CACI International Inc (CACI) Q4 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the CACI International Fourth Quarter FY 2013 Conference Call. Today's call is being recorded. [Operator Instructions] At this time, I would like to turn the conference call over to Dave Dragics, Senior Vice President of Investor Relations for CACI International. Please go ahead, sir.

Thanks, Allie, and good morning, everyone. I'm Dave Dragics, Senior Vice President of Investor Relations of CACI International, and we're very pleased that you're able to participate with us today. Now as is our practice, we are providing presentation slides, so let's move to Slide #2. Now about our written and oral disclosures and commentary, there will be statements in this call that do not address historical fact and, as such, constitute forward-looking statements under current law. These statements reflect our views as of today and are subject to important factors that could cause our actual results to differ materially from anticipated results. Now factors that could cause our actual results to differ materially from those we anticipate are listed at the bottom of last evening's earnings release and are described in the company's Securities and Exchange Commission filings. And our Safe Harbor statement is included on this exhibit and should be incorporated as part of any transcript to this call. Now I'd also like to point out that our presentation today will include discussion of non-GAAP financial measures, and these non-GAAP measures should not be considered in isolation or as a substitute for performance measures prepared in accordance with GAAP. So to open up our discussion this morning, here is Ken Asbury, President and Chief Executive Officer of CACI International. Ken?

Thank you, Dave, and good morning to everyone. Thank you for joining us today. With me this morning are Tom Mutryn, our Chief Financial Officer; John Mengucci, our Chief Operating Officer and President of U.S. Operations; and Greg Bradford, joining us from the U.K., is the Chief Executive of CACI Limited. Last night, we released our fourth quarter and full year results for fiscal year 2013. Today, we'll discuss those results, provide more information that supports our outlook for fiscal year '14 and our plans for CACI moving forward. Tom will review the financials, and John will provide some operational details. Let's go to Slide 4, please. The fourth quarter and full year results are in line with our most recent guidance expectations and reflect our ability to adapt to an uncertain market environment. We grew revenue in our high-growth market areas, as well as received half of our fourth quarter contract awards from the same high-growth market areas. We reduced cost structure, which helped us drive efficiencies in delivery of our solutions and services to our customers and helped improve bottom line results. As we indicated on our fiscal year '14 guidance call, we believe the U.S. government will operate under sequestration throughout our '14 plan cycle. Additionally, we believe it is likely the government will operate under continuing resolutions during its fiscal year '14 as well. This operating environment continues to create low forward visibility for government program managers and the federal contracting community. Our strategy and resulting guidance reflect these realities. Slide 5, please. During fiscal year '14, we'll continue to focus on our 3-part strategy that we have discussed previously: first is to win new business in our large addressable market; second drive operational excellence into everything we do; and third, continue on our successful mergers and acquisitions program. Slide 6, please. Looking ahead, as a result of the actions we took in FY '13, we expect CACI to be increasingly competitive in winning business. We will continue to focus on the high-growth areas of Business Systems, Cyberspace, Healthcare and Integrated Security Solutions. Since the beginning of our new fiscal year on July 1, we are encouraged by several new and recompete wins. John will talk more about that later in the call. Please go to Slide 7. Since I started here at CACI approximately 6 months ago, I've made a number of changes to our business development approach and organization to ensure that we increase our ability to win more and larger deals. We have strengthened an already strong CACI business development capability with 2 key executive additions. Don Fulop, our new Executive Vice President for Business Development, is an experienced industry veteran who has successfully led large-scale business development activities in the technology solutions and services marketplace. We've also added another key business executive, Suzan Zimmerman, who will lead campaign pursuits focused on capturing large, strategic opportunities. Acquisitions remain a priority for the deployment of our capital. They bring us new customer relationships and capabilities. In evaluating potential opportunities, we will continue to make certain they meet our criteria of sound, strategic and cultural fit, are accretive to our earnings and generate returns greater than the cost of our capital. We expect that in the near term, the federal market will likely remain challenged. Our current and long-term view is that the U.S. government will continue to require the kinds of solutions and services that CACI provides. The steps we have taken to better position CACI in this environment, the investments in talent and organization that we've made and the positive start we've seen thus far to the current quarter gives me confidence to reiterate fiscal year '14 guidance. With that, let me turn the call over to Tom for some insight into our financials. Tom, over to you.

Yes, thank you, Ken, and good morning, everyone. Our fourth quarter results reflect growth in our direct labor, our focus on reducing costs and driving efficiencies and strong operating cash flow, although our government customers continue to operate in an uncertain environment. Slide #8, please. As discussed on prior calls and outlined in our release, 3 material onetime items positively impacted FY '12 results. To provide better insight into our fiscal year '13 performance in more meaningful comparisons, we are comparing this year's revenue and earnings results to adjusted FY '12 results. Slide 9, please. For the quarter, revenue decreased 3.8%. Importantly, direct labor, the primary profit driver of our business, increased 4.3%. This was offset by a 9% reduction in other direct costs, which produced materially lower margins and profit. For the year, direct labor grew 5.2%, while ODC declined 7%. This decline in ODC, approximately $115 million, resulted in the FY '13 revenue decrease. For the year, our DL-ODC mix improved, with direct labor almost 41% of our direct costs compared with 38% in FY '12. In the quarter, we took a number of actions to reduce our cost structure to adjust to the current environment. Our indirect costs and selling expenses in the quarter include $7 million in onetime personnel severance and facilities-related expense. For the year, those onetime expenses totaled $10 million. We anticipate that our indirect costs and selling expense in FY '14 will be 3% to 5% lower than FY '13. Slide 10, please. For the full year, GAAP diluted earnings per share increased 6.6% from last year. Diluted adjusted earnings per share adjusts out noncash expenses associated with our convertible debt, stock-based compensation, depreciation and amortization and financing costs and were up 13.7% to $8.33. These increases in earnings per share for the year reflected lower share count as a result of the share repurchase program we completed in July of 2012. Slide 11, please. We generated solid fourth quarter operating cash flow of $107 million and $249 million for the year. On a trailing 12-month basis, free cash flow was $234 million or $9.79 per diluted share. This translates to a free cash flow yield of 14.2% at a share price of $69. Our net debt at the end of the quarter was $532 million. And our net debt to trailing 12-month adjusted EBITDA leverage ratio was at 1.6x. Since our convertible debt matures in May 2014, we now classify it as a current liability. And earlier this month, we amended our credit facility to extend the term from November 2016 to August 2018 and to increase the accordion feature from $150 million to at least $250 million. Slide 12. We are reiterating our FY '14 guidance, which we provided at the end of June. As we pointed out in the call, we expect first quarter operating and net income to decline by double digit. This is due primarily to the impact of a sizable fixed-price contract. For this contract, we recognize revenue on a straight line basis in costs as they are incurred. We are expecting significant expenses in the first quarter of '14, driven by a surge in customer requirements impacting the profitability. This contact generated a profit of about $2 million in the first quarter last year, and we expect a reported loss for the first quarter of '14 of about $4 million. That said, the contract generates solid profit over its life and is expected to generate a normal level of profitability for all of the FY '14. With that, let me turn the call over to John. John?

Thanks, Tom. Let's go to Slide 13, please. This morning, I will provide an overview of operations for our fourth quarter and fiscal year '13 and provide you with information that supports reiterating our fiscal year '14 guidance. To start, we closed our fourth quarter and fiscal year '13 in line with our latest guidance expectations. Key to achieving guidance was our revenue performance and our high-growth market areas. For our full fiscal year '13, our high-growth market areas grew more than 10 percentage points higher than our high-volume markets. In addition, we saw solid direct labor growth for both Q4 and the full fiscal year. Key indicators of future growth are contract awards, funding orders and backlog. In Q4, our contract awards were in line with our expectations at $561 million, with about 50% of those awards in our high-growth market areas. We also received $722 million of funding orders in Q4 and bringing our funded backlog to $1.7 billion or approximately 5.5 months. Our unfunded backlog is $5.2 billion or an additional 17 months of backlog. Let me reiterate that point. We currently have on contract a total backlog of an estimated 22 months at our current revenue run rate. Our focus on operational excellence drove cost reductions throughout the fiscal year. As mentioned during previous calls, this has allowed us to invest in creating cost-efficient solutions that drives cost savings for our customers and margin preservation for CACI. In addition, we exited FY '13 with 0 program cancellations in an extremely uncertain budget environment, a testament to the value we provide our customers. We believe that this combination of factors and our Q4 and fiscal year '13 performance positions us nicely to execute our FY '14 plan. Please go to Slide 14. On our June guidance call, we characterized our FY '14 revenue plan at 65% existing business revenue, 25% of our revenue scheduled to be recompeted and 10% from business that is new to CACI. I am pleased to report that today, we have already improved that position, with 72% existing revenue, 19% recompete revenue and 9% new business revenue, a reflection of the awards we've received in Q4 FY '13 and thus far in FY '14. We also improved our funding position. 50% of existing business revenue is funded, an increase from 45% at the time of our June FY '14 guidance call. This funding position is comparable to this time in previous years and at a level as we move into the government's fourth quarter, seasonally, our largest funding quarter. We also have over 460 open staffing requisitions, which support our strategy to focus on direct labor content. Our pending contract awards now total approximately $10 billion, with about 30% of those in our high-growth market areas. In addition, we plan to submit another $9 billion of bids over the next 6 months, again, with about 30% of those in high-growth markets. I'm also encouraged by several significant wins already this quarter. We were awarded 1 of 4 prime positions to continue providing automated litigation support services to the U.S. Department of Justice and other federal agencies on the $1.1 billion Mega 4 contract. This continues our long history of providing high-value services to our DOJ clients and is a key driver in the reduction of our recompete revenue measure for FY '14. We also announced over $480 million of awards with Intelligence Community customers. This work is tied directly to high-priority work to include intelligence analysis, analysis for products and systems, as well support the high-value missions. These wins allow us to continue expanding our business in our high-volume intelligence market area. In our C4ISR market area, we have discussed the reduction of our Afghanistan-related ODCs, which have been funded through overseas contingency operations or OCO funding. Reflective of our C4ISR strategy to decrease our pass-through ODC work in favor of more profitable direct labor and moving to non-OCO-funded work, we won 2 large single award contracts with a combined value of approximately $240 million. The mix of these 2 awards results in materially higher direct labor content and is funded from the army's core budget versus OCO funding. And finally, in our Healthcare market area, we secured nearly $100 million of recompete awards, supporting revenue in FY '14 and beyond in the areas of Healthcare logistics and Virtual Lifetime Electronic Health Records. These awards, as well as additional multiple award IDIQ vehicles, provide a firm foundation as we begin our FY '14. Given these leading indicators, in addition to the fact that we appropriately modeled sequester and continuing resolution customer behaviors in our FY '14 plan, we possess strong backlog and contract funding position, our opportunity pipeline provide ample growth targets, we are already converting recompete and new business contract awards into revenue for CACI, that gives us the confidence to reiterate our FY '14 guidance. And most importantly, we will continue providing our customers with high-quality, cost-efficient solutions and services, as we have for over 50 years. With that, I'd like to turn the call back over to Ken.

That's great. Thanks, John and Tom. Thank you so much for your remarks this morning. We have a deep understanding of our customers' mission and their highest priorities. We possess the agility to respond quickly in support of those requirements, and we are assisting our customers today in planning their needs from us over the next 2 to 3 years. We believe these attributes will create clear competitive advantages for us in the future. We have adjusted to the new market realities, taken steps to bring in experienced new business development and operating professionals and reduce our cost structure. These efforts, along with our alignment with the nation's most critical missions, position us to continue to be successful in meeting our customers' needs. Let's go to Slide 15, please. To continue delivering an increasing shareholder value, we will be focused on strengthening an already strong business development capability, driving operational excellence, delivering solid cash flow, increasing margins and profitability and exercising our M&A program to acquire new capabilities and customers. I'd like to conclude this morning's remarks by thanking the CACI people for their agility, their total commitment to our customers and the important work they do. They continually perform with integrity and excellence and remain ever vigilant in support of our customers' missions. With that, let's open the call up for questions.

[Operator Instructions] Our first question comes from Edward Caso, Wells Fargo.

Could you frame out for us how much OCO work you have at this time in either dollars or percent of revenue and how you would expect that to tail off?

Sure, Ed. Thanks for the question. This is John. Approximately $150 million, Ed, is assumed in our FY '14 plan. Our FY '13 had about $125 million, and that was the way FY '13 played out. It's important to remember that OCO funding supports numerous initiatives beyond Afghanistan, such as other missions that we support. So it goes a little bit beyond the current effort.

Great. And the other question is around you obviously accelerated the level of severance and real estate adjustments in the fourth quarter. Should -- is there more of that assumed in the current guidance or could there be potential additions as the year goes on?

Yes, Ed, this is Tom. The vast majority of actions that we're planning to take to adjust our cost structure occurred in FY '13 and are reflected in FY '13. There may be a bit of residuals spillover into FY '14, but it's not material or significant.

Our next question comes from Bill Loomis of Stifel. William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division: Just looking at the sequestration and any customer signs of behavior at your customers, are you seeing any sign that they're starting to gear up for more aggressive cuts? Or is -- what you're seeing today kind of the same as what you saw 2 months ago, for example?

Hey, Bill, this is Ken. Thanks for the question. I think John and I'll -- we'll give an operational -- I'll give a top-level view, and John will talk about what he is seeing in the operating arena. But fundamentally, in the last weeks, 6 weeks, we haven't seen a great deal of change. The one thing I would draw your attention to is, since our last call, we did see the implementation of furloughs. And at the beginning, we thought there could be some off-tempo issues, some slowdown in award and the like because we were forecasting that to go through out to fourth quarter. But our recent data tells us that that's now limited and almost largely over, and they've completed that, so we expect the government on the acquisition side, the operations side, as well as the payment side, to be back to full strength. So those are the -- that's probably the biggest change. And John, how about -- if you want to add anything, have you seen anything different?

Sure. So Bill, if I look at the behavior by our customer set, be it DoD, fed civil or our intelligence customer, not a lot has changed across all of our customer sets. We're seeing awards come in but not on the previously announced award dates. We're still seeing an incremental funding. Again, very, very good for support of our current quarter revenue [ph] but not very good for looking at year-over-year comparators. We continue to see customers bridge contracts. There's just been a little change in the dialogue around LPTA in its application as an acquisition option. We have some that are starting to relook where LPTA gets used. The reality is that its use has crept into some non-commodity type buys, and that's putting increased pressure on execution. So I believe that during '14, we'll see some changes in behavior there, and then continue dialogue around how important execution is, and we continue to deliver as we promised in our bids and continue to drive operational excellence. William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division: And just one last one on recompetes. Now Mega 4 is behind you, what are the biggest ones over this fiscal '14?

Bill, there isn't any one single recompete item there. We have about 19% of our revenue remaining now, and that doesn't assume that there's any future bridging. I think we'll see some additional bridging behavior as we go for FY '13, but now that Mega 4 is closed out and they very successful one [ph], I don't see anything large.

Our next question comes from Tobey Sommer of SunTrust.

This is Frank in for Tobey. Wanted to ask about the Healthcare business. You've been doing a lot of hiring and on that [ph] position there. Just wanted to get a run rate in terms of size and what you see in terms of the M&A environment out there.

All right. Yes. Let me comment a little bit on all of our market areas. As we've broken our business into 10 market areas in which we compete, for us to provide discrete revenue numbers growth rate and the like gets very close to competitive information. But what I can tell you is about 30% of our FY '14 revenue is expected to be from our high-growth markets, 70% of that from our high-volume, that our high-growth markets continue to grow about 10 percentage points greater. But specifically in the healthcare area, we have -- we've just come off of winning a little over $100 million of additional healthcare market awards. And as we mentioned in the past, we believe that our Healthcare business is on a path to grow materially greater than the federal government budget growth rate.

Yes, in terms of the M&A pipeline for Healthcare, it's somewhat consistent with the rest of the M&A pipeline, which is a bit slow, I would say, cutting it across the board amongst 2 recent acquisitions, as you know, IDL and Emergint are in the healthcare arena, one focused at CDC activities and the other one's in CMS activities. The acquisition strategy is primarily focused on the high-growth areas, and Healthcare being one of those, so we're looking for new opportunities in that particular sector.

Okay. A quick numbers question, what was organic growth? And then could you comment a little bit on the pricing environment?

Let me find the number for organic growth. And John, if you can talk about the pricing environment?

Certainly. We -- as we've mentioned previously, there hasn't been a large shift in the pricing environment. It's still -- we still compete in a very competitive world. What we did at the end of FY '13, looking forward to FY '14, was to get our indirect cost models in check with where this current marketplace plays out. So pricing pressure continues, but we believe that with the investments we made in developing lower-cost solutions, that we're able to maintain our operating margin between FY '13 and FY '14. Tom?

Yes. In terms of organic growth for the quarter, it was down 7%. That was driven almost exclusively by a decline in other direct costs. Organic direct labor was essentially flat, so we saw a continued decline in ODCs, less profitable business, lower margin business driving that decline in organic revenue.

Our next question comes from Lucy Guo of Cowen and Company.

Lucy Guo calling in for Cai Von Rumohr. Just wanted to ask about the larger awards that you won, the classified awards that you won in Q4 and so far in Q1. They were $425 million, $480 million, respectively. Can you please add some color into some -- maybe talk about is that part of an industry-wide flush and do they -- do these involve any major new takeaway wins?

Okay, Lucy, thanks for the call. This is John. What I can tell you about both sets of those wins, a little over $800 million total, very key wins, about half recompete, about half new. They're all firm awards, so none of those dollar values involve any IDIQ work. Some of that work in our intelligence sector relates to our Cyber business, and so we were very, very pleased to see those awards come in. From an overall mix, it does set the right stage for us. Our intelligence market has been a high-volume market for us in -- over the past years, and we are very, very pleased that we're off in running FY '14.

And just as a follow-up, were these numbers larger than you expected? Is there any particular reason why they were kind of much larger than the previous announcements you've had in classified bookings?

Sure. What we traditionally do is, at the end of the fiscal year, we'll look back and put an announcement out that sort of collects all of the previously unannounced intelligence awards. So the $425 million was a collection of previously unannounced awards in FY '13. If I look at our Q4 FY '13, that played out pretty much in line -- during our June guidance call, we had a good discussion around our expectation that Q4 awards will be right in line with what we saw sequentially with Q3. If we look at the initial set of awards coming in FY '14, part of that was a recompete award, and that was expected. That one came in just about as planned, but there was some other timing changes in that. So all in all, it played out pretty much as we expected.

Our next question comes from Ross Cowley of Crédit Suisse. Robert Spingarn - Crédit Suisse AG, Research Division: It's Rob here with Ross. Just a couple things. Wanted to ask -- Tom, maybe I could go to you with some book-to-bill stuff, but I think on the breakdown, maybe John just gave this when you talked about your high-growth business as a percentage of total revenue. When I do the math with the bookings, it sounds like in the high-growth areas in the quarter, you did a book-to-bill of about 1.3, and then that would leave something maybe just short of a 0.6 for the non-high-growth. Is that fair and is that the kind of trend you'd expect as we progress through this year?

Yes, Rob, this is Tom. I'm reluctant to kind of do that, kind of math on the fly, and we provided a couple kind of data point, and I'm not sure if I can confirm kind of the conclusion that the book-to-bill in those changes. Robert Spingarn - Crédit Suisse AG, Research Division: Well, I'm basing it on half the orders in the quarter going to the high-growth and half going to the non-high-growth.

Yes. I guess, Rob, when I think of book-to-bill, moving forward, it's going to be really difficult for us to estimate given the continuing variability in funding orders and the contract award timing. Both have materially changed, but what I can say is that we expect Q1 to be a larger funding order quarter for us, as it has always been. And as such, given our Q4 awards and our initial Q1 awards, we would expect that our highest book-to-bill ratio would come in the first quarter. So very much driven by funding orders, and given that our customers are funding in smaller increments to us, I don't know if we'll be hitting the traditional high book-to-bill numbers. Robert Spingarn - Crédit Suisse AG, Research Division: Okay. But maybe, Tom if I could then ask you a different way, and then, Ken, I have one for you. Could you isolate the organic growth in the higher-growth businesses? I think you said it was minus 7, but as we think about the 2 sides of the business that way and then Canada, high level, I wanted to just ask for your comments on Secretary Hagel's initial review, SCMR review a couple weeks ago, where he outlined 2 possible paths for implementing sequester-type cuts. One would favor cuts for structure and to preserve modernization, and the other path does essentially the opposite. And I wanted just to think just kind of long term which direction is better for CACI.

Okay, so Tobey, this is -- or excuse me, Rob, this is Tom. I'll start out here. So our high-growth markets are growing faster than our high-volume markets. That has been the case. The award in the fourth quarter reinforced it. A disproportion of awards were in the high-growth markets versus the high-volume markets. And so your conclusion that the higher book-to-bill is a fair conclusion, kind of by definition, so that certainly is the case. In terms of organic revenue, it's about -- the same logic holds. Our DL, organically, was essentially flat. The major reduction in our organic revenue was driven by lower ODCs. And a good portion of those ODCs are associated with C4ISR-related pass-through materials, and so that further reinforces the high-growth markets growing disproportionately higher, as they're expected to do so.

Hi, Rob, this is Ken. Thanks for the question. What Secretary Hagel had to say sort of sets up an interesting dichotomy for his discussions going forward with Congress. You can protect for size at the expense of potential future capabilities or vice versa. And it will be an interesting dialogue to see how that actually plays out. I think with regard -- and it's also a reflection of what choices does he have with regard to the shorter-cycle businesses, which are funded by O&M, versus the procurement in R&D dollars that are in future capabilities. If I was to guess or just speculate, I believe you're going to see some negotiation in this, and it doesn't end up as being much of as an either/or as it will be a continuum. With regard to our exposure to one or the other, we are much less exposed to the -- or we're more exposed to the O&M dollars. However, inside of the mission work that we do today, we've seen, and it's sort of reflected in our performance today, lower pressure on run rates and that sort of thing because we are doing mission-critical work as opposed to volume-oriented training or that sort of exercise. In the R&D and in the procurement world, that doesn't -- that's not a scary proposition for us looking in that part of the market.

Our next question comes from Brian Kinstlinger of Sidoti & Company. Brian Kinstlinger - Sidoti & Company, LLC: The first question I have, I guess I'm curious when I look at the drop in funding orders, I see 3 things impacting that. I'm wondering if you can sort of characterize which magnitude is hurting them the most. You got, obviously, the ODC drop, you got shorter periods that are being funded by the government, then you just have the general current environment, whether it's less pricing or less contract awards out there. So I'm guess I'm wondering, maybe you can characterize what's hurting the funding orders the most.

Brian, thanks for the question. This is John. I guess when I look at where the -- where our government customer and what -- how their buying habits are actually playing out, clearly with our ODC revenue that we've had in previous years, that was mostly funded right up front. So as ODC comes out of the plan, a large tranche of funding comes out also. If I look at how the government is funding, it's the new normal, where this customer is going to be funding in smaller but yet more frequent increments. I'm not sure which one of those 2 play out to have a greater impact. Clearly, as we move towards more direct labor, we'll see the traditional spikes of funding come down somewhat in our year-over-year comparables. And as our customers fund us for smaller amounts on a more incremental basis, we're going to see those numbers come down also. What we're pleased with is when we put our FY '14 plan together, we took a look at these new normals for our customer set, both on timing of awards and on timing to funding, and believe that what we've seen so far in the fourth quarter and where we're trending to in the first quarter, that those funding levels are sufficient on a quarter-by-quarter basis, sufficient for us to meet our FY '14 plan. Brian Kinstlinger - Sidoti & Company, LLC: Great. And my follow-up, clearly, September is your -- the industry and your strongest funding order and contract awards generally, I guess I'm wondering, when I look year-over-year and that quarter seems drive so much, do you expect funding orders and contract awards to be down in line with what we've seen in the last 4 quarters? Do you think all the money will be spent that's budgeted for or do you think it could get a little bit worse as funds are held back?

Yes, thanks, Brian. This is John. I guess, let me take contract awards first. In previous years, and I think it will be the same for FY '14, a lot of our option year awards come in, and our option year funding comes in during the first quarter. I don't think that behavior will change. I think we'll see that kind of behavior stay consistent. I think on funding orders overall, as I earlier mentioned, we're going to see a different funding model. Whereas we use to get 6 to 12 months of funding in the government, fourth quarter getting ready for the upcoming government year, I truly believe that, that's going to come in, in a much more muted fashion. That doesn't create more risk. What it does is we had to model our FY '14 plan, and we've moved our focus on funding from a look of backlog in year-over-year measures down to the program manager level and down to our customer PM level, making absolutely sure that we're working funding on a much more a padded [ph] basis. So I think the year-over-years will look different, but I do believe that based on the last 3 quarters of history that we have with this -- with our customer set, that we're in a fine position for us to achieve the right number of funding to meet our FY '14 plan.

Our next question comes from Jason Kupferberg of Jefferies.

This is Amit Singh for Jason. Just wanted to quickly check, are you still expecting your fiscal '14 operating margins to be sort of in line with fiscal '13? I'm just trying to understand like the cost cutting efforts and the direct labor continuing to grow. What would prevent sort of the margins to grow from fiscal '13 level?

Yes, Amit, this is Tom. I'll answer that question. Yes, we do expect our operating margin to be essentially flat with FY '13. Going up the income statement to kind of gross profit, gross margin is a bit more interesting discussion. As you point out, we expect to have a slightly richer mix, direct labor versus ODC. And everything else being equal, one would think that would drive higher gross margin percentage. The situation is such that we expect a slight deterioration in gross margin in FY '14. That will be offset by SG&A savings such that what we maintain flat operating margin. So the interesting question is, what's driving a lower gross margin percentage? And the answer is that there's a variety of pricing pressures, kind of low price technically acceptable, shift in contract mix, which is kind of resulting in those phenomena. That being said, what are we doing to reverse that trend? And there's a few very concrete things that we're doing. We're focusing on ensuring that our work fees are 100% all the time, that we have very little non-billable direct labor, that we're moving to more fixed-price awards, which we think we operate very effectively at and generate higher margin, focus on greater direct labor content and also focus on more solution versus service business, which should be higher margin. So those are a variety of the initiatives that are in place, that are part of the business development initiatives that we spoke about.

Okay. And just quickly, coming to your fiscal '14 revenue visibility, how much of that revenue do you think right now is absolutely firm? What I'm trying to understand again is, how clear are your clients at this point about how much they have to cut under sequestration? And then if the cuts go through, could you actually see some reduction in scope and spending in your ongoing contracts?

Amit, thanks. This is John, and I'll take that question. So when we began FY '14, we started off at 65% of our revenue firm, 25% recompete and 10% new. Through the first 6 weeks, we're roughly at a 72%, 19% and 9% mix. At a macro level, that's about 7% of our FY '14 revenue that's moved from recompete and new to firm, which in dollar terms is about $0.25 billion moving into firm. Now as I look at those 3 areas, clearly, once it moves to firm, those are always -- all of our revenue is always susceptible to the possibility of cancellation, run rate reductions. But we believe we have the run rate reductions built into our FY '14 plan. And barring any drastic shift in customer priorities, that work to us is firm. I think in our recompete areas, we have a top of class win rate there. We're delivering on our current program commitments. Mega 4 win helps us tremendously there. And our new business side, given the enhanced BD moves that Ken has made, we are very, very confident in that work overall. So clearly, we're always at risk in -- when we're doing federal government contracting, but we're very pleased that 72% of our FY '14 revenue is now firm.

Our next question comes from Mark Jordan of Noble Financial.

A question for Tom first. Wanted to confirm, I believe on the last conference call, when you're talking about your '14 -- fiscal '14 guidance, you addressed that you're assuming a $65 average share price for the diluted share assumption and that the sensitivity was for every $5 increase in share price, there's 0.5 million shares added to the diluted share base. Is that correct? Just confirm that.

Yes, yes. You broke up a little bit, so yes. For a $5 increase in share price, that would add approximately 500,000 shares. So generally, that is correct, with one caveat. Once we get above $68.31, we have further dilution. When we put our convertible debt security in, we've overlaid the convertible with a bond hedged in a warrant. And although there's accounting dilution between $55 and $68, there's no economic dilution. We have an offsetting call option. Above $68, we have a warrant that adds some additional GAAP dilution. So that's the one caveat to that conclusion.

Okay. Second question, relative to M&A, do you have any specific capital deployment goals for fiscal '14 with the $200-some odd million of free cash flow you should generate?

Mark, this is Ken. Thanks for the question. I don't know that we have any specific capital deployment goals. I mean, we keep -- we do believe that M&A is our priority for deployment of cash. And as Tom discussed just slightly earlier, we're seeing a bit of a pickup. We haven't seen anything that -- we're seeing a few transactions come across. We haven't seen anything that's interesting yet, but we'll keep looking and -- but no specific goals.

Our next question comes from Steven Cahall of RBC.

Maybe just to follow up on the acquisition question. I think you said back in June when you did the guidance that you had seen the M&A environment picking up a little bit recently. Maybe could you just cover the trend that you've seen in that market between then and now and is it still picking up, is it stagnant, is it worse, et cetera?

This is Ken. Thanks for the question. Indeed, we have seen a few more transactions coming through. The -- again, it's sort of a part of our normal process for looking at all these. We've also been kind of hearing these discussions about properties what -- properties that are inside of private equity firms and maybe even inside of some of the bigger prime contracts. They may be prime contractors just thinking about doing something there. We haven't seen any of that in any shape, but the -- we haven't seen anything be realized in that, but we have seen -- heard the stories. And so we're kind of looking to see how that plays out.

Great. And then maybe just as a quick follow-up, if we could maybe just go back to the discussion on margin and to that gross margin deterioration, if we're thinking about pricing pressures and the shift in mix, one thing we have heard is that the DoD is actively sequestering the OCO budget. How much have you factored that into FY '14? And if they decided to sequester OCO and protect the base, is that positive to your mix, generally speaking? Does that provide you with some margin tailwind or is it neutral?

Yes, this is Tom. Yes, OCO was sequestered. And if a disproportionate amount [ph] of our OCO is ODC-related, then yes, it would help our margin. It would not help our profitability, kind of bottom line, but it would help our kind of margin characteristics, yes.

[Operator Instructions] Our next question comes from George Price of BB&T Capital Markets. George A. Price - BB&T Capital Markets, Research Division: Just a clarification on something and a couple of questions. The -- just following up on the book-to-bill comments. September quarter book-to-bill is usually well above 1, at least 1.4x. You're noting the $480 million in awards and also the comments about the new funding and award paradigm and not -- maybe not hitting the book-to-bill consistent with historical levels. I guess, do you have any thoughts more specifically about where you see the September quarter coming up in terms of both contract award and funding award book-to-bill?

Thanks, George. This is John. So when I think of book-to-bill, I immediately go to funding orders. So if I look at year-over-year comparators, I believe that our first quarter funding orders will be less than what they were on a year-over-year comparator back to FY '13. However, that's well within our plan. Now having said that the funding is going to be lower, I would expect that toward FY '14, that our first quarter will still be our higher book-to-bill ratio as we look across the entire year. Clearly, not to the same level because the funding orders we expect in the first quarter will be less than what we've seen in previous years, when our customers would front end fund. George A. Price - BB&T Capital Markets, Research Division: Okay. All right. That's helpful. And then just a few things. First, what expectations, if you're willing to discuss, what expectations do you have for direct labor versus ODC in fiscal '14? And then back to fiscal '13, you mentioned the high-growth markets growing 10 points higher than your high-volume markets. I wonder if you could maybe give us how those statements actually grew on an absolute basis.

Yes, this is Tom. I'll do the first part. For fiscal year '14, we expect our direct labor to be in a range of down 2% to up 3%. And then we expect the other direct costs to decline 1% to 6% for the year. And so combining those 2 factors, we expect to get a slightly richer DL-ODC mix in FY '14.

And George, based on your high-growth versus high-volume, I'm reluctant to get into the markets within those 2 areas. However, in FY '14, we expect that our high-growth will continue to outpace our high-volume by that 8 to 10 percentage points as we play FY '14 out. Some of that is going to be based on timing, but overall in FY '14 plan, we are -- we consistently look for more coming from our high-growth versus our high-volume.

And with no further questions at this time, I would like to turn the conference back over to Mr. Ken Asbury for any closing remarks.

Thanks, Allie, and thanks for your help on the call today. We would like to thank everybody who dialed in or logged on to the webcast for their participation as well. We know that many of you will have follow-up questions. And Tom Mutryn, Dave Dragics and Jeff Christensen are available for calls later this morning and then through the day. So this concludes our call. Thank you, and have a good day.

Ladies and gentlemen, this does conclude today's conference. You may all disconnect, and have a wonderful day. Speakers, please stand by.