Feb 3, 2012
Executives
Curt Riggle – Director, Investor Relations Ralph Shrader – Chairman, President and CEO Sam Strickland – Executive Vice President and CFO Horacio Rozanski – Chief Operating Officer Kevin Cook – Senior Vice President and Controller
Analysts
Nathan Rozof – Morgan Stanley Bill Loomis – Stifel Nicolaus Brian Gesuale – Raymond James George Price – BB&T Capital Markets Edward Caso – Wells Fargo Securities Tim McHugh – William Blair Company Robert Spingarn – Credit Suisse Michael Lewis – Lazard Capital
Operator
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 in a listen-only mode.
Later, there will be an opportunity for questions. Right now, I’d like to turn the call to Mr.
Curt Riggle. Please proceed.
Curt Riggle
Thank you, Erica. And thank you all for joining us today for Booz Allen’s third quarter fiscal 2012 earnings announcement.
I’m 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 in the disclaimer on slide three, please keep in mind that some of the items we will discuss this morning will include statements that maybe considered forward looking and therefore our 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 services and other factors discussed in today’s earnings release and set forth under the forward-looking statements disclaimer included in our fiscal 2012 earnings -- 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 over to our CEO, Ralph Shrader and he will start on slide four.
Ralph Shrader
Thank you, Curt. Good morning and thank you for joining us today.
It has been an eventful quarter without the question the global economy has been challenging and the financial markets highly volatile. As you also well aware, our primary client, the U.S.
federal government is in the period of significant uncertainty, characterized by funding delays and budget cuts. Yet, despite these challenging macro trends the demand range remains high for Booz Allen’s capabilities and expertise, and we have continue to grow our topline revenue and improve our margins.
Our client 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 on our federal civil, defense and intelligence markets during the third quarter of fiscal 2012.
We have a large backlog of solid work. Now totaling $12.22 billion and a well-positioned in growth areas such as cyber, health, finance and ISR, which is intelligence-surveillance-reconnaissance and we have a strong capability focused on 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 exploration of our non-compete agreement on July 31, 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 $20 -- $23.6 million in the prior year period. Adjusted EBITDA increase 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 dividends subject to discretion of the Board.
Our Board’s decision to initiate a dividend reflects its confidence in Booz Allen 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 costs 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 call overtime.
However, as we look to the future, we believe there will be more uncertainty in our core federal market and we recognize that Booz Allen’s cost position, particularly the cost of our overhead was not sized for the slowing market we see today and believe will continue. Therefore, the actions taken recently are 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 eight consecutive year.
Booz Allen’s spirit of service shines in our employee volunteerism and efforts which over the past quarter have been focused on carrier opportunities and reintegration of wounded worriers 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 U.S.
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 U.S. 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 stream of new wins 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.
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 were proud of our continued organic growth, margin improvements and strong cash flow. As Curt mentioned in his opening summary, in addition to the GAAP results, Booz Allen also result -- 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 non-recurring or unusual items. This is fifth earnings call Booz Allen has held since our initial public offering in November 2010 and I’m 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 want to 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 $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 year period.
The improvement in operating income was driven by continued growth in revenue, increased profitability resulting from decreases in incentive and stock-based compensation cost 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 cost.
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, effect 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 period, while adjusted diluted earnings per share increased to $0.40 per share from $0.27 per share in the prior year period. Now cash is always a favorite topic for CFOs and I’m very proud of Booz Allen’s stable track record of generating cash from operating activities and 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 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 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 assure you we will be good start of cash and will seek to use it to maximize value for our shareholders.
I’d like to turn back 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.
Ralph Shrader
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 and our agility in the marketplace, and the quality of our staff, and our deep commitment and expertise to help our clients succeed.
We believe Booz Allen is positioned well to serve our clients in 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 enabled us to deploy and redeploy leaders against growth areas.
We recently redeployed three of our Executive Vice President against firm wide growth initiatives, Mark Gerencser, a proven business builder to lead our commercial business; Mark Herman, 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 client advanced cyber capabilities.
We’re aligning additional resources against growth market 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 that focuses on strategic analysis, core mission, and an institutionalized approach to efficiencies 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’s 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.
Sam Strickland
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 months and nine months periods ended December 31, 2011. Booz Allen continues to forecast revenue growth and margin movements, 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 forecast 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 forecast for topline 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 expectations that bottom line performance will continue to benefit from low interest expense on our existing debt and an improvement in operating margins. Our intent is to reinvest the 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 a new government fiscal year.
This measured approach to investment 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 federal government now has an approved budget for the current government fiscal year, which reduces some near-term uncertainty.
Curt Riggle
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
(Operator Instructions) Our first question comes from the line of Nathan Rozof with Morgan Stanley. Please proceed.
Nathan Rozof – Morgan Stanley
Good gentlemen. Thanks for taking my question.
Sam, I wanted to ask you a little bit about the guidance, particularly for fiscal ‘13. I know you normally do a very comprehensive bottoms up approach and I was curious about how you incorporating the potential for further budget cuts or sequestration in your outlook for next year?
Sam Strickland
Again, if you take a look, Nate, we have our funded backlog as of December 31st 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.
Here, I think, we all understand that there is a lot of discussion around the sequestration and whether it should take effect and how it should take effect. It’s my understanding that as we -- 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 weapons programs would have some it 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.
We’ve taken a look at our bottoms-up approach. We’ve taken a look at what we see in the pipeline and 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 ‘13, simply because we’re going through a very political time in the country and 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 beat these numbers.
We are holding back some of our cost savings to protect against whatever uncertainties might occur, we might run into in the back half of our fiscal ‘13.
Nathan Rozof – Morgan Stanley
Okay. That’s great.
I’m glad to hear that you’ve kind of de-risked the numbers here. Just as a follow-up question.
Maybe this one is a little bit more for Horacio, but if any of you guys like to chime in. I’m curious, if you has or can you give us any color on how the government procurement officers are reacting to the potential for sequestration?
I know, they have a budget now, 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, I mean if you could give us kind of any update on how they’re behaving, that would be helpful? Thank you.
Horacio Rozanski
Sure. I’ll take a crack about the, it’s Horacio.
The reality is that you can’t answer this question broadly because it’s one of those where you hit the average, but you actually don’t describe our situation, but if we’re trying to characterize it overall. I would say that there’s still a fair amount of uncertainty in the system.
There still a fair amount of caddishness and we’re 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’re still winning work, we’re still doing well, we’re 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’s to come, but in general, the business is proceeding without disruption.
Nathan Rozof – Morgan Stanley
Thanks gentlemen.
Operator
Our next question comes from the line of Bill Loomis with Stifel Nicolaus. Please proceed.
Bill Loomis – Stifel Nicolaus
Hi. Thank you.
Good morning. Just, Sam, the awards in the quarter, just looking at the backlog change sequentially, I get about $800 million in awards, is that right?
Sam Strickland
Yeah. That sounds right, yeah.
Bill Loomis – Stifel Nicolaus
And that was kind of the lowest I’ve seen for at least a couple years of data, 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 kind of expected award activity, anything like that can you give us a sense of future periods award activity?
Thanks.
Sam Strickland
Got you. Well, Bill, 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 30th.
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 the -- it was a default, we would call the different contract.
I won’t go into that. But it was 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, a funded and unfunded, which I think as we’ve talked about in the past what converts to revenue over the next 12 to 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.
Bill Loomis – Stifel Nicolaus
And any kind of like pipeline metrics or any thoughts you can give us about what we might expect now, the budget got passed in mid-December, I assume, we’d be looking at better awards year-over-year for the March and June…
Sam Strickland
Yeah.
Bill Loomis – Stifel Nicolaus
… possibly because of the earlier budget?
Sam Strickland
Yeah. Well, Bill, as, and you know, as you’ve been in this industry a while, as have we all, it generally takes the government around 60 days after the 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, yeah, we’re expecting for the rest of this government fiscal year to pretty much look like the last few government fiscal years.
Bill Loomis – Stifel Nicolaus
Okay. Thanks.
Sam Strickland
In terms of the future metrics, as we talked about in the past, while we have those metrics in-house in terms of the ability to estimate the amount of awards, 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 we -- while we track those numbers internally, it’s not something that we rely on to run the company, simply because there are so many assumptions underlying them.
Bill Loomis – Stifel Nicolaus
Okay. Thank you.
Operator
Our next question comes from the line of Brian Gesuale with Raymond James. Please proceed.
Brian Gesuale – Raymond James
Hey, guys. Good morning.
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?
Sam Strickland
In terms of staffing trends I would say, as we point out, we did go through restructuring in January that did involved taking out both the client staff, where we did not have a near-term work and this is around -- not around capability but around skills sets. I think as we talked about in the past, we have markets that are growing substantially and markets that have flatter and/or indeed shrinking.
So, as we -- so having to adjust our skill mix. I would expect that our staffing at March 31st will be below December 31st, and then that will bill between April 1st and the end of the government fiscal year.
Beyond that let’s see what happens with government fiscal year ‘13, which starts next October 1st. Are we going to be in a continued resolution, god forbid, are people going to talk about shutting down the government as they go through the political process.
So but it’s a little early to predict what we might do there. So we are feeling -- look for government fiscal year ‘12, which is the first half of our fiscal ‘13, we have a 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 unfunded 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, Brian, one of the things we tell our clients and one of our catchphrases is helping our clients get ready for what’s next, and that’s really what we have been doing here.
And what’s next for us starts in the next government’s fiscal year. We’re trying to make sure that we are lean and agile as we go into that.
We are optimistic. We feel like we’re well-positioned from a growth market standpoint.
Let’s just, we will have to see what happens and react accordingly there.
Brian Gesuale – Raymond James
Okay. 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 towards 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 a color around that?
Horacio Rozanski
Brian, I’ll 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 IDIQs and then our ability to sell task orders under that.
We believe that to be a strength and something that we 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’s much more flexible. And so it also de-risks 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 in either in that direction or away from that direction. We’re just running the business consistent with our philosophy.
In terms of, what’s happening from best value to low pricing technically acceptable, I think, we’re -- 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 its -- that dynamic I think is still in progress and 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 be based more on quality and price and the services that are further away from the mission and the periphery of support where they actually try and save money. And so that’s the approach we’re taking.
That’s why we -- Ralph talked of our core mission, we talk of our 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.
Sam Strickland
And, Brian, I can just to build on that, I would say, you go through this and as 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 we’ll continue to firstly 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 then the things we’ve achieved with our recent restructuring is, is more flexibility around our ability to do just that.
We believe being focused on growth areas that we’ll continue to support the pricing and the margins that we’ve followed in the past, but we are well-positioned to defend, let’s call it legacy markets that we believe are that are important to maintain.
Brian Gesuale – Raymond James
Great. Thanks for the color guys.
And I think the dividend announcement is a very big positive.
Sam Strickland
Glad you like it.
Operator
Our next question comes from the line of George Price with BB&T Capital Markets. Please proceed.
George Price – BB&T Capital Markets
Hi. Thanks very much.
Good morning, everyone. Wanted to ask you first about just from the guidance for the remainder of the year, clearly we’re, you’re reiterating 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 that the low end of the range as I do the back of the envelope even maybe decelerating bit further quarter-over-quarter in the fourth quarter and just curious if you could give us a little bit more color about what happened.
I mean obviously, I know there’s a lot of uncertainty, but clearly something changed fairly significantly in the near-term?
Sam Strickland
I think there are two factors and one of the reasons we wanted to highlight that billable expenses and 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. That’s what we believe is important to the success of our business for a couple of reasons.
One, it’s what drives our margin, it’s what covers our overhead, we get our biggest fees from that, and what’s important there is that 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 that just completed, our pass-through cost or 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, right. If you may recall, we sold our state and local transportation business.
That costs us about 1% on the topline for the quarter. But, 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, it’s -- 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 continue to come in at the mid-single digits.
That will be while not exceeding the first half, it certainly will be very comparable with 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.
George Price – BB&T Capital Markets
And just kind of following-up on that, Sam, what’s the direct labor revenue growth expectation now implied in the fiscal ‘12 and fiscal ‘13 guidance?
Sam Strickland
Well, again, we’re talking in terms of mid-single digits for the fourth quarter for fiscal 2012 and then, we have not changed our expected mix of direct labor and billable expenses for 2013 at this point.
George Price – BB&T Capital Markets
Okay. And then, lastly, if I could just ask you, a little bit more specifically maybe in your fiscal ‘13 assumptions, I mean 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 in terms of the expectations there?
Do we get some level of additional cuts? Is that at sequestration level or 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?
Sam Strickland
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 are that we will not have across the Board reductions we will have -- there will be some agreement around more strategic approach to cost cutting. Again, we have focused our growth and our investment resources in growth areas, which we believe should do well even in a reduced cost environment.
So, but I can’t tell you that we have a consensus around is going to be the full $1.2 trillion over two year -- 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 can run it out on a couple of different scenarios but we feel like that the business we have in hand, the business that we see on the future and let’s call it, some of the hold back from our recent restructuring. Some of those costs that we’re going to invest part of that into these growth markets, we’re 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 will tell you, we’ll hopefully have a little more clarity as we get towards the end of the summer, but at this point I…
Horacio Rozanski
Let me if I can help…
Sam Strickland
Anybody, yeah.
Horacio Rozanski
… 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’re seeing in Sam’s guidance is essentially the middle of the road that assumes, that yeah, there are some, what do we see in the horizon, what do we think can happen and then there are some parts that where we have some downside, there are some parts that have some upside.
So we feel like we have tried to capture sort of the middle of all of that. Some of our growth markets probably would do very well and may be better than we’re planning.
Some other places probably will be hurt by the fiscal ‘13 process. So, we’ve tried to capture both sides of that in the numbers that you’re seeing.
George Price – BB&T Capital Markets
Let me just try and put it down a little bit more specifically and then I’ll turn it over. Do you -- are you assuming some level of additional cuts beyond the currently reflected BCA caps, not amount, not whether it’s sequestration or not, just something we’re going to get an additional round of cuts if some amount beyond what’s currently in the budget?
Sam Strickland
Yeah. I think, I believe that the conventional wisdom is that there will be some additional cuts for government fiscal ‘13.
George Price – BB&T Capital Markets
Okay. Got it.
Thank you.
Operator
Next question comes from the line of Edward Caso with Wells Fargo Securities. Please proceed.
Edward Caso – Wells Fargo Securities
Hi. Thank you for taking my call.
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?
Horacio Rozanski
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 area in terms of finding people. I see now there’s always some challenges around the time that it takes to get people clear than all of that and in -- 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, where we waited for the continuing resolutions and then everything happened once in terms of awards and then everything had to start all at once before the next continuing resolution, 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 idea of we’re operating 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 location that you need them.
So, we’re really going back to our basic operating philosophy and this year in particular, we have the advantage that we actually have a sign budget. So, part of the reason, Sam talked about labor before, the way he did is, that actually should allow us to, in addition to the addition of the restructuring and the cost savings, run the business at or above the billability parameters that we like to see.
So, from the labor perspective, we’re -- I think we’re in a very good place and like I said, the talent of our workforce that’s existing and the talent that we can capture out there is quite good.
Edward Caso – Wells Fargo Securities
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 sort of in your back pocket at the stock as a difficult period, but the dividend sort of 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 in doing acquisitions?
Sam Strickland
Well, as I think you know, Ed, we have not done acquisitions. Our growth for 17 years, actually probably our growth for 25 years has been the results 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’s 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.
But 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, there is -- but we don’t…
Ralph Shrader
Bottom line is that by declaring the dividend, we don’t take anything off the table.
Sam Strickland
Yeah.
Edward Caso – Wells Fargo Securities
Right. Thank you.
Operator
Our next question comes from the line of Tim McHugh with William Blair Company. Please proceed.
Tim McHugh – William Blair Company
Yeah. 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 kind of talked about, but yet you’re also saying kind of this restructuring program you’re holding back some of the savings.
I just wanted to try and understand what’s assumed in 2013?
Sam Strickland
Again, as we’ve 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’ll hold back some of that.
If our topline 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 in margins.
We do have some downside cushion, particularly if our billable expenses are not -- in other words, if that’s -- if we see that continue to drop as a percentage of our overall revenue, that of course, will help our margins, that’s 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 than some of 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.
Tim McHugh – William Blair Company
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?
Sam Strickland
Well, certainly that commercial and international will help. I mean, as it seems right now, that’s less than 2% of our business and we think, it’s insignificant to talk about.
We’d rather wait until we actually had a very robust commercial and international market that will have a meaningful impact. But even at 2% it does help a bit.
Tim McHugh – William Blair Company
Okay. Thank you.
Operator
Our next question comes from the line of Robert Spingarn with Credit Suisse. Please proceed.
Robert Spingarn – Credit Suisse
Good morning.
Sam Strickland
Good morning.
Robert Spingarn – Credit Suisse
Sam, could you talk a little bit about the tax rate in the quarter in your guidance and how that may have changed throughout the year?
Sam Strickland
Well, I’ll make a crack at this 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 earning, 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 tax issues get resolved. That enables us to release reserves.
So I don’t think our fundamental tax rate has changed and yet the accounting around closing out these prior year audits and then the ability to release reserves against that is what’s causing the GAAP tax rates to move around. I think, if you look at the adjusted EPS numbers, you’ll see the tax rates are fairly constant.
Kevin, I don’t know if I get that close to…
Kevin Cook
You’re spot on, Sam, the year-to-date effective tax rate was 26.4%, in Q3 it was 27.2% and we had in both Q2 and Q3 we were able to release those -- some of those FIN 48 tax reserves. FY ‘13 we would expect our rate to be up in the 40.5% range.
Robert Spingarn – Credit Suisse
And Kevin, what are you looking for this year, are you still at 33.5%?
Kevin Cook
I’ll probably come down a bit, closer to 30%, rough.
Robert Spingarn – Credit Suisse
Okay. And…
Sam Strickland
Only to say, again, that’s one of the reasons though that we do report out 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 that let’s call it the non-operating issues.
Robert Spingarn – Credit Suisse
Right. Right.
Well, thanks for that answer, and on a slightly different topic, to go back to billable expenses and you -- 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’s 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?
Sam Strickland
Well, that 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, what, if you took a look at the third quarter, all about $30 million of our quarterly billable expenses is subcontracts and in fact, subcontracts expenses, pass-throughs were virtually flat in this December’s quarter compared to last year’s December quarter. Let see, 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 topline, I’m sorry, with the bottom line look is that that is driven heavily by our labor sales and again, we have reasonable insight into that.
Robert Spingarn – Credit Suisse
Okay. And then just a final question.
This goes back to the growth in the second half, not perhaps quite as high as you would hoped it would be earlier, but then again, you’ve got this visibility into fiscal ‘13. So, just to clarify, some second -- some H2 ‘12 business moving into ‘13?
Sam Strickland
Some H2 ‘12, you’re talking about our…
Robert Spingarn – Credit Suisse
Are your revenues being pushed to the right?
Sam Strickland
Yeah. I got you.
I’m going to say, well, I think that is the case throughout industry. Clearly, and certainly when we were doing 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 ‘13 as well.
Robert Spingarn – Credit Suisse
Okay. Thank you very much.
Operator
Our next question comes from the line of Michael Lewis with Lazard Capital. Please proceed.
Michael Lewis – Lazard Capital
Good morning. So I’ll ask the standard two questions here.
First, I want 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 slowdown specifically in that area.
Are you witnessing that, is that having an impact on the topline versus your original plan?
Sam Strickland
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 little bit slowdown.
I don’t think there has been particularly a slowdown in the revenue, I’m sorry, in the, let’s called the labor sales under that contract.
Michael Lewis – Lazard Capital
Okay. And then, just more of a qualitative question, originally, while we were going through the IPO process.
I think your expectation for Booz Allen was the ability to be able to maintain a high single 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 of 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 ‘13 topline guidance? Thank you.
Sam Strickland
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, we’ve talked in terms of international, commercial, we have a major thrust around government efficiency and effectiveness, and we have a major thrust around cloud and cloud analytics, all areas where we have a great depth of expertise. We expect that to continue.
If you get into some of the more classic (inaudible) work that we believe there’ll continue to be headwinds there as the government grapples with what its spending priorities are going to be, so.
Horacio Rozanski
I will offer in addition to that 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, it’s -- we have our agility and our flexibility, I think, given the latest restructuring which we’ve undertaken really not triggered by a crisis but to repair ourselves and be in the right position to tackle the upcoming markets demonstrate 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’re going to do.
If we actually had when 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 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.
Sam Strickland
Again, one of the reasons we went through the cost restructuring to make sure we’re ready for what’s next whatever is next at this point.
Operator
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.
Ralph Shrader
Well, thank you all for joining us this morning. 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. And we believe that we have the strength, the reputation, the resilience that comes from nearly a quarter of -- nearly a century in this business.
And we have the agility, determination and openness to change that keeps us young. We are very proud of our performance in what has certainly proven to be a very turbulent market.
During the third quarter, we grew our revenue organically as we have for the past two decades. We grew our earnings both overall and on a per share basis.
Our backlog remains very, very strong with a $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.
But we are very excited about the future and very proud of the value that we deliver day after day and 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.
Operator
Thank you for your participation in today’s conference. This concludes the presentation.
Everyone may now disconnect. And have a great day.