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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning. Thank you for standing by and welcome to Booz Allen Hamilton's Earnings Call covering Third Quarter Results for Fiscal 2018. 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.
Thank you, Shannon. Good morning, and thank you for joining us for Booz Allen's third quarter fiscal 2018 earnings announcement. We hope you've had an opportunity to read the press release that we issued earlier this morning. We have also provided presentation slides on our website and are now on slide 1.
I'm Curt Riggle, Vice President of Investor Relations, and with me to talk about our business and financial results are Horacio Rozanski, our President and Chief Executive Officer; and Lloyd Howell, Executive Vice President and Chief Financial Officer.
As shown on the disclaimer on slide 2, please keep in mind that some of the items that 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 their actual results in future periods to differ materially from forecasted results. Those risks and uncertainties include, among other things, general economic conditions, the availability of government funding for our company's services, and other factors discussed in today's earnings release and set forth under the forward-looking statements disclaimer included in our third quarter fiscal 2018 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 the adjustments and other reconciliations of our non-GAAP measures to the most comparable GAAP measures in our third quarter fiscal 2018 slide.
Now my pleasure to turn the call over to our CEO, Horacio Rozanski. We are now on slide 3.
Thank you, Curt, and good morning, everyone. Thank you for joining us. The results we announced today illustrate once again that we are on track and on strategy, uniquely positioning Booz Allen to deliver sustainable quality growth. As usual, Lloyd and I will tag team this call with a goal of providing you a better understanding of how our third quarter performance ties to the bigger picture, both our strategic vision and our expectations for the full fiscal year. Also, because tax reform has just been enacted, Lloyd will offer an initial read on its impact.
I will focus my remarks on our strategy and the results it's yielding, both in terms of our current performance and the foundation we've laid out for long-term success and value creation.
Since the beginning of the fiscal year, we have said a few things. We would aim to accelerate growth in revenue excluding billable expenses. We would continue to bring in the right talent to execute against our record backlog. We would keep investing in the business, so that we can further scale advanced capabilities and solutions across our markets and sustain growth going forward. And finally, we have said that we expected the first half to be a bit stronger than the second when compared to last year.
Operationally, that is precisely how the year has played out. While there remains some uncertainty about the end of the fiscal year, because of the ongoing budget debates and the potential for government shutdown, we are really proud of our fundamental strength of our business. Consistent operational performance allows us to make good on our commitment to deliver near and long-term value to investors. And we're pleased that the new tax reform law will present additional opportunities to invest in our people and capabilities, as well as return value to our investors. This operational strength means that we are on track to finish the year with industry-leading organic revenue growth, a significant increase in earnings, healthy cash generation, and more than $300 million in capital deployed.
We are also right on strategy. As you know, for several years now, Booz Allen has been transforming itself by moving closer to the center of our clients' missions, increasing the technical content of our work, becoming more innovative, building partnerships with other technology companies, and expanding into the global commercial market. These are the objectives of our Vision 2020 growth strategy.
At the core of this strategy, when we created it, was a belief that Booz Allen could simultaneously transform itself and shape the market, and that is exactly what we've done. We have systematically built our capabilities in engineering, analytics, digital solutions and cyber, and we have integrated them with our longstanding strengths in consulting and mission knowledge.
We knew that clients would value the power of that combination. And so today, 52% of our people doing client work are technologists or sit in technology roles compared to 43% four years ago. And while our talent base has grown approximately 10% since 2014, our technical talent base is 34% bigger. This includes a wide range of experts, from software architects to data scientists, from systems engineers to malware experts, to life scientists.
Looking at our strategic progress from the demand or market side of the equation, the value that clients place on our differentiated offerings is beginning to show in our pipeline and awards. We are seeing better potential profitability in both, work we have won and proposals we are submitting. The period of performance and submitted proposals has lengthened, and the average value is increasing, because we are going after larger awards and more complex work. And while there are number of factors at play here, we are confident that our move towards more mission-focused integrated technology solutions is recognized and valued by our clients.
It is clear to us that clients, both new and longstanding, those in government and in the private sector, are demanding technology solutions as never before. They recognize the operational, economic, and security imperatives to move critical processes to the cloud, to reach the digital consumer, anticipate and fend off cyber-attacks on infrastructure, connect and train troops deployed across the globe using virtual reality, apply machine learning to accelerate analyses and intelligence and kinetic response, and so forth.
Our clients are learning that Booz Allen is especially good at creating technology solutions that fuse several advanced capabilities at once through innovations, like secure agile, adaptive cyber, machine intelligence in the cloud, and platform cyber. Throughout our strategic transformation, I and other leaders across the firm, have heard two common refrains from clients.
Number one, they'll say, I didn't know that was possible, followed by a great conversation about the breadth and power of the capabilities we've built and the possibilities they open. And number two, they'll say I never felt like Booz Allen was trying to sell me something. Your firm is focused on helping us find our way out of a complex mission essential problem. And this is Booz Allen today, and it was in full display last week at the annual Booz Allen Excellence Awards.
These awards are a recognition and a celebration of the fact that fundamentally, our success has and always will rest on the quality and commitment of our people. The awards recognize the best of the best from the past year, and the nominations include testimonials from our clients about the outstanding skill of our people and the mission impact of their work. The teams we celebrated are doing things like drastically shortening the time veterans wait for decisions of disability claims; arming war fighters across the globe with secure, reliable mobile devices and applications; improving how the Marine Corps identifies and addresses aviation readiness; and helping commercial clients quickly recover from disabling malware attacks. And that is just a sampling of award nominations featuring functional expertise and innovation in our client work.
Other teams had impact (00:09:19) inside the firm and in our communities, by doing things like promoting diversity in the fields of science, technology, engineering and math; responding to last fall's hurricanes; and providing pro bono consulting services to dozens of nonprofit organizations in the Washington Metro area. These teams, each in their own way, bring our firm's purpose and values to life. Our culture is defined by the values we share and demonstrate each day. And the people of Booz Allen rally around a singular purpose, to empower people to change the world. We show it in our dedication to clients and communities and to each other, and that is the most essential reason for our success today and in the future.
With that, Lloyd, let me turn the call over to you.
Thanks, Horacio. Today, I will cover our third quarter performance in some detail. However, given the annual nature of our business and the significant interest in the impact of the new tax law and other longer-term forces on our business, I will focus on putting our third quarter results in the context of our expected performance for the full fiscal year. Where appropriate, I will also provide commentary on how recent developments could affect our financial strategy and performance longer term. A summary of the results is on slide 4.
Starting at the top line, the third quarter was another strong growth quarter, particularly in revenue, excluding billable expenses. As you know, this is the metric we pay closest attention to, because it's where most of our profitability is generated. Revenue ex-billables grew 8.3% versus the same quarter last year. Billable expenses grew less rapidly than in previous quarters, primarily due to the timing of purchases required on certain contracts. We still expect billable expenses to be between 29% and 31% of total revenue for the full year. In addition to delivering near-term performance, we continue to build the foundation for sustainable quality growth over the long term by maintaining momentum in hiring and in capturing opportunities.
In the third quarter, we added another 522 professionals to our talent base and total head count is now 7.4% higher than a year ago. Excuse me, everyone. I'm fighting a cold. As of December 31, our backlog was 23% larger than a year ago, and it remains at a near record level of $16.7 billion. And in what is typically our lightest sales quarter, book-to-bill was 0.99 times, the highest third quarter number since our IPO.
Given our solid year-to-date performance, I am pleased to revise upward our revenue expectations for the full year. We now expect revenue to increase between 5.5% and 7.5% in FY 2018. We also continue to expect that growth in revenue ex-billables will be greater this fiscal year than last, a key objective of FY 2018. Where we land in revenue range will depend largely on the level of billable expenses we see in the fourth quarter and how quickly we can get new hires fully billable on client work.
Moving on to earnings, EBITDA and adjusted EBITDA are up 10% from the same period last year. The near-term cost of hiring and onboarding the talent needed to support and drive growth continues to affect the extent to which our revenue growth has translated to EBITDA performance.
We are exceptionally pleased with our year-over-year head count growth of more than 1,700 people. But this growth comes at a cost, both in recruiting and the time it takes to get new hires fully billable. We estimate that the larger volume of new hires this year and the time it's taking to get them fully billable will add at least $5 million in cost in FY 2018. Still, this is a cost well spent. It fuels our growth this year and will help sustain growth in the future.
Another factor is the legal costs associated from the Department of Justice investigation and other matters which may relate to it. Through December 31, we have incurred approximately $8 million in legal costs, net of initial insurance reimbursement. I will caution you that we expect these net costs to be uneven on a quarter-to-quarter basis. We do not intend to provide regular updates on these expenses. However, based on where we are in the year, we have now included an estimate range of these legal costs for the fourth quarter in our updated FY 2018 guidance. Given our operation performance to-date and taking into account these two factors, we expect our adjusted EBITDA margin for FY 2018 to be in the range of 9.2% to 9.4%.
Below the EBITDA line, there are also two factors affecting our financial results, interest expense and tax benefits. The more straightforward is interest expense. For the third quarter, we had a roughly $6.4 million increase compared to the same period last year. For the full fiscal year, we anticipate spending about $18 million to $20 million more on interest expense than in FY 2017 due to rising rate and the interest expense associated with the $350 million of bonds we issued at the beginning of this fiscal year. So this is an added expense in FY 2018, but it was planned for. It supports our flexible capital deployment strategy and fixes future interest rates on a portion of our debt.
Income tax benefits are the second and more complex factor, and two things are at play here. The new accounting standard adopted early this year for treatment of stock-based compensation and, more recently, enactment of the Tax Cuts and Jobs Act. Please turn to slide 5.
Before today, we had been guiding to an effective tax rate of 37% to 38% for the fiscal year. Taking into account the lower federal statutory rate in effect since December 22 under the new law and additional benefits in the third quarter from adoption of the new accounting standard, we now expect our FY 2018 effective tax rate to be in the range of 33% to 34%.
To be clear, this range does not take into account any onetime noncash impacts due to the revaluation of our deferred taxes, or any benefit we may realize from the completion of tax accounting method changes under the new law. Both assessments are pending the completion of our fiscal year and we will report results in our fourth quarter.
In the third quarter specifically, the company realized a reduction of income tax expenses of about $11 million due to the lower effective tax rate resulting from the new law. We also realized another $1 million of tax benefit due to the new accounting standard. Together, they added about $0.08 to DEPS and ADEPS in the third quarter as compared to the same period last year.
Going forward, beginning in FY 2019, we expect our effective tax rate to be between 25% and 27%. This takes into account a full year of the lower federal statutory rate, plus our expectation that we will likely be able to maintain our more sizable federal and state tax credits. We will provide greater specificity about the rate when we give guidance for the next fiscal year on our fourth quarter earnings call in May.
We also anticipate significant cash savings in coming years and expect the majority of the benefit from our lower income tax expense to drop to the bottom line. We will be better positioned to provide more information once our annual planning process for the new fiscal year is complete. What I can tell you today is that we remain committed to deploying at least 100% of free cash flow in the form of dividends, share repurchases, acquisitions, and we will continue to invest in our business and our people to drive future growth.
Taking all of these top and bottom line factors into account, our adjusted net income for the third quarter was just over $70 million, up 24% from the prior-year quarter. This quarter ADEPS increased $0.10 to $0.48. To ground our full-year forecast for DEPS and ADEPS, let me remind you where we started the year.
We started with a DEPS range of $1.76 to $1.86 and an ADEPS range of $1.79 to $1.89. Based on the perspective I've just shared on our strong operational performance, and other above and below the line factors, today we are both increasing and narrowing our bottom line guidance. We now expect FY 2018 ADEPS to be between $1.87 and $1.95 per share, and DEPS to between $1.86 and $1.94 per share, which is based on 148 million weighted average shares outstanding.
Before concluding, I want to comment on cash and capital deployment. Net cash from operating activities for the nine months ended December 31 is down from the same period last year due to higher cash taxes paid and higher accounts receivable. We have discussed both previously. Those factors, plus a $33 million increase in capital expenditures due to improvements in new and existing lease space, have led to a $69 million decline in free cash flow. That said, we remain in a strong cash position with approximately $290 million cash on hand at quarter's end, and we still expect to convert about 100% of adjusted net income to free cash flow in FY 2018.
Throughout the year, we have emphasized that Booz Allen's value to investors is grounded in two things, our status as the industry's organic growth leader, and our flexible capital deployment strategy, supported by strong cash generation.
Please turn to slide 6. With three quarters of the year behind us, we have deployed approximately $300 million in dividends, share repurchases, and the purchase of Morphick, a tuck-in acquisition that boosts our high-end cyber managed service capabilities. In the third quarter, we repurchased about 833,000 shares of stock and paid out about $25 million in dividends.
We remain committed to generating near and long-term value for our shareholders through the flexible deployment of capital. Under our current share repurchase authorization, we can buy up to an additional $271 million worth of common stock. And as you saw in the press release, given our strong operational performance and confidence in the future, we announced today a $0.02 increase in our regular quarterly dividend to $0.19 per share. The dividend is payable on February 28 to stockholders of record on February 14.
In sum, we have a lot to be excited about at Booz Allen. Our revenue growth continues to outpace the industry. We are ahead of our stated goal of deploying at least 100% of free cash flow for the year in the form of dividends, share repurchases, and targeted acquisitions. We have revised our FY 2018 full year guidance upward, and we are positioned right where we want to be for sustainable quality growth and value creation in the future.
Horacio and I are proud to share these results with you and to represent the hard work and success of our 24,000-plus colleagues each quarter. We look forward to answering any questions you have. Curt, over to you to kick off Q&A.
Great. Thank you, Lloyd. Shannon, at this point, can you give instructions for the Q&A and kick us off?
Sure. Our first question comes from Carter Copeland with Melius Research. You may begin.
Hey. Good morning, guys.
Good morning, Carter.
Good morning.
It's a good thing you guys are – I know you're such nice guys, because this post-Super Bowl Sunday 8:00 A.M. call had me rethinking it for a little bit.
Hey, Carter. I'm from Philly side. I'm going to say my voice is lost due to my cold.
Good for you. Congrats.
Thank you.
Just a couple for you guys. I know you're not guiding for the next fiscal year, but clearly the additional expenses associated with the head count growth and getting the growth plans executed on are clearly a focus among investors. I wondered if you could just speak to – I think the color is helpful in terms of the additional $5 million of expenses. As you think about the normalized margin rate on adjusted basis as we exit the fiscal year into next year, you're clearly focused on still growing the top line and then the head count growth and the backlog growth to support that. How should we think about the interplay of growth versus margin as we transition to the next fiscal year?
I'll start. Fundamentally, it's important to us to grow. We're focused on bottom line as we grow top line as well. We're focused on driving our earnings growth, and believe the most sustainable way to do that is to grow the top line. Growing the top line is best and most effective way for us to deliver the earnings growth, and our adjusted EBITDA is up 10% for the quarter and 7.5% for the year.
Okay. And just to follow-up, with respect to CR, the risk there, and the full-year guidance, how are you thinking about that as we get close to ending the year? I assume it's not a huge risk, but anything you can do to help us quantify that.
Carter, we're, probably like you and everybody else, hoping for a quick resolution to the budget impasse. Certainly a budget is better than a continuing set of CRs, but we have been here before. We are staying focused on supporting our clients. We're staying focused on their missions, and a number of these missions are critical and will continue even in the face of budget uncertainty. So that's, I think, what we're thinking about right now.
Is it fair to say the risk is appropriately bounded in the guidance you've given us? I guess is the only...
Within reason.
Okay. Okay. Thanks, guys. I'll hop back in the queue.
Thank you. Our next question comes from Tim McHugh with William Blair. You may begin.
Hi. Thanks. Just wanted to follow-up on the discussion of, I guess, the cost for incremental hiring. Can you talk about – I guess, besides the sheer number of people, I guess, is there anything about the underlying economics of the projects in terms of how many people you need, or is there anything about, I guess, the cost to hire people, I guess, wage inflation and so forth that's impacting that number? Just kind of trying to get to the more underlying structural issues.
Well, at a structural level, like Lloyd said, we are very much focused on driving earnings growth and, I think, the results speak for themselves there. At the top line, our growth strategy is working and we find ourselves in a very good place, where the business is strong. You saw the numbers on pipeline and backlog are at or near records, and the type of work that we're selling is reflected in the workforce that we're hiring. That's why, in the opening remarks, I talked about the significant growth of our technical workforce. And that work has inherently higher profitability and the capacity to absorb the salaries and the costs of those folks. So, all of that, I think, plays in our favor towards a virtuous cycle of great work that attracts right people, that attracts great profitability, that attracts great work, and that's pretty much how we're seeing it.
I would just add that if you looked at our Q2 on a hiring basis, we had a surge, which was great, and we've been absorbing that number of people. And throughout this year, we've also been up 1,700 year-to-date. We expect going forward to get into a more normalized pattern next year. But, as Horacio and I have been saying, our growth has allowed us to attract great folks with the capabilities that also are reflective of what's in our backlog.
Okay. That's helpful. And then, I know it's early, but a topic that a lot of investors ask is the potential that tax cuts are used by people in the industry to compete more aggressively and perhaps take lower margins on work, I guess, to spur their own growth. Do you see risk or evidence of that? I mean, can you share your thoughts on that and the potential?
We don't – no, absolutely. It's a good question, we've been getting similar question. But we don't see any of that at all. I mean, as you know, our business – first of all, the way we've positioned ourselves, we've positioned ourselves at the center of the mission where quality matters the most. And we are driving a business that is based on that, and that's reflected, again, on the quality of our backlog, the potential profitability of that backlog, and the pricing flexibility around it.
Beyond that, the other thing to note is this is a business that operates in a place where pricing is really not driven by the margin. It's driven by the overall cost approach. And we're not seeing the pricing pressure that we saw three years ago, and we don't expect to see that into the future. We believe that we can drop a lot of this tax upside to the bottom line and to investments in the business as it makes sense.
Okay. Great. Thank you.
Thank you. Our next question comes from Jon Raviv with Citi. You may begin.
Hey. Good morning, guys.
Good morning.
Just a question. Horacio, just from perspective, I know you've mentioned that the government and industry have been in a continuing resolution status before, but it seems that it's relatively unusual to be in this sort of place at the same time that we're looking for significantly accelerated defense spending or even budget spending on security issues. So just some color on how you think this is all going to play out weighing the CR type budget constraint argument versus this need to spend more, given what's going on in the world today?
What we're seeing is significant demand for our services and we're seeing those really across most parts of our business. All of the large elements of our business are actually doing well, and so we're optimistic. And, obviously, as I said before, we would love to see a quick resolution, and frankly, we would love to see a multiyear deal on the budget. I think that would be helpful. But, in the meantime, our core clients are focused on mission-critical activity that needs to continue. They are investing in modernizing around that. They're setting priorities that we're aligned with, and you see that in our top line growth and in our ability to drop that to the bottom line.
Thanks. And then a quick follow-up on that, Horacio, is are these budget uncertainties impacting at all the conversations you have with clients with regard to pushing more fixed price type work, really achieving more of those positive mix shifts that you guys have been looking for – or are planning for in the next couple years?
We don't see that. Again, every client is different and, as you know, there's more turmoil in some agencies than others and more changes in some agencies than others. But if I were to characterize, the vast majority of our conversations with clients are very positive about their intent to continue to drive their business. They are positive about the capabilities that we're bringing and the people that we're bringing. And they are looking for a way to structure those contracts in a way that makes the most sense to them and to us.
For the long term, we're not seeing, at least at this moment, in any significant way, a pullback either from fixed price or anything. In fact, as I mentioned before, we're seeing longer period of performance in proposal work. Everything points to – at least where we are positioned in the market, I can't speak to where we're not – where we are positioned in the market, we're seeing, again, full steam ahead to do the right thing for the nation.
Great. Thanks so much, guys.
Sure.
Thank you. Our next question comes from Brian Ruttenbur with Drexel Hamilton. You may begin.
Yes, thank you very much. On a couple different notes then, any update on investigations? And then I have a question about the shutdown and impact from the one-day shutdown and potential shutdowns in the future.
On the investigation, we have nothing new to report. We continue to cooperate with the government and seek appropriate resolution.
Okay. And then, in terms of the shutdown, obviously, you had one day where you were impacted. That's minor I assume, but can you address that? And then, if you've had any lingering impact because of the shutdown, beyond that one day?
You're correct. I mean, it wasn't material for us. Essentially, it covered the weekend and part of a day. In prior shutdowns because our strategy has been so focused on getting closer and closer to our clients' mission-critical work, in many ways, that's been the best insulation from shutdowns. But this one was really not material.
Okay. And then one final question, just about costs. Do you see – as you sit back and you look at Booz generally, do you see your costs rising faster than your peers, because you're trying to attract a different type of employee, maybe higher tech skills, higher security clearance? It appears that everybody's costs are rising, but yours are rising at maybe a slightly higher rate. Maybe that's just my perception. You can address that.
Yeah. I mean, we are conscious about our costs, obviously. Because we have focused on attracting the capabilities and the candidates with those capabilities, and because we've done very well bringing on the talent we have, as we said in our opening comments, expect those costs associated with labor to be at least $5 million. I'm not in the best position to talk about our competitors other than our costs are in alignment with our strategy, it's working, and it's supporting our organic growth.
To build on that, we are very cognizant of the fact that we need to drive earnings growth, and so we're pricing our work to be reflective of the costs that we're seeing. We've always occupied a premium position in the market, and that's reflected throughout.
Okay. Thank you.
Sure.
Thank you. Our next question comes from Cai von Rumohr with Cowen and Company. You may begin.
Yes. Thank you very much. So, your legal expenses, the $8 million, you said they could be volatile on a quarterly basis, but $8 million reflects three quarters. So should we assume that $2 million to $3 million is a reasonable pace for legal expenses until this matter is settled?
Short answer, Cai, is no. I mean, we've shared the information that we can. It is $8 million net cost to-date. We've baked it into our FY 2018 guidance. And we also expect it to be uneven. This is an active investigation and we're working very closely with the government, and we really don't have any further comments to make on the matter.
Okay. And then, you said that next year you're expecting more normalized pattern in hiring. I assume, therefore, not continuing the same hiring expense. And yet, as I look at your guide for the year, it seems to imply that operating margins will be in the area of 7.2%, 7.3% or down 80 to 100 basis points year-to-year. So, should we assume increasing hiring pressure on the cost side in the fourth quarter, and when does that alleviate if you're going to be normalized for next year?
I have guided, in terms of our margins, being in the mid-9s. And if not for the legal costs, that's exactly where we would be. We're focused on driving our earnings growth. We're driving the top line the best way which we believe to deliver a long-term earnings growth.
Thank you.
Thank you. Our next question comes from Krishna Sinha with Vertical Research. You may begin.
Hi, yeah. So, just looking at your website, you've got about twice the number of open job recs than your similarly sized competitors. So, when you talk about normalized personnel growth, it would seem that you've got a lot more people to hire. So does that mean that your job – or your sort of personnel growth is going to stay elevated for at least several more quarters, if not maybe an entire fiscal year?
So, let me try and separate two things here. We call ourselves the organic growth leader. We believe that driving top line growth is an excellent way to – and sustainable way to drive bottom line growth, where, as Lloyd pointed out, 10% up on the quarter, at the EBITDA line we're 7.5% up on the year. I would love to see us to continue on a growth trend. I think that's what we believe we can achieve. We believe that's how we're going to drive value to our shareholders. We have significant backlog, and therefore significant opportunity to continue to grow.
I'll separate that from a quarter-to-quarter dynamic, where we pointed out we have a significant upsurge in growth in Q2, which positioned us well not just for this year, but for – into next year. And so, we believe and we would like to see a more even pattern of hiring, which then would mean a more even pattern of absorption that may be what we've accomplished this year. But overall, when I look at the recs, the way you look at the recs, I get really excited about our potential into next year and beyond.
Okay. And then just switching over to margin. You've made a lot of progress on growing the fixed price portion of your portfolio mix. What do you think, if you look out into the future, is the maximum available fixed price work to you as a percentage of revenue?
We really don't look at it that way. I mean, as I've said in conferences and some one-on-ones, we're focused on our clients and their most critical missions. And the fixed price work that we end up performing is really with clients that we've had long-term relationships with, we understand them, they understand our capabilities, and we manage it that way.
In terms of a specific percentage of the portfolio, that's not really how we look at cultivating the market and our clients. It's really focused on their missions and performing that work in the best contractual arrangement for both of us.
Thank you.
Thank you. Our next question comes from Tobey Sommer with SunTrust. You may begin.
Thanks. I was wondering if you could elaborate on your comment that RFPs in potential procurements might have longer duration. Could you characterize the drivers of that and kind of how material the change may be? Thanks.
What we saw in the last two years as – on the move towards LPTA and what the government consider the best way to drive competition was a shortening of the period of performance in RFPs. We found that to be counterproductive, quite frankly, for us and for the government. It drove a huge increase of activity in their acquisition shops and to our way of thinking, it did not really drive either more competitiveness or improved pricing. And if anything, it actually made it more difficult to invest in both the client relationship and in the work going forward. So we're seeing, overall, sort of a market swing back to more historical norms.
In addition to that, as we get – our work becomes more technical, more complex, more mission-centric, we are seeing more contracts that are either a longer duration or larger contracts that we go after. And again, we find that both exciting and a confirmation that we are on strategy and our strategy is working.
Okay. And if I could follow-up on the normalized hiring pattern comment for next year. Lloyd, was that to – refer to annual hiring patterns or were you referring to kind of like the sequential burst in hiring that happened in the last quarter?
Yeah, it's annual. I mean, as you can appreciate, we don't give guidance on a quarterly basis.
Sure.
But as we look out over time, we would expect, given the strength of our backlog, given the comments that Horacio has shared so far, for it to normalize over the foreseeable future.
And I know it's maybe a little bit early, but do you have any kind of color or contour that you can give us for CapEx trends? In the calendar 2018 saw a pickup year-to-date, don't know what the outlook is there.
Yeah. I mean, our CapEx increase this year has really been to facility improvements. We see it as key to attracting talent and it reflects our growth. You're right, it's a little too early for us to put something out there at this moment.
Good. Thank you.
Thank you. Our next question comes from Sheila Kahyaoglu with Jefferies. You may begin.
Hi. Good morning, guys, and thanks for the time.
Good morning.
Just going to try to ask this a different way, if possible. On the margin line, the revenues grew 7% year-to-date and if we look at EBIT growth, it's up 12% excluding the $5 million of hiring and $8 million of legal costs. I know it's hard to predict these two items, but maybe can you give an idea of when these costs normalize or how we should think about that $8 million in the context of the SEC investment (00:43:39)?
You're correct, it is hard to project, just given, as we said, the uneven nature to the legal cost. I mean, what we have said is we are targeting mid-9%. And again, if it weren't for the legal costs, that's exactly where we'd be. That's supported by our strong growth focused on the bottom line and hiring as a result of that, but that's really all I can say on it.
Okay. And then you mentioned some larger contracts, you alluded to them once before already. Can you just maybe talk about what's this change in size of these contracts and the change in scope of work?
We pride ourselves of the fact that we have both some larger contracts coming into the portfolio, because those speak of the impact of our strategy and our ability to drive different client work. But quite frankly, we're equally proud of the fact that we work with clients at all different sizes and that our portfolio itself is both quite diversified by design, that gives us what we believe is – it allows us to manage uncertainty, it allows us to drive both pricing and profitability, and we wouldn't have it any other way.
So I think the portfolio and the pipeline, again, support the notion that all elements are in place for this notion of sustainable quality growth that we have been talking to our analysts and our investors now for many years. We have the right portfolio in our backlog. We have the right talent base. We are positioned with our clients where we want to be. And the business underlying, all of this is really strong.
I'd just add that no contract's greater than 2.8% of our portfolio. What we're really excited about is the fact that, increasingly, the work we provide on those contracts is really integrated in nature, all the capabilities that we've been investing in and all the talent that we've been attracting to the firm.
Okay. And then just last one if I could sneak it in in terms of pricing, Horacio, I think you mentioned you're not seeing the same pressure as three years ago. Maybe can you comment on pricing year-to-date? Is it up? Is it flat?
We are seeing – if you go back three, four years ago, we were actually seeing a pricing decline across the industry as the government was pushing very hard on LPTA everywhere. We have seen the LPTA wave – at least for the work that we're doing, I won't comment on the entire industry – wane. And while there are still some pockets that are still operating that way, the vast majority of our clients are thinking more of true best value, are thinking more of investing, modernizing, improving their readiness, and therefore, they're looking for new capabilities, they're looking for innovation, they're looking for the things that we can do, like Lloyd just mentioned, when we fuse multiple capabilities together to create a novel technical solution.
And as a result of that, we see pricing beginning to go the other way. We see increased profit potential in these contracts. And we see more differentiation, which I think over the long run, I believe, should also ensure our ability to continue to win recompetes and those kinds of things.
Great. Thank you.
Thank you. Our next question comes from Rayna Kumar with Evercore ISI. You may begin.
Good morning.
Good morning.
Can you discuss your progress in expanding your commercial business? How much revenue did commercial generate in the third quarter, and what percentage of revenue do you expect it to generate in FY 2019 and beyond?
Sure. Thank you for the question. We don't provide quarterly results that are that specific. I would just add that we're very excited about our commercial business. It has grown 22% and 23%, respectively, over the past two years. They're having another very strong year, but we fundamentally don't give specific revenue performance for parts of our business.
Thank you.
Thank you. Our next question comes from Joe DeNardi with Stifel. You may begin.
Hey, guys. Good morning.
Good morning.
Good morning.
Just wondering if you could talk about the procurement environment a little bit in terms of the use of bridges and extensions, whether that's hurting or helping you. I think we've heard from one of your peers that there's a lot more of that activity. Just interested in your perspective on that.
We are seeing bridges and extensions continue to happen as the government looks to continue our work on critical missions. And it's maybe a little higher than we've seen in the past, but I don't think it's out of the ordinary or we don't view it as a major trend in the business. Where we're excited is where we see sometimes these bridges come on to, so the government can have the time to expand scope or deepen a set of opportunities in the next round of procurements.
And to the extent that you've seen our win rates as being quite robust in both existing work and new work, that tends to play to our advantage. And again, I'll come back to this notion of sustainable quality growth both at the top line and at the bottom line. And what we're seeing in the market is the opportunity to continue to do that. And from our perspective, we believe that after years of preparing and investing, all the elements are in place.
I would just add that the protest environment is still alive and healthy. For us, about $57 million of awards are under protest as of December 31. We don't include that number in our backlog, as you may know. But with that being said, it's still a dynamic in the procurement environment.
Okay. Yeah, that's helpful. And then I think, Lloyd, you mentioned that you're excited that you're seeing more contracts that are, I guess, fully integrated. Can you just talk about what excites you about that, and should we expect your win rate to improve since maybe you guys can do a better job at that than your peers if that continues?
Sure. I mean, the first reason we're excited is our clients are increasingly engaging us on how do they approach their challenges with more integrated capabilities and take advantage of advancements in technology that they see in the private sector. The second reason is we're bringing on candidates, as you see with our head count numbers, that are reflective of those capabilities. And thirdly, we've worked very hard over the past five years to integrate these capabilities and to engage our clients. And given the growth in our backlog, given the conversations that we're having, there's a lot to be optimistic about in terms of accelerating our metrics, specifically revenue ex-billables.
Thank you.
Thank you. This concludes the Q&A session. I would now like to turn the call back over to Horacio Rozanski for closing remarks.
I want to thank all of you for your questions this morning. We have two months remaining in FY 2018 and Booz Allen is on track for another successful year. We're working as hard as ever to ensure that our growth is sustainable, our value is clear, and our impact on the world is truly meaningful. Those are the things that inspire Lloyd and I, and all of the people at Booz Allen, to constantly get better and stronger and to make this institution better and stronger. So, thank you again for taking the time to be with us this morning and have a great day.
Ladies and gentlemen, this concludes today's conference. Thanks for your participation and have a wonderful day.