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

So welcome to our interview with Booz Allen. We're delighted to have with us Lloyd Howell, CFO, EVP; and also Laura Adams, who is Interim Treasurer and Head of IR. Laura, do you want to make a comment?

Sure. Thank you, and good afternoon. Thank you, Cai, for having Booz Allen at your Annual Aerospace Defense and Industrials Conference. We're excited to be here with everyone. Before we get started, and I hand it over to you and Lloyd, 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 and other general economic conditions and other factors discussed in our filings with our Securities and Exchange Commission, including our annual report on Form 10-K for the fiscal year ended March 31, 2021, which can be found on our 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 our 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 and forward-looking statements whether as a result of new information, future events or otherwise. So with that, back to you.

Terrific. Thanks so much. So Lloyd, sales growth in your recently reported third quarter missed consensus by a little over 4%. CACI had a similar situation, certainly, the mood from the other guys we've had here, whether they reported or not is that tough. I think [indiscernible] called it lethargic. Maybe walk us through kind of like what's happening there. I guess with 2 things specifically, one is some people are mentioning increasingly stringent occupancy limits at the Pentagon as something new. And the other one is the CR, and I guess my question would be there's always a CR. So like what's different this time?

Sure. Before I get into it, Cai, I want to thank Cowen and you for hosting today's conference. It's a pleasure to be here. And to your question, without a doubt, I think we, along with many of our peers are operating in a very unique environment, certainly this year, but I think it's fair to say over the past couple of years. The headwinds though, I think are known sizing those has been a challenge. So we give ourselves credit for at least we get what the issue is, but it's, like I said, been a challenging to size it. What we are experiencing this year are really 3 factors that pushed our top line performance down. One was around temporary funding delays, which -- in a minute, I'll get to your lethargic comment. And we saw that impact being $30 million to $80 million, followed by a lower staff utilization, which we believe is a number of factors, not the least of which the overhang of COVID in the form of the Omicron variant but we saw lower staff utilization in the range of $20 million to $40 million. And then lastly, the ever present low billable expenses, which arguably are empty calories to us, but at the top line, have a $50 million to $100 million headwind. So when we look at the overall performance, we're encouraged that momentum around top line continues to grow. I think we exited Q2 a little over 4%, Q3 sort of mid-6s, but below where consensus was. So those were the factors that pushed us to where we are. We're encouraged that certainly with staff utilization, that's in our control, and we're already seeing improvement in that regard. But the other 2 dynamics persist and we're working on things that we can control and move forward from there. As to lethargy, where we've really seen that is even with awarded work, just a slower tempo and getting things going. I think in defense of our clients, it's not with the desire or lack of desire to do so. But nevertheless, it has resulted in things ramping up a little bit slower. Hand-in-hand with that are programs that have shifted to the right. And I have to admit a bit of deja vu on our part because we saw a similar dynamic in Q3 of last year. So we remain persistent in engaging our clients, pushing as appropriate, but it has been what it has been. We're encouraged by recent dynamics where I think DoD has begun to at least articulate the intent to open things up a little bit more. We certainly see that as a tailwind to the future where we would be in a position to engage physically with current and potential clients as well as with one another in terms of -- within the Booz Allen team. And so we find that encouraging. We also find what others have pointed out in terms of the Omicron variant starting to dissipate and the expectation that things will continue to improve. And we only see that is also contributing to more upside than downside. But make no mistake, there have been a lot of variables that have created the volatility. We have focused on those things that we feel are in our control.

So I think if we look at those factors, so I think that the Pentagon lockdown went through January, I'm not sure quite where it is now. We have a CR that might make it to beyond March, we don't have a budget. And so I think my sense was, and I think you mentioned on the call, it's hard to say how long this would last. Certainly, I can't feel really very bullish about March quarter revenues just for the whole sector because these bookings factors. On the other hand, a number of folks have made the comment like Roger from Leidos made the comment because a lot of the bids have been pushed. RFPs have been pushed from '21 into '22, that will turn into revenue into bookings in '23. And because the money has been appropriated for '22, I guess, is that a setup for a big potential big budget flush at the end of the year that kind of will get a reversal from this extreme lethargy at some point.

Yes. Well, let's -- for Booz Allen, let's try to unpack that a little bit. When you look at our Q3 results, we saw a nice pickup, 90% year-over-year in our backlog. Now we also saw a continued add to our workforce organically at 3.6%. And we see the pickup or the adding to the workforce has a real contributor to converting our strong backlog. You'll also see our bookings for the quarter were 0.39x and trailing 12 months, 1.28x. So on a demand signal basis, the signals are there in a positive way. And on a supply side basis, we see steady improvement in that regard. So for the basics, the most fundamental aspects that we can control, it points to a more positive results going into next fiscal year than not, absent sort of my first response with some of the headwinds that we're dealing with. When you consider then next fiscal year, there are several scenarios that we see as playing out. On the budget side, what happens after March with a potential budget or another CR is anyone's guess. The hope is that as we get into next fiscal year, the current administration will find their way towards putting a budget in place, the latest of which before the midterm elections. At that point, it's anyone's guess what may transpire certainly in the second half of the year. So I believe from what we're seeing, our existing clients intend to release RFPs even in the midst of the CR environment. They are working their way towards what's considered old work or existing work versus new work. And this is a dynamic to your point that we have worked our way through in the past with favorable results, and we will do so again. As to whether the government will then accelerate or pull forward RFPs or awards prior to the midterm elections is anyone's guess, but we've seen that dynamic occur in the past, and we would expect some of that to happen as well. The issue, though, however, is how much of that will be considered new work or additions to existing work. And I think on a case-by-case basis, we all will be working our way through that. So any way you cut it, there's more certainty even in the face of an uncertain environment budget to the first half of our fiscal year than in the second half. So we are in the midst, Cai, of working our way through how do you guide in that with those different dynamics. But these are the variables that we're taking into account.

Got it. And so you mentioned your book-to-bill. In protest, I noticed Halfaker is protesting a Liberty win, and that was denied. Also, SAIC protested [ RSS, ENS ] takeaway. But -- so some of those things look like they're breaking, you had a large cyber program, I guess you did mention it last quarter. Has that one been turned back on?

Sure. To your protest commentary, this is the world we live -- we all live in. And we do our best to conservatively account for that. We're hopeful that things break our way, but it is what it is. And we expect that to continue going forward. As it pertains to the second half or second part of your question. If you could remind me specifically what that was, I forgot.

Well, the [ RSS, ENS ] takeaway that you took away from SAIC, I think it's about $70 million or so a year for them.

Yes. I won't comment specifically. We'll let the government work through the adjudication process and the merits of the protest, and we're hopeful that it will be -- continue to be affirmed in our favor. But that's kind of the dynamic we're in. As you may be aware, we do not include protests in our backlog calculations. And so we're still encouraged by the year-over-year growth in our backlog.

I was thinking of it exactly as more of an opportunity. And the large cyber program that you mentioned some quarters back, has that restarted?

It has. Part of the -- let's call long pole in the intent was for new leadership to get in place. That has -- is occurring, and we're seeing a slow ramp-up in that program. So as we expected, just given the critical nature of the support that program provides, there's recognition on the government to not let that slip any more than it has. And so the momentum is it's building, not yet at pre-pause levels, but it's certainly moving in that direction, and we're encouraged by that.

Terrific. And then so I think when we were talking about your book-to-bill in the current quarter, there were 2 large contracts, potential awards that would be an important determinant of where you came out, I think one was a public health award, one was a defense recompete. Can you give us any color on that?

They are still moving in a favorable direction. What I will say is I'll point back to my previous commentary that our historical book-to-bill quarterly performance or patterns is going to continue to change in large reason of what we're talking about. Things get protested and when they're finally resolved, it may occur in a sort of atypical quarter. We saw that play out last year this time where things that had either slipped or been under protest finally came in. We had an unusual high book-to-bill quarter Q4 of last year. So I want to say that, that will be the case this year, but certainly, the same dynamics are in play. We're excited about both opportunities. They are very much in keeping strategically with our Bolt strategy and the type of work we want to do. But we still have to account for and manage our way through the protest environment.

Got it. So turning to revenues. Your reset guide implies a pickup in organic growth from 0.5% in the third quarter to something like 5% to 10% in the fourth. And I think you'd mentioned you have several timing headwinds in the third quarter that should reverse in the fourth quarter. Help us kind of like what are those and maybe what's their impact likely to be?

Sure. So let's start with the things that are in our control, namely bringing on the talent and raising their utilization. What we saw in Q3 is that we added about 3.4% on an FTE basis and an additional 3.5% in terms of salaries. And that trend continues. And if we net about 130, 135 folks both in February and March, that's going to go a long way toward contributing to our organic growth. Hand in hand with that is raising the utilization, particularly of our more junior colleagues about 1%, about 1% that is underway as well. We've seen a nice rebound in January, and that has persisted into February. And so again, giving us confidence that on the organic side, we're going to see improvement in that regard. So again, for the things that are in control, we're doing that for the things that are a bit out of our control. We continue to remain close to the clients and make sure that whatever pivots or adjustments they make, such as the DoD beginning to open up things we can aggressively take advantage or move into that as well.

Great. And I think there was something that you talked about, the timing of New Years that basically hurt you in the third quarter but would help you in the fourth.

Right. So New Years sort of fell into the third quarter as opposed to its traditional fourth quarter. So we would get sort of an extra day in the fourth quarter that would also contribute. Now such as life being what it is, we've had more snow days than as of late, we saw high PTO in the third quarter. That has sort of retreated certainly in January. So again, we're pushing on winning work. We see our win rates still maintaining for incumbency at about 90% for new work in the low 60s. That also is giving us a lot of confidence on the demand side. So we're going to stay focused on that. And our best of our ability, we see that translating into a continued strong fourth quarter performance.

Got it. And so the trailing 12, as you pointed, is book-to-bill is like, I think, 1.28. If you really do the 5% to 10% in the fourth, I mean, it's not from what I'm hearing, there's nothing abnormal in the fourth. I mean it's an easy compare, but it's nothing abnormal. So doesn't that imply you should have some pretty good momentum going into fiscal '23?

That's how we see it. If we continue to keep pace with adding to our backlog, continue to keep pace with bringing on the right skills to convert that backlog, that momentum will certainly carry into FY '23. Our mentality is, let's get out of the blocks as strongly as we can given the uncertainty in the back half of '23. And that's where everyone is focused. That's what we're all about. And so far all the indicators that I'm looking at indicate that, that momentum is continuing to build.

Got it. And so one of the mistakes I know I made in looking at this is Omicron, a, it came and that as it relents presumably, there are a number of pluses, you got higher billables that helps the revenues, you get lower PTO impact, and you got to pick up in work once the access to facilities increases. So what are the relative importances of those, the whole -- the impact of COVID?

Yes. I mean from a supply side, a workforce perspective, tremendous. What we saw in Q3 in terms of the available labor headwind was close to 2%. And then we also saw a little over 1% headwind in terms of the drop-off in utilization. So that right there adds what, almost 300 basis points back in a favorable way. So that momentum, assuming that we're on the other side of COVID, it really speaks to what I think everyone's been asking me in terms of where is this inflection point. And we may be facing an inflection point as we get into our fiscal year, where the demand side and the productivity side become more in alignment. And when we get to forecasting and things of that sort, the variables start to be a bit fewer. At the same time, there'd be a pickup in billable expenses, assuming that travel and all these discretionary costs will start to reverse. So that would put pressure, obviously, on margins, but at the same time, also be accretive to gross revenue. So these puts and takes are going to play themselves out, and that's the business that we're about now in terms of assessing what are the relative impacts of these dynamics as we get on the other side of hopefully the pandemic.

Right. So -- you've indicated the desire to migrate your revenue mix toward more higher-end technical work. It's now, I guess, what, 50% to 60% of revenues, it's about twice what it was before Vision 2020. So you've made some pretty big moves, and it looks like Liberty and Tracepoint kind of fall into that bucket. Do you have any specific goals as to where this higher-end work would be at the end of 3 years or 5 years?

Yes. When you look at our updated long-term guidance, the investment thesis, we certainly see, over the next 3 years, organic growth being in the 5% to 8% range, in large part based upon continued movement into these higher-end technical areas, cyber, system software development, data analytics, engineering and science, to name a few. And at the same time with an eye toward generating $1.3 billion in EBITDA dollar growth, approximately 50% of where we are today. So that's the sort of the long-term guidance. We think we'll get there in mid-10% EBITDA margin. But with a considerable capital deployment of $3.5 billion to $4.5 billion over that stretch of time. So continued pushing into the transformation of our capabilities into these areas. Hand-in-hand with that is bringing on the talent that can deliver on those capabilities. But we think financially, it's going to make our investment thesis real, and that should be compelling to our investors and shareholders.

So CACI has started to break its revenues into technology and expertise sectors to give investors a little bit more transparent look at where they think their revenue mix is going. Any chance that you might do something? I know you always break out the customer that's customers by sectors. That's helpful. But any chance you might get a cut something like this to help people understand what's happening?

I don't believe in the near term, but in the long term, it's certainly our objective to be as transparent as will be helpful. I can just say during my tenure, we provide a lot more detail and bridges as to why the performance is what it is. And I found that to be extremely helpful for people to think...

It is. I agree.

What's going on. I think the cut that some of our peers are doing is probably in the same vein. And so I wouldn't rule out that we'll look for ways to both explain and educate and make folks feel good about at least their understanding, but not necessarily in the near term from what we're doing today.

Got it. So I think back a quarter or 2, you were saying demand isn't the gating factor hiring is, but your legacy headcount was up 3.6% in the latest quarter. So could you say things have changed? I mean, it looks like 3.6% given the rate of revenue growth we're talking about that, that should be plenty of folks to basically achieve your numbers. Is that essentially correct?

Essentially, as we go into every fiscal year, we're targeting mid-single digits in terms of adding to our workforce. And over the past couple of years, it's fallen a little bit short, but I'm encouraged by the continued momentum that we're seeing. So to your earlier question, the momentum is building, and I think that's going to carry forward into '23. And if we do indeed get on the other side of COVID, I think that's going to only pick up. So on the supply side, we're encouraged by the improvement that we've seen and the execution around that. Also keep in mind, for us, we have not seen a spike in attrition. So it's one thing to bring on the talent but we are not near or we're still short of prepandemic level. So we are mindful that even if we bring it on the talent, we got to retain it. So that's the other gating factor as it pertains to talent. But we are getting the skill sets we want. We are retaining the people we want. We expect that's going to translate into converting our backlog.

Great. So I think we've talked a little bit about the empty calories of billables, they go back up. It helps the revenues. It doesn't do as much for the profits, for the margins. But with your revenue mix shifting towards more higher tech growth, which I think you admit, that's where things are going. Can that outweigh the margin headwind of the uptick in billables because -- so that your margins may be instead of being in the mid-10s that they could be closer to the 11 or maybe a little higher?

Yes. There are several swing factors as, say, billable expenses begins to pick up. And one of the initiatives that we have currently underway, we expect to continue going forward is cost management. I think during our Investor Day, I had an illustrative chart that said, hey, there is some potential for greater investment capacity depending upon what we're able to do with our cost management initiatives. So as billable expenses reverses, we are being mindful of where can we prudently cut costs to create that investment capacity toward future growth or hyper growth opportunities such as digital battle space and cyber reform. So this is sort of the dynamic that we're playing in. What we see in terms of long-term guidance is sort of mid-10s. But certainly, where we can achieve greater than that, we're going to do so, still executing the business contractually well, still being prudent with our cost management. But again, keeping a watchful eye on what's happening with billable expenses and not getting out of sync with that given our objectives for around margin.

Right. So like you mentioned billables come back, but John Mengucci of CACI was on before, and he was saying, travel is never going to go back to where it was. So the billable ratio we used to know is probably not going to recur CapEx, probably going to be lower as a percent of sales as more people are working remotely. So could there be some secular benefits from all of this that we don't go back to exactly where we were.

There could be. I would just share with you over the past 2 years, I'm far away now from making any sort of absolute statements. I thought after Delta, we would -- things would open back up aggressively than they have. I think there will be a period of time where travel will resume. It may not be at the same levels of pre-pandemic. And I think that's sort of a common expectation but beyond that, I think we, along with others, will be looking for opportunities to carry forward remote delivery, being more prudent with what meetings need to be in person versus virtual, taking advantage of those cost savings and memorializing them, if you will, but also with constant communication with our clients who, in large part, are going through the same dynamics. So we may have a view as a contractor about travel, but our clients may have a different view, and it's certainly what we've learned is not going to be universal. So we're trying to -- where we're in alignment with their expectations and are being responsive with what they're expecting. I think we are benefited by -- if you look at our civilian business, it's largely in the Washington, D.C. metropolitan area. I think there have been some saving opportunities there where things have been able to be executed in a very positive way. We'd want to keep that going forward. If you look at our defense business as a much larger geographic footprint, global in fact. And so just common sense would say travel is going to pick up certainly, when you consider our Western European presence. And then Intel, again, maybe not as significant in the dimension of travel. But nonetheless, I think we're trying to keep pace with where our clients are and what they would like to do and being...

Great. So you have a new ERP system since April, and I think the first quarter, you warned that the DSOs might move up and then the second quarter looked like they were coming back down. And now they bumped back up, they're like at 65 days, most of your peers in the mid-50s. How come you're that high? And you've talked about more focus, but what are you really doing to kind of get those DSOs back down with the rest of the crowd?

Yes, I think you've characterized the dynamic as frustrating as it is to us, it's real. I think the first point I'd make, it's not got anything to do with the system. In many ways, the system has highlighted areas where we can become more efficient. When you look at what occurred this year, we had some onetime events tied to the Liberty acquisition that sent our cash, I think, down $11 million. We did great, very strong in the second quarter and then again, took a step back in the third quarter. When we do the forensics, what we see is that it's not system-dependent or that wasn't the reason. It was really the fact that we still have a fair amount of the human being needs to remain diligent on invoicing, tracking the -- throughout the collection process and making sure the check is in the mail. And what we saw is we were not as diligent in that regard. We've got Laura now, is our Treasurer, who is probably job #1 to tighten that up. But nonetheless, we need to do a better job on collections. On disbursements, that's coming along just fine. So we are a bit out of sync in Q3, but I and Laura are confident we'll have a much better Q4 than we did in Q3. I think going forward, Cai, this is the drill to bring DSOs sort of back within range of our peers here is we'll get there. We still see a path towards 100% conversion. So I think the fundamentals are there. We just need to execute, and that's what we're going to do.

So is there anything other than telling everybody go out and collect the dough, I mean in terms of incentives or sort of specific initiatives that would encourage people to kind of do better?

Culturally, once we put a spotlight on a topic, that's about all the incentive our workforce has ever needed. So we haven't played with financial incentives and things of that sort in the past. And quite frankly, this should just be a part of the normal job description. So where we believe that we will get where we need to get is just really focusing the mind and the activity in that regard, and we have tended to see things greatly improve, much like we did over the past 2 or 3 years where this was also an issue. So we're not pursuing a different incentive other than the ones we have. We brought it to everyone's attention and everyone is all in. And I'm, again, confident we're going to get there.

Terrific. So net debt-to-EBITDA, 2.4x, what's your target level and kind of update us on the cash deployment priorities?

Sure. Our range is still 3 to 3.5x. Could it ever go north of that for the right opportunity that's strategically aligned, we're confident regarding integration and things of that sort, for sure. And if that were to come to pass, we would provide all the necessary explanation around that. Our capital deployment as we articulate our long-term guidance is 3.5 to 4.5. It is going to remain a mixture of share repurchases or dividend and M&A. And I think the most notable change, if you will, is our emphasis on strategic M&A going forward, which we believe is really going to accelerate our growth. So we're not looking to scale for scale sake. But where we can find small to midsized acquisitions that build upon the capabilities that we believe our clients are going to be demanding such as in the case of Liberty, we're going to pull the trigger and pursue that. So still patient, still deliberate, still keeping our eye on what are our strategic objectives and our confidence on integration, but also at the same time, adding that more so to our growth mix than what we have done historically.

Right. And so one question I always have is usually sort of these smaller entrepreneurial shops basically people get paid different amounts. And kind of your structure is like if you're in Level 5, you get the same as everything else in Level 5. On the other hand, clearly, you're a tech shop, which is also more attractive probably than going to Lockheed Martin or some other place. But -- so how does -- is there a cultural issue that it's difficult to bring folks in because of the partnership structure? And if so, how do you deal with that?

Yes. No, great question. When we are in the early stages of due diligence, we spend a lot of time with the management of the company that we're interested in acquiring in terms of understanding where they are in their careers, understanding what their compensation objectives are and really working with them to kind of meet those needs, those requirements. And at the same time, an eye toward on an integration basis what's going to be successful. And in some cases, Cai, we haven't been able to bridge that gap and have walked away. In the cases where it has worked, it's worked with the most critical, in our view, leaders that we want to be with us that we've been able to accommodate what their financial objectives and career objectives are. And frankly, they wanted to be a part of our Booz Allen culture, not everyone. Some folks take the package and depart. But for those that we want and who also want we've been able to make that work. And frankly, that's led to the success around Liberty and Tracepoint. So you're spot-on. Now that's a large part of making sure that the values of the company we're interested in are aligned with ours that the leadership wants to do the deal and also sees a path forward. And I think we've been able to craft different schemes and packages that have met both needs, the Booz Allen culture as well as the needs of the folks coming in. Because frankly, what we've learned and in some cases, much smaller deals, and we've gotten that wrong, is really painful. So we've learned, I think, from the small amount of deals we've done is that's really an upfront issue, and we spent a lot of time, Horacio does, I do, other leaders in our business too, to make sure that everyone is comfortable and wants to move forward.

Terrific. Well, thank you very much. I really appreciate your willingness to be so candid and to offer all of your insights. And guys, Laura, thank you very much, and have a great day.

You too. Thank you very much.

You might as well.

Wonderful.