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

Okay, guys. My name is Sheila Kahyaoglu with the Jefferies Aerospace and Defense Equity Research team, for those of you who don't know me. And we have Booz Allen once again here. I don't have any ready remarks for your introduction, Lloyd, I usually do. But Lloyd is CFO and Treasurer of Booz Allen.

And maybe just to start, Lloyd, how are you thinking about the current market, given some of the recent budget trends that we've seen and your robust organic growth to start your fiscal Q1?

Thank you, Sheila. It's good to be here. Currently, just using our most recent quarter, as a litmus test, we're seeing strong growth signals on the demand side. Each of our markets was in positive territory led by our civilian business up overall around 27%, 12% organically, followed by Intel up 8% and defense up 5%. We have a very small global commercial component to our portfolio, and that was also up somewhere around 40% for the first quarter. When you look at other demand signals, our backlog was up about 6.7% year-over-year. And our win rates is an incumbent at 90% and for new work, 65%. What was a little bit curious to me was our bookings for the quarter came in at 0.72x, which is historically a lighter quarter over the course of the year. But we're seeing some volatility and a change in the traditional booking pattern, largely due to larger procurements that can come in at any point in our fiscal year. So again, the demand signals remain strong, even on a trailing 12-month basis, 1.2x for bookings and that typically is where I'd like to see us there or greater. So across the board, Sheila, a lot of strong demand signals, and that's given me a lot of confidence about building the momentum in the first half of the year.

And when we think about each of your 4 customer verticals, how do you think about the growth trajectory for your fiscal '23 and which one outperforms the other?

Yes. We haven't disclosed historically what we're looking at per business segment. But overall, for the year, each are projecting to be mid-single digits or higher. Historically, our civil business sees higher growth rate, higher profitability than the other 2, but -- just under 50% of our business is tied to defense services and agencies, as well as the joint combatant commands. So from my perspective, we have a very diverse business. I've been at the firm for approximately 34 years. And over the course of that period, those percentages have largely remain the same even with changes in administration. So I think we're looking at, call it, over the past years, sort of an increase in the domestic agenda, namely health. We've seen a nice uptick in our public health business, expect that to continue. But given what's going on in the world, defense and Intel will always be an important part of our portfolio. And so I would expect that to continue to be very strong.

Yes. And you've made some successful changes there, too. When we think about your fiscal '23 guidance, it's maybe a wider range than you typically have. So what are the sort of the considerations you have for the second half?

Yes. Over the past 2 years, if anything, I've learned that we're not in a very predictable environment. And as we looked at this year, there were a couple of parameters or variables that we had to take into account. One was COVID. We've seen over the past 2 years that namely during cold and flu season, there's a variant. It does have an impact on the productivity level of our workforce. And in the past, an impact up towards 300 basis points on available labor. Even with the current sort of summer variance, we're seeing about 70 basis point headwind to that. So that just gives you a sense of the range of what it could be. So that's one. Number 2 is the upcoming midterm elections. I think the current thinking is that the House or Senate will flip, if not both. Historically, what that has translated into is impasse on a budget or approval of a budget and the result is either repetitive CRs or an extended CR. Now that's not the end of the world, but it does have a dampening effect on the issuance of new work. And it also has a dampening effect on our client's eagerness to issue RFPs with extended periods of performance. So you end up in the sort of choppy issuance environment, both Booz Allen, our peers as well as procurement officials, this is not a new dynamic. It's one that we wouldn't prefer, but we all know how to compete in that. So it's just a more challenging procurement environment, and it does have a sort of a dampening effect on what it could be in terms of what we're experiencing right now with having a budget in place. Then we have sort of macroeconomic events like Ukraine, what may or may not happen with Taiwan, macroeconomic dynamics with inflation, the impact on wages and whether the government will continue to absorb that or not. And so those 4, 5 issues or what we see largely coming into having an impact on the second half. And that's why Horacio and I've said, hey, first half of the year, we have a cleaner line or sight than the second half. So it's so important for us to get off to a strong start in the first half of FY '23.

And going a little bit bigger picture, I've asked you this before maybe only 24 hours ago. But I like your answer so I wanted you to share. What makes Booz win and what do you think creates that organic growth so much above peers?

Right. So take this with a grain of salt, certainly coming from someone who's been at Booz Allen for a long time, but I really think there are 3 fundamental dynamics that contribute to our success. One is around process, two is our people and three is our culture. From a process standpoint, we are fundamentally looking to grow relationships with our clients. We have an 108-year history of doing this, 90 of which has been tied to the federal government. So we look at all our clients really through our relationship lens and are we providing the best counsel and advice to our clients. And the process by which we do that is years in advance of an actual procurement. We're engaged with them on what's happening from a technology perspective, an innovation perspective, how it impacts their mission requirements and how we can be of service to them. So years before there's a procurement, we're engaged in shaping -- even if it's a 50,000 opportunity to kind of get things rolling. That puts us, we believe, in our first mover advantage. And so as more larger procurements emerge, whether it's AI, cyber, we've been engaged with our clients for years on these various topics. Number 2 is our people. And I know everyone says they hire the best and brightest, and I'd like to believe we do, too. Because we are a people business, if we do not have the best product in front of our clients, we'll know pretty directly. And the issue with that is because we've been with our clients for as long as we have, these relationships have grown during that period of time. So it's not as if we can in hire the most recent retired General Officer and connect with a particular program, it really goes back to all levels of our workforce, engage with their counterparty and then growing up with that individual so that when they become decision-makers, whether it's procurement or on the technical side, there's a familiarity with our people in a relationship where when your own speed dial, that makes all the difference in the world. And then it comes down to our culture. We're a value-based culture. When I joined, we had 10 values and then we sort of collapsed a lot of them combined, and now we have 5. But it really speaks to doing the right thing in a respectful way and being a great citizen in the community. And that resonates with -- particularly with today's workforce. When you go to work and you're expecting your employer to have an opinion, a comment on issues that we're all seeing in the paper, being active in the community, treating one another with respect, valuing diversity. And that is actually carried over into our clients as well. So it's good for business. It's certainly good to recruit the right people. And we've seen that by sticking to that. Historically, we've been able to grow and outperform.

And maybe on the second part of your wide Booz wins, the people element. Hiring grew 5.7% in fiscal 2022. I think you ended at about 30,000 employees last year. How do you think about your hiring targets going forward? And how does your maybe recruiting and pay structure differ from competitors?

Right. So I'll give you the math. We go into every fiscal year targeting mid-single digits in terms of adding to our workforce and in particular, our client-facing colleagues. Over the past 2 years, that's been a challenge for a variety of reasons, tight labor market, individual candidates not wanting to necessarily make changes in the midst of COVID. And we saw a yield somewhere between 2.5% to 3.5%, a little bit below where we want it to be. It was offset a bit by low attrition because of the environment. But now as things are opening up, that's begun to change. So I'm super excited that in Q1 for our client-facing colleagues, we were up 3.8%. So it's getting closer into that mid-single-digit range, but at the same time, attrition has also picked up. So in addition to increasing the volume of hires, we're also focused on what retention changes can we make so that it's not running at the same pace as bringing folks on board. So the math is that if we're able to bring in FTEs in the mid-single-digit range, on top of that, wage inflation by our projections being somewhere between 3.5% and 4.5%, we get into that 5% to 9% organic range for the year. And so this is our operational priority. You may have noticed that we recently announced Kristine Martin Anderson as our COO. This is at the top of her agenda. And when you look at improvements we've made on the recruiting process, it's really stripping our way a lot of redundant steps we've had for historical reasons. Obviously, a lot of the work we do requires clearance and security. So we had like 3 different background checks. We don't need 3 different background checks. So we've taken those sort of rudimentary steps to improving the process. We've been able to shrink, which was sort of up to a 45-plus day dynamic down to 3 weeks. We've sort of streamlined decision-making so that we can just get that number of hires up. And so we're beginning to see that improvement, which has led to getting closer to mid-single digits.

That's great. And then how do we think about how you're targeting wage inflation? Your consulting revenues grew 6% last quarter, your headcount was up 5%, but your organic growth was up 8%. So is the delta that wage inflation we should be considering?

Yes, that's the bridge.

Okay. That makes sense. And then thinking about your profitability, actually, I'm sorry, I'm going to ask a simple question. I'm sorry about that. Civil growth, up strong 12% this quarter. How do we think what's driving that business? And how maybe the acquisition of Liberty has changed that portfolio?

Sure. So we've got 3 engines of growth or accounts in our civil business. One is public health. So that's all the HHS agencies, bureaus, including VA. We've got, what we call, citizen services which includes agencies like labor, agriculture. And then we have, for lack of a better description, law enforcement, DHS and FBI and whatnot. And each of those are positively contributing to that 12%, led by public health. It's the largest contributor to our civil business, has been for some time even when I ran our civil business. And in large part, I believe, supported politically by both parties, recognition that the country has been facing a lot of health challenges over the years and a priority domestically and otherwise. So the recipient of budget, recipient of political support and love our positioning in that, and I think that in large way has contributed to the 12%. Liberty was a successful transaction for us. One of the functional trends in the civilian market is a need for software development. Agile, I guess, is the banner, but within that, low-code, no-code development. And we found in Liberty, a company that really was in the forefront of low-code, no-code development, particularly in public health. So they were also supporting many of the same clients we were, are growing organically, low-code, no-code developers was far behind where Liberty was. And as Horacio and I have said, we think about M&A as an accelerator to our organic growth and this fit that strategy right out of the gate. So at the time, they had about 600 professionals. They had just won a significant IDIQ contract with a huge ceiling, and it really represented a lot of revenue synergies more than anything else. And I'm happy to report that it exceeded our expectations. So at the time of the deal, we were expecting $300 million annualized in the first year, finished at $340 million, as well as a nice margin and profitability pickup given that most of their work is on a firm fixed price basis that had very healthy margin profile. So across the board, accretive and not the least of which really contributing to the overall growth.

Within Civil, how big is the health business, if you could give us some whatever an idea? And what is Booz's primary function in health? When I think of health, I think of Leidos' veterans affairs. So who are your competitors there?

So just under $2 billion, including Liberty. Liberty at the time that we did the deal was about $725 million. So a nice pickup contribution in that regard. And I would say for the vast majority of our health clients has really been around IT modernization of legacy pen and paper processes that are underway. So we really have not only modernized many of their historical legacy processes. But on top of that, introduce data analytics, cybersecurity, AI, things that we believe are with the client it's going to benefit from. And quite frankly, what they would like to take advantage of. So it's really a mix of everything that's in our toolkit, Sheila. And really focused on legacy systems that the client has recognized that they need to update and that's really been sort of the fuel to our growth.

And then one on defense. It's accelerated quite a bit, but it's still one of the slowest growers, up 5% in the quarter. What are you seeing in this market? And I believe your new Cypress win with NASA is within defense. So kind of how do you think about your NASA relationship?

Yes. NASA, for us, we've sort of had an episodic relationship with over the years, but it's clear that NASA as they have been upgrading their sort of mission and relevance to us as taxpayers, they want to also take advantage of many of the advancements that are out there in technology. And so the award, we feel is a reflection of that, really combining cybersecurity as well as artificial intelligence toward what NASA wants to do in that particular program. If I take a step back from NASA in and of itself, it's actually a good example of what we're seeing across many of our DoD clients where historically, we were program managers, maybe staff augmentation oriented. But now just given the change in our adversaries, the threat environment, every single one of our DoD clients want to dive deeper into artificial intelligence, deeper into cybersecurity, leverage, commercial advancement, Silicon Valley startups, things of that sort to really feel that we're not only keeping pace with our adversaries but also having more of an advantage than we may have had in the past. That also has been fueled to what we talked about in terms of digital battle space. Conceptually, not a new concept. Even when I was much more junior, we talked about net centricity and how to integrate various platforms that are within the DoD architecture. The same thinking is at play. But now given the advancement in technology, how do we bring these advancements into a more integrated, more interoperable environment. And we like to be seen as one of the vendors that kind of is doing that in a very forward-leaning way. So for us, in our sort of footprint, we're working with our clients in this direction, working with our clients to not only do things in the near term like cloud migration, but how do we sort of take advantage of these innovations that are out there to current missions as well as future missions as their leadership has discussed.

Turning to margins maybe, I think we all forget how much you've improved margins since your last target was set. I think your framework now is stable mid-10 margins. Can you talk about some of the puts and takes with obviously volume and tailwind, but maybe some of these costs coming back as a headwind?

Sure. So our long-term guidance is mid-10s. And at the time, last October when we had our Investor Day, I had an illustrative slide that said, basically, what has gotten us here is strong contract execution, managing our costs, a bit of a tailwind because billable expenses were low, discretionary costs also low because we weren't traveling as much, but really sort of a solid foundation. On top of that, we had a variety of cost management initiatives underway to really get more efficient, reduce the redundancy and that -- the combination of those 2 essentially would present me the opportunity of about 100 basis points of investment capacity to deploy into these hyper growth areas, be it digital battle space or the cyber platform. And it was absent of any sort of quantitative number at the time. So fast forward to our FY '23. Q1, we come out of the gate at $11.2 million. And understandably, everyone wants to know, all right, how do you fall back to mid-10s? And I don't believe we fall back to mid-10s. That's where our guidance for the year is mid- to high tens, but a couple of other dynamics have emerged. One is that because things are opening up, to what expenses are now, we expect to be around 30%. So accretive at the top line, but nonetheless, having a dampening effect in margin. Number 2 is because we're traveling more discretionary and unallowable cost has also picked up. So again, not unexpected but just a reflection of things normalizing. That being said, starting at $11.2 million, it's also, I believe, going back to where we were pre-pandemic. If you looked at us in FY '19, you'd see that we come out of the first half pretty high in terms of margin, and it drops off in the second half. Why? Because that's the half we're investing in our people. We're hiring on demand, and we're investing in our IT infrastructure. So for the year, it kind of lands at a place that's a little bit below how we start for that fiscal year. And I believe that's the pattern we're going to be in this year. So will we spend 100 basis points? No. But it gives me the potential or the capacity should we ramp up faster to go there, but I don't believe we'll go there for the entirety of the year. I think it will be gradual. These other more systemic dynamics with business opening up, I think will be the new normal. And I think it will land us somewhere in the mid- to high 10s. So that's sort of my commentary on margin.

That's great. And maybe one last one on margins. Your target is to grow EBITDA 50%. Maybe if you could break that down how much of that is organic versus acquired?

Yes. I'm expecting what we said is about $2 billion deployed over that period of time in strategic M&A, and that will translate into $150 million to $250 million in EBITDA dollar growth. So that's sort of the rough math of how we'll get there. We're off to a good start, I think for Q1, $253 million out of the gate. And for the year, we're expecting to land between $950 million and $1 billion. So a strong start first quarter, got a long way to go in terms of out to FY '25, but I like where we are both in the annual guidance as well as the long-term guidance.

One last one for you before we wrap up, Lloyd. Of the $2 billion in M&A, how are you thinking about potential target areas and $150 million to $250 million of EBITDA is quite strong there. So there should be a certain margin profile with a company you might consider.

So when you look at our strategy, it's across our portfolio. So we've got small to midsized opportunities that we're cultivating, they are in the areas of system software development, data analytics, a little bit of engineering and science, some are market-specific opportunities, some are geographic, some are pure capability tuck-ins, but strategically very much in line with our Vault strategy, how do we sort of capture, add to what we may have already underway organically and accelerate that. We obviously are looking for these opportunities to be accretive across the board. So where we're able to replicate our Liberty acquisition. I guess, I would hold that up as sort of the case study, accretive across the board. We're realist, so we understand that every deal will go as planned. But at the same time, we're really being patient and disciplined as to what we're cultivating so that we have a higher chance of success going forward.

Thanks so much, Lloyd, for all that. And thank you, everyone, for listening in. Appreciate it.

Thank you.