Oct 28, 2015
Operator
Good morning. Thank you for standing by and welcome to Booz Allen Hamilton’s Earnings Conference Call Covering Second Quarter Results for Fiscal 2016.
[Operator Instructions] I’d now like to turn the call over to Mr. Curt Riggle.
Curt Riggle
Great, thank you, Kylee. Good morning and thank you all for joining us for Booz Allen’s second quarter fiscal 2016 earnings announcement.
We hope you’ve had an opportunity to read the press release that we issued earlier this morning. We’ve also provided presentation slides on our website and are now on Slide 1.
I’m Curt Riggle, 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, Executive Vice President and Chief Financial Officer. As shown on the disclaimer on Slide 2, please keep in mind that some of the items we’ll discuss this morning will include statements that may be considered forward-looking, and therefore are subject to known and unknown risks and uncertainties, which may cause our actual results in future periods to differ materially from forecasted results.
Those risks and uncertainties include, among other things, general economic conditions, the availability of government funding for our company services, and other factors discussed in today’s earnings release and set forth under the forward-looking statements disclaimer included in our second quarter fiscal 2016 earnings release and in our SEC filings. We caution you not to place undue reliance on any forward-looking statements that we may make today and remind you that we assume no obligation to update or revise the information discussed on this call.
During today’s call, we will also discuss some non-GAAP financial measures, and other metrics, which we believe provide useful information for investors. We include an explanation of adjustments and other reconciliations of our non-GAAP measures to the most comparable GAAP measures in our second quarter fiscal 2016 slides.
It’s now my pleasure to turn the call over to Horacio Rozanski, our CEO, and he’ll start on Slide 3.
Horacio Rozanski
Thank you, Curt, and good morning everyone. As we’ve always done on these calls, today we’ll focus on both our financial performance in the most recent quarter and how that performance advanced as to our sustainable quality growth that will create additional value for our clients, our investors, and the talented professionals at Booz Allen.
Sustainable quality growth is our goal and consistent performance year-over-year paves the path to that objective. As you already saw in the press release, we had a strong quarter, with revenue growth and an excellent award season.
Our success in winning contracts as the government’s fiscal year close confirms that we read the demand signals in the market accurately and we made the right choice as to invest ahead of growth so that we could capitalize on these opportunities. It’s important to understand that we’ve been building to this success brick by brick for the last three years.
Throughout the downturn, we proved our ability to operate efficiently and deliver results, while making significant investments in new capabilities, talent and markets. Now with our client base more experienced and coping with budget uncertainty, we are well positioned to gain share and accelerate.
It is equally important to understand that we have more work to do to reach sustainable growth. We will continue to invest with a long-range view because what matters most at Booz Allen is growing the right way.
We’re preserving our traditional strengths, while adding new sources of differentiation in the form of innovation, advanced capabilities, specialized talent, new markets and new service offerings. Against that backdrop, the big headline for this quarter was the strength of the demand side of the equation.
On our first quarter call, we talked about how the quality of our proposal pipeline and our aggressive financial and operating stance towards winning work was evolving. You now see the results in our backlog and book to bill.
We had a tremendously successful award season, winning contracts across our client base that support their highest priorities, including implementation of the Affordable Care Act and MyVA Initiative, identification and mitigation of emerging global security threats and protection of federal information infrastructure from cyber risks. These and many other wins show more than skill in capturing work.
They reflect the depth of our talent, capabilities and client relationships. And they were made possible by our investments throughout the downturn.
While we will begin to feel some of the benefits later this fiscal year, much of the payoff will come in FY 2017 and beyond. Perhaps more important than how much we are winning is the type of work we are bringing into our portfolio, work that is core to our clients’ missions, based on our differentiated positions and aligning with our strategic growth areas.
Consequently, we view it as more sustainable long term. The evidence of sustainability is in more stable prices and an increase in both the size and duration on new task orders and contracts.
Another important accomplishment in the second quarter was our transition from SURVIAC. Thanks to the tremendous effort by the transition team, led by Joe Logue and Robin Portman, we retain more than 90% of the professionals who performed work under SURVIAC and the vast majority have moved on to new contracts and follow-on tasks.
There are, of course, costs associated with the transition which Kevin will cover in more detail, but the downside of the contract expiration has been mitigated and we expect the impact for the year to be within the range we originally estimated. At the same time, we have created the opportunity for the future through the follow-on work we have won.
Again, thanks to the expertise and the hard work of those who executed the transition; we competitively won a large percentage of the follow-on contracts and tasks; and we have more than replaced the ceiling value lost during the contract’s expiration. In fact, in many cases, the scope of work has expanded which has been a headwind for us in FY 2016 into a tail wind in future years.
One win we are highlighting as an example of the upside is the global threat mitigation program. The $937 million five-year contract was competed and awarded by GSA’s Federal System Integration and Management Center or FEDSIM and is one of the largest single award wins in Booz Allen’s history.
It continues similar threat mitigation work that we did for the Department of Defense under SURVIAC but expands the scope while also generating efficiency for our clients. The previous work focused primarily on countering improvised explosive devices for the Army.
The new contract leverages additional technical capabilities to cover a diversity of current and emerging global threats, both physical and cyber, for a broader range of clients in both the Army and the Joint Combatant Commands. We are, of course, pleased that we won the contract, but more than that, we are extremely proud to support this particular program because of its larger goal.
Simply put, we are helping save lives. In my book nothing is more mission-critical or more inspiring to the people of Booz Allen.
And so when you look at the content of our work, the success of the SURVIAC transition and our second quarter awards overall, we believe the results confirm that we have the right people and the right strategy in place for the people towards growth. Against that backdrop, we are pleased to announce today the issuance of a regular quarterly dividend of $0.13 per share payable on November 30 to shareholders of record on November 10.
As we open the second half of the fiscal year, we are very pleased with our year-to-date performance, but also keenly aware of what we need to do to finish the year as planned. Our bottom line has been impacted by relatively high indirect spending, primarily on proposal activity and retaining staff to the SURVIAC transition.
These expenditures were planned and they produce great results. In the second half, we will moderate spending and work to increase billability.
However, we still see opportunities to build our business pipeline and we will not shy away from spending what we believe is necessary to capture additional demand. Hiring and retaining superior talent will also be crucial, especially given our recent wins.
There is, of course, ongoing debate in Congress about the federal budget and raising the debt ceiling. We are hopeful that some resolution will be reached, but because we can’t begin to predict what Congress will do, we will remain focused on the things we can control, being an essential partner to clients, attracting and developing the best talent, providing high-quality delivery in all our work, gaining share in the federal market and building additional differentiated profitable positions in key areas.
Before turning it over to Kevin, there is one new citing to highlight. Last week, we elected Melody Barnes to our Board of Directors, effective immediately.
Melody is a domestic policy strategist and Vice Provost and a Senior Fellow at New York University and formerly served as Assistant to the President and Director of the Domestic Policy Council for President Obama. Melody brings a wealth of public policy expertise that will help broaden our perspective on issues important to our clients and to our own strategic planning.
We are pleased to welcome her to the Board and look forward to her contributions. With that, Kevin, over to you.
Kevin Cook
Thank you, Horacio. We had a very good quarter and I couldn’t be more pleased with the outcome of the awards season and the strength of the business across our client base.
With regard to SURVIAC, as Horacio said, the transition was very well executed. We will land within the $100 million to $200 million revenue reduction we estimated for the full fiscal year.
But the transition played out a little differently that we expected. The best way to think about it is in terms of short-term negatives and long-term positives.
Billability is down somewhat due to the transition and recruiting slowed as we focused internally to place employees on new contracts; also, the ramp up to follow-on contracts is still underway. Those were all short-term issues with associated cost that affect the bottom line.
Additionally, with the obligated all remaining SURVIAC unfunded backlog when the contract expired, which reduced our total backlog amount this quarter. Longer-term, there are real upsides from the SURVIAC transition.
We would capture the vast majority of the work and in many cases expanded scope. We retained all but a small number of those who performed work under SURVIAC and we maintained pricing and margins.
This is what creates the tailwind in the FY 2017 and beyond. Now, let’s turn to details for the quarter and the first half of our fiscal 2016.
I’m one Slide 4. Even with the SURVIAC gap, our revenue grew in the second quarter which again reflects the strength of our entire business.
The growth was driven primarily by an increase in billable expenses and the revenue impact of relatively higher indirect spending on bid and proposal and strategic investments compared to the prior year. As we have discussed previously, our decision to focus a larger portion of our annual spending in the first half so that we could capture demand lead to flatter margin profile for this fiscal year, meaning relatively lower margins than last year in the first half with the plan for relatively higher margins in the second half when compared to last year.
So as you look at the bottom line, the decline in adjusted operating income was driven by the combination of costs associated with the SURVIAC transition and our decision to pull more indirect spending into the first half. Another factor was that lower margin billable expenses were a higher proportion of the revenue mix in the quarter.
The decline in adjusted operating income was partially offset by write-ups on the fixed-price engineering contract and the accrual of relatively lower incentive compensation expense. The decline in adjusted net income was driven by the same factors, but was partially offset by a lower effective tax rate in the quarter.
The decline in adjusted diluted earnings per share was driven by the same factors as adjusted operating income, but benefited from a lower share count as a result of repurchase of 1.2 million shares in the first quarter. Turning to backlog, the September quarter which coincides with the end of the government fiscal year has long been important for backlog replenishment.
We did especially well in that front this year, recording the highest book to bill ratio since the company became public in 2010 and the largest total backlog in nearly three years. The big increase in priced options is worth highlighting as it is different from what we’ve seen in recent quarters.
Priced options represent revenue potential over a multi-year period, while funded and unfunded backlog are usually available within the next 12 to 18 months. As a result of second quarter awards, priced options increased by more than a third as compared to the prior year period, indicating strong revenue potential over the longer-term.
Now, some details on our cash position. Net cash provided by operating activities for the first half of fiscal 2016 was down from the prior year period.
This is related to the relatively higher spending we have already discussed. Invoice timing associated with the SURVIAC transition also affected our cash position and will likely continue to have an effect on days sales outstanding.
Additionally, there are a number of differences in the occurrence and timing of specific cash payments in the first half of fiscal 2016 as compared to the first half of 2015. Those differences related to share repurchases, special dividends, and rollover option exercises.
Required principal payments on our term loans have also increased and we spent more on CapEx this year than in the recent past due to facility changes in the Washington DC area that will position our staff closer to their clients. Our estimate for CapEx for the full year, full fiscal year remains $60 million to $70 million.
With all of that as context, I’ll conclude with a discussion of our guidance and how we are thinking about the future. Please turn to Slide 5.
Today, we are reiterating our guidance for FY 2016 and as always we will take another look at it at the end of the third quarter. We expect revenue for the full fiscal year to be roughly flat with a range of 2% decline to 2% growth.
At the bottom line, we expect diluted earnings per share to be $1.55 to $1.65 and adjusted diluted earnings per share to be $1.60 to $1.70. Over the past few years, while the market and our revenues were shrinking, we have delivered value to our shareholders at least in part through EBITDA margin expansion.
In fact, we have one of the highest margins in the government services sector today. Over the next year or two, we expect our adjusted EBITDA margin to be relatively flat from year-to-year because we intend to reinvest heavily in building the pipeline, capturing opportunities and developing our talent, capabilities and markets.
We still see solid contract profitability across our business portfolio, but because we will continue to invest to drive growth, margins are expected to be flat. As we look ahead, the resulting primarily organic revenue growth is expected to be a key source of shareholder value creation.
We are optimistic about delivering organic revenue growth in this fiscal year. But more importantly, we are setting ourselves up to accelerate growth in fiscal 2017 and 2018, while realizing that growth requires sustained investment.
We are encouraged by the success of our strategy to date and we will continue to build our business brick by brick. That’s the path to sustainable quality growth that delivers value to shareholders, clients and our people over the long-term.
Now, I will turn it back to Horacio and he is on Slide 6.
Horacio Rozanski
Thank you, Kevin. In the middle of last year, we have spent time on each of our calls with you talking about our Vision 2020 growth strategy, specifically the growth platforms that we have invested in substantially since 2013.
They are systems delivery, engineering, cyber, innovation and the commercial and international markets. Another way to understand the progress we are making is by looking at the fundamental objectives of this strategy, objectives that reach beyond the platforms themselves to leverage the traditional strengths of our core business.
Under our strategy, we are moving closer to the center of our clients’ missions. We are increasing the technical content of our work.
We are attracting and retaining superior talent in diverse areas of expertise. We are also delivering to clients more complex end to end solutions and we’re creating a broad network of external partners and alliances.
We have a lot of content covering today’s call and want to leave adequate time for your questions. So I won’t go into these topics in depth now, but I wanted to at least share this framework with you and set up an ongoing discussion in future calls.
In the past, we’ve touched on these principles in the context of our innovation agenda, growth capabilities and new markets. And even today, in the global threat mitigation program, you can see many of these elements coming together [indiscernible] mission, application of advanced technologies, diversity of expertise and so on.
Understanding our current performance in the context of our strategy is important because as we progress concurrently on each one of these paths to our objectives, we’re capturing the kind of growth that enhances our differentiation in both the client and talent markets and can lead to significant value creation for our shareholders. With that, Curt, we are ready to move to Q&A.
Curt Riggle
Great. Thank you, Horacio and Kevin.
Kylee, at this point, can you please provide instructions for the question-and-answer session of the call?
Operator
[Operator Instructions] Our first question comes from the line of Carter Copeland with Barclays.
Carter Copeland
Just a couple of quick ones, the first on the margin commentary, Kevin. I wondered if you might help us get some colors.
Is this more a hiring ahead of demand sort of putting people and capabilities in place ahead of what you see similar to what we saw before the downturn or are there any particular pricing or mix dynamics at work?
Kevin Cook
I’d say in reverse order, no, I don’t think there is a mix dynamics. I think what we’re dealing with here is trying to ramp up our hiring based on the backlog that we’ve won at the end of the second quarter.
One of the impacts of the SURVIAC transition was that we were so focused at placing people coming off of SURVIAC contract on new work that we slowed down on our recruiting somewhat and we’re in the process now of ramping that back up. So we really need to see how fast we get the talent in the door and apply them to these contracts.
That’s really one of the margin implications in the second half. As well as the fact that we still have quite a number of opportunities in our pipeline and we are not going to shy away from investing to capture even more market share as we go forward.
So all in all, we do plan on maintaining what we believe is the highest margin rate in the government services sector, but we may not just see the overall growth over the next year or two as we invested more heavily.
Carter Copeland
And one for Horacio, just looking at the market landscape, obviously across the services spectrum, there’s a lot of discussion about assets changing hands and the value proposition around consolidation and parts of the industry. I wondered if you might just share your thoughts about what that – if that value proposition makes sense for the industry at large or if there is any desire whatsoever to participate in any way or just how you think about it.
Horacio Rozanski
I guess I’ll avoid the punditry around the overall industry opinion. I’ll just share the way we think about it.
We find ourselves, as Kevin said, in a very good place where we are building towards sustainable quality growth which is largely organic growth. We believe we have the right level of scale and we believe we have the right level of scope to accomplish all of that.
And so we are not in the business of going out and buying revenue and frankly at least the way we look at it, these very large deals tend to be risky and seldom pay off. So we would hold that to a very, very high bar.
Our real focus and you should expect from us is really on the M&A front smaller capability oriented plays that are on our strategy, in our growth platforms and where we can drive then horizontally across all of our clients, leveraging our superior client relationships. And so we think that that ultimately empowers our team to grow faster and generate more organic growth as opposed to use inorganic as a source of creation.
Operator
Our next question comes from the line of Bill Loomis with Stifel.
William Loomis
Just on the revenue, revenue was up, but then we had the sequential decline in consulting – consultants and I assume that was the timing on SURVIAC transition. But still, how did revenue go up with that, because gross margin was higher, so it didn’t look like it was a lot of pass throughs boosting that?
Horacio Rozanski
In the second quarter, Bill, the primary drivers of the revenue growth were an increase in billable expenses year-over-year as well as the cost that we spent in the first half actually drives higher revenue on our cost reimbursable contracts. Those are the two primary drivers.
We will be recruiting heavily in the third and fourth quarters to staff the backlog that we won as I said earlier.
William Loomis
And then just on the SURVIAC transition, so you won 90%, but sounds like of the 90% or a little more than you won, the ceiling on that was actually greater than 100% of the prior contract, am I getting that right?
Horacio Rozanski
Actually we won more than 90%. I think the 90% was the number of staff that we retained from the SURVIAC contract to the new work.
We won well in excess of that as far as the replacement ceiling and you’re absolutely right, we now have more ceiling to go after on the new suite of contracts than we had on the original SURVIAC contract.
Kevin Cook
Bill, I got to give you credit on this because I think it was maybe one or two calls ago you asked the question as to whether there was an opportunity in this SURVIAC transition, not just on ceiling, but on scope. And I think at that time we said it was a possibility, but it was too soon to call it.
And I think as we look at it now, your question was right on and that’s exactly what’s happened.
Operator
Our next question comes from the line of Edward Caso with Wells Fargo.
Edward Caso
Is it possible to pull out the strength of your awards this quarter, separate what you did with SURVIAC and what happened, ignoring the effort to replace SURVIAC so we can get a – I don’t know if normalize is the right way to express it, but a normalized awards number?
Horacio Rozanski
I’m not sure that we can do that that way, Ed. What I would say is when you look at the strength of backlog and the strength of demand and the success in capture effort is across the entire system, it’s not just in the places where we have – we were dealing with the SURVIAC transition.
Across our civil business, they’ve done extraordinarily well for example and SURVIAC was not a factor there. So I think what we’re seeing over and above that transition is generally positioning by our teams and an extraordinary job capturing new demand, capture and recompete and positioning us well into the future.
I think Kevin said it, but it bears repeating, we expect that to pay off over the next couple of years as opposed to the next couple of quarters because we need to build the headcount to accomplish all of that. But this is in that sense a good medium-term story.
Edward Caso
There was no repurchase in the quarter. Can you talk about your strategy on that front, maybe remind us of your priorities for cash distribution and if there’s a base cash level we should be thinking about?
Kevin Cook
We did not repurchase anything in the second quarter. Our goals in the share repurchase area are to maintain share count relatively flat over time.
But in order of priority, our uses of cash haven’t changed for many quarters now. Obviously, operating cash and recurring dividend are high on the list, followed by M&A.
But M&A, as Horacio said, for smaller capability focused opportunities that we can be a force multiplier across our business, followed by special dividends, followed by may be opportunistic share repurchases if the share price dips and lastly, paying down term loans. And I say that in a fairly static interest rate environment.
If interest rates were at a spike, which I wouldn’t expect, then we might look at paying down some of the term loans a little bit quicker, but that’s not in the game plan right now.
Operator
Our next question comes from the line of Jon Raviv with Citi.
Jon Raviv
I was wondering if you could talk about what happens to fiscal second half sales to put us at flat for the year, especially in light of the fact that we seem to have gotten past the SURVIAC hole?
Horacio Rozanski
As I said in the remarks earlier, we do expect organic growth for FY 2016. The reason we reiterated the prior guidance was that we really want to spend the third quarter seeing how many people we can get in the door and apply against this backlog.
We also have, you may not know, but we have seven holidays of our 10 holidays in the second half of the year, which isn’t helpful as far as driving top line. But we do feel like we will have organic revenue growth this year, but it’s all about getting the people in the door and applying them against the contracts.
Jon Raviv
As a follow-up to that, Horacio or Kevin, could you talk a little bit more about how you quantify or how we should quantify sustainable and quality growth going forward? Is that a mid single digit number and perhaps an important part of that discussion would be share gains.
You referenced those a lot. Any color there as to where you are gaining share and maybe the type of company against who you are gaining share would be helpful.
Horacio Rozanski
Let me start back to front on that questions and I will ask Kevin to augment. We try to track to the best of our ability, recognizing is not an exact science, how we are doing vis-a-vis a broad range of competitors.
And if you go back as far as I can see, we always do better at top line and now we’ve been at the bottom line organically than the rest. And so if you take the average of all of them in the good years where the market was growing, we grew faster than the average by quite a bit.
In the years in which the market was declining, we declined quite a bit less than the average. And we expect that trend to continue.
And that’s sort of our definition and our view about taking share. The areas in which – we are growing well in all of the areas, in particular the ones that have been investment priorities for us over the last few years and we talked about those: systems development, engineering, cyber, commercial and international, the different elements of our innovation agenda as they relate to different markets.
And so that creates strength of the portfolio throughout and the ability to win work throughout. The other element that we’ve talked about in the past is this idea that we are positioning ourselves at the center of the clients’ missions and the places where quality is most important, which in a very competitive market shields us to some degree, I’m not saying 100%, but to some degree, from extreme price competition that is happening in other segments of the market which is why unlike some other folks in the industry, we can talk about some more price stability and we are not seeing pressure on our margins.
So that’s the overall picture. We believe, as Kevin said, I think the precise words is we will remain optimistic that within our guidance we will deliver some modicum of organic growth this fiscal year.
We expect the growth rate to be higher next fiscal year than this one and the one after that will be higher still. But again, I don’t – we are not looking, I am not looking for a great acceleration of that that then we cannot sustain.
I am looking at – I think we talked about brick by brick. Can we do better every year over the next few years in terms of our organic growth rate, in a way that we have confidence that we can retain and sustain that business.
I will give you – just to give you a little color on that, I was in a conversation yesterday with one of our group leaders and I had similar conversations with all three of them, around one of this big contracts that we just won. And coming back from the kick-off meeting, and already having a discussion about what work are we going to want to do on this contract that guarantees we can win the recompete five years from now.
These big contracts, you can put a lot of work in them that would “fit” within the scope, but may not actually be essential to the mission, may not be viewed as great value by the client. I suppose the temptation to do that is there, but if you do that, then five years from now, you have to get on a call like this one and explain how we lost them.
So our goal is systematically to deliver on the promise we make each year, to do better if we can, but not at the expense of eating our seed corn or sacrificing the growth in the out years. I don’t know if that answers your question with a precision that you were hoping, but that is our viewpoint of how we want to play for the next two or three years.
We think that – my conversations with many of you and with the investor base is that, especially our long-term holders are the very comfortable and then supportive of that and certainly the people with Allen would like to see it happen that way because that gives us stability, the ability to invest and the potential for long careers that attract and retain the best people.
Operator
Our next question comes from the line of Robert Spingarn with Credit Suisse.
Robert Spingarn
I wanted to follow on that theme. Obviously, the backlog numbers are just excellent.
And I want to talk a little bit more about organic sales growth. You touched on this a second ago, Horacio, but last time that you had a backlog profile like this was mid-2013, and your sales at that time were a good 9% higher than they are today.
You mentioned growth, organic growth this year and then rising next year and the year after. Where is the real inflection point here, because it seems like there is going to be a real nice kick sometime after this year?
Horacio Rozanski
I think it depends on how you define inflection point. I think the inflection point you’re seeing it.
We are living it. I mean, we are no longer talking about finding ways to deliver shareholder value exclusively through margin impact because we don’t see top line opportunities.
We are now saying we see top line opportunity. And like I said, the willingness and the desire to take this growth rate up a notch every year for the next, at least the next couple until we get to a sustainably exciting growth rate, that’s where we are going.
As I said, if you look at into the backlog and Kevin can speak to this probably better than I could, a lot of it is in priced options. And the priced option growth is actually important for us, because that is years and years worth of potential.
And so while we have more than sufficient funded backlog to do what we need to do and to deliver on our commitments in the next 12 months, we’re particularly excited about how this builds forward into the future.
Kevin Cook
I would agree, Horacio. I would add that going back to a question earlier, this increase in priced options was broad based.
It wasn’t just SURVIAC replacement; it also is in our intelligence market as well as in our civil markets. So we are very pleased with the growth of priced options and that really does set us up for the next couple of years.
Robert Spingarn
Kevin, on that note, is there a way to compare the duration of this backlog? And I am speaking to the priced option, since that’s half of it.
But the duration of this $12 billion to the $12 billion we saw three years ago?
Kevin Cook
Rob, I’d have to look at all those contract by contract to answer that and I can’t. But I will say most of these contracts are either three or five years in duration that we won.
But it’s hard to compare three years ago to now.
Robert Spingarn
And then just one last thing, I know SURVIAC recovery plays a role here, but you’ve gotten a lot of backlog in this compressed period of time. We’re looking at a budget deal or on the verge of a budget deal here.
How should we think about the bookings environment for the rest of the fiscal year?
Horacio Rozanski
I would say the following. First of all, you said we are looking at the budget deal, I think we should say we are hopeful that this deal passes and is consummated.
And if that were to be the case, as Kevin said, we still see – we have a very robust proposal pipeline, very robust set of proposals outstanding as we speak and we see opportunity to continue to shape and drive more like we haven’t seen in the last couple of years and we are going to be focused on that. How exactly – whether any of that is going to shift to the right or stay exactly where it is, I think will depend on a lot of the details around how this appropriation bills ultimately get written if this budget deal passes and I obviously – I am not smart enough to speculate on that.
But I think in general, the general message I would offer you to take away is the demand environment that we see is one in which we want to invest and one in which we want to continue to drive an increasingly – a steady increasing growth rate over the next couple of years.
Kevin Cook
In relation to the current backlog, as you know we have a very conservative approach to backlog where the signed contract and the signed task order, it’s not in our backlog. We also have – back to your question about future bookings, $270 million of protested awards that aren’t in that backlog number that we would hope to be successful on over the next quarter or two.
Robert Spingarn
Last thing, Horacio, on the proposed budget deal, while it’s not at the President’s request level, I think it is a little bit above expectations when you throw all the money in there that we’re looking at. Would you say that the numbers out there match your expectations or what you’ve planned for or would you say it’s better or worse?
Horacio Rozanski
The $5.5 billion in revenues, we walk around feeling like we’re pretty big, but in comparison to the federal budget, we really aren’t. And so as we’ve said in the past, it’s the overall certainty around the budget that allows for our clients the ability to do what they need to do to focus on their right priorities and us being right there is what we look at as opposed to sort of specific numbers, the line item numbers.
Certainly, if the deal that is being discussed were to pass, that would create or sustain that level of certainty that would continue to allow us to be optimistic about the demand situation like we are. So that’s really more of our focus than any given number, any specific number.
Operator
Our next question comes from the line of Ron Epstein with Bank of America Merrill Lynch.
Kristine Liwag
This is actually Kristine Liwag calling in for Ron. Following up on Rob’s earlier question regarding the duration of the backlog, how should we think about the cadence of conversion of the backlog into sales?
And then how much of your full year fiscal year 2016 revenue outlook is actually now in the backlog?
Kevin Cook
I would think most of the second half is already in backlog. I would say what I said before which is we are very conservative in how we book our backlog and therefore there is a very high percentage of that backlog that turns into eventual revenue.
It’s also hard to predict over the exact timeframe because there are so many contracts in past quarters. But certainly, we are pleased with the backlog and I think it will drive us back towards sustainable quality growth in the long term.
Kristine Liwag
And switching maybe to operating margins, when your top line was declining, you were able to improve margins through cost cutting and head count reduction. But now, as organic growth picks up, will you be able to expand operating margins, and the second part of that question would be, Horacio, you mentioned a few times that you need to make investments for future growth.
Can you also quantify what that means?
Horacio Rozanski
We won’t get into the specifics of trying to quantify future investments. It all comes down to the cost that we spend and trying to recover those costs in our rates.
I do want to correct one thing you said, we didn’t improve our margins by cutting our cost. We have indirect rates with the government that we negotiate every year, the key is to live within those rates and not overrun those rates.
And the growth that we saw came from a variety of things, including growth – faster growth in our commercial and international markets which are at a higher margin rate. So on cost plus contracts that are 50% or 55% of our work, if we were to cut cost, we wouldn’t have given that money back to our clients in lieu of investing in capabilities that can then help them with their missions on a go forward basis.
Kristine Liwag
And the part on if organic growth picks up, will you be able to get margin expansion too?
Horacio Rozanski
As I said earlier, we expect over the next year or two that with the investment in our capabilities, our people and our pipeline that we expect the margins to be somewhat flat. I do think there is an opportunity depending on the commercial and international growth to still see some modest increase, but we are not planning for that right now.
Operator
Our next question comes from the line of Cai von Rumohr with Cowen and Company.
Cai von Rumohr
So, Kevin, if we look at the SURVIAC revenues you had in the quarter and add to it the revenue on the revenues on successor vehicles that you recognized in the quarter, do they total about – I came up with about $105 million versus $160 million last year, so you would have had about a $50 million drop as a result of that. Is that roughly what the number looks like?
Kevin Cook
You can’t look at that that way, Cai, because first of all, the contract ended on July 7. So frankly, we had one week of revenue in Q2 from the original contract.
And then the other replacement contracts and task orders played out over a number of months well into September. So there is really no way to quantify that.
At the same time, the reason we said we feel like we are in that revenue range, a reduction that we gave I think on the Q1 call is that with that gap in revenue, I guess the good news is there was a gap, and that we didn’t lose the work. We were concerned, if you remember, of losing work to small businesses, a lot of competition driving lower pricing, really none of that manifested itself.
So the replacement work once it starts will continue. But if you look at all the hiring we did, the fact that we carried the staff which was I think a significant decision we made and was the right decision, that added cost that offset some of the revenue reductions because it increased cost on our other cost reimbursable contracts.
That’s why it’s almost impossible to identify down to the specific dollar what that impact was, but we have done enough work that we’re comfortable that it’s within that original range that we provided.
Cai von Rumohr
But I guess where I’m driving with this is, as you said, you only had about a week of SURVIAC work, so it might have been, I don’t know, $20 million or so. And you mentioned this gap so that if you didn’t get a whole lot of lift out of the new programs and I know you got some cost benefit on cost plus contract, so that you have sustained the biggest portion of the revenue drop in this quarter, which really gets me to the issue, how come the revenues are not going to be stronger in the second – shouldn’t be better in the second half?
Horacio Rozanski
As we have said here this morning, it’s all about the people, Cai. We need to get them in the door and apply to these contracts and we took a bit of a wall on our recruiting side as we focused on placing the people coming off the SURVIAC work and now we are out ramping up our recruiting machine to try to get people in the door to staff those contracts.
And then we have the holiday issues in the second half of our fiscal year as well. So we’re pushing for organic growth this year, but we are going to wait and see what happens in the third quarter.
Cai von Rumohr
Where I’m going with this is, if you’re hiring aggressively here in the third quarter, but you haven’t gotten all the people yet, I would guess by the fourth quarter, you will have gotten them. And given that the holiday usually falls the same in each quarter year-over-year, your fourth quarter growth should be considerably better than your third quarter growth.
Is that a fair assumption?
Kevin Cook
We don’t give quarterly guidance, Cai, but I can’t say that I disagree that the fourth quarter should be stronger than the third. Hopefully, we will have a lot of folks hired in the third quarter, although it is difficult to recruit to some extent during the holiday season.
So some of this could spill over into the fourth quarter easily actually.
Horacio Rozanski
Kevin, I don’t know if I am summarizing or amplifying, but let me just try and wrap some of your comments. If I look out this last quarter that we are reporting on, I couldn’t be prouder of what the people at Booz Allen accomplished.
It was, I would say, near-perfect execution of our strategy. The SURVIAC transition both in terms of finding new vehicles and reassigning people and realigning people was really very good.
More broadly across the markets, the capture efforts, the sales efforts, as you said, in defense, in intelligence, in the civil market, the innovation agenda, everywhere was really very, very strong. The difference between near-perfect and perfect is that while we were doing all of that and with the ability a little over and then in September with the threat of the government shutdown, we did not recruit as aggressively as in hindsight now with all of this backlog may be we would have wanted to.
Now, the government had shut down on October 1, we would have looked like genius for not having done it. But on the whole and on the main, we just have to work to hire a lot people that we want to have to deliver on our promises to our clients through this backlog.
That part of it, as you said, that’s going to happen over the next six months, because it also positions as for FY 2017 where we want to have better organic growth than in FY 2016. And it’s important to understand, first of all, there are some headwinds in the third quarter to that because with Thanksgiving and Christmas and New Year, actually it isn’t the best hiring quarter in general.
And then we really are looking for outstanding people, we are not just looking to get always in the door, again part of this sustainable quality growth mantra is really good people coming in and doing great work for our clients to sustain and retain. Historically more than 50% of our hires have been through employee referrals.
We wanted trend to continue because we want, again, people that fit with our culture, that fit with our mission to do great work for our clients. And so while we are on this trend line that we are talking about, I think it’s important for people to understand that operationally we want to build it in a way that is sustainable and exciting as opposed to a flash in the pan.
Operator
Our next question comes from the line of Michael French with Drexel Hamilton.
Michael French
I want to ask for an update on the international and commercial side, particularly in the Middle East. Since we last talked oil prices have come down, which presumably would affect the war chest of potential customers there.
But obviously, a competing factor is that angst and instabilities have been increasing, which might increase the appetite for the kinds of services that you offer. So, just wondering if what we’re seeing in the news is having any impact on your business there.
Horacio Rozanski
I think you got your own path. I think that both dynamics that you described are both there.
In some of our work, the oil price decrease has had an impact and in some other of our work, the instability in the region has expanded the demand. It has may be moved some of the work from the Gulf into Saudi Arabia for example.
We are seeing significant growth in that area, we’ve had sustained double-digit growth since we started there that is not abating in any way. And we are excited, we are optimistic, we’re happy with the progress.
We always have to remind people it’s a small part of our portfolio, so we are keenly aware of and interested in growing because it’s exciting work, it creates great opportunities for people and it has a very strong margin profile. So again, when it talk about we don’t want to pull back on investments, one of the things for example we wouldn’t want to do is decrement our investment there because we are experiencing higher BMP in the United States.
We want to make sure that these long-term investments over time will enhance our margin and enhance our profile continue to get funded. But overall, as you said, there are some puts and some takes and the trend line for us in the Middle East business continues to be strong.
You didn’t ask, but our US commercial business, or maybe you did ask, also very strong. And we are pleased with the work that we are doing there beyond the traditional work we are doing for example around cyber, we are now focused on issues of telematics and other infrastructure protection issues that, we believe, will provide great growth opportunity for us there.
And that’s another part where growth and margin continue to do very well and expand and we continue to be excited and invest, albeit from a small base of business. Bigger than it used to be, but still in the context of the overall firm, a smaller base of business.
Kevin Cook
Horacio, I will just add that even in our new Singapore office which has been open less than a year now, we are seeing a fairly nice pipeline shaping up over there. So I think the demand for what we offer is strong worldwide.
Michael French
And I had one follow-up on hiring folks for the SURVIAC work. Is most of the hiring going to happen there in the national capital region?
What’s the employment market like right now?
Horacio Rozanski
Let me just slightly amend, it’s not really hiring for the SURVIAC work because as we talked about the ongoing SURVIAC work, we have about more than 90% of the folks transfer from their old contract to either existing or similar tasks on new vehicles. It is hiring more broadly to capture the growth.
And it’s really all over, very strong requirements everywhere. There is no doubt some skill sets are in very high demand right now, sought after not just by our traditional competitors, but by broad industry at large.
I mean we have for example one of the largest data sciences teams out there, north of 600 people, and we continue to hire aggressively against that. We’re not the only ones looking for data scientists right now.
So it’s competitive, but our ability to attract the right kind of people, I don’t see any issues with that. If anything, the more of this that we do and the more excitement builds internally, the more we are going to be able to attract, no doubt the environment is going to continue to tighten, but we have differentiated offering when we go out and recruit that helps us.
Operator
Thank you. I would now like to turn the call back to Mr.
Rozanski for closing remarks.
Horacio Rozanski
First of all, thank you for your questions. And once again if you will allow me a moment, I would like to brag for a minute about the 23,000 people of Booz Allen that Kevin and I have the privilege to come and represent on this call, because it’s really their performance that drives the results and really create the opportunities for the future, not just for us as professionals, but importantly for all of our investors.
So to wrap up, I will simply underscore again that Booz Allen is executing the business in the near term and implementing a strategy for the long-term that will allow us to provide a greater value to clients, investors and our people. This two-pronged mutual reinforcing approach has always been the foundation of our success.
We are extremely gratified that our work over the past several years is beginning to bear fruit and we are very energized with the opportunities that lie ahead. We appreciate your time today.
Thank you and have a good day.
Operator
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect.
Everyone, have a wonderful day.