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

All right. Good morning, everyone. Welcome back to the Barclays Industrial Select Conference. Our next company is Booz Allen Hamilton, and we're pleased to have Lloyd Howell, the CFO; and Rubun Dey, from Investor Relations. So before we get started, I think Rubun wants to give the forward-looking statements.

Yes. Thanks, David, for having us here. Please note that we may discuss forward-looking statements that are subject to unknown risks and uncertainties as well as certain non-GAAP measures that we believe are useful in understanding our business. More information about our forward-looking statements and reconciliations of non-GAAP to GAAP are included in our SEC filings. So with that, back to you, David.

All right. Thanks, Rubun. So Lloyd, welcome. Thanks for joining us. Wanted to get started at a high level, and a question I'm sure you've gone a lot over the years, so what is unique about Booz Allen that has allowed for such high levels of growth relative to your peers? So I'm thinking about both organizationally and both from an end market perspective as well in terms of what has allowed you guys to consistently grow a couple of hundred basis points above your peer group?

Great. David, let me echo also, great to be here, and thank you for hosting today's conference. You're right. I do get this question quite a bit. And I'd point everyone to a couple of key attributes to the firm. One is our history. We're over 100 years. We've been in the federal market, going back to World War II, and that history has really allowed us to develop great relationships with many of our federal clients in defense, the civil federal agencies and as well as the intelligence community. And that has afforded us the opportunity to really understand our clients' mission and operational requirements to a fairly deep level. Number two is what we provide in terms of support to those clients. Over the past 8 years, we have moved more and more to more technical support in the areas of cybersecurity, data analytics, system software development, AI and digital. And that really is a reflection of what our clients are in need of, but also, we have something to say about that. Thirdly is the people. We hire great talent to provide that type of support. The clients and our people have gotten to know one another over a long period of time, and clients have come to rely on the expertise that we're able to provide through our people. From an operational standpoint, we have a single P&L, which allows us to move resources seamlessly and quickly across the portfolio, so whether that's pursuing an opportunity or addressing a challenge. And we found that, that agility has really served us well over a long period of time. And I think, lastly, we have very tenured and senior people. I've certainly been at the company for over 30 years, as has Horacio. But that longevity allows us to have seen and experienced lots of different cycles, lots of different transitions and so that type of leadership, I think, has served us well over the generations.

So you touched on this a little bit in your answer, but how much of your portfolio or revenue would you consider to be high-tech? So you've touched on AI and cyber and cloud and 5G among the other -- among all these different things. So how much of your portfolio actually accounts or is accounted for by those type of efforts?

Yes. I'd point everyone back to 7, 8 years ago when we launched our most current strategy known as Vision 2020. And at that time, we would have estimated about 1/3 of our portfolio where it was in these higher tech areas. Today, we're well over half of our portfolio is in these spaces, and it continues to grow and evolve. It's challenging to give you a point estimate, in large part, because many of these offerings are so integrated and blended. Nothing is pure, even how our people define themselves. But I think it's fair to say if you look at our open requisitions for candidates and the nature of what's in our backlog, it's certainly tilting more and more to these areas around AI, cyber, cloud, and most recently, 5G.

So as part of that Vision 2020, you talked about your option value effort. What has come out of that in terms of the last couple of years? What can you quantify has actually come out of that? And what should we expect from that? Or what could we see come out of that over the next couple of years?

Yes. We remain excited about the various initiatives and opportunities that we've categorized as option value. At present, there are 4 that have matured, the first, being a reservation system known as Rec.gov for the Department of Agriculture, which really, for us, representing an opportunity to develop a system on our own nickel, and then through a fee arrangement with the government, recoupe that investment and do better than a traditional time and materials or cost reimbursable contract. What it represents for us is a different delivery model than just 100% labor and a modest sort of financial benefit that has many more years to go. So still on the early side, but increasingly showing a lot of merit and traction even in the midst of the pandemic. The second is what we call directed energy. That really is taking laser and sonar technologies and putting them on smaller platforms than what currently is the case today. Exciting to us. Gets us a little bit more into developing and shaping a product. We're excited about it. Recently passed some prototype testing, and orders are beginning to build as the interest has begun to build, particularly with our defense clients. Here, again, I think the benefit is monetizing some intellectual capital that we had developed, working with our defense clients on something new and innovative. And then down the road, seeing the financial benefit from that as well. The third is what we call District Defend, which is essentially securing mobile devices, particularly for our intelligence and our defense clients. Diversity and delivery, again, more of a solution product for our clients, and exciting because also getting into productivity in a different way with the government as well as government-to-government. So again, on the early side, but increasingly showing and getting a lot of interest from the defense and intelligence community. And the last is what we call Modzy, which is really artificial intelligence applications that would be available for both commercial and federal clients. This, I think, opens the door to our federal clients have access to technologies and innovations from a commercial standpoint, which they have increasingly been seeking, and at the same time, working with a known contractor, such as ourselves, to provide that artificial intelligence support. I'd describe it as still in the development stage. Interest is continuing to grow. But really, across all of these different initiatives, I think still on the earlier side of showing any sort of material financial impact. We suspect it'll be more contributing on the margin and bottom line over time, not necessarily at the top line. But I think taken together, diversity of delivery, some margin and bottom line enhancement, but also demonstrating that we are an innovative company and look to do so going forward.

That was great color. I wasn't aware of the effort on the laser side of things. So I wanted to talk about headcount. You had been -- you typically grow at kind of a mid-single-digit rate from a headcount perspective. You've been running below that for about the past year. I guess, it really came into focus here in this last quarter. But what's been the main reason that headcount growth has kind of lagged what we would have expected? It looks like the backlog growth has been there to support a higher level of hiring. So what has been the hindrance to kind of the typical headcount growth that we've typically seen?

Sure. There are environmental as well as process and operational issues here. One, from an environmental standpoint, you're correct. We go typically into every fiscal year targeting mid-single digits. We exited FY '20 at 4.2%, with a fair amount of momentum going into this fiscal year. And that's when COVID hit. We had a run rate just over 3% in the first half of the year. And as you made reference, it dropped off in the third quarter. So as much as it may sound like an excuse, COVID really challenged us in terms of sourcing candidates, bringing candidates onboard and then deploying. But given our high productivity in the first half of the year, and adding to the workforce, the 3% attrition was very low, we were okay with that but certainly wanted to improve. Now in the third quarter, what we saw was productivity snap back in November, and yet the hiring was only at 1.4%. So we put more emphasis on sourcing, bringing on candidates. That's going to be a building process over the next couple of quarters. But we remain optimistic that we will get back to sort of the mid-single digits over time. We're going to rely on -- nearly 30% of the candidate pool are from referrals from our existing workforce. And the fact that we are a known entity to many candidates exiting the government as well as our competitors and folks looking to make a change from the private sector. So we've made some process improvements as well. We've got the right spotlight on the challenge. And as I said, everyone is motivated to bring on the strong talent to convert the backlog that's been growing at a nice clip year-over-year.

So you think this takes a couple of quarters to kind of turn around. And what about the competitive environment to hire? What does that look like today, particularly in light of the kind of people that you're trying to hire today, more on the kind of technology side of things?

Yes. I mean, this end of the labor market that we are increasingly weighing into is very, very tough. Not only are we looking for this talent, but whether you're a commercial or a federal company, you're looking for the same talent, largely in response to the demand signals that we're seeing. We believe that we will continue to do well, in large part, because of the content of the work that we provide, our culture. And we represent an environment where people can begin to build upon their base of capabilities. So just because we hire you as a cyber professional doesn't mean your career will be -- that's all you'll do. We have lots of training and development programs where you can add to that. So the labor market is very competitive. We knew that going into the pandemic. But we feel that we will continue to be successful in attracting candidates to the company.

So let's spend a second on PTO, just so everyone kind of gets it. Talking about where you were in Q3, what's baked into your expectation for Q4? And then initial thoughts on the potential impact next year with -- next fiscal year with the vaccine rollout and potentially people wanting to take more time off than what we've seen here during the pandemic.

Sure. So where we were prior to the third quarter was virtually, our workforce was not taking any PTO, highly utilized. Available labor was also at a high -- all-time high and attrition was at an all-time low. So taken together, the productivity of our workforce was extremely high. And we knew that, that was not sustainable. We were beginning to hear stories and communication regarding folks starting to burn out, needing more of a break. And so we actually encouraged our workforce to take a break with the appropriate approvals and whatnot. What we underestimated was the degree to which people were going to do that. And what we saw in November was basically a return to more normal levels of productivity. And so from 1% headwind, that was about a 2% to 3% headwind than sort of where we were going into the third quarter. And we suspect that, that normalization is going to continue. We do have, as a part of the $100 million resilience program that we set up earlier in the year, a win or -- use-or-lose dynamic to PTO. So folks who needed extra time could essentially go into a PTO bank and take out more time. But that expires the end of March. And so what we expect to see beyond the fourth quarter is a continued normalization of PTO and the productivity levels of our workforce. That, coupled with stepping up with recruiting, we think, will get us to where we were pre-pandemic. And that's sort of the expectation going into next fiscal year. Certainly, the rollout of vaccines will continue that normalization from our perspective. And so we're in the midst of working our way through how to plan for the upcoming fiscal year, taking that into account.

Got it. Okay. So your quarterly revenue grew 3%. But ex-billables, it was 6%. I think that got lost a little bit. 6% still compares very favorably to your peers. Any thought of guiding going forward on an ex-billable basis? I think -- I would think that might be a little bit more predictable and kind of focus investors on really what we should be focused on.

Yes, no, you are correct. Revenue ex-billables, still strong. This is a topic, certainly since my tenure as CFO, that we continue to grind a bit internally on. The challenge is how to come up with a number around billable expenses. We've historically provided a range, 29% to 31%. But to come to a number for the fiscal year is a challenge, in large part, because it's not necessarily a metric totally in our control. The government will decide when they want to purchase equipment, subcontractor costs and the like. And particularly this year, given the impact of lack of business travel due to COVID was another challenge. But we continue to debate amongst ourselves. I think it's possible. Certainly, our advisers, both internally and externally, say that we could do that. But it's an annual decision as to what to give guidance on going forward.

Got it. Okay. So transitioning over -- talking about EBITDA margins a little bit. So you've obviously had nice EBITDA margin expansion, benefiting a bit from the billable side of things. But when I ex out billables, it looks like you're probably seeing about 30 basis points of margin expansion, up 15, 15-plus percent range. I guess, first of all, am I doing the math right? And second of all, what has driven kind of what I would refer to as this core margin expansion? And then lastly, not to throw a bunch at you, but it looks like in Q4, you're calling for like 100, 150 basis point drop in this ex-billable margin, best I can tell. So what is -- I know there's some seasonality, but what else is going on there?

Right. All right. I'll try to parse my way through all that. Fundamentally, our focus is on EBITDA dollar growth, not necessarily managing to a margin level. That being said, what we have seen certainly this year is the continuation of solid contract performance. As you may be aware, with the 3 contract types, there are ranges on cost reimbursable and time and materials that are essentially capped given the contract type. And that's mid- to high single digits. And for fixed-price contracts, albeit the smallest percent in our portfolio, we can get into the teens, depending upon the nature of the work and whatnot. So we've had solid contract performance, strong operational performance that has sort of driven our performance as of late. We've also increasingly done a better job of managing our unallowables. And certainly this year, discretionary costs that involve travel, conferences and meals and overhead have been a lot lower in the midst of the pandemic. And then lastly, given the lower billable expense mix, that's also contributed to it. Going forward, some of those things will reverse a bit. We expect that our strong contract performance will remain. And we expect that the continued sale of these higher-end offerings will continue to be rewarded by our federal clients. To explain sort of the seasonality of it, typically, in the back half of the year, we're rewarding our people. We're looking to do infrastructure improvements. We're investing in capabilities -- new capabilities and hiring in anticipation of the upcoming fiscal year. And so the drop-off, if you will, is largely due to that. I'm often asked, "Well, how high could margins be?" And I certainly could do some things in the near-term, transitioning highly compensated people that have low utilizations. But we don't really think that would be a smart thing to do in the long run, largely because these professionals are the ones that help shaped IC, help shape relationships and future offerings. So operating in the low 10s, mid-10 range, we feel has been a good place for us to be, in large part, because we're focused on bottom line growth. And we've been able to do that very well over the past 3 years.

So you mentioned targeting EBITDA growth. Care to share kind of what you guys target is long-term sustainable EBITDA growth?

Not at this time. I would just offer that in the third quarter, we posted 8.3% and year-to-date, 11.3%, which we think is great. And when we say focus on EBITDA, increasingly over the years, we've gotten our business and market leaders to not just focus on the top line but also the bottom line. And so that has been a good guidance because it also shapes the type of opportunities we're pursuing, the work that we're shaping. And we feel that with the right attention, as it currently is, that's going to serve us well going forward. But it's an annual journey. Certainly, our last investment thesis established a longer-term set of objectives that we were trying to hit. We're coming up on the time to do that again and update. And so we're working our way through what that will be going forward. But essentially, it will be the same framework. We just got to put the finishing touches on it.

Got it. So with this 3-year plan, you have $1.4 billion that you targeted for capital deployment. I think with one quarter to go here, you're at about $1 billion, $1.1 billion, something like that. So what -- I mean, I wouldn't say you've fallen short. But what has been surprising from the standpoint that you haven't been able to deploy that $1.4 billion? Was it the M&A side, more than anything? That you just ended up not doing as much as you would have thought there?

Yes. I mean, the $1.4 billion as an objective, we think was a good target. And given the strength of our balance sheet, we certainly feel we've got the wherewithal to get there. M&A is certainly a part of that, specifically for us, capability tuck-ins. We have, not up to this point, been highly acquisitive. And we didn't -- no apologies about that but opportunities that we've looked at either didn't align strategically to what we felt was the right thing to do, integration issues, and then lastly, the math. But I'm excited about the opportunities that are growing in our pipeline. They're small to medium-sized, but they certainly meet sort of the capabilities that we want to grow or deepen, and they're essentially capability tuck-ins. So it's building nicely. And I'm optimistic that we'll see that lever pull a little bit more than it has in the past. Share repurchases, I'd say over the past 3 years, has predominantly been a lever of capital deployment as well as our regular recurring dividend. And I've always maintained that we're going to do what's in the best interest of our shareholders in the near, mid- and long term and pull the right levers that make sense. So you're right, with about 6 weeks left before the end of the fiscal year, we've got a little bit way to go, but I remain optimistic that we'll close that gap.

Got it. Okay. And then a question along the same lines. A lot of your peers seem to be comfortable running at 3, 3-plus x levered. You guys are seeing, I think, a little over 1x net lever today. You've got over $1 billion in cash. How much cash do you need on the balance sheet, number one? And number two, would you -- I guess, what do you see as your targeted leverage level? And would you be willing to -- if the right deal came along, would you be willing to go up to that kind of 3x plus range?

Yes. I guess I'll pick it up in reverse order. We certainly are comfortable being between 3 and 3.5 and currently are well below that. But given the strength of our balance sheet, we think it gives us a lot of flexibility regarding how to deploy that capital and then also anything that comes along. Now we certainly weren't anticipating a pandemic over a year ago, but certainly, having that on our balance sheet has given us comfort regarding resiliency and flexibility. In terms of the other parts of your question, yes, if the right opportunity or sets of opportunities came along, we would certainly move closer to that range. But as I say, we're looking at a variety of future M&A opportunities. They tend to be in the small to mid-sized. And we think we have the financial wherewithal to get those deals done should that come to pass.

Okay. And the last thing I had. So I think it's time for another 3-year forecast. Is that still the plan, to give this one? And is that going to come with Q4 or at a later date?

Yes, no, that's still the plan. We're in the midst of updating our corporate strategy as well as the financial underpinnings to that. Horacio and I, we're hopeful that we'd be able to do that in person at the beginning of the summer. It's now looking more likely in the fall time frame. We intend to lay out that future investment thesis at that time. But come the end of this fiscal year, as we've done in the past, certainly give guidance for FY '22, but sort of in the fall, as I say, give the longer-term investment thesis and also discuss the strategic plan.

Got it. Okay. Well, we're out of time. Lloyd, that was terrific. Thanks very much. Rubun, thanks. And again, thanks for joining the conference again this year, and hopefully, next year, down in Miami. But enjoy the rest of your day, and hope you guys have great meetings.

Thank you, David, and thank you, Barclays, for hosting the conference.

Our pleasure.