangible assets charges of $150.3 million… sucked directly from NCI’s profits.

Hopefully, NCI wouldn’t make the same mistake again. But that, along with its down-trending revenue and low margins, make scalability somewhat unpredictable at the moment.

C.H.A.O.S. Meter: 8/20

Chaos meterOVERALL C.H.A.O.S. RANKING: 60/100

Final Verdict: NCI plays a vital role in protecting our nation from digital acts of terrorism in some of the most sensitive areas, like defense, healthcare, mobile payments, and cloud storage.

As our digital culture evolves, it’s inevitable that cyber security spending will soar. However, given the unpredictable political landscape and a presidential election edging closer, there is some risk for NCI.

That said, the company does boast upside potential. For example, NCI has beaten earnings estimates for the last 12 quarters. And when using an absolute P/E valuation model (which accounts for earnings growth rate and financial risk), it indicates that NCI shares should be around $13.67 – 31% higher than the current price.

The company reports quarterly results on October 27, with analysts projecting earnings of $0.15 per share. But it could be even better, since NCI has a history of reporting between $0.20 and $0.25 in Q3.

Wait for some weakness before you consider buying a few shares.

Your eyes in the Pipeline,

Marty Biancuzzo

Marty Biancuzzo

, Technology Analyst

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