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

Okay. Good morning and welcome to day 2 of Morgan Stanley's Virtual Laguna Industrials Conference. My name is Matt Sharpe, and I am the firm's government services analyst. Before I get going here, I do have a disclaimer I have to read. Please note that this webcast is for Morgan Stanley clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see Morgan Stanley's research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. With that, I'd like to introduce Lloyd Howell. Lloyd is the CFO of Booz Allen Hamilton. Good morning, Lloyd, and thanks for joining us.

Good morning, Matt. Great to be here.

So maybe we'll just dive right into it. I think Booz amongst the landscape of government services providers is rather unique in many ways. And I think it might be helpful here to kick this off with sort of a conversation around what differentiates the firm relative to some of its peers, maybe discuss a little bit about the business model, a little bit about the go-to-market approach and how you're positioned.

Sure. It's probably not any one individual thing, but I think it begins with our heritage as a general management consulting firm way back to 1914. We actually did our first engagement in the federal space during World War II, supporting the department -- the Navy. And I think it didn't really pick up at scale until the '70s and '80s, and it's been going gangbusters ever since then. At the heart of it is our people. We have incredible people that really think of Booz Allen as a career, not just a job or a contract. And actually, in terms of that, are looking to advance their technical skills and advance and be well compensated and really work on really cool things, on really important matters in the eyes of our clients. So a combination of our history, our culture, and the fact that we are a value-based organization really is facilitated by the fact that we have a single P&L, where we're able to jump on opportunities, address challenges, really overnight. And so we do not have some of the classic segmentation challenges that maybe others have in terms of coming together, bringing in different capabilities, integrating those capabilities and then shaping opportunities in the eyes of our clients. What that leads to, we believe, is the market seeing us as a trusted adviser. Not just out for a buck, or a buck's sake. And I think that has occurred over many years where we are talking about forward-looking opportunities as well as technology, how to bring that to our clients' missions and requirements. Certainly, they all have been doing more with less. And so that has created an environment where technology has really bubbled up as a high priority across the board. And we, in turn, have adjusted as well. So going back 8 years with our current strategy, we've been pivoting the firm towards more high-tech solution setting capabilities and offerings. Our workforce is increasingly a reflection of that. And frankly, as we enter a bit of an uncertain time, be it the presidential election and the budget, we feel this puts us in a good position around a priority that all clients have expressed they want to keep a focus on going forward.

Sure. Sure. So you just touched on the strategy, right? And you sort of embarked on this path to move closer to your customers' mission a number of years ago, Vision 2020, right? You're in the payoff rate period now. It's clearly working for the firm, but it's Vision 2020. And we are in 2020. So I guess my question to you is, how do you think about evolving the firm going forward at this point in time? Is there another -- not necessarily a pivot, but is there a refocus? Is there a new emphasis coming down the pipe? What do you see as the evolution of Booz going forward here?

Yes. No, not only timely sort of questions but ones that we've been working our way through. We're currently in the midst of recasting and updating our vision. I don't know if we'll call it Vision 2030. I'll leave to our marketing communications team. But suffice it to say that if you look back 8 years when we developed the current strategy, the times are quite different. The overall market was contracting. We, like many of our peers, were making difficult decisions on cost reduction and containment. We also were anticipating what the world will look like on the other side of the reduction. So we began to invest in a bunch of capabilities that now I think we take for granted or then certainly have matured. But today is a bit different than where we were back then. We feel we -- as you say, we're in the payoff period. We got a fair amount of momentum with our clients, our backlog, the things that are increasingly maturing. So when we think about the next 5, 10 years, it's really how do you leverage those things that are going well? How do you accelerate things that are showing promise? And then thirdly, what is really kind of in an embryonic stage that we think is worth making a bet on in terms of its maturity and the demand for that going forward. So I would not, at this point, expect a significant a pivot as we did way back when because the circumstances are quite different, even though there's a bit uncertainty around the budget, and we'll see what happens in November. And given our momentum going into this uncertain -- these uncertainties, I feel, and I think my colleagues feel pretty optimistic about what the next strategy is going to look like and how to jump on those things even more aggressively than we were able to do 8 years ago.

Yes. You mentioned momentum. And I think that, that's pretty evident, right? You came off of a fiscal '20 with some really healthy top line growth, and you were able to sustain that into the first quarter of your fiscal '21, I think you guys posted about 7% year-over-year growth. The guidance range right now is -- correct me if I'm wrong, but 6% to 10% for the year. Maybe you could sort of peel back some of the layers here and help us think about what the building blocks of growth are from here on out and how that might cadence throughout the remainder of the year and into next? Are there cold spots, hot spots, maybe in the context of, say, your defense, intel and civil, you could sort of shed a little bit of light on that.

Sure. So we are continuing to see strong, positive momentum in our defense and civil markets. A lot of '20 was fueled by the expansion in those markets, and that has continued through our first quarter performance. At the same time, we have begun to address some of the headwind challenges we were seeing in our national security markets, first, with some management changes. But then also, frankly, getting into client engagement, business development changes that are underway. And as Ross and I have said, we expect to see that strengthen going forward as well. They've got a few key opportunities, new work opportunities in their pipeline, and we're optimistic about our positioning and our ability to compete for that. The smallest wedge in our portfolio is our global commercial. And coming off of a -- for them, given their historical performance of [ 5 ]20 %, low 30% growth, still grew more in the low teens, around low teens. But even in this current COVID environment, off to a very strong start, there as well, up 9% in the first quarter. So the overall portfolio is still growing. You see in our backlog, a nice pickup overall, finishing at $23 billion. And I think if you decompose that in terms of funded, unfunded and priced options, you'll also see that priced options increased by a healthy percent. And we see that as a leading indicator of clients' desire to do more as well as their satisfaction with Booz Allen. So we're sort of approaching the end of the government fiscal year. It's been a very competitive procurement season. There's been lots of activity. We did not see COVID impact the opportunities that we were responding to or the award decisions. And I think that bodes well for our annual forecast for '21 to remain on track to where it has been. I do feel the need to kind of poke at the 7%. For the gross revenue line, it's a mixture of sort of what you would expect in terms of awards, but also billable expenses. And billable expenses in the COVID environment have been less than even we had forecasted for the year. So you're not seeing the request for small business or equipment purchases or unallowable cost because, frankly, people are not traveling. Hard to say where that will go for the remainder of the year. But if you look at our revenue ex billable expenses, that was up 10.5%. And that's the metric that we feel and look at internally, but a true reflection of productivity and everything hinges off with that. And that's came in very healthy, so we're encouraged by that.

Absolutely, and fair point. Obviously, underpinning a lot of the growth is -- well, frankly, underpinning growth is the DoD budget in part, right? I mean, obviously, you're exposed to other portions of the federal budget. But I just want to get your take here going into an election cycle what your expectation is for the budget, how the various outcomes of both the White House and Congress might impact it going forward, and what you guys actually need to grow. Can you grow through a flattened budget environment? Just help us think about what the implications are here for Booz Allen?

Sure. So from a historical standpoint, going back many, many, many decades, you'll see that Booz Allen tends to outpace the budget growth in peaks and valleys by 2% to 3% over the years and outpace sort of our sector by even more than that. And we feel that we've been able to do that because of a couple of reasons. One is, as I mentioned earlier, our close alignment to the priorities of our clients. So regardless of administration changes, the IRS is still going to need to process tax returns in a secure manner, regardless of political changes, the Department of Defense is still going to be monitoring, tracking, protecting us from adversaries as well as for the benefit of our allies. And so some of these requirements are just so tightly coupled with their mission that despite what we may see politically, they endure. And the closer we feel we are to that, will ensure sort of the ability to arrive through this volatility better or the uncertainty better than not. So we have been working with our clients. And what has emerged, frankly, from both parties is an emphasis on the IT infrastructure of the federal government and the modernization of that. We've already seen some of that occur with things like the JEDI procurement. But even beyond that and things that we've talked to, significant awards in the areas of artificial intelligence, cybersecurity, and I think, a general recognition that, hey, our clients need to not only move out on these topics but continue to invest in them in a way that doesn't sort of create a higher risk or fall backwards. So in an uncertain budget, and again, our crystal ball is as murky as anyone's. We suspect these technology initiatives are going to endure regardless of who's elected in November. And with -- if we go into a repetitive continual resolution until we ultimately get to a budget, we think our clients are -- have the experience now of navigating through that, know how to manage the procurements and the work so that things will be sustained. What we have seen with changes in administration is that you really have to separate what has been said during a campaign versus the reality once they get their security and defense briefings. What all that sort of will reveal? And historically, what we've seen is that the incoming party, once they get the benefit of how ugly the world really is, there's sort of a dampening effect, if you will, or at least a more moderate approach to maybe some of the things that are said prior to the election. And we would expect that in due course to occur as well. So what that looks like is the incoming party, by and large, is inheriting about 9 to 12 months of the previous administration's agenda. There will be, obviously, policy changes, discussions that will begin to occur. But the reality is we'll see that more so in our fiscal year '23. We begin to make the pivots that we may need to make in our FY '22, but really see the rubber hit the road, so to speak, in fiscal year '23. And that gives us, we feel, time to understand the priorities, the shifts, where the opportunities may be for us. And frankly, given our portfolio in a single P&L, we have a history of pivoting and redeploying pretty quickly, and we would expect to do that if needed this time.

Great. Great. So maybe shifting gears here a little bit, moving down the P&L. Let's touch on margins. Booz has had pretty healthy margins over the last several years. I think you probably expanded a little north of 50 bps over, call it, a 3-year window. There are some things in the pipeline, some of the option value initiatives that you have going on such as Rec.gov or District Defend or Modzy that might sort of change the trajectory or the what's possible, if you will, in terms of that 10% EBITDA margin level that you're guiding to currently. How do we think about this going forward in the future? What levers do you have to actually continue to expand it beyond sort of that, that sort of high-end boundary that government services traditionally has at 10-ish -- so percent?

Yes. You certainly have touched upon many of the levers that we would expect to continue to pull toward margin expansion. It's the continued sale of these capabilities that garner at the upper end of the fee range. So in a traditional cost reimbursable or time and material contract where you're looking at mid-single digits to high single digits, these capabilities get you more towards the high single-digit range. And necessarily, if we just pick the contract type, the fixed-price contracts, which gets you well into the teens, we would smartly and carefully execute work with that in mind as well. I would caution everyone that it's not that I would want to dial it up to such an extent that it runs counter to what our clients would like, but where we can execute smartly on some fixed price work, we will do that. But fundamentally, the continued expansion of these high-end technology capabilities that we're seeing really begin to take root, would continue, and that would contribute to margin expansion. Number two is continued growth in our global commercial business. It's now about 3 -- range between 3% and 4% of the overall portfolio. And we would like that to be larger and a larger contributor. We get 2.5 to 3.0x better margin performance than what we would see federally. And that essentially drops right to the bottom line. So from a financial standpoint, growing that business, expanding that business, would also contribute to margin expansion. And then maybe not as visible to everyone is the continued strong operational execution within our business. We have over many years, and many of you have asked me about aspects to it doing a better job managing our costs. From a business development perspective, our business leaders now are more sensitive to not only the top line but also bottom line growth. And so many of the bid decisions we're now looking at, top line, margin, profitability and then bottom line performance. And I think we have seen, on a corporate basis, improvement as well. We're also executing on these contracts better than we ever have. So we're not having as many issues. When there is an issue, we've got the appropriate review committees in place to make sure that they remain on track and, knock on wood, things are continuing to go well. Number -- the third point is, as we have added to our workforce, historically, it was pretty choppy. So you'd see a peak in the second and third quarter and then, "Gee, Lloyd, what's going on here? Can you even that out?" So the team has really worked hard to have a consistent adding to the workforce over the course of the fiscal year. We had a strong Q1, especially given current circumstances, and we're keeping our foot on the accelerator. So I think in our past, we tried to modulate a little bit. We found that can't really do that well. It's better just to keep a constant push on sourcing and recruitment of people. But internally, what we see is that once we have a candidate on board, we've been able to deploy them to billable work more efficiently than we ever have. And as a result, you see that the bench not really getting too large, which historically was putting pressure on our margin as well. So we've been able to manage that as well. So it's been lots of little things or not little, but lots of things that I think have contributed to the expansion, but we certainly would like to continue to lean into those going forward.

Fantastic. Well, I just want to pivot here to some questions we have coming through the client portal for a moment. We've got one here at the top, real quick. Can you give us a teaser on the next 3-year strategic plan? How wide is the scope for potential strategic shifts into commercial? And what's the scope for M&A at the moment?

Yes. I mean, to my previous response, unlike 8 years ago, we're actually looking at this in a couple of different ways, what to do more of that's working, what to probably diminish, that's not working as well as we would like. And then from an embryonic or small scale, what to jump behind, to push even more aggressively going forward. I think what that looks like is a continuation of our push into high-tech areas and capabilities. I think what that may look like in terms of markets and geographies is adjacency as opposed to we're going to do a full pivot to something that we're not confident in or just because it has the patina promise, I think we should expect to see investment and activity that extends what we think is already a pretty good foundation. And then to the specific question around commercial, probably a continued push into that, that would also include inorganic adds. We've done a very small managed service acquisition over the years. We've seen the benefit of that. But I think collectively, we've got higher aspirations for that business and we'd like to accelerate that to the extent that we can.

Fantastic. Just one last one, maybe here in the final moments, sort of dovetailing on M&A, capital deployment, you guys have nearly $580 million remaining on your $1.4 billion commitment. Obviously, there's various avenues or flavors that, that could take, whether it's M&A or dividends, special dividend, buybacks, et cetera. How do you trade amongst your two various paths here?

Yes. It starts with what's the market presenting to us. So with roughly $600 million left to the $1.4 billion, we're still targeting the $1.4 billion. And herein lies, I think, just the opportunity not to do something stupid just to chase a number, but still to do the right thing in a disciplined and patient way for the benefit of our shareholders. So you're right. We've got those levers that we historically have pulled. They have tilted toward share repo and the regular recurring dividend because, frankly, that's what the best course of action was given what the market conditions were. What we have said most recently in our earnings call is that we expect there to be increasing volatility across the board, with the economy, within our sector. And it's hard for us to know what will fall out of that. But we want to be in a position, and we feel that we are with the strength of our balance sheet, to do a deal in terms of an acquisition. And that's what we said. And I think people heard that like, "Oh, Booz Allen is going to become more acquisitive." And the reality is that we're not stopping with looking at the number of opportunities that we look at every year, which is about a little over $100 million. We won't hesitate to pull the trigger if that -- one of those opportunities really passes our criteria. And that's what we were saying. So I feel pretty confident that we will see some opportunities, some of which we're cultivating today, depending upon how long this uncertainty around COVID extends. We can see some deals also potentially come to the market. And we're in a position where we feel financially where that won't be the impediment. It will be strategy. It will be integration. It will be some of these other things. But from a finance or a financial perspective, we feel pretty solid with that. So the levers remain what they are. We're trying to do the best we can to react to the market conditions, which we think we've done. There's still a gap to the $1.4 billion, but we remain optimistic that we'll close that gap by the end of the fiscal year.

Fantastic. Lloyd, with that, I believe we're out of time here. I just want to thank you for joining us this morning. It's good to see you. And hopefully, next time, we can do this in Laguna Beach in person.

Yes. So thank you, Matt, and the Morgan Stanley team. I'm sure I speak on behalf of everyone, I would rather be in Laguna, but it's good to see you nonetheless.

Great. Take care.