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

Good afternoon, everyone. My name is Sheila Kahyaoglu with the Jefferies aerospace and defense equity research team. And thank you for joining our virtual Jefferies Industrials Conference. We have the Booz Allen team with us. So we have Rubun Dey, who's Investor Relations; and Lloyd Howell, who's CFO, EVP and Treasurer at Booz Allen. I'm going to hand it over to Rubun, actually, for a few remarks, and then we'll kick it off into questions. Rubun?

Sure. Thanks, Sheila. 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 with that, I'll pass it back to you, Sheila.

Great. So Lloyd, maybe to start, you just reported earnings on Friday. And taking a step back a bit, bigger picture before your next Investor Day coming up in October, you're coming off of a 3-year period where you beat forecast every quarter essentially with huge EPS growth. How are you thinking about the next 3 years and focus objectives going forward?

It's a great question, a timely question, but it's good to see you. And good afternoon, everyone, and we're happy to be at this year's conference. We are in the midst of putting together an update to our strategy and the underlying investment thesis. And I don't want to get too far ahead, but essentially, it's a growth story. It will continue to be a growth story. And what we're looking at is what's going to contribute to that growth. Certainly, there's an organic component to that. But we're looking at areas that we're terming super growth or hyper growth. And we're trying to determine what the contributions will be to the organic growth. And on top of that, what inorganic activity might we have that could be really compelling. It's still a bit too early to say what metric we're going to particularly hype, but it's a exciting thing -- it's a exciting thesis as it's coming together. It's got everyone internally really excited about the art of the possible. And we're trying to frame it in a way for our investors to digest and to also get excited.

Then we look forward to what you guys show us. In terms of growth in fiscal '21, you grew 5.3% and low single digits in fiscal Q1. So I think your guidance is 4% to 7% organic with a slower start in the first half and ramp in the second half. Can you talk about the drivers of the improvement as we head into the second half?

Sure. Well, on the demand side, it's got to be the continuation of our strong demand performance. In the first quarter, our backlog was up 16.5%. And our book-to-bill was 1.3 with 1.2 trailing 12 months. So all the demand signals remain strong, and we've got to continue to lean into that. As you may be aware, we're in the midst of a heavy procurement season. And our win rates are holding, and we're excited about the position that we have. The real governor, however, is our ability to bring on the talent to convert that backlog. It's been steadily improving from the third quarter last fiscal year. It's the #1 operational priority in our business. And Horacio and I have been pleased with the improvement that we're beginning to see. Started in the fourth quarter of last year, built up this year with a 3% quarter-over-quarter improvement and a year-over-year of 4.3%. So we want to build on that momentum. July and August are looking strong. And so bringing in the talent, getting them deployed is really going to be the governor of where we finish in that 4% to 7% range.

I'll ask a few more talent questions later. Actually, since we're on it, how do you think about hiring talent when they become revenue generators? And is there a difference between normal individual versus a classified individual?

So we're in the midst, and have been for some time, in a very competitive labor market. And we have a couple of levers that we've traditionally pulled and some newer things that we've done once folks are in the door. We get 30% of our candidate pool from employee referrals, and we've enhanced that program to continue to get that type of yield. At the same time, we get a number of candidates from the government itself, particularly in the defense market. So as folks are leaving active duty at the 5-, 10-, 15- and 20-year points, we want to make sure that they consider Booz Allen as their next employer. We feel we've got a bit of an advantage because they have typically familiarity with us on the programs that they were on as a client. And they want to continue with those programs, and they see us as a great destination to provide that support, albeit from the private sector. The balance of our candidate pool comes from competitors, folks who may be looking at a different work-life balance scenario if they're coming from the private sector. And so we certainly are increasing our outreach and communication to those candidates so that they consider Booz Allen. And then once folks are in the door, we've enhanced our development program. So it's one thing to get talent in this market, and it's equally a priority to retain that talent. So we've done a lot in that regard. We don't expect that the war for talent is going to abate anytime soon. These are very hard-to-find skills and greatly sought after by a variety of industries. So we're doing our best to continue to get our foot forward, our story forward. And we're beginning to see improvement in that regard.

In addition to headcount, one of the things that must give you visibility is bookings. Bookings -- book-to-bill has been trending above 1 at 1.3x end of the quarter. How do you correlate bookings to converting to revenues?

So bookings aren't necessarily the internal metric that our business leadership is focused on. We're more focused on growing the backlog, which we've been doing very well and then the conversion of that, which is dependent upon do we get the necessary talent in the door. The 3 components to the backlog: funded, unfunded and priced options. The conversion of funded is near 100% short of a cancellation or something of that nature. And then the combination of unfunded and priced options tends to convert 60% to 70% of the time. We carry a bench of talent, and those folks are typically the first we reach to, to deploy on new work or recompeted work. And then we're typically hiring ahead of demand to make sure that as the work comes in, we can quickly deploy the talent in that regard. So a little bit of, I'll call, science, but also a fair amount of art because we have to balance out what the high probability wins are and leaning into what, as I said previously, is a really tough job market.

And that's helpful color. And then now, I want to go into some of your business segments or units. I really wanted to ask about intelligence on the earnings call because I think that's somewhat interesting. It declined 3% last year, I believe 6% in the quarter. Can you tell us a little bit about what's going on with intel? Is it specific contracts? And how your strategy there has evolved over the last year?

Sure. So there are 3 accounts that make up our intelligence business. The one that's been consistently performing well is what we call national agencies. And so that account has seen mid- to high single-digit growth. And we've also been able to bring on the necessary cleared talent. Those agencies have been open, too, while people are awaiting clearances, getting them to support various programs. And so that's working well. The second is known as cyber. We support a variety of cyber-related programs. One, in particular, is very large. And the client is looking for, at the moment, ways to extend that support while they consider how they want to structure the recompete contract. So a little bit, if you will, a delay that began last fiscal year. But the momentum and their comfort and happiness with us has remained high. So we feel we're positioned well for that work. The third account has been the one that's been the most in transition. It's known as defense military intelligence. We have been trying to diminish our exposure to pure program management, staff augmentation work. And that has contributed to a decline in that business while, at the same time, positioning ourselves for more of the higher-end technical work that makes up the rest of that business. So as the DMI account improves, we're also expecting to see an overall improvement in our intelligence business. We're expecting this year to be a growth year. And we believe that we've bottomed out, if you will, and are on the path for a successful year. Clearances is always going to be an impediment or at least a sensitivity. But increasingly, in talking to our clients, we've been able to work together to find ways, while people are awaiting clearances, to still have productivity. And then once those clearances are approved, get them fully on board.

I just want to ask a follow-up if that's okay on this. Is it 1/3, 1/3, 1/3 national agencies, cyber and DMI? And within DMI, you said diminish exposure to program management and go higher technical work. Is that like a cognizant strategy? Or is that like -- are agencies just shifting the type of contracts? Can you maybe provide a bit more color?

Yes. It's not quite 1/3, 1/3, 1/3. We never disclosed down to the account level. We tend to move things around. So in one sense, it would be a bit misleading. But I will say that for that DMI account, that has been purposeful. I think we recognize that where the business was wasn't where we want it to be. And now was the time to make the changes. So it would start with making some leadership changes. That is well underway. And conversations with prospective or newer clients, that's also underway. We're beginning to see some wins come in, albeit small, that we think we can build from there. So go way back 8 years ago when we launched our Vision 2020 strategy. This was the direction that we wanted to move in. And this account is just on the path of doing that. So we're encouraged by the early results. We feel we're getting the necessary traction, and we expect that to contribute to our intelligence business having a growth year.

Super helpful color. Turning to commercial portfolio. I know it's small. It's about 5% of your business. You exited the Middle East business in fiscal '21. With the shift to U.S.-based cyber business, can you tell us how does your pipeline look? Are there opportunities there? What do you expect that business to do?

Sure. So our commercial business is now 2% of the overall portfolio. And you're correct. We did diminish our exposure to Saudi Arabia while, at the same time, build up our presence elsewhere in the Middle East. And that has contributed to the decline, if you will. And at the same time, we're also focusing on U.S.-based cyber businesses, and the demand signals there are very strong. So we've got a growing pipeline of opportunities, a variety of industries. The bad folks did not slow down at all as we've seen with some of the more notable intrusions that have occurred. And the challenge, similar to our federal business, is talent. So the recruitment and retention of the talent is what everyone is focused on. We've made some leadership changes, which has been helpful and brought some folks into that business. And we expect that, going forward, it to also have a growth year. And so a bit off to a slow start, but we're encouraged by the demand signals and the improvement that we expect to see on the people front.

We'll talk about all the positive stuff now, now that we've gotten the 2 negatives out of the way. You've historically talked about option value and moving over -- converting over a high percentage to wins. Is there any way to think about or size, low-code, 5G, AI, quantum, all these buzz words? And what sort of opportunities they mean for Booz?

Yes. We've learned a lot over the past 3 years with many of our option value initiatives. And I think with all the goodness there, it's also opened our eyes to what's on the horizon. And 5G and AI and quantum are just a few. It will also -- when we get to October, you'll see these areas also as a part of our emerging strategy. Difficult to size now just given where they are in the maturity curve. In the case of 5G, DoD has really been cultivating their approach and what is the art of the possible really through their research labs, which we've also been supporting. So as the services pick up 5G as programs of record, we hope to compete to support them in that regard. AI is a little bit farther along. We've won some notable early procurements in that space. We're working with our clients on those programs. And we expect that, that also, as time progresses, will become more and more prevalent. And we like our early positioning. As we think about the future, we see these and other areas really growing. We already see, in the case of low-code, increasing demand for that type of support, in fact, a large driver for why we were attracted to Liberty. They have a very strong presence, particularly in federal health as do we. And we thought the combination of the 2 made a lot of sense and would be great. And we expect there'll be additional deals and opportunities like that. And so for us, this is sort of the future, and it also has impacts on the type of talent that we're trying to bring to the firm. But definitely see these as growth areas, and we've already begun to see the beginnings of that.

Since you mentioned Liberty, I'll ask, what does it do for the organic profile of the business? How do you think about some of the near-term benefits? It's only -- I think it contributed $16 million with [ 15 ] days in the quarter. So how do you size how much Liberty contributes this year?

Yes. I'll point you back to -- I think it was the May 4 call that we had when we made the announcement. We're expecting $300 million in revenue annualized and $200 million in revenue synergies. And so from an organic standpoint, they've got about a $2 billion ceiling that we want to, obviously, begin to chip away at. And that will be in the form of bringing on the talent. At the time that we made the announcement, they were about 600 people. At the end of Q1, it's about 750 folks. So good improvement on the headcount front, and we just want to keep a focus on that while we continue to work together and integrate. The integration is going well, in some regards, even better than expected in terms of cultural alignment and thinking about the market and client receptivity. So that's how I would offer up how to frame sort of the financial contribution as well as how the integration is going.

That's great. And then turning to the defense portfolio a little bit. It was up nicely last year, up 9% and 4% in Q1. How do you think about what the market is growing, what the base market is growing and what you're growing?

Yes. So we have historically done very well in defense. We're off to another good start this fiscal year. It's really based upon our positioning with our current clients as well as opportunities that we're shaping. I mentioned a few of them earlier, AI being one of them, and holding well when it comes to our recompete and new work win rates. And so all of that on the demand side is going well. Recruiting is a challenge, and so bringing on the talent to convert that demand is also a priority of the defense team. But across the board, each account is off to a good start. We're improving on the headcount, and we expect defense to have another strong growth year.

And the civil business is also growing nicely. How long can we expect this to continue? And where are your maybe your largest agency exposures within civil?

Yes. This is a business that is near and dear to my heart in the sense that I used to run it before I became the CFO. Unlike defense and intel, it is more transactional. So smaller size opportunity, shorter in duration, but really neat work, cool work. And in the case of our federal health business, they're off to a strong start. And you add Liberty to that, I think it's going to have another good year. This large cyber program that was paused as we went through the last presidential election, leadership is being confirmed. We're having meetings with those leaders about their priorities. And so as the funding becomes more apparent, we're expecting that program to commence again. And the rest of the accounts, which we term in the civil business, are also doing good work. You've heard me mention Recreation.gov, which is a part of agriculture. That continues to do well as people are beginning to take vacations and book reservations. And so as we get to the end of the government fiscal year, we're expecting civil to have another strong year in that regard.

No, that's great. That's why I asked because I knew it was such a winner because you used to run it. In terms of profitability, I know you guys aren't throwing big parties this year, and that's why your margins are at 12%. So how do you kind of -- your outlook is about mid-10s for the year, implying a kind of a big step down into the second half. What were your considerations as you thought about that guide?

Sure. Last year was anything but normal. But when you look at our margin and the trend, we typically burn a little bit hotter in the second half, in large part because we're investing in our people in the form of the annual assessment season. We probably won't be at the level of celebrations over the holidays, but we tend to do a lot of team-building activities as well and then invest, quite frankly, into the new fiscal year. And so that will naturally bring the margin from Q1's 12% down to what we believe will be the mid-10s. A little bit of arithmetic. We've also this quarter benefited from low billable expenses. And so we would expect that over the course of the year, as we emerge from COVID, that billable expenses will also grow. So mid-10s is what we think where we're going to land. But starting out the year with 12% was a nice start.

Yes, that's great. And in terms of free cash flow, just to touch upon that as we're almost up with time, how do we think about conversion? Does it stay above this 100% mark? And any changes post Liberty or capital requirements?

Yes, that's the intent, that we do stay above 100%. We, as you know, have been historically a strong cash generator. And so we would expect that the things that we're doing will remain in place. But in terms of where the conversion will be, yes, staying above 100% is what we would expect.

And last question in terms of inorganic. How are you thinking about capital deployment from here as you prioritize dividends, more bolt-ons or strategic M&A and share repurchases?

Yes. So historically, we've tried to be a good steward of deployment for the benefit of our shareholders in the near, mid- and long term. M&A activity has picked up. But we're not ignoring our regular recurring dividend as well as share repurchases. So this quarter was a perfect example of that. We did about $52 million in our quarterly dividend, $111 million in repo plus the Liberty acquisition. So we have a disciplined and patient approach. M&A, we want to still see as a growth accelerator. We're not looking to do transformative transactions. Much of the things that are in our pipeline are small to midsize and across our portfolio. Liberty was just first out of the chute this fiscal year. But the pipeline is growing. We're excited about how it will contribute to our overall growth, but we're still holding fast on -- it has to be aligned to our strategy, and integration is paramount.

Great. Well, we look forward to what you have in store for us in October, Lloyd. Thank you so much for joining us.

Absolutely. Good to see you, and thank you very much.

Thanks, guys. This concludes our webcast.