Booz Allen Hamilton Holding Corp (BAH) 2012 Q3 法說會逐字稿

Good morning. Thank you for standing by and welcome to Booz Allen Hamilton's earnings call covering third-quarter fiscal 2012 results. At this time, all lines are on a listen-only mode. Later there will be an opportunity for questions. I'd now like to turn the call to Mr. Curt Riggle. Please proceed.

Thank you, Erica, and thank you all for joining us today for Booz Allen's third-quarter fiscal 2012 earnings announcement. I am Curt Riggle, Director of Investor Relations and with me to talk about our 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've also provided presentation slides on our website and are now on slide two.

On today's call, Ralph will provide you with an overview of our business performance, recent developments, and strategic positioning. Sam will then discuss our financial results in detail including our income statement, balance sheet, cash flow, and backlog. Ralph and Sam will discuss our guidance for fiscal 2012 which began on April 1, 2011 and provide an initial forecast for fiscal year 2013.

As shown on the disclaimer on slide three, 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 2012 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 other reconciliations of our non-GAAP measures to the most comparable GAAP measures in our fiscal 2012 third-quarter earnings release and in these slides.

It is now my pleasure to turn it over to our CEO, Ralph Shrader, and he will start on slide four.

Well, thank you, Curt. Good morning and thank you for joining us. It has been an eventful quarter. Without question the global economy has been challenging and the financial markets highly volatile. As you are also well aware, our primary client, the US federal government, is in a period of significant uncertainty characterized by funding delays and budget cuts.

Yet despite these challenging macro trends, the demand remains high for Booz Allen's capabilities (technical difficulty). We have continued to grow our topline revenue and improve our margins. Our clients' success is our highest calling and we are committed, as always, to being an employer of choice and good corporate citizen.

Booz Allen continued to grow revenue in our federal civil, defense and intelligence markets during the third quarter of fiscal 2012. We have a large backlog of sold work now totaling $12.22 billion and are well positioned in growth areas such as cyber, health, finance and ISR, which is intelligence, surveillance, reconnaissance. (technical difficulty) ability focused on crop helping clients improve effectiveness and efficiency in their core missions.

Additionally, we are growing and investing for future growth in the commercial and international markets that have opened to us since the expiration of our noncompete agreement on July 31 of 2011.

In terms of financial highlights, our third-quarter revenue increased to $1.44 billion, up from $1.39 billion in the third quarter of fiscal 2011. Net income for the quarter increased to $62.9 million, up from $23.6 million in the prior year period. Adjusted EBITDA increased to $120.1 million, up from $105.9 million from the third quarter of fiscal 2011 and adjusted diluted earnings per share increased by $0.13 for the quarter to $0.40 per share. We again generated solid free cash flow and have consistently managed cash for the long-term success of our business.

Today, we are announcing that our Board of Directors has declared a cash dividend in the amount of $0.09 per share. The dividend is payable on February 29, 2012 to stockholders of record at the close of business on February 13, 2012. We intend to begin payments of regular quarterly cash dividend subject to discretion of the Board. Our Board's decision to initiate a dividend reflects (technical difficulty) confidence in Booz Allen's financial strength and growth potential.

Internally, we have taken important and difficult steps to reduce the size of our senior and middle management ranks and take cost out of our infrastructure and overhead. In the month of January, we reduced our headcount by approximately 2% overall, which includes deeper cuts on the order of 10% in our senior and middle management ranks and our internal operations. We have continually evaluated our staff capacity and the size of our leadership corps over time.

However, as we look to the future we believe there will be more uncertainty in our core federal market, and we realize that Booz Allen's cost position, particularly the cost of overhead, was not sized for the slowing market (technical difficulty) today and believe will continue. Therefore, the actions taken recently a more significant and reflect our determination to get out in front of a changing market so we can continue to deliver profitable growth into the future.

We believe these measures will better position Booz Allen for continued growth by making our cost structure more flexible and freeing up additional resources to invest in growth areas across government, commercial, and international markets.

Booz Allen remains deeply committed to being an employer of choice. Last month, we were again selected for inclusion in Fortune Magazine's prestigious list of Best Companies to Work For for the eighth consecutive year. Booz Allen's spirit of service shines in our employees' volunteerism efforts which over the past quarter have been focused on career activities and reintegration of wounded warriors and women veterans; helping children in need; and raising funds for healthcare research.

Booz Allen was recently honored by The Leukemia & Lymphoma Society for raising over $100,000 in a single year.

Our success as a business enables our firm and our employees to give back to the communities in which we work and live. Evidence of that success is seen in continued client demand for our services. Here are just a few of the major contract awards and task orders we have recently won.

A $43 million task order from the Centers for Disease Control and Prevention to provide enterprise system support; a $458 million IDIQ contract from the US Army to provide training and support services to the Maneuver Center of Excellence at Fort Benning, Georgia; an $18.4 million award from the Department of Homeland Security to support the immigration and customs enforcement for secure communities; a $67.4 million award from the US Navy Space and Naval Warfare Systems Center Pacific for signals intelligence and information operations; a $27 million contract for IT business solutions and systems for the National Science Foundation; and a growing (technical difficulty) in commercial and international markets especially in the cyber area. These and numerous other new contract awards will drive revenue going forward.

To look back on our just-completed third quarter in greater detail I'd like to turn now to our Chief Financial Officer, Sam Strickland.

Good morning and thank you for joining us. Those of you who analyze and invest in our industry know that it is a period of significant uncertainty. Yet despite these macro trends, we believe Booz Allen stands out as an exceptional company and we are proud of our continued organic growth, margin improvement, and strong cash flow.

As Curt mentioned in his opening summary, in addition to the GAAP results, Booz Allen also reports certain non-GAAP measures such as adjusted operating income, adjusted net income, adjusted EBITDA, adjusted diluted earnings per share, and free cash flow. We believe these metrics provide better insight into our operational results because they remove the effects of nonrecurring or unusual items.

This is the fifth earnings call Booz Allen has held since our initial public offering in November 2010, and I am again pleased to report positive top and bottom line growth for the quarter.

Let's turn to slide five for a closer look at our third quarter results for fiscal 2012, which shows a 3.9% increase in revenue over the prior year period. It is notable that our revenue derived from direct consulting staff labor grew 5% during this quarter while we saw a 0.6% growth in billable expenses.

All of our major federal markets -- civil, defense, and intelligence -- continued to grow and we won work in our new business areas of commercial finance and health and from international clients in the Middle East.

In the third quarter of fiscal 2012, operating income increased to (technical difficulty) [$98.2] million from $75.1 million in the prior year period and adjusted operating income increased to $104.7 million compared to $92.3 million in the prior period. The improvement in operating income was driven by continued growth in revenue, increased profitability resulting from decreases in incentive and stock-based compensation costs, and lower amortization of intangible assets. The profitability increases were partially offset by a significant investment in business development as well as unbillable staff compensation costs.

Adjusted EBITDA increased 13.4% to $120.1 million in the third quarter of fiscal 2012 compared with $105.9 million in the prior year period for the reasons cited above which drove the corresponding increase in operating income. None of the cost reductions Ralph mentioned affect the third quarter because these were implemented in the month of January.

Net income increased to $62.9 million from $23.6 million in the prior year period and adjusted net income increased to $56.4 million from $35.2 million in the prior year period. The increase in net income was driven by the increase in operating income as well as a decrease in interest expense as a result of our debt refinancing in February 2011.

In the third quarter of fiscal 2012, diluted earnings per share increased to $0.44 per share from $0.18 per share in the prior year's period while adjusted diluted (technical difficulty) per share increased to $0.40 per share from $0.27 per share in the prior year period.

Now cash (technical difficulty) always a favorite topic for CFOs and I am very proud of (technical difficulty) track record to generating cash from operating activities and of our consistently strong cash collections. Free cash flow was $53 million in the third quarter of fiscal 2012 compared to $87.4 million in the prior year period. The primary driver of this change was higher federal taxes paid this year to date. The increase in federal taxes was partially offset by reduced interest expense.

In the past quarter, Booz Allen continued to demonstrate strong cash collections as evidenced by an average day sales outstanding for the third quarter of fiscal 2012 of 69 days. This, despite the many holidays in the quarter.

Our backlog continues to be very strong. Total backlog as of December 31, 2011 was $12.22 billion compared with $11 billion as of December 31, 2010, an increase of 11%. Funded backlog was $[2.97 billion] (technical difficulty) as of December 31, 2011 compared to $2.74 billion as of December 31, 2010, an increase of 8.4%. Unfunded backlog increased to $3.72 billion as of December 31, 2011 compared with $3.39 billion as of December 31, 2010, an increase of 9.7%. Priced options under existing and new contracts in the third quarter of fiscal 2012 increased by 13.3% compared with the prior year's period.

As discussed on our last earnings call, we continually evaluate all options for the use of our cash, including debt prepayments, payment of dividends, share repurchases, or funding of acquisitions, and are fortunate that our strong cash position gives us both stability and flexibility in how we operate our business and create value for shareholders.

On December 12, 2011 Booz Allen's Board of Directors approved a $30 million share repurchase program, which we believe provides flexibility to enhance shareholder value relative to our stock price. At this point in time, we have not exercised the option to repurchase any shares.

As Ralph noted and I'm sure you saw in this morning's press release, our Board of Directors this week authorized and declared a cash dividend for the third quarter of fiscal 2012 in the amount of $0.09 per share. The dividend is payable on February 29, 2012 to stockholders of record at the close of trading on February 13, 2010. Booz Allen intends to begin payment of regular quarterly dividends. However, the declaration of any such future dividends and the establishment of the per share amount, record dates, and payment dates for such future dividends are subject to the discretion of the Board. The Board will take into account future earnings, cash flows, financial requirements and other factors.

I want to (technical difficulty) we will be good stewards of cash and will seek to use it to maximize value for our shareholders.

I'd like to (technical difficulty) to Ralph who will talk briefly about Booz Allen's strategic positioning and then I will finish the formal part of our discussion with Booz Allen's guidance for the fiscal year 2012 and a first look at our fiscal year 2013. We are now on slide seven.

Booz Allen is determined to take the important actions that will position us for continued growth, allow us to invest in future growth and ensure that Booz Allen remains strong in a tough market. I firmly believe that Booz Allen is an exceptional company in our agility in the marketplace, in the quality of our staff, and in our deep commitment and expertise to help our clients succeed. We believe Booz Allen is positioned well to serve our clients and their core missions. We are aligned against growth areas in the market and we have a superb reputation for excellence, integrity, and client service.

Booz Allen's single P&L structure and our matrix of functional capabilities serving all markets enables us to deploy and redeploy leaders against growth areas.

We recently redeployed three of our Executive Vice Presidents against firm-wide growth initiatives. Mark Gerencser, a proven business builder to lead their commercial business; Mark Herman (technical difficulty), a recognized thought leader to head our cloud-based services; and Pat Peck, an innovation champion, to drive our initiatives in organizational efficiency and effectiveness.

We continue to invest strongly in cyber and last month formally launched the Booz Allen Cyber Solutions Network to bring clients advanced cyber capabilities. We are aligning additional resources against growth markets in health, C4ISR and finance, as well as in the Middle East where we are growing our headcount in Abu Dhabi.

We have also developed a firm-wide approach to addressing organizational efficiency and effectiveness. It focuses on strategic analysis, core missions, and an institutionalized approach to efficiency to help clients do the most important things and do them very well in a budget-constrained environment.

Internally, we will be lean, agile and precise in how we recruit and deploy our talented people and how we manage our infrastructure and operations; and how we deploy our capital.

These are challenging times, but exciting times. Booz Allen's strategy is to be out in front, to act boldly and decisively to ensure that our clients and our firm are ready for what is next. We have been doing this for 98 years through up cycles and down cycles and have remained focused on the future, on the long-term success of our clients, and our institution.

I'd now like to turn back to Sam to talk about our forecast.

Thank you, Ralph. We are now on slide eight. In January 2012, as Ralph discussed, Booz Allen took cost reduction actions to reduce certain personnel and infrastructure costs, which included a reduction in senior and administrative staff.

As a result, we anticipate incurring a restructuring charge of approximately $10 million to $14 million pretax in the three months ending March 31, 2012 associated with one-time termination benefits that will be paid to departing employees. No amounts related to this cost restructuring have been accrued in the accompanying financial statements as of and for the three-month and nine-month periods ending December 31, 2011.

Booz Allen continues to forecast revenue growth improvements and, at this point, we are forecasting year-over-year revenue growth for fiscal 2012 to be in the 4.5% and 5.5% range.

For fiscal 2012, we are narrowing our prior guidance for diluted earnings per share, which is expected to be in the range of $1.66 to $1.70 per share and our guidance for adjusted diluted earnings per share which is expected to be in the range of $1.58 to $1.62 per share.

Looking ahead to fiscal 2013, which begins on April 1, 2012, Booz Allen currently forecasts revenue growth and margin improvements to continue despite the generally challenging business environment for government contractors. For both this year and fiscal 2013, there has been and will continue to be greater uncertainty in the second half of our fiscal year which coincides with the beginning of the new government fiscal year.

Our initial forecasts for top line growth in fiscal 2013 is to be in the low to mid-single digits; diluted earnings per share in the range of $1.62 to $1.72; and adjusted diluted earnings per share on the order of $1.71 to $1.81 per share.

Overall, our EPS outlook reflects the expectations that bottomline performance will continue to benefit from low interest expense on our existing debt and an improvement in operating margins. Our intent is to reinvest cost savings from restructuring which we currently estimate to be approximately $80 million into growth areas of our business, while holding back a prudent amount for uncertainty that could arise in the second half of Booz Allen's fiscal 2013, which coincides with the beginning of the new government fiscal year. This measured approach to reinvestment will help us protect net income if market conditions or disruptions negatively affect our expectations for fiscal 2013 topline.

These EPS estimates are based on fiscal 2013 estimated average diluted shares outstanding of approximately 145.4 million shares. And I should point out that there have not been any share repurchases at this point.

I'd like to close by emphasizing that our willingness to provide an early outlook for fiscal 2013 is a sign of confidence. It is based on work we have in-house, on our very large backlog, and the fact that the federal government now has an approved budget for the current government fiscal year, which reduces some near-term uncertainty.

Thank you, Sam, and thank you all for listening to our summary of results and outlook. Our Chief Operating Officer, Horacio Rozanski, and our Senior Vice President and Controller, Kevin Cook, are also here with us today to answer questions.

Operator, please provide instructions to those on the call.

(Operator Instructions). Nathan Rozof, Morgan Stanley. Please proceed.

Sam, I wanted to ask you a little bit about the guidance, particularly for fiscal 2013. I know you normally do a very comprehensive bottoms-up approach and I was curious about how you were incorporating the potential for further budget cuts or sequestration in your outlook for next year.

Again, if you take a look, we have our funded backlog, as of December 31 is up almost 9%. Overall backlog is up accordingly. So the business is there. Certainly at the current time we have ample opportunities in the pipeline.

I think we all understand that there is a lot of discussion around the sequestration and whether it should take affect and how it should take effect. It's my understanding that as the law is written, it would be represented across the board cut for everything let's call it. And clearly, I believe that the Department of Defense and certainly the Secretary of Defense has said that it would make more sense to do more strategic cost-cutting.

At this point, I don't know that anybody is smart enough to know exactly where those cost cuts will be. Clearly, I would think that the programs would have -- would probably take a significant chunk of those additional cost cuts.

That's one of the reasons we are holding back some of the cost savings that were created by our cost restructuring (technical difficulty). We've taken a look at our bottoms-up approach; we've taken a look at what we see in the pipeline; we feel like the numbers we have put out are achievable.

By the same token, we would have to say that there is uncertainty around fiscal 2013, simply because we're going through a very political (technical difficulty) country. It's not clear where all the priorities will end up.

So we feel like we have both the business in hand and on the horizon to meet these numbers. We are holding back some of our cost savings to protect against whatever uncertainties might occur, what we might run into in the back half of our fiscal 2013.

That's great. I'm glad to hear that you have de-risked the numbers here.

Just as a follow-up question, maybe this one's a little bit more for Horacio but if any of you guys would like to chime in, I'm curious if you have or can give us any color on how the government procurement officers are reacting to the potential for sequestration.

I know they have a budget now and they have authorization. So are they proceeding as business as usual or are they holding a little back because of that risk for next year? If you can give us any update on how they are behaving, that would be helpful.

Sure, I'll take a crack at that. It is Horacio. The reality is that you can't answer this question broadly because it's one of those where you get the average but you actually don't describe the situation. But if we are trying to characterize overall, I would say that there's still a fair amount of uncertainty in the system; there's still a fair amount of skittishness. And we are still seeing things sliding to the right and so forth.

So there's not the level of confidence on the client side that you would expect with an approved budget and all that.

Having said that, as Sam pointed out, we are still winning work, we are still doing well below still getting funding. So there's -- if this was a few years ago you wouldn't have seen this level of uncertainty. I think people are still looking forward and wondering what is to come.

But in general, the business is proceeding without disruption.

Thanks.

Bill Loomis, Stifel Nicolaus.

Sam, the awards in the quarter, just looking at the backlog change sequentially, I get about $800 million in awards. Is that about right?

That sounds right, yes.

And that was the lowest I've seen for at least a couple years of quarterly data I have for you. What are your thoughts on the reason for that? And then any metrics you can give us on pipeline or expected award activity -- anything like that that can give us a sense of future periods of award activity? Thanks.

Well, there's two things there in terms of our awards for the quarter. One, of course we had a bang-up September quarter, so as we thought and I think as we talked about in earlier earnings calls, there was a fair amount of award activity coming up to September 30. If you take a look at last year's awards compared to this year's awards, I think in each of the last two third quarters, there was a fairly significant award.

So for example, last year it was what we called the [detri] contract. I won't go into that but it was a couple of hundred million dollars. We did not have anything of that size this year. Those large contracts, of course, were multi-year contracts. So again if you take a look at the funded backlog, it was up, funded and unfunded, which I think as we talked about in the past is what converts to revenue over the next 12 months that 15 months. Those are up 8.5% and 9.5%, respectively.

So while we didn't add as much to the priced options as we may have in prior third quarters, we still had in terms of our near-term revenue, we had a very good awards quarter.

Any pipeline metrics or any thoughts you can give us about what we might expect now that the budget got passed in mid December? I assume we'd be looking at better awards year-over-year for the March and June quarter possibly because of the earlier budget?

Yes, Bill, and you know this, you've been in this industry a while as have we all. It generally takes the government around 60 days after lifting of its continuing resolution to start getting awards out. We think that will continue. We believe that between now and September 30, we will see the awards activity keep up. So, yes, we're expecting for the rest of this government fiscal year to look like the last few government fiscal years.

In terms of future metrics, as we talked about in the past, while we have those metrics (technical difficulty) in terms of the ability to estimate the amount of those (technical difficulty), estimate the value that's going to come out of those contracts, estimate the timing of those contracts, to us involves so much in the way of assumptions and estimates that while we track those numbers internally, it's not something we rely on to run the Company simply because there are so many assumptions underlying them.

Thank you.

Brian Gesuale, Raymond James.

I wanted to maybe follow up a little bit on the booking side, maybe taking a look at the alternative side of that with the staffing. Can you maybe give us a little bit of insight into what your expected staffing cadence might look like, given where bookings trends have been over the last few quarters?

In terms of staffing trends, as we point out, we did go through restructuring in January. That did involve taking out client staff where we did not have near-term work. And this was around -- not around capability, but around skill sets. I think as we've talked about in the past, we have markets that are growing substantially and markets that are flat or, indeed, shrinking. So as we -- so we are having to adjust our skill mix.

I would expect that our staffing March 31 will be below December 31 and that will build between April 1 and the end of the government's fiscal year. Beyond that, let's see what happens with government fiscal year 2013, which starts next October 1. Are we going to be in a continuing resolution? God forbid, are people going to talk about shutting down the government as they go through the political process?

So it's a little early to predict what we might do there. So we're feeling -- look, for government fiscal year 2012, which is the first half of our fiscal 2013, we have government funding appropriation bills in place. We have proposals in the backlog and proposals in process and submitted under evaluation. We have an increase in our funded and non-funded backlog. So our visibility there is very good.

We believe that we are well positioned in the future. We have been investing for several years in areas that we will be -- are growth areas regardless of what happens with sequestration. But this is going to be a very political year and we're --.

Brian, one of the things we tell our clients and one of our (technical difficulty) is helping our clients get ready for what's next. And that's what we have been doing here. And what's next for us starts in the next government's fiscal year. We are trying to make sure that we are lean and agile as we go into that. We are optimistic; we feel like we are well-positioned from a growth market (technical difficulty) point. It's just we will have to see what happens and react accordingly there.

Terrific, Sam, thank you. And maybe just talking a little bit about the contract award activity. Looks like you guys had a fairly nice run in the IDIQ type variety of contracts. Can you maybe comment if there's any mix moving toward those vehicles? And then also maybe any emphasis from your clients from best value to lowest cost technically acceptable? And maybe just a little bit of color around that.

Brian, I will try. On the first part of your question, a lot of our business, as you know has really been based and continues to be based on (technical difficulty) [IUs]. And then our ability to sell task orders under that. We believe that to be a strength and something that we'd like to see continue. It allows essentially all of our staff to be part of the sales force as opposed to having a separate sales force. And it allows us to work on the problems that are most immediate to clients in a way that is much more flexible.

And so, it also derisks the portfolio to some degree, because then we don't have any one thing that is a huge contract that puts our revenue stream at risk.

So I don't know that there's been anything moving either in that direction or away from that direction. We're just running the business consistent with that philosophy.

In terms of what's happening from best value to low price technically acceptable, I think we've seen the pendulum swing towards low pricing technically acceptable in some clients. It's happening in others. By the same token, we're seeing some clients go through that experience and, so to speak, get burned. It's the old you get what you pay for -- and beginning to swing back to more of a best value mindset.

So it's -- that dynamic, I think, is still in progress and is still playing out. But I think our expectation over some period of time is the pendulum to swing much more to center and to have the services that are core to the mission of our clients (technical difficulty) quality and the price of the services that are further away from the mission in the periphery of supports where they actually try and save money.

And so that's the approach we are taking. That's why Ralph talked about core mission; we talk about core mission so much. We are trying to focus our business in the places where our higher quality and our excellence at work is going to provide sustainability and good pricing.

And Brian, just to build on that, I would say you go through this and certain markets let's say come under pressure from a pricing standpoint, we of course have to make a strategic decision, how important is that market to us.

We have always and will continue to fiercely defend those markets that we believe are strategically important. So if that means being competitive at a cost basis, we will -- we have done that in the past and we will continue to do that in the future. And one of the things we've achieved with our recent restructuring is more flexibility around our ability to do just that.

But we believe being focused on growth areas that we will continue to support pricing in the margins that we followed in the past, but we are well-positioned to defend, let's call it legacy markets that we believe that are important to maintain.

Thanks for the color, guys. And I think the dividend announcement is a very big positive.

Glad you like it.

George Price, BB&T Capital Markets.

Wanted to ask you first about just some guidance for the remainder of the year. Clearly we're -- you reiterated at the Analyst Day in mid-December the prior guidance of higher growth in the fiscal second half, and clearly we're seeing slower than expected growth at this point, potentially growth at the low end of the range is if I do the back of the envelope, even maybe decelerating a bit further quarter over quarter in the fourth quarter.

I'm just curious if you can give us a little more color about what happened. Obviously I know there's a lot of uncertainty but, clearly, something changed fairly significantly in the near term.

I think there were two factors and one of the reasons we wanted to highlight that billable expenses. If you go back when we first were going public and went public, you may remember I talked about focusing on what we call value-added revenue, which is really direct labor sales in.

That's what we believe is important to the success of our business for a couple of reasons. One, it's what drives our margins (technical difficulty) what covers are overhead. We get our biggest fees from that. And what's important there is sad when we're selling our labor we have our staff with our clients demonstrating our value-added.

I will tell you, in the third quarter just completed, our pass-through costs, are billable expenses were flat yet our labor sales were 5%. Now 5% was a bit lower than we were expecting but there are a couple of impacts there. As you may recall, we sold our state and local transportation business. That cost us about 1% on the top line for the quarter.

Frankly, 1% is not material but if you're talking about the difference between 5% and 6%, then that's a factor.

Clearly we thought we would be able to overcome that. We haven't yet. So, as we take a look at the fourth quarter, we're not yet seeing the lift that we expected as a result of having the continuing resolution lifted and given the backlog, that we've -- particularly the increase in backlog that we've seen.

So we are being cautious. We believe that labor will (technical difficulty) come in at the mid-single digits that will be, while not exceeding the first half, it certainly will be very comparable to the first half, which we think in this environment is pretty good, actually. So we've tried to take all that into consideration as we outlook both our fourth quarter and our fiscal 2013.

And just following up on that, Sam, what's the direct labor revenue growth expectation now implied in the fiscal 2012 and fiscal 2013 guidance?

Again, we're talking in terms of mid-single digits for the fourth quarter, for fiscal 2012. And then the -- we have not changed our expected mix of direct labor and billable expenses for 2013 at this point.

Okay. And then lastly, if I could just ask you, a little bit more specifically maybe in your fiscal 2013 assumptions. Obviously, there's a tremendous amount of uncertainty out there, but can you be a little bit more specific in terms of what your assumptions are around in terms of the DOD budget, sequestration, additional cuts? What are you baking and in terms of expectations there? Do we get some level of additional cuts? Is it at sequestration level, is it half of sequestration levels? And maybe any other kind of key assumptions to help us understand what you've baked into your guidance?

It's an excellent question. I wish I could tell you what our expectations were in terms of sequestration or half sequestration or quarter sequestration.

Our expectations (technical difficulty) are that we will not have across-the-board reductions. There will be some agreement around more strategic approach to cost-cutting. Again, (technical difficulty) focused our growth in our investment resources in growth areas, which we believe should do well even in a reduced cost environment.

But I can't tell you that we have a consensus around is it going to be the full $1.2 trillion over 10 years or is there going to be something between where we are now and where we are in the future. Frankly, we just don't know. We could run it out in a couple of different scenarios, but we feel like that the business we have in hand, the business that we see in the future and let's call it some of the hold back from our recent restructuring some of those costs, that we are going to invest part of that into these growth markets. We are going to hold part of that back to be prepared for what's next when we do get into fiscal 2013, the government fiscal 2013.

And I'll will tell you, we will hopefully have a little more clarity as we get toward the end of the summer. But at this point in time I -- (multiple speakers).

I mean, if I can help and amplify because I know this question keeps coming up and just maybe describe a little bit of our process. Part of our planning process is, we look market by market and account by account from a bottom up perspective as to what we can expect. And I think what you are seeing (technical difficulty) Sam's guidance is essentially the middle of the road that assumes that yes, there are some -- what do we see on the horizon? What do we think can happen?

And then there's some parts that probably have some downside; there are some parts, some upside. So we feel like we have tried to capture the middle of all of that. Some of our growth markets probably will do very well and maybe better than we're planning; some other places, probably, will be hurt by the fiscal 2013 process. So we've tried to capture both sides of that in the numbers that you are seeing.

Let me just try and pin you down a little bit more specifically and then I will turn it over. Are you assuming some level of additional cuts beyond the currently-reflected BCA caps? Not amount, not whether it is sequestration or not, just something we are going to get an additional round of cuts in some amount beyond what is currently in the budget?

I think -- I believe that the conventional wisdom is that there will be some additional cuts for government fiscal 2013.

Thank you.

Edward Caso, Wells Fargo Securities.

Could you talk a little bit about the labor side, how difficult it is getting labor in the markets that you want? And are you moving more towards a real-time hiring model? And what implications that might have for your staffing pyramid.

That's a great question. On the first half, this is actually, as I see it, a very good labor market. And I think we're seeing talent available to us of quality and at levels that we probably haven't seen for a while. So I feel pretty good. I don't think we're going to be constrained, even in our growth areas, in terms of finding people.

As you know, there's always some challenges around the time that it takes to get people clear and all of that. And that continues to be an ongoing industry phenomenon. But in terms of finding the right people and being able to convince them to come to Booz Allen, we're doing pretty well.

On the real-time hiring discussion, that has always been our pattern is to try and hire real-time. Over the last couple of years we waited for the continued resolutions and then everything happened all at once in terms of awards, and then everything had to start all at once before the next continued resolutions. We had to come off of that and be more aggressive in terms of having staff in hand before the work started. That's not our ideal because you never get that exactly right; you never have exactly the right kind of people at the price point, with the skill sets and the (technical difficulty) you need them.

So we're really going back to our basic operating philosophy here. And this year, in particular, we have the advantage that we actually have a signed budget.

So part of the reason Sam talked about labor before the way he did is that actually should allow us in addition to the additional, the restructuring and the cost savings, run the business at or above the [ability] parameters that we like to see. So from the labor perspective, I think we're in a very good place. And like I said, the talent of our workforce that is existing in the talent we can capture there is quite good.

My other question is on the interest level and doing acquisitions now in the wake of this dividend announcement, I assume the share repurchase is in your back pocket as the stock has a difficult period, but the dividend sends a different message. And historically companies in your sector like to hoard cash for acquisitions. Does this mean that you're reducing your interest level and doing acquisitions?

Well, as I think you know, Ed, we have not done acquisitions. Our growth for 17 years, actually our growth for 25 years, has been the result of organic growth.

But we have always said that if we found the right acquisition at the right price, we would certainly do it. With that said, we do not have a group that is out beating the bushes. We don't have stated goals as to we're going to do an acquisition.

I will point out that we still have even after the declaration of dividend, we have excess cash that we are continuing to discuss with the Board what we do with it. We also have ample room under our current credit lines to access additional cash should we need to do so.

So again, we have not been acquisitive. You know, there is -- there are -- we don't.

Bottom line is by declaring the dividend we don't take anything off the table.

Thank you.

Tim McHugh, William Blair & Company.

Just wanted to know if you could talk in fiscal 2013 about your margin assumptions. It seems there's probably a little better margin improvement than the 10 basis points you've talked about but yet you're also saying this restructuring program, you're holding back some of the savings. I just want to try and understand what is assumed in 2013.

As we talked about, good visibility we feel like between now and September 30. It gets a bit cloudier after that. We have held back -- we will hold back some of our cost savings. We will invest in growth markets. We will hold back some of that. If our top line expectations are not being met, then we will have some flexibility at the cost line.

So we again have figured and planned in, let's call it, our traditional growth and margins. We do have some downside cushion, particularly if our billable expenses (technical difficulty) if we see that continue to drop as a percentage of our overall revenue that of course will help drop our margins, simply because we don't drive the same margin on that business as we do on our labor sales.

So I think the other thing you'll see as we expand in our growth markets, those markets normally have a bit higher margin there as well. Our traditional markets that are now flat or perhaps shrinking a bit as the market gets a little longer in the tooth, let's say, those margins will tend to come down.

Is there any assumption in there that the Commercial or International business becomes significant enough to have an impact there or is it based on -- is that not --?

Well, certainly, that Commercial and International will help. As it stands right now that's less than 2% of our business and we think it is insignificant to talk about. We'd rather wait until we actually had a very robust Commercial and International market that will have the meaningful impact.

But even at 2% it does help a bit.

Thank you.

Robert Spingarn, Credit Suisse.

Sam, could you talk a little bit about the tax rate in the quarter and your guidance and how that may have changed throughout the year?

I'll make a crack at this and then I'll think in terms of turning it over to Kevin Cook, our Controller.

If you look at what's happening to our tax rate this year. And one of the reasons we do GAAP earnings -- diluted earnings per share and adjusted diluted earnings per share, as we settle out tax year audits, the FIN 48 requires us to set aside reserves against tax positions. And once you undergo an audit, of course, those audit issues get resolved. That enables us to release reserves.

So I don't think our fundamental tax rate has changed, and yet be accounting around closing out these prior-year audits and then the ability to release reserves against that is what is causing the GAAP tax rates to move around. I think if you look at the adjusted EPS numbers you'll see that the tax rates are fairly constant.

Kevin, I don't know if I got that close --

You are spot-on, Sam. The year-to-date effective tax rate was 26.4% and Q3 is it was 27.1%. (technical difficulty) we had in both Q2 and Q3 we were able to release some of those FIN 48 tax reserves.

For FY 2013 we would expect our rate to be up in the 40.5% range.

And Kevin, what are you looking for this year are you still at 30 (technical difficulty) --?

Probably would come down a bit, closer to 30%, Rob.

I was going to say, again, that's one of the reasons though that we do report the adjusted diluted earnings per share, because that takes you back to a normalized tax rate. In other words, we do not take those tax gains when we calculate adjusted diluted earnings per share. So we get rid of all, let's call it, the non-operating issues.

Well, thanks for that answer.

On a slightly different topic, to go back to billable expenses. And I think you mentioned earlier, Sam, I don't know if it was you or one of the others who talked about the ratio is relatively constant, but going into an environment that is going to be significantly different than let's call the past decade, is there going to be an effort by the customer to push those billables down?

That's an excellent question. It has been incredibly steady over the last five or six years as we've been looking at it. We'll see.

If you took a look at the third quarter, all but about $30 million of our quarterly billable expenses is subcontracts. In fact, subcontract expenses passthroughs were virtually flat in this December's already (technical difficulty) last year's December quarter. We don't yet know if that's going to continue. So we're keeping an eye on that.

Honestly, that's why I say we focus on labor sales. We have good insight into that. Pass-through costs, subcontract costs are a bit more difficult to judge.

One of the reasons we still feel comfortable with the top line -- with our bottom line look that is that that is driven heavily by our labor sales. And again, we have reasonable insight into that.

And then just a final question. This goes back to the growth in the second half not perhaps quite as high as you had hoped it would be earlier, but then again you got this visibility into fiscal 2013. So just to clarify (technical difficulty) second, is some H2 2012 business moving into 2013?

Some H2 2012 -- you're talking about our -- ?

Are your revenues being pushed to the right?

Yes, I got you. I was going to say -- well, I think that is the case throughout the industry. Clearly -- certainly, when we were (technical difficulty) during the continuing resolution but we are seeing awards pushed out to the right. We are seeing clients holding back on spending levels as they try and understand what's going to happen in government fiscal year 2013 as well.

Thank you very much.

Michael Lewis, Lazard Capital Markets.

So I'll ask the standard two questions here. First, I wanted to talk about the contract base. If you look at one of the contracts that you hold like S3 where I think we're experiencing some slowdowns specifically in that area, are you witnessing that, does that have an impact on the top line versus your original plan?

I think S3 is one of those areas where we have not seen a growth in subcontracts, for example. So I guess you would consider that a bit of a slowdown. I don't think there has been particularly a slowdown in the revenue -- I'm sorry, let's call it the labor sales under that contract.

And then just more of a qualitative question. Originally while we were going through the IPO process, I think the expectation for Booz Allen was the ability to be able to maintain a high single-digit to low double-digit organic growth. Now with that said, I understand we have a totally different market environment with the sequestration trigger out there and all these headwinds, but what other changes have you seen in the business relative to those original expectations? And where is the Company seeing the most significant headwinds with regard to how you lined up the fiscal year 2013 topline guidance? Thank you.

Well, I think that the most significant headwinds would be, again, we've laid out our growth markets. We've talked in terms of cyber, healthcare. Talked in terms of national, commercial. We have a major thrust around government effici -- (technical difficulty) effectiveness. We have a major thrust around cloud and cloud analytics. All areas where we have great depth of expertise.

We expect that to continue. If you go to get into some of the more classic [SEDA] work, that we believe, there will continue to be headwinds there because the government grapples with what its spending priorities are going to be.

I will offer in addition to that, that's the number one issue that we're dealing with is uncertainty. And it's not a -- and both the depth of the uncertainty and the length of the uncertainty is probably unprecedented. And if this was a more settled market -- we have our agility and our flexibility, I think, even the latest restructuring which we've undertaken (technical difficulty) the prices to prepare ourselves and then be in the right position to tackle the upcoming markets demonstrates that.

But it's hard to be agile when there's so much uncertainty and our clients themselves don't know where they're going to go and what they are going to do.

If we actually had -- if we had more clarity around that, that would be a much easier operating environment for us, probably for the industry as a whole. But for us it's clearing up the uncertainty is the number one thing because we know we can adapt and be successful under just about any budget circumstance. We just need a budget.

Again, one of the reasons we went through the cost restructuring is to make sure we're ready for what's next, whatever is next, at this point.

That concludes the Q&A portion of the call. At this point I'd like to turn the call back to Ralph Shrader for any closing remarks.

Well, thank you all for joining us this morning and thank you for your questions.

In closing, I'd just like to summarize why we here are very confident about Booz Allen's continued success. We believe that we have the strength, the reputation, and the resilience that comes from nearly a century in this business. And we have the agility, determination, and openness to change that keeps us young.

We're very proud of our performance in what has certainly proven to be very turbulent market. During the third quarter we grew our revenue organically as we have for the past two decades and we grew our earnings both overall and on a per-share basis. Our backlog remains very, very strong with $12.22 billion. And we continue to generate cash at a very impressive rate.

Booz Allen's Board of Directors declared our first quarterly dividend of $0.09 per share which certainly reflects the Board's confidence in our financial strength and our growth potential.

So, we are very excited about the future and very proud of the value that we deliver day after day. This is value we deliver to our clients, to our employees, to our communities and to our investors.

So with that, I'd like to close and say thank you again for your time and your participation here this morning.

Thank you for your participation in today's conference. This concludes the presentation. Everyone may now disconnect and have a great day.