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

Yes. Good morning, everyone, and thank you for joining us on this next session. It's my pleasure to have with us, Lloyd Howell, CFO and Treasurer of Booz Allen Hamilton; and Rubun Dey, Head of Investor Relations. Before I kick it off, let me hand it off to Rubun.

Thanks, Ron. 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, let me pass it back to you, Ron.

Great. And Lloyd and Rubun, thank you for joining us. I'm on the line here with my colleague, Mariana Perez Mora. She does a lot of the work on the team on the services company. So Mariana and I will be having a conversation with Lloyd and Rubun.

So let me just kick it off with a couple of questions. So Lloyd, the recent budget from the Biden administration shows that flattening out after we've had several years of strong growth. How's Booz positioned to continue to grow in a more pressured budget environment?

Sure. First of all, good morning, everyone, and thank you, Ron and Mariana, for inviting us to participate in today's conference. I think it's fair to say prior to the pandemic, there was a view that whether it was a continuation of the Trump administration or a new administration, there would be a flattening to the budget. And we largely would have subscribed to that after several years of growth. From our perspective, we are positioned and have been shaping opportunities which we believe are still going to be in high demand by all of the federal agencies, but in particular, defense, namely those that involve higher-end technical support in the areas of cybersecurity, AI, digitization for the soldier. These are programs that we've been working with and looking to support many of our clients. So even in a flattening budget, we would expect those programs to still get a fair amount of resourcing. And that, in turn, I think helps our financial performance.

Got it. And a question we get and I think it would be interesting to hear your take on it, what makes Booz different than some of the other services contractors?

I get this question from time to time. And I think it starts with our heritage as a general management consulting firm. We have long looked through relationships to support clients on their most pressing critical needs not just to capture work for work's sake. And I think that, in turn, is the foundation that has built long-standing relationships going back 75, 80 years, increasingly working toward their most critical mission requirements, which, in turn, has led to supporting these clients and their most I guess challenging and opportunistic areas. And I think many of our competimates, we all say the same words, but we tend to try to be on speed dial with our clients even if there is an imminent RFP about to be released or they're just struggling with a business challenge that we're able to support them with.

Got it. Got it. And one of the other questions that comes up frequently is, if you look at the last budget downturn, some of the defense services providers were pretty heavily impacted. What's different now than in the previous downturn?

Yes. I think ourselves included, we had been supporting most of our clients in a program management, see the type of environment. And it really was, albeit 10 years since 9/11, sort of a tale of we'll do whatever it takes to address adversaries, terrorism. And we were sort of winning the war, so to speak, or at least mitigating the threat and, in turn, the Biden administration had put an emphasis on cost containment and reduction, which then led to LPTA-based awards. And I think it caught a lot of folks short because we had all been working on value -- best value type of award decisions coupled with many of the support areas were increasing, getting commoditized, plus small business set asides and an emphasis on that. And that, initially, was the catalyst that launched our Vision 2020 strategy. I think what's different today is now we find ourselves supporting areas that the government themselves say, "Hey, we really need the support even in a constrained budget environment." And their award behavior is still consistent with that. So we're not seeing some of the tea leaves starting to change and say, "Hey, look, we're going to revert back to the way it was 10 years ago." They are still showing and saying things that they still need support in these areas.

Yes. Yes. That's -- yes, it's fascinating. When you think about Booz's positioning, how is the company positioned to benefit from certain DoD priorities, for example, on C4ISR, cyber and other, what I would say, cutting-edge technologies?

Yes. We feel that our positioning is very strong in large part because we've also been the recipient of some of the initial awards in these areas. Certainly, AI, cyber are already integral solutions that we've offered in our firm. And in the case of AI, we've had awards around programs such as eMAPS and the JAIC, they've both been single award, highly sought-after contracts. And we see that as sort of a first-mover advantage. It's not that other competitors aren't also offering these, but the fact that we were early award recipients, that helps. And in the area of cyber, we also have been awarded large programs in the civilian federal space, of note, DHS and VA. And 5G, which is still emerging in early days, we're doing today almost $50 million in work across defense and national security. So we feel our positioning is strong. And it's given us a bit of a runway to see really what the requirements are, how they might be addressed by these technologies, and that's also helping us shape future work.

Could you give us a feel for -- one of the things you didn't mention is the work that Booz is doing on immersive technologies, things like virtual reality, AI. Maybe some color on the scope and scale of that work.

Yes. Given my -- what I just said, it's about -- today, we're doing about $50 million as it relates to 5G. AI, it's really difficult to size it given that the integral nature of the work. So not only it may have a banner of AI, but includes cyber, change management, system software development as well. If we take a step back and maybe do a bit of a trend analysis in the answer, 7, 8 years ago, about 30% of our portfolio was in these areas. Today, our estimate is 50% to 60% is providing support in these areas to our federal clients with a tremendous amount of upside and addressability as we see it not only in defense, but intel as well as civilian. So that, from a sizing perspective, I think is a good approximation. Similarly, when you look at our workforce, folks that have these capabilities have also transformed and I'd say it's comparable to that 50% to 60% range that I just gave you.

Got you. Got you. Got you. Just maybe as a natural follow-on to that, what other opportunities is Booz pursuing related to national defense?

There are many underway and not to give any competitive secrets away on the call, but it comes in 2 buckets. One is certainly recompete opportunities where we're already providing the support to existing clients. We have a pretty good win rate when it comes to that, around 90%. And on the new work side, it stems from the current work we're supporting, but additional DoD or intel clients also wanting to get similar support. And so that new work bucket, we typically win around 60% of. That extends also to the civilian agencies, which I would say are a little bit behind defense and intel largely for how they've been resourced over the years, but definitely are in conversations with other federal colleagues, learning how it may be applicable to their missions and their requirements. And we're in the midst of that. Certainly, with the new administration coming on board and getting confirmations done, they're beginning to also move out with requesting support in these areas. And we expect in the current procurement season to compete, to support them in that regard.

Got it. Got it. What next-gen technologies are the Booz team most excited about? What next-gen technologies is the company interested in investing in?

Yes. I mentioned a couple of them already. In the area of 5G, it's still early in the journey. But in particular in DoD, really through many of their research labs, they have initiated a variety of pilots over the next couple of years, which we're supporting. So as the services are also involved in eventual get to programs of record, we would look to support -- shape and support them in that regard. So we see a lot of upside potential in that regard. Similarly, with AI, we have been making investments in that in terms of talent, intellectual capital and so on. And we're beginning to see that more and more DoD and intelligence clients are also requesting that type of support both at the service level -- service-wide level as well as specific programs. And I guess back to one of your first questions, a reason why we've been effective is we've been supporting these clients going back to the 2000s where soldiers would be in front of banks and banks of screens trying to discern a millimeter movement of an object and what that might mean, feeding that information up to their superior to make an operational decision. Seeing that, we made a variety of recommendations, which, then, 10, 15 years later is now termed AI in terms of the technical solutions to that. And that's just a small example of how we have been positioning ourselves to support current as well as future clients. Cyber has been out there a while, the least of which is with all the recent intrusion, SolarWinds probably of note and its impact on many of the federal agencies has really been a catalyst to speed up efforts that were already underway. And given our experience on the defense and intelligence community, we're able to support them in that regard. And then lastly, with many of our option value, initiatives in directed energy, district defense, which is providing security around mobile devices, we've seen a pickup in that, in particular, not the least of which is since everyone's been virtual, how to continue to conduct business and still do it in a secure way.

Got it. Got it. And maybe changing gears just a little bit to the financials. Organic growth slowed down to sort of mid-single digits from high single, low doubles in 2020. Could you give us some color on the main drivers and discuss the main trends that will determine kind of growth over the midterm from here?

Sure. So on the demand side, even in the midst of COVID, we still saw strong demand signals. If you look at the growth rate in our backlog, finishing the year '21 at $24 billion, finishing our fourth quarter with 1.38x in book-to-bill, the demand is there. The governor on growth for us is our ability to bring on the talent to convert that demand. Last fiscal year was anything but normal. We go into each fiscal year targeting mid-single digits in terms of headcount growth. And in the first half of the year, we were at a run rate of 3%. And we were good with that given the high productivity that our workforce was producing at that time, low attrition, lowest ever, huge available labor, low PTO. And so frankly, Ron, recruitment was not sort of top priority. It was sort of welfare, how do I take care of my dependents and no one is taking vacation. That snapped back to a more normalized productivity level in Q3. And I think we exited Q3 at a little over 2% in terms of headcount growth and finished the year at 2%. So the fall off at the top line is really attributable to not only the lack of headcount growth, but also a little bit of a drop in billable expenses and some shifting in programs, which we talked about in our earnings call. We're beginning to see improvement with any of the program shifts as indicated by our book-to-bill. We also had slight improvement in our fourth quarter with headcount growth, which we're looking to capitalize on over the next couple of quarters. But to take a step back to the top, it's really our ability to bring on the talent to convert the backlog that's going to govern where we end up within our guidance range.

Got it. Got it. And has there been much disruption in the award task order environment due to the change in administration and COVID? And if so, can you kind of maybe discuss those impacts a little bit?

Sure. I'd say I've been in the business now going into my 33rd year. We've been through lots of transitions during that time. I think what was unique in this one were a couple of things. One was you always expect the political appointees to depart either just prior or just after any transition. And that did indeed occur. What also occurred is that the senior civil servant executive levels, we saw also departures earlier than expected, retirements or just retirement in and of itself. And why that's critical is that layer really directs and manages many of the programs we support. So they're really in charge of the issuance of the RFPs, the award decisions. If additional funding is required, they make the request. And so with the absence of leadership there, it was difficult for things to proceed as they always do. At the same time, we and I think the contractor base were told, "Hey, look, we're not canceling these programs. They still are needed, but they're going to shift to the right until the new leadership is in place." And we began to see that in our fourth quarter. So what we expect is the momentum to continue to build. For Booz Allen, that means a bit of an inverse where we'll see slower growth in our first half and a pickup in our second half. And it's really a function, Ron, of leadership getting in place, budget decisions being finalized and the trickle down of those budgets into these programs. But we like our positioning certainly on the programs that were paused or shifted, our win rates are holding. And as I said, it's really a function of let's get the talent engine going so that we can bring on the folks to convert our backlog.

Got it. And how does the pipeline look into 2021?

Talent or business?

Both.

For both. On the business side, it's looking good. The government has stayed true to what they told us, and that's across our portfolio. So RFPs are being released. And it's -- the volume is I think typical of what we would see going into any procurement season. And at the same time, our larger procurements that were also experiencing a bit of a disruption, there's activity there as well in terms of soliciting from the contractor base input and then draft RFP, followed by a formal RFP. And on the talent side, we are not -- full stop sourcing and building up to the front end of the funnel candidates that are in the skill sets that we need. It's still not at a volume that we want, but it's certainly building. And we expect over the course of each quarter to see some improvement on the number of folks that we are able to bring on board. So our guidance, we're standing by it. I think it's an accurate reflection of what we expect in the year. But the signals from the market both the demand side and the supply side are improving.

Got it. Got it. So I'll probably ask you one more and then hand it over to Mariana. When you think about sales to the intelligence community, it seems like they've lagged a bit over the last several years. Why is that the case? And then how should we think that evolving over the next several years?

Sure. For us, there are 3, let's call it, accounts that make up our intel business: national agencies, cyber and military -- defense and military intelligence. And each of those accounts are at a different rate of improvement. And lead of the pack, our national agencies business has been doing well, high single-digit growth, bringing on talent, but it's not the largest component of the portfolio. Next, followed by cyber, which, really, the headwind there has been a slowdown in release of RFPs. The government itself is taking time to think about future RFP releases and their strategy around that. We're doing great work. Clients are very pleased with the work we're doing. But the growth indicators or the growth contributors haven't really come about yet, and we expect that to occur this fiscal year. And the laggard has been our defense military intelligence work. We have been supporting those agencies really from a staff augmentation base, which was subject to LPTA and being commoditized. Our win rates weren't where they wanted them to be. But even with that, we weren't shaping the type of work that we want to do going forward. So with the combination of new talent, new leadership, we're very pleased with the changes and the progress that we see underway. And we expect improvement this fiscal year but in the midterm, even greater improvement. So the team is off and running, and they're looking at strengthening their organic performance and also looking at more inorganic opportunities than they ever have. So the combination of those, Ron, we expect the improvement in our intel business going forward.

Got it. So let me hand it off to Mariana for the next set of questions.

Sure.

Perfect. So next one from me is on the kind of like civilian agencies. They now represent about like 30% of your revenues. How should we think about customer technologies driving growth in that arena? And how large that can be of Booz Allen portfolio?

Yes. It's interesting. As we went into COVID, the pandemic, I don't think anyone was clear as to how things were going to play out. And what we experienced was a near seamless transition to a virtual state across the portfolio with a couple of exceptions. The support and delivery to our clients was working. As I mentioned in Ron's previous question, we had high productivity, the government's payment offices were working, invoices were being paid on time. And so COVID from that perspective wasn't a significant -- it didn't represent a significant impact from a business perspective. One of the exceptions was the intelligence market. As you can expect, a lot of the programs there are highly classified, very sensitive in nature. And what that community want to is a shift work arrangement. And at the same time, because of the CARES Act, the contracting base could not invoice with -- for a fee. And I would say we reached a good medium. The headwind around the inability to bill for a fee was not as great as we had originally expected. And as we emerge from the virtual world, we would expect a similar performance to continue and things to improve. So I think where we are now is many of our clients as well as the contractor base are in conversations to determine at what rate will things go back to normal and how fast. Many of the military clients are sort of building up in a percentage of 25%, 50%, 75% reemergence, and we're working side by side with them. Many of the civilian agencies are having the debate. And I think the dust is yet to settle. And defense is somewhere -- I mean intel is somewhere in between or has already pivoted back to being as it was prepandemic. The award pipeline, as I mentioned to Ron, I think we're expecting it to be strong. And given our win rates, we expect to have another solid year.

Next one is there has been an increased focus on cybersecurity after SolarWinds breach, how should Booz Allen benefit from that?

Yes. You never want to say you're going to benefit from a hack or an intrusion, but I think what that definitely highlighted is there's work to be done on strengthening and building up cyber programs across the federal government. Defense and intel have long been doing that. And I believe it's fair to say they were impacted to a lesser degree. But many of the civilian agencies were exposed, and it wasn't for a lack of effort already underway. It just wasn't at the level to combat an adversary like we saw with SolarWinds. So it's got everyone's attention. Everyone is definitely motivated. We hear that certainly in the media coming from the administration. We also witnessed some of the countermeasures and techniques that law enforcement has put in place as it related to the pipeline incident. And we, as a contractor in this space, are looking to continue to support our clients. We're seeing a building in demand for this level of support in cyber areas. And so we're optimistic that we'll be successful to win that work.

Interesting. And next one is on competitive dynamics. There is an increased interest from nontraditional competitors to get into the market of like U.S. government cyber security, U.S. government data analytics. How does it change the competitive dynamics for Booz Allen?

Yes. I think it varies by market segment for us. In the intelligence and defense markets, we still see at a prime position folks in our sector, your SAIC, your Leidos, CACI, among others. But the teaming composition is beginning to change. So in cases where it's cloud migration in nature, a TV partner would be a Google or a Microsoft or an AWS. And we too team with those vendors. This dynamic looks pretty different in the federal civilian space where the barriers are much lower. You don't have the same level of classification, citizenship requirements. And so there, we definitely see a vast -- a broader spectrum of competitors. But it's -- for us, it's a function of what agencies and departments are you really focused on. We've narrowed it over the years. And so for HHS, Treasury, DHS, we feel we've got a pretty good competitive positioning. We understand how they -- what their expectations are around pricing, level of support, talent. And so we're going to continue to shape and compete as strongly as we can in those markets. But we take everyone seriously. We're watching the dynamics. I think a lot of the competitive behavior is going to be shaped with how procurement officials are thinking about procurements, what flexibility or not they're willing to impose. And so we're staying close to that community as well.

Perfect. And then you mentioned talent in a lot of your answers. Talent is really important for Booz Allen. What makes Booz Allen different? What's Booz Allen's strategy to attract this talent and to retain that talent?

Sure. It starts with our culture. I think the pandemic was a great example of where our culture came into play. At no point at the beginning where we're thinking about laying off anyone. We were thinking about how to retain and help and support our folks. And we put in place the $100 million resilience program to do that. And I think we've been the recipient of that type of commitment. More specifically, one of the levers we have is we get 30% of our candidates from employee referrals. And so we bolstered that program and encouraged our existing workforce to refer friends and family and colleagues, and we're seeing a pickup in that activity. Number two is we get a number of our candidates from the government itself, particularly DoD. And so as individuals leave at the 5-, 10-, 15- and 20-year mark, they still want to support these programs, but they want to do it from a private sector employer. And so they know Booz Allen. We're making sure we've increased our communication with those individuals. And barring any sort of conflicts of interest, we're able to bring on those folks as well. And then thirdly, every year, we make a number of contingent offers based upon what we see as a probability to win. We're reviewing that inventory. And where we are feeling pretty optimistic, we're turning on those contingent offers to be offers themselves. And so we expect a combination of those 3 activities plus just sort of maybe a pickup in folks being open to moving and changing employers that we'll see improvement in our recruiting activities.

Perfect. Next one is on capital deployment. Would you mind describing what Booz Allen's strategy on that end?

Yes. It starts with our balance sheet. We have a very strong balance sheet and the ability to generate a lot of cash. So I think we finished the year a little over $900 million in cash. And so that dovetails into what our capital deployment strategy is. We've got a couple of levers, share repurchases, our dividend and capability tuck-ins. We have been communicating that we do want to add to our organic performance with some acquisitions and then recently announced the acquisition of Liberty IT Solutions, which is in our federal health care space. So we're patient. We're disciplined. We look at market conditions to figure out which levers make the most sense. And we've been able to do that, and we expect to do that going forward.

So you mentioned Liberty. Would you mind describing what capabilities and end market that acquisition brought to the table?

Sure. They are principally in the federal health care space as are we. Our existing business is a little over $1 billion. And we became aware of Liberty competing against them and teaming with them over the years. Looking at market signals, particularly demand for low-code, no-code development, we were interested in accelerating our existing efforts in that space. And Liberty was near-perfect match in terms of cultural fit, strategic alignment and the financials were accretive and attractive. So we approached Liberty. We engaged in a dialogue with them. It went exclusive fairly early on. We were able to consummate a deal, which we announced in the early part of May and expect to close in the first quarter. So that is an example of the type of acquisitions we're looking at. At the same time, we've been building out our pipeline of potential deals of small and medium size across the portfolio. I used to get the question is Liberty some sort of statement about the defense or intel market? It's not. It was just the first transaction to kind of happen in our pipeline. But we have other opportunities that would certainly address defense and intel that we're optimistic about.

And how should we think about those opportunities in terms of technologies and markets, what Booz Allen is attracted to?

I'd say in terms of prioritization, we're looking at acquisitions that will accelerate our strategic direction. And that direction has really been focused on the capabilities of cyber, digital, system software development. And if such a company happens to be in defense, intel or civil, that's a second consideration. We're looking at how do we accelerate efforts that are already underway. So that's sort of the first cut, capability; second cut, market and/or geography; and then obviously, cultural integration, alignment and fit. So those are sort of the hurdles, if you will, that we go over before we ultimately make an offer or put an offer on the table.

Perfect. Interesting. So I think we are past the 35 minutes. Thank you very, very much for joining us. And I'll pass the word to you if you have any like closing remarks.

No. It's always a pleasure to see you and Ron, and thank you very much in Bank of America, and we are looking forward to having another strong fiscal year.

Thank you very much.