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

Good afternoon, and welcome to day 2 of the aerospace defense track at the 2021 JPMorgan Industrials Conference. And we are very glad to have Booz Allen Hamilton with us now and grateful to have the company's CFO, Lloyd Howell; and from Investor Relations, Rubun Dey. And so welcome, gentlemen. Thanks for being with us. And I think probably we'll start with -- maybe we'll just do some Q&A. Kind of fireside chat this afternoon. I don't know if there's any kind of forward-looking statement or anything you guys need to start out with, we could do that at the top here, and then we'll dive into questions.

Yes. So let me just start with -- I mean, before we start, just note that we may discuss forward-looking statements here that are subject to known and unknown risks and uncertainties as well as certain non-GAAP metrics that we think 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. And with that, I'll pass it back to you, Seth.

Okay. Cool. Maybe we'll start off just a very kind of a open-ended way. And Lloyd, maybe you could tell us a little bit about what Booz Allen does. I think most people probably have some idea of what they do, but I think it's helpful for you to define it and talk about what makes it different from peers in the federal IT space and kind of how you see your addressable market evolving.

Great. Thank you, Seth, and thank you, JPMorgan, for having us, and it's our pleasure to be here today. I guess the way I'd start in terms of describing Booz Allen is, we are a government services contractor that provides a variety of high-end IT services and support to the federal market. We have a small global commercial business as well. But within the federal IT space, capabilities around cybersecurity, artificial intelligence, data analytics, system software development as well as engineering and science are the services that we provide. We have over 27,500 folks that make up the team, spread around the world, but predominantly in United States. And in terms of addressability of markets, our portfolio, in addition to global commercial supports defense, all the services, agencies and joint combatant commands, the civil federal agencies, principally Homeland Security, Treasury and HHS. The intelligence portfolio supports all the 3-letter agencies as well as the military intelligence agencies and as I mentioned, global commercial. We are over 100 years. A vast majority of that in the federal market going back to World War II and have a high percent of our workforce that is cleared and have historically outperformed our peer group in terms of the organic growth. And so with that, Seth, back to you.

Okay. Great. Maybe fast forward into sort of current events and what's going on now. Management had noted, but before the election that the company was able to kind of adjust for whatever political environment emerged in Washington. And so now that we're kind of 5 months out from the election, what are some of the changes underway at Booz Allen? And what are some of the ways that you're adjusting the company for this new administration?

Sure. Well, in the near term, I'd say, it's business as usual. We are continuing to support our clients and at the same time, appreciating how their priorities may change in the foreseeable future and are shaping opportunities to meet those changes and positioning ourselves to compete for what we think will be the subsequent RFPs that get released. And so in that regard, not much is changing from what we typically do at this point in the year. In the mid to longer term, we're also in the midst of updating our current strategy known as Vision 2020 and expect to reveal that sometime in the fall. We had originally wanted to do that before the presidential elections. And as things have played out, we wanted to also do that in person. And it appears that in the fall, we'll be able to do that. And there, we're exploring all aspects of the business in terms of our markets, clients and what we feel may represent additional growth opportunities for the business. Internally or from an infrastructure standpoint, we've also been underway updating many of our legacy systems and are looking to roll out in April, our new financial system. So all of these changes, both from an infrastructure standpoint as well as attention to our clients, we think will position us to continue on the growth trajectory that we've been on.

Okay. Excellent. The update to Vision 2020 is interesting. And sort of when we think about -- it's probably early to talk about the content. But when we think about what that might entail sort of 3 to 4 years ago, I think there was this general sense that the defense budget was on the upswing, and so the market environment and the things that aren't under management's control might have seemed fairly clear. Does the environment that we're in now lend itself to making the same kind of multiyear projections and having the same kind of multiyear outlook? Or is it just a different environment?

Well, I think going into the pandemic, there was a point of view that there would be a general flattening to the budget and, in particular, defense. And we at Booz Allen would -- have subscribed to that as well. After seeing a number of years where budgets were growing, it's just reaching a point where there would be a different part to the cycle, and we were right there in terms of the thinking. I think the pivot was anyone's guess as to where that and when that would occur. But even with that as the broader context, we still feel that there is plenty of upside potential just given the need for many of the IT advancements to be adopted by many in the federal market. And as we have been positioning ourselves, both in terms of our portfolio as well as with our clients, in our understanding of their ever-growing mission requirements, we feel that even in a flattening budget, we'll still be in a position to continue to provide great service and support. And hopefully, that will be reflected in our financials going forward.

Okay. Yes. I guess that kind of gets to the next question I had, which was thinking about the -- what sort of the appropriate pace of growth for the company over time? If we think about the 5 years that are going to end here shortly for you in fiscal '21, saw a very nice annual growth of 8%, I don't know if this makes sense, but is it possible to kind of dissect that into a portion that's kind of structural and through-cycle versus a portion that might have been sort of a kicker on top of that, that came from where we were in the budget cycle?

Yes. If you look back at our performance and various budget cycles, we tend to be 1 point or 2 better than what the growth rate of the budget may be at that point in time. And we feel that's due to a couple of factors: One is our long-standing relationships with many of our clients that go back 70, 80 years, where we essentially have grown up with insight and relationships that, to this day, allow us to support them and be seen as an honest broker, if you will, more so than out for a buck. Number two is having the right capabilities that are relevant. We have consistently looked at our toolkit and have made investments over the years to anticipate where the client's demand is going to be. And with the current strategy, that was a pivot from program management and SETA to really focus on cybersecurity data analytics and the other capabilities that I mentioned in my opening comments. Hand-in-hand with that is you have to have the talent to back that up. And so we have consistently sourced and recruited the talent, albeit in a very competitive labor market, to bring that talent on board, to deliver on these capabilities. And I'd say the ability that we have to integrate these capabilities has also proven to be a market differentiator. So when you think about those elements to how we go to market, our relationships, that served us well in certain and uncertain budget environments, and we expect that to continue going forward.

Okay. I guess drilling down a little bit to the last call, company talked about the impact of the presidential transition on sales, and it was a bit more protracted than usual at the beginning of 2021, I think, particularly at the defense department. Why do we see that having a little bit more of an outsized impact at Booz Allen relative to some other service providers? And then now that we're a couple of months out from the inauguration, do you see things starting to move back more to normal conditions?

Yes. For us, it was really a function of what were the programs we were supporting and what were the dynamics that impacted our programs and our potential programs versus maybe others. I can't speak to others, but in our case, because of the departures, particularly at the senior civil servant levels, who typically maintain a program through transitions, advocate for their program, both politically as well as financially, there was a void given some of the departures that -- on the programs that we were supporting. And that was true in our civilian market as well as our defense and intel markets. So it was what it was. The good news is that none of these programs were canceled. They just hit the pause button. And what we see now, Seth, is that the government is resuming the activity that we had hoped that they would do. So leadership is getting in place with the stimulus package in the mix. There is funding -- potential funding that's out there. I think this will play out over the ensuing months in terms of how that rains down across programs and agencies. But we continue to stay close to our clients, continue to help them advocate for their requests and remain hopeful that they'll get what they need in order to resume the activities that were underway prior to the election.

Okay. Yes, the mention of the stimulus is interesting because we don't always think about that necessarily having much of an impact on the IT service contractor community. But is there anything you'd highlight coming out of that? Or anyways, maybe even if it's not specific to Booz, but across the end market, where that might have an impact?

Yes. I think the way to look at it, even at a sort of a broader budget is that having any budget is better than not. So what it does is it gives our clients the confidence that there is funding available, which then translates into the issuance of RFPs and awards. When you have that much more uncertainty, folks are more hesitant to move out and how that looks or shorter durations, a bit of choppiness in awards and so having -- even if the specifics aren't clearly understood, having that in place is an indicator to our clients that this is the direction of the administration and the intent, which is a reassuring dynamic. Now we're a [ bit aways ] from how it all settle out, but the timing of it is also important because we're on the cusp of what is typically a big procurement season, which picks off April, May, runs through the end of September, which corresponds to the end of the government fiscal year. So with that as a backdrop, we expect a good procurement season. Historically, we've had good recompete as incumbents, saw win rates at nearly 90%; and for new work, at or around 60%. So those dynamics give us confidence that we will get back to a performance level that we saw certainly in the first half of this year, but pre-pandemic.

Okay. Excellent. When you think -- last question about the transition is, are changes in administration usually times when the company has an opportunity to make some important hires maybe from folks coming out of government. And if that's the case, is that something that we've seen here in the first part of 2021?

Yes. Going into my 33rd year of being at Booz Allen, I'd say over that period, there have been all sorts of theories and approaches to talent, particularly those departing the government. I think the one thing we've learned as of late is sourcing and recruiting talent is a continuous process, whether it's a transition or not. You certainly do see particularly at a political appointee level departures and candidates sort of emanating from that. We certainly interview and talk to those individuals, but we are focused on folks that are closest to the IT and closest to programs that we're either currently supporting or want to support in the future. And that ends up being sort of our sweet spot in terms of talent. Hard to predict when they may decide to leave the government. But we feel that just strong delivery, solid relationship building gives us the best sort of foundation to recruit those candidates from. You do see a spike in any sort of transition. And as I say, we do our best to recruit the right folks at that time.

Right. Okay. A couple of questions I had about contract mix, both in terms of the type and in terms of the customer set. With the customer set, we've seen the portion of sales coming from intelligence customers trending down from 23%, 24% to about 20%. Still growing a little, but the other portions of the business growing faster. And so I think in general, people tend to associate that work with places where that would have maybe an above-average growth rate at Booz. And so how do you think about enabling further acceleration in growth with that intelligence customer set?

Sure. So to put it in context, we have 3 contract types that make up our portfolio: cost reimbursable, which is currently hovering around 55%, 56%; time and materials, which hovers around 1/4; and then fixed price, which in any given year is in the high teens or low 20s. And that's largely been consistent over the years. The pickup in cost reimbursables is largely due to the growth in our defense business, who has a propensity to issue contracts of that type. And so as we have won, you've seen a pickup with that and a slight change in our mix of contract type. As it pertains to our intelligence business, we've been in the process of transforming that. And that work is happening as we speak. We see progress in one of our sub accounts, known as national agencies, where they're seeing high single-digit growth as well as the growth in headcount, which is particularly a good sign given the challenge of bringing onboard people with clearances. And so that is very encouraging. The next account, which is known as cyber to us, is also doing very well, but is awaiting the release of a significant RFP, which we feel we're positioned well against. And the government through a variety of reasons, has pushed that out to the right, but we expect that to be released and to compete for that. And then the third account, which has undergone the most transformation known as defense military intelligence has really been a function of us repositioning and diminishing our exposure to staff augmentation work for the higher-end work that we would like. And so a combination of not bidding on follow-on work that's in the directions that we don't want and then positioning ourselves for new work that we hope to see in the form of RFPs in the not-so-distant future will drive improvement with that. And with those changes, Seth, underway, we'd expect that the growth rate in that market will continue to improve. And then hard to say what the other puts and takes will be in the portfolio, but I think we're all expecting that to improve from where it is today.

Great. Okay. No, that's very good color, I guess, to follow up on the cyber opportunity that you talked about. An RFP potentially followed by an award, is there an approximate time frame you think about for an award there? Is it something where there might -- I know there's a lot of sensitivity around cyber work, is it something where we might see an announcement?

Who knows is, I guess, the bottom line answer. As I said, it's been pushed off to the right a couple of times. We remain optimistic that the government will issue that. And then given the current work that we're supporting, I think it positions us well to compete for that. But timing, we're not in the best position to comment on that because it's really -- all the cards are in the government's hands in terms of when they're going to be in a position to do that. But we remain diligent through strong delivery and close relationships with the clients. So when they ultimately do that, we'll compete for that work.

Yes. Okay. Yes, I mean, I wanted to follow up and ask about cyber more broadly and hopefully, not running into too much of a brickwall here. I know that it's not something that you're able to talk about in great detail, but it is something that is important to the company and that investors associate the company with. And it's also an area where across the -- both in terms of service providers and increasingly, the hardware as well, there's a need for cyber that is kind of part of everything. So can you tell us sort of what differentiates Booz Allen in this area? And how we can think about -- how the work that you can do can help with and support the government as it seeks to harden some of its systems against the high-profile attacks that we've seen in the news in recent years?

Sure. No. I think everyone says cyber and so you dig into the level of detail you're seeking, it's hard to know really where folks are focused on. For us, if you think about cyber in terms of a stack of offerings, we operate at the top third of it. So at the very top, if you're looking at sort of an assessment or a strategy, we provide that type of support to our clients where they may be looking for better context as to what does the threat -- overall threat environment look like? Who are the adversaries, what are their techniques, motivations and how might that apply to my particular agency? We provide that type of support. Moving down, you get into governance. Am I configured from a governance standpoint to manage cybersecurity in a proactive way? So do I have a CISO? What's the relationship between the CISO, the CIO? If there is someone with a designation of Chief Risk Officer, who might that be? And how does that then interplay with the other leaders in the agency and department. And should there be an event, how would we operate in terms of response and communication, be it to law enforcement or to other parts of the government. So we provide that support as well. Then I would say the next tier is a variety of hygiene and stand-up types of support. So should there be an incident, we certainly have an incident response team and have worked with clients to respond to incidents in terms of what was it? Where did the adversary go? What might they have taken? And how do you sort of mitigate that type of event in the future, taking into account whatever we may learn in terms of the forensics. We then get into penetration testing, monitoring, in terms of preventive measures going forward. So that there's a constant view of the horizon, the landscape and information flow that would result from that type of support. And then sort of bookending it for us is managed services. So providing support at scale across multiple entities where there's a continuous flow of information and support so that if something happens to one, others learn from it and are able to leverage a broader base of support than what they may have otherwise just tried to do on their own. And that sort of depiction is also applicable to our global commercial cyber offerings as well. But we have found that at the end of the day, we're operating the top third of the stack. It's not to say other cyber support isn't necessary, it certainly is. But we feel we've got the competencies to play there more so than elsewhere.

Okay. That's actually super helpful. Just to follow up, you mentioned that you have those capabilities in commercial as well. And the company has not gone -- or it seems to me, correct me if I'm wrong, but it seems has not gone full on in terms of kind of, "We're Booz Allen. We're good enough for the U.S. intelligence agencies. We can help you in the private sector to your cyber, and we've seen others in the defense area who have struggled with it." What's the thing that makes that transition very difficult? And it seems like it's probably been wise for you guys to be judicious about that. Do you see opportunities there long term? Or are some of the differences just so significant that, that it's not really a good idea?

Yes. We feel there's still upside potential in global commercial, and I say thank you for the compliment. But it largely goes back to having had a worldwide commercial business in our history that I think has contributed to our conservative approach. One of the early lessons learned is that you have to have people, talent, infrastructure that are truly geared toward commercial model as opposed to one that's trying to do both federal and commercial at the same time. So we've put that in place, has contributed over the years to the growth that we saw certainly when we were in the high 20s, low 30%. But the other challenges on the talent side. Recruitment at both the senior levels in terms of folks who have relationships, and can do business development as well as more junior professionals that on an engagement by engagement basis can deliver and the retention of that. This is a, as you know, highly demanded labor group, and so compensating and rewarding those individuals is also very important. As we look over the horizon, we certainly feel that we've got the right strategy. We're trying to execute on that. We've made an investment in an incident response startup called Tracepoint, which we think will contribute to our future growth objectives. And we're in the process of integrating and working with them along the way. So it's a lot of different things. You can't rest on your laurels at all in a very fast-moving market. And so we're attempting to continue to invest in that business and provide the right resourcing that they need going forward.

Right. Okay. When we look at the landscape now, there's kind of a conventional wisdom. And I'm curious the degree to which you agree with this and also the degree to which you see the market changing in that as seemingly everything, but particularly maybe electronics and mission systems become more software-defined, there's increasingly a blurring line between, let's say, what you guys and your peers and services do versus what some of the defense manufacturing companies do versus the ability for some established companies in commercial and also start-ups to be involved in serving your customers and also the customers of the major defense manufacturers. Do you see those lines kind of blurring? And if so, how are you adjusting the company for it? What does it mean for your business?

Yes. It's a big question. I would say, lines will blur as driven by the mission requirements of our clients that are also in continuous development and update and growth. Take the most recent dynamic where many of our DoD clients want to migrate to the cloud. That, in the near term, has, from a competitive standpoint, looked like partnerships between ourselves and companies like Google, Microsoft, AWS, where the government proceeds and receives true value in having a company like ours who's been with them and understands the requirements and work with another vendor to do that migration, where they have the scale and the experience to do so. And we expect that, that dynamic will continue, just given where the government is today and where they want to go. As it pertains to other capabilities that may fall with primes or hardware companies, I think it's really going to be on a situation by situation basis. Should the particular program touch upon these other areas, there certainly could be a blending. But in the near term, I think there won't be much change. I think there'll be exploratory conversations to get at what's the art of the possible. They'll need to sort of crosswalk that into procurement strategies on their part as well as what lines they are willing to blur and which ones they're not. What we've always prided ourselves on is, really sticking close to avoiding any sort of conflict of interest, making sure that we are delivering on what we've committed to. But where there are opportunities to have and put together partnerships that makes sense, we're also exploring that, which goes back 7 or 8 years when we stood up our strategic innovation group. And that continues to evolve, and we expect that, that will continue to evolve going forward. But still early days. The government in many ways is behind what we see happening in the commercial market. But they're doing their best to catch up, and we see ourselves as helping them to do that.

Maybe in that regard, to dig into one area where we've done a little bit of work, and it's become a little bit more prominent recently is 5G and a place where the government probably will look to catch up with what's going on in the commercial world. And on the one hand, we've seen Booz Allen win a couple of experimental contracts in that area. We've seen some of the primes kind of speaking about this as a longer-term opportunity. What role do you see for Booz Allen in sort of helping the government and Defense Department adopt 5G communications technology? And how do you see yourself sort of positioned to do that versus maybe other companies that have platforms and mission systems out there?

Yes. Well, that work and that positioning is underway, whether it's 5G or any newer technology, what typically happens is it emanates out of the research labs tied to the DoD. And we have long-standing relationships where we work with them on innovative ideas and the applicability of those ideas to where they want to go. And 5G is no different. So several of the labs launched pilots where we've been supporting them to kind of explore the art of the possible. And at a point where the government feels like, "Okay, we've got the proof of concept. We've got a sponsoring service agency or department," begins to get scale and starts to manifest itself in the form of larger request for proposals and so on. So we're still in the early days. But what 5G represents is an opportunity to integrate lots of different dynamics, AI, cybersecurity and the list goes on and on at high speed. And I think where we are today is how is that aligned with the mission requirements of our clients. And so each client is going to need to look at that and explore the art of the possible. And we have a long history of working side-by-side with our clients to do that. The early days of cyber were no different. And with some of the early AI awards we received, it was also in keeping in that type of approach. So 5G is sort of the next thing, and I'm certainly challenged and I challenge anyone to give me such a specific definition of 5G where you don't quickly talk about other capabilities. And so we're working with our clients to figure out how that definition is applicable to them and then how best to support them. And we're pleased with our initial positioning, but there's so much more work that needs to be done. And so we think that's a very attractive addressable market.

Cool. Very good. We've -- we're about 2 minutes to time and you've indulged me in answering lots of big picture questions. So I'm going to pull it back to the financial statements a little bit and some of the financial questions, as I'm sure people are interested in that as well. I guess in terms of capital deployment, you guys still have relatively less levered balance sheet than some of the peer group. Is that sort of a philosophical thing or just have to do with what the opportunities are that are out there right now? And then specifically, do you still think about yourselves as kind of opportunistic share repurchasers? And how should we think about that right now?

Yes. Well, we're very pleased with the strength of our balance sheet with $1.3 billion in cash. It certainly gives us the foundation to deploy that in a manner that will reward our investors in the near, mid and long term. We've got several levers to do that. Repurchases, as you mentioned, our regular recurring dividend, capability tuck-ins and then the possibility of a special. What Horacio and I have been signaling is that we do expect to add inorganic activity to our organic growth performance. What I'm pleased with is the pipeline of opportunities are ones that we are sourcing and cultivating as opposed to just responding to a banker's book. We look at lots of opportunities, many of which that have already taken place and take a pass or we've taken a pass due to our organic performance, but also our criteria, which is strategic alignment, integration and really our confidence that we wouldn't get distracted. And then on the financial end, looking at it in terms of will it accelerate our rate of growth as opposed to just add scale for scale's sake. And so going forward, we expect that we will be able to do deals that meet up with that criteria. Today, the pipeline is filled with small to midsize opportunities, which gives us confidence on that criteria. And I think equally important, our business leaders are very excited about the possibilities. So aside from the financial engineering, they really see the art of the possible in terms of rate of growth and integration. And certainly, as a CFO, that makes me very excited, too.

Great. Excellent. In terms of the kind of -- I don't know if there's any more you'd be willing to say in terms of potential end-market exposures where there's more in the pipeline right now? That will be the last one and then, I'll let you go.

Yes. I'm going to keep that close to the chest, but I will say the opportunities are consistent with capabilities that we have been growing, so cyber, system software development, engineering, science and data analytics. So those are the opportunity set. And as I say, there is pure capability plays as we're able to source and cultivate.

Excellent. Cool. Well, we're up on time here. So I'll let you guys go. But I really appreciate you being with us and for sharing your time and for sharing the insight.

Absolutely. And again, thank you, Seth, and JPMorgan for having us today.

Great. Okay. Thanks, guys.