Booz Allen Hamilton Holding Corp (BAH) 2019 Q2 法說會逐字稿

Good morning. Thank you for standing by, and welcome to Booz Allen Hamilton's Earnings Call, covering second quarter results for fiscal 2019. (Operator Instructions) 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've also provided presentation slides on our website 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 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 second quarter 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 included 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 am 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 3-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 3 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 payoff 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 3 years. And third, we believe, we are creating option value over and above those 3-year goals by building new lines of business and new business models that will 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 their organizations and make investments for 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. These 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 a 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-billables, 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 cannot yet quantify financially.

In the second quarter, we reached an important milestone with one of those initiatives. We officially launched our District Defend technology. District Defend 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 prelaunch was very positive, but the true test of the value of this technology will be measured in sales volume. Against our yardstick, it's still too early to tell, but we should have a good read over the next 6 to 12 months. We don't expect significant lift of revenue and 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 2 to 3 years out.

Our clients want secure mobility and in the past, they've often had to choose security over mobility. We believe District Defend 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 District 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 are ahead of the pace we'd set for ourselves and just as important, all the leading indicators -- strong headcount growth and our record backlog, funded backlog and book to bill -- support our belief that Booz Allen 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 3 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 in 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 quarterly 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% and priced options increased 34% to $12.4 billion.

This exceptional performance on bookings reflects an uptick in buying through the end of the government 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 1,119 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 the 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 reflect its 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 2 positive factors: first, our confidence in the execution of our cash strategy; and second, additional cash tax benefits 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 disciplined, efficient capital allocation strategy that aims to deliver both near- and long-term shareholder value. We intend to deploy $1.4 billion over 3 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'll 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 ADEPS 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-billables 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 margin 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 your attention to the recently announced changes to our board.

Earlier this month, we announced that Philip Odeen, who has served in 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 adviser 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 as of last week.

As you may know, Ms. Flournoy is a former Under Secretary of Defense for Policy. She is also Managing Director and cofounder of WestExec Advisors, a strategic advisory firm. And she previously cofounded 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, and 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'm also very proud that with their addition, 8 of our 13 board members are women or minorities. Our record in 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.

(Operator Instructions) And our first question will come from the line of Robert Spingarn with Crédit Suisse.

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 guide -- your guidance for '19 at the midpoint is up around 23%. While you are showing excellent organic growth, is there a catch-up due 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, 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 must have the headcount in. Given our strong headcount performance year-over-year as well as what we're able to achieve in this quarter, that really gives us a lot of confidence of being in the range that we guided at beginning of the year. We're off to a great first half. I mean, 6.4% gross revenue, 8.2% gross revenue ex-billable expenses was really -- since we're focused on ADEPS, is driven by revenue ex-billables. So we're on track for our FY '19 guidance of 6% to 8% and the lead indicators as well as the conversion rates such as provided give us the confidence.

Robert, I'll just add -- let me just add, we're -- 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 multiyear contracts, so they speak of our ability to grow not just now, but in the future.

Well, 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. And in other words, I just want to figure out how to calibrate the 2 going forward, so we know how to read and interpret your backlog?

I think you're asking the right question. I mean, recognize, we have primed over 90% of our work. And therefore, there's going to be a -- so -- 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 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 to our ability to keep growing.

Okay. And then just to finish, with regard to headcount and the 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, D.C. corridor, does that change the talent acquisition dynamic for you and your peers?

So if you start with the headcount, we're 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 an excellent work, and we're going to continue to grow. There's -- we've spoke in the past about increased competition for talent. Given our strategy, we have been competing for technology talent now for a while, and we are, 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 it. Competition makes us stronger.

And our next question will come from the line of Sheila Kahyaoglu with Jefferies.

I guess what -- 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? Or you just being a bit conservative there.

Sure. 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. The -- we're very excited about it. We've shared this technology over the years at the Investor Days, as you know, Sheila, because it's -- we started on this path trying to solve the 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 -- escape -- 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 an operating situation, 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 best [tests]. 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 were going to market with Dell. We are taking it to our federal 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.

And our next question will come from the line of Jon Raviv with Citi.

And Lloyd, just on the -- with ADEPS up 40% so far year-to-date and also we've pointed to higher margin. Just any thoughts that $3 a couple of years out, I know, it's still fairly early, but just, for instance, the 10- to 30- basis point margin expansion seems well within reach at this point. So is there any thought 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 6 months into a 3-year outlook. We couldn't be more happy with where we are right now. But in due course, probably towards the end of this year, we'll comment on a 3-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, and there's soon to be some moving pieces around what budgets are going to be and perhaps, there's going to be a defense budget increase or a cut, 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 an election cycle, there's going to be another budget discussion next October, the parameters for that discussion 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 5 years it is to -- we've learned to operate successfully with turbulence and with uncertainty and with moving pieces and with moving parts. So we're going to be watching all of these closely, but we will remain confident that we know what we're doing, that we're adding value to clients and that we're going to keep driving the business.

Our next question will come from the line of Edward Caso with Wells Fargo.

Congrats on the great print here. Can you talk -- 2 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 pulled back here, any change in your view towards share repurchase or the pace of it?

Sure. Ed, today, we're at about 44% fixed versus floating. Obviously, in a rising interest environment, we've been looking at it and we've planned 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 towards the $1.4 billion 3-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.

And our next question will come from the line of Carter Copeland with Melius Research.

Good numbers. 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 -- how many opportunities are there in the pipeline that are like this? Just in general terms, help us get a sense of 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 product sales like this, there's got to be some volume dependency -- but if you hit your expectations, I'm assuming this will be an offering that has margins that are -- have a relatively large multiple of what your current operating margins are. So I just want to verify that.

Sure Carter. I love that question. So let me start by saying this, this whole notion of option value is predicated on having 4-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 to have a portfolio. But across the portfolio, when you look at the economics, you get 3-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 around immersive and a number of other topics. And we'll talk more in earnings calls as these things evolve, 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 really are going to be at the leading edge, if you're really 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, you're just not pushing hard enough.

Is it fair to say, you hope that a handful of these could hit in the next few years?

Absolutely. I mean, we're not just do this for sport. So -- I'm not saying if they all hit, I'm going to be unhappy. But I think, I'm -- 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 shared 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. The 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 this client base to come up to these kinds of things. And so I like to believe that a number of these will be successful and they will be extremely successful.

And our next question will come from the line of Krishna Sinha with Vertical Research Partners.

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 some 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 billing strategy and growth from net income.

With the IRS tax ruling, it's really an FY '19 impact. And as I said in my prepared comments, for the changes that we've made, we'll continue to make around our operating cash, our operating performance, we're going to continue that going forward. So efficient invoicing, active engagement with payment offices and adjusting our vendor management processes.

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 -- you didn't really call that out as a factor this time, you've mentioned some other things. So I'm just worried if -- or I'm just wondering if that's going to pull the margins down as well as utilization ramp on the new hires?

A little bit, I mean, we -- as I said previously, as part of a seasonal dynamics. But again, we're ahead of expectations and for FY '19, expecting 10%, we're 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.

And our next question will come from the line of Cai Von Rumohr with Cowen and Company.

So District Defend, 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 cost-plus, but this presumably has a much higher margin, because it's proprietary. So how do you price it? Do you price it on higher rate per hours or as a product? And how do you price some of the other initiatives like AI and directed energy?

Cai, I mean, the -- it's early days in all of this. Right now -- or take District as the example, there's SKU pricing for the technology through Dell in different types 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 and profitability from the products themselves and then the -- both the implementation and detail behind it of just -- of 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 operating your desktop for a tablet, is you get to ask questions, like, okay, how do I work more efficiently and more effectively, how do I drive productivity out of that. 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' mission's 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 raises our margins overall if they are successful but also splits the value between us and our clients and 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?

It's -- 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 gets priced will be dependent on their solution, whether it's a software-as-a-service-type pricing, whether it's SKU pricing, whether it gets bundled as a total solution price that has a fixed price contract with some elements of which is labor and some is hardware, we'll -- we're going to be -- we're going to, frankly, be as creative on the business model and the value capture of these as we are on the value creation and the ideas themselves.

What does that imply for your adjusted EBITDA margins? Because you basically are up 50 bps this year. And does it decelerate so you only do 10 to 30 on average over your forecast period? Or with this coming in, does it really give fairly meaningful upside to the margin potential?

Well, I mean, again, 6 months into our 3-year outlook, a bit premature to say, Cai. But as we said back in June, the whole rationale around option value is to exceed the, 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.

And our next question will come from the line of Tobey Sommer with SunTrust.

I'm wondering if you've learned anything in the last 4, 5 months since Investor Day that would shade the 4.5% -- 4.4% TAM growth that you described, either higher or lower?

We're on plan, 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 would both call that right and we're going to continue to drive it. And 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 that it gives us more confidence that we're on the right strategy, and we see this part of our Vision 2020 strategy as the payoff period and quarter after quarter that is reflected in our performance. And 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 and, kind of, contract activity, more recently, have you been able to discern a difference in the cadence of activity between the agencies operating under CR and those with the budget?

Absolutely. With a budget in place, and Horacio has said this previously, it's been many years since we have seen a positive environment. Our clients and prospective clients are aggressively issuing [AR] fees, 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, cybersecurity, system software development and engineering and science. Without a 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 and consultant headcount?

Difficult to say today. I mean, we are targeting 5% for this year and we expect to be there with changes that we've made to our recruiting processes, referral processes, 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 on a long-term basis.

Our next question will come from the line of Tim McHugh with William Blair.

Just wanted to ask a 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 expectation to 10% that we shouldn't extrapolate, I guess, to 2020 or any in the next few years? Just trying to make sure there's -- you're not over-earning in some perspective given the magnitude of the improved outlook on margins.

Sure. We have year-over-year been emphasizing and focusing on our operational performance and we've had now 2 very strong quarters, strong contractual performance, solid cost management, though billable expenses are difficult to anticipate, they've been down and so that gives us the confidence to today raise the expectations to 10% for the year. Stars have aligned, we are continuing to keep our foot-on-the-gas in that direction and expect the improvements that we have made will be recurring. Again, 6 months into a 3-year journey, but for this year, we're confident that we're going to be around the 10% range.

Okay. And then just on, I guess, the [back] business unit area that [Q] shows some information on that, so Commercial up, I think, it was low single digits or so year-over-year and the 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 number is around 27-or-so percent growth, which is consistent with this, kind of, strong growth that we have shown for the last couple of years. And so I would say that business is on track.

And our next question will come from the line of Joseph DeNardi with Stifel.

Well just on the pace of order activity, I'm wondering, if all of the awards that you're expecting to be announced were announced or if you expect them to be -- that wave of order floating gets pushed over the next few months?

We're still expecting a few more that haven't been announced, which is, sort of, typical behavior with our federal market to bill in Q2, which is traditionally our highest quarter, that gives us a lot of -- and the overall growth in our backlog -- that gives us a lot of momentum for the balance of the year, but we're still waiting for a few more to be announced

I'll 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 most visible, but the type of work, which is sound strategy and it demonstrates our uniqueness in the market. I would expect that with a budget, passed on October 1, we may actually see some of the activity spread out over the year more than, sort of, it all end in the fourth quarter of the government fiscal year like it has been in the last few years, but I'm not entirely certain that it will play out exactly that way, logically, it should and it might. But we're seeing good activity on 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 a few question on the budget, just, kind of, specific questions. One, where you surprised by some of the recent commentary for lower defense spending in '20? And 2, do you expect Defense spending in '20 to actually come down? Or it's just some, kind of, the initial bargaining chip?

I would say on this, your guess is as good as mine. There's -- we expect that post-election and after the 2-year deal that just finished, 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.

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 and 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 3-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.

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.