Information Analysis, Inc. Is Another NCAV Bargain - IAIC

Before I get back to developments on stocks I've already covered, I want to highlight another company that trades at a discount to net current assets: Information Analysis, Inc.

Many companies and government agencies still depend on software systems and programs created decades ago, written in programming languages that are no longer used. Enabling newer software and hardware to "talk" to these legacy systems involves additional time and expense for IT staff and developers. At some point these costs become unmanageable and it's time to replace legacy systems or at least develop workarounds. That's where companies like Information Analysis, Inc. (or "IAI") come in. Information Analysis's staff specializes in modernizing obsolete software systems and transferring processes away from retired software. IAI also creates web-based programs that can replace PC-based software.

IAI's largest client is the US Government, which accounted for 87% of revenues in 2012. Such a concentrated revenue base is a large risk. The company notes that contracts made with the US Government are generally less profitable than contracts with private industry, and contain many provisions for cancellation or changes.

Information Analysis, Inc. has been profitable in 8 of the last 10 fiscal years, and free cash flow positive in 7 of those years. Revenues have trended downward since 2005, but have been relatively stable since 2008.

Margins analysis is very revealing. From 2008 to 2012, IAI was very successful in signing higher-margin contracts and reducing low-margin business lines like software reselling. Gross margins improved from 25.04% in 2008 to 34.16%. Though 2012 revenues were only $370,000 higher than 2008 revenues, gross profits were higher by $730,000! However, that's where the good news stops. All of the company's growth in gross profit has been eaten up by increases in operating expenses. IAI's operating margin for 2012 was a downright pitiful 1.42%, the lowest of any profitable year in the last decade. IAI has a problem with operating expenses, which rose to 23.9% of revenues in 2012 from 20.0% in 2011. The company explained the increase as the result of non-productive labor expenses in its annual report:

"The increase is primarily due to increases in non-revenue-producing labor costs. These consisted of an increase in overhead labor related to periods of U.S. federal government customer budget uncertainties and to a short-term business development project that did not yield anticipated results."

The Fiscal Cliff and a failed sales initiative. These may be temporary issues, but Information Analysis, Inc.'s high operating costs still leave it perilously close to break-even.

Declining margins and dependence on government revenues may paint a bleak picture, but IAI's real value is in its balance sheet. The company is simply loaded with cash. Cash makes up 72.8% of total assets and is 53% greater than the company's market capitalization. IAI carries very little in the way of fixed assets and has no long-term liabilities.

Information Analysis, Inc. has net current assets per share of 18.7 cents. On a discounted basis, net current assets stand at 17 cents per share. (I used a very low discount for IAI's receivables because they are nearly all government obligations.) IAI's current share price mid-point of $0.1525 represents a discount of 10-19% from the value of its net current assets.

IAI's large cash balance is both an opportunity and a risk. Insiders own 25.7% of shares, so presumably they are interested in using this cash productively and increasing their own wealth. Whether or not they invest this cash wisely will determine the company's future and the returns investors will experience.

Like most businesses that trade below the value of their current assets, IAI faces its share of obstacles and risks. However, like JLM Couture, Information Analysis could make a solid addition to a diversified basket of stocks trading below their NCAV values.

I own shares in Information Analysis, Inc.