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

I'm Brian Gesuale, good morning, everyone, senior analyst covering the defense and industrial technology space for Raymond James. I do miss seeing everyone in person in Florida, but hopefully, we get back to Orlando next year in person. Delighted to have Booz Allen here to present their story today. Lloyd Howell, the company's Chief Financial Officer, will give us an update on the story. We're going to do this in a fireside chat format. So feel free to e-mail me some additional questions, and I'll try to work through those. Lloyd, welcome, and thanks for joining us.

Thank you, Brian. Great to be here, and thank you to you and Raymond James for hosting the conference.

Terrific. Well, let's jump right in here.

Lloyd, let's level set the audience. I think many people know what Booz Allen does, but why don't you just give them a sense for how you fit into the government tech ecosystem. Maybe give us a little bit of an overview of the company, some of the strategic elements of the business and really the broad mix of clients that you serve. And maybe just a little bit of how you differentiate yourself from some of these other government service firms.

Sure. We were founded in 1914, and certainly through different iterations over the years. We went public in 2010 and are largely focused on the U.S. federal government in 3 markets, which I'll speak to in a minute, as well as a small percent of our portfolio that's focused on cybersecurity offerings for commercial clients. Our portfolio supports defense -- defense market, roughly 50%; the intelligence market, roughly 1/4; our civilian federal market, also roughly 1/4. Strategically, we have been working toward getting closer to our clients' core mission and understanding their requirements. We've been positioning our portfolio to provide more technical solution type of support and capabilities and, at the same time, recruiting a workforce that has the requisite skill sets. We've increased our level of partnering with other vendors, be it in the federal as well as the commercial market. And we've explored new markets, such as global commercial to diversify our business. So we have a broad mix of clients. We provide a variety of service offerings and capabilities in the area of cybersecurity, data analytics, system software development, engineering and science as well as emerging technologies such as artificial intelligence and 5G. And we have 27,500 employees spread across the world. About 2/3 of our workforce held a security clearance of some level. And with that, Brian, I'll turn it back to you.

That's great. Well, let's just jump right into the topics, one that's on the front of everyone's mind. Let's talk about the budget. We've certainly had an administration change and the control in Congress with a lot of funds being prioritized towards nondefense uses. Can you maybe talk about what you're seeing during these initial days of the administration change, how the next 2 to 4 years might look for you and how all this compares really to the prior 4 years?

Yes. I think if I go back to pre-pandemic, there was a sense that the overall budget, particularly defense, would start to flatten. And we largely would have subscribed to that as well. After many years of increasing budget, we believe that we're sort of in that flattening cycle and remains to be seen as to whether it would decline from here. Within that flattening, however, we are not seeing any deterioration of interest in supporting IT modernization efforts. I think it was widely understood that the IT infrastructure of the federal government needed to be upgraded, whether that was moving things to the cloud or strengthening cyber programs and whatnot and then quite frankly, taking advantage of commercial developments that exist in the marketplace. And so we expect that to continue. But as it pertains to the budget, we were expecting a flattening. And certainly within that flattening, potential repositioning of priorities to date. Because of the emphasis on addressing COVID and vaccines, we haven't seen dramatic shifts yet. But given the commentary during the campaign and we expect the Biden administration to focus on health -- continuing to focus on health, education, the environment, infrastructure going forward.

Great. I think that's a good segue into the next part of this. I really -- you have a very diverse set of clients. I want to really talk about this by market a little bit. Can you talk maybe how you expect your -- the shift in growth rates to be between your defense, civil and intel businesses really over the next couple of years? And then I think it's also unique the way Booz Allen's got that unified P&L, and it enables you to shift resources in a more agile way than some of the market players out there. So maybe explain to people how you see that shaping up?

Sure. So we do have a single P&L, which we feel has been an asset to us in terms of being able to shift resources literally overnight to opportunities as well as to address business challenges as they arise. Prior to being the CFO, I ran our civilian federal business, which at that time, saw a large pickup in health-related opportunities and, in order to support that, drew upon our talent elsewhere in the portfolio, be it the intelligence or the defense market. When I look out -- when we look out into the future, we would still expect in our intelligence and defense markets to still see growth opportunities really driven by, as I mentioned in my opening comments, the desire by those clients to continue to upgrade their IT programs and resources; take advantage of advancements; and quite frankly, do more with less, which has been a drumbeat for quite some time. In the civilian markets, just taking what we have heard from the administration, we do expect some additional resources and attention to be spent on areas such as health, education, infrastructure, the environment as well as the state department. We have currently support some of that, but not all of it. Certainly, we have a growing and successful health business. But what we typically do is as opportunity surface elsewhere in the civilian market, we'll make a determination whether it's the type of work that we would like to support and if we have a right to compete and to win. So it's certainly not going to be pursuing everything. But certainly, if it's in the areas that we feel we've got competency in, we're going to mobilize and do our best to compete for that.

Yes. That's great. I want to maybe now think about some of the capabilities that Booz Allen has. I think the company has always been very forward-looking. And you invest typically in some of the faster-growing segments before they're growing segments of the market. Will you talk about some of these areas? A couple that I'd point to are certainly artificial intelligence and directed energy. But if there's any other areas you want to highlight, please do and shape their sizes, how they might grow and just how material these businesses are and can be for Booz Allen in the future.

Sure. Let me give you some context as to how we even discover some of these areas to invest in. Seven, 8 years ago, we were in the midst of updating our strategic plan. We made a -- we came to a conclusion that we needed to shift from what was then largely a program management set of offerings to being more so in these areas that now are commonplace: cybersecurity, data analytics, system software development and engineering and science. And we were able to do that through the standup of a strategic innovation group that basically range down across the portfolio. And their sole mission is to have their eyes on the horizon as to what's emerging and how that might be applicable to our current as well as future clients. So some of the areas, Brian, that you mentioned are clearly ones that we feel we've moved out on successfully, have been successful in winning some early procurements, particularly in the defense and intelligence market. That includes artificial intelligence and cyber, for sure. And now we're seeing the emergence of 5G, which represents a whole another paradigm shift. We're also working with current clients to figure out what's the thinking, where might the government go in terms of areas to be supported and how might we have something to offer in that main. And what's exciting about the early thinking is it's really a bringing together of lots of different existing areas, be it cybersecurity, be it data analytics, overall doing it much faster than, say, 4G. But it's a shift that gets historically us pretty excited about what innovative ideas and things can we do to bring into the mix. We also have what we termed option value initiatives that also sort of liberate us from a traditional labor-based model to explore new models of delivery as well as new areas. And directed energy is one of those areas where we're basically taking laser and sonar technology and exploring how to put that on smaller platforms given the current threat environment than maybe existed 10, 20 years ago. Successfully got through some prototype testing. And Certainly, we're beginning to see orders increase from primarily defense clients. You may have the question as to, "Is Booz Allen going into the weapons business?" No, we are not going into the weapons business, but certainly gives us an opportunity to strengthen our IP or IC, explore a different type of product environment that I think it's still too early to talk about what's an exit or an off-ramp look like. But it's been very exciting from an innovative perspective, and it gets our people pretty jazzed. We also looked at a reservation system, which we call recreation.gov, rec.gov for short, for the agriculture department where basically folks are able to reserve camp sites. And in the midst of COVID, we saw really high usage of that given that travel was limited. So again, develop a system on our nickel, work with the government on a fee arrangement where we can recoup that cost as well as achieve better financial performance than a traditional cost reimbursable or time and material contracts. So those are some examples of how we are innovative and areas that we are looking at on the horizon.

Yes, that's great. On rec.gov, it looks like you'll have a new subcontractor partner in Tyler Technologies with the NIC folks being acquired recently or about to be acquired.

Yes.

Yes, let's maybe talk about the cyber practice where you have such a strong position. I really want to hit this on 2 vectors. First, would you help us understand some of your capabilities in this domain, talk generally about sizing this for us and how you view the addressable market as well as any key customers or programs that you want to talk about? Then I really want to talk about, as part of this, how this incremental $10 billion that Biden wants to spend on federal cyber infrastructure can play to your strengths. And frankly, there's many out there that don't even think that's enough. So maybe just comment on that, unpackage a bunch of those points.

Yes. I often get this question in terms of trying to quantify how much of our portfolio is cyber-related. It's a challenge for us given how people self-identify, how the government actually categorizes the nature of the support. But let me try to give you a bit of a framework. So 7, 8 years ago, when we looked at our portfolio of capabilities, about 1/3, I would say, fell into these sort of higher technical solution areas such as cyber. Today, I'd say between 50% and 60% of our workforce is in this sort of technical space. That includes cyber but also data analytics, system software development and engineering and science. And that gets to another part of your question, which is what are the underlying capabilities that we could have put under the cyber umbrella. And there are several. Certainly, system software development and data analytics, but we're typically operating in the top 1/3 of what I would call a cyber stack, which includes strategy or assessment in terms of a report or a threat environment or adversary profiling and motivations. And then that moves into sort of governance. How is a client configured between a CISO, CIO, other decision-makers in terms of reacting proactively or reactively to any future or existing cyber events. It could also include crisis management and communication, but that would sort of be another layer within that top 1/3. And then you get into intrusion response. God forbid an incident happens, how do you mobilize, how you assess the damage, how do you assess what the adversary did, how they did it, what was their motivation, what did they take, what was compromised. And then what is the response in terms of mitigating that risk going forward. We do, do offensive support, but that's primarily aimed at our intelligence clients, not our civil federal or defense. And then you get into what else is in the toolkit, penetration testing, monitoring, all what I would describe as strengthening the overall hygiene of a client in terms of their cyber capabilities, resources. Do they want to explore the standup of a fusion center? We certainly help them in that regard. And then I'd say we kind of rounded out with managed services in the sense of at scale across a sector, how can you sort of share resources through the benefit of more than just 1 client and help them sort of navigate through that. There are clearly other vendors that play in the stack but at different points, but we're typically in the top 1/3. And then the other question that I get, Brian, is like, well, how many employees or workers are tied to cyber. And I'd point you back to with roughly 27,500, somewhere in that 50% to 60% range would sort of be the way I would answer it given that folks would identify as, "Hey, I'm a software developer. I happen to work on cyber programs, but I also support noncyber programs." and so that gives a bit of a quantification challenge to us in terms of how to itemize it. But looking forward, to your comment about is $10 billion enough, a bit biased here. But given the threat environment, what we understand to be the motivations of all sorts of adversaries, whether they're enemy state-backed or not, there's no end in sight in terms of that threat environment. So certainly, the activities and the investments that have been made up to this point by both our federal and commercial clients is important and probably a down payment on programs that they will need to only strengthen and revisit year-over-year, just given how sophisticated adversaries are and what their motivations are.

Yes, that's great. I can certainly understand the self-identification and making it difficult to fully quantify. I know in my pickup basketball league, I think I shoot the ball like Steph Curry, but it doesn't always quite fall like I want. But the second vector I want to cover really is your commercial cyber business. You recently shifted strategies here, repositioning the focus domestically. Can you talk about what made you decide to change? Why the time was now to do that? And really how long do you expect the positioning to take? And when that business can begin to grow again? Because it was quite profitable relative to the overall unit.

Yes. The decision was largely based upon our observation of where were the demand signals coming from and how strong were those demand signals. And we were seeing, even in the midst of COVID, increasing demand and interest in Booz Allen providing that support. And wanting to be responsive to that, we felt that a reshaping of the portfolio made sense where we devoted more resources attention in North America than in some of our international regions, most notably in the Middle East. So we still have a presence in the Middle East, but reduced while we devote more resources to North American opportunities. And some of those, quite frankly, are multinational clients that have a presence around the world. But we felt that supporting those clients with more of a U.S., North American base made more sense. So that's what the motivation was. And we would expect, given that change in focus, that we will get back to the growth rates that we saw in the first several years and maintain the profitability, which is 2.5 to 3x better than what we would see with our federal clients. Exciting work, also weighing into a challenging labor market to recruit the folks that you need. But given content of the work, the clients we're supporting, we think we will prevail there as well.

That's great. I just got a question from an audience member asking how important something like SolarWinds is to what Booz Allen is doing. And obviously, you can't name specific customers, but certainly, you can probably talk about whether you're involved in helping figure that out, if you will.

Yes. It certainly is a factor. And I would say that for every incident that hits the media, there are tons of others that don't. And so SolarWinds from our perspective is a notable intrusion because it goes right at sort of the software supply chain that many companies beyond Booz Allen have been saying really requires a lot of attention. So for existing clients, certainly, we're engaged in helping them to address their particular situation. And then for potential clients, there's been an outreach whether it's SolarWinds or they weren't compromised and -- but they're watching sort of what happened with SolarWinds wanting to make sure that they've got the right safeguards in place as well. So unfortunately, a catalyst for business opportunity, but I think more broadly speaking, whether you're a commercial or a federal, another wake-up call that, hey, we have to remain diligent when it comes to these type of threats and these type of intrusions.

Yes, certainly won't be the last one. That's for sure. I want to shift over and talk about the blocking and tackling of the everyday business and really the people. This is the lifeblood of your business. Can you talk about the market for talent? I've always thought that Booz is really kind of a finely tuned HR machine, if you will. How are you thinking about annual head count growth, maybe how '21 will be different than '20? I'd like to focus on some things like voluntary turnover, consultant productivity. And maybe touch on if you're seeing Amazon out in the market, they have some pretty ambitious plans to have 25,000 employees over the next decade, and really just unpackage a bunch of those points as you think about the war for talent.

Sure. I mean we go into every fiscal year targeting mid-single digits of adding to our workforce. And in some years, we've exceeded that. In other years, we find a little bit shy of it. But that is always sort of the notional target. Our 2020 has been anything but normal. The pandemic hit. And in the first half of this fiscal year, we saw productivity at an all-time high. And part of that was a run rate of 3% added to our workforce, which is a little bit lower than what we saw pre-pandemic. We exited FY '20 at 4.2%. And I think the previous year, we were probably a little bit north of 5%. But nonetheless, with unprecedented productivity and a 3% add to the workforce, all of that translated into a top line growth that was pretty healthy. Horacio and I maintain that -- maintaining that through a year was unlikely. We were beginning to hear stories and see instances where burnout and fatigue was sort of entering. And so we encouraged our people to take PTO. So we expected a sort of a feathering in of a normalized productivity for the balance of the year, certainly with an eye toward the other side of COVID. But what happened was a more immediate snapback and productivity that we saw at the beginning of the holiday season in November, which has persisted. So -- and at the same time, recruiting had dropped to 1.4%. So immediately, we mobilized, hit the accelerator even more on the need to source and bring on the talent. This is a very competitive labor market, especially now folks are grappling with their personal as well as their professional career in a virtual state. So we have a couple of things that we feel are going to help us get to where we want to be. One is that about 1/3, 30% of our candidate pool comes from our own employees as referrals. Number two is we are seen as a good private sector option for those leaving the federal government who have had familiarity with Booz Allen but also want to maintain supporting the programs that they know well, and they see us as a good employer to do that from. And then number three, we bring on folks from competitors as well as individuals that are looking to make a change from the private sector to the public sector. The other dimension is we make a fair amount of contingent offers based upon what we see in the pipeline and the likelihood of win. So we're revisiting that group and sort of saying, "Hey, look, if the probability is pretty high, we can probably lean into that more aggressively than we originally intended." So it will be a variety of things, Brian, that kind of get us closer to what our objective is, not the least of which is being sensitive to, as vaccines roll out, how aggressively do things start to pivot back and whatnot. I think part of your question was around attrition. During this year, we've seen very low attrition levels, which have largely remained. But we're not making the assumption that, that will persist certainly as folks begin to explore options in the future. So we've upped the ante on communication internally, development programs even in a virtual state to maintain the stickiness and to demonstrate that we really do care about our folks and their welfare, whether we're in a pandemic or outside of a pandemic.

That was a great answer. I want to move on to some of the financial targets that you laid out a few years ago. I mean they were pretty ambitious at the time, and you guys just executed nearly flawlessly against them. Congratulations on that. But when you look out over the next 3 to 5 years, how do you think about the mix of business, how that might shift, how the financial model evolves? And maybe any changes in service delivery or any of these other areas as you kind of look out over the horizon? And if you could pick one thing that will be the biggest contract between future Booz and present Booz Allen, what is that?

Yes. It's a very timely question. We're in the midst of updating our strategy. We sort of reached the end of Vision 2020. And so we're at the logical point of what comes next. And it's our intention to unveil that more broadly in the fall as well as the underlying financials or the update to the current investment thesis. I'd say there are a couple of notable differences. Three years ago, we were sort of in an overall budget environment that was still growing. There was a lot of pent-up demand that was getting released. And many of the investments that we had made 7, 8 years ago were sort of coming into their own. We're beginning to see a return on that. Today, those investments, I would say, are more commonplace in terms of it's not just Booz Allen that also provides that, but the competitive landscape has changed a little bit. The budget environment appears that it is changing a little bit. And what we've seen in terms of the level of consolidation that's occurred across the marketplace has also continued to pick up. So again, I don't want to get ahead of what we'll ultimately kind of discuss in the fall, but we'll be taking all of that into account and, at the same time, looking for how to leverage the things that have been extremely successful for us and then what are the adjacencies that we can basically add to the mix to continue to grow and support our clients in the manner that they expect. So I can see different variables that will come into light more so than they did 3 years ago, and I can see the possibility of the contribution of that being a good thing for not only the company and our people, but also our shareholders.

Okay. That sounds great, Lloyd. I think this dovetails into the next question on capital deployment. Your balance sheet is underlevered and you have the good fortune of generating an awful lot of free cash flow, pretty limited CapEx. You've made a couple of years ago a regular dividend a cornerstone of capital deployment, but you also do generally much fewer M&A deals in your peer group. How are you thinking about inorganic growth and maybe more effectively using the balance sheet going forward?

Yes. I mean to the last point you made, we definitely see our balance sheet and the strength of it as being an asset that gives us a lot of options with our capital deployment. I've always said that we're looking to deploy our capital with an eye toward benefiting our shareholders in the near, mid and long term. And given not only M&A, but our share repurchase program, the dividend that you noted and the possibility of special, that all those we look at in terms of what's the best reaction to the market conditions that we see. On the M&A front, you're right, we haven't been very acquisitive in the past for the simple fact that with the organic growth performance that we are experiencing, we didn't feel going out to buy something at scale was, a, either necessary or consistent with our strategic direction. Over time, we have said that where we can find an opportunity that's as close to a pure-play capability tuck-in, we're going to take a shot. And we've done some of that over the past, call it, 5 years. What we think of now is a continuation of that but really with an eye on how will it accelerate our rate of growth. So we're not looking at M&A of scaling just to scale, but how will an acquisition turn into a rate of growth that even better than what we saw previously. And it's still -- the bar is still around as close to a pure capability play as we can find. It's probably leveraging or building upon capabilities that we already have but maybe not as large as we would like. And it may also open up the possibility of supporting new clients and building the bench, if you will. And so in our growing queue of opportunities, there are increasingly more opportunities that we are sourcing ourselves. There is good alignment to the strategy and the direction we'd like to take the company. On an integration standpoint, these opportunities have close cultural alignment, which gives us confidence of being able to integrate more successfully than not. And then on the economics, it's certainly within what we would consider a reasonable range in terms of what -- not only the companies are worth, but what the synergies are that we think would be a win-win. So we're seeing more alignment with all the things that we would like as opposed to in the past where an opportunity was transformative, but we didn't feel we needed to transform or, quite frankly, the economics were such that we didn't see the same value as others did.

Terrific. And this is my last, last question. This is really giving you the last word. So I really do appreciate you taking the time to give everyone an update on Booz Allen. This is the drop-the-mic moment, so no follow-up question for me or anything like that. But what 2 or 3 things do you want investors to know as they evaluate your stock either as potential shareholders or existing shareholders? And we're going to leave it there. Thanks, everybody, for joining us.

Thank you, Brian. I'd say the first is Booz Allen remains long-term oriented in the sense of what's best for our clients and how can we provide that support for years to come, essentially being on speed dial to their most pressing challenges as well as opportunities. Number two, we are a people-driven business with core values. So the recruitment, retention of super bright individuals is very important to us that bring to the support a set of core values that have allowed Booz Allen to provide the type of support that it has over many years. And then number three, we have a history of being financially successful and intend to do so going forward, rewarding our shareholders in the near, mid and long term through prudent capital deployment, prudent M&A activity and also the continuation of strong organic growth.

Great. Thanks so much, Lloyd, and thank you, everybody, for joining us. Have a great day.

Thank you. You, too.