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

Good morning, everybody. Thank you for joining us this morning. I'm Brian Gesuale, senior analyst covering the defense technology space at Raymond James. Delighted to have Booz Allen here to present. We have the company's Chief Financial Officer, Lloyd Howell, to run through the story. The format this morning is we're going to do a very brief presentation just to kind of baseline everybody, give an update on who Booz Allen is, and then we're going to open it up for questions and answers. So I have a handful, but if you have any in the audience, please think about them and don't be shy. But with that, Lloyd, I'm going to turn it over to you.

Thank you, Brian, and good morning, everyone. Welcome to the Booz Allen presentation. A little over 2 years ago, we laid out an investment thesis for our investors that we feel captures our positioning and our story and financially what we're all about and what we're trying to do. Booz Allen's over 100-year-old institution, 80 of which has been in the federal market. And during that time, we feel that it has afforded us some unique positioning with our clients. They go back 80, 90 years in terms of relationship. That then, we believe, leads to a financial set of objectives, where we expect to grow ADEPS by 66% by FY '21. And so we've got one more year, a little over a year to kind of get to that objective. But we feel, as you'll see in the upcoming slides, that we're well on our way. In order to get to that bottom line performance, we feel that we will need to perform at 6% to 9% revenue growth, maintain margins in the low 10s with an eye on deploying $1.4 billion in capital. And in addition to that, we have a set of initiatives, which we have grouped as option value in nature that can be accretive. After a year and some, we're certainly, we feel, on our way to achieving that. We've had 8.7% annual revenue growth. We've had increase in margins of 60 basis points. And we've deployed, after a year, $364 million in capital. We have a very diverse and experienced leadership team led by our CEO, Horacio Rozanski. Each of the members of the team have been over multiple decades in the business. We've all served in a variety of roles, many of which have been one in others. Prior to being the CFO, I led our civilian federal business and prior to that, our strategy and organization practice. We have a little over 27,000 folks spread throughout the world, 500 locations, 25 countries. About 1/3 of our workforce are veterans and 66% have security clearance of some nature, highly educated workforce with all sorts of degrees as well. We've been an industry leader, as I said, over a 100 years, founded in 1914. We were based in Northern Virginia in McLean. We went public in 2010. We have a single P&L. And for the first 9 months, we had $7.3 billion in revenue, $433 million in net income at a 6% margin and $735 million in EBITDA as reflective of 10.1% margin. 96% of our business is aimed at the Federal U.S. government with the balance being global commercial. And we're -- our diversification of over 4,700 total contracts and task orders, not any one of which is greater than 3% of the overall value, leads to a very diversified P&L. In terms of contract types, we've got a mixture of fixed price, cost reimbursable, and time and materials, the majority of which is cost reimbursable. We have a very high win rate as recompete to the mid-80s; and for new work, just over 60%. We also enjoy being in the prime position over about 90% of the time, and the balance being as a sub. With a legacy of a management consulting firm, we have a comprehensive suite of service offerings that we're continuously integrating and combining to meet our client's most pressing needs. At the core of which is a consulting heritage, which we have added in terms of analytics engineering. We look to combine those to produce digital solutions, cybersecurity set of offerings, and as I mentioned, depending upon the needs of our clients, we're continuously talking to them and thinking about what are their future priorities and how best to combine and integrate these sets of offerings. We've got a diversified customer base. Defense comprises about 50%, followed by our civilian federal business. To go back, defense, all the major services as well as the joint combatant command. And the civilian market really centers around homeland security, HHS, veteran affairs as well as treasury and justice. In intel, it's mostly U.S. intelligence agencies as well as the military intelligence agencies, and then rounding out the portfolio is our global commercial business, principally focused on cybersecurity, aimed at financial services, life sciences, energy, transportation. Internationally, we have a presence in the Middle East as well as selected southern Asian markets. About 7, 8 years ago, we put together our current strategy, which is called Vision 2020. We're sort of now in what we believe is the payoff period of that. If I take you back to shortly after we went public in 2010, the market -- the federal market began to contract. And at that time, we put together Vision 2020, which is really focused on a couple of things that we think has been critical to our current performance. One is that we wanted to move closer and closer to our clients' missions. Prior to that, we have been supporting our clients, mostly in a program management capacity, but not necessarily as tight as we want it to be or should have been to our clients' core missions. We wanted to increase the technical content of our work. And to do that, we needed to recruit the talent to provide that technical support. We wanted to put in place a more concerted innovative engine to the business that was continuously looking out over the horizon and bringing those insights into our existing work. We wanted to create a broader set of network of partners and alliances, and then we wanted to expand into new markets, such as global commercial and international. Now what we think that has afforded us, there a couple of things. One, it's insulated our operating performance through budget and economic cycles. It's prevented or put in place barriers to entry, a little bit higher than we had quite previously and that supported our margin. The technical support has brought some stability to hiring, and the retention of that has driven our backlog conversion. Innovation has created these option value initiatives that I mentioned and enhanced our growth. And the partnership has afforded us relationships now with Dell, which has led to the development of one of our initiatives called District Defend which secure -- make secure mobile devices. And the shift, the mix shift has allowed us to increase our margin. The results of our Vision 2020, you can see on this page. It has steadily, on a net income basis, grown from FY '15 to the conclusion of last fiscal year, FY '19 at $419 million. It has also driven strong diluted earnings per share at the bottom line, where at the end of FY '19, we closed that at $2.91. We've also seen strong earnings growth over this period with a CAGR around EBITDA of 6.5% and a CAGR around ADEPS of 14.6%. And then we've seen, in terms of organic growth, the fact that we emerged in a positive way in FY '16 and have maintained that so far closing out at 8.7% at the end of FY '19. Our backlog and book-to-bill have also steadily grown over the years, where we closed out at the end of Q3 at $22 billion. That represents a 7.4% year-over-year growth rate. And at the bottom, you can see our book-to-bill trends, which closely mirror that of the federal government's procurement cycle, peaking in our Q2 which coincides with the end of the government fiscal year September. We've also delivered, over this period of time, high shareholder value. You can see in the top graph our capital deployed as well as our total shareholder return performance since we went public. And at the bottom, our capital deployment strategy really leverages 4 levers, capability tuck-ins for M&A, share repurchases, special dividends as well as quarterly dividends. And so I'll note that it's been some time since we've done a special. This really represents sort of as -- for the Carlyle Group who had been a significant holder since wound down at the end of -- beginning of FY '16. And we haven't done a special dividend since that time. Our dividend performance is very important to us, and we feel that we are an industry leader in that regard. Just this year, we raised our regular recurring dividend twice Q2 by $0.04 and Q3 also by $0.04 really, with an objective of getting around a 2% yield. We see this as representing commitments to our investment thesis as well as confidence in our business going forward. Our Q3 key financial results have been very strong, put us on pace to deliver in accordance with our investment thesis. Virtually in every metric, top to bottom, we're ahead of pace. And it certainly gives us the confidence that we will deliver on our investment thesis at the end of FY '21. So a bit on the Q3 performance. So if I could direct your attention to the bottom 3 rows, continue to be organic revenue leader in our sector, with 8.3% year-over-year. We've had a 5.3% head count growth in Q3, which keeps us on track for roughly a 5% increase over the course of the year. And we increased and narrowed our guidance from an original 9% to 11% to 10% to 11.5% for the year. Our contract performance has been driving our margin expansion. Our EBITDA margin as of the end of Q3 was 10.3%, which is representative of a $190.8 million, that's a 6.2% growth year-over-year. We've had very strong organic growth execution, and then we've also reaffirmed our guidance on margins to remain in the low 10s. And on a capital deployment basis, we remain on track and committed to our $1.4 billion over that 3-year period of time. And we deployed $61 million in the third quarter and announced the -- as I mentioned previously, the $0.04 increase in our quarterly dividend. This page sort of lays out what our capital allocation has been over the past, call it, 4 years, remains, as you can see, diversified. We've got multiple levers that we can pull in order to achieve our capital deployment objectives. We had $61 million, during the past quarter, deployed. We also reaffirmed our $1.4 billion commitment. And we've had $630 million share repurchase authorization that remained as of the end of December 2019. And we feel that our 4 levers of our capital deployment will afford us the ability to deliver the right returns in the near, mid and long term for our shareholders. And with that, Brian, I think we can go to Q&A.

All right. Perfect. We do have the opportunity from the audience to get a couple of questions. So if there's any -- if there are any questions from the audience, just raise your hand, and we'll get to you. So are there any questions out there right now? Okay, perfect. Lloyd, maybe let's talk about the competitive ecosystem a little bit. It's changed a lot since you went public. The primes have largely exited. We've had the rise of engineering and construction firms. We've had growth in some of the other mid-service players, commercial markets as well. How does Booz Allen kind of cut through the clutter and compete against those various groups?

Sure. Well, I think it varies by market, you saw sort of the 4 markets that we're in. And for defense and intel, the landscape has, even with the consolidations that have occurred, remain pretty stable. It's Leidos, SAIC, CACI, ManTech, and then a few new market entrants in terms of Parsons and Jacobs. With that being said, we also see it sort of bifurcating a bit. So for companies that have emphasized scale, that sort of puts them in a different end of the sort of service offering market than what we have been focusing on, which as you saw in my prepared remarks, cybersecurity, systems data, software development, data analytics and engineering and science. As you move to the civilian federal market, I think that landscape really opens up because the barriers to entry are extremely low. Pretty much anyone can get on a pricing schedule and with a modest amount of due diligence contracts. That being said, where we have differentiated has been the relationships that we have, the service offerings and the talent that we've hired and invested on a number of years. We tend to see Accenture more, Deloitte Federal, the big 4 is consulting components, as well as small to larger commercial businesses that any one agency or department might be interested in getting support from. And then on a global commercial basis, it's everyone, very competitive. And we've been holding our own and growing that business as well.

Okay. That's great. Maybe the next part is, let's just talk about how you're -- kind of how you bring in talent to the organization, kind of grow the business that way. Can you talk about maybe how the labor markets feel, how pricing feels and maybe subsegment that from some of the end markets and skill sets that you serve?

Sure. We have been and will remain in a very competitive and tight labor market. The good news is, we certainly feel we're in the game because we've been able to successfully hire the talent and deploy that talent for our clients. But without a doubt, all industries, all sectors are looking for this more technical solution-oriented group of individuals. We've got 4 generations of workers at Booz Allen. And so our sourcing and hiring and recruitment is tailored to each of those generations. So certainly, for the more junior end of the spectrum had an undergrad or graduate program with little work experience, we've got internship programs, very robust employee referral program where we get 30% of our candidates from. And then on top of that, an enhanced development and training set of programs once we get them in the door. At the more senior levels, let's say, 5-plus years of experience, although with some modest differences across our portfolio. The government itself ends up being a source for us, competitors, individuals who are coming from the private sector into the federal business at the 5, 10, 15, 20-year points in their career. And at the most senior levels, could be at a secretarial level where the individual still feels that they've got something to contribute to the market and really end up being a relationship and strategy ambassador. So with that type of broad spectrum of talent, we continuously modify our recruitment processes, our training programs, and as I said, we've been successful in bringing in this talent. Where I think we prevail more than not is because our candidates recognize; a, the type of work they want to do; b, who they want to do it for; and then c, on what program they'd like to deliver that. So they have, in many ways, preselected, the type of work they want and who they would like to do that -- be their employer. But without a doubt, Brian, the market is tough today and will remain so for years to come.

Right. Now that's what we hear quite regularly. Any questions from the audience? I'll just pause here before going to the next one.

The second part of your question, which I didn't address. This is certainly a more compensated, -- highly compensated set of individuals. And we feel that we've been able to -- argue, defend that sort of wage increase profile, compensation profile with our clients successfully where they are paying for that type of support. We've had to build that into our labor rates, into our escalation assumptions and the clients increasingly have been paying for that level of support.

I think really, for the better part of the last 2 years, Booz Allen has surpassed my expectations on a consolidated basis. And we've seen strength across most of the end markets and verticals that you serve. One that's slowed down a little bit has been the intel market. Can you maybe take us through what you're seeing there? And how that reaccelerates for you over the next few quarters?

Sure. I mean the majority of the slowdown from our perspective has been, back to your previous question, the challenge with recruiting clear talent that you need to execute the work that we have in-house. So in many ways, we are not constrained by the sold and funded positions, the backlog. It's how do you get that clear talent, which is really a top secret plus a SEI-poly, if you will, into our business, hired and then deployed on those particular tasks. And so that's been the gating factor. We're all in the sector subject to a background investigation and due diligence, which, in many ways, is sort of backed up a bit. So we're working our way through that. That's been one reason. The other is, we could do a better job with some of the relationships that we have. And so what we've done most recently is Judi Dotson, who previously ran our Joint Combatant Command account is now going to run our security business. And she's going to bring into that market, a set of other leaders that just have a track record of really doing well and getting the penetration and getting the work going and motivating the people. So we are expecting things to begin to improve. You'll press me on when. I'd like to say, over the course of the next year is sort of our expectation. But we are very confident and optimistic that will occur.

Okay. That's great. Really, the last one for me is, I wanted to talk a little bit more about some of the stuff that you had highlighted on in capital deployment, right? You generate an awful lot of free cash. There's not a lot of need to -- for CapEx in your model, and you haven't traditionally been a very active acquirer. Can you maybe just take us through what you're going to do as you continue to just generate all kinds of free cash flow?

So I'll answer that in what we're currently in the process of. So surprise, surprise were at 2020. So we're also updating our strategy and are more than halfway through that. We have multiple work streams looking at a variety of dimensions of our future endeavors, one of which is M&A. We expect that work to come together, be integrated over the course of the summer and then ready for broader dissemination by the end of the calendar year. The challenge with that is, we have a presidential election, as you all know. So we want to find a period where, at least, we know who is the next president administration will be before we kind of reveal what our expectations are financially and whatnot. When it comes to capital deployment, we still believe capability tuck-ins are consistent with our strategy. We've been able to have very strong operational performance, generate fantastic organic growth over the past number of years and would expect to continue to do that. And so there hasn't been a pressing need to do an acquisition or to augment what we've already seen as tremendous growth. We look at, however, over a 100 opportunities every year. We're essentially looking for a needle in a haystack. So it's tough to find as pure capability play as we would like. But to be perfectly candid, the current environment pricing is elevated beyond what we think these assets are worth. So we submit bids, but haven't been selected at the end of the day. That being said, as you say, we generate tremendous amount of cash. So at the same time that we've been performing as strong as we have operationally, we've also been about the business of strengthening our balance sheet to give us the flexibility to leverage that in any number of ways as we go forward. So a bit of a timing issue here in terms of -- we put all the right things in place that we feel we need to. And as the strategy becomes clearer to us, I think that's going to, in terms of the cash generation as well as the balance sheet, give us a tremendous amount of foundation strength in what we want to do next.

Lloyd, thanks so much. We're going to cut the question -- Q&A session off there. We're going to adjourn to a breakout session downstairs. So please join us there for some more open Q&A. Thanks so much, Lloyd.

Thank you, Brian.