Booz Allen Hamilton Holding Corp
NYSE:BAH
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Booz Allen Hamilton Holding Corp
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Good morning. Thank you for standing by and welcome to Booz Allen Hamilton's Earnings Call covering Second Quarter Results for Fiscal 2019. At this time, all lines are in a listen-only mode, later, there will be an opportunity for questions.
I'd now like to turn the call over to Nick Veasey.
Thank you. Good morning and thank you for joining us for Booz Allen's second quarter fiscal 2019 earnings announcement. We hope you've had an opportunity to read the press release that we issued earlier this morning. We have also provided presentation slides on our Web site and are now on Slide 1.
I'm Nick Veasey, Director of Investor Relations, and with me to talk about our business and financial results are Horacio Rozanski, our President and Chief Executive Officer; and Lloyd Howell, Executive Vice President and Chief Financial Officer.
As shown on the disclaimer on Slide 3, please keep in mind that some of the items we'll 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 second quarter of fiscal 2019 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 other reconciliations of our non-GAAP measures to the most comparable GAAP measures in our second quarter fiscal 2019 slides.
It is now my pleasure to turn the call over to our CEO, Horacio Rozanski. We are now on Slide 4.
Thank you, Nick. Good morning, everyone. Thank you for joining us. I'm very excited to share with you outstanding results for the second quarter, results that position us extremely well for the remainder of fiscal year 2019 and to achieve the three year financial goals outlined in our investment thesis.
As always Lloyd and I will tag team on this call. I will take you through our investment thesis and how the current results bolster our confidence about it. And Lloyd will take you through the numbers in depth and their implications on our revised fiscal year guidance. So let's begin.
At our June Investor Day, we described our thesis as having three connected parts; first, as a result of years of market shaping and investment, Booz Allen is uniquely positioned to capture upside in this market, said another way, we have entered the pay-off period for vision 2020.
Second, on the basis of strong consistent revenue growth, modest margin expansion and deliberate capital deployment, we have set a goal of growing ADEPS by 50% over three years. And third, we believe we are creating option value over and above those three year goals by building new lines of business and new business models that would continue to transform our firm and position us for future demand.
Measured against our thesis, we believe Booz Allen's performance in the first half of fiscal year 2019 is an unqualified success. It demonstrates to the investment community that we are progressing on all fronts and well on track towards meeting all our goals.
Starting with the market, we are very pleased with the demand we are seeing and success we are having across our entire client base. The regular budget order that our government achieved in this fiscal year gives our federal clients the clarity and resources they need to transform the organizations and make investments over the future.
Such efforts come in many forms but they share in common the adoption of current and new technologies to better achieve critical missions and because Booz Allen has invested in innovation, talent and capabilities, we are uniquely positioned to help across a wide range of priorities.
This priorities range from civilian agencies embracing digital technologies to improve citizen services, to defense and intelligence agencies confronting ever changing cyber and non-kinetic threats to myriad of tests, pilots and early implementations of AI, block chain and other transformative solutions. While we started on these issues early, we are not necessarily alone in competing for this work, but I believe that in addition to a first mover advantage, we bring to these opportunities something unmatched by our competitors, the ability to drive real mission success through the cumulative value of our deep mission understanding, our consulting heritage, our technical depth, our ability to innovate.
From an investment lens, the visible result of our market differentiation is a financial first half of the fiscal year that is frankly ahead of our own expectations. With the exception of some softness in our billable expenses, which have never been an area of focus for us, all of our performance indicators are at or ahead of plan. Record backlog and book-to-bill, strong revenue [ex-billable] [ph], hiring, profitability and cash.
Most relevant to our investment thesis, today we are reporting very strong ADEPS performance for the first half at $1.40 that's more than 40% higher than the same period last year. We are also pleased to announce that given the strength of our year-to-date performance, we are significantly increasing our ADEPS guidance for the full year. We now expect fiscal year 2019 ADEPS to be between $2.55 and $2.65.
In a moment, I'll turn the conversation to Lloyd, so he can share with you the quarterly numbers in more depth and explain the implications to our guidance. But before we do that, the final building block of our investment thesis is what we call option value, new business opportunities that hold significant promise for the future, but that we can not yet quantify financially.
In the second quarter, we reached an important milestone with one of those initiatives. We officially launched our Digital Defense Technology. Digital Defense enables clients to securely manage highly sensitive or even classified information on mobile devices. Our patented technology is embedded exclusively in tablets made by Dell and we are taking it to market with them, leveraging the power of our combined sales channels. After a successful pilot with a key client, this solution is now broadly available.
Client feedback pre-launch was very positive, but the true test of the value of this technology will be measured in sales volume. Against that yardstick, it's still too early to tell. But we should have a good read over the next six to 12 months. We don't expect significant lift to revenue in profitability from this technology in the near term. But we do see great promise in it and believe it could become a significant contributor to our earnings two to three years out.
Our clients' want secure mobility and in the past they've often had to choose security over mobility. We believe digital defense gives them both and are bullish about its potential particularly if you can imagine extending this capability to more devices including mobile phones. That's what makes option value initiatives exciting for our firm, our people and the prospective talent we need to continue to attract. Fundamentally, innovations like digital defend keep us true to our consulting heritage, while solidifying our brand as a forward thinking provider of technology solutions.
This is what we do. Booz Allen anticipates mission critical needs and works to meet them with ingenuity and imagination. With that Lloyd over to you.
Thanks, Horacio. Good morning everyone.
I couldn't be more pleased with the performance we are reporting today. Booz Allen is generating strong growth at the top-line and continues to translate this growth into profit. We feel really good about the position we're in at the midpoint of our fiscal year.
Quite frankly, we were ahead of the pace we set for ourselves. And just as important all the leading indicators, strong headcount growth and a record backlog, funded backlog and book to bill support our belief that Booz Allen's strategy and market position will continue to deliver strong returns to investors.
As Horacio highlighted, the core of our investment thesis is 50% ADEPS growth from fiscal year 2018 to fiscal year 2021. When we outlined this thesis in June, we said our expected path to get there would be 6% to 9% annual revenue growth. Cumulative margin expansion of 10 to 30 basis points over three years and deployment of $1.4 billion in capital through share repurchases, dividends and M&A.
Our second quarter performance demonstrates that we are well-positioned to meet or exceed these goals. We continue to uphold our commitment to deliver shareholder value both near and long-term through consistent above market revenue growth, effective management of our business and strong cash generation and capital deployment.
I am very pleased to be in a position today to adjust our full year guidance. But first, I want to talk about our second quarter performance. Let's go through the details. Please turn to Slide 5.
Starting at the top-line, second quarter revenue and revenue excluding billable expenses grew by 4.6% and 7.2% respectively compared to the prior year. We are pleased with our revenue ex-billable growth for the quarter which is where the majority of our profit is generated and unconcerned about the overall quarterly revenue growth number, which was driven by a decline in billable expenses from prior year.
Billable expenses comprised 29.6% of revenue for the quarter. At the lower end of our expected range for the year and a meaningful decline from the year prior, we expect to continue to see clearly swings in billable expenses given their nature, which will drive some quarter-to-quarter volatility in year-over-year revenue growth and adjusted EBITDA margins. However, as we have stated previously, our focus remains on revenue excluding billable expenses and the leading indicators there remain strong with both the backlog generation and headcount growth needed to meet our full year objectives.
Book to bill is at its highest level since our IPO at 3.66x and total backlog as of September 30, was $21.4 billion also a record since the IPO. We also hit a second quarter record for year-over-year backlog growth at 28%. Funded backlog of $4.2 billion represents a 17% increase over the prior year. Unfunded backlog at $4.8 billion is up 24% percent and priced options increased 34% to $12.4 billion.
This exceptional performance on bookings, reflects an up tick in buying through the end of the government's fiscal year as well as increasing demand from clients for the mission focused technology solutions that Booz Allen has been and continues to be uniquely positioned to provide.
Headcount as of the end of the second quarter was up by 1119 year-over-year and by 786 since the end of June. Our hiring in the second quarter was strong and all indications are this trend should continue in the back half of the year. As such, we remain confident that we will have the people we need to support our full year outlook. The strength in hiring this quarter and continued demand for talent from across our business indicates that we will meet or exceed the 5% growth in headcount that we targeted at the beginning of the fiscal year.
Moving to the bottom-line. Adjusted EBITDA for the second quarter was $164 million representing a 10% increase compared to the same quarter last year. Adjusted EBITDA margin for the quarter was 10.2%, the high margin was driven by many of the same factors as in the first quarter continued strong contract level performance, a lower than anticipated billable expense ratio, solid cost management and the timing of certain cost recoveries.
Second quarter net income at $93 million was up 26% and adjusted net income grew 32% to $97 million for the quarter. These increases were primarily due to our revenue growth, improved margins and lower tax rate. Those factors as well as a lower diluted share count drove an $0.18 increase in second quarter adjusted diluted earnings per share to $0.68 up 36% compared with the same quarter last fiscal year.
Our weighted average diluted shares outstanding is 5.2 million shares below the year ago level.
Turning to the balance sheet, the delayed draw portion of the term loan A refinancing announced in the first quarter is still undrawn as the firm is prudently managing its cash and taking advantage of optionality. Second quarter cash from operating activities was $302 million, which was 74% higher than the same quarter last year.
After a disappointing first quarter on cash from operations, we implemented a new cash management strategy and the results for this quarter reflected success. I am pleased with our progress in the second quarter and cash management will remain an area of focus. Today, we are revising our expectations for operating cash to be between $460 million and $500 million for the full year. This 30% increase at the midpoint reflects two positive factors.
First our confidence in the execution of our cash strategy and second additional cash tax benefit of $60 million, we will realize in the second half of our fiscal year. This relates to a tax accounting method change we initiated when adopting the 2017 tax reform law, which the Internal Revenue Service approved last week.
Capital expenditures for the quarter were $19 million. We continue to expect CapEx spending of up to $100 million for the full year as we've mentioned previously, this year-over-year increase in CapEx is growth oriented and supports the evolution of our business.
Please turn to Slide 6. As we said at Investor Day, we follow a discipline, efficient capital allocation strategy that aims to deliver both near and long-term shareholder value. We intend to deploy $1.4 billion over three years with share repurchases being a major part of our deployment strategy.
For fiscal year 2019, our goal is to deploy $350 million and with $144 million returned to shareholders through dividends and share repurchases in the first half, we are progressing towards this objective. Given the fundamental strength of our business, our strong first half and our continued confidence going forward, the company announced today that it has authorized a regular dividend of $0.19 per share payable on November 30 to stockholders of record on November 14.
Finally, I will run through our guidance for the full fiscal year which is on Slide 7. Our first half numbers were strong and combined with our backlog and headcount growth give us confidence both to reaffirm our full year revenue guidance and to increase and narrow our ADPES range guidance. Taking these together, we also anticipate full year adjusted EBITDA margins to be higher than the mid 9s, we indicated previously.
Let me take you through our logic. At the top-line, we continue to expect gross revenue growth in the 6% to 8% range for the full year. First half revenue growth combined with our backlog generation and headcount growth puts us on pace to achieve this outlook. Although the timing of billable expenses can be difficult to predict, we currently forecast them to grow roughly in line with revenue ex-billable in the second half of the year contributing to our overall top-line performance.
Again, our focus remains on driving performance and revenue excluding billable expenses where most of our profitability is generated. We are extremely pleased with our adjusted EBITDA margin performance in the first half which quite frankly was stronger than we had anticipated. We currently forecast the margins to be somewhat lower in the second half due to a pickup in billable expenses spending that is typically heavier in the back half of our fiscal year and continued investment in the talent and capabilities needed to fully capture the growth opportunities before us.
Taking those factors into account, we now believe adjusted EBITDA margin for the full year will be approximately 10%. Horacio highlighted the good news at the bottom-line. We are increasing and narrowing our ADEPS range for the full year to be between $2.55 and $2.65 per share, which is based on 141 million to 144 million weighted average shares outstanding and a tax rate in the range of 24% to 26%.
Our ADEPS and tax rate ranges exclude any ongoing remeasurements of our deferred taxes related to the 2017 tax law including the recently approved tax accounting method change that I mentioned earlier.
In conclusion, we are very pleased with our second quarter and year-to-date performance. We are optimistic about the future and look forward to delivering on the financial goals detailed in our investment thesis. Booz Allen is on a strong path and the management team is excited about the opportunities that lie ahead and the value they can create for our people our clients and our shareholders.
Horacio back to you.
Thank you, Lloyd.
Before moving to Q&A, I want to call attention to the recently announced changes to our Board. Earlier this month, we announced that Phil Odeen, who has served I our Board of Directors since 2008 will retire from the Board at the end of this fiscal year. Phil has chaired our compensation committee and has been an invaluable strategic advisor to our firm and to me personally through a decade of significant transformation and growth.
In addition, we announced Michèle Flournoy and Ellen Jewett as our newest Board members effective this last week. As you may know, Ms Flournoy is a former Undersecretary of Defense for Policy. She is also Managing Director and Co-Founder of WestExec Advisors, a strategic advisory firm. And she previously Co-Founded and served as CEO of the Center for a New American Security, a bipartisan think tank.
Ms. Jewett is Managing Partner at Canoe Point Capital and previously held positions at BMO Capital Markets and Goldman Sachs. In recent months, I've had the opportunity to get to know them both. I am thrilled to have Michèle and Ellen on the Board. I have no doubt that we will benefit greatly from their expertise and perspective in defense, national security, infrastructure, capital markets and more.
As an immigrant to this country, I am also very proud that with their addition eight of our 13 Board members are women are minorities. Our record on Board diversity puts us well ahead of corporate America at large. In the Fortune 500, about 22% of Board seats are held by women and about 15% are held by minorities. At Booz Allen those numbers are 38% and 31% respectively. I would also note that 6 of the 11 members of our leadership team are women.
Throughout my career at this firm, I have seen a commitment to diversity. In fact, it is rooted in our purpose and in our values. So Booz Allen will continue to strive for diversity across all levels and dimensions because we believe that diverse perspectives enrich the experience of our people, bolster our ability to solve problems and ultimately strengthen our long-term value as an enterprise.
On that note, Nick, let's open the line for questions.
Thank you. Brian, please open the line.
Thank you, sir. [Operator Instructions] Our first question will come from line of Rob Spingarn with Credit Suisse. Your line is now open.
Good morning. Great numbers guys. And I wanted to ask you a little bit about the relationship of backlog and revenue. Since the end of fiscal '16 your total backlog has nearly doubled, the $21 billion number, the funded backlog is up 56% but your sales -- your guidance for '19 and the midpoint up around 23% while you are showing excellent organic growth is there a catch up to at some point or does this speak to the indirect sales or that you described before, in other words is the composition of the backlog different today. And we should be looking at a subset of the backlog?
Rob thanks for the question. As we've always said, the conversion of our backlog is driven by our headcount numbers as well. And just to remind everyone conversion of our funded portion of our backlog is close to 100%, unfunded below 90%, and then, priced option 60% to 70%. But we won't have the headcount in. Given our strong headcount performance year-over-year as well as what we were able to achieve in this quarter that really gives us a lot of confidence of being in the range that we guided at the beginning of the year.
We're off to a great first half. I mean 6.4% of gross revenue, 8.2% gross revenue ex billable expenses, which really -- since we're focused on ADEPS is driven by revenue ex billable. So we're on track for our FY' 19 guidance of 6% to 8% and the lead indicators as well as the conversion rate I just provided give us confidence.
Yes. Let me just add. Our foot is on the gas in terms of organic growth. If you go back several years, we have been accelerating, Lloyd quoted the 8.2% growth revenue ex billables. We feel really good and when you look at our backlog, please remember that these are multi-year contracts so they speak of our ability to grow not just now but in the future.
On that note Horacio, I guess my follow-up question to that would be, is there a way we can quantify or think about the duration of today's backlog or the trend in that duration? And again, does the backlog include a fair amount of the billable expenses and therefore that's why we see a difference between total revenue growth and revenue growth ex billables? In other words, I just want to figure out how to calibrate the two going forward, so we know how to read and interpret your backlog.
I think you're asking the right question. Recognize, we prime over 90% of our work and therefore there's going to be a sort of the billable expenses load on that backlog for sure. But what really drives it like Lloyd said is, we need to continue to do great work for clients. We need to keep finding great people for that work and we just need to keep driving - contract length has extended a little bit as we've said before, contract price has improved a little bit as we said before. Overall, we're actually very satisfied with both the amount of backlog, but also the quality and the type of work that's in there that speaks to our strategy and for our ability to keep growing.
Okay. And then, just to finish, with regard to headcount and a tight labor market. If you could speak to talent acquisition and I also wanted to frame this, if Amazon should come into the region into the Northern Virginia, DC code or does that change the talent acquisition dynamic for you and your peers?
If you start with the headcount, we are up over 1,100 people year-over-year that puts us back up over 25,000 people overall, 786 I think is the precise number just for this quarter in terms of net additions. So we are confident that we can find great people, we can put them to work, and they can do excellent work and we're going to continue to grow. There's -- we've spoken in the past about increased competition for talent given our strategy we have been competing for technology talent now for a while and we're -- I think more than holding our own. I think we're doing really well.
I believe that competition frankly has made us stronger. It has allowed us to focus more on our employee value proposition and on attracting and retaining the right kind of people. And so as competition continues to evolve, we will evolve with the competition, it makes us stronger.
Okay. Thank you very much.
Thank you. And our next question will come from our Sheila Kahyaoglu with Jefferies. Your line is now open.
Hi. Good morning and thank you very much. Starting with you Lloyd, if that's okay and then Horacio, I have one as well. Lloyd, you mentioned just -- surprised a little bit in profitability in the first half being better than you expected and you kind of expect a softening in the second half. What's driving that? Are you just being a bit conservative there?
Sure. Good morning. What drives it is -- basically we have a certain spending pattern seasonality to our business that is typically heavier in the back half. A pickup in billable expenses, and then, frankly continued investment in our talent and capabilities. That's what's driving it.
Okay. And then, Horacio, just on district defend who is this targeting, is it corporate commercial enterprises. And I guess just with this, if you could elaborate on the technology a little bit more and who you're competing with there?
Sure. We're very excited about it. We shared this technology over the years at the Investor Day. As you know Sheila because -- we started on this path of trying to solve a specific problem which was the problem of secure mobility in a classified setting. As you know there's a lot of concern about classified data leaving scare and so everything gets bolted down. And that while it provides security, it actually makes it harder for teams to interact and interface sometimes real-time in the middle of operating situations. So we knew this was a significant need. And so what this technology is meant to do is to fundamentally secure the data on a geo location basis. So when you're in a particular place, the technology gives you ability to source into that device the data that it needs and only the data that it needs, if you leave the room, if you leave the building, it changes the permissions and the data disappears. If you leave in a way that you shouldn't, the device itself turns into a brick. It works whether the device is on or off it is --and it's been tested and vetted by the very, very best.
So we believe, frankly there's no competition for this technology in the market right now at least that we know of and that it holds significant promise. We we're going to market with Dell. We are taking it to our fellow clients. We heard a lot of resonance for it. But as I said before it's very early days. We just launched and I think the ultimate test will be sales volume and profitability as it is with any business. And we'll know more as we sell more.
Great. Thank you.
Sure.
Thank you. And our next question will come from Jon Raviv with Citi. Your line is now open.
Hey, thanks guys. Good morning. And Lloyd just on the -- with ADEPS up 40% so far year-to-date and also you point of higher margin, just any thought that $3 a couple of years out, I know it's still very early, but just for instance the 10 to 30 basis point margin expansion seems well within reach at this point. Is there any thoughts as to kind of the shape over the next couple of years?
Well, first let me say, we're excited that we're ahead of expectations both on the ADEPS and margin basis. And it's really driven as we said in our prepared comments with the revenue, operational performance as well as just strong overall market. You're right. We're six months into a three year outlook. We couldn't be more happy with where we are right now, but in due course probably toward the end of this year, we will comment on a three year outlook. But right now Jon, we're just in the early stages of our journey.
Understood. And then, Horacio just you deal a lot with customers obviously, there soon to be some moving pieces around what budgets are going to be and perhaps just going to be a defense budget increase or a card? There's a lot of moving pieces. What's your perspective on customer certainty and their capacity to spend, if there are still questions and deficit questions hanging out there?
Our clients understandably are thrilled because for the most -- at least for most of our clients especially in defense and intelligence, they have a budget on October 1. And that is the first time in more than a decade. And it gave them both the clarity and the opportunity to invest. And that's what they're focused on and that's what we're working with them on. I think everybody understands. We're about to go through the election cycle. There's going to be another budget discussion next October. The primes for those discussions are still emerging. But the other thing that I will tell you both about our clients and about Booz Allen is, if we have learned something in the last five years is too -- we've learned to operate successfully with turbulence and with uncertainty and with moving pieces and with moving parts. We're going to be watching all of these closely, but we remain confident that we know what we're doing, that we're adding value to clients and we're going to keep driving the business.
Thank you.
Thank you. Our next question will come from Edward Caso with Wells Fargo. Your line is now open.
Hi. Good morning. Congrats on the great print here. Could you talk -- two related questions, your capital structure, how much is fixed now what is sort of your targeted level of fixed versus floating debt? And just sort of with the stock in the group pull back here any change in your view towards share repurchase or the pace of it? Thank you.
Sure. Good morning, Ed. Today we're at about 44% fixed versus floating obviously in a rising interest environment. We've been looking at it and we plan for it and we feel we're in a good position just given market conditions. That being said, at the very beginning of the journey, we had always targeted about 50:50. So we're tracking any interest rate hikes with that in mind.
As it relates to our capital deployment, overall our objective has always been to maximize shareholder value. To-date, we've returned $144 million and we're confident that we're going to achieve our $350 million for FY '19 toward $1.4 billion, three year goal.
There's a lot of volatility in the market. As everyone can appreciate, we remain focused on repurchases, but we also have regular recurring dividend and acquisitions as a part of our capital deployment strategy.
Thank you.
Thank you. And our next question will come from Carter Copeland with Melius Research. Your line is now open.
Hey, good morning, gentlemen and good numbers.
Thank you.
Good morning.
Good morning. Just -- I wondered Horacio, if you could follow-up quickly, I appreciate all the color on district defend, but I wondered if you could go back to the whole option value concept. And just one, how many opportunities are there in the pipeline that are like this, just in general terms help us get a sense of what the -- what the funnel looks like and how many of these irons you may have in the fire? And then, just with respect to the business case, and I realize that for a product sale like this there's got be some volume dependency, but if you hit your expectations, I'm assuming this will be an offering that has margins that are relatively large multiple of what your current operating margins are. So I just want to verify that. Thanks.
Sure, Carter, I love that question. So let me start by saying this. This whole notion of option value is predicated on having four plus innovations any of which could actually be very significant down the road and we don't expect them all to succeed by the way. That's why you need our portfolio. But across the portfolio, when you look at the economics you get three plus years out, you're looking at businesses that do carry higher margin than our traditional labor business and should carry accelerated revenue growth beyond our -- how many people can we bring on board in a quarter. So that's the underlying basis for this.
And so we're excited district defend again is one of those programs, we've talked in the past about AI; we've talked in the past about directed energy. We're thinking about things on the immersive on a number of other topics. And we'll talk more in earnings calls. These things have all because we want you and our investors to have a sense for how the portfolio is evolving. But again, my focus and I hope our collective focus is on the portfolio as opposed to any one initiative because if you're really going to be at the leading edge, if you're really going to be innovating then you're not going to get 100% success across all the initiatives, if you're getting 100% success across all the initiatives, we're just not pushing hard enough.
Is it fair to say you hope that the handful of these can hit in the next few years?
Absolutely I mean we're not just doing this for sport. And I'm not saying if they all hit, I'm going to be unhappy. But I think just to be realistic, district defend again is a breakthrough technology. And if it delivers on its promise, it changes the game much like when we were at Investor Day and we share with you some of the things we're doing on AI. They could change the game in terms of topics as broad as cyber and ISR for our federal clients. They work on directed energy could change the game.
And so all of these are game changing technologies and I'm really proud that Booz Allen is taking 100 years of knowledge of consulting and of these client base to come up to do these kinds of things. And so I like to believe that a number of these will be successful and they will be extremely successful.
Great. Thanks for the color Horacio.
Thank you. And our next question will come from Krishna Sinha with Vertical Research Partners. Your line is now open.
Hi. Thanks. On your free cash flow, you raised the guidance for -- to $460 million to $500 million of operating cash flow, $60 million of that was driven by tax benefits and then sort of the remainder being driven by a better billing strategy, if I'm reading into that correctly? Can you break down the forward impact of both of those meaning is the tax benefit a structural benefit you're going to continue to get going forward, or is that going to come out of the numbers next year, and then, you'll just see better cash flow from the from the billing strategy and growth from that income?
With the IRS tax ruling, it's really in FY'19 impact and as I said in my prepared comments, for the changes that we've made and we'll continue to make around our operating cash, our operating performance. We're going to continue that going forward. So [mission] [ph] invoicing, active engagement with payment officers and adjusting our vendor management processing fees.
Okay. And then, on your headcount increase, last year when you had a similarly large headcount increase, you noted that there was a depressive effect on margins just based on utilization rates. Is that something you're going to see this time going forward, you already have talked down the margins in the back half. But I'm just curious -- you didn't really call that out as a factor this time. You mentioned some other things, so I'm just worried if -- or I'm wondering if that's going to pull the margins down as well as, utilization ramp on the new hires?
A little bit. As I said previously, it's part of our seasonal dynamic, but again, we're ahead of expectations and for FY '19, expecting 10%, we are very excited about that. And so we're going to continue with that gives us a lot of confidence about our headcount goals for the year as well.
Okay. Thank you.
Thank you. And our next question will come from Cai von Rumohr with Cowen & Company. Your line is now open.
Yes. Thank you very much. So district defense, how do you price it? I mean by that I assume that some of your -- most of your business is priced at a particular rate, if it's service cost plus. But this presumably has a much higher margin because it's proprietary. So how do you price it, do you price it higher rate per hours or as a product? And how do you price some of the other initiatives like a iron directed energy. Thanks.
It's early days in all of this. Right now, for example, the district as the example, there's [SKU] [ph] pricing for the technology through Dell in different type of bundles and there's pricing for the labor that goes into actually making the technology operational and successful. And we view the success of this program as this integrated solution which drives our position with the client, direct revenue of profitability from the product themselves. And then, both the implementation on detail behind it, of just creating value from the solution.
If you think about bringing mobility to a space that didn't have it, it's not just about the coolness factor of trading your desktop or a tablet is, you get to ask questions like okay how do I work more efficiently and more effectively? How do I drive productivity? We believe that these are the kinds of things that all of these technologies will allow us to do which is to make our clients missions more effective. And we're going to be very nimble in terms of pricing each and every one of these in a way that both rises our margins. Overall, if they're successful, but also splits the value between us and our clients and then supply chain partners the right way.
So are there any other elements here like AI or directed energy, where you believe you may be able to implement SKU pricing?
Each one of these things will have its own pricing dynamic. To answer your question specifically, we don't think that any of these products will be priced primarily through hours of labor.
Now each one of them -- how each one of these solutions get priced will be dependent on the solution whether it's a software as a service type pricing, whether it's SKU pricing, whether it's get bundled as a total solution price that has fixed price contract with some element of which is labor and some is hardware. We're going to be -- we're going to be as creative on the business model and the value capture of this as we are on the value creation and the ADEPS themselves.
What does that imply for your adjusted EBITDA margins because you've basically you are up 50 bps this year and does it decelerate so you only do 10 to 30 on average over your forecast period or where this is coming in. Does it really give you fairly meaningful upside to the margin potential?
Again, six months into our three year outlook a bit premature to say Cai. But as we said back in June, the whole rationale on option value is to exceed that's sort of the baseline thesis and we would remain very optimistic that it would enhance our margins. But today it's a bit early for us to comment on the long-term impact.
Terrific. Thanks so much.
Thank you. And our next question will come from Tobey Sommer with SunTrust. Your line is now open.
Thanks. What did you learn anything in the last four or five months since Investor Day that would shade the 4.4% CAM growth that you described either higher or lower?
We're all in line. We're on track against the investment thesis that we put forward in June as we've been saying. The success we've had in the first half of this fiscal gives us confidence that we both got that right and we're going to continue to drive it. It's foot on the gas across all of the key metrics to try and maximize shareholder value, but it's too soon to do anything beyond that.
I would just add to that. It gives us more confidence that we're on the right strategy. And we see this part of our vision 2020 strategy is the payoff period, quarter-after-quarter that is reflected in our performance. I think that's what we've learned since June. We're on strategy and we've got to just continue to drive.
Within your contract awards kind of contract activity more recently, have you been able to discern a difference in the cadence of activity between the agencies operating under a CR and those with a budget?
Absolutely. With the budget in place, and Horacio said this previously, it's been many years since we've seen a positive environment. Our clients to prospective clients are aggressively issuing [indiscernible], making award decisions, working through protest situations as efficiently as possible.
And in the case of Booz Allen engaging us on many of the things that we've been talking to them for some time around digital cyber security systems software development and engineering and science. That I doubt much better environment than CR after CR So couldn't be happier with the environment today.
From a multi-year perspective last question for me. What sort of spread should we look for between your expected organic rate of revenue growth and your growth in consultant headcount?
It's difficult to say today. I mean we're targeting 5% for this year and we expect to be there with changes that we've made to our recruiting processes, referral process, hiring practices, we're optimistic that we'll be able to achieve that. But, I think we need a little bit more time in order to comment on spread in a long-term basis.
Okay. Thank you very much.
Thank you. Our next question will come from Tim McHugh with William Blair. Your line is now open.
Thanks. Just want to ask some margin question maybe a little differently. Is there anything unusual I guess about this year in terms of the step up from the mid-9 to expectation to 10 that we shouldn't extrapolate I guess to 2020 or any of the next few years. Just trying to make sure there's -- you are not over earning in some perspective given the magnitude of the improved outlook on the margins.
We have year-over-year been emphasizing and focusing on our operational performance. We've had two very strong quarters, strong contractual performance, solid cost management, global expenses that are -- it's difficult to anticipate. They've been down. And so that gives us the confidence to today raise the expectations to 10% for the year.
Start of a line, we are continuing to keep our foot on the gas in that direction and expect the improvement that we've made will be recurring. Again six months into a three year journey, but for this year, we're confident we're going to be around the 10% range.
Okay. And then, just on -- I guess by business unit area, the Q shows some information on that, so commercial up, I think was on the low single digits or so year-over-year prior quarter was up significantly. And so any color on the variability in the growth rate there.
I'll comment on that. I mean recognize, it's a relatively small part of our business; we're talking about 3% of total revenue. And so small changes get magnified quarter-to-quarter. If you look at the first half, I think the numbers are on 27% or so percent growth, which is consistent with a kind of strong growth that we've shown for the last couple of years. And so I would say that business is on track.
Okay. Thanks.
Thank you. And our next question will come from line of Joseph DeNardi with Stifel. Your line is now open.
Yes. Thanks. Good morning. Just on a piece of order activity and wondering if all of the awards that you were expecting to announce for now, or if you expect some of the -- that wave of water flowing in over the next few months.
We are still expecting a few more that haven't been announced, which is sort of typical behavior with our federal market. [indiscernible] in Q2, which is traditionally our highest quarter, that gives us a lot of -- and the overall growth in our backlog. This is a lot of momentum for the balance of the year, but we're still waiting for a few more to be announced.
I will amplify. I think we have --
Balance of the year, but we're still waiting for a few more to be announced.
I will amplify. I think we have a robust pipeline and we're excited about the pipeline as I always say not just the quantity of it, which is more visible, but the type of work, which is on strategy and it demonstrates our uniqueness in the market. I would expect that with a budget passed on October 1st, we may actually see some of the activity spread out over the year more than sort of it all and in the fourth quarter of the current fiscal year like it has been in the last few years. But I am not entirely certain that it will play out exactly that way logically it's true that it might. But we're seeing good activity in awards. We're seeing good activity on proposals and we're bullish about the next few months.
Okay. That's helpful. And then, Horacio just few questions on the budget kind of specific questions. One, were you surprised by some of the recent commentary for lower defense spending in ['20] [ph]. Do you expect defense spending in '20 to actually come down or than in the initial marketing channel?
I'll say on this. Your guess is as good as mine. We expect that post election and after the two year deal that just finish that the negotiations will be intense and that things will move around a lot before they settle somewhere.
Having said that, what has me excited about all of this is, our clients at the operating level in these agencies especially the larger ones understand the mission, understand the priorities, feel supported to get things done and feel supported to invest and we're sitting there where technology meets mission where 100 years of consulting can add value and make a difference. And I think the results speak for themselves.
Thank you.
Thank you. Ladies and gentlemen, this concludes our question-and-answer session for today. So now it is my pleasure to hand the conference back over to Mr. Horacio Rozanski for any closing comments of remarks.
Thank you everyone for your questions and for joining us. I hope Lloyd and I have conveyed our excitement about the strength of our business. We do believe, we are headed towards a successful fiscal year and we feel very confident about our three-year outlook for growth and for shareholder value creation. So we look forward to continuing the conversation with you in the coming months. Have a great day.
Well, ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program and we may all disconnect. Everybody have a wonderful day.