Booz Allen Hamilton Holding Corporation (NYSE:BAH) Q3 2023 Earnings Call Transcript

Booz Allen Hamilton Holding Corporation (NYSE:BAH) Q3 2023 Earnings Call Transcript January 27, 2023

Operator: Good morning. Thank you for standing by, and welcome to the Booz Allen Hamilton’s Earnings Call covering Third Quarter Fiscal Year 2023 Results. At this time, all participants are in a listen-only mode. Later, there will be an opportunity for questions. I’d now like to turn the call over to Mr. Nathan Rutledge.

Nathan Rutledge: Thanks, operator. Good morning, and thank you for joining us Thanks, operator. Good morning, and thank you for joining us for Booz Allen’s third quarter fiscal year 2023 earnings call. We hope you’ve had an opportunity to read the press release that we issued earlier this morning. We have also provided presentation slides on our website and are now on Slide 2. With me today to talk about our business and financial results are Horacio Rozanski, our President and Chief Executive Officer; and Matt Calderone, Executive Vice President and Chief Financial Officer. As shown on the disclaimer on Slide 3, please keep in mind that some of the items we will discuss this morning are forward-looking, and may relate to future events or 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 call.

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 call, we will also discuss some non-GAAP financial measures and other metrics, which we believe provide useful information for investors. We include an explanation of adjustments and other reconciliations of our non-GAAP measures to the most comparable GAAP measures in our third quarter fiscal year 2023 earnings release and slides. It is now my pleasure to turn the call over to our CEO and President, Horacio Rozanski.

We are now on Slide 4.

Horacio Rozanski: Thank you, Nathan, and good morning, everyone. Thank you for joining the call. Matt and I are very pleased to share exceptional results for the third quarter of fiscal year 2023. These results show Booz Allen is gaining momentum. We are positioned well for the remainder of this fiscal year, and on track to achieve our investment thesis. This quarter, we delivered industry-leading double-digit organic revenue growth. Our strong demand momentum and continued acceleration in hiring bolster our confidence as we look ahead. Given the strength of our performance, we are making positive adjustments to our guidance ranges, which Matt will discuss in a few minutes. Additionally, and as you may have seen, Standard & Poor’s upgraded our credit rating to investment grade last week.

This is a reflection of our strong track record of growth and our consistent financial performance. Today, Matt and I will discuss these results in the context of our investment thesis. I will also update you on the progress we are making on VoLT, focusing on how we continue to outpace the market through the Velocity dimension of our strategy. Let’s begin with our investment thesis. At our Investor Day in October of 2021, we laid out our plan to grow adjusted EBITDA to $1.2 billion to $1.3 billion by fiscal year 2025. We said, we expected to achieve that goal through the combination of industry-leading organic revenue growth, strong and stable margins, allowing for continued investment in our people, innovation and infrastructure, and capital deployment that prioritizes strategic acquisitions.

The results of the last several quarters put us on track to achieve our adjusted EBITDA targets. On balance, we see more momentum on organic growth and profit than we originally anticipated. And while acquisitions remain a priority, the pace of M&A has been slower than we originally expected. We will continue to move strongly on both fronts in the coming quarters. Diving deeper into our current operational performance. Let me highlight the following areas of momentum. First, our hiring results are exceptional. We grew client staff 7.5% year-over-year and continue to quickly place new hires into billable roles. Second, and despite a relatively light book-to-bill ratio this quarter, demand remains strong. This is reflected in our trailing 12 months book-to-bill and a robust pipeline, which includes several large pending near term awards.

Additionally, with the federal budget in place, our clients have clarity on the resources available to invest in their priorities, further strengthening the demand picture. And third, we are operating faster and more efficiently by empowering our decision-makers and streamlining internal workflows. As a result, even with significant inflationary pressure, our corporate costs are growing well below our revenue growth rate, creating additional capacity for investment. These operational metrics give me confidence of continued momentum in the business. One additional note on the financials we are reporting today. In our 10-Q, we disclosed we have entered into settlement discussions with the Department of Justice related to their investigation into certain elements of our cost accounting and indirect cost charging practices.

We are exploring whether a negotiated resolution to the matter is possible with the DOJ. In connection with those discussions, we recorded a reserve for $124 million in the third quarter of fiscal year 2023. At this time, we do not know if or when a settlement might be achieved, and if achieved, with the total dollar amount might be. Before turning the call over to Matt, let me take a few moments to update you on VoLT. Over a decade ago, Booz Allen correctly anticipated that technology would become the dominant force in the success of the federal government’s core missions. We prepared for that evolution and established a unique position in the market. Today, as the change we saw coming is upon us, we have first mover advantage and are a recognized leader in driving technology adoption in the government.

In this moment, when technology has become a catalyst for mission success, speed is key. Technology, missions and the competitive environment are all changing more rapidly in this next evolution of the market. In response, the V for Velocity in VoLT represents our imperative to get faster and stay ahead of the pace of change. So in addition to faster decision-making and streamlined internal processes, Velocity includes twp market focused dimensions. The first is leveraging technology to accelerate organic growth. And the second is using M&A as a strategic accelerator. Our aerospace business helps illustrate the first point on accelerating organic growth. As an example, earlier this fiscal year, we reported winning the CyPrESS contract, which is transforming how cyber is delivered across the entire NASA enterprise.

Our investments and experience innovating in the most complex cyber missions uniquely positions us to win this work. We have quickly hired and ramped up on this contract, and are now one of the main providers of cybersecurity at NASA fully engaged in protecting the space agency’s assets and infrastructure. In other parts of aerospace, we’re also leveraging technology to evolve the mission. We are accelerating digital transformation across the Air Force’s weapons, enterprise and test ranges. And in today, rapidly evolving threat environment, we are helping our clients re-imagine the future of secure communications on military aircraft platforms. From exciting new wins, to expanding on decades long work, we are inserting new technology across Air Force, Space Force and NASA missions.

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And as a result, our aerospace business has accelerated from flat to double-digit organic growth over the past 2 years. Let’s turn now to the second dimension of Velocity, using M&A as a strategic accelerator. EverWatch is our most recent example of this. We are pleased to have completed the acquisition in October, and integration is underway. Through EverWatch, we gained access to classified software development capabilities to support national security missions faster than we could have built and scaled them on our own. At a time when mission success or failure is dependent on the right technology, acquisitions like EverWatch help us bring innovation to missions at speed. We continue to build our M&A pipeline with a focus on acquisitions that have potential to accelerate our organic growth.

One final point to close. In December, I participated in the Reagan National Defense Forum, with some of our most senior clients, industry colleagues and legislators. Our discussions centered largely on how technology is fundamentally redefining the battlefield and what we need to do as a nation to be better prepared to stay ahead of facing threats, especially China. These conversations, like many I have with our clients across defense, intelligence and civil agencies, reinforced for me, the technology has gone from an enabler of mission to a catalyst of mission success. Thus, I believe the investments Booz Allen has made over the past decade, combined with our continued progress on VoLT, and of course, our incredible people, uniquely position us to accelerate into the next decade, outpace our competitors and make the greatest difference through the work we do for all our clients.

And with that, Matt, over to you to take us through the financial results.

Matt Calderone: Thank you, Horacio, and good morning, everyone. As Horacio noted, we are extremely pleased with our financial results, both for the third quarter and for our fiscal year-to-date. We remain the industry’s organic growth leader and continue to operate the business very well. We have built excellent momentum toward reaching our fiscal year and investment thesis objectives, and we expect this momentum to continue given our strategic positioning, our strong execution and a positive budget environment through the end of the government fiscal year. Before discussing our third quarter results in detail, I will highlight a few key areas of our fiscal year-to-date performance. Over the first three quarters, we delivered 9.5% organic revenue growth.

This is a result of us winning work aligned with our VoLT strategy and hiring, retaining and efficiently deploying the right talent. Our adjusted EBITDA margins of 11.5% in this period reflect continued strong contract level execution and prudent cost management. We deployed $714 million of capital through three quarters, a combination of dividends, share repurchases and the strategic acquisition of EverWatch. As a result, Booz Allen remains on track to achieve our investment thesis goals and to continue delivering excellent value to our shareholders. Now please turn to Slide 6, as I discuss our third quarter results in detail. At the top line, total revenue in the third quarter grew 12.1% year-over-year to $2.3 billion. Revenue excluding billable expenses grew 11.2% to $1.6 billion.

Almost all of this growth was organic, as our organic growth accelerated to 11.6% for the quarter. I am particularly pleased that our revenue growth was driven by double-digit contributions from each of our three federal markets. In Defense, revenue grew approximately 10% year-over-year led by strong performance in our Aerospace and Joint Combatant Command accounts. In Civil, revenue grew by approximately 16% year-over-year, highlighted by growth in our health account, and in the mission-critical cyber and digital solutions work we perform across the civil market. In our Intelligence business, we grew by approximately 14% year-over-year, driven by our National Cyber and Defense Intelligence accounts, as well as our strong hiring across the board.

At this point, we expect a stand-alone fiscal year 2024 contribution from EverWatch of between $180 million and $200 million. Our Global Commercial business, which accounted for roughly 3% of our revenue in the quarter, declined approximately 13% year-over-year. This reflects the sale of our MENA and Managed Threat Services businesses in the second and third quarters, respectively, that streamlined our commercial business and positioned it well for future growth. On the labor supply side, our client staff headcount grew to 28,269 at the end of the third quarter, an increase of 1,975 employee’s year-over-year, or 7.5%. Total headcount, inclusive of corporate staff increased to 31,130, this equates to growth of 1,677 employees year-over-year, or 5.7%.

These figures included over 400 employees who joined at Booz Allen from EverWatch in the third quarter, as well as the approximately 80 employees who left the firm with our MTS divestiture. The transformation of our talent acquisition life cycle and improved levels of attrition in the quarter drove this continued acceleration in headcount. These results show that we continue to attract and retain the high end talent we need, even in an extremely competitive labor market. On the demand side, net bookings for the third quarter were approximately $197 million, which translates to a quarterly book-to-bill of 0.09 times. Our trailing 12 months book-to-bill metric remained solid at over 1.2 times. This is the best indicator of sustained demand as it normalizes for quarter-to-quarter volatility.

We can attribute our relatively light book-to-bill number this quarter to two factors. First, seasonality, as this is consistent with our historical bookings pattern. And second, the timing of a few large awards and protest resolutions that were pushed into the fourth quarter. This timing dynamic includes a large contract award in our intelligence market that Horacio referenced in our last earnings call. This award, which has meaningful overlap with work we are performing today is currently under re-evaluation. In the quarter, total backlog grew to $30 billion, which is approximately 8.2% year-over-year. Funded backlog grew 12.4% to $4.5 billion. Unfunded backlog grew 7.6% to $10.1 billion and priced options grew 7.5% to $15.4 billion. We are very comfortable that this backlog and the strength of our proposal and award pipeline support our near and medium term growth aspirations.

Consistent with our strong top line performance, we generated $244 million in adjusted EBITDA in the third quarter, up 9.8% year-over-year. We ended the quarter with an adjusted EBITDA margin of 10.7%, down 20 basis points year-over-year, and in line with our expectations. Our adjusted EBITDA margin reflects a mix of drivers with strong contract level performance and solid cost management, offset by a higher billable expense mix, higher unallowable spend, and the impact of wage inflation on our fixed price and time and materials contracts. Our net income decreased 76.2% year-over-year to $31 million. This was primarily a result of the $124 million legal reserve, we recorded this quarter in connection with the DOJ matter. Adjusted net income, which excludes this legal reserve was approximately $142 million, up 4% year-over-year.

These were driven by our strong operating results, which were partially offset by higher tax and interest expense compared to the prior year. Diluted earnings per share decreased 75.8% compared to the prior year period to $0.23, primarily as a result of the aforementioned legal reserve. Adjusted diluted earnings per share, which excludes the legal reserve, increased 4.9% year-over-year to $1.07. Turning now to the balance sheet. We closed the third quarter with a cash balance of $371 million, and a $1 billion untapped revolver. Free cash flow for the quarter was $117 million, the result of $139 million in cash from operating activities, net of $22 million of capital expenditures. Operating cash was supported by collections that kept pace with our revenue growth, but with seasonally light due to acquisition and divestiture-related expenses paid out in the quarter.

Now turning to Slide 8. During the third quarter, we deployed $510 million of capital. This included approximately $440 million connected with the EverWatch acquisition, $11 million in share repurchases at an average price of $96.30 per share, and $57 million in quarterly cash dividends. Our net debt at the end of the third quarter was approximately $2.5 billion, and our net leverage ratio was approximately 2.5 times. As Horacio mentioned, we were delighted by last week’s news from Standard & Poor’s, who upgraded us to BBB minus and investment-grade credit rating. We look forward to the enhanced flexibility and access to capital markets that this upgrade will provide, and we will continue to be good stewards of our balance sheet, while deploying capital in a patient and disciplined manner.

To this end, I am pleased to announce that our Board has approved a $0.04 increase to our quarterly dividend. This dividend of $0.47 per share will be payable on March 1st to stockholders of record as of February 10. Finally, let me summarize our updated guidance for full fiscal year 2023. Please turn now to Slide 9. Our excellent performance and sustained momentum through the first three quarters give us confidence in our ability to finish this fiscal year strong. At the top line, we are increasing our guidance for full fiscal year revenue growth to between 9.5% and 10.5%. As a reminder, our fourth quarter has one fewer working day when compared to the prior fiscal year, which impacts year-over-year quarterly growth comparisons. We still expect margins to be in the range of high 10% to low 11%.

We now expect adjusted EBITDA to be between $995 million and $1.15 billion in sync with the increase in our top line guidance. We are also increasing our ADEPS guidance to a range of between $4.35 and $4.50 per share. We now expect capital expenditures to be between $80 million to $90 million for the fiscal year. And lastly, our fiscal year 2023 operating cash flow guidance remains unchanged from last quarter. In closing, like Horacio, I really want to thank our dedicated employees, whose relentless focus on the mission is really the root of our outstanding performance. Because of them, Booz Allen remains on track to achieve our investment thesis goals and to continue to deliver excellent shareholder value. With that, operator, let’s open the line for questions.

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Q&A Session

Operator: Certainly. And our first question will come from Sheila Kahyaoglu . Your line is open.

Sheila Kahyaoglu: Good morning, everyone. And….

Horacio Rozanski: Hey. Sheila…

Sheila Kahyaoglu: Thank you for the time. So Horacio in your opening remarks, you mentioned M&A as a strategic accelerator, and you typically haven’t done deals, but you’re focused on them now. Can you maybe give us an update on Liberty and Tracepoint, as well as EverWatch, given you just closed the books on that one? And it seems like the revenue contribution is coming in a lot better there?

Horacio Rozanski: Yes, absolutely. So let me start by saying, we’re very happy with the results of the quarter and particularly happy with the organic performance of the business, which is really ahead of our expectations at this point on the trajectory of our investment thesis. And as I mentioned on the opening remarks, we are a little bit behind where we thought we would be at this point on the M&A side, largely environmental factors. But overall, we’re very pleased with what we are on the journey, and we’re on track. And that’s really the key message. One click down from that. As I mentioned, now work backwards, EverWatch is finally closed in October, we’re integrating it. There was a little degradation of talent levels, while we were waiting for it to close.

And so we’re accelerating their hiring because they have pretty robust demand there that we want to meet, and that’s where that is. Tracepoint is getting fully integrated into our commercial business. As you know, that is a small acquisition and a small business, but it’s an important capability as we do incident response more aggressively across the commercial market. And then Liberty, which is now fully integrated into our business has been an extraordinary success and continues to be – they are – it’s a big part of our health team. They brought low code, no code capability that is both really valuable across the health account, but really increasingly across the federal government, and we’re really pleased with that. So overall, we’re looking to do more things that look like Liberty.

They’re hard to find. And we’re – as Matt always says, we’re going to be patient and disciplined on this, and that’s where we’re going.

Sheila Kahyaoglu: Thank you for that. Maybe if I could follow up just on the civil business as a whole, which clearly includes Liberty. You mentioned I mean the business is growing at a spectacular mid-teens rate. So what’s sort of driving that? You mentioned health and cyber mission work? Is it a few contracts? Or is it just you’re going into new addressable markets there?

Horacio Rozanski: It’s broad-based. I think that’s a great question. I think this speaks to really VoLT and Velocity and everything else that we are doing across the business. This notion of inserting new technology into existing missions really resonates with our clients. It’s what they need to do to meet the demands of the moment. I honestly believe it is what’s driving this double-digit growth that we experienced this quarter and really the broad-based growth across many parts our portfolio. In civil, in particular, it’s not just health. There is significant elements of our treasury business that are growing very well. And we’re happy with what we’re seeing. I mean, the civil agencies are focused on digital transformation. They need to be, and we like to believe that we are a catalyst and a partner with them on this journey, and that’s what underlies our growth opportunity.