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

I am 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 43rd Annual William Blair Growth Stock Conference. We are pleased to be hosting a 30-minute fireside chat with the management team of Booz Allen. And joining me today is the CFO, Matt Calderone; and Head of Investor Relations, Nathan Rutledge, who's in the crowd. This is the fourth year in a row that Booz Allen has presented and the first for Matt. And this is the eighth year total for Booz Allen at our conference. I am required to inform the audience that a complete list of research disclosures and potential conflicts of interests is available on our website at williamblair.com. Matt, thanks for joining us.

Thanks for having me.

And Matt, you took over as CFO in October after having served as the Chief Strategy Officer and other roles for the past 20 years. Can you tell me about your first 8 months on the job as CFO? And maybe can you also recap how you finished your fiscal year and where Booz Allen is headed.

Thanks, Louie. So it's a broad open heading question to start. So really enjoyed the first 8 months. As you said, I've had a lot of different roles in the company. Served as Lloyd's deputy in some ways for a number of years. So I was familiar with the finance function. And obviously, a long relationship with Horacio, running corporate development as a Chief Strategy Officer. So what's been new and interesting and exciting for me in this job has been a couple of things. First, the opportunity to get to engage with folks like yourselves and our investors, to really understand how you view the firm and our strategy. And I really mean this, even when you're in these rapid-fire sessions at conferences like this, you learn, right? You learn from the questions people are asking, how they view the company, how they view our performance, how they view the industry, what they're hearing. It's always really thought-provoking. And the other major observation I have is I've had to learn the business in any way when you're out here talking about it a lot. I know you're going to ask me about -- questions about AI, and that's been really invigorating because we -- we're doing some really fantastic stuff across all 3 of our core markets and across, not just AI, but a range of capability areas. And the government's mission itself is evolving. If you think about the needs for climate and border protection and Ukraine and China, and -- you name it, it's just been really interesting for me now from this perch to learn what the firm does in a new way. In terms of our performance, we had a great year. I think we were double-digit growth at top line, 9% organic. Most of that flowed through the bottom line. Equally as important, we talked a lot about having momentum in the business. And then, certainly, on the supply side, to the extent that we haven't seen really in recent memory, a client-facing headcount growth at over 10%, and I'm sure you going to ask me questions about that. On the demand side, there's a lot of demand for our services across our 3 markets in cyber, digital, AI, some of our [ cloud ] capability areas and in these critical mission sets that we're serving. And then operationally, there's momentum there as well. And a lot of credit, not just to the corporate team, but to our business leaders, who are running the business pretty efficiently. So we feel like there's a lot of momentum going into the year built on strong organic growth performance last year.

And can you talk about your strategy and how it evolved from when you were private and part of Carlyle and coming into being a public company? And then there was, I think, the withdrawal from Afghanistan and the budget sequestration in 2011. And then it seems like you guys and the rest of the industry were in fifth year coming out of that. And how has your strategy evolved from that?

Another broad question. I feel like I should lean back for this one. So we've had 2 major strategic thrusts in the last decade. And first was what we call our Vision 2020 strategy. And flash back to when that was put in place, that was right around the time of sequestration, this was the budget -- the dynamic was changing. As you said, there was a huge influx of lending the global war on terror that was changing and whatnot. But fundamentally, for us, what that was about was a couple of things. One was becoming more of a public company. We've only been public since 2010 and learning how to run the business in a more efficient way. But from a market-facing standpoint, it was primarily about evolving from a consulting and general services company largely into more of a technology company, more of a technical services company. And we've talked publicly about, give or take, 1/3 of our business -- 1/3 of our workforce back then had technical backgrounds, now it's 2/3 and climbing. And that's cyber. It's -- at the time, it was called data science, engineering and the like. Fast forward to where we are now and our VoLT strategy, and it's really about taking what we've built in the foundation, becoming more of a technology company and going to the next step. And the 3 elements of VoLT are velocity, which is a broad term, in some ways amorphous, but it's just a recognition that the needs of our clients are changing so quickly. And the technology that can be deployed against those needs is evolving so quickly, we just have to get faster. And that means faster internally, that means faster as part of an ecosystem like partnerships, access to innovation. That's what our clients demand and 97% of our work is with the federal government, that's what we need to provide. And there's an element of that getting faster internally in terms of how we operate. But that's because we want to be able to evolve with or, to the extent we can, get ahead of where our clients are going. And we were just talking about this in the way in. Who knew that, this time last week, we were worried about forest fires and its impact on the Eastern Seaboard. It's just that is what's happening in our environment today, and you need the ability to react quickly. The second is leadership, and that's, obviously, at some level, but for a company like Booz Allen and you asked about the Carlyle transition. Back in 2007, we were a private partnership, and we were very comfortable being behind the scenes. We knew Booz Allen -- people knew who Booz Allen was, they didn't know what we were about. And Carlyle was very helpful to us in emerging to be a public company. Any -- a public company with a public persona, and leadership is about going to the next level and really becoming -- or further enhancing our position as truly a mission-critical partner in the digital transformation of government. And then technology is -- it obviously, stands by itself. One of the elements that we're focused on there is working, as I said, with a broad array of partnerships, investments and the like to have access to a more significant swath of the technology ecosystem. If you think about the challenges that the government is facing, almost always, it involves an element of digital solutions, cyber, which is ubiquitous now, AI and mission understanding, and that's where we're headed.

Right. And Booz Allen, you have the reputation as like the best-of-breed government contractor. A lot of industry people refer to you as the McKinsey of government's contracting. And my question is like what differentiates Booz Allen? Is it the fact that you have this brand as the best-of-breed that allows you to attract the best talent? And it's that cycle, such that because you have the best talent, and you're able to produce the best solutions? Or -- how are you different from your peers in this industry? Because there's a lot of like direct comps that investors look at and how do you...

Yes. It's a great question and one that's always hard to answer, in part, because, yes, we serve the federal government. But as you know, the end markets are so heterogeneous. And what you do for the IRS is different than what you do for a 3-letter intelligence agency is different from what you do in support of the war in Ukraine. That's just the mission sets. We talked about the diversity of technical and mission capabilities you deploy against them. So I'm going to go back a little bit. You almost have to answer it at the business model level, on culture level. Yes, I think there are a couple of things that differentiate us. One, and this is a legacy of -- I both like and don't like the McKinsey analogy because we're not a consulting firm. But it's a legacy of us being a private partnership and a consulting firm is we have an entrepreneurial culture that is built on being inside client organizations and solving their problems and selling through that, it's no different. I spent some time as a commercial consultant, both at Booz Allen and BCG, that mentality and that mindset. Now we are bringing a wholly different set of capabilities. We're solving things at scale. We're selling large multiyear contracts. That is different, but that mentality of -- I understand how the IRS or how the Army works and how to solve this incredibly complicated problem because I've been committed to you as a partner for decades is valuable and the selling culture that sits behind it. And the second is -- it's funny I was going to use a different form of this cycle. We talk about the virtuous cycle inside of Booz Allen. We are a higher-value, higher-investment model, and that's the bet that we make, that we invest more in our people and capabilities that produces more value for clients. They recognize that value and are willing to pay for it. And that allows us to provide returns for shareholders, returns for our people, and continue that cycle. And to go back to your previous question, that was a very conscious decision that we had to make in and around sequestration. It was not to -- and as you may recall, this was a time with low price technically acceptable contracting. There was massive price competitions, it was to not play that game because we thought it was important for us not just to maintain the brand but to maintain our value proposition to our people and to our clients because that's what our clients expect, and that's the kind of place that our people want to work at.

And along these lines, can you talk about the culture of Booz Allen? And related to this, how generally you're considered having a very deep bench. And there have been several examples of management turnover at the highest levels amongst several of your peers. And they brought in an external CEO, there are pros and cons with that. But you've also had like different transitions within Booz Allen recently. And for most of those, there have been like internal promotions. Can you discuss like the importance of maintaining the culture for Booz Allen? And along those lines, like when you integrate a company with M&A, how you bring that culture into the Booz Allen culture?

Yes, absolutely. And I talked a little bit about what's unique about -- not unique, but what we think is different about our business model. And that is very much true in terms of our culture. Like it's a good culture. It's an ethical culture, it's a mission-focused culture, and I think that's probably true of a lot of folks in the industry. I know it's true, right? We're here because we believe in the mission. Booz Allen, and this, again, is a nature of the fact that we still have 1 P&L, that we have a private partnership for a long time. We still call each other partners, less so than we used to. We still do, even though, obviously, we're not a private partnership. We have a model where we flow talent and capabilities across the institution, not seamlessly, but I think, certainly, probably more than many folks in our industry do. It's highly collaborative. They're downsized to that. There's -- that's in conflict to the V in velocity oftentimes. But it is very well-honed. There's an old -- when I made a partner, which is equivalent of the Senior Vice President, one of the rules, internal rules, was other partner calls you, you pick up the phone, you help with a problem. And that very much is the mentality or the mindset of Booz Allen leaders today as it's continued to scale. And so it does tend to lend itself to people that know how to operate in that system. That said, particularly as our work has become more technical, they need to get faster. We have gotten better at -- we're not as good as we need to be, at integrating people with outside perspectives and unique talents. In the old model, people that -- who were incredibly good at running multi-hundred million -- person technology programs probably weren't valued as much as they are. Now we will hire -- if you know any, let me know, we'll hire as many as we can. So that's part of the evolution of the firm, but a strong culture. And look, I don't know, maybe I'm honest, but we have a history of performance. And so I don't feel like we -- at certainly, at the senior levels, we've needed to go outside. Now from an M&A standpoint, that's both a challenge and an opportunity. And here, again, one of the things that we've learned is how to absorb companies with different cultures and different business models because that's additive to Booz Allen and not to take away their secret sauce. And it's a constant challenge. Do you fully integrate them? Do you build around what they're doing? There's many places you're going to be in that spectrum, but we're trying to be more conscious about...

And why can't peers replicate that? Such that like over the past decade plus since you became public from Carlyle and you've grown much faster than everybody else in the industry. And what prevents that? Is it the fact that you had this first-mover advantage in artificial intelligence, data analytics, augmented reality, cybersecurity. And because you're the incumbent on these contracts that you and other cybersecurity contracts, is it that plus the culture? Is there just an explanation for why you're growing faster than everybody else?

Yes, and the business model, right? So I'm not saying a corporate, we don't look over the horizon and say, we want to be investing more in 5G or quantum, where we didn't 10 years ago in AI, which, at that point, was sort of this melding of data science and technology. But again, this is a legacy of how we've grown up. A lot of that innovation happens organically in the business, right? So we have a very, in some ways, decentralized business model, where we -- our leaders have a tremendous amount of flexibility to adapt, to not just what the clients are asking for through the form of an RFP now, but to look ahead. And our job is to catalyze that with investment, and we've gotten better at that over time. We've been investing in AI for well over a decade. But the idea is we weren't centrally housed, right? They were [ terminated ] by people who are doing incredible work for clients in the mission set. And oftentimes, how they evolve is you sell a $5 million task order because the government has [ end ] of your money and they're looking to do something interesting in pilot, and then it grows to a $20 million contract, which grows and grows and grows. And that is, again, very consistent with our business model, and it's actually -- it's how the government works and it's how these positions, whether it's in cyber or in AI, are built, right? We didn't win the JAIC contract because we said AI is going to be the next big thing, and we got to win it. We won it because our people knew that, that was critical to the mission. And they've been building AI capabilities over time, and it just came together.

Yes. And you just mentioned AI several times, and that's obviously very, very topical. And...

I was predicting your next question.

I'm writing several pieces of research compending that your AI exposure is unappreciated by investors. I think a lot of government, defense investors realize that you are the leader or 1 of the leaders in artificial intelligence. But investors across like broader technology, don't see that. And yes, could you just say what do you do with artificial intelligence? And how do you -- first just answer that question.

What do we do with artificial intelligence? We try to make AI work to solve mission problems. And that's -- that sounds like a platitude, but it's -- that's the core and the crux of the challenge. And if you think about -- there's a lot of discussion about how do you get AI to the edge? And how do you get AI to the Warfighter? How do you make it operational, right? Because that's -- you're can use AI all you want to help you sort internal databases and whatnot, but that's, for a large portion of our client base, that's where the value is. How to use AI really to make breakthroughs -- we're at the NIH, and what is required to get something to the edge. I'm holding up my phone because I use this analogy a lot. If you think about -- and you've seen this in the war in Ukraine, right? There's drones providing real-time intelligence, and you need to get that back to someone who needs to act on that. That is an extraordinarily complex challenge that involves hardware-software integration. It involves numerous different systems having to communicate to one another. It's got to be secured through cyber. You've got to deal with latency and bandwidth issues. That's why we invested into the CVC and a company called Latent AI because that's what they've -- so no one company is going to build that system. It's just not possible. To solve a problem, you're going to have to pull together lots of different companies, lots of different capabilities, have understanding of how all these piece, parts work. You saw the problem. And that is what we do. That is -- we saw the problems. And in some of that, we do have libraries of AI algorithms because so much of this is experience based, and we're trying to codify that. Because we do believe we have some level of first-mover advantage. But I think it's true, government and commercial, but particularly for the government, the application of AI to solve a problem in an area where there's public trust and the consequences are so high, you have to approach it systemically.

And you do a ton of prototyping. And you are, in many respects, like the liaison between the Department of Defense and different commercial vendors. And I think investors have the impression that AI didn't exist prior to ChatGPT. And now this is something that's going to be really disruptive. Can you talk about just ChatGPT and how you think about language learning models and how that flow through to the DoD?

So as you said, we've been doing this for well over a decade. We've got a bunch of large contracts: JAIC, eMAPS, EDITS has a component to this, I think it's called decision advantage, but that's -- obviously requires some level of automated intelligence. And we're seeing AI built into procurements across many, many portions of our business, all of a sudden, there's tremendous interest. So what has ChatGPT done? I would say nothing technically because, for the most part, we know that, that existed, but it's raised public consciousness and public awareness of AI. But let me take it a step further because I think this analogy is important. If you think about governmental functions, I used this earlier today in one of our sessions, AI and the application of AI in data analysis could be very powerful for the IRS in terms of determining who to audit now. But given the public trust, given the need for it to be ethical, given the regulatory requirements, what's important? Traceability. And that every step in the logic flow is traceable. You understand where it is, how it exists, what not. ChatGPT doesn't do that, right? ChatGPT doesn't...

No attributions.

It doesn't have bibliography, right? And if you know how the intel community works in terms of writing reports, if you understand the functions, that is critically important. So it's cool. It's a nice piece of technology. I think it excites the mind, making that useful requires a lot of work. Not just from us, but from a lot of partners.

And notoriously slow moving. And like it would seem that like you'd be involved in like years and years and years of prototyping and testing before those types of models in the -- or even...

I'm not sure I'd say the government is slow moving, right? I mean, I think, there's a view that -- because a lot of innovation, even in the space of AI, has happened with the government and inside the contractor base. A lot of the sort of object detection, geolocation, geotagging. Again, with the war in Ukraine, you're seeing this happen over Twitter, people real-time geolocating tanks and whatnot. A lot of that technology and a lot of the methodologies around that have been developed by the government and its partners like Booz Allen. Yes. And I think in part because of their requirements are different, right, because it's harder. So look, I think, ultimately, and I'm just picking one aspect of it, traceability in AI is going to become critically important in the commercial world, too. It's okay for ChatGPT to produce something that -- all 3 of my kids graduated 2 weekends ago. And all 3 of the speeches, they made a joke about how it was generated by ChatGPT, and they read off what they said, and it was funny in part because it was 10% wrong. That doesn't work for a lot of government functions.

Yes. That's great. And you mentioned Latent AI as one of your strategic investments. And I think you announced another strategic investment this morning, Shift5. Can you discuss your M&A strategy such that from 2009 through, I think, 2019, you made 1 acquisition, while like peers made 75. And like why didn't Booz Allen need to make acquisitions then, but you've recently voiced that you want to be very more acquisitive now? But what circumstances have changed?

Yes. I'll unpack your question in a couple of different ways and answer the latter part first. So what has changed has been our recognition that again, as technology markets evolve as you're seeing this convergence, one way for us to leapfrog internal development cycles, particularly at scale, is to buy it or to partner it with -- to get it to acquire it to have access to it, or in the case of Shift5 or Latent, and these are equity investments through our venture group. So I've used this example in the past. Why did we buy [indiscernible] Liberty, which was the preeminent low-code, no-code provider to the federal government. We had probably 50 people doing low-code, no-code development, and they had 500 and they were doing it better than we were. They just beaten us in a large procurement, and they had enough experience that they understood this wasn't just about applying Salesforce but building your own library of APIs and ways to integrate these prefab software components in new and unique ways and the experience solving mission problems. And we've been able to take that and not just use it to great effect in the VA market or across the health market to make current programs better and to make us better qualified for new work. But we're now starting to use it as a hub for other parts of our business. So that's the mentality is that we do a lot of things really well, it is a hugely complex ecosystem, and they're -- and on this flip side of it, it's a very efficient use of capital if done well, and we generate a lot of cash. We have a strong balance sheet. So there's both the need and the opportunity to be more acquisitive. And we actually had. We bought more than 1. I think we bought 9 companies over our tenure, but certainly, we've picked up the pace.

Yes. Certainly. And yes, we only have time for one more question. And the question I wanted to ask is, like hiring and headcount additions and keeping attrition down has been a focus for Booz Allen recently, as you and previously Lloyd have said that Booz Allen is not demand constrained whatsoever. And...

I think you added whatsoever, but yes.

But can you discuss the labor environment and whether you'd been able to benefit from tech layoffs and including your replacing of headcount...

Is it -- we've seen -- we had a great year from a headcount perspective, both hiring and our attrition dropped significantly in the back half of the year, as we stated publicly. And that's both a combination of what we're doing. We're hiring better. We're doing more interesting work. it's more technical, that's more appealing to our folks. I always say there are people that are supporting the war in Ukraine or the VA health systems or some 3-letter agencies that are engaged in all these geopolitical issues that are very real time. They're not sending their resumes out, right, because they're excited about what they're doing, both from a mission and technology standpoint. And we've gotten better from a process standpoint in terms of hiring and, undoubtedly, the labor market has been better for us. We typically don't hire directly from the technical tech firms that much. 70% of our work requires clearance, and you're not going to make [indiscernible] from Silicon Valley and show up in, say, the next day. But it has helped us from an attrition perspective, and I think as people are charting out long-term career paths, the trade-off has changed.

Great. And that is the conclusion of the webcast. And we are now commencing the breakout right in this room, right now. Yes, if anybody in the audience has questions for Matt or Nathan in the audience, feel free to fire away. Or I can continue with my questions.

Thanks, everybody.

Thank you.