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

Good morning, and thanks for joining us for our Ninth Annual Credit Suisse Industrials Conference. I'm Brian Markovich, the North American industrial sector specialist. I'm pleased to present the management of Booz Allen Hamilton. With me today are Lloyd Howell, the CFO; and Laura Adams, the Chief Accounting Officer. Just to get started, Lloyd and Laura, thanks for both joining us today. Maybe I'll just start off by offering you the opportunity to give an update on the business and the latest trends you're seeing.

Sure. Thank you, Brian. I think Laura has a disclaimer statement she needs to run through, and then I'll jump into it.

I do. I do. Thanks, everyone, and good morning. Thank you, Brian, and thanks for hosting Booz Allen at your Global Industrials Conference. We are excited to be here. Before we get started, as Lloyd mentioned, please keep in mind that some of the items we will discuss today relate to future events of 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's services and other factors disclosed in our filings with the Securities Exchange Commission, including our annual report on Form 10-K for the fiscal year ended March 31, 2021, which 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 in forward-looking statements, whether as a result of new information, future events or otherwise. With that, over to you, Lloyd.

Thank you, Laura. And Brian, thank you and Credit Suisse for hosting today's conference. We're very excited to participate. I have a couple of opening comments before we jump into Q&A. We recently announced our second quarter performance. And from our perspective, it is very much in line with how we've guided for the year. We had guided for this fiscal year to see in the first half, low single-digit growth followed by an acceleration in the second half, and we feel we're definitely along that path. Our revenue in Q2 was up 4.3%, really based on our solid operational performance, some inorganic revenue contributions from our Liberty and Tracepoint acquisitions. And we expect that, that will continue to accelerate into the second half. We're really excited about the improvement that we've seen in hiring. We saw a total head count growth of 5.8% year-over-year and a quarter-to-quarter improvement of 2.3%. This is really a function of increased attention and energy towards sourcing and recruiting hard-to-find skill sets and our business leadership is all over it. Margin was also very strong in the second quarter, really a function of profitable contract level performance, prudent cost management and our ability to bill for fee, particularly in our Intel market. So we saw an improvement of 18 -- a little over 18%, which brought us to 12.8% in EBITDA margin. ADEPS was also strong, up 22.3%, again, based on strong operational performance, a lower effective tax rate and a lower share count. And so again, the business is operating very well. On a cash basis, we saw a 10.5% improvement, really strong cash management, fueled by consistent operational performance. Cash taxes were from a lower effective tax rate. And then from a capital deployment, we saw $50 million in quarterly dividends, a little over $100 million in share repurchases and $129 million in M&A, which is really the Tracepoint acquisition. So again, the demand signals are strong. Our improvement on the supply side in terms of hiring continues to improve. And that is really the fundamental reason why we affirmed our guidance for the fiscal year. The top line to finish somewhere between 7% and 10%, margins at 10.5% and ADEPS between $4.10 and $4.30. On a cash basis, we also affirmed our guidance to finish between $800 million and $850 million. So we are performing as expected, and we expect to see the acceleration in the second half. I'll just finish with, we held our most recent Investor Day in early October, where we provided our long-term guidance and that's really a focus on increasing EBITDA dollars by 50% by the end of our fiscal year '25. The way that we expect to get there is with strong organic performance between 5% and 8%, margins holding at 10.5% and capital to be deployed between $3.5 billion and $4.5 billion. I think there are lots of details involved in that. But one is we expect our inorganic activity to increase, to accelerate our organic growth. And again, Brian, I'm sure there may be some follow-up questions in that regard. But let me stop there, and we can jump into your more specific questions.

Okay. Thanks for that update. Let's just get into the growth and hiring a little bit. What are your current expectations for the 2022 budget growth? And how do we think about the relationship between your growth and that of the budget going forward?

Yes. If you look at our performance vis-a-vis the budget going back 20 years, we have a CAGR of about 10%. So both in certain and uncertain budget environments, we tend to do very well. Really as a result of our strong client relationships, being close to our clients' core missions and an increased attention and focus on technical solutions, which in certain and uncertain environments tend to be top priority. And that's how we've sort of written through some of these cycles. With the current environment, I think going into our pre-pandemic, there was a belief that the budget would begin to flatten, if not decline. And we would have subscribed to that as well. I think what we've seen out of the gate is a slight uptick. And I think that's a function of the continuation of programs, the fact that from a defense and Intel perspective, the world is still pretty messy, and we need to make sure that the country is protected as well as the interest of our allies. And so at some point, we expect there'll be an inflection. It's hard to crystal ball when that is. But we remain close to our clients, their priorities and expect that the addressable market, which is very large, will continue to grow, and we've got more upside than downside potential.

Okay. And if we get a final DoD appropriations number that's higher than the President's initial request, do you see any areas where you guys specifically might stand a benefit? Or does that extra money, you think just goes to hardware platforms?

Well, one of the areas that we're very excited about that we spoke to during Investor Day is digital battlespace. And this is really a framework that includes lots of existing and future technologies, be it AI, 5G, cybersecurity. And we expect that our -- certainly in DoD, many of our clients are going to begin to migrate to that. And that will present lots of known and unknown opportunities for us, but that's where we're sort of excited where we're spending our time and thought leadership, thinking through how best to not only support our clients, but also shape opportunities that are consistent with that. There are certainly lots of ongoing and incumbent support that we expect that we'll continue to do. But the digital battlespace is really what excites us in terms of the future.

Okay. Great. Well, you talked about the hiring that you had in your opening remarks, 5% year-on-year, 2% Q-on-Q. A good chunk of that being organic. Obviously, there was a big focus at the Investor Day as well. But can you recap like the major enablers of how you're getting this hiring strength?

Yes. Without a doubt, we're facing into a very competitive labor market, especially for these hard-to-find IT skill sets. We believe we've got a couple of levers that are helping us to navigate through that. One is that we get 30% of our candidate pool from employee referrals. And that is very valuable in the sense that in many ways, the candidates, no Booz Allen have been prequalified and are a great source of hiring for us. The other lever is the government itself, particularly the defense community as people depart at 5, 10, 15, 20-year points in their career. Many of them want to continue to support the programs and the missions that they know. But they want to do that from a private perspective as opposed to public. And they know Booz Allen. And in most cases, like our culture, like how we work and want to join. And so we stepped up our efforts in terms of recruitment and awareness for that community. The balance is a mixture of folks from the private sector who may want a different geography or work-life balance, some competitors. But overall, we've been successful in increasing the volume of candidates and then that has resulted in a higher yield that we have begun to see throughout this calendar year.

And maybe just talk about like improved retention versus higher gross hires, how those kind of levers work out for you guys right now?

Yes. We've pretty much from the beginning of the pandemic have seen attrition at all-time low levels. I think some of that is a result of people not wanting to change employers in the midst of a very uncertain environment. And even as vaccines have rolled out and people are feeling more comfortable, what we've seen is our attrition levels are still at historical lows. And we believe it's a result of a couple of things. From the very beginning, we emphasize the health and welfare of our colleagues. And I think that bought us some emotional goodwill and really spoke to the values of our company. Number two, we are in constant communication with our colleagues about how are they, what's bothering them, how are they navigating the pandemic, taking care of dependents. And I think that sensitivity and outreach is also said to our folks like, "Hey, look, we care about you individually, we care about you from a career standpoint. And I think that has made folks sticky. And the last I would offer is we really have stepped up our development and training program where colleagues have an opportunity to get new skills. And so instead of working at Booz Allen just because of a contract, people are able to update their skill set, certifications, move on to other projects. And so that opportunity and that potential deployment has also kept our folks with us as opposed to departing. We know it's you can't rest on your laurels. So we're constantly with the leadership of our Chief People Officer, Betty Thompson, looking at our benefits and whatnot to make sure that we're keeping pace. But I think that has contributed to the relatively low attrition based on pre-pandemic levels.

So was there anything special about the second quarter? Does that not necessarily repeat? Or how has COVID kind of been playing into this as well? It's maybe -- you mentioned vaccines -- is that kind of easing the whole hiring process now that a lot more people are vaccinated?

At Booz Allen, once we get the machine up and running, there's a certain amount of momentum that is created. And I think what we saw, particularly in the second quarter, was that momentum kind of hitting a level of efficiency that we had hoped would kick in and it did indeed kick in. I think what we've also seen with the rollout of vaccines is today's workforce wants the flexibility of working remotely as well as an office. And we have worked with our facilities team to enable that. And so whether it's a candidate or an existing colleague that flexibility is very attractive to people and really scratches sort of their need of what they want going forward. So I think it's been a combination of lots of different things. But clearly, having the flexibility is very important. We've heard our people, and we put in place programs to allow that to happen.

Okay. Maybe we'll go to the Intel business that returned to growth last quarter. Maybe just give us more of an update on that business, what enabled it to return to growth expectations going forward?

Yes. We're very excited about the fact that our Intel business got into a positive territory in Q2. And this has been an effort that is required changes in leadership, repositioning some of our accounts toward higher growth areas and as well as diminishing our exposure to areas that we'd like not to continue to support. So to give you a little bit more detail, our Intel business is comprised of 3 accounts, national agencies, cyber and defense military intelligence. Our national agency account has been doing well for a number of years. We have been successful in working with the government to bring on folks awaiting clearances where they can be productive. Once those clearances come through, they then move on to more classified or sensitive programs. And so that has allowed us to improve on the hiring front as well as support the missions of those agencies. Cyber, also very important work. The government was working its way through what the recompete or the follow-on work was going to be. They ultimately extended us. And so that has also fueled continued growth in that account. The defense military intelligence was really, the account where we are seeing the most transformation. We had probably too much exposure to program management, staff augmentation types of tasks and we wanted to diminish our exposure to that, not the least of which was a sort of commoditization of that work that was not in keeping with strategically what we wanted to do. And so with new leadership, we've been shaping new opportunities in the higher-growth technical areas. We've seen this year awards come our way, and the momentum has continued to build. So with that improvement in DMI with the continued progress that the other 2 accounts have made. Now that really has contributed to the pivot back to growth for our Intel business. We are expecting that to be a -- have a growth year, and then the momentum to continue to build from that. But that's really, Brian, what has been going on in our Intel portion of our portfolio.

Okay. Great. At the Investor Day, you talked about 5% to 8% growth from 2023 to 2025. there's wage inflation for your kind of business in there. You've got some fixed price work, but how does the math work? Can you basically hit the low end of that guide with just a point or 2 of head count growth, assuming wage inflation is kind of in that 5% range?

Yes. A couple of things went into the modeling. On the head count dimension, we always target mid-single digits going into every fiscal year. And on top of that, with inflation, that sort of gets us to the lower -- to the mid part of that range. So if we continue to make progress on bringing on the talent, we think we will be certainly within range just on that alone. On top of that, it's the continuation of seizing on the type of work that we want. We've been successful in doing that. At the end of Q2, we grew our backlog by 18%, had just over 2x book-to-bill on a trailing 12 months, 1.28x. And so maintaining those strong sort of organic efforts to win. recompete, our win rate for recompete is at or around 90%. For new work, it's at or around 60% and we've been able to maintain that. So what went into the thinking was continued strength across our portfolio, continued strength in recruiting and onboarding the talent. And then for the go get white space seizing on that while we maintain our win rates. On top of that, as I mentioned, we're excited about these emerging businesses, digital battlespace and cyber. And as we continue to build that out, we think that pushes us to the upper half of that range, if not potentially a little bit north of the 8%. But those -- that's going to be in the make. Certainly, we're going to be investing in those businesses in terms of talent and asking folks to think through ICIT, thought leadership, new relationships, but we expect that to grow and to contribute to the 5% to 8% as well.

Okay. And stock comp has picked up over the last few years, at least relative to where it was back in 2018, 2019. Some of that's probably just due to headcount additions. But have you been using that more as a mean to attract and retain talent as well?

Every year, we're looking for how to include equity as a part of our compensation to our senior executives. I think many of us would like for it to be even more aggressive than we've been able to achieve at this point. But it's certainly a growing dimension to how we compensate our people, how we incentivize our people. And I guess we're at 11th year of being public even though we're over a 100-year-old institution, I think folks are now winning that, hey, this is an important part of Booz Allen as well as their career and also the potential for wealth generation. So again, I think folks like myself would like for everyone in the organization to benefit. Right now, it's really targeted to the most senior executives, but we are seeing and getting good feedback from our colleagues.

Okay. Maybe we'll shift to margins a little bit. You brought in all the head count in 2Q, but the margin stayed at a very healthy level. So sometimes there's a delay in productivity to be a drag, but that didn't happen. So just kind of walk around the margin strength and the hiring stream.

Yes. So when we bring on talent, there are really 2 buckets that folks could go into. They're sold and funded work where if I hire Laura tomorrow, she can start work and be highly utilized and start contributing to the growth of the institution. The second bucket or what we call capability hires where we expect that on the horizon, there's opportunities, but it may not be in-house at the moment. And so we sort of carry those folks, which would have a headwind on margin performance. Sold and funded, immediate contribution capabilities, it takes a bit. What we've seen is that the mix of sold and funded hiring versus capabilities has been about [Audio Gap] the other contribution is with the addition of Liberty, much of their contract type is fixed price and that tends to also have a higher margin profile than cost reimbursable and time and materials. So the contribution of our fixed price work increasing a little bit. The fact that we've been efficient with hiring, bringing on folks. The other reality is that billable expenses has been low in this COVID environment. At some point, that will pick up and become a headwind. But essentially, it's been a tailwind. That, coupled with our unallowable cost has also been low. So part of this is a function of timing. Part of it is a function of just strong operational performance on a contract and on an operational basis, but that's what has pushed us sort of at that 12.8% level. I do get questions as to Lloyd, your guidance is at 10.5%. What's going to happen in the second half that's going to swing you all the way back to 10.5%. We certainly run a little bit hotter in our second half of the fiscal year, largely because that's the period where we're investing in our people, our infrastructure, technology. That being said, and one of the things I said during Investor Day is we want to have a cushion to start investing in some of these emerging businesses. So I wasn't prepared at the end of Q2 to change the guidance. We are probably going to be in a better position to address that at the end of Q3. But we're doing very well and it pertains to margin. It's creating the capacity to invest in the business, and we'll update guidance as we get to the end of our third quarter.

Okay. Maybe let's turn to cash flow. What are the big items we should be mindful of that should swing between this year and next year?

We have done, from my perspective, a great job in our cash generation. From a receivable standpoint as well as payables, we've gotten that imbalance. In Q1, it was slightly down, largely due to the Liberty transaction and collections was a little bit light. We turned that around in Q2, and that really was -- what drove our guidance to still remain at $800 million to $850 million. So on a go-forward basis, we expect to continue to generate strong cash. We expect that we'll deploy that with the levers that we have. be it the regular recurring dividend or repurchases and M&A and conversion to be around 1,if not slightly north of that.

Okay. And then your new financial ERP system that you implemented. Can you talk about how that's helping you on the working capital? And could that be a tailwind for next year as well?

Yes. We're very pleased with the rollout and implementation of that. We've seen no technical issues. We've been able to close our books. And at the same time, it's given us greater line of sight as to what parts of the business are doing well with parts of the business that we need to focus in on. And I think that's only going to continue to improve going forward. It's allowing us I think, to make better business and operational decisions. And there's still features that we have yet to turn on that we expect to see additional benefits. So on a go-forward basis, I do believe it's going to continue to be a tailwind. It's going to allow us to be more efficient as we leverage technology going forward. And it allows our business leaders to have a better understanding of the overall portfolio than they once did.

Okay. In the closing minutes, maybe we'll just move on to capital allocation. You've laid out a bunch of things at the Investor Day, but maybe just kind of tell us what the M&A environment just like right now, like a number of deals coming across your desk and the multiples you're seeing?

Yes. So at present, we are building out our pipeline of opportunities. They are across our business. we are still emphasizing capability tuck-ins in the areas of system software development, data analytics, cyber and engineering and science. For us, many of the opportunities are small to midsize, and it's really with an objective of accelerating growth, not scale for scale's sake. The environment is competitive. We haven't seen a retreat in terms of pricing and/or the underlying multiples. We expect that, that will remain. We're trying to shape and cultivate opportunities much like what we did with Liberty where the valuation is appropriate fair and accretive to Booz Allen, hard to do, but that's the objective that we're moving out on. And I expect that on a go-forward basis, we'll probably do several smaller deals as we are putting in the right puzzle pieces as opposed to large transformative deals, which we don't believe we need to do.

Okay. Does the experience with Liberty acquisition give you confidence to perhaps get a little bit more aggressive with M&A?

It does. On the heels of the Liberty deal, we also completed the transaction with Tracepoint. We're building out our lessons learned, which is helping us, we believe, to get smarter on a go-forward basis. As I mentioned, the pipeline is continuing to grow and more and more of our business leaders are excited about the prospects of accelerating their growth given the M&A and the strength in our balance sheet.

All right. With that, I think, we're bumping up against time. So I just want to thank you guys once again for taking the time today.

Great. Thank you, Brian and Credit Suisse, and everyone have a good and safe upcoming holiday season.

And to you, too. Bye, guys.

Bye-bye.

Bye.