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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 2006
|- | --------------------------------------------------------------------------------------------------------------------------------



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

Commission File Number

000-51579



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NCI, Inc.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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



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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.    x  Yes ̈No

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



|Large | accelerated filer ̈Accelerated
filer ̈Non-accelerated filer  x
|----- | ------------------------------------------------------------

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

As of November 1, 2006, there were 7,027,760 shares outstanding of the registrants Class A common stock. In addition, there are 6,300,000 shares outstanding of the registrants Class B common
stock, which are convertible on a one-for-one basis into Class A common stock.



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##### Table of Contents

NCI, INC.



|         |  |                                                                                                                  |  |     
|-------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |                                                                                                                  |  | PAGE
|PART I:  |  | FINANCIAL INFORMATION                                                                                            |  | 1   
|Item 1.  |  | Financial Statements                                                                                             |  | 1   
|         |  | Consolidated Balance Sheets as of December 31, 2005, and September 30, 2006 (unaudited)                          |  | 1   
|         |  | Consolidated Statements of Operations (unaudited) for the three and nine months endedSeptember 30, 2005 and 2006 |  | 2   
|         |  | Consolidated Statements of Cash Flows (unaudited) for the nine months endedSeptember 30, 2005 and 2006           |  | 3   
|         |  | Notes to Consolidated Financial Statements (unaudited)                                                           |  | 4   
|Item 2.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 13  
|Item 3.  |  | Quantitative and Qualitative Disclosures About Market Risk                                                       |  | 20  
|Item 4.  |  | Controls and Procedures                                                                                          |  | 20  
|         |  |                                                                                                                 
|PART II: |  | OTHER INFORMATION                                                                                                |  | 22  
|Item 1.  |  | Legal Proceedings                                                                                                |  | 22  
|Item 1A. |  | Risk Factors                                                                                                     |  | 22  
|Item 2.  |  | Unregistered Sales of Equity Securities and Use of Proceeds                                                      |  | 22  
|Item 3.  |  | Defaults Upon Senior Securities                                                                                  |  | 22  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                              |  | 22  
|Item 5.  |  | Other Information                                                                                                |  | 22  
|Item 6.  |  | Exhibits                                                                                                         |  | 22  
|         |  | Signatures                                                                                                       |  | 23  



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##### Table of Contents

PART 1

FINANCIAL INFORMATION

Item 1. Financial Statements

NCI, INC.

CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except per share data)



|                                                                                                             |  |                        |        |   |                         |   |         |  
|------------------------------------------------------------------------------------------------------------ |  | ---------------------- | ------ | - | ----------------------- | - | ------- | -
|                                                                                                             |  | As ofDecember 31, 2005 |        |   | As ofSeptember 30, 2006 |  
|                                                                                                             |  |                        |        |   | (unaudited)             |  
|Assets                                                                                                       |  |                        |        |   |                         |   |         |  
|Current assets:                                                                                              |  |                        |        |   |                         |   |         |  
|Cash and cash equivalents                                                                                    |  | $                      | 12,323 |   |                         | $ | 18,599  |  
|Accounts receivable, net                                                                                     |  |                        | 46,611 |   |                         |   | 54,494  |  
|Deferred tax asset, net                                                                                      |  |                        | 4,570  |   |                         |   | 2,502   |  
|Prepaid expenses and other current assets                                                                    |  |                        | 669    |   |                         |   | 1,153   |  
|                                                                                                             |  |                        |        |   |                         |   |         |  
|Total current assets                                                                                         |  |                        | 64,173 |   |                         |   | 76,748  |  
|Property and equipment, net                                                                                  |  |                        | 6,031  |   |                         |   | 5,243   |  
|Other assets                                                                                                 |  |                        | 558    |   |                         |   | 821     |  
|Deferred tax asset, net                                                                                      |  |                        | 494    |   |                         |   | 432     |  
|Intangible assets, net                                                                                       |  |                        | 1,338  |   |                         |   | 612     |  
|Goodwill                                                                                                     |  |                        | 17,427 |   |                         |   | 17,427  |  
|                                                                                                             |  |                        |        |   |                         |   |         |  
|Total assets                                                                                                 |  | $                      | 90,021 |   |                         | $ | 101,283 |  
|                                                                                                             |  |                        |        |   |                         |   |         |  
|Liabilities and stockholders equity                                                                         |  |                        |        |   |                         |   |         |  
|Current liabilities:                                                                                         |  |                        |        |   |                         |   |         |  
|Accounts payable                                                                                             |  | $                      | 8,854  |   |                         | $ | 18,575  |  
|Accrued salaries and benefits                                                                                |  |                        | 9,416  |   |                         |   | 8,612   |  
|Other accrued expenses/liabilities                                                                           |  |                        | 2,936  |   |                         |   | 5,482   |  
|Deferred revenue                                                                                             |  |                        | 1,012  |   |                         |   | 787     |  
|Distributions payable                                                                                        |  |                        | 5,866  |   |                         |   |        |  
|                                                                                                             |  |                        |        |   |                         |   |         |  
|Total current liabilities                                                                                    |  |                        | 28,084 |   |                         |   | 33,456  |  
|Other liabilities                                                                                            |  |                        | 204    |   |                         |   | 185     |  
|Deferred rent                                                                                                |  |                        | 4,562  |   |                         |   | 4,242   |  
|                                                                                                             |  |                        |        |   |                         |   |         |  
|Total liabilities                                                                                            |  |                        | 32,850 |   |                         |   | 37,883  |  
|                                                                                                             |  |                        |        |   |                         |   |         |  
|Stockholders equity:                                                                                        |  |                        |        |   |                         |   |         |  
|Class A common stock, $0.019 par value37,500,000 shares authorized; 7,027,760 shares issued and outstanding |  |                        | 134    |   |                         |   | 134     |  
|Class B common stock, $0.019 par value12,500,000 shares authorized; 6,300,000 shares issued and outstanding |  |                        | 120    |   |                         |   | 120     |  
|Additional paid-in capital                                                                                   |  |                        | 57,658 |   |                         |   | 57,563  |  
|Deferred compensation                                                                                        |  |                        | (741   | ) |                         |   | (548    | )
|Retained earnings                                                                                            |  |                        |       |   |                         |   | 6,131   |  
|                                                                                                             |  |                        |        |   |                         |   |         |  
|Total stockholders equity                                                                                   |  |                        | 57,171 |   |                         |   | 63,400  |  
|                                                                                                             |  |                        |        |   |                         |   |         |  
|Total liabilities and stockholders equity                                                                   |  | $                      | 90,021 |   |                         | $ | 101,283 |  
|                                                                                                             |  |                        |        |   |                         |   |         |  

See accompanying notes



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NCI, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(amounts in thousands, except per share data)



|                                                                                     |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------ |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                     |  | Three months ended September 30, |        |   | Nine months ended September 30, |  
|                                                                                     |  | 2005                             |        |   | 2006                            |   |        | 2005 |  |   | 2006    |  
|Revenue                                                                              |  | $                                | 50,081 |   |                                 | $ | 59,895 |      |  | $ | 143,956 |   |  | $ | 153,786 |  
|                                                                                     |  |                                  |        |  
|Operating costs and expenses:                                                        |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Cost of revenue (exclusive of depreciation and amortization, shown separately below) |  |                                  | 43,038 |   |                                 |   | 52,221 |      |  |   | 122,709 |   |  |   | 132,786 |  
|General and administrative expense                                                   |  |                                  | 3,053  |   |                                 |   | 3,325  |      |  |   | 10,292  |   |  |   | 9,519   |  
|Depreciation and amortization                                                        |  |                                  | 418    |   |                                 |   | 422    |      |  |   | 1,219   |   |  |   | 1,238   |  
|Amortization of intangible assets                                                    |  |                                  | 261    |   |                                 |   | 238    |      |  |   | 800     |   |  |   | 726     |  
|                                                                                     |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Total operating costs and expenses                                                   |  |                                  | 46,770 |   |                                 |   | 56,206 |      |  |   | 135,020 |   |  |   | 144,269 |  
|                                                                                     |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Operating income                                                                     |  |                                  | 3,311  |   |                                 |   | 3,689  |      |  |   | 8,936   |   |  |   | 9,517   |  
|Interest income                                                                      |  |                                  | 29     |   |                                 |   | 259    |      |  |   | 55      |   |  |   | 584     |  
|Interest expense                                                                     |  |                                  | (491   | ) |                                 |   | (22    | )    |  |   | (1,260  | ) |  |   | (67     | )
|                                                                                     |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Income before income taxes                                                           |  |                                  | 2,849  |   |                                 |   | 3,926  |      |  |   | 7,731   |   |  |   | 10,034  |  
|Income tax expense                                                                   |  |                                  | 129    |   |                                 |   | 1,512  |      |  |   | 348     |   |  |   | 3,903   |  
|                                                                                     |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Net income                                                                           |  | $                                | 2,720  |   |                                 | $ | 2,414  |      |  | $ | 7,383   |   |  | $ | 6,131   |  
|                                                                                     |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Earnings per common and common equivalent share:                                     |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Basic:                                                                               |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Weighted average shares outstanding                                                  |  |                                  | 6,779  |   |                                 |   | 13,328 |      |  |   | 6,779   |   |  |   | 13,328  |  
|Net income per share                                                                 |  | $                                | 0.40   |   |                                 | $ | 0.18   |      |  | $ | 1.09    |   |  | $ | 0.46    |  
|                                                                                     |  |                                  |        |  
|Diluted:                                                                             |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Weighted average shares and equivalent shares outstanding                            |  |                                  | 7,641  |   |                                 |   | 13,450 |      |  |   | 7,636   |   |  |   | 13,485  |  
|Net income per share                                                                 |  | $                                | 0.36   |   |                                 | $ | 0.18   |      |  | $ | 0.97    |   |  | $ | 0.45    |  
|                                                                                     |  |                                  |        |  
|Pro forma income tax information: (See Note 10)                                      |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Income before taxes                                                                  |  | $                                | 2,849  |   |                                 |   |        |      |  | $ | 7,731   |   |  |   |         |  
|Pro forma provision for income taxes                                                 |  |                                  | 1,108  |   |                                 |   |        |      |  |   | 3,006   |   |  |   |         |  
|                                                                                     |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Pro forma net income                                                                 |  | $                                | 1,741  |   |                                 |   |        |      |  | $ | 4,725   |   |  |   |         |  
|                                                                                     |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Pro forma earnings per common and common equivalent share:                           |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Basic:                                                                               |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Weighted average shares outstanding                                                  |  |                                  | 6,779  |   |                                 |   |        |      |  |   | 6,779   |   |  |   |         |  
|Pro forma net income per share                                                       |  | $                                | 0.26   |   |                                 |   |        |      |  | $ | 0.70    |   |  |   |         |  
|                                                                                     |  |                                  |        |  
|Diluted:                                                                             |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Weighted average shares and equivalent shares outstanding                            |  |                                  | 7,264  |   |                                 |   |        |      |  |   | 7,241   |   |  |   |         |  
|Pro forma net income per share                                                       |  | $                                | 0.24   |   |                                 |   |        |      |  | $ | 0.65    |   |  |   |         |  

See accompanying notes



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NCI, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(amounts in thousands)



|                                                                                  |  |                                 |         |   |      |   |        |  
|--------------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------ | -
|                                                                                  |  | Nine months ended September 30, |        
|                                                                                  |  | 2005                            |         |   | 2006 |  
|Cash flows from operating activities                                              |  |                                 |         |   |      |   |        |  
|Net income                                                                        |  | $                               | 7,383   |   |      | $ | 6,131  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                 |         |   |      |   |        |  
|Depreciation and amortization                                                     |  |                                 | 2,019   |   |      |   | 1,964  |  
|Decrease in cash surrender value of life insurance                                |  |                                 | 334     |   |      |   |       |  
|Gain on sale and disposal of property and equipment                               |  |                                 | (2      | ) |      |   | (3     | )
|Stock-based compensation expense                                                  |  |                                 | 540     |   |      |   | 97     |  
|Deferred income taxes                                                             |  |                                 |        |   |      |   | 2,131  |  
|Changes in operating assets and liabilities:                                      |  |                                 |         |   |      |   |        |  
|Accounts receivable, net                                                          |  |                                 | (4,700  | ) |      |   | (7,883 | )
|Prepaid expenses and other assets                                                 |  |                                 | (846    | ) |      |   | (748   | )
|Accounts payable                                                                  |  |                                 | 2,846   |   |      |   | 9,722  |  
|Accrued expenses/other current liabilities                                        |  |                                 | 1,617   |   |      |   | 1,544  |  
|Deferred rent                                                                     |  |                                 | (185    | ) |      |   | (319   | )
|                                                                                  |  |                                 |         |   |      |   |        |  
|Net cash provided by operating activities                                         |  |                                 | 9,006   |   |      |   | 12,636 |  
|                                                                                  |  |                                 |         |   |      |   |        |  
|Cash flows from investing activities                                              |  |                                 |         |   |      |   |        |  
|Purchase of property and equipment                                                |  |                                 | (1,171  | ) |      |   | (273   | )
|Proceeds from sale of property and equipment                                      |  |                                 | 8       |   |      |   | 6      |  
|Cash paid for purchase of SES                                                     |  |                                 | (1,919  | ) |      |   |       |  
|                                                                                  |  |                                 |         |   |      |   |        |  
|Net cash used in investing activities                                             |  |                                 | (3,082  | ) |      |   | (267   | )
|                                                                                  |  |                                 |         |   |      |   |        |  
|Cash flows from financing activities                                              |  |                                 |         |   |      |   |        |  
|Proceeds from line of credit, net                                                 |  |                                 | 17,332  |   |      |   |       |  
|Repayments on term loan                                                           |  |                                 | (2,100  | ) |      |   |       |  
|Principal payments under capital lease obligations                                |  |                                 | (205    | ) |      |   | (227   | )
|Distributions to stockholders                                                     |  |                                 | (20,978 | ) |      |   | (5,866 | )
|                                                                                  |  |                                 |         |   |      |   |        |  
|Net cash used in financing activities                                             |  |                                 | (5,951  | ) |      |   | (6,093 | )
|                                                                                  |  |                                 |         |   |      |   |        |  
|Net change in cash and cash equivalents                                           |  |                                 | (27     | ) |      |   | 6,276  |  
|Cash and cash equivalents, beginning of year                                      |  |                                 | 40      |   |      |   | 12,323 |  
|                                                                                  |  |                                 |         |   |      |   |        |  
|Cash and cash equivalents, end of period                                          |  | $                               | 13      |   |      | $ | 18,599 |  
|                                                                                  |  |                                 |         |   |      |   |        |  
|Supplemental disclosure of cash flow information                                  |  |                                 |         |   |      |   |        |  
|Cash paid during the period for:                                                  |  |                                 |         |   |      |   |        |  
|Interest                                                                          |  | $                               | 1,260   |   |      | $ | 67     |  
|                                                                                  |  |                                 |         |   |      |   |        |  
|Income taxes                                                                      |  | $                               | 312     |   |      | $ | 26     |  
|                                                                                  |  |                                 |         |   |      |   |        |  
|Supplemental disclosure of non-cash activities:                                   |  |                                 |         |   |      |   |        |  
|Equipment acquired under capital leases                                           |  | $                               | 93      |   |      | $ | 181    |  
|                                                                                  |  |                                 |         |   |      |   |        |  

See accompanying notes



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NCI, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. Basis of Presentation

The accompanying unaudited consolidated
financial statements for NCI, Inc. and its wholly-owned subsidiaries (the Company or NCI) as of and for the three and nine months ended September 30, 2005 and 2006, have been prepared, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. As a result, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. In the
opinion of management, the accompanying unaudited interim consolidated financial statements reflect all necessary adjustments and reclassifications (all of which are of a normal, recurring nature) that are necessary to a fair presentation of the
results for such periods. The information disclosed in the notes to the financial statements for these periods is unaudited. For further information, refer to the financial statements and footnotes included in NCIs Form 10-K for the year ended
December 31, 2005, filed with the Securities and Exchange Commission on March 30, 2006. The current periods results of operations are not necessarily indicative of results that may be achieved for any future period.

2. Business Overview

NCI is a provider of information
technology services and solutions to federal government agencies. The Companys focus is on designing, implementing, maintaining and upgrading secure information technology (IT) systems and networks by leveraging the Companys skills
across four core service offerings: network engineering; information assurance; systems development and integration; and enterprise systems management. The Company provides these services to defense, intelligence and federal civilian agencies.
Substantially all of the Companys revenue was derived from contracts with the federal government, directly as a prime contractor or as a subcontractor. The Company conducts business throughout the United States. In addition, the Company may
conduct business internationally in support of federal government contracts.

The Companys operations are subject to certain risks and uncertainties
including, among others, dependence on contracts with federal government agencies, dependence on significant clients, existence of contracts with fixed pricing, dependence on subcontractors to fulfill contractual obligations, current and potential
competitors with greater resources, dependence on key management personnel, ability to recruit and retain qualified employees, and uncertainty of future profitability and possible fluctuations in financial results.

3. Summary of Significant Accounting Policies

Basis of
Consolidation

The consolidated financial statements include the accounts of wholly-owned subsidiaries.

Reclassifications

Certain amounts for prior years have been
reclassified to conform with the current presentation.

Revenue Recognition

Substantially all of the Companys revenue is derived from services and solutions provided to the federal government, primarily by Company employees and, to a lesser extent, subcontractors. In some cases, revenue
includes third-party hardware and software purchased on behalf of clients. The level of hardware and software purchases made for clients may vary from period to period depending on specific contract and client requirements. The Company generates its
revenue from three different types of contractual arrangements: time-and-materials contracts; cost-plus contracts; and fixed-price contracts.

Revenue on
time-and-material contracts is recognized based on negotiated billable rates multiplied by the number of hours delivered plus allowable expenses incurred. The Company considers fixed fees under cost-plus contracts to be earned in proportion to the
allowable costs incurred in performance of the contract. Revenue for performance based fee incentives is recognized as earned.

The Company has three basic
categories of fixed-price contracts: fixed unit price; fixed-price level-of-effort; and fixed-price completion contracts. Revenue on fixed unit price contracts, where specified units are delivered under service arrangements, is recognized as units
are delivered based on the specified price per unit. Revenue for fixed-price level-of-effort contracts is



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##### Table of Contents

NCI, Inc.

Notes to Consolidated Financial Statements (continued)

3. Summary of Significant Accounting Policies (continued)

Revenue Recognition (continued)

recognized based
upon the number of units of labor actually delivered multiplied by the negotiated rate for each unit of labor. Revenue on fixed-price completion contracts is recognized on the percentage of completion method using costs incurred in relation to total
estimated costs.

Contract accounting requires judgment relative to assessing risks, estimating contract revenue and costs, and making assumptions for
schedule and technical issues. Due to the size and nature of many of the Companys contracts, the estimation of total revenue and cost at completion is complicated and subject to many variables. Contract costs include material, labor and
subcontracting costs, as well as an allocation of allowable indirect costs. Assumptions have to be made regarding the length of time to complete the contract because costs also include expected increases in wages and prices for materials. For
contract change orders, claims or similar items, the Company applies judgment in estimating the amounts and assessing the potential for realization. These amounts are only included in contract value when they can be reliably estimated and
realization is considered probable. Estimates of award fees for certain contracts are also a significant factor in estimating revenue and profit rates based on actual and anticipated awards. Anticipated losses on contracts are recognized in the
period they are deemed probable and can be reasonably estimated.

Cash and Cash Equivalents

The Company considers cash on deposit and all highly liquid investments with original maturities of three months or less to be cash and cash equivalents.

Income Taxes

Prior to October 20, 2005, the Company elected, by
the consent of its stockholders, to be taxed as an S corporation under Subchapter S of the Internal Revenue Code (the Code) and under relevant sections of the tax law of the various states that conform to the Code. As an S corporation, the net
income or loss of the entity was reportable on the personal tax returns of the stockholders. Accordingly, through October 19, 2005, the Company was not subject to federal and certain state corporate income tax. However, the Company was subject
to income taxes in certain states in which it conducts business.

In connection with the Companys initial public offering, effective October 20,
2005, the Company revoked its status as an S corporation and became subject to taxation as a C corporation. Disclosures regarding accounting for income taxes for the three and nine months ended September 30, 2006 are in Note 10.

The unaudited pro forma income tax information included in the statements of operations for the three and nine months ended September 30, 2005, in the pro forma
Earnings per Share calculation discussed below in this Note, and in Note 10, is presented in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes(SFAS No. 109), as if the Company
were taxed as a C corporation and thus subject to federal and certain state income taxes for that period.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from
those estimates.

Fair Value of Financial Instruments

Estimated fair values of our financial instruments were determined by management using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated
fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may
have a material effect on the estimated fair value amounts.



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##### Table of Contents

NCI, Inc.

Notes to Consolidated Financial Statements (continued)

3. Summary of Significant Accounting Policies (continued)

Fair Value of Financial Instruments (continued)

The carrying values of the Companys financial instruments, including cash equivalents, accounts receivable, accounts payable, accrued expenses and bank loans approximate their fair values.

Disclosure about fair value of financial instruments is based on pertinent information available to management. Although the Company is not aware of any factors that
would significantly affect the reasonable fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the
amounts presented herein.

Earnings Per Share

SFAS
No. 128,Earnings Per Share, requires presentation of basic and diluted 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. The computation of earnings per share presented is for both Class A and Class B common stock.

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.

The following details the historical and pro forma computation of basic and diluted earnings per common share (Class A and Class B) for the three
and nine months ended September 30, 2005 and 2006, respectively. The pro forma net income and earnings per share data for the three and nine months ended September 30, 2005 are pro forma for C corporation income taxes. (See Note 10)



|                                                                            |  |                                       |       |                                       |   |        |  |      |       |  |   |       
|--------------------------------------------------------------------------- |  | ------------------------------------- | ----- | ------------------------------------- | - | ------ |  | ---- | ----- |  | - | ------
|                                                                            |  | Three months ended September 30,      |       | Nine months ended September 30,      
|                                                                            |  | 2005                                  |       | 2006                                  |   | 2005   |  | 2006
|                                                                            |  | (in thousands, except per share data) |       | (in thousands, except per share data)
|Historical Net Income                                                       |  | $                                     | 2,720 |                                       | $ | 2,414  |  | $    | 7,383 |  | $ | 6,131 
|                                                                            |  |                                       |       |                                       |   |        |  |      |       |  |   |       
|Weighted average number of basic shares outstanding during the period       |  |                                       | 6,779 |                                       |   | 13,328 |  |      | 6,779 |  |   | 13,328
|Dilutive effect of stock options after application of treasury stock method |  |                                       | 862   |                                       |   | 122    |  |      | 857   |  |   | 157   
|                                                                            |  |                                       |       |                                       |   |        |  |      |       |  |   |       
|Weighted average number of diluted shares outstanding during the period     |  |                                       | 7,641 |                                       |   | 13,450 |  |      | 7,636 |  |   | 13,485
|                                                                            |  |                                       |       |                                       |   |        |  |      |       |  |   |       
|Basic earnings per share                                                    |  | $                                     | 0.40  |                                       | $ | 0.18   |  | $    | 1.09  |  | $ | 0.46  
|Diluted earnings per share                                                  |  | $                                     | 0.36  |                                       | $ | 0.18   |  | $    | 0.97  |  | $ | 0.45  
|                                                                            |  |                                       |       |                                      
|Pro forma net income                                                        |  | $                                     | 1,741 |                                       |   |        |  | $    | 4,725 |  |   |       
|                                                                            |  |                                       |       |                                       |   |        |  |      |       |  |   |       
|Weighted average number of basic shares outstanding during the period       |  |                                       | 6,779 |                                       |   |        |  |      | 6,779 |  |   |       
|Dilutive effect of stock options after application of treasury stock method |  |                                       | 485   |                                       |   |        |  |      | 462   |  |   |       
|                                                                            |  |                                       |       |                                       |   |        |  |      |       |  |   |       
|Weighted average number of diluted shares outstanding during the period     |  |                                       | 7,264 |                                       |   |        |  |      | 7,241 |  |   |       
|                                                                            |  |                                       |       |                                       |   |        |  |      |       |  |   |       
|Pro forma basic earnings per share                                          |  | $                                     | 0.26  |                                       |   |        |  | $    | 0.70  |  |   |       
|Pro forma diluted earnings per share                                        |  | $                                     | 0.24  |                                       |   |        |  | $    | 0.65  |  |   |       

Stock-Based Compensation

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004) (SFAS No. 123(R)), Share-Based Payment, which requires that compensation costs related
to share-based payment transactions be recognized in financial statements. SFAS No. 123(R) eliminates the alternative to use the intrinsic method of accounting provided for in Accounting Principles Board (APB) Opinion No. 25 (APB
No. 25), Accounting for Stock Issued to Employees, which generally resulted in no compensation expense recorded in the financial statements related to the grant of stock options to employees if certain conditions were met.



6



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##### Table of Contents

NCI, Inc.

Notes to Consolidated Financial Statements (continued)

3. Summary of Significant Accounting Policies (continued)

Stock-Based Compensation (continued)

Effective
January 1, 2006, the Company adopted SFAS No. 123(R) using the prospective method. Under this method, compensation costs for all awards granted after the date of adoption and modifications of any previously granted awards outstanding at
the date of adoption are measured at estimated fair value and included in operating expenses over the vesting period during which an employee provides service in exchange for the award. Prior to the adoption of SFAS No. 123(R), the Company
accounted for stock-based compensation in accordance with APB No. 25 using the intrinsic-value method. The Company issued non-qualified stock options to employees at various times during 2003 and 2004 with vesting periods ranging from zero to
seven years and any related expense for the amount by which the fair market value at the date of grant exceeds the exercise price is being amortized over the applicable vesting periods. Under the prospective method, we will continue to apply APB
No. 25 in future periods to awards outstanding at the date of adoption.

In adopting SFAS No. 123(R), companies must choose among alternative
valuation models and amortization assumptions. The Company uses the Black-Scholes-Merton option pricing model and straight-line amortization of compensation expense over the requisite service period of the grant. The Company will reconsider use of
the Black-Scholes-Merton model if additional information becomes available in the future that indicates another model would be more appropriate, or if grants issued in future periods have characteristics that cannot be reasonably estimated using
this model.

The following weighted-average assumptions were used for option grants made during the nine months ended September 30, 2006:



| |  |  | Expected Volatility. The expected volatility of the Companys shares was estimated based upon the historical volatility of the Companys share price. The expected
volatility factor used in valuing options granted during the nine months ended September 30, 2006 was 35.31%.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Expected Term. Because the Company does not have significant historical data on employee exercise behavior, we have used the SEC safe-harbor for calculating the expected term
by averaging the vesting period and term of the option. The expected term factor used in valuing options granted during the nine months ended September 30, 2006 was 6.4 years.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Risk-free Interest Rate. The Company bases the risk-free interest rate used in the Black-Scholes-Merton valuation method on the implied yield available on a U.S. Treasury
note with a term equal to the expected term of the underlying grants. The risk-free interest rate used in valuing options granted during the nine months ended September 30, 2006 was 4.82%.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Dividend Yield. The Black-Scholes-Merton valuation model calls for a single expected dividend yield as an input. The Company has not paid dividends in the past nor does it
expect to pay dividends in the future. As such, the Company used a dividend yield percentage of zero.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In prior years, under the
intrinsic-value method of APB No. 25, the Company did not include an expected volatility rate in the valuation calculation. Additionally, the Company did not use an expected forfeiture rate when calculating option expense. Under SFAS
No. 123(R), the Company has estimated forfeitures and is recognizing compensation expense only for those shares expected to vest.

During the nine
months ended September 30, 2006, the Company granted stock options to purchase 40,000 shares of Class A common stock at a weighted average exercise price of $13.13 per share, the fair value of Class A common stock on the date of
grant. The Black-Scholes-Merton weighted average valuation of the options granted during the nine months ended September 30, 2006 was $5.84 per share. These options have a graded vesting period between three- and five-years and an expiration
period between seven and ten years.



7



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##### Table of Contents

NCI, Inc.

Notes to Consolidated Financial Statements (continued)

3. Summary of Significant Accounting Policies (continued)

Stock-Based Compensation (continued)

The
following table summarizes stock option activity for the nine months ended September 30, 2006:



|                                  |  |                                       |   |  |                                         |      
|--------------------------------- |  | ------------------------------------- | - |  | --------------------------------------- | -----
|                                  |  | Options                               |   |  | Weightedaverage exerciseprice per share
|                                  |  | (in thousands, except per share data)
|Outstanding at December 31, 2005  |  | 640                                   |   |  | $                                       | 7.88 
|Granted                           |  | 40                                    |   |  |                                         | 13.13
|Forfeited/cancelled               |  | (50                                   | ) |  |                                         | 7.53 
|Exercised                         |  |                                      |   |  |                                         |     
|                                  |  |                                       |   |  |                                         |      
|Outstanding at September 30, 2006 |  | 630                                   |   |  | $                                       | 8.24 
|                                  |  |                                       |   |  |                                         |      

Information regarding stock options outstanding at September 30, 2006 is summarized below:



|                         |  |                  |  |                              |       |                                          |     |                    |   
|------------------------ |  | ---------------- |  | ---------------------------- | ----- | ---------------------------------------- | --- | ------------------ | --
|Range of exercise prices |  | Number ofoptions |  | Weightedaverageexerciseprice |       | Weightedaverageremainingcontractual life |     | Optionsexercisable
|                         |  | (in thousands)   |  |                              |       | (in years)                               |     | (in thousands)    
|$1.00  $2.00            |  | 5                |  | $                            | 1.90  |                                          | 7.1 |                    | 5 
|$6.00  $7.00            |  | 357              |  |                              | 6.65  |                                          | 6.4 |                    | 8 
|$10.00  $11.00          |  | 228              |  |                              | 10.02 |                                          | 8.2 |                    | 49
|$12.00  $14.00          |  | 40               |  |                              | 13.13 |                                          | 8.1 |                    |  

The Company recognized stock-based compensation expense of approximately $166,000 and $540,000 ($0 and $57,000 in
Cost of Revenue and $166,000 and $483,000 in General and Administrative expenses) in the three and nine months ended September 30, 2005, respectively, and approximately $40,000 and $97,000 ($10,000 and $11,000 in Cost of Revenue and $30,000 and
$86,000 in General and Administrative expenses) in the three and nine months ended September 30, 2006, respectively. Of the stock-based compensation expense in the three months and nine months ended September 30, 2006, approximately
$11,000 and $18,000, respectively, was related to the expense of new options granted during 2006 under SFAS No. 123(R).

Under the prospective method,
results for the three and nine months ended September 30, 2005 were not restated to include stock-based compensation expense. The table below presents the pro forma effects of recognizing the estimated fair value of stock-based compensation for
the three and nine months ended September 30, 2005.



|                                                                                                                       |  |                                       |       |   |                                    |   |       |  
|---------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ----- | - | ---------------------------------- | - | ----- | -
|                                                                                                                       |  | Three monthsended September 30,2005   |       |   | Nine monthsended September 30,2005 |  
|                                                                                                                       |  | (in thousands, except per share data) |      
|Net income as reported                                                                                                 |  | $                                     | 2,720 |   |                                    | $ | 7,383 |  
|Add: Stock-based employee compensation expense as reported under APB No. 25 for all awards, net of related tax effects |  |                                       | 166   |   |                                    |   | 540   |  
|Deduct: Stock-based compensation expense determined under SFAS No. 123 for all awards, net of related tax effects      |  |                                       | (181  | ) |                                    |   | (599  | )
|                                                                                                                       |  |                                       |       |   |                                    |   |       |  
|Pro forma net income                                                                                                   |  | $                                     | 2,705 |   |                                    | $ | 7,324 |  
|                                                                                                                       |  |                                       |       |   |                                    |   |       |  
|Weighted average number of basic shares outstanding during the period                                                  |  |                                       | 6,779 |   |                                    |   | 6,779 |  
|Weighted average number of diluted shares outstanding during the period                                                |  |                                       | 7,641 |   |                                    |   | 7,636 |  
|                                                                                                                       |  |                                      
|Pro forma basic earnings per share                                                                                     |  | $                                     | 0.40  |   |                                    | $ | 1.08  |  
|Pro forma diluted earnings per share                                                                                   |  | $                                     | 0.35  |   |                                    | $ | 0.96  |  



8



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##### Table of Contents

NCI, Inc.

Notes to Consolidated Financial Statements (continued)

3. Summary of Significant Accounting Policies (continued)

Stock-Based Compensation (continued)

As of
September 30, 2006, there was approximately $735,000 of total unrecognized compensation cost related to unvested stock-based compensation agreements. Of this amount, approximately $548,000 is related to options accounted for under APB
No. 25, and approximately $188,000 related to options granted during 2006 and accounted for under SFAS No. 123(R). This cost is expected to be fully amortized over the next five years, with approximately $54,000 in fourth quarter of 2006,
and approximately $214,000 in 2007, $209,000 in 2008, $203,000 in 2009, $51,000 in 2010, and $4,000 in 2011.

Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation (FIN) 48, Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with SFAS No. 109. This Interpretation defines the minimum recognition threshold a tax position is required to meet before being
recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the effect that the adoption of FIN 48 will have on its financial position and results of
operations, and therefore the ultimate impact of its adoption is not yet know.

In September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with U.S. generally accepted accounting principles, and expands disclosures about fair value measurements. This statement
addresses how to calculate fair value measurements required or permitted under other accounting pronouncements. Accordingly, this statement does not require any new fair value measurements. However, for some entities, the application of this
statement will change current practice. SFAS No. 157 is effective for the Company beginning January 1, 2008. The Company is currently evaluating the effect that the adoption of SFAS No. 157 will have on its financial position and
results of operations, and therefore the ultimate impact of its adoption is not yet know.

4. Accounts Receivable

Accounts receivable consist of billed and unbilled amounts at December 31, 2005 and September 30, 2006 as follows:



|                                      |  |                       |        |                        |   |       
|------------------------------------- |  | --------------------- | ------ | ---------------------- | - | ------
|                                      |  | As ofDecember 31,2005 |        | As ofSeptember 30,2006
|                                      |  | (in thousands)       
|Billed receivables:                   |  |                       |        |                        |   |       
|Billed receivables                    |  | $                     | 29,364 |                        | $ | 29,087
|Billable receivables at end of period |  |                       | 16,008 |                        |   | 24,047
|                                      |  |                       |        |                        |   |       
|Total billed receivables              |  |                       | 45,372 |                        |   | 53,134
|Total unbilled receivables            |  |                       | 1,924  |                        |   | 2,150 
|                                      |  |                       |        |                        |   |       
|Total accounts receivable             |  |                       | 47,296 |                        |   | 55,284
|Less: Allowance for doubtful accounts |  |                       | 685    |                        |   | 790   
|                                      |  |                       |        |                        |   |       
|Total accounts receivable, net        |  | $                     | 46,611 |                        | $ | 54,494
|                                      |  |                       |        |                        |   |       

Unbilled receivables primarily consist of fees withheld by the client in accordance with the contract terms, items
waiting on customer acceptance, and conditions that will be billed upon contract completion and approval of indirect rates.

5. Distributions Payable

In connection with the revocation of the S corporation tax status, the Board of Directors approved a distribution to the stockholders of record on the
date of revocation representing the balance of undistributed S corporation earnings through the date of revocation. The distribution amount was determined after giving effect to the operating results through the revocation date with the filing of
the final S corporation tax return. In January of 2006, the Company paid approximately $5.9 million in the final distribution of previously undistributed S corporation earnings to the stockholders of record at the S Corporation termination date.
This amount is reflected as a current liability as of December 31, 2005.



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##### Table of Contents

NCI, Inc.

Notes to Consolidated Financial Statements (continued)

6. Loan and Security Agreement

On March 14, 2006, the Company entered into a new Loan and Security Agreement (the Agreement). Contemporaneously with the execution of the Agreement, the Company
terminated the prior Loan and Security Agreement relating to the Companys $30.0 million revolving credit facility, $14.0 million term note and $15.0 million time loan.

The borrowing capacity under the Agreement consists of a revolving credit facility with an original principal amount of up to $60.0 million, which includes a swingline facility with an original principal amount of up
to $5.0 million. The Agreement also has a $30.0 million accordion feature allowing the Company to increase its borrowing capacity to up to $90.0 million, subject to obtaining commitments for the incremental capacity from existing or new lenders. The
outstanding balance of the facility accrues interest based on LIBOR plus an applicable margin, ranging from 100 to 175 basis points, based on a ratio of funded debt to earnings. The credit facility expires on March 14, 2011.

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 Agreement contains various restrictive covenants that, among other things, restrict the Companys
ability to:



| |  | incur or guarantee additional debt;
|- |  | -----------------------------------



| |  | make certain distributions, investments and other restricted payments, including cash dividends on the Companys outstanding common stock;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  | enter into transactions with certain affiliates;
|- |  | ------------------------------------------------



| |  | create or permit certain liens; and
|- |  | -----------------------------------



| |  | consolidate, merge or sell assets.
|- |  | ----------------------------------

In addition, the Agreement contains
certain financial covenants that require the Company to:



| |  | maintain a minimum tangible net worth;
|- |  | --------------------------------------



| |  | maintain a minimum fixed charge coverage ratio and a ratio of funded debt to earnings; and
|- |  | ------------------------------------------------------------------------------------------



| |  | limit capital expenditures below certain thresholds.
|- |  | ----------------------------------------------------

Funds borrowed
under the revolving credit facility will be used to finance possible future acquisitions, to provide for working capital expenditures and for general corporate uses. As of September 30, 2006, there were no amounts outstanding under the credit
facility.

On August 1, 2006, the Company entered into the First Amendment (the Amendment) to the Loan and Security Agreement dated as of
March 14, 2006. In general, the Amendment permits the Company to indemnify and grant liens in favor of surety companies that issue performance bonds guaranteeing performance under certain of federal government contracts, provided that the
aggregate amount of work to be performed under all such bonded contracts shall not exceed $20,000,000 at any time.

7. Stockholders Equity and
Related Items

Reincorporation Transaction

NCI was
incorporated in Delaware in July 2005. In September 2005, the Company completed a merger and share exchange as a result of which NCI Information Systems, Inc., a Virginia corporation, became a wholly-owned subsidiary. Pursuant to a share exchange
agreement, the majority stockholder of NCI Information Systems, Inc. transferred all of his shares of common stock of NCI Information Systems, Inc. to the Companys wholly-owned subsidiary, NCI Acquisition, LLC, a Virginia limited liability
company. The majority stockholder received one share of Class B common stock in exchange for each share he transferred. NCI Information Systems, Inc. then merged with the wholly-owned subsidiary, with NCI Information Systems, Inc. surviving the
merger. As a result of this merger, each issued and outstanding share of common stock of NCI Information Systems, Inc., other than the shares transferred to the wholly-owned subsidiary by the majority stockholder, was converted into one share of
Class A common stock. In connection with this merger, NCI assumed all of the issued and outstanding options to acquire capital stock of NCI Information Systems, Inc., and these options became exercisable for shares of the Companys
Class A common stock. As this transaction represented a merger of entities under common control, the transaction was accounted for similar to a pooling-of-interests whereby all financial information prior to the transactions has been restated
as if the combined entity existed for the periods presented. The above transactions are collectively referred to herein as the Reincorporation Transaction.



10



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##### Table of Contents

NCI, Inc.

Notes to Consolidated Financial Statements (continued)

7. Stockholders Equity and Related Items
(continued)

Common Stock

As described above, the
Company completed the reincorporation of its business in September 2005. As a result, the Company maintains two classes of common stock. In connection with the initial public offering, on October 3, 2005, the Company affected a 1-for-1.9
reverse stock split of both its Class A and Class B common stock. The effect of this reincorporation, including the reverse stock split, has been reflected retroactively in the accompanying consolidated financial statements.

Holders of Class A common stock are entitled to one vote for each share held of record, and holders of Class B common stock are entitled to ten votes for each share
held of record, except with respect to any going private transaction, as to which each share of Class A common stock and Class B common stock are both entitled to one vote per share. The Class A common stock and the Class B
common stock vote together as a single class on all matters submitted to a vote of stockholders, including the election of directors, except as required by law. Holders of common stock are entitled to receive, when and if declared by the board of
directors from time to time, such dividends and other distributions in cash, stock or property from our assets or funds legally available for such purposes. Each share of Class A common stock and Class B common stock is equal in respect of
dividends and other distributions in cash, stock or property, except that in the case of stock dividends, only shares of Class A common stock will be distributed with respect to the Class A common stock and only shares of Class B common
stock will be distributed with respect to Class B common stock.

Each share of Class B common stock is convertible into one share of Class A common
stock at any time at the option of the Class B stockholder, and in certain other circumstances.

Stock Options

The Board of Directors of the Company duly adopted and approved the 2003 Performance Incentive Plan (the Old Plan) on January 31, 2003. The Board of Directors of the
Company has adopted the 2005 Performance Incentive Plan (the Plan) which has been approved by the Companys stockholders, and under which 3,157,895 shares of Class A common stock were reserved for issuance under the Plan. Stock options
granted under the Old Plan, together with certain non-qualified stock options granted to two executives in 2000 and 2001, were assumed under the Plan and, thereafter, became exercisable for shares of Class A common stock. The Plan provides for
the grant of incentive stock options and non-qualified stock options, and the grant or sale of restricted shares of common stock to the Companys directors, employees and consultants. The Board of Directors of the Company administers the Plan.
As of September 30, 2006, of the 3,157,895 shares reserved under the Plan, 976,314 shares have been issued under exercised options, 630,236 are outstanding under current option agreements, and 1,551,345 shares are available for future grants.

Stock options granted in 2003 and 2004 will fully vest over a period of zero to seven years from the date of grant in accordance with the individual stock
option agreement. The achievement of certain performance criteria, or a change in control as defined by the option agreements may accelerate the vesting period. Stock options granted during 2005 and 2006 will fully vest over a period of three to
five years from the date of grant in accordance with the individual stock option agreement.

During the first nine months of 2005 and 2006, the Company
granted options to purchase 78,945 and 40,000 shares of common stock, respectively, to certain employees and directors under the Plan. Stock-based compensation costs related to stock option grants has been reflected in the net income for the three
and nine months ended September 30, 2005 and 2006.

8. Related Party Transactions

The Company purchased services from Net Commerce Corporation, which is a government contractor wholly-owned by Rajiv Narang, the son of Charles K. Narang, the Chairman and Chief Executive Officer of the Company, under
a subcontract and a blanket purchase order. For the three months and nine months ended September 30, 2005, the payments for services and expenses incurred under these agreements were approximately $270,000 and $841,000, respectively, of which
$111,000 was included in accounts payable at September 30, 2005. For the three months and nine months ended September 30, 2006,



11



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##### Table of Contents

NCI, Inc.

Notes to Consolidated Financial Statements (continued)

8. Related Party Transactions (continued)

approximately $17,000 and $215,000 was incurred for services and expenses incurred under these agreements, respectively, of which $0 was included in accounts payable
as of September 30, 2006. These agreements have expired prior to September 30, 2006.

The Company has used private aircraft to accommodate the
travel needs of our executives for Company business. These aircraft are owned, directly or indirectly, by Michael W. Solley, the President and a director of the Company. The Company has reimbursed approximately $45,000 and $80,000 during the three
and nine months ended September 30, 2005, respectively, and nothing during the three and nine months ended September 30, 2006, to Mr. Solley or his affiliates for fees and expenses associated with the business use of these aircraft.

Management believes that all transactions with related parties have been conducted based on then current market conditions.

9. Contingencies

Government Audits

Payments to the Company on federal government contracts are subject to adjustment upon audit by various agencies of the federal government. Audits of costs and the
related payments have been performed by the various agencies through 2003. 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

The Company is party to various legal actions, claims, government inquiries, and audits resulting from the normal course of business. The Company believes that the probability is remote that any resulting liability will have a material
effect on the Companys financial position, results of operations or liquidity.

10. Income Taxes

In connection with the Companys initial public offering, the Companys S corporation status was terminated effective October 20, 2005, and the Company is
thereafter subject to federal and state income taxes as a C corporation. Because the Company was an S corporation, deferred taxes were not historically reflected in the financial statements, and the Company was not responsible for these income taxes
until the termination of its S corporation status. For informational purposes, the statements of income for the three month and nine month periods ended September 30, 2005 include a pro forma provision for income taxes that would have been
recorded if the Company had been a C corporation during this period when the Companys S Corporation election was in effect, calculated in accordance with SFAS No. 109.

The differences between the provision for income taxes at the statutory U.S. federal income tax rate and those reported in the pro forma provision for income tax information for the three and nine month periods ending
September 30, 2005 and the income tax provision recorded for the three and nine month periods ending September 30, 2006, relate to the impact of state and local income taxes and other differences. Other differences include, among other
items, the nondeductible portion of meals and entertainment, nondeductible penalties and fines, nondeductible dues, and nondeductible officers life insurance premiums, as well as any tax-exempt items of income.

The reconciliation between statutory U.S. federal income tax rates and those reported in the consolidated statements of income for the unaudited pro forma income tax
information for the three and nine months ended September 30, 2005 and the unaudited income tax provision for the three and nine months ended September 30, 2006 is as follows:



|                                            |  |      |   |  |      |  
|------------------------------------------- |  | ---- | - |  | ---- | -
|                                            |  | 2005 |   |  | 2006 |  
|Statutory federal income tax rate           |  | 34.0 | % |  | 34.0 | %
|State and local taxes, net of federal taxes |  | 4.8  |   |  | 4.7  |  
|Other                                       |  | 0.1  |   |  | 0.4  |  
|                                            |  |      |   |  |      |  
|                                            |  | 38.9 | % |  | 39.1 | %
|                                            |  |      |   |  |      |  



12



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##### Table of Contents

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

Forward
Looking Statements

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: regional and national economic conditions in the United States, including conditions that result from terrorist activities or war; changes in
interest rates; currency fluctuations; failure to achieve contract awards in connection with recompetes for present business and/or competition for new business; the risks and uncertainties associated with client interest in and purchases of new
products and/or services; continued funding of U.S. Government or other public sector projects, based on a change in spending patterns, or in the event of a priority need for funds, such as homeland security, turmoil in the Middle East, the war on
terrorism or rebuilding Iraq; government contract procurement (such as bid protest, small business set asides, etc.) and termination risks; individual business decisions of our clients; the financial condition of our clients; paradigm shifts in
technology; competitive factors such as pricing pressures and competition to hire and retain employees (particularly those with security clearances); our ability to complete and implement acquisitions appropriate to achievement of our strategic
plans; material changes in laws or regulations applicable to our businesses, particularly legislation affecting (i) government contracts for services, (ii) outsourcing of activities that have been performed by the government,
(iii) delays related to agency specific funding freezes, (iv) competition for task orders under Government Wide Acquisition Contracts (GWACS) and/or schedule contracts with the General Services Administration; and (iv) expensing of
stock options; our own ability to achieve the objectives of near term or long range business plans; and other risks described in the Companys Securities and Exchange Commission filings.

Overview

We are a provider of information technology services and
solutions to federal government agencies. We focus on designing, implementing, maintaining and upgrading secure IT systems and networks. Our technology and industry expertise enables us to provide a full spectrum of services and solutions that
assist our clients in achieving their program goals. We deliver a wide range of complex services and solutions by leveraging our skills across four core service offerings:



| |  |  | network engineering;
| | - |  | --------------------



| |  |  | information assurance;
| | - |  | ----------------------



| |  |  | systems development and integrations; and
| | - |  | -----------------------------------------



| |  |  | enterprise systems management.
| | - |  | ------------------------------

We generate substantially all of our
revenue from federal government contracts. We report operating results and financial data as one operating segment. Funding for our contracts and task orders is generally linked to trends in federal government spending by defense, intelligence and
federal civilian agencies. The following table shows our revenue from the client groups listed as a percentage of total revenue for the periods shown.



|                                                    |  |                                  |   |  |                                 |   |  |      |   |  |      |  
|--------------------------------------------------- |  | -------------------------------- | - |  | ------------------------------- | - |  | ---- | - |  | ---- | -
|                                                    |  | Three months ended September 30, |   |  | Nine months ended September 30, |  
|                                                    |  | 2005                             |   |  | 2006                            |   |  | 2005 |   |  | 2006 |  
|Department of Defense and intelligence agencies (1) |  | 74.1                             | % |  | 83.9                            | % |  | 73.4 | % |  | 80.4 | %
|Federal civilian agencies (1)                       |  | 25.5                             | % |  | 16.1                            | % |  | 26.1 | % |  | 19.4 | %
|Commercial and state & local entities               |  | 0.4                              | % |  |                                | % |  | 0.5  | % |  | 0.2  | %

---

|(1) | Percentages may not reflect disclosure in prior filings as a result of the reclassification during the second quarter of 2006 of a contract awarded in third quarter 2005, that was
initially classified as a federal civilian agency contract, as a Department of Defense and intelligence agency contract.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenue

Substantially all of our revenue is derived from services and solutions provided to the federal government, primarily by our employees and, to a lesser
extent, our subcontractors. In some cases, our revenue includes third-party hardware and software that we purchase on behalf of our clients. The level of hardware and software purchases we make for clients may vary from period to period depending on
specific contract and client requirements.



13



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##### Table of Contents

Contract Types

Our services and solutions are provided under three types of contracts: time-and-materials; cost-plus; and fixed-price. Our contract mix varies from year to year due to numerous factors including our business strategies and 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 September 30, |   |  | Nine months ended September 30, |  
|                   |  | 2005                             |   |  | 2006                            |   |  | 2005 |   |  | 2006 |  
|Time-and-materials |  | 51.4                             | % |  | 37.5                            | % |  | 56.7 | % |  | 42.5 | %
|Cost-plus          |  | 29.7                             | % |  | 26.5                            | % |  | 27.0 | % |  | 28.9 | %
|Fixed-price        |  | 18.9                             | % |  | 36.0                            | % |  | 16.3 | % |  | 28.6 | %

We have been experiencing an increase in the percentage of fixed price revenue we receive, and a decrease in the
percentage of time and materials revenue. This is due to the increased use of our government wide acquisition contracts (GWACs), where the majority of the tasks are fixed price level of effort instead of on a time-and-materials or cost-plus basis.
Additionally, we have seen an increase in product sales under our NETCENTS contract, which are typically on a fixed unit price basis.

The amount of risk
and potential reward varies under each type of contract. Under time-and-materials contracts, where 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. Under cost-plus type contracts, there is very little
risk, since we are reimbursed all of our allowable costs, and therefore, the profit margins tend to be lower on cost-plus type contracts. Under fixed-price contracts, we perform specific tasks or provide specified goods for a predetermined price.
Compared to time-and-materials and cost-plus contracts, fixed-price services contracts generally offer higher profit margin opportunities but involve greater financial risk because we bear the impact of potential cost overruns in return for the full
benefit of any cost savings. The majority of our services work under fixed-price contracts is fixed-price level-of-effort work, which has a lower risk than fixed-price completion contracts, such as software development. Some of our GWACs include
provisions for both services as well as product (hardware and software) purchases. Fixed price product sales, such as under our NETCENTS contract, tend to carry lower margins, but with lower risk as well, since our prices from our vendors are fixed.

See Critical Accounting Polices - Revenue Recognition for a more detailed discussion of the various contract types.

Operating Expenses

Cost of Revenue

Cost of revenue primarily includes direct costs incurred to provide our services and solutions to clients. The most significant portion of these costs is salaries and
wages, plus associated fringe benefits including stock-based compensation, of our employees directly serving clients, in addition to the related management, facilities and infrastructure costs. Cost of revenue also includes the costs of
subcontractors and outside consultants, third-party materials, such as hardware or software that we purchase on behalf of our clients, and any other related direct costs, such as travel expenses. These other direct costs are incurred in response to
specific client tasks, and vary from period to period. Changes in the mix of services and equipment provided under our contracts can result in variability in our contract margins.

General and Administrative Expenses

General and administrative expenses include the salaries and wages, plus
associated fringe benefits including stock-based compensation, of our employees not performing work directly for clients. Among the functions covered by these costs are facilities, corporate business development, bid and proposal, contracts
administration, finance and accounting, legal, corporate governance, and executive and senior management.

Depreciation and Amortization

Depreciation and amortization includes the depreciation of computers, furniture and other equipment, the amortization of third party software we
use internally, and leasehold improvements.



14



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##### Table of Contents

Amortization of Intangible Assets

Amortization of intangible assets includes the amortization of identifiable intangible assets over their estimated useful lives. Non-compete agreements are generally amortized straight-line over the term of the
agreement, while contracts and related client relationships are amortized proportionately against the acquired backlog.

Provision for Income Taxes

Prior to October 20, 2005, the Company elected, by the consent of its stockholders, to be taxed as an S corporation under Subchapter S of the
Internal Revenue Code (the Code) and under relevant sections of the tax law of the various states that conform to the Code. Under our S corporation election, all items of income and expense were passed through and taxed at the
stockholder level for federal tax purposes. As a result, NCI was not required to record a provision for federal income taxes. However, we have recorded a provision for state income taxes for those states that do not recognize the S corporation
status. For all periods after October 20, 2005, the Company is taxed as a C corporation and is recording a provision for estimated taxes on that basis.

Results of Operations

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



|                                    |  |                                                            |   |  |                                                           |   |  |       |   |  |       |  
|----------------------------------- |  | ---------------------------------------------------------- | - |  | --------------------------------------------------------- | - |  | ----- | - |  | ----- | -
|                                    |  | As a percentage of revenueThree months ended September 30, |   |  | As a percentage of revenueNine months ended September 30, |  
|                                    |  | 2005                                                       |   |  | 2006                                                      |   |  | 2005  |   |  | 2006  |  
|                                    |  | (unaudited)                                                |   |  | (unaudited)                                               |  
|Revenue                             |  | 100.0                                                      | % |  | 100.0                                                     | % |  | 100.0 | % |  | 100.0 | %
|                                    |  |                                                            |   | 
|Operating costs and expenses:       |  |                                                            |   |  |                                                           |   |  |       |   |  |       |  
|Cost of revenue                     |  | 85.9                                                       |   |  | 87.2                                                      |   |  | 85.2  |   |  | 86.3  |  
|General and administrative expenses |  | 6.1                                                        |   |  | 5.6                                                       |   |  | 7.2   |   |  | 6.2   |  
|Depreciation and amortization       |  | 0.9                                                        |   |  | 0.7                                                       |   |  | 0.8   |   |  | 0.8   |  
|Amortization of intangible assets   |  | 0.5                                                        |   |  | 0.3                                                       |   |  | 0.6   |   |  | 0.5   |  
|                                    |  |                                                            |   |  |                                                           |   |  |       |   |  |       |  
|Total operating costs and expenses  |  | 93.4                                                       |   |  | 93.8                                                      |   |  | 93.8  |   |  | 93.8  |  
|                                    |  |                                                            |   |  |                                                           |   |  |       |   |  |       |  
|Operating income                    |  | 6.6                                                        |   |  | 6.2                                                       |   |  | 6.2   |   |  | 6.2   |  
|                                    |  |                                                            |   |  |                                                           |   |  |       |   |  |       |  
|Interest income                     |  | 0.1                                                        |   |  | 0.4                                                       |   |  |      |   |  | 0.4   |  
|Interest expense                    |  | (1.0                                                       | ) |  |                                                          |   |  | (0.8  | ) |  |      |  
|                                    |  |                                                            |   |  |                                                           |   |  |       |   |  |       |  
|Income before taxes                 |  | 5.7                                                        |   |  | 6.6                                                       |   |  | 5.4   |   |  | 6.6   |  
|Provision for income taxes (1)      |  | 0.3                                                        |   |  | 2.6                                                       |   |  | 0.3   |   |  | 2.6   |  
|                                    |  |                                                            |   |  |                                                           |   |  |       |   |  |       |  
|Net income                          |  | 5.4                                                        | % |  | 4.0                                                       | % |  | 5.1   | % |  | 4.0   | %
|                                    |  |                                                            |   |  |                                                           |   |  |       |   |  |       |  

---

|(1) | Provision for income taxes for the periods ending September 30, 2005 only reflects taxes paid as an S corporation.
|--- | ------------------------------------------------------------------------------------------------------------------

Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005

Revenue: For the three months ended September 30, 2006, total revenue increased by 19.6% or $9.8 million, over the same period a year ago. This increase was primarily due to new task orders under our GWAC
contract vehicles, primarily NETCENTS, ITES and TEIS, as well as growth on existing programs. A significant amount of the NETCENTS growth in this quarter is attributable to Federal Government fiscal year end purchases of products under the contract.
These increases were partially offset by funding reductions on some intelligence and civilian contracts and revenue loss from contracts that ended.

Cost of revenue:Cost of revenue increased 21.3%, or $9.2 million, for the three months ended September 30, 2006, as compared to the same period a year ago. The increase was attributable to an increase in
subcontractor and other direct costs and the increase in revenue. As a percentage of revenue, cost of revenue was 87.2% and 85.9% for the quarters ended September 30, 2006 and 2005, respectively. The 1.3% increase in cost of revenue as a
percentage of revenue for the quarter ended September 30, 2006 compared to the quarter ended September 30, 2005 resulted primarily from an increase in subcontractor and other direct costs, including the hardware and software purchases
under NETCENTS, as a percentage of cost of revenue.

General and Administrative Expenses: General and administrative expense increased 8.9%, or $0.3
million, for the three months ended September 30, 2006, as compared to the same period a year ago. The increase is due mainly to increased legal fees related to a government contract protest and increased bid and proposal costs. Others cost
increases were offset by reduced non-cash stock compensation expenses. As a percentage of revenue, general and administrative expenses were 5.6% and 6.1% for the quarters ended September 30, 2006 and 2005, respectively.



15



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Depreciation and Amortization:Depreciation and amortization expense was approximately $0.4 million
for each of the quarters ended September 30, 2006 and 2005.

Amortization of Intangible Assets: Amortization of intangible assets was
approximately $0.2 million and $0.3 million, respectively, for the quarters ended September 30, 2006 and 2005. The decrease is due to lower amortization associated with the contracts and client relationships intangible related to the SES
acquisition, which is being amortized using an accelerated amortization method.

Operating income: For the three months ended September 30,
2006, operating income was $3.7 million, or 6.2% of revenue, compared to $3.3 million, or 6.6% of revenue, for the three months ended September 30, 2005. Operating income was higher for the three months ended September 30, 2006 due to the
higher revenue volume as compared to the same period in the prior year. Operating income, as a percent of revenue, was lower in the three months ended September 30, 2006 compared to the same period in the prior year due to the higher amount of
subcontractor and other direct costs, including hardware and software purchases, especially the product sales under the NETCENTS contract, which typically carry lower profit margins as a percentage of cost of revenue.

Interest Income/Expense: The decrease in interest expense of $0.4 million and increase in interest income of $0.2 million for the quarter ended September 30,
2006 compared to the quarter ended September 30, 2005 was attributable to proceeds from our initial public offering in October 2005. The proceeds paid down all of our existing bank debt, thereby significantly reducing our interest expense, and
our excess cash has been invested in high quality, highly liquid investments, increasing our interest income.

Income Taxes: The increase in income
taxes of $1.4 million is the result of our conversion from an S corporation to a C corporation for income tax purposes. For the three months ended September 30, 2005, we have recorded a provision for state income taxes for only those states
that do not recognize the S corporation status. The effective tax rate reflected for the three months ended September 30, 2006 is 38.5%. This effective rate is higher than the federal statutory rate primarily due to state and local taxes and
certain non-deductible expenses.

Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005

Revenue: Revenue was $153.8 million and $144.0 million for the nine-month periods ending September 30, 2006 and 2005, respectively, an increase of $9.8
million or 6.8%. The increase is primarily from revenue on new contracts and task orders under our GWAC vehicles, including product orders under NETCENTS as discussed above, and growth on existing programs. These increases are offset by reduced
revenue on some civilian and intelligence contracts due to funding reductions and other contract scope reductions in contract follow-ons, as well as the loss of revenue on programs which have ended.

Cost of revenue:Cost of revenue increased 8.2%, or $10.1 million, for the nine months ended September 30, 2006 compared to the same period in
the prior year. As a percentage of revenue, cost of revenue is 86.3% for the nine months ended September 30, 2006, compared to 85.2% for the same period of the prior year. This increased cost of revenue, in both dollars and as a percent of
revenue, is due to increased subcontractor and other direct costs, including hardware and software purchases under NETCENTS.

General and Administrative
Expenses:General and administrative expense decreased 7.5%, or $0.8 million, for the nine months ended September 30, 2006, as compared to the nine months ended September 30, 2005. This reduction was attributable to lower
stock compensation expense, lower bid and proposal costs, and a reduction of other expenses, including IPO related costs. As a percentage of revenue, general and administrative expenses were 6.2% and 7.2% for the nine months ended September 30,
2006 and 2005, respectively.

Depreciation and Amortization:Depreciation and amortization expense was approximately $1.2 million for
each of the nine-month periods ending September 30, 2006 and 2005.

Amortization of Intangible Assets: Amortization of intangible assets was
approximately $0.7 million and $0.8 million for the nine-month periods ending September 30, 2006 and 2005, respectively. The decrease is due to lower amortization associated with the contracts and client relationships intangible related to the
SES acquisition, which is being amortized using an accelerated amortization method.

Operating income: For the nine months ended September 30,
2006, operating income was $9.5 million, or 6.2% of revenue, compared to $8.9 million, or 6.2% of revenue, for the nine months ended September 30, 2005. Award fee notices, which have a direct impact on operating income, received in the nine
months ending September 30, 2006 were approximately $330,000 lower than those received in the same period in the prior year. Additionally, the portion of the revenue increase that is due to higher subcontractor and other direct costs, including
hardware and software purchases, carries a lower profit margin, which decreases the operating margin. The higher revenue volume and the lower general and administrative costs offset the higher cost of revenue and lower award fees, resulting in the
higher operating income.



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Interest Income/Expense: The decrease in interest expense of $1.2 million and increase of interest income of $0.5
million for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005, is the result of initial public offering completed in October 2005. The proceeds were used to pay down all of our existing bank debt
and the excess cash has been invested in high quality liquid investments, thereby reducing interest expense and increasing interest income.

Income
Taxes: The increase in income taxes of $3.6 million is the result of our conversion from an S corporation to a C corporation for income tax purposes. For the nine months ended September 30, 2005, we have recorded a provision for state
income taxes for only those states that do not recognize the S corporation status. The effective tax rate reflected for the nine months ended September 30, 2006 is 38.9%. This effective rate is higher than the federal statutory rate primarily
due to state and local taxes and certain non-deductible expenses.

Contract Backlog

At September 30, 2006, December 31, 2005, and September 30, 2005, our estimated backlog was $599.6 million, $578.6 million and $562.4 million, respectively, of which $92.6 million, $69.7 million,
and $75.9 million, respectively, was funded. 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,
assuming the exercise of all related options. 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 backlog does not include any estimate of future potential delivery orders that might be awarded under our GWAC or other multiple award contract vehicles. Additional information on
how we determine backlog is included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, previously filed with the SEC.

Effects of Inflation

We generally have been able to price our contracts in a manner to accommodate the rates of inflation experienced in
recent years. Under our time-and-materials contracts, labor rates are usually adjusted annually by predetermined escalation factors. Cost-plus contracts automatically adjust for changes in cost. For our fixed-price contracts, we include a
predetermined escalation factor to account for projected increases in costs. Historically, we generally have not been materially adversely affected by inflation.

Liquidity and Capital Resources

Our primary liquidity needs are for financing working capital, investing in capital expenditures and making
selective strategic acquisitions. Historically, we have relied primarily on our cash flow from operations, borrowings under our credit facility and proceeds from our initial public offering to provide the capital for our liquidity needs. We expect
the combination of our current cash and cash equivalent balances, cash flow from operations and the available borrowing capacity on our credit facility to continue to meet our normal working capital and capital expenditure requirements. As part of
our growth strategy, we may pursue acquisitions that could require us to raise additional external capital or increase our borrowings.

Cash flow:
The following table sets forth our sources and uses of cash for the nine months ended September 30, 2005 and 2006.



|                                                    |  |                                 |        |   |      |   |        |  
|--------------------------------------------------- |  | ------------------------------- | ------ | - | ---- | - | ------ | -
|                                                    |  | Nine months ended September 30, |       
|                                                    |  | 2005                            |        |   | 2006 |  
|                                                    |  | (in thousands)                  |       
|Net cash provided by operating activities           |  | $                               | 9,006  |   |      | $ | 12,636 |  
|Net cash used in investing activities               |  |                                 | (3,082 | ) |      |   | (267   | )
|Net cash provided by (used in) financing activities |  |                                 | (5,951 | ) |      |   | (6,093 | )
|                                                    |  |                                 |        |   |      |   |        |  
|Net (decrease) increase in cash                     |  | $                               | (27    | ) |      | $ | 6,276  |  
|                                                    |  |                                 |        |   |      |   |        |  

Operating cash flow is primarily affected by the overall profitability of our contracts, our ability to invoice
and collect from our clients in a timely manner, and our ability to manage our vendor payments. We bill most of our clients and prime contractors monthly after services are rendered. Cash provided by operating activities for the nine months ended
September 30, 2006 was the result of net income of $6.1 million, depreciation and other non-cash items of $2.1 million, net changes in operating assets and liabilities of $2.3 million, primarily due to decreased receivables and increases in
accounts payable, and a decrease in deferred tax assets of $2.1 million. Cash provided by operating activities for the nine months ended September 30, 2005 was the result of net income of $7.4 million, depreciation and other non-cash items of
$2.9 million, and a net decrease in operating assets and liabilities of $1.3 million.



17



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##### Table of Contents

Cash flow used in investing activities consists primarily of capital expenditures. The $267,000 used in investing
activities for the nine months ended September 30, 2006 is primarily for capital expenditures, whereas the $3.0 million in cash used for investing activities for the nine months ended September 30, 2005 represents a $1.9 million payout for
the final SES acquisition payments and $1.1 million in capital expenditures, the majority of which was due to leasehold improvements to expand government certified facilities to pursue additional classified business.

Cash flow used in financing activities consists primarily of proceeds from and payments on our loans, capital lease payments and distributions to our stockholders.
During the nine months ended September 30, 2006, we paid the final distribution to our S corporation stockholders of $5.9 million. During the nine months ended September 30, 2005, we borrowed a net $17.3 million on our credit facility,
paid $2.1 million on our term loan, and paid out $21.0 million in distributions to the S corporation stockholders.

Credit Agreement: The borrowing
capacity under our Loan and Security Agreement (the Agreement) consists of a revolving credit facility with an original principal amount of up to $60.0 million, which includes a swingline facility with an original principal amount of up to $5.0
million. The Agreement also has a $30.0 million accordion feature allowing us to increase our borrowing capacity to up to $90.0 million, subject to obtaining commitments for the incremental capacity from existing or new lenders. The credit facility
expires on March 14, 2011. Funds borrowed under the revolving credit facility will be used to finance possible future acquisitions, to provide for working capital expenditures and for general corporate uses. As of September 30, 2006, there
were no amounts outstanding under the credit facility.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Critical Accounting Policies

Our significant accounting policies are described in Note 3 to our accompanying consolidated financial statements. We consider the accounting policies related to revenue
recognition to be critical to the understanding of our results of operations. We prepare our financial statements in conformity with U.S. generally accepted accounting principles. As such, we are required to make certain estimates, judgments and
assumptions that we believe are reasonable based upon the information available. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of
revenue and expenses during the periods presented. If any of these estimates or judgments proves to be incorrect, our reported results could be materially affected.

Revenue Recognition

Our revenue recognition policy addresses our three different types of contractual
arrangements: time-and-materials contracts; cost-plus contracts; and fixed-price contracts.

Time-and-Materials Contracts:Revenue on
time-and-materials contracts is recognized based on negotiated billable rates multiplied by the number of hours delivered plus allowable expenses incurred during the period.

Cost-Plus Contracts: Revenue on cost-plus contracts is recognized based on the allowable costs incurred during the period, plus any recognizable earned fee. Revenue associated with fixed fees under cost-plus
contracts is considered earned in proportion to the allowable expenses incurred in performance of the contract.

Fixed-Price Contracts: The Company
has three categories of fixed-price contracts: fixed unit price; fixed-price level-of-effort; and fixed-price completion contracts. Revenue on fixed unit price contracts, where specified units are delivered under service arrangements, is recognized
as units are delivered based on the specified price per unit. Revenue for fixed-price level-of-effort contracts is recognized based upon the number of units of labor actually delivered multiplied by the negotiated rate for each unit of labor.
Revenue on fixed-price completion contracts is recognized on the percentage of completion method using costs incurred in relation to total estimated costs.

For contracts with performance based incentives or award fees, revenue is recognized as earned. Certain fees are not recognized until award notification is received, which may result in revenue and profit variability from quarter to
quarter.

Contract accounting requires judgment relative to assessing risks, estimating contract revenues and costs, and making assumptions for schedule
and technical issues. Due to the size and nature of certain of our contracts that require the use of estimates or related assumptions, the estimation of total revenue and cost at completion is subject to many variables. Contract costs include
material, labor and subcontracting costs, as well as an allocation of allowable indirect costs. Assumptions have to be made regarding the length of time to complete the contract because costs also include expected increases in wages and prices for
materials. We apply judgment in estimating the amounts and assessing the potential for



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##### Table of Contents

realization. Further, we utilize a number of management processes to monitor contract performance and revenue estimates,
including quarterly management reviews of contract estimates. These amounts are only included in contract value when they can be reliably estimated and realization is considered probable. Estimates of award fees related to performance on certain
contracts, which are generally awarded at the discretion of the client, as well as penalties related to contract performance, are considered in estimating sales and profit rates. Incentives and penalties are recorded when there is sufficient
information for us to assess anticipated performance. Anticipated losses on contracts are recognized in the period they are deemed probable and can be reasonably estimated.

From time to time, circumstances develop or actual amounts are determinable that require us to revise our total estimated costs or revenue expectations. We record the effect of any revisions to our estimated total
costs and revenue in the period in which circumstances requiring revision become known. Consequently, operating results could be affected by revisions to prior accounting estimates. Historically, these changes relate to changes in the contractual
scope of our work, and have not significantly impacted the expected profit rate on a contract. We do not expect that revisions to our estimates and assumptions would have a material effect on the Companys consolidated results of operations,
cash flows or financial position.

Stock-Based Compensation

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) (SFAS No. 123(R)), Share-Based Payment, using the prospective
method. Under this method, compensation costs for all awards granted after the date of adoption and modifications of any previously granted awards outstanding at the date of adoption are measured at estimated fair value and included in operating
expenses over the vesting period during which an employee provides service in exchange for the award. Prior to the adoption of SFAS No. 123(R), the Company accounted for stock-based compensation in accordance with APB No. 25 using the
intrinsic-value method. Under the prospective method, we will continue to apply APB No. 25 in future periods to awards outstanding at the date of adoption. The Company issued non-qualified stock options to employees at various times during 2003
and 2004 with vesting periods ranging from zero to seven years and any related expense for the amount by which the fair market value at the date of grant exceeds the exercise price is being amortized over the applicable vesting periods. During 2005
and 2006, the Company issued incentive stock options and non-qualified stock options to employees and directors with vesting periods ranging from three to five years.

In adopting SFAS No, 123(R), companies must choose among alternative valuation models and amortization assumptions. The Company has elected to use the Black-Scholes-Merton option pricing model and straight-line
amortization of compensation expense over the requisite service period of the grant. In valuing stock option grants, we use an expected volatility factor based on the historical volatility of the Companys stock, an expected term equal to the
vesting period plus the term of the option divided by two, a risk-free interest rate based on the implied yield available on a U.S. Treasury note with a term equal to the expected term of the underlying grant, a dividend yield of zero based on the
Companys expectation to not pay dividends in the future, and an estimated forfeiture rate.

We estimated stock-based compensation expense from
existing stock option agreements to be approximately $151,000 in 2006, $214,000 in 2007, $209,000 in 2008, $203,000 in 2009, $51,000 in 2010, and $4,000 in 2011.

Goodwill and the Amortization of Intangible Assets

Our accounting policy regarding acquisitions is in accordance with SFAS
No. 141,Business Combinations, whereby the net tangible and identifiable intangible assets acquired and liabilities assumed are recognized at their estimated fair market values at the date of acquisition. At the time of the acquisition,
all intangibles including the contracts and related client relationships and non-compete agreements are reviewed to determine the term of amortization for each intangible asset.

Our accounting policy regarding goodwill and the amortization of intangible assets requires that goodwill be reviewed periodically for impairment and no longer be amortized against earnings. Annually, on
October 1, we perform a fair value analysis of our reporting units using valuation techniques prescribed in SFAS No. 142.

Long-lived assets are
reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset many not be fully recoverable in accordance with SFAS No. 144,Accounting for the Impairment of Long-Lived Assets. An impairment loss
is recognized if the sum of the long-term undiscounted cash flows is less than the carrying amount of the long-lived asset being evaluated. Any write-downs are treated as permanent reductions in the carrying amount of the assets. Contract rights are
amortized proportionately against the acquired backlog. Non-compete agreements are amortized over their estimated useful lives.



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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk relates to
changes in interest rates for borrowings under our Loan and Security Agreement. Since we had no outstanding bank debt during the three and nine months ended September 30, 2006, a change in interest rates would have had no impact on our interest
expense or cash flow.

Additionally, we are subject to credit risks associated with our cash and cash equivalents, short-term investments and accounts
receivable. We believe that the concentration of credit risks with respect to cash equivalents and investments are limited due to the high credit quality of these investments. Our investment policy that requires we invest excess cash in high quality
investments which preserve principal, provide liquidity, and minimize investment risk. We also believe that our credit risk associated with accounts receivable is limited as they are primarily with the federal government or prime contractors working
for the federal government.

Item 4. Controls and Procedures

Quarterly Evaluation. Management carried out an evaluation as of
September 30, 2006 of the effectiveness of the design and operation of the Companys disclosure controls and procedures. This evaluation was done under the supervision and with the participation of management, including the Companys
Chief Executive Officer and Chief Financial Officer. Rules adopted by the SEC require that management present the conclusions of the Chief Executive Officer and Chief Financial Officer about the effectiveness of the Companys disclosure
controls and procedures as of the end of the period covered by this quarterly report.

CEO and CFO Certifications. Included as Exhibits 31.1 and
31.2 to this Quarterly Report on Form 10-Q are forms of Certification of the Companys Chief Executive Officer and Chief Financial Officer. The forms of Certification are required in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002. This section of the Quarterly Report on Form 10-Q that you are currently reading is the information concerning the evaluation referred to in the Section 302 certifications. This information should be read in
conjunction with the Section 302 certifications for a more complete understanding of the topics presented.

Disclosure Controls and Procedures and
Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate disclosure controls and procedures and internal control over financial reporting. Disclosure controls and procedures are designed to
provide reasonable assurance that information required to be disclosed in the Companys reports filed or submitted under the Securities Exchange Act of 1934, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and
reported within the time periods specified in the SECs rules and forms. Disclosure controls and procedures are also designed to provide reasonable assurance that such information is accumulated and communicated to the Companys
management, including the Companys Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Internal control over financial reporting is a process designed by, or under the supervision of, the Companys Chief Executive Officer and Chief Financial Officer, and effected by the Companys management
and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those
policies and procedures that:



| |  |  | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the Companys assets;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that the Companys receipts and expenditures are being made only in accordance with authorizations of management or the Companys Board of Directors; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Companys assets that could have a material adverse
effect on the Companys financial statements.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Limitations on the Effectiveness of Controls. Management, including the
Companys Chief Executive Officer and Chief Financial Officer, do not expect that the Companys disclosure controls and procedures or the Companys internal control over financial reporting will prevent all errors and all fraud. A
control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered



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relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur
because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by managements override of the control. The design of any system of controls also is
based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate
because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Scope of the Assessments. The assessment by the Companys Chief Executive Officer and the Companys Chief Financial Officer of the
Companys disclosure controls and procedures included a review of procedures and discussions with other employees in the Companys organization. In the course of the assessments, management sought to identify data errors, control problems
or acts of fraud and to confirm that appropriate corrective action, including process improvements, were being undertaken. The assessments of the Companys disclosure controls and procedures is done on a periodic basis so that the conclusions
can be reported in the Companys Quarterly Reports on Form 10-Q and Annual Reports on Form 10-K. The Companys key controls related to its internal control over financial reporting are updated on a periodic basis by management and other
personnel in the Companys accounting department.

Evaluation of the Effectiveness of Disclosure Controls and Procedures. Based upon the
evaluation, the Companys Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2006, the Companys disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting. The Company made no change to its internal control over financial reporting during the three months ended
September 30, 2006, that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.



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PART II

OTHER INFORMATION

Item 1. Legal Proceedings

The Company is party to various legal actions, claims, government inquiries, and
audits resulting from the normal course of business. The Company believes that the probability is remote that any resulting liability will have a material effect on the Companys financial position, results of operations or liquidity.

Item 1A. Risk Factors

No significant changes from those discussed in Risk Factors included in
NCI, Inc.s Form 10-K, filed with the Securities and Exchange Commission on March 30, 2006.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None.

Item 6. Exhibits

Exhibits



|     |  |                                                         
|---- |  | --------------------------------------------------------
|31.1 |  | Section 302 Certification of the Chief Executive Officer
|     | 
|31.2 |  | Section 302 Certification of the Chief Financial Officer
|     | 
|32.1 |  | Section 906 Certification of the Chief Executive Officer
|     | 
|32.2 |  | Section 906 Certification of the Chief Financial Officer



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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: November 7, 2006 |  | By:        |  | /s/ Charles K. Narang                       
|                       |  |            |  | Charles K. Narang                           
|                       |  |            |  | Chairman of the Board,                      
|                       |  |            |  | Chief Executive Officer and Director        
|                       |  |            |  | (Principal Executive Officer)               
|                       |  |           
|Date: November 7, 2006 |  | By:        |  | /s/ Judith L. Bjornaas                      
|                       |  |            |  | Judith L. Bjornaas                          
|                       |  |            |  | Senior Vice President                       
|                       |  |            |  | Chief Financial Officer                     
|                       |  |            |  | (Principal Financial and Accounting Officer)



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