DLH Holdings Corp. Q2 FY2022 Earnings Call

Thank you, and good morning, everyone. On the call with me today is Zach Parker, President and Chief Executive Officer; and Kathryn JohnBull, Chief Financial Officer. The Company’s earnings release and PowerPoint presentation are available on our website under the Investor page. I would now like to provide a brief safe harbor statement, which is also shown on Slide 2 of the presentation. This call may include forward-looking statements that relate to the company’s outlook for fiscal 2022 and beyond. These forward-looking statements are subject to various risks and uncertainties that could cause actual results and events to differ materially from these statements. Please refer to the risk factors contained in the company’s annual report on Form 10-K and in our other filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements. On today’s call, we will be referencing both GAAP and non-GAAP financial measures. A reconciliation of our non-GAAP results to our reported GAAP results is included in our earnings release and in the investor presentation on DLH’s website. President and CEO, Zach Parker, will speak next; followed by CFO, Kathryn JohnBull, after which we’ll open it up for questions. With that, I’d now like to turn the call over to Zach Parker. Please go ahead, Zach.

Thank you, Chris, and good morning to everyone. Welcome to our fiscal 2022 second quarter conference call. We continue to produce strong results and remain on track for one of our best years ever. Before addressing the financials, I want to recognize the exceptional performance of our nationally dispersed workforce during this period. Business transformation and performance depend on our people, and we are fortunate to have a committed team. Additionally, our thoughts are with the Ukrainian people who are suffering from the ongoing crisis due to Russian aggression. Now, turning to our second quarter results, I am pleased with our progress. Our results align with expectations and showcase strong execution in both revenue and EBITDA. Once again, our short-term contracts with FEMA in Alaska significantly boosted our revenue to $108.7 million this quarter. Even without the $39.8 million from FEMA-related work, we achieved an organic sales growth of 12% from 2021, indicating solid demand for our programs, even amidst a slowdown in the award environment in Washington. Revenue grew across all three of our market segments year-over-year. This quarter, we experienced a reduction in pandemic impacts alongside the global disruptions from the unprovoked Russian invasion of Ukraine. Since our last meeting, Congress has enacted the FY ‘22 appropriations, providing federal clients with the budget visibility needed to align their priorities with funding levels. The subsequent funding responses to the Russian aggression also illustrate the national strategic shift in our military positioning. Our nation’s commitment to strengthening military readiness suggests we can foresee both short- and long-term benefits for our DoD and Defense Health Agency portfolios. Growing 12% organically without a formal budget is a testament to the value of our services and essential capabilities across all agencies. Our operating income reached $10.3 million or 9.4% of sales, marking the highest level in years, reflecting our shift to more advanced and value-added solutions. We achieved EBITDA of $12.1 million, with second quarter earnings of $0.50 per share or $0.22 excluding FEMA work, while also reducing our term loan to $37.5 million during the period. As Kathryn will discuss shortly, our debt reduction efforts continued post-quarter. Lastly, we ended the period with a backlog of $554.7 million, down sequentially from Q1 due to the slow pace of awards and the drawdown from the Alaska work, yet we are well-positioned for the remainder of FY ‘22 and beyond. Now, I'd like to elaborate on the current market outlook and our growth strategy. Federally prioritized budgets continue to support DLH and the agencies we serve. As we mentioned, decision-making should speed up now that a formal budget has been adopted, positively influencing our business volume heading into FY ‘23. For DLH, the demand for our services is highlighted by projects within current appropriation bills and the presidential budget requests, reaffirming our alignment with healthcare-related government spending trends. Simultaneously, we are becoming recognized for consistency in revenue growth, margin expansion, and underlying financial performance. We continue to execute our strategy of investing cash into our workforce while reducing debt, thereby enhancing our organization and balance sheet simultaneously. Our team keeps leveraging technology to support our clients and distinguish our work while investing in initiatives to address current workforce challenges. We are deploying capital wisely, not just for growth but also for value creation, and our market remains robust. We are equipped to tackle complex challenges faced by federal civilian and military clients, whether in data analytics, disease control solutions, or innovative systems engineering for the Defense Health Agency. We bring decades of experience and highly trained professionals to address these needs, utilizing digital transformation, big data, secure analytics, and more to help our clients meet future challenges. Our ongoing investment in human resources and technology will further strengthen our organization. We have a world-class workforce focused on enhancing public health, holding top certifications, including our recent ISO 27001 achievement. This accreditation confirms that our Information Security Management System meets the ISO/IEC 27001:2013 standards, the only globally recognized certifiable information security standard. It encompasses our IT systems supporting operations, as well as our cloud platform services, and was earned after an extensive audit reviewing our risk management and control processes. This validation underscores our commitment to top-tier information security and data management practices, assuring federal clients of our rigorous security and risk management protocols. It's another example of how we are leveraging technology to support our clients and attract new business. Before handing the call over to Kathryn, I want to highlight the significant changes we've experienced in recent years. Our transformation has rapidly turned DLH into a diversified organization serving three core federal markets, consistent with our strategic goals. Strategic acquisitions along the way have broadened our capabilities and the agencies we serve, in line with our long-term strategy. Ultimately, it all comes down to our people, both new hires and long-serving employees, who have driven our progress. I am extremely proud of our team’s professionalism and enthusiasm, which have been key to our success in securing and executing contracts with FEMA in Alaska over the past six months. This clearly demonstrates DLH’s potential to become a major player in the GovCon space and positions us for even greater achievements in addressing the nation's healthcare and systems engineering needs. We are on track for strong results this year and are positioning the company for even better outcomes ahead. Our talented team is developing innovative solutions for our clients and winning new business that capitalizes on our expanded capabilities. With the federal budget in place and FedRAMP authorization achieved, combined with demand for our services, we are optimistic as we approach the second half of fiscal 2022. I will now hand the call over to our Chief Financial Officer, Kathryn JohnBull.

Thank you, Zach, and good morning, everyone. Happy Cinco De Mayo. We’re happy to report another quarter of excellent results. Turning to Slide 6. We posted revenue of $108.7 million for the three months ended March 31, 2022, versus $61.5 million in the prior year’s fiscal second quarter. The growth reflects the impact of roughly $39.8 million in revenue tied to the Alaska FEMA contracts, as Zach discussed, along with a 12% revenue increase across the other parts of our business. As an aside, we do not expect to see any material impact in Q3 related to Alaska since the work there has been largely fulfilled. Income from operations was $10.3 million for the fiscal 2022 second quarter versus $4.6 million last year, again, reflecting the additional short-term FEMA contracts in Alaska. Operating margins improved to 9.4% from 7.5% in fiscal 2021. Note that the FEMA work this quarter was positively impacted by end of contract incentives, while our non-Alaska operations were impacted by planned investments in human capital and business development activity. Going forward, our margins will return to more typical levels associated with our sustaining revenue and program mix. Interest expense was $0.6 million in the fiscal second quarter of 2022 versus $1 million in the prior year period, reflecting lower debt outstanding. DLH recorded a provision of $2.5 million and $1 million for tax expense during the second quarters of fiscal 2022 and 2021, respectively. We reported net income in the second quarter of approximately $7.2 million or $0.50 per diluted share versus $2.6 million or $0.19 a share last year. Excluding the Alaska business, non-GAAP earnings for the fiscal 2022 second quarter were $3.1 million or $0.22 per diluted share. A reconciliation of these results is included in the back of this presentation. EBITDA for the second quarter of fiscal 2022 was $12.1 million, versus $6.6 million in the prior year period due to the reasons I discussed earlier. As a percent of sales, EBITDA rose to 11.2% this quarter versus 10.8% last year. Excluding $5.5 million related to our Alaska business, EBITDA for the fiscal '22 second quarter was $6.6 million, reflecting the planned investments in human capital and business development in the current quarter. A reconciliation of GAAP net income to EBITDA is provided in our earnings statement and at the back of this presentation. Slide 7 gives an updated snapshot of our debt position at the end of Q2. As of March 31, we had approximately $37.5 million of debt outstanding under our credit facilities versus $46.8 million at the end of fiscal 2021, and our leverage ratio nudged under 1x. Furthermore, after the end of the quarter in April, we paid off all remaining debt from our acquisition of Social & Scientific Systems in 2019, extinguishing that $70 million five-year term debt in 35 months. As promised, we’ll use our substantial cash generation to pay down debt and delever the balance sheet, leaving us in a strong position with plenty of financial flexibility for any appropriate transaction on the horizon. At this point, we expect to end the fiscal year with under $25 million of indebtedness. This concludes my discussion of the financial statements. With that, I would now like to turn the call over to our operator to open for questions.

This is Joshua Zoepfel filling in for Joe Gomes. So my first question was, I know that the Head Start program revenues in the second quarter kind of jumped from the first quarter a little bit. Can you tell me a little bit what is behind that? Do we expect that $8.9 million going forward?

Yes. Great question, Josh. Yes. As we have been indicating in prior quarters, we’re severely impacted largely by the COVID-19 impact for these guaranteed facilities throughout the country. A big part of that reduction was associated with our abilities to go out to these sites and conduct on-site investigations. With the cessation of the pandemic as well as some innovations that we put into place with regard to how we’re going to conduct those audits, we started to pick those back up during this quarter. And we’re optimistic and hopeful that that will be sustained at that level and will continue.

I understand that you have made additional investments in human capital management, as discussed last quarter. This is intended for employee retention and attracting new talent. It also seems like you're preparing your workforce in anticipation of potentially increased work. Is that a reasonable way to think about it?

Yes. All of the above, Josh. Certainly, we’re in some tough times. We’ve always had challenges sometimes come with regard to the workforce, but the great resignation has really challenged all of the GovCon community in a special way. So Maliek Ferebee, our Head of Human Capital Management, has really worked very closely with each of our operating unit leaders and our team to really come up with some innovative ways to address that. And that is going to continue to be very important for both retention and attraction. At the same time, we’re implementing some new measures to help build new tools and capabilities in all aspects of human capital, whether it’s talent acquisition systems, talent management, learning management systems, et cetera, bringing in some best-of-breed tools to help us as we move forward in the future. So we’re starting to see some of those investments this year, and we’ll continue to do so. As I indicated earlier, we’re in the people business, and we’ll continue to go. Kathryn, anything to add?

No, that’s exactly what would have been my observation. Obviously, we’re fundamentally a people business. And so even pre-COVID and pre-great resignation, we really understood the importance of continuing to really build that pipeline of talent and really give people visibility into the trajectory of their career path here. That’s our really foundation for sustaining a growth outlook for the company. And so continuing to develop the one DLH culture that really weaves together the resources that come in via various acquisitions, helping people understand how they can matrix across the organization, continuing to scale up people and give them a path forward. And then, of course, nothing about COVID and the great resignation has done anything but reinforce really the strategy we already had at play. So I think all those things really speak to the importance of committing meaningful resources to human capital development.

I would like to know if you can provide more details about the major contracts you have bid on or are considering bidding on, including their sizes and the expected timing.

Yes, the range of our pipeline does vary. We’ve experienced a particularly heavy period in the past few quarters due to some of our recompetes, which are not very material but are strategic for us. These involve contracts less than $50 million but over $5 million. At the same time, we’ve been working on IDIQs, which are contracts that allow us to compete for task orders over the next five or ten years. We will continue to focus on securing a stable of these types of IDIQ contracts going forward. We are also optimistic that with the current budget certainties, we will soon see RFPs for larger opportunities exceeding $75 million and $100 million. Our customers have extended incumbencies on those contracts and have been reluctant to fund new procurements. However, we are hopeful that moving away from the continuing resolutions we’ve experienced for several years will bring more budget transparency and advance those opportunities. We have been preparing for these RFPs, and as Kathryn indicated, our pre-RFP activities are geared toward developing technical solutions and value propositions in the capture process that will provide significant benefits after submitting proposals and awaiting awards.

Great. And just last question, if I may. I just wanted to kind of get an update just on the pipeline looking or seeing the valuations out there when you’re looking at those companies.

You’re talking about on the corporate development M&A side?

Yes.

Sure. Happy to address that. So I think it’s a factor of the M&A industry in general and particularly in our space that a lot of opportunities pulled forward into 2021, just the general expectation of the tax rate increase that ultimately never materialized. And so that sort of drained the queue, if you will, for the first quarter of calendar 2022. But everybody that we network with and our own sense of things was that things would start to spring to life in the April timeframe. And indeed, that is what we are observing. So I do expect there to be healthy volume for the balance of calendar 2022, and we’re definitely going to be in there, evaluating the opportunities that are relevant for DLH. So we’re encouraged about our ability to have the capacity to respond to those opportunities. And we think there is a lot in the market that would be meaningful in terms of continuing to expand our capabilities.

And let me add that Kathryn and I were pretty proactive at the beginning of the calendar year to actually meet with our close friends in that side of the business to let them know kind of what our strategy is. We have expanded our strategy in many ways. We believe that we’re well prepared to do larger types of opportunities than we had before. And then we’re also opening our aperture a bit, while health is going to continue to be a core component of us. But the technology side and differentiating capabilities that we have built over the last couple of years, we think opens up some additional markets that will also come into play. So we think that we’ve got some pretty good alignment so that they understand our expanded strategic vision on that side of the house, and that will help to drive, we think, opportunities in the near future.

Congrats on the quarter, guys.

Thank you, Josh.

Thanks for joining, Joshua.

Our first question comes from Joe Gomes with Noble Capital Markets. At this time, there are no additional callers in queue. So I’d like to turn the call back over to the President and Chief Executive Officer, Mr. Zach Parker for any closing remarks.

Well, thank you to everyone for joining us today. This concludes our presentation this afternoon. As usual, Kathryn and I will remain available for any follow-up discussions. And for the rest of you, please have a blessed day, and we look forward to chatting with you next quarter. Bye for now.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.