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

All right. Good morning, everyone. I'm Brian Gesuale, senior analyst covering the government services space for Raymond James. Welcome. It's so good to see everybody. Still on the second day. Nice to see everyone in person. I'm delighted to have Booz Allen here to present their story. The CFO, Lloyd Howell, will be taking us through it. Timing really couldn't be better. The stock has been on a fantastic run here over the last few weeks, and we really think they're well positioned to deal with some of the geopolitical instability that we're seeing. So with that, I'm going to turn it over to you, Lloyd.

Great. Laura is going to read the disclaimer.

Hi. I'll try. Hi. Good morning. Before we get started, please keep in mind that some of the items we will discuss today are forward-looking statements which may relate to future events or our financial performance of the future and involve known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from forecasted results discussed in our filings with the Securities and Exchange Commission. All forward-looking statements are expressly qualified in their entirety by the foregoing cautionary statements and speak only as of the date made. 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.

Great. Thank you, Brian, and thank you, Raymond James, for hosting the conference. It's great to be here. Maybe a few high-level comments about Booz Allen, for those of you who aren't familiar with the business, and then we can jump into more detailed questions.

Perfect.

108 years old, 97% of our business is focused on the U.S. federal government, 3% on what we call global commercial, which is principally cybersecurity support to financial services, energy sector, a little bit of manufacturing, a little bit of retail. And I think rounding out the portfolio, life sciences. Of that 97%, about 47% is tied to DoD, 30% to the civilian federal agencies and the balance to our intelligence agencies. We primarily provide higher technical end solutions in the space of cyber, AI, systems software development, data analytics and engineering and science. If you look at the totality of our capabilities, about 2/3 of our business is in those areas, the balance in what I'll call program management, staff augmentation. And over the last 8 to 10 years, we've been diminishing our exposure to program management for the simple fact that we see better economic performance at the higher end of the spectrum as well as what we believe that clients are demanding. Our Q3 results, we grew top line 6.6%. That was really from a strong performance in headcount growth. Organically 3.6%, overall 6.8%. What makes up that difference is we bought a low-code/no-code company by the name of Liberty in Melbourne, Florida in our public health market. And so they've had a strong contribution out of the gate. We saw strong margin performance, 10.9%, in Q3. And that's really a function of strong contract execution, the ability to bill for fee in the intel market and, quite candidly, a low-cost environment since we're not traveling due to COVID. And then on a cash basis, area we need to pick up our performance. Though we had strong Q2 results, we saw collections drop where disbursements continued to rise also due to some employee expenses. So Laura, who's moonlighting today as our IR, is also our Treasurer, and so we're going to be laser focused on that going forward. In October last year, we updated our long-term guidance. We're really focused on growing EBITDA dollars by 50% to land around $1.3 billion by the end of FY '25. We believe we'll get there with strong organic performance in the range of 5% to 8%, and we believe we'll do that really in the mid-10% margin range. We also intend to deploy $3.5 billion to $4.5 billion in capital over that period of time. A difference in our deployment is also focusing on strategic M&A as a growth accelerator, not just for scale. I'm sure Brian will have some questions around that. But that's the long-term guidance. We feel our FY '22 is setting us on a path of momentum into that, and I look forward to your questions.

Great, Lloyd. That's a great level set, and we'll double-click on some of those areas as we move forward. I want to zoom out a little bit more on the macro to start with. Obviously, the invasion in the Ukraine is really ushering in an era of great rival conflict that's been in the making for a decade or longer with Russia and China. Can you talk about how you think that impacts defense spending, both the continuing resolution that's been an overhang but also the long-term defense spend as we try to cover both the Pacific and now a lot more resources back to Europe?

Yes, it's definitely a topic that I get asked quite a bit certainly during investor season. To take a step back, I think even prior to the pandemic, there was a lot of sentiment that felt that defense spending in particular was going to flatten if not start to decline, and we would have subscribed to that as well. No one knew where the inflection point and certainly no one envisioned a pandemic or an invasion. But here we are. We've had sort of a couple of CRs facing into what I hope -- we hope will eventually turn into a budget. And certainly, this conflict would be a catalyst toward getting defense and intel in particular kind of settled. So we remain optimistic that a budget is in the not-so-distant future. In terms of what that would be in terms of an increase, we're guesstimating 2% to 3%. Now with any sort of conflict, it's hard to envision how long it will go and then what the repercussions of that will be. We are not seeing any sort of immediate sort of windfall as a result of that. A conflict is a horrible situation. That being said, the clients that we do support that I do have exposure to are likely just to mod our existing contracts and we would continue to provide the support if not shift it to areas of priority. The longer it goes à la Afghanistan, certainly OCO funding would probably come into play. Historically, we have not had a great deal of exposure to that, and I wouldn't envision that we would should that come to pass. But we're early days of the conflict, and we're hopeful that it will be resolved peacefully without a lot more loss of life. But in terms of defense specifically, we would envision that there'll be a lot of energy to get a budget in place, and then we're expecting sort of a 2% to 3%-plus increase to that.

Great. So maybe if we talk a little bit now about some of the capabilities that Booz Allen brings to the table during what we think is this great rival conflict, really critical areas such as artificial intelligence, directed energy, certainly a really amazing cyber skill set. Can you talk about those areas, maybe frame those up a little bit for people to understand how they mix into your portfolio and some of the things that you're doing that you're able to talk about?

Yes, building upon some of my opening comments, we've been on this journey into these areas for quite some time. And the demand signals have also been forcing us to think through solutions on an integrated basis. So though everyone wants me to itemize, well, how much cyber do you do, cyber's actually table stakes for everything we do. AI is a perfect example of that in that you have to have cyber systems software development, change management, all of these in an integrated way to support the demand and the needs of our clients. So in aggregate, if I look at our workforce, it really had shifted where about 2/3 of our workforce are in these technical areas and the balance, as I said, was in program management and maybe some staff augmentation engagements that we have. The demand signals as we see it are very positive and very strong whether you're in DoD, intel or the civilian markets. The SolarWinds incident is a perfect example of though our intel and our defense clients are fairly sophisticated, fairly mature in what they have done, our civilian clients have room to improve. And so we are supporting programs in that market as well, in particular cyber related, to provide that type of support. So those are the skill sets. Growth rates in these have been strong. The economic profile, it sort of garners a higher profitability than others though were capped by the fee range on any contract type. We tend to be able to operate at the higher end of that based upon these capabilities as well as the talent that we're recruiting to provide that support.

Great. Let's maybe double-click back to the recent activity. Your bookings have been exceptional. I think backlog was up 19% year-over-year in December, and your hiring has accelerated more recently. Revenue conversion has been a little bit slower to matriculate. Can you talk about and maybe quantify some of the reasons for that revenue lag? And we see them as very transitory, so maybe talk about the timing for those to reverse out.

Yes. We're -- we've been in this environment, call it, 2 years where there's just been a lot of volatility, a lot of choppiness at the top line. So we're always looking at the demand and the supply signals. And you're right, on the demand side, backlog up 19% year-over-year; trailing 12 months bookings, 1.28x. And even on a quarterly basis of 3.9x, sort of seasonal pattern. So those things look solid. Win rates also look solid. Recompetes, around 90%. New work, at about 62%. So nothing on the demand side, even the conversations that we're having with current and prospective clients, wouldn't lead you to believe there's anything wrong in the market. On the supply side, we saw Q3 of our FY '21 really the need to pick it up when it came to recruiting. And so over the course of this fiscal year, we saw really good improvement in that. As I said in my opening comments, organic up 3.6%, overall 6.8%. So what's creating the choppiness? Well, one is Omicron. So we saw sort of in the fall/winter months of last calendar year the emergence of Omicron. That resulted in a spike in PTO usage. Utilization dropped. And so that, from a workforce perspective, we saw productivity drop back. Number two, when you look at sort of the release and the ramp-up of awards, a little bit slower than what we were expecting. So we saw a -- in some cases, a shift to the right. But even with work that we've won, just slowness in ramping things up. It's hard for me to sort of articulate the exact reasons why other than in this work remote world we're in, things just move a little bit slower than I think anyone would like. Processes are working, but they're just not working at a pace that we had hoped that it would. Our clients are aware of it. We're aware of it. I think it affects the sector overall. But it is what it is, and so that contributed to it. And then more on a sort of an accounting or a financial perspective, billable expenses still a bit of a headwind in terms of contributing to the top line. At Booz Allen, we're really focused on revenue ex billables, so it's empty calories to us. But nonetheless, it contributes to the choppiness. So that's really been why the conversion hasn't occurred at the rate that we had hoped. On a go-forward basis, some of these headwinds, we think, are going to subside. We're looking at our FY '23 and almost half a year there's still some COVID overhang. And in half a year, we kind of finally get on the other side of this. So those are the dynamics. And we would expect with that sort of shift over '23, what are now headwinds become tailwinds, and we get back to more consistent top line conversion.

That makes a lot of sense. Your -- let's -- I want to talk a little bit about your intel business. It's been a bit choppy. It kind of bottomed out the last couple of quarters but seems to be accelerating or improving at a really nice rate here. Can you talk about your outlook for that? And then maybe just tie it in as we think about all the intel activities that are starting to go around the world globally, how that might impact and -- plus some of the existing contract work that you have.

No, no, thank you for asking the question. Usually, I was asked, like what's going on in intel? So it's good to get the question on the other side. Just to level set with everyone, we've got 3 accounts that make up our intel business. So what we call national agencies, cyber and then defense/military intelligence. National agencies has been going well for quite some time. We were able to work with those three-letter agencies to basically, as we bring on talent or awaiting clearances, they can still be productive. They get their clearance and then they go into whatever classified program. So from a headcount standpoint, which is really a challenge in this market overall, we sort of worked through a way to kind of take on the clearance -- awaiting clearance challenges, and that's been going well. In our cyber account, it was really sort of a contractual dynamic in that we are waiting for a recompete RFP to hit and had been delayed. And in the process, we saw expansion, but it was slower than if you actually get the recompete and then you commence with the new work. So we had continuity with the work, but there is -- really wasn't a whole lot of upside. That's beginning to change. We're seeing the resulting improvement there. The real laggard was our defense/military intelligence account, where we were overly tilted towards staff augmentation and program management. And what has happened there certainly going back probably 1.5 years was we began to reshape how we approached clients, what we were shaping to do in terms of the type of work. And now we're starting to see awards come in, so we saw a pickup there. So of the three legs to the stool, they're all now moving into a much more positive posture, and we're seeing that play out certainly on a quarterly basis. To your macro point, we are seeing and sensing those demand signals as well. Obviously, I can't speak in this forum to what the specific programs are, but it's across the board. And I think there is a recognition of the shift of who our adversaries are, what their sort of attack or posture is with America and our allies. And so we're assisting those agencies in both offensive and defensive things.

The intel budgets are typically growing a bit faster than the core market. Is this something where you expect your intel business to be able to grow at a faster clip than the overall Booz Allen core or about in line?

In line. Even from where they were coming from to where they are today, we're very pleased with that improvement. And when we looked on sort of our long-term guidance what their contribution would be, very solid and in line with the other markets. So from that standpoint, we're feeling really good. Now if we can do better than that, we certainly will update our guidance and tell you why. But at this point, we just really improved that. When we look at what they're able to do, current positioning, go get, all of that is looking a lot more stronger than it has historically.

Fantastic. I want to move to hiring and really hit this from a couple of vectors. First, a little bit on how tight are the labor markets and what does employee turnover look like. But also, I'm curious with the pandemic if your delivery model can change over the long term now you have lessons learned that you can deploy going forward that were really valuable in the way you delivered services during the pandemic.

Yes. The labor market is extremely tight, especially for these skill sets. They're hard to find. I think every candidate we talk to has got certainly half a dozen offers that they're considering. A mix of really private sector as well as public sector. If it's a private sector offer, it's very rich both in terms of cash and equity. So we're facing into a very tight labor market. And why we've been able to win up to this point is a couple of reasons. One is about 30% of our candidates are employee referrals. So our current employee base is actually sort of vetting and referring folks. So by the time they get into the formal interview process, it doesn't take like 50 rounds. One round in both the candidate and we are typically sold. The other big source is the government itself, particularly DoD. So as uniform or civilian folks punch out at 5-, 10-, 15- and 20-year points in their career, they're typically looking to go into the private sector but yet still support the missions that they've grown up with or that they have a lot of passion around. They also typically know Booz Allen because of our years of relationship building and experience. So there's already a great deal of familiarity, and we're able to close on those candidates as well. The balance is a mix of folks who are interested in leaving the private sector, maybe seeking greater work-life balance that particularly is an issue in today's workforce given COVID and being remote and having flexibility. We get a few but not a great percent from our industry peers. Largely, if there's a contract we win, lost, people will flip badges, but that's not a great number of folks. So all of that is sort of what contributes to what we've been able to post. And we have found that even in the midst of COVID, we just have to be super aggressive with letting people know we're hiring, talking about what the benefits are, our culture and repeat, repeat, repeat. And so that's really been the driving force. What have we learned in COVID, which I think gets to the sort of delivery model, is we have to have greater flexibility going forward. We've been working our way through that every time we think we're about to open, sort of that take a step back. We're now launching into our future of work program where we've been able to really think through how can we still support our clients with more of a hybrid model than on-site every single day. Naturally, we need to coordinate with our clients, so we have a lot of discussions with them as to what their plans are, what their wishes are, and then try to come up with something that's a win-win. And I'd say that our clients, particularly in the intelligence community, they've been very sensitive now to the talent flight because they're experiencing the same dynamic as people leave the government and go into the private sector. So they don't want to lose the talent in their perspective as well. Inflation. Inflation is here, and it's real. If you look at our Q3 results, we grew FTEs 3.5%, and the inflation factor on top of that was another 3.5%. So we sort of are accommodating it at the moment. The government has been willing to pay for that, but we're not making any assumptions about that going forward. So we're talking to our procurement officials all the time about what are they saying, where is their temperature, where we have to make adjustments. But at the moment, the government has been accommodating that really because of the contract types, cost reimbursable, time and material.

Right. No, that's what we're hearing, too. And I think we view this space as a bit of an inflation hedge because you're able to pass so many of those costs on to the government. I want to maybe take that in context and transition to your longer-term margin outlook. Can you maybe remind investors where margins are today, what your outlook is over the next few years? And then maybe weave in the free cash flow conversion cycle and how -- what your targets are there.

Sure. So we raised our guidance for margins to be about 11% for this year. And then the longer-term guidance is 10.5%. So Lloyd, what's up? All right. So this is the -- how we're thinking about it. The bit -- the parts of our -- contributing to our margin in that was going well. We still expect that to continue going forward. And that's contract execution, the sort of mix shift, contract mix that we're seeing. Fixed price is up a little bit from historical levels. It's really due to the Liberty acquisition. We have some aggressive cost management initiatives already underway and also planned for the future. So if you look at what I said during Investor Day, I said, "Hey, 10.5% is sort of our going-in position, and with continued strong execution plus the cost management initiatives we have, I wanted to create basically about 100 basis point where I can invest back into the business," in particular what we believe are hyper growth platforms in the area of digital battle space and cyber. We have others sort of in the works, but those are the two that are most mature at this point. So that's how we're thinking about margins going forward. So at this point in the journey, 10.5% is where I am, but the dynamics are there are sort of puts and takes but really with an eye toward investment. So could it be greater than that? For sure. If we somehow overachieve on the cost management initiatives and really don't use up the 100 basis points at this point in the journey, yes, we can get north of that. If we see greater sort of contract mix due to Liberty and maybe other future acquisitions, that could be the case as well. But at this point, in terms of giving everyone an indication of where we're going, those are the dynamics around margin.

Well, it wouldn't be the first time you've outperformed.

Well, that's the game plan. Free cash flow. So even though in Q3 we did not do what we had hoped to do, we're still targeting 100% free cash flow conversion, and we believe that we will get there based upon efforts already underway and an improvement on what we did in Q3.

Okay. Fantastic. I want to shift maybe to one of the things that's been -- maybe one of the most significant message changes that I've heard since covering Booz Allen, and that's capital deployment and M&A. I think last year, you deployed nearly $600 million largely towards buybacks and dividends. You've clearly messaged that you want to do more acquisitions in the future. Can you talk about what's driving that change and what types of properties you'd be interested in and looking at and how they'd fit into the Booz Allen culture?

Sure. So if we take a step back and we look at our balance sheet, over the years we've been strengthening our balance sheet and in particular our cash generation. So when we think about it in terms of deployment, we've always had three levers: repo, dividend and M&A. I've always described our M&A posture as really looking for capability tuck-ins where we're confident on strategy, confident about integration and the math makes sense. So what's not different are those guidelines. What is different is we're looking at M&A to accelerate our strong organic growth posture. So it's not for scale. It's usually aimed at where we've already begun to develop capability and we could see an opportunity where we can accelerate that. The Liberty acquisition is a great case example where we were already developing low-code/no-code capabilities. But with familiarity with Liberty, with knowing them in the public health market, with being impressed with what they brought to the game, the acquisition made a lot of sense strategically from a cultural standpoint and mathematically. So that's what we're looking to do. Our pipeline is building around small to midsize opportunities spread across the portfolio. So we've got every sort of version of an opportunity in there. Still in the small to midsize, still staying true to strategically and culturally what we want to do. So would we stretch if like a great, larger opportunity came along? We would. But it would really have to be spot on and we would really have to lock arms around that. So we are on the journey, kind of new kid in the block, so to speak. But we've had some recent success, we believe, with Liberty, Tracepoint and then some smaller spinoffs. So we're building the muscle.

Well, we'll trust the process. So, well, this is the end of the formal program. A lot of times, I want to give you the drop-the-mic moment. This is where they get to hear straight from the boss' mouth real quickly the message you want to leave -- the audience to leave with. No follow-up for me, and we're going to head to the breakout room as soon as Lloyd finishes up.

Thanks a lot, Brian. Booz Allen is a growth company. Historically, we've always been focused on growth. Our long-term guidance is in that same mode. We're looking to continue to outperform the market. There are certainly a lot of variables that are contributing to some of the choppiness at the top line. But we've always been focused on things we can control and deal with as best we can the things we can't. So we said our top priority was recruiting. Even in the midst of a tight labor market, we're seeing success there and, at the same time, continuing to win. So we remain confident about our long-term prospects and the basic foundation that we're building from. So thank you very much.

Thanks, Lloyd. Thanks, everyone, for joining us. We will be going to the breakout room.