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

Good afternoon. I'm Louie DiPalma, I cover Booz Allen and the broader aerospace and defense sector on William Blair's equity research team. This is day 3 of the 42nd Annual William Blair Growth Stock Conference. We're pleased to be hosting a 30-minute hybrid slide presentation, fireside chat with the Booz Allen management team. Following the session, there will be a breakout in the Alder -- or Adler room. Joining me today are CFO, Lloyd Howell; and the Head of Investor Relations, Laura Adams. This is the third year in a row that we have had Lloyd present at our conference. And as a side note, Booz Allen was actually founded here in the Chicago suburbs approximately 108 years ago. So this is a homecoming in that respect for Booz Allen. But it goes to show you that this company has been around for a very long time. And it's very versatile and technology changes, and Booz Allen has been able to change with the technology. And Laura will say a few prepared comments.

Yes. So the exciting part of this presentation is before we get started, some items that we discuss today are forward-looking and relate to future events or future financial performance and involve known and unknown risks and other factors that may cause our actual results to differ. So back to you.

Thanks, Laura. Thanks, Louie. It's good to be here. Good to see some familiar faces I haven't seen in person in quite a while. I've got some reasonably high-level slides to run through just to orient you all if you don't know Booz Allen, and then Louie has got some really hard questions he's going to ask me and I'm going to try to answer. Our history does indeed go back to Chicago. We are in the government services space, principally focused on supporting DoD, civil federal agencies and the intelligence community. What you can see from this slide is that our presence in the federal market goes back to World War II. We originally supported the then Secretary of the Navy as they were grappling with strategically what and how to engage our adversaries. Since that time, our firm has grown steadily in the federal space. At one point in our history, we also had a strategic management commercial business, which, in 2008, we spun off with the help of the Carlyle Group, and then went public in 2010. Carlyle ultimately wound down by 2016. And most recently, we've been a little bit more acquisitive than what we've been historically, looking for capability tuck-ins in the areas of cybersecurity, system software development, a little bit of engineering and science. And you can see on the slide what some of those transactions look like. Why do we invest in Booz Allen? We think we've got a super compelling story when it comes to our organic growth history. We view ourselves as the organic growth leader in our sector. As I mentioned previously, we're looking to augment, complement that with capability tuck-ins. But our growth is really stems from the fact that increasingly, we're close to our clients' key mission. We understand their requirements. We've got a significant amount of tenure with these clients. So we've built up relationships over a long period of time, and we're able to introduce innovative ideas, concepts to them which keeps us very sticky. Financially, we have a very strong balance sheet. We're looking to put that cash to use increasingly. And given our capital deployment, we feel we've got the right 3 levers to do so, which I'll get into in a minute. The other thing I would share with you is that we're in a very large addressable market. So that's roughly $8.3 billion in revenue, we see a tremendous amount of upside to support the federal market and our clients that make that market up. We've got a very diverse team, also very tenured. Each of us have been in one another's shoes. And either I'm the CFO today, I used to run our civilian federal business, which Kristine now our current COO has run; Rich Crowe. Kristine, myself have worked together, as an example, over the past 20 years. And so each of us know and have experienced what's going on in one another's market. Roughly about 30,000 people worldwide, very educated, also holding about 70% of our workforce clearance is at a high level, which, given the markets we support, is really a table stake. Our growth strategy, VoLT, is an extension of what our previous strategy was, which was called Vision 2020. The first velocity, we want to do things faster than what we've done in the past. Given that we're increasingly more technically oriented with a set of offerings in that space, necessitates that we look for ways to bring solutions to our clients in the faster and faster capacity. We need the right leadership to do that. And lastly, it has to be with the right technologies that our clients are demanding currently and what we expect that they'll be demanding in the future. So VoLT is really, for us, the extension of where we've been and doing things in a much faster capacity to meet our clients' needs. The capabilities that we offer stem from what these are really the basics to what we do. Analytics, obviously, digital solutions, engineering, cyber consulting, all bringing that together toward what our clients need. I often get asked, well, how much cyber do you have? And we really don't look at it that way as much as it's table stakes to what our clients want in terms of support. And so the combination of these different capabilities allow us to support our clients and the things that they need supported. Our business is made up of the following markets. About 50% just under in defense, all the major services and joint combatant commands. Our civilian business, federal, Homeland Security, HHS, this is sort of waxed and waned in terms of who we support. Over the years, we've been able to narrow who we support really based upon what departments receive bipartisan support, therefore, their resources to do what they want, which departments are implementing and seeking support in the technical areas that we provide and where do we have a right to play and a right to win. And so over the years, what could obviously be many, many, many agencies and departments, we've narrowed it down. Intel, all the major U.S. intelligence agencies as well as military intelligence. Over the past couple of years, we've worked to improve the leadership within that team, focus on the capabilities that are in demand, and we finally have begun to see an inflection point with -- into positive growth territory. And then rounding out the portfolio, global commercial. This is not the traditional strategy management consulting work that we spun off in 2008, but it's really principally focused on cybersecurity to really multinationals that emanate from North America. Have a small presence in many of the Western European countries, again, extensions of what we're doing in the states. And we recently unwound our presence in the Middle East to focus on our North American clients. We've had strong financial returns over the years. If you look at in the upper left, what we've done in terms of organic growth, you can see we had a CAGR of just under 7%. Margin expansion also about 140 basis points from FY '17, traditionally strong cash flow generation and increasingly levering our 3 capital deployment levers, most of which culminated in about $1.5 billion in FY '22. Our capital deployment strategy as I've mentioned, includes not only quarterly dividend, but acquisitions, again, to accelerate our organic growth, repos and then smart capital expenditures really aimed at modernizing our infrastructure and supporting our people. Over the years, we feel that we've outperformed the market, as you can see, in terms of our total shareholder return versus our peers as well as in broader indexes, and we feel very proud about that. The reason we've been able to do that is historically, we've had strong backlog growth, and you can see it's steadily been rising over the years. 3 components to that, funded, unfunded and priced options. We internally look at priced options as a leading indicator of not only our client satisfaction with us, but also their optimism about future tasking that they would like to initiate. We've got about 4,600 task orders and contracts that make up our portfolio, not any one of which is greater than 3% of the overall value. And so very resilient, and our win rate is 90% as an incumbent, low 60% for new work. And so we're obviously winning more than we're losing, but we also had a lot of resiliency over the years. And then our historical book-to-bill pattern, really a reflection of the government fiscal year. On a quarterly basis, you'll see that it builds in our Q1, peaks typically in Q2, falls off in Q3, and then we start the cycle all over again. Contorting a bit. Most recently, the government has been bundling, legacy task orders with new task orders and then issuing that, very large procurement, typically $1 billion-plus. And some of those we cited in our last earnings call. Number two dynamic is because of the enterprise nature of the IT solutions, they're naturally coming out as larger and larger procurements. So still a pretty robust protest environment, but these larger procurements, winner takes all, which is also contributing to the protest, dynamic. ESG, very important to us. We get high grades on the social aspect, as you saw with our leadership team, very diverse. We have a significant number of women that are in not only our executive leadership team, but also on our Board. And increasingly, we're looking for ways to improve on the E and the G portion of ESG. Real quick. Those are the results, which you can see, another strong year and looking to repeat that in the current year, which look for us, April to March.

Thank you. And you mentioned how one of your task orders is 3% of revenue, your largest task order. Is that your eMAPS to machine learning contract that you just recently won?

It's not. It's in our classified space, and that's all I can say about it. But it's a long-standing contract that we've had for a number of years, supporting one of the major 3-letter agencies. And it's been probably in place for as long as I've been at Booz Allen.

Nice. Yes. I think that's in the 10-K, which is good. One of the hot topics, perhaps the hottest topic as it relates to you is the tight labor market. And on one of your prior slides, it showed how there are 29,000 Booz Allen employees, and I think you have 26,000 consultants that range from data scientists, cybersecurity experts, like data analytics experts. And the labor market is tight, and it impacts your ability to recruit talent, which is one of the major drivers for your revenue growth. Can you share how you are able to continue to recruit and compete against other, like, technology firms that are also trying to recruit these same software developers?

Sure. So just some context setting. If you look at our financial performance, we believe we're not demand constrained. The growth in our backlog, our win rate, our bookings all to us indicate that the market is solid. There's demand for the type of support we provide. The governor, to Louie's question is really, "Can we bring on the talent to convert our backlog?" In terms of conversion for the funded portion, 100% short of a cancellation, the combination of unfunded and priced options 60% to 70%. So if we do indeed bring in the talent that has the capabilities we need, we'll hit sort of my guided range of 5% to 9%. So what do we target? We target mid-single-digit every year. Last 2 years, because of the pandemic, below that. Our exit in '22 organically was 2.8%. We had taken some folks out of the business. If we had not done that, we would have been 3.6% organic year-over-year. So we're within range at the bottom end of that. The bridge is that if we target -- if we bring in 5% to -- 4% to 5% organically, combination of wage inflation that puts us into my guided range. So how do we get there? We've got a bunch of levers, not any one of which is a silver bullet. The first is 30% of our candidate pool comes from our own staff. So we've got a very vibrant referral program, which is great with the assumption that we've got great people. They know great people, and we can get them in the door and get them as productive right away. The other categories that we have or the other sources that we have, the government itself, particularly DoD. As folks leave the government at the 5-, 10-, 15-, 20-year mark, they still want to support many of the programs and missions they worked on. They have familiarity with Booz Allen because we were supporting those programs. So it's a natural bridge for them. They still want to do what they've been doing, albeit from the private sector, and we're an attractive employer in that regard. The balances for our competitors should we win a contract, there's some -- a modest amount of badge flipping, but that's not the predominance of what we do. And then folks who are previously or currently in the commercial market looking for a different sort of work-life balance mix than maybe what they have currently, which leads to flexibility, hybrid, remote, all sort of table stakes in today's job market, which everyone is looking for. On the retention side, we've invested in our training and development programs. So it's one thing to get the great talent in the door, but we got to retain it. And we have seen that. With these programs, folks can get repurposed, reskilled. They find that attractive. And whether they're with us for 5, 10 years, or my case, 34 is irrelevant, but we can keep them in today's job market a little bit longer than we would otherwise. So it's a variety of things both on the recruiting end as well as the retention.

And there was a slight reduction in your headcount in the March quarter. Has the labor market improved into the spring and the summer? And can you talk on your high-level headcount trends?

Yes. For us, the fourth quarter, as I just mentioned, was us taking out some unproductive folks or people in markets that we are trying to diminish our exposure. We believe we're back into a prepandemic sort of hiring attrition cycle. And for us, that means the pretty robust hiring in the spring through the fall. As we get into the holidays, folks really aren't looking to make a change. And then come on the other side of the new year, folks then may typically make a change. We dispersed bonuses in June, and we'll see some attrition post the bonus season. But that's where we are. And so we're expecting to have a nice positive yield going forward.

Nice. And how quickly does headcount growth flow into revenue in terms of onboarding? And how does that translate?

So we have 2 categories when we recruit, sold and funded positions, and then capability hires. The sold and funded positions on Day 2, they're productive. Now do they get to the utilization target right away? Typically, it takes like 5 business days, but they're off and running. It's [ sole-funded work ] We've got the positions, we find the candidate, the way to go. Capability hires, as short as 30 days, as long as 60. We do those in the hard-to-find skill sets where we're envisioning. We see what's in the pipeline, they go get. The labor market itself says if you find such a unicorn, you got to hire them. And so that's what we do. But those are the sort of the ranges of how quickly or how long.

And you began your presentation by saying you saw many familiar faces in the audience. And many of these faces in the audience, they owned Booz Allen during the time period from 2015 through 2019, like the glory days of Booz Allen in which you had like double-digit organic growth. And you just made the comment on how the demand trends have been robust, and you can see that in the slide in terms of your year-over-year backlog. And you've suggested that the hiring trends are starting to resemble like prepandemic. So I was just wondering, what is the difference now in terms of supply and demand versus 2018 in which you had organic growth of 11% or 12%? Is demand today not as strong as demand in 2018? Or is the supply of talent, even though it's better, just not as strong? Like what prevents your 5% or 6% organic growth from being back at 2018?

Right. So that we internally refer to as the payoff period. So 2018 is great. And what were the conditions at that time? Well, we had on the demand side probably still a certain amount of political friction, but we were positioned against the right programs and the right areas that were also in demand for as long as you could see. So all that to the good. I think on the supply side, we had an easier flow. Yes, the job market was still tight, but candidates were switching to new employers. We were positioned well, and the math ended up being what it ended up being. So what happened? Well, there was this thing called the pandemic. It really threw a wrench and -- on the supply side. People were not changing employers and didn't really want to. And so we had to adjust. And I think the investments we made on the training and development side are going to bear fruit as we get back to what I consider a more seasonal pattern to recruiting, I like our chances. The demand signals are there. So really, the governor of getting back to the glory days or the new glory days is really getting the folks in the door, getting them productive as soon as possible and the way we go. But we've got the right capabilities, right programs. We're winning at a good clip at historical levels. We just really got to improve on the supply side.

Great. And another topic, how does inflation or wage inflation in general, how does that impact you?

So we've got 3 contract types, cost reimbursable, about 53% of the portfolio; time and materials around 1/4; and then the balance being made up in fixed price. What's unique about cost reimbursable and time materials is we can pass. The government is willing to pay for the inflation. And the reason for that, if you look at the procurement process, it's really -- I'm going to grossly generalize here, but 2 steps. If it's an IDIQ vehicle, which is really a license to hunt, in the pricing submission is a menu of all the labor categories with an associated wage inflation index or a factor. The government looks at that and all the bids and it says, is it reasonable? And typically they say yes. So now the folks through the first gate have a license to hunt, so along comes a task the opportunity. I have to be smart on how I mix and match those -- that labor to be competitive and hopefully provide value in the eyes of the client. So the government gets 2 bites of the apple. One is a reason less. One is in the function of for the technical response, does it have the right support, I've already signed off on the labor categories and the inflation. So that's how it gets absorbed. Fixed price, they just want the product to date certain within budget, and then I have to figure out a way to deliver that as profitable as possible. So at the moment, it's passed on, but we live in strange time. So we're talking to our procurement officials. We're seeing, if anything, is going to change, where we might have to adjust our strategy at the moment. That's how we're able to get it through.

And as it relates to this discussion of wage inflation, what are the different puts and takes and margin drivers for you? At your Analyst Day back in October in New York City, you laid out like a 3-year margin path. What are the different drivers there?

So steadily over the years, many of you used to ask me about margin all the time. We've been able to see it improve for a variety of reasons. One is our market leadership is not only looking at the top line of opportunities, but also the bottom line. So we're executing in a more profitable way. And though we're constrained by the contract types we have, it's at the higher end of the fee range. And we're also committing less sort of self-inflicted wounds. So deliveries improve, and we've got forward leaning sort of market leadership in that regard.

So when you negotiate your, like, cost-plus or time and materials contracts for, like, certain value-add type artificial intelligence or cyber, you're able to negotiate the plus portion of the cost plus, too?

In some cases. I mean because of the nature of the pricing submissions, what's typically weighted in that regard is your technical response or approach. So that's weighted more heavily than, say, pricing, which all the sort of [ backroom ] is really about -- and we're going to have the right talent given the price ranges that you've got, given the inflation factors that are in there and as your response -- your technical response deemed better than other folks. And so that's what the key differentiator is in those case, it's not price in and of itself, right? Now when we were in an LPTA environment, yes, pricing was like the #1 criteria because response was deemed equal across the board. But back to your margins. So stronger delivery, go get, managing our costs better. I suspect those things will continue to remain going forward. They also -- our contract mix shifted with the acquisition of Liberty. So if you've known us for a while, it used to be in the sort of high teens in terms of the fixed price percent. Now it's in the low 20s, and that's really due to the Liberty acquisition. So higher margin profile contributed to better margins. Over the past 2 years, billable expenses were lower, so that helps in the margin level, and we weren't traveling. So -- and then costs were low. I suspect -- and you probably heard this on the call, that'll begin to normalize as things open up. So then that will become a headwind to margins, and our costs would presumably rise a little bit as well. So that's the logic behind the guidance of mid- to high 10s versus our exit of [ 11-2 ].

Does work-from-home impact your margins? So are your employees able to work from home and serve the customers?

So we went into the pandemic virtually almost it feels like overnight. So within 5 business days, 30-some-thousand people, like, started working from home. What we're finding as we emerge is that it's really looking like more of a hybrid environment. Our...

So is that a good thing?

It certainly is a good thing in terms of what the labor market is requesting. It's been a good thing in terms of productivity. It's a challenge in terms of culture, retention, maintenance, relationship building, all of that. Things feel more like transactions as opposed to let's-go-grab-a-bite to eat, how are things going, things where relationships really get built. It's a challenge in terms of elbow-to-elbow with prospective clients and current clients. So I used to live in the cafeteria of all my clients, can't do that. We haven't been able to do that in the past 2 years. So there are puts and takes. And to be fair -- so our journey is we are constantly evaluating are we in an optimal position or do we have to make additional changes? So we're encouraging our people to come back. We haven't mandated folks return to the office, but offices are open. And bit by bit, more and more people are coming in.

Great. And the defense budget has also been a big macro topic with the Biden administration. And it seems to be a very strong preliminary 2023 budget with a lot of geopolitical conflict. When you scout out your bidding pipeline and the different opportunities, are you able to grow, like, at a spread that's faster than the budget such that if the top line of the budget is growing at 5% or even 10%, should Booz Allen have an alpha of, like, 3% above that just because you're able to scout out the fastest-growing programs? And that's how you've been around for so long is that your business development team says, "Oh, artificial intelligence is growing the fastest, cybersecurity is growing the fastest." So we're going to invest in those fields. Is that -- how do you think about?

So historical context, if you look at our CAGR, going back 20 years, and you look at the sort of federal budget profile, we've grown 10% over that stretch of time. And what that looks like is 2% to 3% better than our peer group as well as what the budget is. And I'd say with a modest amount of strategic planning, insight, sensing, technical trends, we have been able to jump on the emerging technical waves that have looked like cybersecurity, have looked like artificial intelligence, that now looks like of 5G. And the mechanism internally that has allowed us to get there is we stood up a strategic innovation group 10 years ago. And their sole mission is to scour the landscape, spot trends and then ask, "Is this relevant to what your client's mission is and what you're trying to do?" We've also complemented that recently by taking investment stakes in small start-ups. The government, especially DoD, is one that access the Silicon Valley. Technical advancements, it's been difficult, it's been challenging for them to do that. So we're, in many ways, a proxy for our clients to get at the technical advancement insights that they otherwise wouldn't be able. So it's a mix of lots of different things, which I went through in the presentation, but it's really what's going to facilitate the mission of our clients.

Great. And one final one. We only have 30 seconds. But you mentioned how you believe now is the right time for M&A in that you're fairly quiet in terms of M&A over the past decade or so. So what conditions are present in the market that are making you want to do deals?

A couple of factors. Since my tenure, we've been steadily strengthening the balance sheet. We've been looking for ways to generate cash in a more consistent basis. Every now and then, we have a little bit of a hiccup, but I'm comfortable on that path. So having the cash to do something with has been a first step. Number two is that we sense that there will be greater volatility in general in the market. And for companies that we've either teamed with in the past, as they're considering sort of their off-rent options, we want it to be seen as a possible destination. Number three is we've historically had very strong organic growth, which the institution has been principally focused on. And we're looking for ways, back to our VoLT strategy, to accelerate that. And if we can make smart capability tuck-ins like we did in the case of Liberty, it will actually accelerate the growth rate for not only that capability, but for the business overall. And so that's been the rationale in what's been behind. We're not looking for transformative acquisitions or deals. We're just looking for ways to maybe get a step function change in a positive way around certain capabilities.

Great. Thanks. Thanks, Lloyd. Thanks, Laura. Now we are going to make our way to the Alder Room for the breakout session. Thanks.

Thank you.