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

Good afternoon, everyone. This is Jon Raviv, Citi's U.S. aerospace and defense analyst. Very pleased you could join us here. Even more pleased that Lloyd Howell from Booz Allen Hamilton, the CFO, is here with us for this conversation. We'll be having a quick 40-minute review of what's going on, what they're seeing and what they're seeing going ahead. Before we get in that conversation, I do want to welcome also Rubun Dey, Head of Investor Relations at Booz Allen Hamilton, for a brief statement on disclosures. Rubun?

Thanks, Jon. I guess before we get started, please note that we may discuss forward-looking statements that are subject to unknown risks and uncertainties as well as certain non-GAAP metrics, we believe are useful in understanding our business. More information regarding our forward-looking statements and reconciliations of non-GAAP to GAAP are included in our SEC filings. So I guess, with that, back to you, Jon.

Thank you very much, Rubun, and good to see you both. And again, thank you, Lloyd, for joining us. We'll start the conversation where everyone starts the conversation, and that's on growth, clearly. So any perspective on really what has allowed Booz Allen Hamilton to deliver, what I would consider, recent quarter notwithstanding, but I consider very consistent, high single-digit, strong growth and any sort of thought on how sustainable that is in this budget environment that we're in right now. Again, we can get into some of the dynamics you pointed out in the last call, but just big picture, what has enabled you to really outperform the market here for the longest period.

Sure. Before we get going, Jon, thank you for having us and Citi as well. So good to see you and good to talk to you. Our growth is really a function of a couple of dynamics. First and foremost, our history and the relationships that we've built with many of our clients across our portfolio. We're seen as a trusted adviser who provides objective advice and counsel. And that advising and counsel has increasingly come through on more technical solutions than ever before. So in addition to the relationships, we're actually providing advice and making recommendations on technical solutions that will help our clients meet their mission requirements and operational needs. Thirdly, it's our people. We feel we recruit and onboard and deploy great talent that possesses the skills our clients are looking for. They end up being seen themselves as trusted advisers and build the right relationships that certainly endure in certain and uncertain times, and we certainly have seen that in evidence over the past year. And then probably most important, a culture of values that we always lead with. And so we believe we provide the support we do in a very strong foundation that's been built on core values that go back to our founding partners.

And then a little bit -- let's get into a little bit on the dynamic around last quarter, some of the items that pressured your top line number last quarter and also for the year, keeping in mind that you only had a quarter left, so it's hard to make up everything, if there are any sort of unintended or unexpected dynamics in the single quarter and then really how to get out of that. How do you fix some of those slower growers or some of those items that weighed on the top line last quarter?

Sure. So as we exited the first half of the year, we guided to 7% to 9%, which implied sort of a 5% to 9% in the back half. And we -- we're aware of several factors that had a fair amount of uncertainty around them, COVID, the election and the budget. We obviously finished Q3 at 3% versus where we had hoped to be, but there were at least 3 reasons that contributed to that. The first was lower billable expenses than what we had expected, especially on a comparable basis. So it came in even lighter than what we thought, about 3% really due to a lack of business travel as a result of COVID and reduced equipment purchases that we had seen in Q3 of FY '20 in our aerospace account. The second was productivity snapping back to historic norms in November, which was another sort of 2% to 3% headwind. We had been running highly productive, sort of 300 basis points to the first half, even in October, but we saw increased PTO usage, normalization of available labor. And at the same time, which I'll get to more in a minute, the additions to our workforce came in at 1.4%. So with that snapback, that also had a corresponding impact on the top line. And then thirdly, a lag in adding to our headcount. We finished at 1.4% for the quarter. If we had not made the small sale that we did of an Army-related contract, it would have been at 1.8% but still well below where we want to be in terms of additions to our team. And there were also, I might add, programmatic shifts that occurred, not all in the same manner across our portfolio but common themes have been the aftermath of the transition, programs being paused and/or shifts when clients intended to launch or make the award. So these -- the 4 dynamics kind of came together. We sort of had the right framing of them, but they came in, in a magnitude that was more significant than what we had expected.

And the other thing that you mentioned, not necessarily weighing on the quarter or the year with those big numbers and those 4 dynamics, but also you mentioned some -- I mean, this is part of the delays actually with some slowness in the intel -- on the intel side of things. How much of that is stuff you still need to fix? I know intel has been a watch item for you guys for a little bit versus how much of that was really just customer acting in ways sometimes the customer will act and it will come back to you almost automatically? How much is go-get versus how much is going to come just to you?

Yes. To really answer the question, Jon, you got to look a little bit deeper into the composition of our intel business. We have 3 accounts that comprise it. And one of the accounts is doing great, growing at high single digits, adding talent. And we couldn't be more pleased with the fact that the changes that we made approximately a year ago are really taking root. Another account where we've experienced the most transition is still, we believe, underway. We continue to reshape the opportunities or shape the opportunities we want to work on going forward. We are diminishing our exposure to legacy work that we had, and quite frankly, we're struggling with the recompetes of that work largely because of what we want to do versus what we were doing. But that is underway as well. We have some early indications from our clients that they indeed take us as credible competitors, and we're optimistic about that going forward. In the third account, we do experience a shift in follow-on procurement, largely, we believe, to administrative reasons. So the government has indicated they still intend to issue the follow-on work. They've delayed it twice but have indicated that sometime in our next fiscal year, they do indeed intend to release the RFP and go forward. Why that's significant is even with follow-on tasking and incremental funding on the work we're currently provided, it kind of dampens our opportunity to kind of add more people like we would with the follow-on work. So it's a much larger increase in scope and dollar amount. And so again, we like our positioning. We get good report cards from the government for what we're doing today. So we think we're well positioned to compete for that work when the government releases it.

So is there a world where organic growth is going to be a certain amount in your current fiscal year, heading into the following fiscal year, is there going to be some kind of recovery? Or we'll still see the typical Booz Allen type organic growth rates but it will just be comprised of some of the things that slipped out of 2020? I mean it's hard to see kind of like the big snapbacks in this kind of business, but is there like someone watching these things that have slipped out of '20 or out of the current fiscal year coming up in the next fiscal year?

Yes. I mean, we certainly believe that this is a temporary dynamic. And I think not so much snapback, but the building back is a function of a couple of things. One is as we increase the intensity on recruiting, that's going to take a couple of quarters to get to where we want to be. The demand signals remain strong, and we remain confident that that's also going to come into being over the next couple of quarters as well. And that will be partly a function of the leadership being in place, which is underway but also as we hit the upcoming procurement season where we typically see not only recompete opportunities, but also new work opportunities, essentially beginning in April and running all the way through September. So combination of those dynamics I think will put us back to where we need to be. Even in the third quarter, our win rate for recompetes remained at 90%. And it's just the volume of new work releases was a lot less and the aftermath of continuing resolutions and whatnot. And we would expect that also will come back, and we'll get back to our win rate on the new work as well. So lots of different things coming together. But as I say, we remain confident that, that will occur, and then we'll be performing the way we want to perform.

And one of the things in the last quarter that, despite the sales -- the sales softness and having to cut the guidance for the year, was that margin was strong; cash flow, very strong. So how have you been able to offset that growth shortfall, at least again for this year based on those items we just reviewed with the margin and the cash-related EBITDA dollars still coming through pretty nicely?

Yes. No, thank you for that. We're extremely pleased and remain confident that we're operating the business well. On the margin side, we've always focused our managers on EBITDA dollar growth, not just managing at the margin level itself. And we saw 8.3% growth in the quarter and up 11.3% year-to-date. In addition to that, really strong contract execution and prudent management of our discretionary expenses. So taken together and my previous comments regarding the lightness in billable expenses has kind of put us in a position where we're expecting to be at the mid -- the high 10s for this current fiscal year. We typically spend more in this back half of our fiscal year around rewarding our people, infrastructure improvements and future capability development. We're going to continue to do that as we build momentum going into next fiscal year. But even with that being said, Jon, we feel good about where we're going to be with margin. And on cash generation, really, all the improvements we made over the past couple of years with collections, tighter management of payables, has really put us in a position where, again, we've got strong cash flow performance. And that obviously leads into the strength in our balance sheet and then how to deploy that capital. But bottom line, we're operating the business well. And I think these metrics kind of indicate that.

Yes. So you just hit on all the rest of my questions with that one answer. So well done by you. Let's just go back a moment. Yes, we can end it here. But let's go back a moment on the future capabilities development or investments for short. Can you spend a little time on how your investments that you made over the years, and the company really has made this big pivot over the last decade, but have those -- where have those investments been? How are they resulting in this strong sales growth and really margin expansion? And how do you sense those requirements or those focus areas may be shifting, maybe not and as you go back into a potentially resource-constrained environment?

Yes. So 7, 8 years ago, when we began this journey, we looked at our business and came to the conclusion that a lot of what we were doing was becoming commoditized, especially around program management and some of the SETA areas that we were supporting. And given at that time, there was also increasing pressure on costs and pricing, we felt that we needed to make some pivot with what was in our toolkit and what was going to be in demand in the future. And we landed on cybersecurity, and we landed on data analytics, digital, systems software development and engineering and science. And what, over that period of time, proved to be the case with these as budgets sort of stabilized and began to grow and the pent-up demand by our clients was released, that these were indeed the areas that our clients wanted increasing support. And we think going forward that, that will still be the case. Along the way, some additional technologies have emerged, principally around artificial intelligence. And so we are and have been investing in that on an annual basis in terms of asking our senior colleagues to develop intellectual capital, to build relationships, to work with potential and current clients. And what we're beginning to see is that pipeline of opportunities continue to grow and being the recipient of some key, what we think, are awards, particularly in the defense market. So we have a history of evaluating our business every 5 to 7 years, laying down some markers around investment. And not all of the investments that we've made have always panned out, but most have. And I think what we experienced 7 or 8 years ago exceeded even our expectations of how things would go.

Yes, I mean you laid out some EPS targets 3 years ago and you've exceeded those over time. So there does seem to be a history of outperformance. I mean I was going to save this for a little bit later, but as long as we're on the topic of investments and strategy, you made that shift 7, 8 years ago when you started that shift and you've continued to refine, refine, refine. We're now at the end, if you will, of one set of strategies, Vision 2020. What are some of the options you're considering in a new strategic plan? And when could we expect to hear a little bit more about that? I know that it puts a little pressure on Rubun there, right, to put an event together when we're all allowed to gather. But any sort of thoughts on what that next step might look like?

Yes. We're in the midst of updating our strategy. We had hoped to be in a position to deliver that as well as with the underlying financial thesis in early summer. It's looking more like it will be fall when we can finally get together, but that's the time frame that we hope to deliver it in person. That being said, as you would expect with any strategic plan, we're looking at everything, competitive landscape, current capabilities, trends from independent parties, client input, workforce input. And as you might expect, there are some things that we're doing today that we would continue to want to do. There are some things that we want to repackage and there are some new areas that I'm not prepared today to get into. But we think will have the right demand and addressable market for years to come, and that's pretty exciting to us. And I'm speaking largely on an organic basis, but clearly, inorganic will be a part of that as well as Rossi and I have been talking about over the past couple of quarters. But the fall is what we're targeting now, and we expect to have the financial underpinnings to that also at the ready to present.

Okay. Well, we'll look forward to that, and I imagine maybe in the D.C. area, although by that time, maybe we'll all be jonesing get to a beach somewhere. But I assume D.C. or New York makes the most sense, I suppose.

I think that's a safe assumption.

Yes. Okay. All right. You can't blame me for trying. One of the items that you mentioned, it was a soft spot in the quarter but it also is a core competency of any company that is recruiting. So can you go over some of the challenges and opportunities in the labor market today, how they're impacted by the pandemic and what you've -- with the changes you've had to make in order to attract, onboard, and I suppose, retain also that top talent?

Yes. I mean, our people are very important to us. We spend a lot of resources and investment on their development, education and so forth. As it pertains to the labor market, pre-pandemic and through the pandemic and probably after, it's hotly contested, especially for the capabilities in areas that we're looking to build. So it's not just Booz Allen out there, but whether you're high tech, whether you're a start-up, whether you're a financial institution, we're all weighing into this -- these sources. We believe that we'll be successful and be able to build back up to where we want to be through a variety of mechanisms. One is that approximately 30% of our candidate pool comes from referrals from our existing workforce. So part of the activity is to continue to keep the heat on, getting our colleagues to make those referrals, friends and family, and fill that pipeline with candidates, in many regards, are already prequalified and have familiarity with Booz Allen and what we do. Number two is continued outreach to other sources, namely in the government, as folks depart from the government, particularly DoD at 5-, 10-, 15- and 20-year marks. Many of them want to continue to support the programs and the missions that they have an understanding about. And many of them, at the same time, know Booz Allen because we've been supporting them in that regard. So we end up being an attractive employer to them in large part because now they can continue to leverage what they know and do it for the private sector. So we've stepped up our efforts in that regard. We usually get a flow of candidates from competitors and also the private sector, folks who want to make a change to the public sector and they see us as providing a platform to do that. And then to round it out, we make a series of contingent offers every year in anticipation of work that has a high probability of win. And we're going through that list and asking ourselves are we being too conservative or can we extend some offers and start to build the bench that we need in order to execute the work once it comes through the door. So it's lots of little things, Jon, that I believe are going to get us back to where we need to be. But it takes a little bit of time to do that because, as you can tell in my response, each of these has a unique process, and each of them has a set of decision-makers that we need to all get in line and have rowing in the same direction. So that's sort of the process and the sort of the mechanics of how we'll get there. And I believe, as I've said previously, our performance is supply-constrained. We've got plenty of backlog. We even saw in Q3 a growth of 6.1%. And so getting this talent in the door to convert that backlog is job #1 for us.

And in terms of those items that you went through, is it changing processes or just pushing harder on the processes that are in place? Because I mean you have the referrals program. You have the outreach which you know how to do really well. So I mean, all 4 of those things, I feel like you have pretty good control over, maybe the one where you think to make a bit of a structural change is the contingent offers dynamic. So as I understand it, is it a process change or just pushing hard on the processes that exists?

It's the former. It's pushing harder. I don't want this to sound as an excuse. This has been anything but a normal year. So you have to be careful how hard you push and when you push, but I think it's really just pushing harder and going that extra mile to bring on the talent when folks are already pretty fatigued. So we believe we'll get there. As I said, it will take a couple of quarters to kind of build up the momentum. And then also, there are some macro conditions that we also think are going to come our way in terms of vaccines being administered and folks feeling more ready, if you will, to make job changes and things of that sort. Doing this in a virtual world is -- in some ways, it's not that different, but it is very different when you're setting up interviews and doing interviews on Zoom or Webex, wherever the case may be. And then basically hiring a new colleague and deploying them. So I think we, approaching a year, have now a fair amount of experience doing that. And so now I think it's really just being more efficient with the processes we have.

Understood. Thinking about margin here. Clearly, as you said before, the margin performance so far in the fiscal year, despite the sales shortfall, has been quite strong. You stated that the lower billable expense is the fact that no one's flying anywhere or traveling to customer sites, et cetera, is actually contributing to some margin uplift. But big picture, what do you view as the underlying profitability of the kind of businesses that you run over there? And what is the long term really upside to, call it, the 10-ish number that we've historically talked about here? Is that going to be just mix shift, new business models coming through? So how should we think about margin over a long term?

Yes. I think for us, it's always going to be a function of mix shift, the continued sale of these higher fee-generating capabilities, strong contract execution and just managing our cost as tightly as we have up to this point. I'm always challenged to kind of place a number on it because as you can appreciate, I could do some things in the near term, jack up the margin and then hurt our long-term growth prospects. So we took out some of our most highly paid senior underutilized people that, on one hand, would make sense. But on the other hand, these are the folks that have relationships, shape opportunities and really are driving our growth for years to come. And so we think pre-pandemic, we were sort of in the low 10s, and we were able to post strong top line and bottom line performance. I don't want to get ahead of what we're going to ultimately land on come this fall. But I think we had a rhythm in the business that was repeatable. So again, there are other decisions around should we make more of a significant investment in the future that would sort of provide a headwind on the margin. And if anything else untoward were to occur in the broader market. But I like the way the business is being operated. I like the way it's being run. Increasingly, we have business leaders thinking about the top and the bottom line. I think that is sustainable. So it's really rinse and repeat, but we do have to kind of work through this period of choppiness, certainly at the top line, to get where we ultimately want to be.

Right. And it is reasonable to assume that some of that lack of travel, if I put it that way, or lack of visiting your doctor, using some of those fringe benefits, is that materially also showing up here on the bottom line? And that when we start going to the doctor again and maybe go to a couple more conferences and whatnot, that will start to weigh on margin a little bit?

Yes. I think it's a fair set of assumptions that as we emerge from our current state, what now is a tailwind will start to become a headwind in terms of where it was pre-pandemic. But by the same token, we expect the top line to be strong. We expect recruiting to pick up. And so from an arithmetic standpoint, we still expect to kind of hit our stride as we emerge. But yes, I think the way you framed the question is completely fair.

I assume there's also -- is it fair to assume there's also a dynamic where things that you weren't able to deliver during the pandemic because you're simply not able to access certain sites and, therefore, you're just collecting -- you weren't collecting fee on that activity, that comes back, too? So I guess there are multiple moving pieces going into pandemic and coming out of pandemic, and it's really kind of '20 and 2022.

Absolutely. I mean, there are all sorts of known and unknown puts and takes that I think we experienced as we got into this, that we're also going to experience as we emerge. I mean just the ability now to talk to a colleague or a potential client more casually where that's a constrain today is going to have benefit, we believe, going forward. And by the way, it's not just us but others in the sector as well. But I'd point folks back to our history, we do very well in that dynamic, and we would expect to do so going forward.

Indeed. And one thing that the company has talked about for a few years here is this idea of option value. Rather than just running through -- I mean, feel free to take an update on some of the option value, but any thought on when option value becomes value?

Yes. In one sense, it seems like we've been talking about it forever, but it's really just been over the past 3 years. And I think across the board, we've been pleased with the progress that has been made. I think none of them are sort of materially going to impact our overall performance, certainly not up to this point. But keep in mind that top line wasn't necessarily the objective. For half of them, certainly margin enhancement was more the case than top line. And in some cases, it was really a different mode of delivery than just 100% labor, case in point, rec.gov and District Defend and Modzy. So we're pleased with the diversity of them and the progress they've made. What we want to be in a position to do is, in the fall, also provide more transparency on the financial performance. I think all of them are at or approaching breakeven but still in the early stages of ultimately their longer-term financial projections. So still on the make but learned a lot. And I think for our people, certainly exciting for them to work on some of these initiatives.

Understood. So on capital deployment, so we covered the strong cash generation. We talked about the improvements you've made in cash collections and, therefore, working capital enabling you to really turn in robust cash generation overall. That's accreted in a big way to your balance sheet. I think maybe it's 2 or 3 quarters ago, you and Horacio started talking more about the balance sheet as an asset, a strategic asset in this environment. So what are your -- what are the options for unlocking the value of that strategic asset? Because I know that my bank is not paying you much to keep cash, just sitting there.

Yes, no doubt. It's always been our objective to reward our shareholders in the near, mid and long term, and we're not backing away from that at all. So when you take into account the components of our capital deployment, be it share repurchases, capability tuck-ins or regular recurring dividend, it's my expectation we're going to pull all the levers that make sense in order to meet that ultimate objective. As you pointed, Horacio and my commentary around M&A has shifted a bit because we are growing opportunities in our pipeline. They are still consistent with our desire to do capability tuck-ins. They're on a small to midsized level and are in alignment with capabilities that we've been growing and where we see future growth. I'm also excited that it's not necessarily black and white. So with our most recent investment in Tracepoint, an incident response start-up, we're also growing the chops around different ways to add to our portfolio above and beyond just straight acquisitions. And so I'm pleased it's not just responding to a banker's book. It's really opportunities that we are cultivating, and our business leadership is super excited about. So more to come on that. But to the broader question, we're going to apply all of the levers as they make sense and always have and we always will.

Is there -- so more and more to come on that. I mean, is there a dynamic? It seems like for -- good assets still cost a lot. And maybe there was a worry 11 months ago, 10 months ago that -- basically March-April 2020, that there's going to be a real reckoning across many markets, when, in fact, multiples have gone just up and to the right for a lot of technology companies, not your average defense prime but a lot of technology companies. And it seems like you play in the technology space. So how do you keep up with that dynamic where things seem to have gotten relatively expensive? There are a lot of buyers out there with pretty deep pockets, money is free. There's a need to show -- to do something, especially in the PE world sometimes. Don't -- we can talk about SPACs also, I suppose. But there's a lot of financing available out there. So how does Booz Allen compete against all of that?

Yes. I think for us, it depends on at what point do we catch the wave. With Tracepoint, it's a start-up. And we see a lot of merit in what's possible with them going forward. And we have been able to craft an arrangement where we get first dibs, if you will, on an ultimate acquisition. I think for larger opportunities that we're pursuing, it's also a function of culture. And to the extent that we are comfortable and they are comfortable that a fit makes a lot of sense culturally and strategically, we are able to find our way through the financials as well. So you're right. Money is cheap and sky has been the limit on multiples. But we're trying to be as careful as possible not to get swept up so much up on that, but to stay true to is this a strategic fit, can we integrate this company as smoothly as possible and can we get the anticipated savings to get the performance to where we need it to be. And with the sensitivity that, yes, premiums might carry the day, but we're also trying much like with the talent part of our discussion really lead with what's the best for Booz Allen, what's the best for our shareholders and, as I've always said, not do stupid things just for the sake of deploying capital.

When I look at your balance sheet, I mean, there is quite a -- it's a pretty large dollar number. And if you're looking at still typical Booz Allen acquisitions, which are not that big, that then implies multiples of those acquisitions. Is that how busy the pipeline is right now? Should we be surprised if Booz Allen were to pull off 3 or 4 acquisitions in a given year? Or is it an element of like, yes, some things could happen, some things couldn't, and if those things don't happen, we can pull other levers. I mean Booz Allen has done things like special dividends in the past and whatnot.

Yes. I would say all options are on the table. And I think the position that we have affords us that flexibility. I think as it pertains to acquisitions, just the nature of what is currently in our pipeline, and it's hard to crystal ball the timing of any of this because they're all in sort of different time lines and expectations. But I would not be surprised if we do multiple small deals. I think it would be consistent with our strategy as well as our integration. And I think it would also be consistent with what our broader business leadership is looking at. So in many regards, my job is to make sure we can facilitate what we want to do on the business side, and I think we're in a position to do that.

Is having -- I mean, it seems like you've gotten close to the end of developing the next multiyear strategy, and you're just waiting for the right time to unveil it, given all that's going on in the world. Does having that, a little more locked down, enable the M&A -- that enable the M&A conversation a bit more?

For sure. I mean we want to complement and support what we're trying to do from a business standpoint. I know that's stating the obvious. But as it pertains to the inorganic contribution, we want that also to have that clarity where one meets the other. So as I communicate with the equity investors as well as our credit investors, there's a logic and a rationale that kind of hangs together. And so absent that, I feel like I want to -- out there on a limb. So it's coming together, and I like the way it's coming together. But certainly, you and your peers will want to get into more specifics, and we're working our way through those specifics so that when we get to the investment pieces, you have the total picture.

Yes. We're really looking forward to that wherever that event might be come fall, hopefully sooner rather than later. But we know it's not really under your control. So much respect to at least trying to get something on the calendar. I know that in this environment, I'd like having anything on the calendar that involves me not being right here all the time. So thank you very much, Lloyd, for joining us this afternoon. It's great to see you again. And same with Rubun, thank you so much for supporting our conference. And thank you, everyone, who's tuned in here and have a great afternoon. Stay warm, stay safe, stay healthy.

Our pleasure, Jon, and thank you and Citi.

Absolutely.