Booz Allen Hamilton Holding Corporation (BAH) Earnings Call Transcript & Summary

Okay. If we can have your attention, we're going to move along. We're delighted to have with us next, Booz Allen Hamilton, and their CFO, Lloyd Howell. Lloyd, thanks for coming to join us.

Thanks, Cai.

So if we look at your third quarter, your December quarter, you had 11.2% sector growth. But your book-to-bill of 0.4, it was near the bottom of your peers, your 12-month book-to-bill, 1.2, solid but down for the fifth straight quarter. How do we -- what should we think about these mix of items?

Sure. Well, overall, we're very pleased with the growth of our backlog, which year-over-year was 7.4%, coming in at $22 billion. And given sort of the robustness of the procurement season, our track record with awards, we're really looking at the book-to-bill dynamic as a bit of a timing issue. We are pursuing larger procurements, which are a function of our clients wanting to bundle multiple task orders as well as add to that. Those larger procurements are subject to a little bit more volatility in terms of award decisions, things slipping slightly to the right. And then also the ever president-protest environment. But when we take into account the overall backlog, the growth of that backlog, plus our track record with winning work with over 4,700 task orders, we don't feel that we're demand-constrained and it really comes down to, can we hire up the talent to convert that backlog.

Got it. So also in the third quarter, your billings spiked to 32.5% of revenues. So that held your revenues ex billables to up 8 plus. Why is this so high? Is this going to change? Or -- I think at one point, you said 30% was kind of the normal average.

Yes, we have forecasted billable expenses to come in at 29% to 31% for this year. And last quarter, a spike to closer to 32% on the heels of which were small business set asides and ODC pickups with our Defense business. Our Defense business has been growing very well. But it's also subject to the small business set asides and ODCs, which essentially are empty calories. That being said, our margins have maintained strong performance coming in at 10.3% for the quarter. And so we're not seeing any material impact on our EBITDA margin, even with the pickup in billable expenses.

So you also had, I mean very mixed end markets. I mean Defense was up 18%. I mean even if you have a couple of empty calories in there, as you said, I mean there's still a spectacularly strong number. How come it was so strong? I mean anything particular happening that you're doing?

Yes, I think it's been the combination of the positioning and shaping of work, particularly in the areas that we want to support our defense clients in, which is cybersecurity, data analytics, system software development, engineering and science. So across the Defense portfolio, with all the agencies and departments, we really have started the year very strong, and that continued into the third quarter. Same can be said for our civilian federal agencies. That continues to grow at a nice clip on the basis of our health-related businesses as well as our financial, Regulatory & Justice and Homeland Security work. The one market that we're giving a fair amount of attention to when we spoke to on the earnings call, has been in the intelligence business. Long had the headwind of finding cleared staff, bringing on that cleared staff, which is -- has a dampening effect on growth. But we made the decision to change leadership. We brought in a long-tenured colleague, Judi Dotson, to lead that. Judy has begun an evaluation of that business and we feel very confident that she's going to sort of ride the ship with a lot of our help and get back to the growth profile that we've seen previously. But overall, given our performance this year, the raise and tightening at the top line, sort of affirming and also raising and tightening at the bottom line, we're still having a very good year.

So usually, companies don't change management, unless the performance or the win rate has not been satisfactory. So I mean if you're up only 1%, I assume it's more than just the ability to hire people. I think as I look at your 10-K, or was it like 7 of your top 10 contracts are in the Intel space, or certainly a substantial number of them. Has there been any execution issue, at least on the capture side, that caused you to make this change?

No, it's a combination of lots of things. I mean persisting, recruiting challenges where we think we can do better as it relates to execution, shaping client relationships. And then also as you point out, at 1%, we feel that we can do better. Christopher Ling, long-tenured colleague, retired. And Judy is more than willing and capable. She is coming to that position from our JCC market, which she really turned around and also has made a very profitable part of our Defense business. So this is part of the natural evolution of what we do and we thought now is the time to do that, and Judy has our full support.

And so what are you guys doing to kind of reinvigorate the Intel business?

Several things. One, we are meeting with our current account and sub-account leadership. We're appreciating, with the help of our Chief Personnel Officer, what the recruiting challenges really are. We're targeting our sold and funded positions as low-hanging fruit to be filled. And then we are, let's say, reinvigorating our relationships with our current clients as well as evaluating what is in the pipeline in terms of new prospects. And so that top to bottom evaluation with all hands on deck is what we typically do. You'll recall that you were asking me lots of questions about operating cash not too long ago and this is what we do. Once we sort of spot and identify an area for improvement, we go all out to address it, and we're going to do the same thing with our intelligence market.

So usually, the gestation period, it's kind of you're starting to connect and getting things done is you have to see a bid come up, it takes a couple of months, you put your bid in until you get a decision. How long, would your guess is, I mean is this sort of something that we'll start to see this pick up relatively soon? Or this is something we should think about the next 3 or 4 quarters?

Yes. The timing issue is -- it's difficult to nail down because the gestation period in this current market is really several years. So for things that we have in the pipeline, they've long been being shaped and we've been putting sort of forward our best arguments of why we have the best intellectual capital team and whatnot. Some of that is naturally going to come into play next fiscal year. And knock on wood, we'll hopefully be successful in some of that. And then there are other things that under Judy's immediate watch will get going. So we are expecting to see improvement sooner than later. But it's hard to pin it down to at what point in the fiscal year those things are going to ultimately kick in. A lot of it has to do with when does the government make the award decisions, and then when do we sort of ramp up and get going. So we're optimistic that the changes that have already begun will start to take effect early part of next fiscal year. But I'm hesitant to say exactly what we'll see change at what point in the year until we get further into it.

All right. So some companies basically give us data in terms of the bids submitted, the dollars have been submitted. And so if the dollars have been submitted go up, if your capture rate is more or less the same, hopefully the numbers go up. Have your dollars have been submitted been trending up?

I think it's been consistent with our stated 6% to 9% top line growth as a part of our investment thesis. We have one sort of P&L in that, have a great deal of fluidity in terms of how we swarmed the opportunities and what gets submitted. So we're on a trend that we have been on with -- in terms of historical submissions. And we think that is sufficient to allow us to reach that institutional range of 6% to 9% top line growth. And the intelligence market will play an important role in that. For everyone's benefit, it's just under 25% of our overall portfolio, Defense accounts for about 50%, our Civil/Federal agency work is also about 25%, and then global Commercial, sort of rounds it out, around 3%.

Right. So you mentioned when you started that you're going after bigger potential targets. What can you tell us about that? I mean are you going after single award -- single-award contracts, single-award IDIQs, multiaward -- what type of things are you going after? What areas? And what should we look for there?

Sure. The answer is yes to all of the above, largely driven by a couple of factors. One, our clients, particularly in the Defense and Intelligence space -- spaces, are bundling existing task orders and adding 2 or 3 additional ones. And when you sort of sum it all up, you get into a $1 billion range. Some of that is winner take all, some of it is ceiling, and some of it is sort of the IDIQ. We are sort of -- have an incumbency position as well as new work or takeaway opportunities. So it's really a function of the evolution of the market the decision-making process, the procurement officials and agencies are making. We, as a significant player in the market, reacting to that. And it's not anything more than that, we're not pivoting and sort of solely focusing on large procurements. We still have a very healthy transactional part of our portfolio, sort of accounting for 4,700 task orders. We're not neglecting that. We're continuing to grow that. But as a part of the natural evolution, there are going to be these bigger pursuits, which we are pursuing.

Do you feel -- I guess, historically, you said, well, we think we're about the right size. Do you think you would benefit from having greater scale to go after these bigger deals?

We think at $7 billion, plus $7 billion. We have the scale. We've long maintained that. We think that once any company in this sector sort of cross $4 billion, they're at scale. Scale to us is a byproduct of the work that we're trying to do in the spaces that we're trying to do it. We have long sort of pursued strong capability development being close to our clients' missions, and then hiring the best talent that we can to execute that. And then the scale is going to be what it is. So at the current size that we are, we feel that we've got plenty of scale. There's not an opportunity that we don't see, an opportunity that we're not invited in on to compete for. So we think we're there.

Got it. So how would you characterize the current demand environment for your services? And what impact, if any, do you think the upcoming elections might have on your business?

Yes. I'd say the current demand will persist for at least another fiscal year. In our investment thesis, we said that we expect it to be 6% to 9% top line growth, margins in the low 10% and at the bottom line, sort of see about 66% ADEPS growth going back to FY '18. And there's nothing that we see in the next 12 months or so that would sort of take us off of that. As we get to the end of this fiscal year, I'll forecast what we think ultimately FY '21 will look like, but we're not at that point. I think to your question, which is a bit of a crystal ball question. Who knows? It's a bit too early to say who's going to emerge from the Democrat side. It's clear with the recent budget submission or proposal that the administration is made kind of where their priorities are. Their priorities do line up. So the book of business we have and the continuation of what we're executing. But as we get closer to the election, there's bound to be some surprises and some changes, some adjustments and we'll have to be flexible on that. The other thing to keep in mind is that the existing work, we'll have a tail to it leading into either the continuation of the current administration or a new one. So it's not like it'll be an abrupt pivot come November or anything or January. And there's also the sort of administration of putting in a new cabinet or updating the existing cabinets. So there will be some natural disruptions that sort of lead to, and from a historical standpoint, the continuation of existing programs and whatnot. And we'll be very close to our clients. And as we anticipate either a change prioritization, we'll be on the ready to react to that.

Right. So your commercial business was up 4% year-over-year, but it -- I can't remember the exact number, but it was a nice uptick sequentially. I think at one point, you said you'd lost some people about, I don't know, 9 to 12 months ago. What's happening there? Is that business starting to pick up again?

Yes. We -- if you go back the last 3 years, that business has been growing in the high 20s to low 30%. And we had a couple of jobs, one was -- which was a task -- I'm sorry, which was discontinued. Another one was pushed out to the right. And so on a relatively small business, it's not unexpected that that would sort of create a little bit of a bump. There's nothing fundamentally at issue other than getting back on pace, and that's what the team has begun to do. A nice backlog of work, nice quality of multinational blue-chip clients who are increasing their demand for our type of support. So we're optimistic that we get back to that double-digit growth from where we are today. But it's still growing, still doing very interesting work. I might add that in the Middle East region, which is a part of that, we have a new leadership team in place done a significant job cleaning up sort of the contractual and invoice, really issues that we were having in that space. That's contributed nicely to improving our DSO profile, but more work to be done there, and also the prospects are pretty attractive in that part of the world.

So you mentioned the job -- discon ones slip, do you have any kind of relatively large ones that if you win them, we'd get back to this 20% relatively soon?

Certainly hope so. We have the opportunity for continued improvement. We've been sort of guiding and encouraging folks to look at our operating cash generation, which we think is true representation of our overall performance. But we're certainly looking on a receivable/payable basis to continue to have improvement there and some of the changes that we put in place over a year ago have started to take root and giving us the confidence that we're on that good path.

Right. So hiring, you're up 0.7% sequentially, which is, okay. Last year, you were higher. But I think you started off this year a little bit better. How do you feel? Is this sort of what you need? I guess you should get to your 5% target. But are we seeing deceleration? And is this a function of the environment? How should we think about all of that?

Yes, we're feeling good about where we are with onboarding the talent. We forecasted the year to come out of the gates pretty strong in the first half, given, at that time, the budget uncertainty, we expected the second half of the year to be a little bit uncertain. So we exactly -- tracked exactly to that. First half of the year, very strong in terms of hiring. Q2, we were up 6.5%. It fell back in Q3 to 5.3%, but looking at the year, we're on pace to be at that 5% objective. That then, in turn, gave us confidence to raise and tighten the top line guidance. Still a very competitive market in terms of the job market. Unemployment in the Washington, D.C. area for the skills that we're pursuing, close to 0. But keep in mind that of our 27,000, 12,000 or so are in D.C. and the balance is out in the rest of the country, which is growing at a rapid -- more rapid rate than Washington, D.C. So we feel we're positioned in the geographies to continue that pace. We're competing very well in San Diego, San Antonio, Denver, Colorado Springs, Charleston, to name a few. And we expect that to continue going forward.

Got it. So you've also talked about monetizing IP and you've launched this AI software platform. I think it's called Modzy. Where are you in terms of developing this strategy?

If you look at the main of our business, our AI intellectual capital has taken root in all our defense agencies and department clients as well as the intelligence community. Modzy is more of a venture into a commercial application, very, very, very early stages. And so with the rollout and the announcement, it's created the right type of buzz and interest from a variety of potential clients. The team is still in the formative development phase. It's going to probably be a while. So we have some tangible financials to kind of look at, but this is what is representative of what we call an option value initiative. So a bit speculative, but certainly in a space that holds a lot of promise and a lot of potential. And as that matures, we see these types of initiatives being accretive to, sort of, the main of our federal business.

Got it. And so you said you hope to improve free cash flow. What are you doing to improve this goal? One of the things you mentioned, the change in the Mid East, anything else?

No. This is, from my perspective, real blocking and tackling in its purest form. We had gotten sloppy on the receivable cash selection side. We brought in a new team -- leadership team to address that. We've gotten the attention of our business leaders that this is a priority, and it's really made a difference in the cash collection side of things. On the payable side, we've also made some improvements. Still, from time to time, a miscue. So we don't quite have the right and left hand, synced up as we want. But again, made some improvement there. The Middle East is sort of an example of where we have both sides working very well. We've tightened up the terms and conditions of future contracts or new contracts. We've solidified or strengthen the relationships with the clients. So we have more timely payments of invoices and sign off on deliverables. And we're rolling that out across the institution. So in a sense, I could say, "Hey, we're there, but given sort of the -- our culture and the opportunity to source some additional improvement, we're going to keep pushing on this."

So your DSOs, I think, last quarter were 70 days, down from 76. Right direction, but you're still above peers. Where do you think you can get them ultimately? Any -- what's the range you would guess, you would be in?

Well, depending on the time frame, I mean we want to be consistent with where our peers are. And we think we're on the right path and doing the right things to kind of get there. It's easier for it to get out of sync than to get it back into sync. And so we're going to continue to kind of push on the changes that I just mentioned a minute ago and get, as best as we can, closer and closer to being on par with our peers.

Okay. And then just in terms of timing of awards, your book-to-bill last quarter was a little lower than -- I mean in what's seasonally not a particularly strong quarter.

Right.

Should we think, kind of the current momentum this quarter, things would be kind of more in line with your historical averages or better? Or -- I mean because most of the other people here are talking about, like, this is a really robust environment.

Yes. We're going to track to our historical trend line and continue to do the best that we can to kind of improve upon that. But we track very closely to the government fiscal year and I have no expectation that it's going to be dramatically different than that. And we're expecting to perform and do well, consistent with what our investment thesis is and the fact that we're in a pretty attractive market right now.

Well, if you're chasing bigger contracts, should we expect your book-to-bill to be lumpier going forward or more or less? Because historically, haven't you basically gone after task orders on the IDIQs? That's been your real unique strength. But if you're going after bigger things, we're going to see more -- much better, maybe not quite as good type of trends?

Yes, we made reference to this on our call. We're going to maintain the momentum on our historical pursuits, which we expect to still yield win rates consistent with what we've always done. When we're an incumbent, we tend to win in the mid-80% of the time. And for new work, that's bumped up to sort of low 60% win rate. As I said on the call, the increase or the uptick in volatility will be due to sort of the pursuit of these larger procurement opportunities, subject to protest this, things may be moving to the right as it may be. But we see that as sort of the evolution of the market not necessary pivot. We see that as sort of a balancing of the overall portfolio and reflective of what the market is giving us to pursue.

Got it. So you mentioned your 6% to 9% growth. But I think your guide for this year is more like 10%. And if Defense is strong with more ODCs, I mean is there a message in the 6% to 9%, that sort of the current rate is sort of above normal, and you'd go back to that rate? Or how should we think about?

Yes. We raised and tightened the guidance for this year to be between 10% and 11.5%. And our investment thesis for the 3-year period is 6% to 9%. There's nothing to read into that other than when we get to the end of this fiscal year, we'll address and forecast what FY '21 will look like. We have a very comprehensive planning process, which we're nearing the end at. That will be factored in as we look at where we exit, where the opportunities are. But at this point, looking at a 6% to 9% last year, our investment thesis is pretty good from our perspective, all things considered. And given a raise and tightening this year, I think it also points to the momentum and the tailwinds that we are experiencing and clearly, others in the sector are experiencing.

Right. So I guess with the cash flow improvement, you have a goal of deploying $1.4 billion. What are you doing? What are your priorities? Historically, you've been very generous to the shareholders, less on M&A. How should we think about this going forward?

Yes, the 4 levers to our capital deployment remain the same: share repurchases, regular occurring dividend, capability tuck-ins and then the possibility of a special. We are looking to option -- increase the value to our shareholders, both in the near, mid- and long term based upon what the market is giving us and what combination of those levers to pull. So we don't go into any period of time preset, but we're looking at what makes the most sense given the market conditions and so forth. So this year, as you made reference to, we did an out-of-cycle raise around our dividend, $0.04. And then we did in Q3 another raise to get us closer to that 2% yield. And that's indicative of or an example of how we think about our capital deployment. We're committed to the $1.4 billion. We think that we've got plenty of strength in our balance sheet to achieve that. But we're also remaining patient and disciplined in doing so. So we've got plenty of time. Balance sheet is strong. We feel like we've got the right levers to pull if the conditions indicate and away we go.

So if we think about M&A, historically, you've done less than your peers. We have kind of record low interest rates. I think the last couple of weeks have been kind of the food fight, who can do more deals more quickly. And actually, people doing some interesting things in terms of moving outside of their core, where their legacy business has been. As you think about M&A, what are you thinking about? I mean historically, you've just bought little niche technology accelerators. But what are you looking at? Would you be a little bit more aggressive to get more scale? Would you kind of look at maybe moving into a quasi product area, what Parsons, what CACI did? How do you think about all of that?

Yes. I mean we pick up our M&A strategy based upon what our broader strategy has been, which has really been the emphasis of capabilities and service offerings in cybersecurity, digital, system software development, engineering and science. So where we see as pure capability opportunity as we can find or that is available, we really do our homework, look at it and then if we can get there, submit a bid and hopefully prevail. We look at over 100 opportunities, many of which have transpired recently. We do our due diligence, we do our evaluation on the math to see if it fits in alignment with what we're trying to achieve. We bounce that off of our strategy. And then we also heavily question the integration and all the known and unknown risks around that. We, given our organization -- or sorry, our organic performance, haven't felt compelled to do a deal for the sake of doing a deal. And that has really sort of guided our infrequent acquisitions, as you point to. And as we are sort of coming at the end of our investment thesis period, sunsetting sort of Vision 2020, which is the corporate strategy that I made reference to, we're also putting in place and looking at what's the next set of strategy, directions and objectives for the institution. I'm not prepared today to say what, hypothetically or from a speculative standpoint, that might lead to. But I will say like we're looking at everything. Whether it's products, whether it's a combination of products and services, whether it's an extension of what has been working for us over the past 8 years, whether it's adjacent markets and/or offerings to what we're currently doing. That will be the guiding principle to what ultimately M&A or M&A posture looks like going forward. I will say we've got a strong balance sheet. We're not feeling capital constrained. We're trying to think longer term than just sort of react in the near term, and we like sort of our position to date. So we're not feeling that we're missing out. We're not feeling that, hey, the market is passing us by or subscale. It's really, hey, let's in a Booz Allen fashion, let's take our time, think about all the different things and then plot a course so that when we do and if we do, do a deal, it will hang together in terms of the strategy, to the execution, to the economic.

But you've been very picky. I mean the fact that you've done fewer deals, are you concerned that maybe your integration capability is not as what it is for the other companies who do a couple of deals a year? Is that something that you need to improve on and...

Yes. I think when it comes to M&A and all the processes and whatnot, certainly, we'll be evaluating our internal processes, our talent, so that if we were to become more acquisitive, we've got that in place with all the right experience to kind of do that. But keep in mind, our strategy hasn't been to be overly acquisitive. It has been capability tuck-ins. And so for the deals that we have done, we felt that our integration processes have been appropriate. Certainly, if the volume of deals were to increase or the size of deals were to increase, we would also look at our integration capability. But we don't feel that that's a bridge too far or insurmountable. It's an addition to the team that we already have.

I mean the reason you've done so few deals, is it that you have difficulty finding properties of interest? Or is it basically that they've been too expensive?

A little bit of both. There always have been, with any deal, aspects to it or a component of it that we've liked and components that we haven't. Surprise, surprise, the seller isn't really interested in parsing it the way we want necessarily. So it is what it is. Coupled with where the pricing and the multiples around these deals have been, they've been different than how we value the assets, many of which are companies that we've worked with in the past. So we feel that through experience, through due diligence, a pretty good handle on what it is and the competitive bid process being what it is, we've got to accept that. So it's a mixture of asset hasn't been quite what we want the opportunity, but we do submit half a dozen bids in the current environment, but also surprise, surprise they haven't been the highest. So the seller goes in a different direction. But we're getting the bat. We're swinging the bat. We'll see where the future goes.

Got it. So as you think about this year, what are the 1 or 2 things that could make for more disappointment over the next year and maybe a couple of the opportunities that maybe the market doesn't have adequately factored in for Booz?

Contextually, disappointment, if the spigot of opportunity were to dry up for reasons beyond anyone's who can envision, that could be disappointing. So you're now looking at, instead of a robust set of opportunities, really limited. If the cost or the pendulum swings back to more of an LPTA award environment from what is now I think pretty balanced between value and LPTA, that would be a bit of an unanticipated headwind. And then for us, if for whatever reasons, the available job market tightens even more than what is already a pretty tight job market, that begins to tweak sort of the supply side of the equation. Beyond that, I think it comes down to the basic blocking and tackling that historically we've done a pretty good job at and maintaining that to kind of offset some of the unknown or unanticipated headwinds.

You haven't mentioned anything on the upside that could make things better.

An emphasis on IT modernization and a pivot within the broader government of leadership, budget, even law, to some degree, to kind of encourage that to occur more rapidly. I think that would really be something that would be great. But here, again, we haven't seen anything immediately to that effect. I think, with our clients, there's broad recognition that, hey, this is an area and a trend that's going to continue to pick up momentum, but there's a couple of other indicators if they were to come to pass. I think we could see an acceleration in that.

Anything else?

What?

From the upside?

Nothing. Nothing really comes to mind.

Okay. Well, I mean how should we balance this? Because you've mentioned, as I look at these fewer bids, I mean we're in a pretty robust environment. That doesn't seem that realistic. LPTA, I mean that might happen, but that doesn't sound like it's anything that's going to happen in the next year or so. And I guess hiring is a real issue. But I mean as you look at all of these, would you balance these, they're more on the upside, more on the downside? Or...

I would say more on a net basis, more on the upside. So we wouldn't be exiting or at least forecasting the remainder of this year strongly as we are if we felt that, hey, there's going to be something on the horizon that would offset the momentum that we've built so far. We wouldn't be coming off of -- or we wouldn't be adjusting our 3-year investment thesis objectives, which we think are pretty positive if we felt, okay, there's something doom and gloom in the next 12 to 18 months. So all the indicators, as we look at, are still pretty positive. If you're detecting any sort of hesitation or conservative approach in my comments, we are conservative, and that's how we kind of go about it. We'd like to get to the end of this fiscal year first to forecast what FY '21 is going to be. But at the present, most of the leading indicators are supporting continued growth and we're going to ride that wave like everyone else.

Now you talked about Vision 2020, you got one more year to go. But obviously, from what you're talking about, you're thinking about what is the next step. I don't know, Vision 2023, but what's the earliest? When might you tell us a little bit more about where the longer term, yes, the next 3-year plan or whatever it is, is going to be?

Sure. We're in the process of, as I said, enhancing our current strategy and figure out what comes next. And historically, Booz Allen does this type of evaluation every 5 to 7 years. We are more than halfway through it. We're going to be working with our Board over the summer, kind of put the finishing touches and hope to be in a position to share that kind of in the fall time frame. So certainly, before the end of the calendar year, we're looking to be in a position to kind of share that more broadly, along with sort of the financial underpinnings and assumptions of why we think whatever we're going to think. We have this thing called the presidential election. So we're sensitive for the messaging not to get drowned out by that event as well as wanting to maybe turn over or see a few more cards get turned over before we go final, final. But here again, that's a detail that I think will sort itself out. But we're looking to be in a position to share more broadly by the end of the calendar year.

Terrific. Thank you very much. That was great.

Thank you.