Earnings Call Transcript - DLHC Q3 2021

Chris Witty, Investor Relations Adviser

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 2021 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 the 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. Please go ahead, Zach.

Zach Parker, President and Chief Executive Officer

Thank you, Chris, and good morning, everyone. Welcome to our third quarter conference call. I couldn’t be more pleased with our performance, and we’re on track for our best year ever with even greater plans in place for fiscal 2021. I want to express my pride in our tremendous employees across the globe who continue to deliver top-quality services and solutions to our clients despite very challenging times. Starting with Slide 3, I’ll first provide a high-level overview of the quarter and some insight into the outlook for the rest of 2021. Revenue rose nearly 20% year-over-year to $61.6 million, as we’ve benefited from the acquisition of IBA, along with organic growth across the enterprise. We posted operating margins of 8%, reflecting a strong mix of programs and earnings of $2.9 million or $0.21 per share. We also generated approximately $9.3 million of cash from operations and used this to pay down approximately $9 million of debt during the quarter. Year-to-date, we’ve paid down roughly $16.2 million of debt due to the company’s strong cash-generating ability. We continue to de-lever and improve our overall financial flexibility, as Kathryn will discuss more in a moment. We previously announced that we won the VA’s CMOP Medical Logistics Award in the third quarter, which was expected to add over $200 million in contracted value over a five-year period to our backlog. During the quarter, this contract was protested by a small business bidding entity, and the government continues to work through their standard process, addressing the concerns to proceed to a resolution and award. In the meantime, the company’s Medical Logistics CMOP contract was extended through November of 2021, and our backlog remains robust even as we await resolution on this contract, for which we expect a favorable outcome. Now, turning to Slide 4, I’d like to update our investors on our long-term strategy for success, which continues to evolve as we grow the company. Given our track record of successfully integrating acquisitions, delivering excellent performance on large, nationally dispersed programs, and expanding our healthcare technology capabilities, we believe that DLH has enhanced its position for growth within the markets that we serve. While several long-term anchor contracts give us visibility and stability regarding a portion of our revenue base, our diversification strategy has given us a presence across the full range of the federal health and military health systems and services with key programs and agencies in our sights. We continue to serve the citizens, the soldiers, the service members, and our veterans. However, even as we’ve expanded, we’ve remained focused on our formula for success, serving clients where we can truly bring value-added, real-world solutions to address the healthcare needs of today and tomorrow. Our services are leveraging an expanded set of technology solutions, but our targeted agencies are largely the same, as this is our dedication to our strategy and to the utmost in customer service. We continue to hire the best and the brightest, leveraging talent that we bring from a variety of healthcare-related industries and companies. We’ve built a foundation for strong long-term growth with a professional, highly credentialed workforce that can compete and win against the most respected names in the industry. Therefore, we’ve been able to see revenue rise to a level of nearly $250 million annually, and we are confident that we’re well-positioned to grow to our next revenue target of $500 million based on our existing platform, including research, technology, healthcare delivery, and performance management. The past year during a pandemic has shown that our services are more valuable than ever and that our workforce is flexible, committed, and can adapt to rapidly changing requirements in terms of working remotely, interacting with customers in new ways, and winning business that leverages our expertise in digital transformation, artificial intelligence, advanced analytics, cloud-based applications, modeling and simulation, telehealth systems, and more. And we’ve accomplished all this in a sensible way in terms of capital deployment by accessing our credit lines to make acquisitions and invest in the business; we prevent frequent equity dilution of our existing shareholders. We then use our substantial cash flow generation to pay down debt and strengthen our balance sheet, which enables us to replicate this process. We’ve used this strategy consistently, leading to a refined acquisition process that maximizes shareholder returns and growth on the capital deployed. We remain well-positioned to take advantage of the opportunities ahead, and are confident that as we near fiscal 2022, the company will continue posting solid financial results. Our backlog remains strong, and we will capitalize on the increasing need for technology-enabled healthcare solutions for which we are so well-known and respected. I feel confident in our ability to provide the returns our shareholders have come to expect, just as I am proud of our staff and partners for performing so well during such unusual times. With that, I’d like to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?

Kathryn JohnBull, Chief Financial Officer

Thank you, Zach, and good morning everyone. We’re pleased to have once again posted solid results this quarter. Turning to Slide 6 in the presentation, we posted revenue of $61.6 million for the three months ended June 30, 2021, versus $51.5 million in the prior year’s third quarter. The variance reflects the impact of roughly $7.3 million in revenues tied to the acquisition of IBA, along with organic growth across a variety of existing programs that follow increased activity this year. We anticipate such trends to continue in the fourth quarter and into fiscal 2022. As Zach mentioned, our CMOP Logistics award is being protested, so we’re operating under an extension of the prior award through at least November. We remain optimistic about a favorable outcome of the award. Turning to Slide 7, income from operations was $4.9 million for the fiscal 2021 third quarter versus $3.8 million last year. Operating margins improved to 8% from 7.4% in fiscal 2020, reflecting favorable program mix and greater operating leverage. We reported net income of approximately $2.9 million or $0.21 per diluted share versus $2.1 million or $0.16 a share last year. DLH recorded a provision of $1.2 million and $0.9 million for tax expense during the fiscal 2021 third quarter and fiscal 2020 third quarter respectively. Interest expense in the current year quarter increased by $0.9 million versus $0.8 million for the three months ended June 30, 2020, due to higher outstanding debt levels reflecting the acquisition of IBA. Turning to Slide 8, EBITDA for the third quarter of fiscal 2021 was $7 million versus $5.5 million in the prior year period, as a percent of sale EBITDA rose to $11.3 million this quarter versus $10.7 last year. A reconciliation of GAAP net income to EBITDA is provided in our earnings statement and in the back of this presentation. Slide 9 gives an updated snapshot of our debt position at the end of the third quarter. As of June 30, we had $53.8 million of debt outstanding under our credit facilities versus $62.8 at the end of last quarter. We generated approximately $9.3 million of operating cash flow during the quarter and paid down roughly $9 million of debt. We estimate debt below $50 million at the end of fiscal 2021, reflecting a stronger balance sheet and a much lower leverage ratio than at the beginning of the year. This concludes my discussion of financial statements. With that, I would now like to turn the call over to the operator to open for questions.

Operator, Operator

Thank you. The first question is from Joe Gomes of NOBLE Capital. Please go ahead.

Joe Gomes, Analyst

Good morning.

Kathryn JohnBull, Chief Financial Officer

Good morning, Joe.

Joe Gomes, Analyst

Thank you for taking my questions.

Kathryn JohnBull, Chief Financial Officer

Great to hear from you.

Zach Parker, President and Chief Executive Officer

How are you doing, Joe?

Joe Gomes, Analyst

Doing well here, we’re doing well. Hopefully, the same for you guys this summer.

Kathryn JohnBull, Chief Financial Officer

Absolutely.

Joe Gomes, Analyst

First question, you saw some organic growth in the quarter. The last year or so you had pointed out the absence of travel-related pass-through revenues. I was just wondering, have they returned to help pump up the organic growth, or are we still waiting for those types of revenues to come back?

Zach Parker, President and Chief Executive Officer

Yes. Those are still slow to come back. We are starting to see some plans that were pretty determined before the Delta variant started to come into play. We’re starting to see plans where later this year we’ll start to do more of that travel, even though mobility has substantially increased in our country. We’re still looking at it, since ours involves inspections and being around some of our clients and ultimately some of our team members, we’re still proceeding very cautiously that way. So, the majority of the organic growth has been with the delivery of key talent for our customers, and we’re pleased to see that.

Joe Gomes, Analyst

Great, thanks for that. And on the logistics contract, maybe give a little more color as to what exactly caused the VA to cancel that contract. I know you had some verbiage in there in the press release, but maybe we can get a little more color there. When do you think timing will be, and why are you confident that you will ultimately be successful in getting this award?

Zach Parker, President and Chief Executive Officer

You bet. Joe. Thank you for the question. Yes, it is pretty unfortunate, a pretty common course now that when there are some larger contracts such as this one for the VA, that the government will frequently see a protest. They had a large number of potential bidders who made the investment to pursue work of this magnitude. They're very focused on seeing if there’s an opportunity for them to have a chance at it. So, it has been a normal course of action nowadays to see a protest arise on contracts of this size. Regarding the process, the deal conforms with all of the federal agencies that must evaluate and treat seriously any protest. This particular one happened to be from a small service business. And so they're going through their normal course of action to adjudicate and ultimately ensure that they can make an award that meets the requirements. We, however, remain optimistic that our proposal, commitments, and effort will prevail, but it is going to have to go through its usual course, and we're a couple of months into it now.

Kathryn JohnBull, Chief Financial Officer

And really, the basis of our confidence is two-fold. Firstly, the nature of the procurement is the best value procurement. So, in the best interest of the government, from our perspective, our strong cash performance and the quality and cost-effectiveness that we've introduced over many years of working in support of the VA represents the best interest of the government. So that's really the basis of our confidence in a successful outcome.

Joe Gomes, Analyst

Okay, great. Thanks for that update. And last quarter, you talked about some of the opportunity set that you've seen over the next couple of years. I was wondering if you might be able to give us a little more update as to what you are seeing in the near term that could be coming up for award that you're pretty confident or hope to see winning those awards.

Zach Parker, President and Chief Executive Officer

Yes. So great recall there. We still remain optimistic that the deals coming out of our pipeline will mature. This has been a very heavy proposal-development quarter; it's one of the largest we've seen in a while. A couple of our very strategic opportunities that are great examples of positioning DLH, as a result of the capabilities we acquired over the last few years, have just now emerged. There are a couple of large-scale, indefinite quantity, multiple award contracts that will determine the opportunities over the next two years, one for the Department of Defense, which involves military health and research; obviously, the capabilities that were derived from IBA and S3 were critical towards raising our profile and profitability. That is currently in an indefinite quantity status this quarter. We're also in the throes, as we speak, of one of the large indefinite quantity contracts for the National Institutes of Health associated with biomedical research and IT systems, referred to as CIO SP4. It is now on the street, and we anticipate having the proposals delivered and completed this month. So those are two large government-wide-type access contracts that we believe will provide us with high degree of success. Those have been our hunting license-type vehicles, if you will, we have identified a large number of past orders that we think are very addressable by us. In addition to that, normal courses, we've continued to see some of our major projects slip to the right. However, we're still optimistic that we'll see more this remaining fiscal year. We do expect a continuing resolution, and all indications suggest that the budget process is still very active, but we’re not optimistic that the infrastructure bill and everything will be resolved by September 30. But having said that, we do think that there are still a good number of opportunities for us to have some continued organic wins, and that will lead to a good launch point in FY 2022.

Joe Gomes, Analyst

Thank you for that. Let me ask one more. And I'll jump back into queue. In your comments, you kind of mentioned here, we're leading right into the potential for a continuing resolution for the budget, and in the queue. You talk about some of the budgeting proposals being made for various agencies like the VA and Health & Human Services. Looking at the potential budget proposals today, is there anything that jumps out as a huge positive for you guys or anything that would be on the flip side, kind of disappointing from your viewpoint?

Kathryn JohnBull, Chief Financial Officer

Yes, our general assessment of the budget proposals is that they are not surprisingly extremely favorable to the agencies that really support Health & Human Services initiatives. So from our perspective, we think that while we understand that there's still quite a bit of the process to play out to get to the final number, we believe the general sentiment is that these programs are highly supported from a bipartisan perspective. And of course, veterans always enjoy strong support from both sides of the aisle, and they did receive a very nice proposal for an estimated increase in their budget. In addition to that, there's not surprisingly a substantial increase in the NIH funding, which is ongoing. We are exiting Phase I triage critical response, though we may have to revisit it a little due to the Delta variant. But naturally, we expect there will be a long-term demand for scientific analysis and study of the impact of COVID-19. Both independently and its effects on comorbidities for the public health populations that we study. So, we're not surprised to see the increase; but we believe it validates that the country is really focused on those sustaining health issues that affect many people. We think we are extremely well-positioned with the skills required to respond to these opportunities, and just going back and doubling back a little on those IDIQs that Zach mentioned, it is gratifying because it was the intent of our first phase acquisition program to build a full set of capabilities to be prepared to respond fully, even without reliance on teammates. Of course, we will team where appropriate, but our independent capability to fully respond to those large IDIQ vehicles and be positioned to have the hunting license as the past quarters mature, was a key part of our strategy over the last few years. It has been validated by our response to those large RFPs. So, we’re certainly bullish on the opportunities we enjoy both organically and those that will emerge from the budget increases we see evolving.

Joe Gomes, Analyst

Great, thank you for answering my questions. I'll jump back in queue.

Kathryn JohnBull, Chief Financial Officer

Always great to hear from you, Joe. Thank you.

Zach Parker, President and Chief Executive Officer

Yes, thank you, Joe.

Kathryn JohnBull, Chief Financial Officer

Thank you.

Operator, Operator

The next question will be from Brian Kinstlinger of Alliance Global Partners.

Kathryn JohnBull, Chief Financial Officer

Hey, Brian.

Brian Kinstlinger, Analyst

Yes. Hi, thanks for taking my questions. How are you?

Zach Parker, President and Chief Executive Officer

Good. How do you do?

Brian Kinstlinger, Analyst

Really, the questions I had, and maybe I missed it, is can you provide the basis for the work I was looking for the small business that protested? Was it not enough small businesses being evaluated? Did they think they had the best value? What was the basis that was upheld?

Zach Parker, President and Chief Executive Officer

Yes, there's a little bit of publicly available information on the basis of the protest. You can usually find those at gao.gov. So, we really just don't get into specifics. We know nothing more than what is publicly available in that regard. However, we do know that the VA has started to operate on its due course, to render an opinion. Each one of our previous proposals on these CMOP contracts has always sustained the protest. The VA is going through this process, and we remain optimistic about the outcome.

Brian Kinstlinger, Analyst

Okay. But additionally, clearly, the protest was upheld, and so it's going through a new proposal, or they're still evaluating that.

Zach Parker, President and Chief Executive Officer

No, yes, what they do is always find some way to suspend the award, so that we aren't starting anew until such time as they go through what’s usually a 120 or 180-day process due to the nature of it.

Brian Kinstlinger, Analyst

Right, when you said cancel the contract it confused me whether it was upheld or being reproposed. And so the answer is no, it's not being reproposed yet. They're evaluating the protest.

Zach Parker, President and Chief Executive Officer

That's correct.

Brian Kinstlinger, Analyst

Is that right? Okay good. And then my second question for you, as you pay down debt with cash flow, at what point again do you get comfortable evaluating M&A opportunities? Thanks.

Kathryn JohnBull, Chief Financial Officer

We remain active in that space, regardless of transactions that we've just closed, so we never really stop looking. But certainly, once we slip below three times leveraged, which we’re well below right now, we would expect that we've got capacity to execute on a deal. Having said that, even if we were over three times, we have an extremely supportive lending group that is responsive to opportunities as they emerge for us.

Brian Kinstlinger, Analyst

Right. Okay. Thanks so much.

Zach Parker, President and Chief Executive Officer

Thank you, Brian.

Kathryn JohnBull, Chief Financial Officer

Thanks for joining us, Brian.

Operator, Operator

At this time, there appears to be no further questions in the queue. I would like to turn the conference back over to Zach Parker for any closing remarks.

Zach Parker, President and Chief Executive Officer

Thank you, Carrie. And once again, thank you all for your attention, interest, and continued support of DLH. We look forward to following up with you as we approach our year-end, and to give you some insight not only around the results for FY 2021, but our future forecast and our vision for what's yet to come. Thank you again. Have a blessed day. Bye for now.

Operator, Operator

Thank you. The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.