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

Perfect. Well, good morning. It's Day 2 of our Barclays Industrial Select Conference in Miami. Today, we have the pleasure of hosting Booz Allen Hamilton with Lloyd Howell, CFO; and Laura Adams, Chief Accounting Officer and Interim Head of Investor Relations. Thank you both for joining us.

Good to be here.

Good to be here. Before we get started, I just wanted to remind everyone that certain things that we discuss today relate to future events or financial performance. and involve known and -- may involve known and unknown risks and uncertainties and other factors that may cause our results to differ from financial performance of the future. Please refer to our forward-looking statements in our SEC disclosures in our Form 10-K.

Thanks, Laura. So starting out, we'll just talk about your Investor Day targets, 5% to 8% organic growth is contemplated there. And the backdrop is kind of considered within those targets of 2% U.S. budget growth on a total basis. So if we think about how your thinking has changed since October, kind of what have been some of the change factors and how do you expect growth to progress with you?

We certainly are in unprecedented times here. I'd say going back to October where we have been historically and where we think we're going to continue to be as a growth company. And we're focused on the next 3 years growing EBITDA dollars, about 50% to $1.3 billion. And a lot of ways to model that. But as we look at it, it's on the basis of a strong organic growth profile between 5% and 8% margins in the mid-10s and significant capital deployed being $3.5 billion to $4.5 billion. Underpinning that is an emphasis on strategic M&A, not so much for scaling, but really to accelerate our organic growth profile. Fast forward to today, we certainly still believe we are getting a growth [ posture ]. It's interesting, many of the demand signals that we historically have looked at are still very strong. Our trailing 12 months book-to-bill, 1.28x, overall backlog up 19%, win rates holding for recompetes at near 90% for a new [indiscernible] 60%. So the demand signals are strong. And on top of that, discussions that we're having with clients about immediate follow-on as well as things that they'd like to do are still very robust. And then on the supply side, also seeing strong performance there. We added organically 3.6% to our workforce and including Liberty and Tracepoint 6.8%. So again, supply signal, demand signals strong even in the face of Omicron and [indiscernible] and things of that sort. I think what we are experiencing is a bit of a translation issue. So we're bringing on the folks, the man signals are strong. So what's happening that's sort of creating the choppiness at the top line. There's a variety of factors, not the least of which are things are just low and ramping up. We're seeing them most prominently in our defense part of our business awarded work but getting folks on task and ramping up slower. Also seeing something shifted to the right as well as some cancellations, but that is one of the reasons we're experiencing some translation issues. [indiscernible] environment has been here for quite some time, and I think that just adds to the underpinning dynamics, but we're expecting [ protest ] to continue. And I think what we've experienced in the past few years with COVID, it impacts the workforce in somewhat predictable ways, but the longevity and the severity of those impacts has also varied. So with the [indiscernible] of Omicron, we saw still continued available labor headwind drop off in utilization and then a pickup in PTO usage certainly over the holidays. Some of those factors have returned to normal, utilization is up. But here again, this is sort of the dynamic that we and others have been dealing with over the past couple of years. But in terms of our long-term guidance, we're definitely growing and definitely seeing the fundamentals [ have increased solid ].

Got it. Got it. And if you think about kind of looking at the near term, guidance implies high single-digit organic growth as you're looking at kind of the last quarter. And [indiscernible] discussed FY '23 [indiscernible]. So maybe if you can talk to us on kind of the building blocks towards growth acceleration in some of the markers that we can look at from the public side?

Yes. Understanding our acceleration is really staying on top of those dynamics that are in our control. I think if we've learned anything, there's a lot of different variables that are beyond our control. But one of the things in our control is the ability to source and bring on the talent to translate and convert the strong backlog performance that we've had. So that's number one. Very competitive job market, a lot of discussions about wage inflation since October. We believe with about 55% of our contract types being cost reimbursable, another quarter, time and materials. At the moment, the government has been accepting of that inflation. And we're not taking it for granted. We're watching it closely, but at the moment, that has been passed on. Number two is the strong execution of the business. We've seen a nice pickup in our margins, strong bottom-line performance. What's underpinning that are just basic blocking and tackling around contract execution, our bid-no-bid decisions, pursuing the type of work that we want to pursue. And I think all that's translated in sort of strong operational performance. And again, as we look out over the horizon, if our governments can find their way towards [ asking ] a budget, I think that will go a long way toward giving our clients the confidence that the resources will be there for moving out on the things that we're talking to them today as well.

Got it. Got it. And circling back to the Investor Day targets. If we think about that 2% total budget growth number, kind of what are you considering? And what are you contemplating as defense growth within that top line number?

Yes. If you go back over, I think, the past 10 years, our CAGR has been about 10% growth rate. And so we've sort of outpaced the sort of aggregate market by a couple of points. And that's been on the back of our relationships, mission understanding, win rates, things of that sort. That's also included budget certainty as well as uncertain environments. I think pre-pandemic was widely held that there'd be a flattening to even a decline in the defense budget. So current events, notwithstanding, we do expect that to kind of be the dynamic. What we're focused on are those areas that really are the technical solutions and the capabilities. Clearly, in alignment with what, in particular, DoD has been demanding, whether it's AI, cybersecurity, that type of support. And in our conversations with the clients that, that still remains the priority. So we feel we've got good positioning that will contribute to that historical growth rate. We still feel we're on relevant to the things that they'd like to do, despite sort of the immediate circumstances and that has contributed to why we believe that 5% to 8% organic growth is a good range over the next 3 years.

Got it. Got it. And then if we think about, obviously, defense has kind of been in focus with FY '22 being held up and FY '23 is potentially higher submit obviously elevated threat environment globally. But if you think about Booz's balance exposure to defense, Intel and Civil health, where are you seeing the best demand signals across kind of those underlying markets?

Yes. At an aggregate level, defense is about 50% of our portfolio, Intel about [indiscernible] 25% over the years and same could be said with Civil. Defense, as you can imagine, is comprised of the services as well as the [indiscernible]. And I'd say the majority of that portfolio still has a pretty decent to strong growth prospects. The one aspect to our portfolio that's had more headwind has been the army. And we believe that DoD has been sorting through its sort of strategic priorities. I think they're shifting, which has also contributed to some of the maybe slowness, if you will, of things ramping up as department works through its priorities. We still feel we're positioned against the right priorities that will still be in demand. But the overall dynamic as sort of we begin to focus on the Pacific Rim and the adversaries in that part of the world is contributing to some of the sort of the transition. And we think that as we sort of work through the installing year, the dust will begin to settle, and we'll have a -- like a bit more clarity as to what specific programs where we're sort of prioritizing and placing bets. And we had some commentary around this during our Investor Day where we highlighted digital battlespace, where we really believe that across DoD, that's going to be priority for many of our clients. And so a lot of our investment activity work we're doing today is what we're positioning for is the one...

Got it. Got it. And then just sort of going back to the comments you made in terms of 80% cost pass-through through contract exposure. Can you just talk us through kind of what the customer feedback is in terms of the affordability of these options? And how much of that matter as you think about the underlying capabilities?

The first thing to appreciate is our portfolio is made up of about 4,600 task orders and/or contracts. So the customer is not through this homogeneous [indiscernible]. So literally on a case-by-case basis, we're having discussions around pricing, technical delivery, you need it. And when I say at present, pricing hasn't been sort of the top -- sort of topic, it's really been technically how can our client base modernize sort of an antiquated IT infrastructure and take advantage of some of the advancements in the areas of AI, Cyber and so forth. There's an appreciation at the talent to do that work is expensive. It is in a competitive job market. I think many of our clients are also seeing talent flight and folks leaving the government to -- for commercial opportunities. So they feel it as much as we do. And what I've seen is that there is an appreciation of that interest in retaining and recruiting talent to deliver on these very critical programs. So that at the moment, there's an appreciation of the broader dynamics. The world being what it is, things can change. I think part of living through the 2011, 2013 sort of era has made us sensitive so you can't take it for granted. So we're constantly in dialogue with our clients about -- on an award basis, what is that criteria? Where is there pricing sensitivity. And certainly, in parts of our business, pricing has always been a sensitivity. In other parts, less so, but in the main, much of the work that we're awarded is value-based. But there are about 1/3 of the business where pricing is definitely a sensitive topic or award decision criteria. We're doing our best to be compliant with that.

Got it. Got it. And then if you come over to margins and consider kind of FY '25 10.5% adjusted EBITDA target. Can you just update us on kind of what you're -- how you're progressing in terms of mix shift, cost containment and growth investment buckets that you own?

Yes. So just in this year with our updated guidance, we expect to finish about 11%. We started FY '22 in the mid-10s. And what's contributed to that increase, there are a couple of different things. One is just strong contract execution. Our market leaders are not only worried about the top line but also the bottom line, being very selective in the type of work that they are pursuing and/or shaping. We've also had the benefit of billable expenses being low and so that's contributed to that. And I think with the introduction of Liberty, we've seen an uptick in our fixed-price contracts. So that mix shift in contract mix has also contributed to the increase in margin. Many of the questions I get, will now sort of where does that go? And as we look out over the next 3 years, just get back to my commentary during Investor Day is I'm interested in how to increase investment capacity into the business. And we think we're going to get there at this point in a couple of different ways. One is the continuation of what we're currently doing on contract execution, the mix shift in contract mix, just managing the business as tightly as we have. We also have both currently and expected some cost management initiatives that we think will also contribute to an increase from the stated mid-10s. So Lloyd, what's going to take you back to mid-10s? Well, that's where the investment sort of capacity would present itself. So at this point, looking at about 100 basis points, whether to inject that back into the business is really the going-in proposition. And where would that go? Digital battlespace, the Cyber platform that we talked about during Investor Day. We see both of those being hyper growth areas, already sort of residents with the market and with what clients are looking for. And so that's sort of how we're thinking about margin. Could it get higher? Sure. If there are sort of as things pick back up, billable expenses become the headwinds of the things shift and become tailwinds, we'll sort of adjust as we go, much like we did with the last investment thesis, but we think that mid-10s is going to allow us to get the EBITDA dollar growth to achieve some of the other metrics that are part of the thesis.

Got it. Got it. And then switching over to Investor Day targets, roughly $4 billion of M&A and share repo that you have as a placeholder. Can you just remind us on kind of what your assumption is in terms of inorganic contribution to the adjusted EBITDA targets for FY [ '21 ]?

Yes, we were looking at is somewhere seen $150 million, $200 million in terms of contribution. But before we just get to the [ MAC ], I think what we put as a priority is really strategically is the activity, one point. Number two, we value our culture very highly. And so from an integration standpoint, do these transactions translated to continued strengthening of our culture. Then we get into the MAC and does the MAC lead us to believe it will be accretive on some of the traditional metrics as well as what we're talking about here in terms of contribution. So it is an aggressive target for sure. We are feeling confident at least of which is our most recent deals with Liberty and Tracepoint, going very well across all those dimensions. And we're going to sort of stick to our [ heading ], still be patient, still be disciplined, still be focused on the things that I'm talking about this morning. But increasingly, our pipeline is growing really small to midsized opportunities across the portfolio. More or so deals that we're cultivating as opposed to a traditional auction. And if there were a larger opportunity to come along, we'll certainly take a look at it and consider it seriously. But by and large, we like our strategy, we like our approach, and we're feeling good about our ability to execute.

Sure. If you think about kind of the balance of M&A versus repurchases? What do you need to see or kind of what are the return handles that you weigh for an M&A deal versus potential accretion of share repurchases?

Yes. Without overusing the word, flexibility, that's really our approach ever since I've been the CFO has really been to -- let's react to what the market has given us. On the repo side, we look at our intrinsic value and look at where things are trading and make a determination through the execution of our grid as to where we have confidence in our future and what makes sense. Similarly, on the M&A side, we don't want to get sort of caught up in deal frenzy. We still want to stay true to what strategically we're trying to do, and that's leading us more down the path of capability tuck-ins. So is there an opportunity that makes sense? Does it make sense from a pricing perspective and that MAC perspective as investors will certainly want to be clear that we're not going down the wrong path and then balance that with the other lever, which is our regular [indiscernible] dividend. So we looked at all the dynamics and try to make the best call for our shareholders in the near, mid and long term and do it in a patient and disciplined way. So we have some guidelines, but I'd say it's really what's the market presenting and let's be current and consistent with that.

Sure, sure. Something over to M&A. If we think about your Liberty IT acquisition, what are some of the key lessons that you learn from acquiring them? And how is that informing your relatively nascent M&A strategy versus peers?

Yes. I mean some of it I have spoken to in terms of being patient and being disciplined, but more tactically, really being in sync with the management and leadership of the company. And on the very, very start, it was hard to distinguish between Booz Allen and Liberty just given their values, how they approach their workforce, very consistent with our own. So tactically making sure that they had the right financial incentives that they felt part of the broader team that they had a voice at the table was, if not [indiscernible] list. And then it really got down into let's not upset the things that are working well. They know what they're doing. They have great relationships in the market. There's no reason to [ retrude ] or interrupt that. And in the case of one of their competencies around low-code/no-code development. We had a nascent growing capability, but let's like learn from the pros and try to multiply that. And then I think from a cultural standpoint as quickly as possible getting them integrated into the things that we do second nature and being mindful of not overwhelming folks with all the things we've got in place for decades. So a lot, I think, to be learned more so on the cultural side and seeing how well that's gone. And then I think on the market, delivery, technical side, letting folks to do what they do best, which is -- and they've already had some significant wins [indiscernible] adjudicated. And so they're really eating into that $2 billion ceiling in a nice way and had at least of our [ initial ] forecast of what we thought where they would be at this point.

Right. And then -- so just focusing on the cash balance, you previously called it a strategic asset. How do you think about that versus deploying it efficiently over time? And some -- what are some of the key catalysts that you watch for that would kind of drive that cash deployment?

Yes. I mean, so from a working capital requirement, $150 million to $200 million is sort of what we need. So for the balance of that kind of goes back to your previous question of are we deploying it in a matter that really is rewarding our shareholders in the near, mid and long term. So we feel we've got the right levers. We are constantly talking to ourselves, our financial partners about what's the best way given other changes that are on the horizon being interest rates or opportunities in our M&A pipeline that we're still pursuing. So it's a constant dialogue with ourselves and as well as our stakeholders as to what's in the best interest of everybody and trying to balance that out. So when I say we've got a strong balance sheet, I think that is true with that type of liquidity gives us the flexibility to do lots of good things. So we just need to make sure that we're doing it in responsible in a way that rewards the right focus.

Kind of crystallizing capital allocation here. If we think about Booz Allen Hamilton's spin strategy and how [indiscernible] has informed that and kind of what your expectations are for the rest of the portfolio? Maybe if you could just articulate what the strategy is, how do you expect it to progress?

Yes. One of the things that we said back in October is the option value initiatives, we learned a lot. There was never a top line sort of financial objectives, if anything, margin and bottom-line contributions in the sense that higher margins, high tech areas, some emerging technologies at that time. And then I think, quickly getting into what are the ways you can monetize on some of these pursuits. So Modzy, SnapAttack, other investments that we've made really were with that mindset that what would put those initiatives in the best way to achieve the financial returns may not necessarily be under Booz Allen as it's currently disrupted. So how do we sort of accelerate things. It's certainly like we would expect, had sort of life cycle cost models and breakeven points? And how do you make that happen sooner? And so the decision to spin out some of these opportunities is really sort of in that framework and Modzy fell perfectly into that. So way back line in 2018 when we presented sort of AI, the concept of Modzy that really came into fruition and the reality was spinning it out was the best sort of financial win-win for everyone, for our people or the initiative and for the marketplace. And that's another sort of lesson learned. Booz Allen is a place where we can attract talent where there's also a financial return to occur beyond sort of traditional compensation model. So a lot of our workforce is interested in that as well. They may not want to jump out in a pure startup, but if they can monetize [indiscernible] and sort of the [indiscernible] in a way that still meets that objective. These spinouts have also contributed to that. There is a modest amount of like looking at the portfolio and making sure that we're focused and whatnot with 30,000 people that now make up our workforce with varied interest, different generations, other options that they have in the broader labor market. The spinouts have certainly been speak to that and also sort of contribute to their career and [ whatnot ].

Sure, sure. And just coming into strategy. If you think about Booz Allen Hamilton strategy and AI, kind of to what extent are you developing indigenous capabilities versus using commercial shelf tools and integrating them? And how do you expect that to influence Booz's growth and margin profile going forward?

Yes. I think we've always had a mix of both of those dynamics. It starts with probably more of an indigenous into of the spectrum, but a realization that there are other attributes certainly in the area of AI that -- the client base is expecting us to be knowledgeable about and also expecting us to intelligently think through how do you integrate these different contributions. On the indigenous side, I get this question several years ago, the [ exportability ] that's the word. We're able to do that probably more consistently than ever today. But I think it starts with the fact that we made the investment in the talent and the capability to build out the relationships that sort of provide the bridges to do that. But at the same time, given the speed at which these technologies are advancing, we have to open up and avail ourselves to if there's another contribution or another tool that's out there that has relevancy to what our clients are trying to accomplish. We've got to bring that into the mix. So many of our leaders are increasingly more comfortable with not always being embedded here. And it's really also been complemented by our partnership strategy with a variety of both big and small vendors that are more commercially oriented than the federal.

Got it. Got it. The last question here in our final minute. But if you think about Booz's strategic consulting business and kind of how it informs your strategy, to what extent is being inside the [indiscernible] decision curve kind of allow you to make better investments versus peers? Or is that just something where all services kind of benefit from that sort of dynamic?

Yes, it's interesting. I began my career over 30 years on the strategy side. And I think that's sort of the underpinning of Booz Allen sort of legacy and history. Today, it's so integrated. I don't think we think of ourselves as a strategist and technologist, all one and the same. And quite frankly, our clients expect both simultaneously. So when it comes to your direct question about being in the sort of the chain, I think because of our emphasis on relationships, thinking over the horizon, trying to be the honest broker, I think our clients here are advice maybe a little bit different than others. But with that being said, it's clear that it's going to do something, you got to implement something, the things have to improve. And I think that more than anything is taking great ideas, but it really has to translate into a solution, and that's what we've been investing in for quite some time.

Got it. Got it. Well, in our last few seconds here, we should have some survey results from the QR codes, our investors in the room, maybe if we can get those up on screen. So far, results have been [indiscernible], still informative. No. Okay. No worries.

Thank you so much. Appreciate it. Thank you.

Thank you.