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

Okay. Yes. Good morning, everybody. I'm Matt Akers, I'm the Aerospace and Defense and government services analyst here at Wells Fargo. Next up, we've got Booz Allen Hamilton. So excited to have Matt Calderone, CFO. So thanks, Matt, for joining us. I think, did you want to lead it off with a few opening things?

Sure. Thanks for having us. Great conference, great event to be in Chicago. I see some familiar faces, but some that may be new to us, I'll start with me. I'm Matt Calderone. I've been the CFO since October of 2022. Prior to that, I was Chief Strategy Officer, had a variety of positions at corporate and in the business. And then a little bit about Booz Allen. We delivered $10.7 billion worth of revenue last year. About 34,000 employees. Had a fantastic year. I'm sure you'll ask some questions about that. We grew over 15%, almost all of which was organic. 98% of our work is with the U.S. federal government. The other 2% is a high-end commercial cyber business. And really what Booz Allen does is we are a company that brings technology to solve mission problems at the scale being complexity that the U.S. government demands. That's how we've been positioning ourselves and repositioning ourselves over the last decade. I think we are very much in the middle of the technology transformation of government and technology transformation of government missions. Those are 2 related but different things. And we're seeing really that bear fruit not just in our numbers, but in the quality of work and the capabilities that we're developing. Taking a step back, Booz Allen, we're celebrating 110th year. This year, we're ringing the bell of the stock exchange in a couple of weeks, which is exciting. It's particularly fun for me to be in Chicago. Booz started in 1914, first management consulting firm in the world, older than McKinsey. If you've been to the Allen building up at Kellogg, that is the Allen in Booz Allen. Obviously, a very different firm and very different companies. And in fact, when Booz was starting with time of motion studies, but it's fun for me. We're spending a lot of time thinking about the 110 years and what makes Booz Allen unique and different. It's fun to be back in Chicago, sort of where it all got started.

Great. I guess maybe to kick it off at high level, you mentioned the strong results last year. I think back to the Investor Day 2021, so you guys guided 5% to 8% organic growth, mid-10% margin. You actually did double-digit growth, 11% margin. Can you just talk about sort of some of the swing factors that enabled you to beat that?

Yes, that's right. I think -- and underneath that, the headline was we're targeting growing adjusted EBITDA to $1.2 billion to $1.3 billion at the end of the 3-year time period. And we're pleased to just guide to $1.26 billion to $1.3 billion. So we're going to be near or at the top end of our guidance, almost entirely through organic performance, which actually is a little bit different than we thought back then. So really pleased to have exceeded not just our organic revenue targets, but delivered margins in roughly the 11% range when we thought we'd be a little bit below that. But even more so, that resulting in us being where we wanted to be from an adjusted EBITDA perspective with a lot of balance sheet capacity in the tank. So what drove that, Matt, you've followed us for a while. We've talked a lot about the virtuous cycle in our business, where we tend to deliver -- we're a high-value company, which requires a lot of investment in people, technology, capabilities, partnerships. Lets us generate value for customers. That, in turn, allows us to share that value certainly with our shareholders, with our clients in the form of incremental investment, to come back around the circle, and our staff. And we've been in that cycle, right? As I mentioned at the start, we have very intentionally positioned the firm first. We've migrated from being a general services firm to a technology services firm with a very strong mission focus. And increasingly, as I mentioned, we are the company that's bringing technology, whether it's home grown, through partnership, we used, developed in the face of a client to solve very specific mission problems and many problems at scale. And that is where the government is headed. If you think about all of our missions, whether it's what's happening maybe in the Pacific, in the war in Ukraine, in the Middle East, climate change, global migration in health care, right? Technology is driving the solutions to all of those challenges. And the speed and scale and power of technology is fundamentally transforming government and the missions that government performs. And we're happy to be at the middle of the ecosystem and making it work at the edge. That's the strategic answer. And operationally, I think we've run the business pretty well from a margin perspective. We have both grown faster than we thought we would and generate enough scale that we've been able to invest largely in a way that has included margins. We're investing more than we ever have been before and maintaining margins, as you mentioned, at roughly 11% level, which we think is appropriate. And we are reaping the benefits on the supply side. We are largely still a labor-based, labor-driven business from doing really important impactful work. But there's an energy inside Booz Allen and a vibrancy. People are excited by the quality and the impact of the work they're having, and that's helping with creating an attrition and all the things that drive the supply side of our business.

Got it. Okay. I guess, as you approach the end of that, the 3 year horizon, is there a plan to put a new guidance out there anytime soon?

I mean, I would expect, if you look at our previous -- we've gone through 2 waves of 3-year investment thesis with a gap in between because of COVID. So I would expect that we'll probably have another multiyear investment thesis discussion once this fiscal year ends. So whether that's next summer or the subsequent fall, to give folks a sense of what the next horizon is going to look like. But a lot of momentum in the business.

Yes. Got it. I think people typically think of you as kind of more of a defense company, but you have a big civil business as well, has actually grown faster. I know there's some M&A that's happened there. But just think about how you've got mixed and if you continue to shift more towards civil over time?

Yes. If you look at our portfolio from a revenue perspective, we're slightly less than half defense, a little more than 1/3 civil, and the remainder is in the intel business. And then this small, exclusively interesting commercial cyber business. We don't give out the business that way for a couple of reasons. One is we have one P&L. But more importantly, we have a business model that very much supports the flow of investment and capabilities and people and technology across the Booz Allen ecosystem. If you think about a lot of our sort of higher-end capabilities, we have the largest AI business in the federal government. We have one of the largest cyber businesses in the world. We're increasingly doing very sophisticated digital solutions work. A lot of those were -- the cyber and AI were germinated in the intel business. If you think about where a lot of the source of government innovation and scale. And then it sort of migrates from intel to defense to civil. And conversely, a lot of the typical commercial applications or technology start in civil business and go the other way because of the clearance requirements. So it's huge value actually to the portfolio, not just to sort of wade through different funding environments, right, different administrations and congresses have different priorities. But the business itself, you're constantly pulling or at least Booz Allen is, talent and people and capabilities and technology from one portion of the business to another. And so a lot of the real-time situation awareness, full motion video analysis that allows you to do real geo location, for example, in the intel space, well, there's obviously real defense applications to that. Well, and FEMA is sure interested in that, right? So how do I create a network of drones that gives you real-time situational awareness across the flood zone. So that's how our business works, and that's part of the value we provide to our customers. And it really comes from us having touch points across government, right? Very different endpoint missions with a lot of the technologies and tools and capabilities you develop to serve them have portability. So love the civil business. It's growing fast. Defense actually grew faster last year than civil. I think defense grew at 20% and civil grew at 18%. We're seeing broad-based growth actually across all portions of our market, particularly when you look at our intel business. As you know, we had a major contract loss there. So the fact that they grew 5% is pretty good. We are not intentionally camping down or repositioning growth anywhere. We're letting the business run. We're investing in all the technology, as you'd imagine, that may manifest itself differently across different markets. But that's not -- we don't have that vision.

Got it. Okay. And I guess, kind of related to that, the intel business, like you said, the contract loss. But do you foresee that kind of growing? Or is there a reason that has kind of grown more slowly?

I mean, historically, the intel business has grown more slowly for 2 reasons. One is on the labor supply side, that's where you need the highest level clearances, and that's a very captive pool, right? And our business model, again, where you're sharing capabilities and really working across organizational boundaries in ways that I think our competitors can't. There's some natural limitations to doing that in the intel pace given the compartment and nature of some of that work. Now we're having more success in labor market in the intel business. We've sold a lot of really interesting work there. I think the intel business and government on a whole is in a way where they're really interested in innovation and getting access to commercial technology with [ tens ] of people's horizons. So we feel -- I feel good about where our intel business is. It's -- we've talked a lot about the loss of [ F2 ] we wouldn't talk about everywhere. We're talking about it again, even thought that was a while ago. I actually think in some ways, it's a real blessing because it's allowed us to take a truly world-class cyber and analytics experts and distribute them across other parts of the business, and we're seeing sort of more broad growth.

Got it. Okay. Good point. So the guidance for this year, you guys have talked a little bit about trying to build some momentum in the first half, a little bit more uncertainty always after the election, I think there's always a little bit of uncertainty. I guess, do you think this year is maybe a little bit more volatile given the political environment? Or just how do you think of kind of the potential outcomes as we get through [ them all? ]

Yes. So our fiscal year starts April 1, so it splits the government fiscal year. So I think structurally, we always talk about building momentum in the first half and uncertainty in the second half because, as you know, we've been under a CR or some form of budgetary uncertainty for most of the last decade. So it's a pattern we're very familiar with. Yes, there are a couple of schools that thought about being an election year and what that may or may not mean for the budget. I think if you look back historically, you actually tend to see more stability in the given year, right, because people want to -- just want to get out and campaign. We've got a lot of experience, as you know, working in a continuing resolution environment if that's where we end up as do our clients, importantly. But I think obviously, this election, there's more general uncertainty around it than most, right? So if you look at past patterns, you'd say there's probably actually in some way is going to be more stability, but there's a lot of unknowns about what's going to happen this year. So yes, as I mentioned, we're fortunate in that we're used to this pattern. Most -- typically our best book-to-bill quarter, as you know, you followed us for a long time, is our second quarter, which is the end of the government fiscal year. So it's been -- for decades, that's the most aggressive selling season for us. So I think we're going to just execute that playbook, which is sell as much work as you can. Do as many things that you can do to position yourselves and missions of enduring national importance, build staff. And then if uncertainty comes, you wade through it. So I don't think we're seeing -- there are no signs now yet that there's anything other than what you'd see in a typical year, but we'll see.

Right. Another thing that came up on the call, a little bit lumpier recompetes maybe in this year. Can you talk a little bit about that and how that sort of relates to the typical percentage of sales that comes up with the recompetes in a given year?

Sure. I think from a percentage of sales, we're not necessarily outside of the normal balance, maybe slightly at the higher end of typical ranges. It's the size of the recompetes. And that's just a function of the fact that we sold more large work. I mean, you followed us for a long time. Booz Allen's traditional strength was, as I mentioned earlier, tactical selling, selling at $5 million, $10 million, $15 million, $20 million, $50 million task order. We have coupled that ability where we're inside clients, providing innovation, providing ideas, generating demand with over the past 5 years, the ability to win some pretty large contracts. I think we've won $8 billion contract in the last 4 or 5 years. And so the very nature of that means those are going to start coming up for recompete. And so -- and the good news is we also have a larger pipeline than we ever had before, including a lot of billion-dollar jobs we're hoping to win that are either greenfield or new work, right? So in aggregate, we feel very good about where we are. We just wanted to call out the fact that, yes, the jobs that we won 3, 4, 5 years ago are starting to come up for recompete, and that's just something we built into our calculus.

Got it. Are there any particular ones you can call out or any timing during the year that...

As you know, government procurement cycles, things always shift to the right. So they may even happen this fiscal year. Just know that we're coming up on them. There's 1 or 2 on our health business, in our defense business, I think we called both of those out on the call that we got our eye on. We feel good about them. Our traditional or historic recompete win rate is 90%, but it's possible that you lose one. I will say, the advantage we do have on the downside, you saw this with F2 is given our business model, we have a lot of levers available either to shift work or client staff to other jobs. I think we retained roughly half our F2 staff, including a lot of the higher-end cyber experts. So it's just a reality, right? I wanted, in the spirit of transparency, investors to be aware. But stepping back in aggregate, sino-strength and we feel very, very comfortable about the overall size of the proposal pipeline, which is up, I think, 38% year-over-year.

Got it. I guess, a question on free cash flow. So over the last few years, we've seen a few swings. I know there's been some tax planning items in there. You're back kind of closer to normal this year. I just -- how should we think about kind of that going forward? Is that a more stable cash flow conversion?

Yes. So we have aspired, we still aspire at 100% or greater free cash flow conversion. On a normalized basis, we obviously weren't there last year for a couple of reasons. DOJ settlement, some catch up around 174 and the like. If you look at our guidance this year, we're guiding to slightly above 100%. Underneath that, there are a couple of things that I would like to highlight. We are making a long plan change in our payroll cadence, which will generate more cash. That's largely offset by 174, by a sort of lingering CapEx receivable we talked about on the call, about $15 million, $20 million. And sort of the remnants of some of the tax planning and some unbilled tax items. So net-net, the way I think about that is it's probably $40 million is a good from all those sort of nonrecurring stuff. So subtract that out from our cash guidance, we're probably slightly below 100% or touch 100%. So we're getting there. Still more work to do. It's beginning to normalize. I think we feel good about the vector that we've seen. We have been consuming more cash just given the pace of growth in the working capital. Obviously, the growth rate, we're going from 15% guiding to 8% to 11%. That will also begin to normalize, but we're getting there.

Yes. And maybe if you could remind us, the Section 174, if that does ever gets kind of gets overturned, is there dollar amount we should think of, how much you could potentially get back?

I'm looking at Nathan. We'll get back to you on that one. Yes, we've said it publicly before, but I'm failing the memory test.

Got it. Got it. Sorry to surprise you.

That's okay.

Can you talk a little bit about AI? It's been a big journey to guys. You guys have talked about it for a long time. So you're not jumping into this because it's hot now, but can you sort of talk about because you've invested in it for so long, what your advantage is there? And what makes it difficult for some of your competitors to replicate some of your success there?

Yes. I mean, stepping back, we've got a long history of investing ahead of trends that we think will be important for the U.S. Federal government. It used to be consulting. Increasingly, its technology. And AI is a great example of that. We started doing machine learning work in some of the intel -- some of our intel clients in the '90s. Then in sort of the late 2000, early ops, we were at the forefront of the data science wave and movement. We actually had our first Investor Day when we rolled out -- second Investor Day, but when we rolled out our first investor thesis in 2018, we had someone come up and talk about our AI strategy and business that we build. So we've been ahead of the curve. And it's really been a combination of a lot of folks who were passionate about AI, who are entrepreneurial, supported by internal investment and the fact that we won a couple of early big, large contracts because our view is that AI is a tool, right? And we intentionally called -- be able to [ invent ] last October. We actually paid, if you want to see some of the presentation materials called -- and we called it AI and because people aren't saying, I want to buy AI. Using AI often in combination with other forms of technology to some of solve a very specific mission challenge. So it's AI and cyber. It's at some point, going to be AI and 5G. It's AI and space. It's -- folks aren't buying AI. And so we were fortunate to hone our AI capabilities, our AI talent, our AI partnerships because a lot of this is bringing in commercial technology and making it relevant for government. Our understanding of the unique environment the government works in and constraints and objectives related to AI, whether it's ethical or traceable or what have you. I think that experience base, coupled with we've got some technology platforms we've developed through this experience, I think, provides us a head start competitively. But it's a competitive environment, lots of folks talking about it. We know that people are coming after us. We think that again, our ability to make AI work to solve problems. And increasingly, we're beginning to scale the solutions to these problems. That's what differentiates us. And that's rooted in the decades of work we've done in the more recent contract experience.

Yes. Got it. Within AI, you guys talked about $600 million of sales. Could you help us understand how that sort of breaks out? Is that a lot of contracts that have a little bit of AI and the few kind of big ones or just sort of how to think about how chunky those are?

Yes, it's actually a combination. I think we said publicly, it's crossed 200 projects. A lot of those projects exist on a couple of large contracts. Our eMAPS contract, which I think is $1.5 billion, it's not all AI, but a meaningful push of it is AI. our contract with CDAO, the Chief Data Analytics Office and Department of Defense similarly. But I think it -- so it's -- some of them are aggregated in the larger contract vehicles, but it's actually pretty widespread. And the reason we talk about projects, I think it just shows the scale of where government is right now. I mean, government isn't buying $50 million, $100 million, $200 million projects for AI to do X because they're trying to figure it out with people like us and others on their side. I could just -- to give you an example of how I think about AI, and what's unique in the government. All 3 of my kids graduated from high school or college last year this time. And all 3 of their graduation speeches, they had the same troupe of Gen AI create their speech and blah, blah, blah. And we all laughed, right? Why was it funny, right? It's funny because you combine your data with lots of other people's data. It's funny because you don't really know how it generates it. And it's funny because it was like 95% right and 5% wrong. And if you think about the government and the mission of the government, all 3 of those things are challenging, right? Government doesn't want to combinate without the people's data, particularly because we all know that through this new emerging and terrifying field of algorithmic warfare, countries are actually trying to infect one of those models. So the government doesn't want to -- so that's a challenge, so they don't want to. They have constraints in a real operational concerns about doing so. Traceability is important. If the IRS uses an AI, they're going to flag you for audit, you're going to want to know why, right? And that's not how a lot of AI models are built, right? It's very expensive to have feasibility. If an analyst report the CIA says, we assert X. The first thing they say is, well, how do you make that assertion, right? That's how AI works. And then 5% wrong doesn't work for the public remission. So it's just a couple of examples of how AI is different, putting aside a lot of the responsible and ethical concerns we have about using AI, not just in the commercial space, but for government. And there, again, is we're having experience of attempting to do these things in the field, not in the lab, I think, provides you an advantage.

Got it. Are the economics of some of this AI-related stuff any different? If you could have tremendous productivity cost savings, does that accrue to Booz Allen? Or sort of how does that work?

Yes, not yet. It's as best we can tell and AI is so intermingled with other pieces of work we do. It underscores -- best we can tell, it's probably slightly more profitable than our average business, and that will underscore slightly. And I think that's in part because the market is still developing. We don't know how to sell it from an outcome basis, the government does not buy it on an outcome basis. Hopefully, that will continue to emerge. I think that's one of the thresholds that we and others in the industry would like to cross at the right time. But it's also because we're not really seeing now a push for efficiency so much as it is for speed and for effectiveness, right? If you think about what's happening, you cover a lot of companies, right? It's all about speed, right? China, speed, speed, speed. Interoperability, speed, it's about capability. It's not about efficiencies. I mean, of course, you're generating efficiencies, but you're using that to invest in broader coverage and capability. So a long-winded way of saying we are not right now seeing any material benefit to margins from our AI business. I think you can envision a scenario when that would come, but we're nowhere near calling that. That market just hasn't evolved to that point yet.

Yes. Got it. And so AI, I mean, you've invested in this years ago to get to the point you are now. What are the things you're investing in now that you see 10 years from now, these will be the [ startup ] technologies?

It's interesting. I mean, it's a combination of things that may seem interesting and hot and things that are sort of old and legacy. And if cyber feels like it's old and legacy, but if you -- what's happening, as I mentioned earlier, the introduction of AI and cyber, hugely emerging field, Zero Trust, obviously, is an area where we and others are investing a lot, and we have the advantage of having the Thunderdome contract, one of the largest, if not the largest, Zero Trust, architecture and implementation contract in the government. [ OT ], I'm just talking about diver in securing things. Critical infrastructure. So there's a lot of investment around those areas, which are taking cyber, which is an old technology, but it's just changing so rapidly and applying into certain mission areas. We're investing a lot in AI, of course. Quantum, 5G, anything at the edge because that's really where a lot of the value is taking place. I mean -- and one of the -- how I think you're starting to see the market emerge is we are trying to leverage the investments that others are making through commercial partnerships. You've had a lot of rich, robust discussions with commercial tech players who have the ability and the capacity to invest in some of these foundational technologies that we don't, but we can apply them in couple of them with things that we do to solve real-world mission problems, perhaps in a way that they can't or they don't want to and fit their model, they're a very natural partnership there. So I think the term investment has changed significantly, at least for me, in the last 5 years. It's not just rebuild things. It's how do we source investment and innovation from a lot of different places, including some of the strategic stuff we do, but recognizing -- and the government is in the same mindset that there's a lot of, obviously, innovation that's happening out there that you want to bring in the government to make useful.

Got it. Got it. Okay. I just wanted to touch on M&A. You guys have done some deals historically. Talk about how big a priority that is. What are some areas you could look at? And maybe what you're seeing in the marketplace of assets that are coming out for sale?

Sure. Well, we're pleased to announce the deal yesterday. I got one over the finish line, really excited about [ Pargov ] and what it's going to do for us, especially I talk to about in a minute. And we're broadly -- still want to do M&A. Our capital deployment strategy hasn't changed. We've, I think, worn out the phrase patient and disciplined, but that's how we're going to approach this. We were a couple -- closing a couple of small deals last year that fell through. Happy that PAR got across the finish line. In general, we are looking at, I would say, tuck-ins, Par, it's public record because they're a public company, we paid $95 million for it. So maybe that has a low end and then to -- in the $100 million to $250 million, maybe $500 million range feels right for us because we're not buying scale. We don't need scale and contract access in terms of talent. We're buying capabilities, business model, products and solutions that we don't have access to that we can couple with things that we do and push them across our channels, as I talked about earlier, civil, defense and intel in new and unique ways. And Par is a great example of that. What they do is we've seen our Head of Investor Relations has told me the [ parent lease ]. Anybody who played Call of Duty knows what this is, but they have a tax system that sits -- it's a sort of a communication and real-time situational awareness device on your chest, right? They provide a lot of the software and develop these systems. And you think about coupling that with what we do from an AI perspective, Zero Trust number at the edge perspective, some of what we're doing in terms of decision advantage, right? It's a really natural partnership. And [indiscernible] making hardware, the hardware from Samsung. They do a lot of the software and configuration and other things on top of that, that coupled with what we do opens up a lot of opportunities. So that's perfectly emblematic of the kind of M&A we want to do. It's not necessarily swinging for the fences, but it's a really nice add for our clients, first and foremost, because we can development new capabilities but can obviously generate synergies for us.

Got it. Got it. Maybe just touch quickly on the labor. Are you guys seeing any more availability of people just given some of the tech layoffs we've seen? Is things getting any easier?

No, I think the labor market has been reasonably stable for the past 6 months, but stable in a place that's been really attractive for us. There's still a lot of competition for high end technical talent. Not just with commercial tech but inside our space, as you know. I think we're growing faster than anybody else, but there's a lot of folks growing in our business. So there's a lot of demand for technical talent. So it's -- I wouldn't say it's an easy labor market, but it's certainly looser than it was 2 years ago back when the commercial tech firms were stockpiling talent.

Yes. Got it. I guess, is there anything -- anybody from the audience before I -- I got a couple of more minutes. Talk a little bit about the Pacific, the pivot there on the last earnings call. Can you talk about some of the opportunities there? How big that is? Any different kind of strategy to win there versus work they've done in the past?

It's -- I'm trying to figure out how to define that market, right? I mean, it's -- [indiscernible] our CEO just wrote an article in Forbes magazine yesterday talking about, a, the need for speed; and b, the need, not just for a whole government approach, but for a whole of industry approach to the Indo-Pacific and to ensuring there is a balance in this great power competition. So inside that rubric, there's a tremendously wide area of opportunity. What are we seeing? We're seeing a lot of interest in not just how you prepare for kinetic activities with nonkinetic activities. The need for interoperability across not just traditional platforms, but other war fighting domains, right, whether it's space, cyber, economic, EW and the like. We're seeing a real emphasis on speed. Speed requires automation and machines in the loop. And it requires kind of interoperability in a common picture. We're seeing a lot of interest in how we work in new and different and better ways with our allies. If you think about the [ nature ], may or may not happen in that part of the world, which comes with its own advantages and challenges. So pulling back, all of those things are going to require innovation. All those things are hard problems and that those typically are conditions where Booz Allen [ feed ]. There's no preset answer to them. You're going to have to cobble together answers based on, first and foremost, your mission understanding; second, there's going to be a huge technology component to it; and third, you're going to have to be creative. So there's a lot of opportunity there. Our business is growing both directly and indirectly. You measure it by the number of people we have in Hawaii. You can measure it by the size of our defense business. It's an area that I think there is a lot of unanimity across government that we need to get better at, right? I mean, we're behind China in a lot of ways, and it's going to take, as Ross here noted, speed, full government approach, full industry approach to make sure we retain balance.

Got it. Got it. Great. I think we've got maybe a minute left. Any closing remarks you want to wrap it up with?

Yes, I think -- and we said this on the call, we're obviously just coming off probably the best -- Certainly, the best year we've had since our IPO. We see a lot of momentum in the business. Momentum creates resiliency. We're not predicting anything in the back half of the year or post election, but we recognize that there's volatility out there, and we've been preaching to internally. The best way to develop resiliency is to build as good a business as you can, and we feel good about where we are and the leadership position that we have and that we're growing into.

Great. All right. Yes. Thanks, Matt, for joining us, everybody for listening.

Sure. Thanks.