Jan 28, 2015
Executives
Curt Riggle – Vice President, Investor Relations Horacio Rozanski – President & Chief Executive Officer Kevin Cook – Senior Vice President & Chief Financial Officer
Analysts
Carter Copeland - Barclays Bill Loomis - Stifel Steven Cahall - Royal Bank of Canada Timothy McHugh - William Blair & Company Jonathan Raviv - Citi Edward Caso - Wells Fargo Denny Galindo - Morgan Stanley Robert Spingham - Credit Sussie
Operator
Good morning. Thank you for standing by.
And welcome to the Booz Allen Hamilton's Earnings Call Covering Third Quarter Results for Fiscal 2015. At this time all lines are in a listen-only-mode.
Later there will be an opportunity for questions. I'd now like to turn the call over to Mr.
Curt Riggle.
Curt Riggle
Good morning. And thank you all for joining us today for Booz Allen's third quarter fiscal 2015 earnings announcement.
We hope you've had an opportunity to read the press release for our third quarter earnings that we issued earlier this morning. We've also provided presentation slides on the website and we're now on slide 1.
I'm Curt Wriggle, Vice President, Investor Relations and with me to talk about our business and financial results are Horacio Rozanski, our President and Chief Executive Officer and Kevin Cook, Senior Vice President and Chief Financial Officer. As shown on the disclaimer on slide 2, please keep in mind that some of the items that 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 services and other factors discussed in today's earnings release and set forth under the forward-looking statements disclaimer included in our third quarter fiscal 2015 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 will 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 third quarter fiscal 2015 slides.
It's now my pleasure to turn the call over to Horacio Rozanski, our CEO and he will start on slide 3.
Horacio Rozanski
Thank you, Curt. And thank you all of you for joining us.
Let me being by saying how proud and humbled I am to lead this remarkable institution as begin our second century in business. I am fortunate to be surrounded by a highly skilled and experienced leadership team that is both managing the business exceptionally well and executing our ambitious strategy for the future.
Today Kevin and I will take you through our third quarter results, and how we view them in the bigger picture. Then, as in recent calls, I will talk a bit about our progress on the Vision 2020.
The growth strategy we launched over 2 years ago. As you saw in the press release this morning, we have good news to report for the third quarter.
This reflects what we believe is the beginning of a recovery in the government contracting market, which is improving our revenue and backlog. The market is not yet growing, but the decline is easing.
Clients are feeling less budget uncertainty which allows them to focus more on mission and at the same time prices are beginning to stabilize. Having said that, we're still operating in a highly competitive environment, on both pricing and demand.
And of course, there remain significant political uncertainty as we look ahead to congressional debates on the federal debt ceiling and the government’s fiscal 2016 budget. In this environment, our focus is two fold, gain market share by being an essential partner to clients, which are already is stabilizing our revenue base and investing capabilities on markets that best position us for the long-term vis-à-vis our competition.
This combination, gaining market share, investing for the future will create sustainable quality growth. We are not simply taking an easy road, looking for short term revenue gains.
We're playing the long game, pursuing a multi-year strategy and making necessary investments. It may take some time to reach sustainable quality growth.
But this approach ensures that Booz Allen remains what it has always been, the differentiated leader in our industry. With that as backdrop, let me give you the financial headlines.
Third quarter revenue was $1.3 billion, compared with $1.27 billion in the prior year period, a 2.5% increase. This gain must be viewed in context, when we factor in the estimated $30 million revenue impact of last Octobers 16 day government shutdown, our revenue is roughly flat.
Still, represents continuing improvement in our top line as it follows diminishing revenue declines in the first and second quarters of this year. Adjusted diluted earnings per share was $0.36 for the third quarter compared with $0.33 per share in the prior year quarter.
We saw positive trends in adjusted EBITDA margin, day sales outstanding and funded and unfunded backlog. We also have a seasonally strong book-to-bill ratio.
We are revising our guidance for the fiscal year, raising our top line revenue and narrowing our bottom line ADEPS [ph] with an increase to the midpoint. We're announcing an increase to our share repurchase authorization, which now totals $180 million.
We're also announcing an 18% increase in our regular recurring quarterly dividend, beginning this quarter it is $0.13 per share which reflects both our confidence in the business and our commitment to return value to our shareholders. Before turning the call over to Kevin for more detail on our results, I want to take a moment to highlight an extraordinary accomplishment of the men and women of Booz Allen.
December 31st, marked the end of our Centennial Community Challenge. A year long campaign in which we challenge our staff to give at least 100,000 hours of volunteer service to their communities.
As it is usually the case of Booz Allen, our people charged way past our goal. They volunteer more than 155,000 hours benefiting nearly 1500 non-profit organizations across the country.
Josh Guenther, our associate in northern Virginia, was our top volunteer with nearly 3700 hours as a firefighter and animal rescue volunteer. Together, our top three volunteers gave more than 9,000 hours.
We're incredibly proud of the lasting impact our staff made in celebration of our first 1000 years. And I know that we'll carry the spirit of service forward.
It is fundamental to our culture and success at Booz Allen, one of the truly special things about working here. Let me at this point turn the discussion over to Kevin, who will walk you through our third quarter in greater detail.
Kevin Cook
Thank you, Horacio. As Horacio noted, we've delivered a strong third quarter in fiscal year 2015 with growth both – at both the top and bottom lines.
We are experiencing a more stabilized government spending environment as a return – result of a return to budget uncertain – to budget certainty, even if only for the remainder of government fiscal year 2015. Our 2.5% revenue growth in the quarter is a result of a number of factors, including the improving environment.
However, I want to repeat Horacio's comment that when you adjust for the estimated $30 million impact of last year’s government shutdown, the quarter was relatively flat. That said, we are pleased to see that the third quarter continues the sequential trend of lower rates of revenue decline.
Additionally, margins were up as expected and we saw growth in funded and unfunded backlog and a seasonally strong book-to-bill ratio. I echo Horacio's point that all of these positive outcomes give us confirmation that we are on the right track and that our long-term strategy of investing smartly today to drive sustainable quality growth for the long-term is the right approach.
Operationally, we saw continuing strengths in the third quarter, staff productivity remains high. We are maintaining effective management of our cost structure and we continue to experience solid profitability on contracts and task orders.
In fact, the third quarter saw the first quarterly organic net gain in consulting staff headcount in more then 3 years. We continue to lean forward on hiring to take advantage of our backlog of work and to build the bench for opportunities that lie ahead.
Now, I'd like to go through the specifics of our performance in the third quarter, so please turn to slide 4. The 2.5% revenue growth was a result of an improved government spending environment compared to the year ago period which was impacted by the 16 day government shutdown.
Specifically the increase over the prior year was the result of an increase in staff billability, which drove an increase in billable hours and an increase in billable expenses. Before I leave revenue, I'd like to point to out, that we saw an increase in the percentage of fixed price revenue in the quarter.
The factors that contributes to this increase primarily include delivery of equipment on a government contract that was converted from cost reimbursable to fixed price during the first half of fiscal 2014 and revenue increases from 2 fixed price commercial contracts. So the situation also contributed to the increase in operating income and operating margin in the third quarter.
We do expect the percentage of fixed price revenue to return to a more normalized level in the fourth quarter. Operating income increased by 8.5% and adjusted operating income increased by 7.2% over the prior year period.
These increases are attributable to revenue improvements, including the increase in fixed price revenue I mentioned a moment ago, lower aggregate compensation and related benefits based on lower headcount when compared to the prior year period and to a lesser extent a decrease in depreciation and amortization expense. The operating income improvements were partially offset by an increased level of bid and proposal activity in the quarter, as well investments in growth platforms.
This increase in investment activity was expected and is consistent with the ramp up that we previously indicated would occur in the second half of our fiscal year. Adjusted EBITDA margin of 9.2% for the quarter benefited from effective management of staff productivity and the qualification for certain federal and state tax credits, a portion of which benefits our indirect rates and therefore benefits EBITDA.
Year-to-date, the adjusted EBITDA margin of 10.6% is inline with our forecast and as occurred last year reflects an expected decline in the second half as a result of higher indirect spending and higher costs for fringe benefits, including holidays and paid time off. The factors that drove the increase – increases in net income and adjusted net income compared to the prior year period were largely the result of the factors affecting operating income and adjusted operating income.
In the third quarter, diluted earnings per share increased to $0.35 per share from $0.31 in the prior year period. Adjusted diluted earnings per share increased to $0.36 per share compared to $0.33 in the prior year period.
The per share earnings were driven by the same factors as net income and adjusted net income. Turning to backlog, while the December quarter is a seasonally light award quarter for our business, you should note that our 0.36 times book-to-bill ratio was a significant improvement over the December quarter prior to fiscal years.
Total backlog declined by 3% over the prior year period. However, within the overall backlog, funded increased 7% to $2.7 billion and unfunded backlog increased by 1.4% to $2.7 billion.
The decline in overall backlog was therefore driven by a decline in priced options. A primary driver of this priced options declined is the timing of contract transitions and extensions.
Next, let's talk about cash. Cash balance at December 31st reflects payments for two acquisitions, the repurchase of 1 million shares of our stock and the one time payout of the deferred executive compensation plan all of which occurred during the quarter.
Free cash flow in the first three quarters of fiscal 2015 declined 24.8% over the prior year period to $210.6 million. Although collections were strong in the quarter as reflected in the decrease in day sales outstanding, the overall accounts receivable balance is down year-over-year as a result of revenue declines.
With that, I'll turn it back over to Horacio and please turn to slide number 5.
Horacio Rozanski
Thanks, Kevin. Now as we've done in recent quarters, I would like to highlight a few developments under our long-term strategy.
You may recall that Vision 2020 is a comprehensive second century growth strategy that we described in three building blocks. First, expanding our capacity to serve as our client’s essential partner, through a combination of deep domain understanding, market leading consulting expertise and broader technical capabilities.
Second, investing in differentiated growth platforms, including engineering, system delivery, cyber, advanced analytics, our innovation agenda, and the commercial international markets. And third, building distinctive business and people models to support those growth platforms.
Today I'll focus my remarks in two areas particular, international and engineering. We announced last summer a significant expansion of our business in the Middle East and North Africa, where we see market growth and margin opportunities.
That business is already showing great potential. Today, I am pleased to share news that we have opened a regional Southeast Asia office in Singapore.
Initially, we will focus on building business in Singapore, then broaden to Indonesia, Malaysia, Thailand, Vietnam and possibly other countries in the future. Applying lessons learned from our entry into the Middle East, we will start with a small core team and focus on offering clients our unique blend of general management consulting, combined with technology, cyber and analytics expertise.
Let's turn now to engineering. Applicable to great technical content in the work we do is central to our growth strategy.
Clients are demanding it and we need to deliver. This was the reason for our acquisition in little over 2 years ago the significant engineering capability now called Booz Allen Engineering Services or BES.
Under Joe Logue, the leader our defense and intelligence group, we have seen excellent performance from BES among its called client base and we're extending its services to markets across our business. To give you the big picture, our opportunity pipeline for engineering has grown by 30%.
Government spending has declined in 2 years since we made the acquisition, yet BES has maintained gross revenue year-over-year and improved profit margins. Also BES is winning new areas of work for us, including a $413 million air force contract and it plays on the $22 billion Department of Homeland Security Eagle IDIQ contract.
Let me give you a few tangible examples of the engineering solutions we're delivering across our client base. Working with The Defense Department, we reverse engineered, the damage that improvised explosive devices inflict on mine resistant ambush protected vehicles or MRAPs.
We then modify the vehicle design adding more safety exits. This improvement will not make a MRAP safer, but can also be incorporated into future vehicle designs.
In the area of systems engineering and integration, we applied a new approach to the Air Force's operational launch range systems, an innovation that transformed how the enterprise operates. Through these multi-year effort, the Air Force space command now has extensive documentation for aging systems, a better decision making process driven by data and million of dollars in annual cost savings.
That success has led to additional business for us related to the nation’s space launch infrastructure. A final example is VAMPIRE, a device that conducts real time forensic analysis in the field.
It performs onsite fingerprint identification and matching analysis in just seconds. Innovations of the product are underway, by federal law enforcement, defense and intelligence agencies.
VAMPIRE is opening doors to new clients and changing the brands with current ones. Put simply, these innovations deepen and expand our ability to serve our – to solve our clients of his problems, and we are proud that this early in the game VAMPIRE was awarded Law Enforcement Magazine's Hot Products of 2014.
As we create and demonstrate these and other engineering solutions, we see more and more opportunities to provide them to clients in the US and internationally. It is early days, but I am excited about the progress we're making.
Importantly, all of our Vision 2020 investments are enhanced by our innovation agenda, led by Karen Dahut, who oversees our strategic innovation group. As we approach the third year of the SIG, we're beginning to move innovations that are developed or scaled within the SIG into new markets.
You can expect to hear more about the impact of our market driven innovation in future calls. Retuning now to the financials, Kevin will give our new guidance for 2015.
Kevin Cook
Thanks, Horacio. Before I talk about guidance, I want to note how pleased I am with our announcements today that we're increasing our regular quarterly cash dividend and increasing our share repurchase authorization from $30 million to $180 million.
The increase of the quarterly recurring dividend represents our confidence in our business and the success of our business model, relative to the share repurchases, our intent is to keep the diluted share count relatively stable over time, and the approval we are announcing today provides the authorization necessary to execute on this intent. Please now turn to slide 6.
For the full year of fiscal 2015, we are increasing our top line revenue guidance from a mid-single digit percentage decline in revenue to now reflect our expectation for a low single digit percentage decline. At the bottom line, we are narrowing the range by increasing the bottom end of our guidance.
We are now forecasting our full year diluted earnings per share to be in the range of $1.52 to $1.56 per share and adjusted earnings per share to be in the range of $1.58 to $1.62 per share. Let me also point out, that in the fourth quarter of fiscal 2014 we realized $0.025 associated with qualification for certain state and federal tax credits.
This year we again qualified for these credits, however the benefits associated with these tax credits were realized in the second and third quarters. Now, I would like to turn the call back to Curt, so we can move to the Q&A portion of our call.
Curt Riggle
All right. Thank you, Kevin and Horacio.
Shannon, at this point can you provide instructions for the question and answer portion of the call.
Operator
Sure. [Operator Instructions] Our first question is from Carter Copeland of Barclays.
You may begin.
Carter Copeland
Hey, good morning guys and good quarter.
Horacio Rozanski
Thank you. Hi, Carter.
Carter Copeland
Just – a couple of questions regarding your comments Horacio on the growth agenda. First off on the expansion into Southeast Asia, can you kind of give us some color around what the thrust of that effort is, at least, from a capability basis, relative to what you were doing in the Middle East and North Africa?
And secondly, you mentioned that we'll hear more about capabilities to come out of the SIG in the coming quarters. So are they from a high level particular end markets or customers sets that were most likely to see those kind of first capabilities going to?
Horacio Rozanski
Two great questions. On the international expansion, our view regarding Southeast Asia based on the work we've done there as we prepare to launch, is that the capability requirements and the – call it the cocktail that is creating the success in the Middle East will apply there just as well.
The notion that we bring in, the traditional management consulting expertise, blended with the ability to bring in through technologist cyber experts and analytics, especially in the big data side is where we think the sweet spot is going to be. In addition as you probably a number of companies have set up during their innovation centers in Singapore and the fact that we have a strong innovation agenda and a lot to say about that, we believe we'll be of value.
And so that’s our starting point and then we will go from there based really on what the clients demand, much like we've done elsewhere. With regards to the SIG, I think the way to think about the SIG is not about specific end markets, but really about building capabilities and building innovations that apply to the vast majority of clients.
There is really the MO is, and part, coming up with new things in the SIG, but in large part, looking for things that we're doing already for our client that are truly breakthrough, some breakouts and figure now how we can make that service or that offering available to the breadth of our client base. And that’s where the success has been and that’s probably where the success will continue to be.
So its really a play, a horizontal play if you will across the entirety of our markets that we're focused on.
Carter Copeland
Is it – should we think about it as taking a capability primarily from one end market to another, as opposed to developing new kind of breakthrough technologies or what's the more likely thing we'll see?
Horacio Rozanski
I think you're going to see all of the above and in addition to that, you're going to see us leveraging the alliances and partnerships that we're forming with our innovators to be able to be a channel of those innovations into the federal market place. So it’s really where do we find the best ideas, whether internally because we're doing them, rather we create them externally to focus on solving our clients of his problems.
That’s really the core of what we do and that’s what the SIG is, is really helping us leap forward on.
Carter Copeland
Okay. Great.
Thanks. I'll stick to.
Horacio Rozanski
That was free by my…
Carter Copeland
The follow up, the follow up in a different way. Thanks, guys.
Operator
Thank you. Our next question is from Robert Spingham of Credit Sussie.
You may begin. Robert Spingham, your line is open.
Please check your mute button. Our next question is from Bill Loomis of Stifel.
You may begin.
Bill Loomis
Hi, thank you. Good morning and congratulations on some good results.
Horacio Rozanski
Thank you.
Bill Loomis
Just Horacio, can you – you mentioned a couple of times prices are stabilizing and Kevin did, what do you mean by that, is that the competitive pressures have cooled off a little bit or clients pushing less to lowest price technically acceptable, what are you seeing to cause you to say that?
Horacio Rozanski
Bill, my sense is that the – first of all the competitive pressures are still extremely strong because the market is declining. And so there is more capacity and demand if you will.
But having said that, we are beginning to see in some parts of the market that when very strongly into everything LPTA early on, and have some of the missions be affected by the over reliance of that mechanism. And so we're seeing something’s come back as value or qualified in a different way, so that quality really enters into the equation much more strongly.
It’s not through everywhere, not – these – we tend to talk about these markets, market as if its one thing and it really isn’t. Its lot of different sub-markets and accounts, each one of them, with its own dynamics.
But on their whole and on the main, the movement towards LPTA well, the number of contracts that are like that is still very high, it doesn’t seem to be accelerating anymore.
Bill Loomis
Okay. And on the bid pipeline, you certainly, you know, you talked about customers more comfortable on funding.
How do you see – can you give us any sense of, thus you have outstanding and what that pipeline looks for you, do you expect pick up in awards here in your final quarter or how do you see that playing out over the next couple of quarters?
Kevin Cook
Hey, Bill. It’s Kevin.
The pipeline is fairly for – I think what we're seeing, I mentioned earlier that we have seen some increase in bid proposal cost in our third quarter ending December 31st. That’s a bit unusual, as you know there is a ramp than marketing bid proposal leading up to the September 30th quarter end at the end of the government of fiscal year.
But we would – we kind of look at it as on those days a smaller, but a second bidding season that we're going through right now, specifically in the civil market with also some ramp up in defense, intelligence market as well. So, how it goes, even if awards are made, there is protest.
And so I think we're very much more optimistic that we were those time last year I'll say that. And I would look for a continuing awards.
Horacio Rozanski
Bill, the macro point I would make is, we've said all along that its not size of the market, that affects our ability to compete, is our clients uncertainty about their budgets. And as the budgets have become a little more certain clients can begin to set priorities and spend money on things that matter because they know they are going to have it, can turn back to delivering on mission and looking for quality in the places where they really need because it’s central to their mission.
That’s the dynamic that we're hoping will continue its stability, remain aside, also said in the remarks, we're all thankfully aware that the political processes are not stable yet and that we're going through a debt ceiling debate, we're going through a new budget for next year and that could change the dynamic. But right now it is comforting to see clients really be able to plan and execute their mission with a little more certainty in the past.
That’s where we play best.
Bill Loomis
Okay. Good.
Thank you.
Operator
Thank you. Our next question is from Cai von Rumohr of Cowen and Company.
You may begin.
Unidentified Analyst
This is Lucy dialing in for Cai. So you talked about some of the initiatives on the international front.
Can you maybe provide an update on the other end markets, defense Intel, civil and commercial?
Kevin Cook
Sure. This is Kevin Cook.
We are seeing demand coming out of our civil market and a variety accounts from health to other civilian agencies strong demand in commercial space which you may or may not know, but we kind of house that within our civil market. So, in the civil space, specifically and that’s a variety of capabilities, whether its software development or others.
In the defense space, I think it goes back to what Horacio was just saying, the clients are more comfortable with the budget levels they've been operating in this mode for a while. There is less uncertainty.
So, we are seeing a pick up across the board actually in many sub-accounts as we call them air force, army, et cetera. So its pretty broad based I would say and especially I would highlight demand in the commercial space in a variety of vertical markets in commercial.
Unidentified Analyst
And then secondly, maybe just, on an adjusted basis you saw flat revenues year-over-year in the quarter, you've sort of hinted was the increase in headcount that you were expecting revenues to pick up gradually here, can you maybe speak to the cadence as how you are expecting that to happen over the coming quarters, would that be head of your peers, et cetera?
Kevin Cook
Well, there is lot of variability that goes into that, different contracts want a different point, so the year – it is going to be choppy. We can’t say that with the 2.5% organic revenue growth this quarter albeit flat when you factor in the $30 million from the government shutdown a year before.
That doesn’t mean that we're going to see growth every quarter from here one out. We'll give our FY 2016 guidance on our earnings call at the end of May.
As Horacio mentioned, our potential road bumps along the way with the debt ceiling debate, as well as the government budget for their fiscal year 2016. So, we're going to take the next 3.5, 4 months, evaluate all that and give you an FY 2016 revenue forecast when we get together again.
Operator
Thank you. Our next question is from Steven Cahall of Royal Bank of Canada.
You may begin.
Steven Cahall
Yes. Thank you.
Maybe a first question on cash deployment. So you raised the dividend, you spent more on share buybacks in the quarter than we've seen for probably ever and increased the authorization and your largest shareholder may or may not have been a big fan of special dividend, is now below 50%.
Is it fair for us to think about this as a turning point in cash deployment with possibly incrementally more M&A ahead, as well as a much bigger focus on the recurring dividend and the offsetting share Creek from here?
Kevin Cook
Hey, Steve. Its Kevin.
No, I would not view it as a turning point or an inflection point. Our commitments are the same priorities, operating cash, followed by recurring dividend then the preference for M&A.
We've talked about it before where we're somewhat choosy. We're looking for capabilities, not just revenue.
It has to be a good culture fit and as they priced reasonably. So we continue to look activities picking up, after acquisitions I would say we're still looking at special dividends, share repurchases.
As I said in the commentary leading up to the Q&A, this doesn’t mean that we're going to shift from special dividends to share repurchases. What we're really trying to do here is try keep the share count relatively flat, so that it doesn’t put any downward pressure on the earnings per share going forward.
It doesn’t mean we're moving away from special dividends at all. It’s just another mechanism we have to deploy capital.
Steven Cahall
Okay.
Kevin Cook
I don’t see us paying debt anytime soon, as well as the interest rates are.
Steven Cahall
That’s very helpful. And then maybe just as a follow up, as we think about what the guidance implies for the fourth quarter, just kind of looking at the mid point numbers, I am guessing like historically with the nice revenue pick up you're going to have a lot of headroom on the general and administrative expenses line to pick up your cost there.
When we think about how you allocate that, you've got a lot of bid and proposal out there, I am very sure you spoke a lot about the opportunities in terms of organic capability growth. So how do we think about the allocation of some of those general expenses over the next quarter?
Kevin Cook
Steve, normally we don’t talk about the quarter, but since you've probably got three quarters of actuals and you've got our full year guidance, I'll give you a little color. We managed – the last 2 years we've managed the first half very tightly.
2 years ago it was because we didn’t think there will be a government shutdown, but we managed tightly just in case and it turned out to be a very good decision on that part. This year we managed almost as tightly to make sure that we are going to be able deliver on our commitments to you all, and our investors.
But what that means is then we really invest heavily in the second half of the year into our growth strategy, which Horacio discussed earlier. So, you'll see investment activities in the SIG ramp up.
Clearly commercial and international, we continue to invest in. And in addition to the bid and proposal that we see in the government side, I mean, those are types of cost that we'll really – we'll spend on and we did spend in on third quarter and we'll continue in the fourth quarter.
Steven Cahall
Thank you.
Operator
Thank you. Our next question is from Tim McHugh of William Blair & Company.
You may begin.
Timothy McHugh
Excuse me. Yes, just want to ask a little bit to your comment about I guess, first just the headcount and then consultant headcount and I guess, you mean the administrative headcount are not consulting headcount picking up sequentially.
I guess, along the lines of a earlier question is that an inflection point as we think about the overall business you're at. I know other [ph] areas you've been investing, but you've been doing that all along the way.
Are you just at a point generally speaking where given the market or given how far you've cut back, just to exceed the kind of overall headcount growing from here?
Kevin Cook
Its Kevin, again. Well, clearly we need two things to grow, we need backlog and we need headcount.
We drove a very high book-to-bill in our second quarter ending September 30th, and we had a seasonally strong book-to-bill in Q3 compared to the prior 2 years. So we are driving backlog.
We are hiring to meet that demand. I would say that that the headcount growth we saw was fairly modest quarter-over-quarter.
So we're still at work. One of the things we haven’t been able to do in the last couple of years frankly is build a bench if you will.
We were at a point where it was just in time recruiting. We lend [ph] the contract and we'd recruit as opposed to the model we used to follow which was recruiting ahead of the demand that we saw coming and having people on the bench ready to go.
I don’t think we're going to be back to where we were maybe 3 years ago. But we are trying to build somewhat of a bench which will also use up some of the indirect cost of the previous caller was asking about in our fourth quarter, positions us well that go into the next year, albeit, with some potential bumps along the road there with the federal government at ceiling and budget discussions.
Timothy McHugh
Okay. And then just at a high level, your comment about, earlier in the call that the market is still declining.
I guess, but – I guess, in the context that you've also described the market is stable. I guess can you elaborate, I mean, as we think at very high level, the budget environment being stable, but you're still seeing, I guess, your perception at the markets still in decline and I think you made the comment it will take, it could take some time to transition that I guess?
Can you elaborate a little bit more on what you meant?
Horacio Rozanski
It’s Horacio. I am not sure that there was much more – we can say our sense is there are still significant pressure on the industry overall.
In terms of revenue, we look at ourselves as doing better than our peers and gaining market share. But the reality is it’s a very tough market out there.
It continues to be a tough market. The only good news in that is like said there was a sense of stability from our clients perspective in terms of knowing what money they have in front of them and being able to plan accordingly to prioritize our missions.
And so that’s where we believe is the opportunity for us. That’s why as Kevin highlighted, we're getting little more aggressive on capacity.
That’s why we believe our backlog is growing. But at the end of the day, it will be – it will take while for the market to completely shake out and then organize itself on the new dynamic.
It’s beginning to do it, but – somebody talked about it, as an inflection point, I don’t think were there, I think we're talking about maybe a nascent recovery and a fragile one, at best. But certainly the market is better and our clients feel better than they did 2 years ago and hopefully that trend will continue.
Timothy McHugh
Okay. Thank you.
Operator
Thank you. Our next question is from Jon Raviv of Citi.
Your may begin.
Jonathan Raviv
Good morning, guys. And nice quarter.
Horacio, I was wondering if you could talk to whether your clients are maybe better equipped to deal with uncertainty versus previous years, even if we had a budget buzz, or sequester. Do you think they can weather it more effectively and not subject you guys the same volatility that we've seen over recent years?
Horacio Rozanski
I am peering deep into my crystal ball and I am not sure, that I will say that on both sides of industry and decline base, certainly this is a much more battle tested and savvy group that we're dealing with then we were all a few years ago when frankly this market have not seen a significant downturn. And so, from that perspective clients have begun to adjust and their practices and then their ability to deal with this is greater.
However, a big shock to the system is the big shock to the system and it does paralyze activity. And so it is very hard to tell whether a more experienced, more savvy crew would handle a return to the sequester more effectively or not if that were to pass.
Quite candidly our focus is on the things we can control and so we're driving our business smartly. We're focusing on the areas where we think the government will have to invest in grow the regardless of the overall budget process and we're playing for the long game recognizing as Kevin said that, things are still going to be choppy and then we're trying to focus on what exactly would happen in one quarter versus another more focus on one year versus another and then over time.
Jonathan Raviv
Thanks. And as a quick follow up perhaps for Kevin, how is margin growth impacted by turnaround and end markets, given your higher BNT [ph] and investments you want to make.
I mean, margin growth is still pacing ahead of that 10 basis points you guys always talked about. But does this margin growth perhaps slow to that 10 basis points, as things pick up?
Kevin Cook
That’s a good question. Clearly for FY 2015, we feel like we're in pretty good shape on delivering on that goal of a 10 basis point improvement at the adjusted EBITDA margin line.
Going forward, we think that with the some of the new innovations coming out of the SIG which will drive higher margin revenues both of the government and commercial space and the overall accelerating growth of our commercial and international markets which are at a much higher margin than the government space. We think the combination of that will continue to allow us to deliver on that 10 basis point growth year-over-year.
Clearly we've knocked the ball out of the park since the IPO in that regard I can't say that we're going to maintain that pace. But we are comfortable with the goal of growing the 10 basis points per year.
Jonathan Raviv
Thanks.
Operator
Thank you. Our next question comes from Edward Caso of Wells Fargo.
You may begin.
Edward Caso
Good morning. Congratulations on the results here.
I wanted ask again about the shift what appears to be away from cost plus towards fixed price. You mentioned a few specific items in the quarter, but there has been a definite up tick in the amount of fixed price work.
Is that changed in government client behavior, is that a mix of the commercial business and then what influence is that had on the margins you've been able to produce?
Kevin Cook
Hey, Ed. It’s Kevin.
I think that the fixed price percent of revenue will drop back in Q4. I think we have a heavy deliverable on that one fixed price contract I mentioned earlier.
We used to be in the 15% range. I think we'll probably stay in the 18%, 19% range, but that’s developed over the last couple of years and to be honest I think it is – the governments is looking to do more fixed price work.
I don’t know that it really matches with the types of services we deliver, but that doesn’t necessarily stop our clients from trying fix price things. So I would think that 19% range is probably more steady state.
And the commercial does impact a little bit but it’s such a small part of the portfolio today that its not that significant.
Edward Caso
Could you talk a little, it’s a completion question, can you talk about are you focused at all on trying to pick up some of the services business traditionally done by the aerospace and defense primes, as a market focused, particularly with your engineering group? Thank you.
Kevin Cook
Yes. We don’t necessarily look at that as to whether its work that used to be done by the aerospace prime [ph] services division or one of the government’s services pure plays.
We look for where we can sell our capabilities to our clients, whether that’s generally in a prime position, sometimes its sort of sub contractor position. But we don’t shy away from competing with anybody, whether its aerospace firms or pure plays.
It’s really about what clients need in our capabilities. Now, to your point with the engineer growth and engineering, and some of our other technical areas, we may be in the future competing what was some of those, but make no mistake we're very focused at OCI.
We will stay on that. Let's call friend of government side.
We're not going to compete certainly with the product side of those aerospace firms. And I guess I sum it up that way.
Edward Caso
Thank you.
Operator
Thank you. Our next question is from Denny Galindo of Morgan Stanley.
You may begin.
Denny Galindo
Morning.
Kevin Cook
Good morning.
Horacio Rozanski
Good morning.
Denny Galindo
I had a question what we'll see first, in terms of when things pick, when we reach an inflection point, whether would see a book-to-bill increase first to going over one, or whether we would see persistent growth in your employees like on a year-over-year basis? Which one of those is the first thing that you would see?
Kevin Cook
Well, its got to be backlog, right. Because we're not going to hire a lot of people on – run the risk of having over capacity and having the downsize.
So backlog has to come first. We feel good about the backlog we're building, then you have to go out and make sure that you got the people to deliver against that backlog.
So its really the combination but the backlog has to come first.
Denny Galindo
Okay. And then on a different topic, with all the talk of cyber security in North Korea hacking, is that translating into more commercial wins for you guys or maybe at least more opportunities to bid for new work?
Kevin Cook
I think across the board, whether its North Korea other government sponsored initiatives, organized crime and almost you know, expense to water front. I think what's happened is over the last couple of years that boards in particular are becoming in much more tuned to the threat and therefore in many board rooms I think the cyber risk is becoming a much higher priority.
And that’s my way of saying yes, its driving increased demand, not only in the financial services, healthcare and energy markets that we've been focused on, but we're also seeing demand coming out of manufacturing and especially retail given some of the headlines. So I think that demand will continue, I don’t see any fall off in demand in that regard.
Denny Galindo
And then lastly just dwelling into the backlog a little bit, you talked about priced options were down and that was due to the timing of extensions and additions. Could you give a little bit more color on that in terms of what we can read into that number, does it mean that customers are more likely to take advantage of these options, are they standing for an advance and that’s why some of its rolling off early or there any – is there any other kind of read that me make on that number?
Kevin Cook
Now, there is really two factors, the first that was mentioned in earlier was, the timing of extension. So a lot of what's happened is that in lieu of awarding new contracts on the timetable originally targeted by our clients, in many cases that has slipped or just use an example that slipped a year.
So when we get that bridge or extension to that original contract the funding goes into funded and unfunded. Where as if they had originally – if they had awarded the re-compete and we won we would have seen funded unfunded and priced options go in their backlog.
So you don’t see the priced options when you see the contract extensions. That’s the first item.
And then the second factor is that, we have talked on this call before that we've seen the average period of performance dropped across the contracts that we've been bidding and winning in the last couple of years. And so if the governments going from 5 year contracts to 3 year contracts that by definition going to show up as a bigger reduction in priced options than it would in funded or unfunded.
Those are the two primary drivers. At some point, if the government reverts back to longer contracts then I would expect to see that trend reverse and priced options begin to increase.
Denny Galindo
Thanks for taking my questions.
Kevin Cook
Certainly.
Operator
Thank you. Our next question is from Robert Spingham of Credit Sussie.
You may begin.
Robert Spingham
Good morning. Apologies for not being there earlier, I just have been moving between calls this morning.
But Haracio at a high level I wanted to ask you about the upcoming defense budget? And the numbers look pretty good from a request perspective.
And I wanted to perhaps think about those from your perspective it proves, it looks like we may get about a 7% increase in the base budget request. But there is going to be some crowding out from procurement which is actually looking to go up in the mid teens based on early reports.
How do you think about your positioning and your exposure to O&M versus procurement and whether Booz can perform at the growth rate that the budget shows or is there some kind of adjustment we should be thinking or context we should be using?
Horacio Rozanski
To be honest, we look at the budget process more in terms of the overall certainty or uncertainty that it will create for clients and the specific numbers. Our business is really driven by great people building this client relationships and as being making ourselves valuable in the core mission and solving their problems.
And then hoping that the budget process does not create such big dislocations that our clients essentially become paralyze until things get sorted out. So the movement of money between accounts and those things are a secondary order for us.
Our order business here is to be build the sustainable quality growth platform by bringing new capabilities and by helping our clients across the breadth of their needs, but increasingly the closer we get to the core mission the more sustainable our position becomes, because at the end of the day as budgets move around and especially as budgets get challenged, the things that are closer to the mission will get prioritized and protected over everything else. I think it will be interesting to see how the budget process unfolds, and what ultimately gets done vis-à-vis their request.
But I don’t think that that is going to be assuming sort of a steady course of events. That’s not going to be the primary driver of our performance.
Robert Spingham
Okay. That’s a very fair answer.
Maybe just thinking about it, a slightly different way, if we get away from the movement before the inter play between the accounts and we just think about the fact that would this kind of growth in the request and likely some kind of meeting in the minds on the actual budget that shows growth for the first time and let's call it 5 years. Should we assume that the better behavior you're seeing out of the core, the greater ability that the customer has now to make decisions that you're experiencing here in the last few quarters.
That should improve even further as we get into this growth budget?
Horacio Rozanski
I think the budget remains to be seen Rob, I am not sure that I want to I am in a position to comment intelligently as to what exactly is going to happen through the legislative process and how its going to affect us at this point.
Robert Spingham
Okay. Fair enough.
Thank you, Horacio.
Operator
Thank you. I'll now like to turn the call back over to Horacio Rozanski
Horacio Rozanski
Thank you very much for the questions and the conversation. I hope we have conveyed our pride in Booz Allen strong financial performance and our focus on investing to create a sustainable quality growth platform for the future.
Clients always tell us and I believe deeply that we have the best talent in the business and we also have an experienced leadership team executing on a solid strategy. By building this foundation for a second century, we will not only maintain, but rather strengthen our position as the industry leader.
That’s what we're focused on Booz Allen and I hope we convey that to you on the call. Thank you for joining us.
Operator
Ladies and gentlemen, this concludes today's conference. Thank you for your participation.
And have a wonderful day.