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

Hi, everybody. Thank you for joining us. My name is Ryan Fenske, I'm the High Yield Services Analyst here at BofA. Pleased to have Booz Allen Hamilton joining us today. From the company, we've got Matt Calderone, CFO. We also have Laura Adams, Treasurer; and David Dudish, Senior Treasury Manager. So I'll turn it over to Laura for a sec for some commentary.

Yes. I'll just start off. Good afternoon, everyone, or good morning, I should say, nice to see everyone and thank you for joining. Before we get started, just wanted to open it up with a disclaimer. Please keep in mind that some of the items that Matt will discuss this morning are forward-looking and may relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from forecasted results discussed in our filings with the SEC and on this webcast. 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. During today's webcast, we will also discuss some non-GAAP financial measures and other metrics, which we believe may provide useful information for investors. We include in our materials that are on our SEC website, explanations for the adjustments and other reconciliations to these measures. So appreciate it, and enjoy the webcast.

Okay. Great. Thanks, Laura. So maybe just to begin, I'll turn it over to Matt for just some brief introductory remarks, and you can tell us just a little bit about what Booz Allen does for anybody that's not familiar.

Sure. Thanks, and thanks for hosting us to the conference. It's been nice to get out and meet some folks that support our deck and folks who're looking to get into it. And I appreciate the opportunity to speak to people in the room as well as people on the webcast. So what is Booz Allen? Booz Allen is a growth company that specializes in deploying technology and tradecraft to solve mission challenges for our clients. And our clients, 97% of them are in the U.S., federal government. So from biographical standpoint, a $9 billion company, just crossed the 30,000 employee mark, very diversified set of clients across defense, intel and civil, large number of contracts. I think only one of our contracts is more than 1% of our overall business. A multi-decade legacy of serving the federal government. I won't go back to the original origin story about how Booz Allen invented consulting. But to give you a sense of decades long relationships we've had with our clients, we got our start in the federal government when the Secretary of the Navy in -- I think it was 1941, asked the Booz Allen leadership to redeploy the entirety of the firm to help support the World War II wartime production effort. And it's funny when I think back to that, we, to this day, are still bringing innovative, now technologies, back then, it was thoughts and frameworks and business methods to our government clients. So back then, it was supply chain. Now, it's cyber, 5G, AI, digital solutions and the like, but what really distinguishes us is not just our expertise and those capabilities, but our ability to translate that to solve mission problems for clients. I always say that Booz Allen is great at solving the last mile with the last mile that's where value is created. So that's Booz Allen in a nutshell. We have a relatively unique business model. We still have one P&L. We're a very values-based company, client-focused, people-centric. We talk about the virtuous circle inside Booz Allen, where we invest in our people and innovation, which then coupled with our relentless client focus allows us to build things that are differentiated and valuable that our clients want that supports growth. And historically, we have grown -- our organic growth has been well above market and well above peers, which creates more investment capacity and off we go. So we've delivered strong performance over the last few years. Most recently, we introduced our second multiyear investment thesis that covers the period from our fiscal year FY '23 through '25. We're 6 months into that investment thesis. That thesis is targeted at growing adjusted EBITDA dollars, but the foundation of that is organic growth. It's based on a target a 5% to 8% organic growth plus M&A, which we believe will be a catalyst for additional growth on top of that and continued strong margins. And so far, so good. We're 6 months into it. And if you follow our earnings calls, we just in our most recent earnings call actually updated and raised guidance across the board. So there you go, that's the Booz Allen commercial, look forward to the discussion.

Okay. Great. Thanks, Matt. Appreciate it. So you guys have talked a lot recently about not being demand constrained. We saw that in your numbers this past quarter with a very impressive 2.4x book-to-bill ratio. Maybe just to start us off, it'd be great to dive into some of the key drivers of that impressive performance this past quarter.

Sure. I think underlying our book-to-bill this quarter was growth across all portions of what we call our backlog. We had a couple of big wins, some nice recompetes that really were across all 3 of our major market segments: defense, security and civil, as well as what we call tactical selling. It's -- [ any government ] fiscal year, Booz Allen, given the nature of our work, how close we are with clients, we have a long history of doing a good job of selling $5 million, $10 million, $15 million projects. There are often just task orders on existing contracts that are very strategic and consume clients end of fiscal year money but often set us up for more growth across multiple fiscal years. So deadline number was great. Q2 is typically our strongest book-to-bill quarter, but it was really the quality of the work that we sold across all 3 markets, large things, small things that we're particularly pleased with.

Okay. Great. And on the flip side from that, you guys have seen some really impressive client head count growth. It seems like that's been trending pretty strong over the past couple of quarters. Maybe could you give a little commentary on through your fiscal third quarter thus far, how that's trending, whether you've seen those trends like maintained versus the September quarter?

Yes, I don't want to get ahead of our Q3 earnings discussion. But we absolutely had a great net head count quarter last quarter and followed up on a pretty strong Q1 as well. So good momentum in the business on both levers, right? It's hiring and attrition. I think VoLT is working, is energizing our focus on mission, and the kind of work we're doing has been a core part of our employee value proposition and is resonating not just with potential new hires but with our staff that we want to keep.

Okay. Great. So it sounds like labor availability trending about how it was last quarter. In terms of wage inflation, you guys have talked about it at 3.5% to 4.5% range. Are you still trending towards the higher percent -- higher end of that range? Or any updates on what you're seeing on the wage inflation front?

Yes, no updates. I believe in the last quarter's call, we said we were towards the higher end of that range, and that's still true. And as we discussed, we're able to pass on most, if not all of that to our clients. Government has been very accommodating, they're dealing with the same pressures. And honestly, wage inflation at that level it was something that we really can't absorb in most of our contracts. It's not too far outside of historical norms. We are, on the other hand, to accommodate that long-term and to maintain where we want to be from a price point perspective, we are also running the firm more efficiently. So I'd point you to the fact that our non-client head count has gone down, and that's been very intentional and very structured because while it's great that in the short run, we can pass these costs on to our clients, primarily in the government, we do want to maintain our long-term price competitiveness in the industry.

Okay. Great. And maybe pivoting to capital allocation as part of the VoLT strategy that you mentioned earlier, you guys are talking about deploying anywhere from $3.5 billion to $4.5 billion over the next several years. Could you maybe talk us a little bit about the various priorities and how you're thinking about digging that up.

Sure. I don't think our priorities have changed. We have been, and we aim to continue to be a consistent payer of dividends. We'll be opportunistic with respect to share repurchases. And I think if you look back over the past 3 to 5 years, you'll see that we have been opportunistic and very situational. But that's really [ argue to ] M&A second. That's really, I think, just part and parcel of Booz Allen is, we're long-term focused. We're patient. We're disciplined. We've got a lot of levers available to us. We are focused on long-term value creation. We believe that's core to our value proposition both to our equity and our debt holders is the stability, stability in our growth and our value creation. And that's how we're approaching M&A to get to the final piece of the capital deployment puzzle. That is our priority. If we can find opportunities that are a cultural fit, strategic fit, catalyst to organic growth, catalyst to where we want to go from a technology standpoint at the right price, but that's a high bar. And part of the reason that we have a multiyear investment thesis is that allows me the flexibility and us the flexibility to deploy capital to M&A or not in the short run. And I think we have the kind of organic performance. We don't have to do anything. We can remain patient.

Okay. Great. And then sticking to the M&A theme. Could you give us a little bit of an update on the integration efforts with Tracepoint and Liberty? And then obviously, EverWatch only closed about 6 weeks ago, but any early observations that you're seeing there?

Each of those is different, not just the company, but our strategy behind them. So we've had a different integration philosophy. And if you're asking for trends, that's certainly one is that we are learning how to be a better acquirer and better integrator and that starts upfront with the business team and their vision for how it's going to be an accelerant to growth and to where we want to be from a capability and service offering perspective all the way through when you're fully integrated. If you take each of them, Liberty is largely integrated into Booz Allen. We're through the period where we really helped them ramp. They had an intrinsic growth path on 2 large contracts that they had won, and we help them scale. Phenomenal company, great acquisition. We help them scale. We're largely through that period, and we're really working now on the synergies where they do some things that are relatively unique for Booz Allen, and we have the ability to incorporate them into some of our larger bids or larger contracts as a delivery hub, low-code, no-code given that they have a very purpose-built business model. So they're integrated from certainly a back office perspective and they're fully part of Booz Allen. But there is more to go in terms of getting synergies. One of the things we've learned as a strategic acquirer is it takes a couple of years to really get the value out of the long-term pipeline that you can build together. Tracepoint is not as integrated on sort of the back office or the people side, very well integrated into our business model and the combination of what Tracepoint does from a quick turn incident response perspective and their access to the middle market, coupled with some of our higher-end capabilities and our ability to really do long-term remediation. We're seeing a lot of value there. At EverWatch, as you said, it's brand new. I think strong early results, but the teams are just getting to know each other again. It was a little bit of a joining process, signing a deal and then having to wait for 6 months. So more to come on that one.

Okay. Great. And then you guys have talked about some broad themes where you're focused on the M&A front, in key areas where you're focused on serving your clients: 5G, cyber, AI, climate, quantum. You've obviously started to address some of these areas in terms of your recent M&A activities. But going forward, are there any that you view as more pressing to go out and do an acquisition in a certain space or anything that you're particularly focused on going forward?

We make sure we have priorities. Let me take a step back and talk about how our M&A process works because I think that's to be illuminating for people with respect to really the role that M&A plays in our portfolio. The way it works is our business teams, they have strategies that obviously, we incorporate support them with. We build business cases around particular areas of interest. Liberty is a great example, where we knew from discussions we had with some of our civil clients, Kristine Martin Anderson, who's now our Chief Operating Officer, ran our civil business at the time. She had a number of discussions with a number of clients and said, "Hey, this is a hole in your portfolio," as we think about where our needs are headed and where the technology market is headed, and it's a capability that you needed scale, so we went out and sourced it. That's the role of my team in corp dev. And so we probably have half a dozen business cases like that across the firm that touch many of the capability areas that you mentioned. And we're out there constantly talking to potential targets. We don't like auction processes. It doesn't fit how we think about M&A. We're very tuned to culture and strategic fit. We'd like to take our time to get to know people. It helps with integration to your earlier question. When you're aligned on the vision for how the 2 companies are going to operate as one. So that's where we are. The M&A market is an interesting place right now. I'm sure you have a question on that. Further down the road, where not a lot of deals are getting done, but it actually suits us well because it allows us to do the kind of relationship building that's important, not just for M&A, but for us, more broadly. And we have -- our business teams are going to dinners and meeting with folks constantly, does it turn into M&A? 1 out of 100 times, but a lot of partnerships, a lot of opportunity to build business together.

Okay. Great. And speaking of partnerships, you guys recently announced a cybersecurity partnership with NVIDIA. Maybe can you tell us a little bit about that and how that fits into the VoLT strategy more broadly?

Sure. So the VoLT strategy is, the V is velocity. We know we need to get faster, both internally and for our clients, given the pace at which their missions are changing. And with technology, both changes in mission and as a tool to solve it. Leadership, which means getting out in front of clients and getting out in front of the market and really being a market leader and then technology. And again, just for those of you who haven't followed the Booz Allen story for a long time, I ran our Vision 2020 strategy effort for the firm. And back in 2013, about 30% of our client staff had technology backgrounds. It's now 70%, which is a massive change, right? But that's what our clients are demanding, right. They're demanding the ability to use technology to solve mission challenges. And so that's where we need to go. And so NVIDIA is a great example of that, right? It's a partnership with a commercial technology provider where they bring certain pieces of technology, products, expertise. We have things that we developed, homegrown. We can apply what they do to solve mission challenges, and we have the client relationships with the contacts. And you're going to see more and more partnerships like that from Booz Allen, given sort of where our clients are and the need for them to adopt much commercial technology as possible and make it usable in the government space. Our corporate ventures program is a great example of another way to do that, another tool in the toolkit. It's a place where we found -- well, take a step back for 5 years or so, we've had a technology scouting program with a handful of people inside Booz Allen, and their sole job is to build relationships with innovative companies, start-up companies and all the communities you'd expect and bring them on to our contracts in service of government. And building a CVC program was a great way to formalize that and equity is a great tool to align incentives and really deepened the relationship with companies that we think have real value for our government clients and can be catalyst for our growth. So it's all part of the same ecosystem, right, M&A, partnerships, equity placement, our [ tax-cutting ] program. It's all -- these are all tools we have to build relationships with companies that have unique capabilities, delivery models, business models to us that we can use to better serve our government clients.

Okay. Great. And do you expect to pursue more partnerships maybe as a result of the tougher M&A environment that we've seen either because of just the regulatory scrutiny or just lack of deals in the pipeline, how are you thinking about that?

No, I don't think we'll pursue more partnerships because of the M&A environment. I think we'll pursue more partnerships because it's how the market's headed, and it's a core part of our strategy. And I think we've been really gratified by the amount of interest in partnering with Booz Allen. It's -- our people are motivated by solving mission problems. And so their mentality, their mindset is, I want to bring the best tool to bear to solve to help the war in Ukraine, to be a better partner for the VA as they think through how they're going to manage health records to help fight the supply chain war with some of our adversaries in the intel community. That's how our people think. And so we are a great partner, and I would expect that to continue.

Okay. Great. And then on the regulatory component, I mean, how is the tougher regulatory environment affected, how you guys are thinking about M&A at all?

Yes and no. I mean there are 3 things that are happening in the M&A market. There's certainly the posture that portions of the government have taken, there's uncertainty in the financing markets and there's just overall macro-economic uncertainty. We still believe that M&A is a useful tool for us. We're actively engaged in discussions. The nature of those conversations has changed. I believe I said on our earnings call that we're having many, many more one-off bespoke conversations. We're not seeing a lot of broad processes. If there's uncertainty in the environment, both pre-signing and from the period you sign to close, you want to know you have the right committed partner, and they want to know that you're the right committed partner. And so we're having a lot of those conversations. But no, we still believe that M&A is a useful tool. We'll be patient and disciplined as always. We think that Booz Allen is a great partner and a great counterparty. So we look forward to continuing to be active in acquisitions.

Okay. Great. And then shifting back to the equity component of your capital allocation strategy, you talked about opportunistically buying back shares. And we've seen a lot of companies with strong balance sheets to do that this year, the equity market where it is. But your stock has performed exceptionally well. Share repurchases are trending a bit lower this year. Should we maybe expect -- how are you thinking about share repurchases more broadly and any potential increases to the dividend? Is that something that might come into play given where your share price is in terms of that shareholder return piece?

Yes. At the risk of repeating myself, this is the advantage of having multiyear financial targets. It just gives us the flexibility to be patient. So if you look back I think we have in our investor presentation, we've got a 5-year look back on how we've deployed capital. And some years, it's more geared towards M&A, some years it's more geared towards share repurchases. We haven't done a special dividend in a long time, but we're proud of our pretty consistent policy around dividend yield, and we think that offers value to investors. So yes, M&A is our first priority if we can find it. If we can't, then we'll use our capital in a way that makes similar sense.

Okay. Great. And then you guys have a long-standing policy to maintain net leverage in the range of 3 to 3.5x or target that. You've talked about being willing to temporarily go above it for the right M&A transactions. But looking back over the past decade, I don't think you guys have actually ever gotten above that 3.5x. So why are you thinking 3 to 3.5x is the right range? How might that evolve over time? And why is that the right number for Booz Allen?

And I think our leverage has maybe evolved a little bit over time. I'm not sure, I would say it's a target. I'd say we're comfortable operating in that range. And if you do the math, that's where we should be, but we generate a lot of cash, right? So we delever pretty quickly. It's pretty hard to actually stay in that range. And it wouldn't actually be advantageous for either our equity or our debt holders for us to target that artificially. So you're right, we've not been in that range. I think we're 2.5x -- 2.6x net leverage right now after the EverWatch acquisition. We are comfortable operating in that range, but we are comfortable, and obviously, we have been comfortable operating below that as well. And we found that that's not a constraint on us generating value for all of our stakeholders.

Great. Are there any considerations that might make you on a longer-term basis, think about moving that range up or down?

I mean, certainly, we all look at the interest rate environment, and that affects your thinking, when you said, is that temporal or is it long term? Obviously, everyone here is going through analysis around that. As you said, the most likely scenario for us to go above 3.5x would be temporarily if we found an M&A target that we really liked. But I don't foresee anything unique to us that would make us reevaluate -- make us reevaluate that statement.

Okay. Great. Your credit ratings have been on a really nice upward trajectory over the last year or so. We had a 2-notch upgrade from Moody's last year. S&P put you guys on positive outlook. How are you thinking about your ratings? Has the higher interest rate environment added any extra motivation for you guys to manage towards investment-grade ratings?

So we're pretty comfortable with our capital structure. We're, I think, 60% fixed, 40% floating. Average cost of our debt is -- I'm looking at our treasurer, 4.5%, maybe slightly north of that when you take into account our hedges. So we're comfortable with where we are. Would we like to be investment grade? Probably, but I think we're not going to do anything unnatural to get there. As per your earlier question, the way we've managed the business, I think our history of not just organic growth, but really sort of patient calculated capital deployment and effective management of the balance sheet, would tend to put us in the range for where we could be investment grade in the relatively near future. But we're not going to -- and even -- even as we redid our cap structure, I think it was not just current credit agreement -- most recent credit agreement but 2 credit agreements ago, we put in covenants consistent with what you'd expect from an investment-grade company. So we were preparing for it in the background, but it's not something that we're aggressively seeking.

Okay. Have you guys considered adding a Fitch Rating given that you're currently just rated at Moody's and S&P? And if not, is that something that you would consider the next time you guys raise incremental debt?

Yes, I think we're constantly evaluating the range of opportunities, including Fitch. But I don't foresee anything happening at this time.

Great. And then prior to your refinancing in September, you guys were, I think, like about 67% fixed, 33% floating. Longer-term, what's the right mix for your capital structure? How are you thinking about that?

Yes. I mean it's -- that's tough, right? I think we're all going through this analysis. And part of it depends on the ID question, when and if we get there. But we're pretty comfortable where we are. I think in the current environment, 60% to 70% fixed to floating is the right ratio for us. As I said, our interest rate being at 4.5% is in pretty good shape. I'm not sure, I [ trade ] our capital structure for most folks out there. So it's something we're constantly evaluating. We're talking to folks like [indiscernible] all the time, as you know, but I don't foresee any major changes in that front either.

Okay. And then how are you thinking about the role of secured debt in the capital structure, like if you guys were to do incremental debt to fund M&A in the near term or even medium term, would you consider -- you've done unsecured debt recently, but would you consider doing secured debt on that?

I think that's right, all options are on the table. Particularly in this credit environment, you can't go in with any preconceived notions is what I've been told. And folks are on the table around the room are smiling and laughing. So if anybody is making bold predictions at this point, it's not me.

Fair enough. Okay. Great. And we're almost out of time, so just one more to wrap it up. You guys this past quarter, divested your commercial Middle East and North America -- North Africa consulting operations. Obviously, a very small piece of your business, but does this fit into any kind of broader portfolio review? Or why was now the right time to do that?

It was at the right time because we found a good partner. And it was the best -- honestly, it was the best place for our team, for the work, and for the clients out there. We thought Oliver Wyman was right partner. It makes sense from a portfolio perspective for ours. It was a good business, but I'd say noncore, now consistent with where we're headed in VoLT. So the timing was right. We are, I think, more actively looking at our portfolio and what fits and what doesn't, but we're one P&L with a very integrated business model. So honestly, it's hard for us to pull pieces of our government business apart if we wanted to. This was a best book part of the business that ended up in a great place. So we're really happy with that transaction.

Okay. Great. Well, I think we're out of time now. So Matt, thank you so much for joining us. We really appreciate it. And I hope everybody enjoys the rest of the conference. Thank you.

Thanks.