Earnings Call Transcript - DLHC Q1 2020

Operator, Operator

Good day. And welcome to the DLH Holdings Corporation Fiscal 2020 First Quarter Earnings Conference call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mr. Chris Witty, Investor Relations Adviser. Please go ahead.

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 2020 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. Please go ahead, Zach.

Zach Parker, President and CEO

Thanks, Chris, and good morning, everyone. Thank you for joining us to discuss our fiscal ‘20 first quarter performance. Last night, we released our results for the quarter, which indicate continued strong performance in almost all indicators. Turning to Slide 3, we’ve delivered significant financial improvement in both revenue and profitability. Our revenue of $52.2 million for the quarter reflects organic and acquired growth as our operating teams continued to earn the confidence of our customers, resulting in on-contract growth. This growth offset our typical seasonal softness in Q1, as well as some erosion attributed to expiring legacy work that was set aside for small businesses. Operating income rose to $3.1 million in quarter one and we posted EBITDA of $5 million, down slightly sequentially from the fourth quarter’s record results. As I’ll review further in a moment, we're actively bidding on an array of RFPs in an attractive market environment and are optimistic about the outlook going forward. At the same time, we paid the outstanding revolver balance of $1.8 million and an additional $3 million of senior debt in January. We plan to further reduce debt and improve the company's balance sheet this fiscal year as Kathryn will discuss momentarily. Turning to Slide 4. We previously stated that we expected the full integration to be complete near the end of calendar 2019. I'm happy to report that we have accomplished this goal. Our ERP implementation was finalized in early January and our business units are now operating together seamlessly, allowing for certain synergies, as well as business development opportunities. All key decisions have been implemented, but some synergies, such as our planned facilities consolidation efforts, will be realized later in the fiscal year. We will maintain our discipline in surgically reducing costs and streamlining our operations this fiscal year with an eye towards producing solid results and improved top-line growth. In addition, given our quarterly results may fluctuate due to project timing and government procurement policies, I want to say that generally speaking, the past six months in aggregate provided a pretty good benchmark for our performance going forward. We posted over $106 million of revenue during this time, $6.5 million of operating income, and roughly $10 million of EBITDA, while we remain relentless in reducing our debt level with our designs on reinvesting in growth. Today, we have reduced our senior debt by some $17 million since last June's acquisition, and we believe this is smart use of operating cash flow going forward, particularly as we invest in new business development and strengthening our solutions offerings and secure data analytics for our current and future customers that are concerned about cybersecurity. As noted in our 10-K, our VA CMOP recompetes remain unchanged, and at this stage, we see no material impact to our financial performance this fiscal year, and we will address this in greater detail at our annual shareholders’ meeting next month, along with greater visibility into our new business pipeline. With that, I'd now like to turn the call over to our Chief Financial Officer, Kathryn JohnBull.

Kathryn JohnBull, Chief Financial Officer

Thank you, Zach, and good morning everyone. We're pleased to report a great start to fiscal 2020. Turning to Slide 5. We posted revenue for the three months ended December 31st of $52.2 million versus $33.8 million in the prior year's first quarter. The revenue variance year-over-year reflects the impact of our acquisition last June, approximately $17.3 million, and modest growth across our other operations. The first quarter is typically a seasonally light revenue period for us, as Zach mentioned, and we expect both year-over-year and sequential top-line growth in the second quarter. Turning to Slide 6. Income from operations rose to $3.1 million for the 2020 first quarter compared to $2.6 million last year, reflecting operating margins of 6% and 7.6% respectively. The lower margin in fiscal 2020 was primarily due to increased depreciation and amortization expense, including the amortization of acquired intangibles from the S3 transactions, roughly $0.8 million per quarter. G&A rose to $5.9 million in the first quarter from $4.2 million last year, reflecting the addition of S3. G&A as a percent of revenue was slightly below 12% versus our typical range of 13% to 13.5%, largely due to the timing of planned business development expenses. We continue to implement streamlining initiatives largely as outcomes of the integration activities. And as Zach discussed, we were aggressively managing G&A going forward. We reported net income of approximately $1.6 million, or $0.12 per diluted share versus $1.7 million, or $0.13 a share last year. The company recorded a $0.6 million provision for tax expense this fiscal first quarter versus $0.7 million in fiscal ’19, and interest expense was $0.9 million in fiscal 2020 versus $0.2 million last year. Naturally, the year-over-year increase in interest expense was due to higher outstanding debt balances from the acquisition. That said, we continue our actions to pay down debt, and concurrently, we entered into a floating to fixed rate interest rate swap. Each of those factors contributed to this quarter's interest expense being $0.3 million lower than Q4’s. Turning to Slide 7. EBITDA for the three months ended December 31, 2019, was $5 million versus $3.1 million in the prior year period, reflecting the S3 acquisition and improved operating leverage across the enterprise. A reconciliation of GAAP net income to EBITDA is in our earnings statement at the back of this presentation. Slide 8 illustrates our continued commitment to debt reduction, as Zach mentioned. Since the date of the transaction last June, we have consistently used the company's significant cash flow generation to reduce our debt, including an additional $3 million paid in January. We’ve now paid down $17 million of senior debt, and our next mandatory principal payment is not due until June 2022. Prepaying our debt not only strengthens our balance sheet and de-levers the company, it reduces our interest expense, improving the bottom line. From a leverage perspective, we're about 2.6 times levered on pro forma LTM EBITDA. Remember of course that eight months of that pro forma 12 months reflects the actual results since the transaction is eight months old at this point. So obviously, we closed the deal at 3.5 times leverage. We're now putting 2.6 levered provisions and from our perspective, operating cash flow from the enterprise for the year should get us pretty close to that 2 times levered by the end of this fiscal year. This concludes my discussion of the financial statements. And with that, I'd now like to turn the call over to the operator to open for questions.

Operator, Operator

We will now begin the question and answer session. The first question will come from Joe Gomes of NOBLE Capital.

Joe Gomes, Analyst

I know you talked real briefly Zach on CMOP. I was wondering if you could maybe give us an update as of today on the three big contracts, CMOP, the logistics at the VA and the head start that are all either in the process of or potentially in the process of RFP this year. Just where we kind of stand and anything else you could give us will be appreciated.

Zach Parker, President and CEO

Yes, on the CMOP front, we kind of see it as no news is good news. We have continued to operate on extensions. Of course, these now all of these originated in November of 2016 for the heavily pharma one. And we have continued to receive as recently as in the last month sole-sourced extensions for that work. You heard me state that for the foreseeable portion of this fiscal, I do not see a material impact, and that's largely just because of the acquisition cycle. We're currently already into the second quarter. Typically, these contracts are required about 90 days phase in, so the likelihood of having any material impacts upon this fiscal is relatively low. As you indicated, there are two of those CMOP ones. The second of the two is the one we referred to as the logistics CMOP work that proposal, of course, also has been submitted, and every indication is that they will award these in series, and so such that one will continue, we expect that one will continue to bridge for an even longer term into the next fiscal. For the head start recompete, yes, you're spot on that the current contract will currently expire next quarter. It currently runs through May, and we are anticipating we have not yet seen the release of an RFP. If there is a decent likelihood that there may be a small bridge, but we have continued to start well early relative to the RFP, and working our enhanced solutions offering without taking things for granted. And certainly, do not want to fall prey to incumbents. So Helene and our team have continued to work that strategy, and we're well prepared for the eventuality of that RFP and we have a great deal of confidence in our prospects for renewing that work.

Joe Gomes, Analyst

Just switching gears to S3, last quarter you mentioned that you were considering some pending awards and task orders, but revenue for S3 declined sequentially. I understand that sometimes you obtain one-off contracts, but I'm curious about the current status of the awards and task orders you're evaluating, and whether the revenue decline was primarily due to these one-off contracts.

Kathryn JohnBull, Chief Financial Officer

That's really the case. I mean, there were some special events in Q4, largely related to materials used to support surveys, and those happened in a cycle. And so there was a bit of a surge from that in Q4, that's a one-time event.

Joe Gomes, Analyst

And just if I'm looking at the numbers and margins, you talked a little bit about the G&A, gross profit margin, kind of went down a little bit again sequentially. And I was wondering if that’s kind of a new normal or is there something going on there, a mix opportunity that you would see gross margins kind of rebounding in the rest of the year?

Kathryn JohnBull, Chief Financial Officer

I still believe that our 12-month outlook for gross margin will be at the higher end of our previously indicated expectation of 20% to 22%. Last quarter, I mentioned that I thought we were leaning towards the upper end of that range, possibly even slightly above it, around 22.5%. This quarter's results are largely influenced by where our volume is coming from, which predominantly comes from the lower end of our business that is more production-focused and less affected by holidays and time off around Thanksgiving and Christmas. It's typical for our first quarter to see a slight dip in direct labor as people take some time off for those holidays. However, for the entire year, I do anticipate that we will remain at the upper end of our target range, and potentially even exceed it.

Joe Gomes, Analyst

And then one last one for me. Outside of the three big contracts, is there much recompete risk this year with the rest of the business?

Zach Parker, President and CEO

No, those are the three significant contracts we see for this fiscal year. We will likely provide a little update at the annual conference. As we expanded our backlog considerably after the acquisition, we really did not have any individual contracts that would be material in terms of the upcoming year or two. Therefore, we are very confident about our diversification in our business portfolio.

Operator, Operator

The next question will come from Austin Moldow of Canaccord.

Austin Moldow, Analyst

So the first question I have is for Zach. Just looking at the mix of revenues here, it looks like as part of the S3 acquisition that your public health and life sciences revenues have sort of doubled as a share between this quarter and last. So I was just wondering about sort of what the bid pipeline looks like for S3 going forward, and how you guys are sort of leveraging S3 as you go and make some of those bids?

Zach Parker, President and CEO

You're absolutely right. As you may recall, one of our key strategic objectives on our acquisitive side of the growth was to balance our portfolio in those three market areas. And that's why we're particularly excited about S3 and what they did for us in the public health and life sciences arena. We continue to be really excited, we’ve had no disappointments in that regard in terms of how they've really bolstered our position here. And you’re right to anticipate an impact on the pipeline as well. It does help to reshape our pipeline and puts us in a stronger position in certain market areas where we were potentially going to have to lean more on subcontractors or other partners, and we’ve accelerated that as well. A couple of examples of that are, one is relatively recently we were awarded an IDIQ that we expect a few task orders this fiscal year and then more next year. And with the addition of some of the scientific research qualifications, clinical trials qualifications and the like, we really are much better positioned for taking a lead role in some of those than we’ve otherwise might have been. And then as you may recall, we felt that there are one or two real key initiatives that really make that a one plus one equal to three kind of opportunity for us with the addition of S3. There are cases where adding a partner such as S3 would have been a subcontractor for us and now, it really makes a more robust offering for us to the client, and we're really excited about how it shapes the pipelines. It’s still a very competitive market. We're seeing that the M&A world has changed the scale of some of our typical competitors in that arena. But just in S3 in excess of approximately $200 million run rate operation really puts us in a lot stronger footing for some of those opportunities. And we'll give a little more color around some of that again next month at the annual meeting.

Austin Moldow, Analyst

And so just to sort of ask about the whole coronavirus epidemic that's going on right now, given your guys' relationship with the CDC and now the NIH of course. Do you guys foresee contracts coming down for do research studies on related to the coronavirus in the near term that you think could be accretive to revenues?

Zach Parker, President and CEO

We do. We know that some of our customers in both of those areas, quite frankly, are looking at their roles and what they are doing some things in-house right now and talking with us. And some of our peer companies with regard to potentially some new contracts in that arena. There's, in some cases, our customers are still working in somewhat competitive world with folks in the World Health Organization. So they're still trying to rationalize who's on first or few of those things. Our recent IDIQ award happened to put us in a pretty good space with regard to the emergency response type of work such as this. So we're really hopeful that we should see something in the not-too-distant future to support that.

Austin Moldow, Analyst

And then my next question is for Kathryn. So just to sort of go back to the gross margin question. I mean, I understand that the operating margins were down just with the amortization associated with S3. But I'm just wondering, just given the mix shift towards public health. Does the 220 basis point decrease in gross margins year-over-year, is that more of how we should think that will work during the quarter, or that just has more to do with the vacations and just the seasonality of the quarter as you previously mentioned?

Kathryn JohnBull, Chief Financial Officer

I do think that it's not unusual for Q1. Last year happened to be an exception just based again on the timing of some programmatic events, but it's not unusual for us that Q1 would be our lightest quarter gross margin-wise, because of the fact that the volume in the lower end of our business, the CMOP work tends to be constant throughout and indifferent to the fact that there are holidays and vacations. So that probably only means that we work on a weekend if there’s a day during the week that we’re closed. So tends to be indifferent to the holiday schedule. But the more differentiated contracts that generally command the higher margins, of course are going to have some impact from the fact that people generally plan to have plans during that time. So you've got lower contribution from the higher margin direct labor from those contracts. So it's not unusual for us to have a little bit of softness in gross margins in Q1. However, I again retain my expectation that for the year, our gross margins will be more in that range of the higher end of our range of 20% to 22%, I think 22% is our new normal for a 12-month period, notwithstanding that quarter to quarter, we're going to bump around a little bit. Does that help?

Operator, Operator

At this point, there appear to be no further questions in the queue. So I'll turn it over to Mr. Parker for any closing remarks.

Zach Parker, President and CEO

And once again, thank you everyone for your interest and participation in the DLH evolution. I want to re-invite everyone to our annual meeting, which we recently released the information on. During that meeting, we’ll of course not have produced the subsequent quarter. But Kathryn and I look forward to providing added color around the current state of the business. You can follow up with a little greater detail regarding substantial synergies associated with integration, and then some additional information regarding this happening on the market front with regard to targeted agencies. So again, thanks again for your attention, and you all have a blessed day. Bye for now.

Operator, Operator

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