Booz Allen Hamilton Holding Corp (BAH) 2013 Q3 法說會逐字稿

Good morning. Thanks for standing by, and welcome to the Booz Allen Hamilton's earnings call covering third-quarter fiscal 2013 results. At this time, all lines are in a listen-only mode. Later, there will be an opportunity for questions. I would now like to turn the call over to Mr. Curt Riggle.

Thank you, Shannon, and thank you all for joining us today for Booz Allen's third quarter fiscal 2013 earnings announcement. I'm Curt Riggle, Director of Investor Relations, and with me to talk about our business and financial results this morning is Ralph Shrader, our Chairman, Chief Executive Officer, and President, and Sam Strickland, Executive Vice President and Chief Financial Officer. We hope you've had an opportunity to read the press release on our third-quarter earnings that we issued earlier this morning. We have also provided presentation slides on our website, and are now on slide 1. On today's call, Ralph will provide you with an overview of our business performance, recent developments, and the firm's strategic positioning for the future. Sam will then discuss our financial results in detail, including our income statement, balance sheet, cash flow, and backlog, and our earnings guidance for fiscal 2013, which began on April 1, 2012.

As shown on the disclaimer on slide 2, please keep in mind that some of the items we will discuss this morning will include statements that may be considered forward-looking, and therefore, are subject to known and unknown risks and uncertainties, which may cause our actual results in future periods to differ materially from forecasted results. Those risks and uncertainties include, among other things, general economic conditions, the availability of government funding for our Company's services, and other factors discussed in today's earnings release, and set forth under the forward-looking statements disclaimer included in our fiscal 2013 third-quarter earnings release, and in our SEC filings. We caution you not to place undue reliance on any forward-looking statements that we may make today, and remind you that we assume no obligation to update or revise the information discussed on this call.

During today's call, we will also discuss some non-GAAP financial measures, and other metrics which we believe provide useful information for investors. We include an explanation of adjustments and reconciliations of our non-GAAP measures to the most comparable GAAP measures in our fiscal 2013 third-quarter slides. It is now my pleasure to turn over to our CEO, Ralph Shrader, and he will start on slide 3.

Thank you, Curt. Good morning, and thank you all for joining us here this morning. Two years ago, Sam and I had the pride and excitement of hosting Booz Allen Hamilton's first earnings call, following our listing on the New York Stock Exchange. I talked about the strength and resilience that comes from being a respected firm that is nearly a century old, and how we would retain the differentiators in our management consulting heritage and collaborative culture that have established Booz Allen as a high-performing, high-quality brand in the professional services industry. I don't have to tell you how much has changed in the government services sector in these past two years. Back in those heady days of double-digit growth, we certainly didn't envision sequestration, or the fiscal cliff, or the tremendous political divide that is paralyzing our government.

No question a lot has changed since then. But a lot has not. Booz Allen Hamilton remains strong and resilient. I am committed, as is our entire management team, to leading from the center, telling it straight, and ensuring that our clients, our people, and our investors are in good hands. Both in good times, and turbulent times. In the 12 months prior to December 31, 2012, Booz Allen delivered total shareholder returns of 40.2%. Our total shareholder return is better than the S&P 500 over the same period, and better than most of the other companies in our public comp group.

Today, we are reporting results for the third quarter of our fiscal year 2013, which ended December 31, 2012. While revenue was down from the prior-year period, Booz Allen continued to grow our margins, operating income, and adjusted earnings, and we again generated strong cash flow. Here are the financial headlines for our fiscal 2013 third quarter. Third-quarter revenue was $1.39 billion, down from $1.44 billion in the prior-year period. Adjusted net income increased to $59.7 million from $56.4 million in the prior year period. Adjusted EBITDA increased 13.1%, to $135.8 million, and adjusted diluted earnings per share increased by 2.5%, to $0.41 per share.

We ended the third quarter of fiscal 2013 with total backlog of $12.92 billion, compared with $12.22 billion in the prior-year period, and funded backlog of $3.15 billion compared with $2.97 billion in the prior-year period. These figures include backlog from our acquisition of the defense systems engineering and support division of ARINC Incorporated, which I will discuss in more detail here shortly. Today, we are announcing our fifth regular quarterly cash dividend in the amount of $0.09 per share.

A highlight of our fiscal 2013 third quarter was the successful closing on November 30, 2012 for an acquisition of the defense systems engineering and support division of ARINC, known as DSES, which brings approximately 900 talented new people into Booz Allen. As I said on our last call, we are very excited about how their engineering capabilities and specialized expertise in C4ISR, prototyping, specialized software development, and analytics, complement Booz Allen's existing capabilities. These are all areas where we see further growth potential and client demand, to help extend the life of aging weapons platforms and support aviation and navigation systems, and software-intensive operational systems.

At Booz Allen, we are focused on the things we can control in this uncertain market, and there are many. We can control the quality of work we do for clients, the attention we pay to contractual requirements and deliverables, and the ethics and integrity with which we do business. We can reduce costs, manage our operations with agility and precision, and keep a strong balance sheet, income statement, and cash flow, so we have the financial flexibility that will allow us to invest for the long term, and take advantage of market opportunities in this challenging environment. At every level, we are making changes to ensure our cost competitiveness to win and perform work in this current business environment, so we can deliver value to clients, and maintain quality jobs for our people.

Evidence of the important work Booz Allen does for clients can be found in some of the major contract awards and task orders we won during the third quarter. A $19 million single award from the Department of Justice's, Justice Management Division, to provide engineering support services. A $22 million multiple award from the Navy Space and Naval Warfare System Center Pacific to provide a wide range of engineering, analytic, and technology services in support of maritime intelligence, surveillance, reconnaissance, and information operations. A $24 million multiple award to provide technical support services to the Environmental Protection Agency.

A $14 million single award contract from the Air Force Space Command, to provide systems engineering and integration support to the Military Satellite Communications Directorate. And additional new contracts to serve clients in the commercial financial services, energy, and health care sectors. These are but a few of the new and recompeted contracts we've won in the past quarter, and they span all of our major market areas. We recognize that to continue to win and deliver in this very challenging market for government contracting, our Company needs to be more cost competitive, and at the same time we need to invest in areas where we see the potential for revenue and margin growth. And we are doing both of these things.

Reducing our spending, while investing. We are making structural changes today to reduce the cost of our management levels, and undertaking a market-by-market review of our head count alignment and labor costs. Likewise, we are ensuring that our benefits and infrastructure costs support our ability to compete and win. Booz Allen is building for the future in terms of strategy and investment. On our last earnings call at the end of October, I talked about our long-term strategy that we call Vision 2020, which is based on the strong conviction that there are significant potential growth avenues available to us by combining a deeper technical portfolio with our legendary consulting heritage and mission understanding. Vision 2020 is about capturing the best of our past, looking to the future, and implementing changes to make Booz Allen even more successful going forward.

I started this morning's discussion by talking about the things that haven't changed for Booz Allen. These things will never change. Our commitment to be the consultant of choice for our clients, the employer of choice for our talented people, an investment of choice for those who entrust us with their capital, and a good corporate citizen, making a difference in the communities in which we work and live. The broader economic conditions have made things harder, on all of our key stakeholders. Our clients, our people, investors, and communities, and we recognize that.

We are also heartened that despite the challenging environment for employees of government contractors, our people recognize Booz Allen's quality and differentiation. In the internal people survey we conducted in December, 91% of our employees rated as exceptional our client focus, the quality of our deliverables, and our institutional commitment to delivering high-quality services. The spirit of service burns brightly at Booz Allen, and this was especially evident over the holiday season.

Across the country, our people in the firm contributed over 4,800 toys and $49,000 to Toys For Tots, and last month I was honored to give Booz Allen's check to the Marine Corps Sergeant right here in our Washington, DC office. Our commitment to clients, people, investors and communities is strong and enduring. Booz Allen's success today and tomorrow is inseparable from them. I will talk more about our near-term and longer-term strategy in a few minutes, after Sam provides a more detailed discussion of our financial performance for the third quarter of fiscal 2013, which ended a month ago on December 31, 2012. Sam?

Good morning, and thank you for joining us. We are now on slide 4. We take great pride in how we have managed the business this year. We have focused on effectively managing our capacity, and on the deployment of staff to minimize non-billable time. We have focused on controlling infrastructure costs, and on ensuring that we have the right number and caliber of leaders for the market we see ahead. I also want to acknowledge the challenges in achieving those things, when the unknowns of sequestration and a long-term budget agreement won't go away, and when our clients are very unsure of themselves.

To position ourselves for future success in these times, we regularly find ourselves faced with tough choices. We often note to you that our business is one with a highly variable cost base, and we recognize that these costs are primarily related to people. It is a particularly difficult task to address business challenges, when major decisions have faces and names to them, but our approach is to be honest with ourselves. We know that in a slower business environment, we can't allow ourselves to get behind the curve in managing capacity.

As a result of these often difficult choices, we have been able to serve our clients well, and maintain quality jobs for the vast majority of our people, while growing our margins and our earnings, adjusted for one-time items. We also continue to have a strong cash position. The key is, as Ralph said, focusing on what we can control, quality work, tactical selling, cost management, as well as our ongoing investment in growth opportunities, that will continue to drive our future success. As we focus on strengthening ourselves for future growth, we are particularly proud that, even in today's environment, we have been able to deliver a total return to shareholders that is among the top in our peer group.

With that, let's turn to slide 5 for a closer look at our third quarter of fiscal 2013. Overall, we saw a decrease of 3.5% in our top line revenue over the prior-year period. The decline in revenue resulted from lower demand due to market forces, which led to a reduction in head count, and a related reduction in billable hours, which contributed to a decline in our direct labor. Additionally, our continued focus on minimizing non-billable work and effectively managing our non-billable costs has contributed to overall lower indirect costs, and a corresponding reduction in revenue on our cost-reimbursable contracts.

As we have pointed out in previous quarters, the slower spending on indirect costs is actually beneficial, and is part of our management strategy to maintain flexibility within our operations, and to avoid cost overruns that could negatively impact our bottom line. While revenue and cost reimbursable contracts is negatively impacted, the actions we've taken are having the expected results and are beneficial to our bottom line.

So with that understanding, I would like to highlight our continued improvement in other measures below the top line, despite the very challenging conditions I've mentioned. In the third quarter of fiscal 2013, adjusted operating income increased to $120.8 million, from $104.7 million in the prior-year period, while operating income increased to $116.6 million from $98.2 million in the prior-year period. The improvement in adjusted operating income and operating income was driven by continued improvements in the deployment of Booz Allen's consulting staff, and the disciplined management of our costs.

In the third quarter of fiscal 2013, adjusted net income increased to $59.7 million from $56.4 million in the prior-year period. The adjusted net income for the quarter includes the impact of an additional $5.8 million, net of tax and interest expense, as a result of the refinancing transaction that we completed in July, 2012. Net income decreased to $56.2 million from $62.9 million in the prior-year period. This decrease in net income was primarily attributable to the release of a significant income tax reserve in the prior-year period.

Adjusted EBITDA increased 13.1% to $135.8 million in the third quarter of fiscal 2013, compared with $120.1 million in the prior-year period. In the third quarter of fiscal 2013, adjusted diluted earnings per share increased to $0.41 per share, from $0.40 per share in the prior-year period. Diluted earnings per share decreased to $0.38 per share from $0.44 per share in the prior-year period. These metrics were positively impacted by the same factors as adjusted operating income and operating income, offset by an increase in income taxes, interest, and other expenses for the quarter ended December 31, 2012, as compared to the prior-year period.

Adjusted diluted earnings per share and diluted earnings per share for the third quarter of fiscal 2013 reflect a decrease on the order of $0.04 per share, attributable to higher interest expense associated with the July 2012 debt refinancing transaction related to the special dividend paid in August 2012. Please note that the figures we're presenting today are inclusive of the DSES acquisition, which closed in November.

Now, let's turn to cash. Even after issuing a special dividend in the prior quarter, and using cash on hand to fund the DSES acquisition, we have retained a healthy cash balance with strong cash flow. Our historical focus on core growth in our core business, and investments in growth areas like cyber, cloud, and the commercial and international markets continue. And as we have said for many quarters, we remain open to evaluating potential acquisition opportunities that are a cultural fit, and bring us additional client access and/or enhanced capabilities. Regarding capital spending, our CapEx for the third quarter was $6.3 million, down from $22 million in the prior-year quarter. The lower CapEx is primarily a result of the completion of the leasehold improvements to support our facility strategy in the Washington, DC area. CapEx is expected to be about 0.75% of annual revenue through fiscal 2014.

On November 30, we closed our purchase of DSES for $155.1 million, using available cash on hand. We expect the transaction to be accretive to earnings in fiscal 2014, which begins April 1, 2013. Let's go through the basic numbers regarding cash. Our day sales outstanding were 63 days for the quarter ended December 31, 2012, reflecting continued improvement in cash collections. Net cash provided by operating activities in the first three quarters of fiscal 2013 was $399 million, compared to $252 million in the prior-year period. Free cash flow for the first three quarters of fiscal 2013 was $378.3 million, compared with $186.5 million in the same prior-year period. This 103% increase was driven by significant cash collections in our second quarter, which coincided with an acceleration of government payments at the end of its fiscal year.

And now, our backlog figures. Booz Allen's total backlog, as of December 31, 2012, was $12.92 billion. This included $11.39 billion for Booz Allen, and $1.53 billion from our DSES acquisition, compared with total backlog of $12.22 billion as of December 31, 2011. Booz Allen's funded backlog as of December 31, 2012, was $3.15 billion, which included $2.9 billion from Booz Allen, and $247.3 million from DSES, compared with $2.97 billion as of December 31, 2011.

As shown in exhibit 5, our unfunded backlog is down by approximately $100 million from the prior year. There are several reasons for this. Our third quarter, which immediately follows the government fiscal year end, is a seasonally light quarter for contract awards. In the current uncertain budgetary environments, some clients have been hesitant to fully exercise option years, which has a direct effect on our unfunded backlog. And protest after contract awards also affect the realization of backlog.

I would like to turn back to Ralph, who will talk briefly about Booz Allen's strategic positioning and differentiation, and then I will finish the formal part of our presentation with guidance for fiscal 2013 and a discussion of fiscal 2014. We are now on slide 6.

Thank you, Sam. I would like to pick up the discussion about our Vision 2020 long-term strategy with some additional detail. We started this effort last year with extensive research, in which we analyzed what and how federal government buys, which we baselined against our internal business, including our service offerings, structure, and pricing models. We also benchmarked our model for people progression, roles, and responsibilities, against competitors, and other world-class companies. Today, we are in the process of finalizing a new organizational design that will go into effect on April 1, 2013, coinciding with the start of our new fiscal year. It consists of market groups serving our civil, defense, and intelligence government clients, and our commercial international clients.

And a new Strategic Innovations Group, through which we will drive innovation and integration across all markets. We believe this organizational design will continue to foster the collaborative culture that differentiates Booz Allen, and we'll do so through a more efficient matrix model. I'm excited about this focus on innovation and capability development, and we will be continuing our investments in capabilities such as cyber, cloud, health, and government efficiency, and new capabilities such as specialized engineering services, predictive intelligence, and rapid prototyping. As well as in our emerging commercial and international markets. By making the changes where needed, to improve our cost competitiveness today, and building for the future, in terms of strategy and investment, we will help ensure that Booz Allen's second century is even more distinguished than its first. I would now like to turn back to Sam to talk about our forecast, and then we look forward to taking your questions.

Thank you, Ralph. We are now on slide 7, fiscal 2013 outlook. In recognition of our third-quarter top line results, and based on our expectations that the current macro economic trends will continue, and assuming no impact from sequestration, we are updating our guidance as follows. At the bottom line, we are narrowing our previous guidance, with a forecast of diluted earnings per share, to be in the range of $1.40 to $1.45 per share, and adjusted diluted earnings per share to be in the range of $1.60 to $1.65 per share. At the top line, we expect revenue to decline by a low single-digit percentage for fiscal 2013, ending March 31, 2013, as compared with the prior fiscal year. I would note that our guidance today is inclusive of DSES.

In prior years, at this time, in the third quarter of our fiscal year, we have provided some initial guidance about our expectations for the following fiscal year, however, our entire industry is in very different times now, and at this moment, the future is not clear enough for us to give you a projection for our fiscal 2014 that would reflect the confidence and clarity that you have come to expect from us in our financial discussions. And so, for those reasons, we are holding off for the time being, on making projections for the next fiscal year. Curt?

Thank you, Sam and Ralph. And thank you all for listening to our summary of results and outlook. Before we go to questions, I would like to update everyone on a topic about which I've received numerous inquiries. In the coming weeks, an estimate of the amount of distribution made and classified as taxable dividend versus non-taxable return of capital, or a capital gain, during 2012, will be provided on Forms 1099-DIV. With that little bit of housekeeping out of the way, we shall turn to our questions. The Chief Operating Officer, Horacio Rozanski, and Senior Vice President and Controller, Kevin Cook, are here with Ralph and Sam to answer your questions. Shannon, you can please provide instructions for the question-and-answer portion of our call?

(Operator Instructions)

Our first question is from Carter Copeland of Barclays. You may begin.

Ralph, I want to ask a bigger picture question. I mean you can all answer and weigh in on this, but it seems to me you're really maintaining as much flexibility as you can in terms of your cost structure. You're not trying to chase growth in an uncertain environment and you're preparing for all scenarios given the uncertainty we see, but this most likely is not going to be permanent, and we will emerge from this uncertainty at some point in the -- hopefully, the not-so-distant future, and I want to know what you think about what you're doing to the organization today, and whether or not that will make Booz Allen a better organization on the backside of this. How are the changes that you're implementing, and the way you're thinking about how you remain competitive in this environment, impacting how the business will perform once we get past this uncertainty?

Carter, I think you're asking a great question. I actually appreciate some of the things you said in advance of that, which I think we are being smart, and we are trying to be ahead of this. You may recall that a year ago, we took a series of actions which we thought were going to place us well ahead of the curve, and I think they did. Unfortunately, the curve kept changing faster than we thought, and so we're now looking at how we go further with that.

I think the way I would characterize it is this. As a firm, and in particular, as a government business, over the course of last 15 years, we've been fortunate enough, and I think talented enough, to realize some superb growth. We were growing in the mid-teens for any number of years there. And in the course of doing that, while it is a nice -- it is a healthy environment, it does sometimes make you look past the urgencies of how do you actually sharpen up your organization. And I think what we are coming to grips with as an organization over the course of the last couple of years is that, when your growth rate slows, it is time to take a good look at some of the practices that have been put in place over these really good times, and decide whether they're sustainable over uncertain times. And that's exactly what we're doing.

So other than -- we certainly have not undertaken things like mass layoffs and shutting things down, and all of that. Rather, we have looked at fine tuning. And we've come to recognize the fact that in our senior management ranks for example, we have perhaps an excess of talent and capability there that, while it served us in boom times, is not exactly optimized against uncertain times. And so the kind of actions we've taken I think have been very clearly surgical, and they're all about really strengthening the core of the institution. So, I am very comfortable today that the things we have done are all about making Booz Allen Hamilton a stronger institution.

I would actually like to make a slight confession and say that, perhaps, if I at the top and the other leaders at the top had not been so focused on enjoying the growth, there are some things here we should have been doing all along, but the urgency wasn't there because we were so successful. So, I don't think anything we're doing now is in any way cutting into the core of what we've got here. It is all about really sharpening the core, and making the core stronger, and actually giving us the kind of framework against, we believe, we're going to be able to accommodate whatever the scenarios are. We agree with you that over the longer term, the growth will be back. We don't know what that term is, and so we want to make sure that over that period of time while we wait for the growth to re-occur, we've got a strong institution, and the framework is solid and strong.

So, I don't think we've done anything here that in any way weakens the institution, or in any way threatens our ability to grow once we see, shall we say, some better times in the environment. We're actually quite comfortable here that the changes we make are good. So, that is sort of a philosophical approach that we've taken to this. And I think, as I say, it has actually been a good exercise for us because it has put us back in the right mindset here to actually have the right kind of fine-tuned and sharply-focused organization.

Great. Thanks for the color, Ralph. Just a quick follow-up. I wondered if you might speak to the activity you're seeing in the contracting environment since the beginning of the year, and if there is a notable change since we turned the calendar over to 2013.

I will let Horacio speak to that (inaudible) directly.

It is a good question. I think the environment has been uncertain for some time, and the notion of procurement sliding to the right, and things being protested, has been with us for a while. It is intensified, in some ways, around some of the conflicting internal guidance that DoD has been giving the services and the way that is being approached. There has been a couple of instances where we saw one of the services perhaps jump the gun, or over react, to the guidance, and then pull itself back, and so that is the kind of reality that we're experiencing. We keep coming back to this term, uncertainty. I don't know that you could say that on January 4, things were significantly more uncertain than they were on December 23. I think it is just a continuation of a general trend, and just a complicated place for our clients to be in. And we are buffeted by those winds.

Great. Thank you, gentlemen.

Thank you. Our next question is from Bill Loomis of Stifel Nicolaus. You may begin.

Just looking at, Sam, on the -- margins in the third quarter were very strong, I mean the best from an operating margin that we've seen to date. Yet, when I run the numbers on the full-year guidance, the implied fourth-quarter operating margin seems to be the lowest of the year. So I'm trying to understand why some of the cost-cutting measures you had in the third quarter, why we don't see them in the fourth quarter in applied guidance. And I know you're not giving '14 guidance, but there's two different -- pretty significant different margins. Any insight into what we should be -- where margins could trend in the next year?

Well, I think that the best indicator for that would be the guidance for the year, Bill.

Okay.

If we take a look at our fourth quarter -- as you know, we've got -- we manage our indirect rates, our indirect costs on an annual basis. So, during the -- this third fiscal quarter, you will read as you read through the Q, we have made some adjustments for example to bonus accruals to get that, based on where we thought we were going to be towards the end of the year. So I think what you saw in the third quarter was us making sure we have our cost profile for the first nine months, on a cumulative basis, reflective of what we're going to look like at the end of the fiscal year. So, that said, there is no question that this year compared to last year, we were managing our indirect costs much more closely.

As a growth firm, we of course -- and you know this, as you've been watching us for some time -- as a growth firm, we would, what we would call hire ahead of the curve, which is that we would add capacity in anticipation of revenue coming in. And that is a wonderful growth model. And last year, we continued that for a bit. And then it was clear that we weren't going to see the growth that we had in the past. So, as a result, we started adjusting our indirect costs. We started getting very aggressive in terms of the way we manage capacity, to try and make it so that we had just-in-time arrival of the staff. And so I think that is -- you're seeing that, particularly when you compare this year to last year, you're seeing that show up in our indirect cost rates.

While I know there is a lot of talk about pricing going down, it is not that we're seeing a sharp reduction in the drop in our indirect rep rates, let's call it. I would say that we're seeing pressure to reduce actually our direct cost labor rates, which is to say that our clients are tending towards a bit more junior staff. It will be interesting to see whether that trend holds up over the long term. And having been around in the so-called peace dividend, in the mid 1990s, what happened is you saw the government go that way and then recognize that with experience did come some additional capabilities, and so that trend turned a bit.

Okay. Thank you. And then just on your assumptions of continuing resolution, I guess, you haven't given a fiscal '14 guidance, but most of the companies, and you as well for your March quarter, assuming the CR continues, but we are hearing some of the news reports from the Pentagon and what they're saying about if, in fact, it is a full-year CR, that they will see a reduction in spending from current run rates. How are you -- when you're planning your business and your expense base and your hiring over, not only over the remaining quarter in '13, but the start of '14 -- what are you thinking? If we go into a full CR, do you think the spending levels will continue truly at current rates, or will they decline like the DoD has been implying?

I think there, when we talk about the uncertainty, we are uncertain. We're just now starting to see conversations around what costs would be reduced if we go into sequestration. So, we still haven't yet been able to identify how much that would impact us, if at all. Now, you have to assume that if the overall spending goes down, that it would have some impact on us. But, when we talk about our uncertainty, that's certainly one of them.

So, we will just have to, again, go back to saying that we've got our cost structure as variable as we can possibly get it. We've cut down on -- as you know, we started a facility strategy several years ago, to get ourselves in a position to get our costs as variable as we could make it. And so our commitment is to ensure that we continue to manage our costs in relation to our revenue. We are hopeful that, particularly with the acquisition of DSES, that we will continue to have revenue close to the -- let's call it to the flat line, at a minimum. But, in this environment, we realize that is going to be difficult, particularly through the balance of the government fiscal year '14, if the government goes into sequestration. So our commitment is to make sure that we stay agile and responsive, so that we can protect the margins we have, even if revenue does take a hit from sequestration or government shutdowns or whatever.

Okay. Thank you, Sam.

Thank you. Our next question is from Brian Gesuale of Raymond James. You may begin.

I wanted to ask a little bit more about the DSES acquisition. Can you talk to us maybe about how the integration is going? I know it is very early, but I think the last transaction you did was in 1992 or somewhere around then. Just give us a little bit of tenor in terms of color on how that is going, and the strategy to integrate that?

That's a great question. I think we recognize that we are not an acquisitive firm by nature, and that this was something that -- where we were both on-boarding a significant capability in terms of what DSES brings to us, but also, in some ways, developing our capabilities in terms of acquiring and integrating. So we approached it from the very beginning from that notion. We have asked one of our most senior, most experienced partners, Bill Purdy, whom I believe many of you know and have dealt with in the past, to lead the effort of pulling the two entities together. And we've asked -- and then Kevin Cook has been managing the -- call it the back-office infrastructure part of that as well.

And the general approach that we've taken to DSES is -- as they say in the medical profession -- first, do no harm. And so we initiated a transition into us that was essentially as transparent to them as we could make it. And off of that basis, we have now begun essentially two streams, [source of] integration, one deals with marketing our markets efforts where we take advantage of their capabilities into our clients and we begin to understand, and they take advantage of our capabilities into their clients, and we have a very active effort against that. The second stream is around the natural areas where cost opportunities reside in an acquisition of this type, where we're moving smartly along. But we've not tried, nor will we try, to slam this thing together. We actually want this to be a -- if you will, a reasonably natural organic process where, over the coming months, we will continue to reduce the differentiation between the two entities.

Some of the sticking points that you worry about in something like this, in a professional services environment, would be harmonizing benefits packages and those kinds of things that can really create a problem. And the good news in that, and we knew this going in, is that those differences were so minor that they will not, for any intents and purposes, be a big deal. And then you worry about contracts and OCI and those kinds of things. And again, through due diligence, we became very comfortable that those issues, where they exist, are also minor. So, at this point, it's full speed ahead. We're starting to go to clients together and getting resonance in terms of the joint proposition, and we will accelerate that in due course.

Great. Thanks very much. Maybe just one follow-up. Can you talk a little bit to maybe cadence of funding on existing contracts? To date, we've heard about the government funding in shorter increments. Have you actually seen any kind of meaningful or measurable net declines in existing run rates, not just a shorter duration of funding?

In terms of shorter run rates, in terms of time?

The funding being -- we've seen some shorter increment to funding, maybe three or four weeks instead of three or four months. But are you seeing any change in those run rates to those funding levels?

Well, if you take a look at our funded backlog, which would be the key indicator there, our -- let's call it, in the historical Booz Allen, the organic part of Booz Allen, if you will, that funded backlog is down slightly. It is not down dramatically, but we are seeing some of that. I will tell you that, actually, this time in the past, we've generally -- clients haven't -- didn't have a tendency to fund this long term during the third quarter anyway, simply because they were trying to get all of their money lined up for the government fiscal year. We actually started to see, last year, funding get longer term, as we got into the -- let's call it the first calendar quarter.

So are we seeing that? Are we seeing clients who are being very conservative? Are we seeing clients who are holding on to their money? Yes. I wouldn't say that we have seen substantial drop-offs in funding at this point, though. I can assure you, we're watching our direct labor on a daily basis, and if we were to start to see something like that, clearly, we would move to adjust costs.

You are surely executing through that very well. Thanks for taking my questions.

Thank you, Brian. I appreciate the compliment.

(Operator Instructions)

Our next question is from George Price of BB&T Capital Markets. You may begin.

For the fiscal year '13 revenue growth down by a low single-digit percentage, I would ask, is there any way you can be a little bit more specific, maybe put a range around that? And give us -- possibly give us a sense of how much of that is driven by the lower demand and volume impact versus the reduced cost base?

We -- can we be more specific than that? Well, there is probably not more than 3 or 4 percentage points that constitute low single digits, so I will leave that with you. Just bear in mind that we have the DSES acquisition kicking in for a full quarter, so we feel like that will -- I don't know if dampen is the right word, but at least support the revenue base for the quarter, compared with last year's March quarter. So, financially, in terms of the cost base, we will continue to manage our costs closely. So I don't expect our cost management to reduce revenue further in the fourth quarter, compared to the third quarter, if that answers your question.

Okay. So, what we're seeing in the third quarter then is predominantly from the environment, as opposed to -- from the demand environment as opposed to the lower costs flowing through the cost-plus contracts.

I think there is a healthy -- we are managing our indirect costs better this year, compared to last year. For example, last year at this time, we were actually running ahead of our targeted rates. Targeted rates being that which we have billed -- which we are billing in our contracts and which we have bid and are billing in our contracts -- and this year, we are running underneath those. So, as we talked about, that then reduces your -- the revenue on your cost-plus contracts. It does increase your margins on your time and materials and fixed price contracts. We would expect that trend to continue throughout the end of the year, whereas we did not have that dynamic last year.

All right. Shifting over to DSES, can you give us the revenue that the Company contributed or that the business contributed in the quarter, and comment, is the expectation of $110 million to $120 million for fiscal '13 still good? Are you seeing any change in the run rate of revenue of that business versus your initial expectations?

At this point, no. We haven't seen any change in the expectations. So, bear in mind, we're in it for, at this point, about two months. But, as you can see, they have a healthy funded backlog. Their funded backlog as a percentage of their annual revenue is actually higher than the -- let's call it the historic Booz Allen. So we're feeling pretty good about DSES at this point.

And what revenue did it contribute in the quarter?

Well, I think we are getting down to a point now where we're saying, look, it is -- I think you need to take a look at the consolidated number, and at this point, revenue is down 3.5%. And we've given our guidance for our fourth fiscal quarter.

Okay. Great. Thank you.

Thank you. Our next question is from Edward Caso of Wells Fargo. You may begin.

Thank you. Congrats on managing the margins so well here. We've read a lot recently about the efforts to get ready on the defense side. Haven't heard much on the civilian agency side. I was wondering if you had any thoughts that you could share with us on what you're hearing from clients on the civil side.

Well, as you know, the civil is a much more disjointed market than defense and intel. I would say that we're not experiencing growth in the civil markets. It is declining slightly -- let's use that low single-digit number, and we expect that to continue. We feel like where we are in the civil markets, we feel like we're in very mission-critical areas, so we're optimistic that we will be able to hold our own there.

And can you talk about the intel agencies, how much work you do in that area? We're hearing that they have already started to slow down and have for some time now. Maybe level set us on how much DoD, how much intel, and how much civil? Thank you.

Well, you know, historically, our relationship has been roughly half defense and then one-quarter intel and one-quarter civil. That ratio is not changing much, frankly. So it may be changing 1 percentage point, one way or the other. And that's something that we traditionally report out in our 10-Q and that's when it makes sense -- we will sit down and take a look at where we end up for the year. But I think we would say that intel is not immune from what is going on. But, there again, it is not as if it is being any more impacted than, say, the defense or the civil markets.

Great. Thank you very much.

Thank you. Our next question is from Matt Hill of William Blair. You may begin.

This is Matt in for Tim McHugh. It seems like you can't get through these calls without a question on the commercial and international front, so I was just wondering if there was any update to trends you're seeing in that business and kind of how it is stacking up to what you were thinking before.

Well, Matt, as you recall, what we've said is that to ensure that we don't spend a lot of time talking about fairly small pieces of the business, we will talk about commercial and international more when it gets to be a meaningful part of the business. The bottom line is, is that we're continuing to invest heavily. We do see better margins there than we see in the government business. We are adding new clients, we have a very focused strategy there. So, while we're optimistic, I think it is too early to start breaking out numbers on that. I know everybody wants numbers and they want to model it, but we think at this point it is just -- it is important to focus on the total business.

Okay. And then, I wanted a little bit more color on the new organization strategy going forward, just what drove your decision to change that up, and what opportunities do you see that creating for the business?

I will take a cut at that. We came in to this organization discussion from the angle of Vision 2020 that Ralph talked about before, and tried to think about, if our mission and our vision is to integrate, our mission understanding, our consulting approach, and our growing technical capabilities at the point of the client, how could we do that best? At the same time, we wanted to streamline the organization, to make it more responsive to the realities of a market that is changing much faster than the matrix that we had before. And then, finally, we wanted to make sure that we have a focused approach on innovation, one where we could mass resources and people that could serve across all of our markets seamlessly and bring new ideas and new service offerings across all of our clients, even faster than we have in the past.

And that's how we went down a journey that created the -- essentially the fine-tuned matrix that we are going to next, where we are going to serve all four of our markets -- defense, civil, security, commercial, and international -- and we will do that in a more focused way, while at the same time enabling the Strategic Innovations Group to scale up new businesses and new ideas faster. Things like cloud analytics -- we have some recent experience where one or two clients are very intent on that. We spend time working with them. We learn from them. They learn from us. And, ultimately, that intellectual capital, once it matures, becomes extremely valuable to all of our clients.

So what we wanted to do is have the ability to then take that through all of our sales channels as fast as possible. Because in a market like this one, where we spend a lot of time talking about the parts of the business that are likely going to be challenged by sequestration and budget cuts and all of that, there are still significant growth opportunities, and we want to be very focused on identifying those faster and going at them faster. So we have market group leaders, Strategic Innovation Group. And so that makes us, from our perspective, more responsive, more streamlined. It simplifies a lot of our internal processes, puts pricing and capacity management closer to each other, which is something that in the old organization was divided powers, if you will. And ultimately, accomplishes -- we hope, we believe -- the goal simultaneously of bringing us closer to our vision, while making us more responsive to the near-term turbulence.

I think one of the things we have a benefit in is that many of us have been here for quite some time. We have grown up in a commercial management consulting environment. One of the things we learned how to do in that environment was actually to work with companies about how to do things like to take costs out of your business, but to do it smartly --how to align your strategies against changing market conditions, and things like that. And I think we are an example of we actually know how to apply that to ourselves. And a lot of the insights and the understandings that we have, have been gained over a long period of time about how to help some of the world's leading companies do this. And we consider ourselves to be one of the leading companies in this industry, and we're applying a lot of this knowledge and understanding to ourselves. So the structured approaches that we're using are approaches that we have a lot of experience with. And I think we're very comfortable that they yield the right results.

Okay. Great. Thank you very much.

Thank you. That concludes the question-and-answer portion of our call. At this time, I would like to turn the call over to Dr. Shrader for closing remarks.

Well, thank you very much. And I want to thank all of you for joining us here today. I guess if I have a hope for today, it would be that perhaps the key message you take away this morning is really that, while the federal government environment is obviously very, very uncertain, we here at Booz Allen are very focused on those things that we believe we have firm control of, and I will repeat that (inaudible) really our ability to deliver the best value to our clients and our shareholders. And our total shareholder return continues to be among the very top in the government services sector today. So, while we're making changes to ensure our cost competitiveness today, we are still focused on and investing in our future. So with that, I will close, and say, thanks again. Have a good day.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day.