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

Welcome back to Day 3 of Morgan Stanley's Virtual Laguna Conference. My name is Matt Sharpe, and I'm the firm's government services analyst. It's my pleasure to be hosting the team from Booz Allen, CFO, Lloyd Howell; as well as Head of IR, Rubun Dey. Now before we begin, I do need to read some disclosures. For important disclosures, please see the Morgan Stanley Research Disclosures website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, I believe, Rubun, you also have some disclosures before we kick things off here.

Yes. Thanks, Matt. So 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 think are useful for understanding our business. More information on our forward-looking statements and reconciliations of GAAP, non-GAAP are included in our SEC filings. So with that, back to you, Matt.

Fantastic. Thanks so much, and thank you both for joining us here today. It's always a pleasure to speak with the Booz team and get your insights. And every September, it's always a critical point in time for this space, quite frankly. We're approaching the end of the fiscal year for the government, and there's a lot of contract award flow and other things that start to gain traction. So given that context, I wanted to start the conversation off high level talking about your end markets here today. As I noted, this is sort of the high watermark for the year in terms of awards. If I look back over the last few years, Booz is usually in that 2 to 3x book-to-bill range for the quarter. So maybe Lloyd, you can kick us off here by talking a little bit about what you're seeing in your end markets? How healthy are they? Are you seeing stability or continued disruption given just the context of COVID-19 and other dynamics at play here?

Sure. Thank you, Matt, and thank you Morgan Stanley for hosting the conference. And it's a pleasure to be here. You're right, we're -- our Q2, it typically -- or does coincide with the end of the government's fiscal year. And we're in the midst of the heaviest part of the procurement season. What we have seen is healthy procurement activity across our portfolio, civil, defense and intel. That being said, it also varies by the size of the opportunity. So larger procurements are a bit more complex in terms of issuance, adjudication and typically a protest upon award. We expect that to continue. And what we experienced in our third quarter of last year were some programmatic shifts. We saw those come back to us for the end of our fourth quarter and the beginning of this fiscal year. But I think there is always a probability that, that will still be in effect. The government has told us that they intend to continue to issue RFPs and make awards, and they have largely held true to that. There are occasions where things are slipping, but it's hard to say it's a trend other than the unique circumstances around those individual procurements. We had guided to the year a gradual build from the first half to the second half. We expect that to indeed be the case, largely based upon the new administration getting in place, working through the budget and whatnot. What that has looked for us quantitatively, as we saw a strong Q4 book-to-bill, I believe, 1.4 and also a strong Q1 book-to-bill. So from a demand perspective, we're seeing strong demand signals and have seen our overall backlog continue to improve or increase. At the same time, what we told everyone is that we are really pressing hard on bringing in the talent. So with a snapback in productivity that we saw last Q3 for us, we really have prioritized that as our operational priority. And the team has been doing well and building that back up. So we saw improvement from Q4 to Q1, and we've seen strong signals on the supply side through the summer. So I would say it's gradual buildup. It's not necessarily at historic levels, but our win rates are holding. We are bringing on the people, and we think it's really a function assigned as we get on the other side of the pandemic where both the government and the sector will be operating or approaching operations pre-pandemic levels.

Yes. Maybe just thinking about the higher level function here. So that's the deal flow. That's what you're seeing from your end customers. But we've got a budget backdrop here to consider as well. Quick -- can you tell us about what you've seen out of D.C. thus far in terms of the budget, any hot spots, cold spots? And then what are the current views on a CR? Is there a potential for disruption as a result of that? Or is it just simply business as usual?

With every CR, it sort of plays out a little bit differently. What we're seeing is folks are working very hard to get a budget in place, particularly around areas that would be of impact, such as cybersecurity. And I think there is broad support politically for areas like that, infrastructure and so forth. Now whether our elected officials are able to close the deal before October, what or not, I think there are plenty of people who have opinions about that. But if there were -- if it were to result in a CR, the nature of the CR in terms of the continuation of programs that would happen, new work, however, would maybe be suspended or delayed a bit. And I think each contract is impacted differently depending upon how that sponsoring department or agency has sort of defined the nature of the dollars. And so we're working closely with our clients to obviously, work through a CR, whether it's short or lengthy. I think there's a debate as to what that would be. But we're not hearing signals about a shutdown or an impasse or anything like that. It's really -- let us sort of work through the particulars, get resolution and then get a budget in place. So the tone is encouraging. Our direct clients aren't throwing up a flag or a pause as these uncertainties kind of work out. At this point, Matt, I think on our client side, they're fairly sophisticated in dealing with these uncertainties. They prioritize the task orders that they want to commence or continue. And we're sticking close with them to make sure we don't have anything slip through the cracks. So long-winded answer, but yes, we're sensitive to the likelihood of a CR. We've prioritized the task orders that will carry on through that. And at the same time, are engaging with our clients about the new work opportunities that they would like to do. And I think that's important to note as well. We've seen no clients hesitate. They want to meet. They want white papers. They want to engage in terms of what they need to do, particularly on the technical solution end of the market. And that's the space that we've been trying to prosecute for quite some time.

Fantastic. It's funny, I just have to remind people there's a playbook here. We're almost always in a CR, and the subject invariably comes up. And it's just one that -- that's important to be mindful of and discuss and give that context about, hey, clients don't just simply close the door and walk away. It's something they have seen and done before.

Yes, I would say, I mean, you raised -- and I don't think I answered it directly. You mentioned COVID in terms of possible impact on the demand side. And it's hard to quantify the impact of COVID on the demand. We haven't seen things pulled forward or delayed solely because of COVID. But we have seen larger awards just ramp up slower. I don't know if that's because we're all in sort of this virtual, remote state outside of Intel. But we have seen -- and it's been great. We've won great jobs. But they've been ramping up slower than expected. And it's not a problem. It's just sort of the environment that we're kind of all in is what we're attributing it to. So again, verbally qualitatively, strong signals, but slower than what we had typically seen in the past.

Got it. Got it. Now Lloyd, you mentioned -- when we were talking about sort of award pace or activity, revenue and expectation for an acceleration into the back half of the year. Maybe you can just unpack that for us a little bit here and tell us sort of what's underlying that acceleration, get us comfortable with whether or not you have line of sight on that acceleration and what to consider as we think about the probability of success there?

Sure. So one part of it is sort of demand; another part, supply; and the third part is sort of the comparable analysis. So on the demand side, we're expecting procurement activity to continue to grow into the second half. And that's a bit different than in the past where as you pointed out at the beginning, September -- end of September sort of completes the government fiscal year, and then you reset the clock. Because it's our sense that in the transition, things are still ramping up in terms of leadership getting in place, budget getting resolved, we expect to see procurement activity extend into the second half in our portfolio. And we've been cultivating, positioning, shaping those opportunities. So that's on the demand side, one reason why the second half we expect to be stronger than the first half. On the supply side, as Horacio and I've mentioned, it's a gradual buildup to the volume of onboarding the talent, and that's underway. Start to see it in Q4, starting to build up momentum in Q1. And we've seen a healthy addition to our workforce through the summer. And we will continue to keep our foot on that accelerator as we work through the year. So the combination of the demand plus the supply, it will contribute to a stronger second half. And then on a comparable basis, if you look at a metric like billable expenses, which has been low because there hasn't been business travel, there's been sort of a decrease in subcontractor contributions. We would expect that to pick up as well as we kind of emerge on the other side of the pandemic. And when you look on a comparable basis, we would expect our second half to be stronger than the second half of last year. So those factors is how I would unpack it and what would contribute to the stronger performance in the second half than in the first half.

Fantastic. Let's just stay on supply here for a moment. Hiring is always a gating factor to growth here in this government services space. You noted that you've continued to make additions throughout the summer. What can you tell us about what you're seeing in the hiring market? And what has Booz done to sort of bolster or accelerate the rate of hiring to support that back half acceleration?

Sure. So even pre pandemic, from a talent, labor market perspective, we're competing for the same talent that Morgan Stanley is that the high-tech companies are, start-ups. And so folks with cybersecurity, data analytics, system software development, engineering and science are in great demand and, basically, have upwards to 5-plus offers at any point in time about what and where they might take their career. And so that's the space we want to be in. That's the type of talent we want to attract to the firm. And we've got a couple of levers that we pull in order to compete. The first being that 30% of our candidate pool comes from our existing workforce in terms of referrals. So we've beefed up the incentives to refer a friend or a relative, and we've seen the volume in that particular bucket start to increase. Number two, we get a fair amount of our talent from the government itself. So for example, in DoD, as individuals depart at the 5-, 10-, 15-, 20-year mark, what we have found is they have familiarity with Booz Allen. They want to continue to support the mission or the program that they were doing when they were in the government, but they want to do it from the private sector. And so we're a great next employer for them. So we've improved our outreach and awareness with that community, albeit virtual. And we're seeing that also result in a higher volume of candidates. I'd say the third bucket is a combination of folks from competing companies or people from the private sector are looking for a different work-life balance or geography. And so we're seeing that volume pick up as well. So we've got lots of levers that we're pulling. But that's just on the intake. On the retention side, we've also beefed up our development, training and rotation program. So it's a multi-front war you fight. You've got to bring in folks and then you've got to retain them. And so we've put all those different initiatives, commenced them and we're monitoring, tracking them. And I think we survey our folks pretty regular, so we have a sense of what they like, what they don't like, which is particularly important when we're dealing with vaccines, return to work, things of that sort. So we've got healthy communication with our people, and we're beginning to see that sort of result in a way that I think is going to be encouraging for everyone.

Great. Maybe we just pivot here now -- away from sort of hiring top line end markets to another important piece of the Booz Allen story right now, which is M&A. You guys are just getting off the heels of your largest acquisition, at least since you guys went public. That deal being Liberty IT Solutions, obviously. What can you tell us about the transaction in terms of post-close learning? Anything that caught you by surprise? How are you thinking about the synergy setup? And what can you give us in terms of progress towards integration at this juncture?

Sure. We're very excited about Liberty and probably even more excited on the other side of the actual transaction. We -- to set some context, we see M&A as really a growth accelerator, not purely just a scale play. And we're looking to accelerate growth in key capability areas that we either already invested in, have underway, but with an addition of a company and really sort of give a step function change in terms of breadth of capability, depth of capability and then market impact. So in the case of Liberty, we already have a very strong Federal health business. And the demand signals in that market were indicating to us that the clients were looking for, in this case, low-code, no-code development as opposed to waterfall or even Agile. So it's sort of the next thing beyond that. And we were familiar with Liberty having competed against them, teamed with them and felt that they would be a great partner to Booz Allen to prosecute this market and future markets. So we approached them. They were in agreement. We entered into exclusive negotiation, then we consummated that deal in June. Along the way, we set up an integration team, led by one of our senior partners and, basically from technology, to people, to culture, put in place an integration plan that we have been very disciplined in and been working our way through and have seen no surprises. In fact, we see more upside potential. At the time of disclosing the acquisition, I think I said we see $200 million in terms of revenue synergies. We think that is very much still valid. You'll recall that Liberty was successful in winning work and essentially was looking at a $2 billion ceiling in terms of opportunities. And so chipping away at that, bringing on the talent, continuing to work together in the market is all sort of underway and isn't really indicating any surprises. At the same time, because of their culture and our culture being very close, we're increasingly having joint meetings. It's increasingly hard to distinguish whose former Liberty or Booz Allen. We've got some of our folks down in Melbourne, and their leadership has been participating in meetings with our leadership. So all of that is moving in the right direction. And so really, we're pivoting to how can we accelerate what we thought the case was going to be. We're getting great market receptivity by our Federal health clients. So all of that is going in the right direction. And to your previous line of questioning around people, they're continuing to recruit and onboard talent, which is great to see. So we've already seen growth in that regard as it pertains to Liberty. I mean I think this, Matt, is like probably a great case study for us of the type of deals we're looking to do going forward. Ones that we cultivate; ones there -- there's some awareness; there's a good integration plan; cultures are well aligned; and the financials are accretive. And those are the type of deals we're looking at. What we have in our pipeline are small to midsize. And I would expect that they would follow a similar sort of path in terms of cultivation shaping. And hopefully, we would prevail in any sort of auction should that be the case. So that's what we're doing. And again, really focused on accelerating growth, not scale and really tie to technical areas that we're looking to deepen or to broaden.

And just a follow-up to that. Should we think about the deal as being motivated by the capability? Or should we look at this and say, there's an obvious case to broad it into fed, civ and grow that portion of the business given the political landscape these days?

Yes. I would say capability first. There was understandably questions as to, hey, is this deal some sort of commentary on Booz Allen's outlook for the federal market? The short answer is no. This was just the first that -- from a timing standpoint, that reached the point that it did. But we've got opportunities that are tied to defense, intel; still sticking to capability-first type of plays; ones that are geographic in nature where we see a client or a set of clients that could be best supported from a particular geography. So we're looking at everything. But I'd say it starts with an eye on what capabilities are we looking to broaden, deepen, strengthen, accelerate? And then what's the market relevance in terms of -- and the potential, quite frankly, to get it spread across the rest of the portfolio.

Got it. Got it. Why don't we just real quick jump over to a recent, very recent deal you just did, the Tracepoint deal. It wasn't long ago that you guys made the equity investment in the company. And so to see you guys exercise an option this quickly certainly caught my attention. Maybe you could just tell us real quickly, what you learned over that short period of time? Why you exercised the option and what that company brings to the table for you?

Sure. So we, in our commercial business, had an incident response team that was growing and getting good demand signals. We partnered or invested in Tracepoint largely to deepen that capability with a belief that incident response was going to continue to be in demand, not the least of which our -- what adversaries are doing in the commercial market and unique relationship that Tracepoint had with intermediaries, such as insurance brokers that provided the volume of transaction. So with that investment, what we saw was it exceeded sort of our expectations and the projections we were looking at. And with the potential to have them fully on board was very attractive to us. So really capitalizing on the demand signals that continue to grow and strengthening the bench or the capability set was very attractive. And not the least of which is of a strong management team that they have. And so broadening and deepening our management team, we saw as also being reasons to do it. So that's sort of the backdrop. And then financially, we felt that it was definitely going to meet or exceed our expectations, and it was doing that. And so we pulled the trigger.

Got it. Fantastic. Let's maybe jump back to COVID-19 a little bit here. I know we touched on this throughout our conversation, but I just want to put a finer point on it and discuss a very specific dynamic going forward. And that's any change in economics to the business. We've been working our way through this for 18-or-so months now. And you guys have obviously adapted, successfully adapted to the environment. We've had moments where we thought, hey, it's fading away, the pandemic that is, and we're getting into a more normal and it resurges and so on. At some point, with respect to AOPs, LRSPs, et cetera, you're going to start baking in, all right, well, this stays, and this might eventually go away when we enter the new normal. What can you tell us about what might stick around? And how might that change the economics of the business, either from a profitability standpoint or cash generation standpoint or the balance of capital deployment or otherwise?

Right. So let me try to unpack that, and I'll do it based on demand, supply and then pick up some of the other areas. On the demand side, as we get on the other side of the pandemic as vaccines roll out and boosters and whatever else is on the horizon, we would expect business travel to pick up. That financially looks like billable expenses getting stronger. And though it's largely empty calories for us, it arithmetically contributes to gross revenue, as everyone knows. So that would start to swing to the positive as opposed to where it's been over the past 18 months. So we would expect revenue to sort of normalize back to pre-pandemic levels and billable expenses really sort of driving that. At the same time, a lot of our business development occurs in sort of face-to-face meetings, conferences, you name it. And as those situations increase, we would also expect the overall volume of opportunities to increase, most notably in new work. I think in the sort of recompete dimension, folks know us, they've known us, they know our people. But when you're trying to meet and cultivate a relationship with a new client, having that face-to-face interaction helps. And so we would expect that to contribute as well on the demand side. On the supply side, I think we're already experiencing a normalization in terms of productivity. Folks have started to take PTO variants, obviously, throw a wrench in vacation plans. But by and large -- and we were encouraging our people to take some time. They started to do that. What we've seen is available labor come down. We've also seen utilization maintain. It's come down a bit, but it's maintained. And what's really encouraging is we have not seen a spike in attrition. So I think the attrition tsunami and PTO, payback, PTO dynamics haven't really occurred. We're keeping close tabs on it. But I think we're already in the midst of a more normalized productivity level. It's just continuing to increase on the demand side, will be a governor for the way our year kind of plays out. And so when you look at margin, you'll have billable expenses kind of going up, put some pressure on margins, whereas today, it actually has contributed to a healthy margin profile. But again, as we've guided to this year, we've tried to take that into account. And so we feel we're accommodating that. When it comes to cash flow, we put in place a new system, April 1. It is working, it is accurate. Any sort of delays are really human in nature. And so we're expecting the cash generation to be strong. We're already seeing that happening in Q2. We just need to be mindful and pay attention to it. But very smooth transition with our clients in terms of invoicing. So we're not expecting any hiccups there. And then on capital deployment, I think our strategy that we've had in place in terms of looking at market signals, pulling the right levers. We've talked about M&A. I really would expect that to continue and don't really see COVID as necessarily having an impact financially on what we're doing. Obviously, doing an M&A transaction in the midst of the pandemic is challenging just in terms of logistics, but we worked our way through that with Liberty. So I think we've got the muscle memory around that. So again, there are the other intangibles in terms of, will meetings always be in-person? Probably not. Critical meanings, for sure. So I think the travel, the unallowable expenses that we saw pre-pandemic, I would expect to be lower. And we'll be more precise on what is administrative and critical, what can be done by Zoom or WebEx. And I think throughout our business, everyone is sorting through that.

That's a great insight, Lloyd. I appreciate that. Maybe just one last one here for you, a quick one. I know we're up against our stops time-wise. But if you had one additional dollar of IRAD or one additional dollar of funding for your M&A program, what technology does it go against?

Well, if you're asking me as just one of several voices around the table, it is hard to ignore the growing demand signals around artificial intelligence. And then what that will bridge into in terms of 5G, which some of our clients have already got some, what I'll call, pilot programs underway which we are supporting. And the reason I would sort of obligate the dollar in that direction is the addressable market and the things that would be included. Sky is a limit from where I sit today in terms of program impact, mission -- new missions it would create. So we're coming up on our next Investor Day in early October. And for those of you who are out there who are planning on attending, we'll have some additional commentary about how we see the markets and the areas kind of playing out over the next 3 or 4 years.

We're certainly looking forward to that, and we really enjoyed our time here today with you guys. Thank you so much for joining us once again, and hopefully, we'll see you next year in person. So with that, it was a pleasure, as always, gentlemen.

Thank you, Matt, and thank you Morgan Stanley.