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

Okay. Good afternoon, everyone, and thank you for joining us today. My name is Peter Arment. I'm the Senior Aerospace and Defense Analyst here at Baird. And we're very pleased to have with us management team of Booz Allen Hamilton. This is a fireside chat, so we would encourage anyone who wanted to ask a question via the web portal, and we'll do our best to get that in, if time permits. And from Booz Allen, we have Lloyd Howell, who's the Chief Financial Officer, Treasurer and Executive Vice President; and Laura Adams, who is the Chief Accounting Officer and also, as Lloyd said, doing double duty with -- also hosting Investor Relations. So thank you to both for attending, and I'm going to pass it over to Laura, so we can get the forward-looking statement out of the way. Laura? I think you're on mute, Laura.

Great. Thanks, Peter, and thanks for hosting Booz Allen at your industrials conference. We are excited to be here. Before we get started, please keep in mind that some of the items we will discuss today relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from forecasted results. Those risks and uncertainties include, among other things, general economic conditions, the availability of government funding for our company services and other factors discussed in our filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the fiscal year ended March 31, 2021, can be found on the SEC's website at www.sec.gov. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing cautionary statements. All such statements speak only as of the date made, and except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Back to you.

Okay. Terrific. Thank you, Laura. And Lloyd, I know you want to make some opening comments, maybe give some highlights of where things just ended for your second quarter. So let's do that. Thanks again, Lloyd, for joining us.

No. Thank you, Peter, and thank you, Baird. It's great for us to participate. Hopefully, next year, we'll be doing it in person, but I'd characterize Q2 as well as the first half of our fiscal year as really being in alignment of how we guided the year, which was low single-digit growth and then moving into the second half with a fair amount of acceleration. Q2, we're very pleased with the results at the top line. Revenue came in at 4.3% and then revenue ex billables came in at 3.6%. And this is really a function of solid operational performance, inorganic revenue contributions from Liberty as well as Tracepoint. Total head count, which has been our operational priority this year also improved by 5.8% year-over-year, 2.3% quarter-to-quarter. As Horacio had been saying, this is the focus of our team. We really, since the beginning of the calendar year, have seen steady improvement. We're not taking our foot off the accelerator. It's nice to see that growth. Margin also came in very strong at just under 13%, 12.8%, which was an improvement of 18%. And this is really a function of very strong profitable contract execution, prudent cost management and again, the ability for us to build for fee, particularly in our Intel market. ADEPS came in strong, up 22.3%. Again, many of the contributors to that, consistent with my previous comments, being strong operational performance, a slightly lower effective tax rate, a lower share count due to repurchases. And so that also came in well. You'll recall in Q1, we had some softness in cash. We turned that around in Q2, up 10.5%. And this was really strong cash management fueled by our operational performance. We also had cash taxes from a lower effective tax rate. And then in terms of rounding it out, in capital deployment, $50 million in quarterly dividends, a little over $100 million in share repurchases and $129 million in M&A activity. So the bottom line is for you, Peter, strong demand signals. Our book-to-bill was also very strong in the quarter, a little over 2x. I think trailing 12 months, about 1.28x. So we maintain -- we're not demand constrained. And really, our focus has been on the recruitment of talent, and we're beginning to see improvement in that regard as well. So giving us the confidence as well as the momentum going into the second half.

Terrific. Thank you for that, Lloyd. And it's nice to have you back here. I mean, last year it was different circumstances. I felt like we're just doing everything to kind of keep to get back in person. And now obviously, it's still a challenge, but there's a lot of progress has been made across the board. I wanted to maybe start with your recent -- you had a recent Investor Day, laid out some of your -- kind of your longer-term targets that you put out there. And I think that included a 5% to 8% organic revenue growth. So I was just wondering if you could kind of level set us what kind of budget growth assumptions maybe are baked into that or trying to understand kind of some of the key inputs to that?

The budget question is certainly frequent and also one that's hard to pinpoint as we look into the future. We made an overall assumption that at some point in that journey, the budget would begin to flatten, if not slightly decline. And as you and others may be aware, that's an aggregate level. It certainly has lots of twists and turns as it pertains to departments and agencies. But we've got a track record going back 20 years of a 10% CAGR regardless of certain and uncertain budget environment. So when we were putting together our thesis, we really asked ourselves, can we maintain that sort of productivity and performance where we're outpacing the budget growth rate. And if so, why? And where we landed was the 5% to 8% range, taking into account known, unknown uncertainties, but really based upon our positioning in the federal market today across our portfolio in particular and what we perceive to be high-growth areas and our track record going into the updated investment thesis period. So whether it's defense and what we highlighted was digital battle, space, AI, cybersecurity, whether it's our cybersecurity presence and the intelligence market as well as civilian, whether it's public health in the civilian market, we thought that, that was a great foundation to build upon. We did not give individual market growth rates in large part because of our single P&L and our tendency to move resources where we see opportunities. But it's fair to say across the board, each of our markets would be in that range based upon what I've said so far.

Yes. And so I mean, I've always considered Booz Allen an IT solutions-oriented company and really bringing a lot to bear and a lot of difficult issues. Where are you seeing the most opportunities of growth? Is it kind of what you just said on the AI or cyber front? Maybe if you could call out a few.

Sure. So it's a little bit different by market with some common themes. Upfront, I'll say, cyber, which is I think everyone uses the phrase. To us, it's kind of table stakes. We don't see many opportunities or shaping -- potential opportunities where cyber is not involved. Really the magic for us then is how do you integrate other capabilities, be it data analytics, system software development with cyber to meet our clients' most-pressing issues or opportunities. So in the civilian market, we're expecting public health to continue to have strong growth. I think in the current administration, it is a priority area, not the least of which is as we emerge from COVID and consider future pandemics or whatever the case may be. We also have strong positioning in the Department of Treasury, Homeland Security, to name a few and each of those markets and accounts also have upside potential, which we are competing for. In defense, it's across the board. We've been successful in being a frontrunner on many of the significant AI awards. We're building from that. 5G is on the horizon, and we can talk about that later, but we see that as a continuation with all of the shifts in sort of the geopolitical environment. We, too, are shifting accordingly in conversations with our clients and are really emphasizing the digitization, the modernization with many of our military clients and how best to support them. We have been involved in many of the cloud migration efforts teaming with other vendors, and we expect that to continue as well. And then in Intel, it's cyber, cyber, cyber. I can't get into the specifics of many of the classified programs, but I think it's fair to say we continue to push into IT solution areas. We're getting great receptivity in that regard. In fact, Q2 was a growth quarter for our Intel business, and we're pretty proud of that. Many of the changes that we made, both the leadership as well as market positioning, we're beginning to see that bear fruit. So again, across the federal market, it really is emphasizing system software development, data analytics, cybersecurity as well as engineering and science.

Yes. And when I look back at your last 3-year targets, you beat those pretty handily. And I would have said, "Oh, well, maybe there's an element of conservatism," but it doesn't feel that way, given how well you are positioned and how those end markets have changed. Would you agree with that?

It's interesting. When we put forward our last investment thesis, internally, we felt it was achievable but also a stretch. And what we discovered 1 year into it was that, in some cases, particularly margin, we were exceeding what we originally had put forward in terms of our investment thesis. I'd say with this, it's a similar feeling, particularly when we look at the organic growth range of 5% to 8%, it's a healthy range, we think, best in class, but it's not a layup. So we're going to have to really continue to recruit, bring on the right talent to convert our very strong backlog. But I think it's also important to note, we've got a fairly aggressive capital deployment range of $3.5 billion to $4.5 billion with what I would say a highlight on strategic M&A, which we see as a complement to our organic growth rate, but also an accelerant. So where we are able to find companies, bring them into Booz Allen and accelerate our growth, those are the type of opportunities we're looking at. So very strong objective there as well as on the organic side, and we feel that will translate into $1.3 billion in EBITDA dollar growth. And we feel that, that will be attractive to current as well as future investors.

Yes. No, I'm going to get to that M&A in a sec because I've always considered Booz Allen more of the organic accelerant. And so I do want to ask about that. But you mentioned 5G and so that's the top priority within the DoD. And Booz Allen has got a tremendous heritage and system integration. So how are you thinking about the opportunity there?

Yes. In the federal space, we really see it in 3 phases: an experimentation phase, which is really emanating out of many other research labs in the form of pilots. And we see that really being the case through 2022. At that point, what traditionally happens is programs of record are established. And depending upon the results from the pilots, it will be picked up as such. And that phase, we see being about 5 years from 2023 to 2028 and then moving into more of a maturation phase 2028 and beyond. Now these dates and ranges take with a grain of salt, but the phases we think are valid. We are active in establishing ourselves as thought leaders in many of the pilots. And we feel that, that will position us well to compete for future opportunities as they move into programs of record. The other point I would make is this is a similar pattern to how AI kind of came about in terms of -- if you go way back into the 2000s, machine learning, coupled with data analytics and then moving into what today is probably described more as artificial intelligence. And so our sort of long-term investment orientation really plays well with many of these technologies as they are evolving and maturing.

Got it. So how do you view the competitive environment kind of as that stacks up? When you look at the pilots and the 5G and kind of how primes and what they're doing, maybe how do you see that all playing out as we move forward?

Hard to say with any specificity, but we've got a history of going in alone as well as partnering. And I would expect that the same would apply in the area of 5G. So fairly early on as programs are being established as our clients are trying to sort out what's the best approach, I think that plays to Booz Allen's strength. As it then moves into broader implementation, we would look for who are the best vendors to partner with and what makes the most sense and really listening closely to what our clients want. For us to sell into areas where we're less confident and maybe a prime has the depth and whatnot, they're better -- probably better off going with the prime, but fairly on is where we kind of make our living, and I would expect that, that would be the same in this case.

Okay. That's helpful. So I feel like it's been very few years over the last decade where we haven't had a CR. There may only be 1 or 2 that we could call out of that. So maybe what's your view on how a CR impacts Booz Allen disruptive? Maybe you can talk about that, how you bake that in your expectations?

Yes. I'd say, unfortunately, not only for us, but probably many in the sector and the government itself, we've learned how to operate and how to execute within CR is not every CR is exactly the same as the previous one, but there are a couple of dynamics. One is that we're really good at understanding what our clients' priorities are. And so with the CR, the continuation of work or otherwise described as old money, we're able to continue to support our clients where CRs become an impediment is on the new work dimension. And so those sort of tasks end up being caught up until you reach a budget, understanding even with that dynamic what our clients' priorities are is what we do. And so shaping those priorities, getting in alignment with that at the moment that they emerge from a CR, we're typically well positioned to compete for that additional tasking or the commencement of it. It's hard to say whether a longer term or short-term CR is better, I think it really depends on what's on the other side of it. If the budget become -- comes in place, no matter the level of that, that is a good new thing because you've got certainty in the eyes of our clients. They're feeling pretty confident about having the resources and then work can commence. If it's a shutdown, well, that's another dynamic that unfortunately, we had to deal with. We have done what I think is a good job in terms of not losing our team, maintaining some momentum and then emerging well with a similar sort of approach as in a CR. So we, like anyone, would like to see budget sooner than later. And with an eye of, what do you say, half-full is how we're approaching it. We're constantly doing a lot of scenario planning and making sure that if a CR or multiple CRs were to commence, we'd be well positioned to navigate through that.

Yes. So a big component of your growth is -- in converting your backlog is being able to add talent on the labor side. You've talked about that. So what are you seeing there? You're running into headwinds in this environment. Can you talk to us about that?

Yes. I take you back to Q3 of our last fiscal year where we saw a snapback dynamic with our workforce in terms of productivity. So the first half of '21 through the roof in terms of productivity, people weren't taking any time off. Utilization was at all-time high. Attrition was at an all-time low, and people were essentially working around the clock. As we got into Q3, encouraging folks to take a break to avoid burnout, what we saw was a snapback, and at the same time, we were not recruiting at a level and adding to our workforce like we needed to. So we've picked up the pace there and still dealing with some comparative headwinds as it pertains to the sort of productivity dynamic, which we expect will begin to subside as we get into the second half. So recruitment for us is really a function of lots of different efforts. We get 30% of our candidates from employee referrals. So we beefed up that program. We also beefed up our outreach to candidates, whether they are coming from the government or private sector. We've seen a nice yield pickup in that regard. And on the other side of the coin, we've really invested in our employee development. So you may join Booz Allen as a cyber professional, but through certification training programs, you can add digital -- sorry, data analytics to that, software development to that and many of our folks take advantage of that. And the return on that is a lower attrition rate than we might experience otherwise. So we've emphasized all these different levers. They are working. We're getting a much higher volume on the intake. And at the same time, we're retaining the folks that we've been able to recruit. And in this labor market, that's a tall order. We're constantly evaluating how can we do it better. We certainly have made it 100% virtual over the past 18 months. And I suspect going forward, it will be a blend of in-person and virtual, but increasingly, we're comfortable working in a virtual environment as it pertains to recruitment.

Yes. No, that's helpful. So you mentioned M&A earlier, and it's not like we've all thought of Booz Allen as someone who's just rolling up companies out there. You guys have had a very strong track record from an organic standpoint. So maybe you could just give us a little bit of insight into what you're looking at specifically or what the pipeline looks like or any sort of criteria that you're using for your M&A strategy?

Sure. So let me -- to answer that, let me give some context and then jump specifically into M&A. So with a strong balance sheet that we have, we feel it's given us the flexibility and optionality to deploy capital different and, at the same time, complement our historic organic growth rate. We've got primarily 3 levers that make up that capital deployment. Dividend, which we intend to maintain a payout ratio of 25% to 35%. Share repurchases, which we take a view on intrinsic value of our shares, and we've got a very robust set of analysis and procedures, and then we look for opportunities to do repurchases as it makes sense in balancing the risk and opportunities of other capital needs. And that then leads to strategic M&A. As you point out, Peter, we have not been terribly acquisitive over the years. But we do feel that with the overall environment being what it is, in terms of opportunities that may present itself, we want to be in a position to jump on areas that will accelerate our growth. And let me use Liberty as the case example. We had been, before Liberty, growing our low code, no code development and overall agile development as a capability. That being said, the demand signals coming from the market were such that it was going to outpace an organic sort of approach. And as we worked with, compete against Liberty, we became not only attracted to them and their depth and capability, but we felt by adding them to our company, we would be able to accelerate our growth. And that is indeed what we're experiencing. So they bring not only the deeper bench in terms of developers, but it's in a market, public health, which we are. And so the integration, the cultural alignment was such that we became even more attractive to them than not. So you've heard me in the past say, our M&A is really characterized by capability tuck-ins, and we really see Liberty as a capability tuck-in. It's sort of on the larger side than anything we've done up to this point. But that's really what's in our pipeline, smaller to midsize capabilities that we feel that should they be a part of Booz Allen will actually accelerate our growth, not only in those areas, but in those markets and/or geographies. And that's what we're looking to do more so going forward.

That's helpful. And you obviously have, as you mentioned, the $1.8 billion of liquidity. So -- and what about on -- so you mentioned capital deployment a little bit, dividends and things that are -- can you maybe just be in the remaining minutes here, we can just talk about kind of the strategy, your focus there as we look out over the next few years?

All right. So with the dividend again, looking at a ratio of 25% to 35%, repos looking at all sorts of dynamics to understand if we feel things are undervalued, and we'll make changes there. M&A also talked about. The split with each of those, we haven't really provided in large part because we've always felt we want to be responsive to what's happening in the broader market and not do deals just to do deals. So I've always said that we want to be patient and disciplined, but certainly build out our pipeline of potential M&A opportunities as we're doing that. Money has been cheap as of late. That sort of has looked like elevated multiples and pricing north of what we would value certain companies. And so we've basically taken a pass. But as things may change in the future, we feel like we're positioned well to do that. Roughly speaking, we're looking at $150 million to $250 million EBITDA contribution from our M&A activity. So that's sort of the going-in modeling. But again, as things change, be it interest rates, the opportunity set, the overall market, we want to be in the best position we can be and that starts with our balance sheet.

Yes. And just lastly, I know we only have about a minute left, but I know that you're also increasing your investment in R&D. But at the same time, you just finished the quarter with very impressive margins. So how do we think about that balance between kind of the investments you're making and kind of holding margins that -- what are best-in-class levels?

Yes. I'm very excited about what we've been able to do with our margin performance in large part because it's been building to be a strength for us. I look at it, we look at it as a means to an end, not the objective. So our market leaders are really focused on EBITDA dollar growth. And as we maintain strong cost management, great project execution, that's actually giving us what I feel is investment capacity that otherwise we may not have seen. So let's take this year, with 12.8% for the first half, my guidance for the year was mid-10s. We typically burn a little bit hotter in the second half where we're investing in our people, their annual assessment, rewards. We also tend to invest in our infrastructure facilities and make investments with an eye toward next fiscal year. During Investor Day, we highlighted 2 businesses that we're excited about, digital battle space as well as cyber. And so with the performance and hopefully, the maintenance of that, that gives me now greater capacity to invest this year with an eye toward next year and beyond. So in essence, giving us a jump, if you will, on these hyper growth areas that we think will contribute not only to that 5% to 8%, but kind of push us maybe to the upper end of that. I provided a bit of an illustrative diagram that said, "Hey, if I have about 100 basis points of excess, if you will, that's really going to give me the capacity to invest in the business." And so we are working our way through some of that already. And hopefully, we'll be able to execute that before the end of this fiscal year.

Terrific. Well, we're right up against our hard stop here, but a really helpful discussion, wide ranging and talking a lot of the key areas for what's happening at Booz and really appreciate your time, Lloyd and Laura. Thanks so much for joining us. Hopefully, we can do this in person and look forward to that. Thanks, again, for joining the conference.

Thank you.

Take care.

Take care.