Earnings Call Transcript - DLHC Q2 2021

Chris Witty, Investor Relations Advisor

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 Investors 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 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

Thank you, Chris, and good morning to everyone, and a special thanks to the troops within DLH that continue to drive great performance, productivity, and quality to our customers, our managers, and our shareholders. During these difficult times, I just can't say enough about the courage experienced and delivered by our workforce. I'd like to welcome the shareholders to the second-quarter conference call. We've continued to post solid results this fiscal year, and I remain optimistic about the quarters to come. Starting with slide 3. I'll first provide a high-level overview of the quarter and some color on the outlook for fiscal 2021. The second quarter was certainly one of accomplishment with revenue rising 12% to a new record of 61.5 million as we continue to benefit from strong performance from our recent IBA acquisition, our AMS business unit, and solid results across the board. The sales increase was followed by higher operating margins at 7.5% and earnings of $2.6 million or $0.19 per share. We were also able to resume our debt prepayments this quarter as Kathryn will review in a moment and closed out the period with a backlog just shy of $610 million. Shortly after the end of the quarter, we announced that DLH had once again won our VA CMOP medical logistics contract, adding over $200 million in contracted value over a five-year period. With that in total, we will have a backlog around $800 million, the highest level ever for the company. This will certainly set the foundation for growth beyond. Turning to slide 4. I'd like to update our investors on DLH's business outlook given the variety of issues impacting our industry. I want to expand on my earlier comment about the CMOP and our recent award. As many of you likely already know, we have served this program under the VA for over two decades, so the win was certainly not unexpected by us. However, the award had been delayed due to several reasons during the procurement process as the VA considered proposals from various tiers of small businesses for a potential set-aside contract. Ultimately they moved through each of those set-aside tiers from consideration and evaluated the proposals only from the large business tier. That competition was eventually awarded to DLH. As a reminder, this program functions as a virtual extension of the VA's medical center pharmacies. Last year, we processed over 120 million prescriptions from seven locations nationwide. While this mail-order service has always been important for our veterans, the COVID-19 pandemic has continued to demonstrate its value at a level that the VA had not experienced before. We are thrilled to continue to provide prescription medications and med-surg products to our various service members in this fashion. We're, of course, waiting for the VA to make a decision on the other part of the pharmacy support for the CMOP, and that acquisition has not restarted. The contract, when finalized, will likely also be worth in the neighborhood of $250 million over five years. So we look forward to that acquisition beginning. As you know, as the country continues to make progress with COVID-19 vaccinations and various states move towards reopening and increased mobility, several of our programs that have experienced revenue erosion over the recent year, attributed to COVID-19, may begin to see a resurrection in the fall timeframe. Our digital transformation team under Helene Fisher’s operation had implemented a new system that reduced costs and increased efficiencies through a major business process re-engineering effort. While that achievement reduced our Head Start-related revenue once implemented in the fiscal year, we did not anticipate further reductions due to COVID-induced diminishment in a couple of very key processes. Both of those key processes involve travel, site reviews, inspections, and things of that nature. The program would truly benefit as restrictions are eased, and we're again hopeful that perhaps by fall time frame we'll start to recover that revenue stream and help to deliver a higher quality to our grantees across the nation. In the meantime, we continue to pursue a strong set of growth opportunities, from strategically small opportunities to very large ones. Unfortunately, like our VA CMOP procurement, several of the large procurements are continuing to slide to the right and continue to be delayed. On the good news front, the Office of Management and Budget OMB has recently issued some new directives to federal agencies, intended to improve the timelines and also drive greater accountability into the contract procurement process. We welcome those changes to help accelerate our organic growth prospects. While both political parties are dedicated to our veterans and healthcare issues, we are also seeing positive momentum in terms of additional investments tied to areas where DLH plays a pivotal role, and we believe that the company is very well positioned for solid organic growth this year and next. At the same time, I'd be remiss if I didn't speak to the strong digital transformation deal flow opportunities within our sector, as market valuations and an interest in adding technology applications heighten interest in the mergers and acquisitions front. There is a demand across the board for next-generation capabilities that leverage Artificial Intelligence, Data Analytics, Cloud Computing, and the types of services that we have been continuously building. The global pandemic has only accelerated the trend towards network modernization, ensuring convenience and security for individuals performing critical work under fluid environments. While the economy is improving and the impact of COVID-19 subsides, some things are here to stay, including a greater reliance on telecommuting and staycations, leading to new opportunities for companies like DLH and the advanced technology service offerings. With valuations near all-time highs, it takes a focused effort to look at numerous opportunities and decide what strategically aligns with the company that is something that we would value. We always believed that corporate culture was a key part of any transaction. We will continue this in the future. We will continue to examine potential deals for near-term and longer-term value creation. Overall, the outlook for fiscal 21 remains very positive for DLH, and we believe the coming quarters offer great opportunities for the company to report solid top-line results and strong underlying performance. Our competitive position, leveraging our expanded capabilities and long-term client relationships at key mission critical federal agencies, leaves us very optimistic about the future. I couldn't be more proud of the team we have assembled here today. We're making it happen and taking DLH to the next level in terms of service, performance, and shareholder returns. With that, I'd 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 continue posting positive results this year. Turning to slide six, we posted record revenue for the three-months ended March 31, 2021, of 61.5 million versus 54.8 million in the prior year second quarter. This variance reflects the impact of roughly 7.4 million in sales tied to the acquisition of IBA, offset in part by a reduction in travel-related revenues on programs impacted by ongoing COVID-19 restrictions. Given the lower infection rates and progress with vaccinations, the constraint on that part of our business has begun to lessen. As Zach mentioned, we believe it will continue to ease in the quarters to come. Turning to slide seven, income from operations was 4.6 million for the fiscal 2021 second quarter versus 3.8 million last year. Operating margins improved to 7.5% from 7% in fiscal 2020, reflecting favorable program mix and operating leverage achieved. We reported net income of approximately 2.6 million or $0.19 per diluted share versus 2.1 million or $0.16 a share last year. DLH recorded a provision of one million and 0.9 million for tax expense during the fiscal 2021 second quarter and fiscal 2020 second quarter, respectively. Interest expense in the current year quarter increased to $1 million versus 0.9 million for the three months ended March 31, 2020, due to higher outstanding debt levels reflecting the acquisition of IBA. Turning to slide eight, EBITDA for the second quarter of fiscal 2021 was 6.6 million versus 5.6 million in the prior year period. As a percent of sales, EBITDA rose to 10.8% this quarter versus 10.2% last year. A reconciliation of GAAP net income to EBITDA is provided in our earnings statement and is included in the back of our presentation. Slide nine gives an updated snapshot of our debt position at the end of the second quarter. As of March 31, we had $62.8 million of debt outstanding under our credit facilities versus $77.4 million at the end of last quarter. We generated approximately $14.6 million of operating cash during the quarter and paid down roughly $14.7 million of debt. As a reminder, the strong cash flow this quarter was due to delayed collections from Q1, largely reflecting transitions in certain contract payment terms. We continue to anticipate strong cash flow this fiscal year and estimate debt of between $50 million and $52 million at the end of fiscal 2021, resulting in a stronger balance sheet and a much lower leverage ratio. The improvement in our leverage ratio during the current quarter reduced the interest rate on our outstanding debt by 50 basis points. This concludes my discussion of the financial statements. With that, I would now like to turn the call over to our operator to open the call for questions.

Operator, Operator

We will now start the question-and-answer session. Our first question comes from Brian Kinstlinger with Alliance Global Partners. Please proceed.

Brian Kinstlinger, Analyst

Great. Thanks for taking my questions. Can you tell us maybe I missed it what the organic growth rate was and then on the mail outpatient pharmacy program, how much larger do you expect that annual revenue contribution to be at peak compared to the prior contract and will you need to hire more resources to deliver any increased scope?

Zach Parker, President and CEO

Great question Brian and welcome. And we thank you for your call. I'll take the second part and pass that first part over to Kathryn real quick. But yes, we're excited about the potential for the renewal of the CMOP contract. Its very nature is one that is somewhat demand responsive to the needs and the challenges faced by our veterans on the health front. We've had, as you've seen, pretty good real growth over the recent couple of years. The COVID-19 challenge has increased that burden, not only from the health standpoint but the protocols associated with going to the VA medical centers and hospitals. With a lot of the restrictions for lingering in areas where they provide those deliveries have led to an increase in the mail order process. What remains to be seen is how if at all any of that will be ratcheted back in the out use. Every indication is that they're here to stay; that the quality and productivity at which the mail order system is delivering the services relative to in-house has proven to be a tremendous value for the VA and our veterans. We expect that, with the new leadership, they will continue to go down this path. So we think the upside is a good bet that we will continue to build on that. With the VA expanding its facilities, we are looking to expand the workforce over the next quarter or so. Kevin Wilson, who leads that effort for us, has been assembling a really great team to ensure that we can be responsive and still grow in some challenging workplace environments. We've had a very low rate of infection, and we aim to continue that. With regard to the numbers that we quoted on...

Kathryn JohnBull, Chief Financial Officer

Sure. Yes. Perfect. So for the period ended year to date, Brian, as we mentioned, the organic revenue is down slightly. Of course, there's growth in the business, as you already referenced in the CMOP part of the business, as well as in the COVID support parts and other places, but those are the two highlights. But that has been offset by the deferral of revenue on the site monitoring, compliance, and monitoring programs that we discussed. So we do expect there's some pent-up demand there, just as a function of the COVID protocols, and as things continue to improve we expect that there will be some recovery of that. Of course, the customer has got to work through exactly how they'll reschedule those programs and those site visits. But we see the pause on those site inspections as beginning to ease in the second half of the year.

Brian Kinstlinger, Analyst

Great. And then were there any changes to the economics of the CMOP contract, such as either lower pricing or efficiencies you need to deliver to the customer?

Zach Parker, President and CEO

For this particular one, the medical logistics, the solicitation did have some differences, some different characteristics than the previous one. These were things that we were fully aware of and were looking forward to. So it will be a little bit of a mixed change, but we did not – given the nature of the work and the complexity of the work, we did not see the need to drive any particular cost or investments into business down. There'll be a fair amount of it that will – and some of the cost there will ease because we've implemented a number of things historically that did not need to be implemented in this next year or two. So a little bit of softening in that regard but nothing material.

Brian Kinstlinger, Analyst

Great. My last question is several – I may have missed it, if you've mentioned this sorry. Several defense IT contractors have been talking about delays in procurements. There's just so much volume of submissions industry-wide coupled with challenging evaluation processes. The DLA is experiencing the same on their submissions and their contracts that are now going through the procurement cycle. Thanks so much.

Zach Parker, President and CEO

Yes. No great question. The answer is absolutely yes. As I've mentioned briefly in my opening comments, we too have experienced that. We build a strong new business pipeline. We've bolstered that with the addition of Jackie Everett to our business development team and she's bringing on resources to help qualify and position us to bid some opportunities. The trouble is, as you've pointed out, my peers are experiencing the same as I am, where while our CMOP and some of our contracts have been on source of extensions for several years, we're seeing the same for some opportunities that we literally thought we would have been bidding and winning in 2019. We have yet to get those solicitations. Yes, the acquisition community is very upfront about the fact that they have lost a lot of talent to help move these contracts and procurements along. They've been incentivizing bringing in new blood, because they've lost a lot through attrition and retirement and just have not been able to make that up cost-effectively. But they're addressing it. When I mentioned the OMB has put into place new initiatives, one in particular is focused on what they call PALT, which is an acronym for Procurement Administrative Lead Time. They are raising accountability and focus on that effort so they can get these procurements in place and contracted in a timely fashion. But it has been brutal for us. It has been the number one headwind towards stunting our organic growth through business opportunities because we just can't wait to get this proposal submitted. We think we've built some really tremendous solutions. We've added our capabilities through M&A, but most of our programs that we have; they are north of 100 million in new business continue to slip to the right for what we call single award contracts. We’re hopeful that that backlog will be uncorked as Kathryn indicated in the next coming months and that they will bode well for our FY 2022 and hopefully still at the end of the FY 2021.

Brian Kinstlinger, Analyst

Great. Thanks for taking my questions.

Operator, Operator

The next question comes from Chris Bliska with NOBLE Financial. Please go ahead.

Chris Bliska, Analyst

Hi. Good morning, Zach and Kathryn. I'm sitting in for Joe Gomes. Thanks for taking my call this morning and my questions.

Zach Parker, President and CEO

Welcome Chris.

Kathryn JohnBull, Chief Financial Officer

Thanks for joining us.

Chris Bliska, Analyst

Glad to be here. A couple of questions that we had have already been addressed, but Kathryn maybe you can answer one about accounts receivable. There were some improvements in the quarter. Are you satisfied with those results or were you expecting more? The timing on getting the accounts receivable down further please?

Kathryn JohnBull, Chief Financial Officer

Yes. So there was progress as you noted during the quarter, and I'm pleased with the progress made, but you know me well enough to know I'm never satisfied. I do think there is additional progress that we will continue to make as we work with paying offices and get an understanding of how to transition for their requirements. I see roughly $3 million that I think will be considered a permanent transition just because of additional layers that the customers have added. I currently sit around 60 days sales outstanding. I see a path to getting closer to 50, so that should free up some strong operating cash flow and get us back into a realm of what I consider appropriate for our business.

Chris Bliska, Analyst

Thank you. And then the next question on VA logistics contract. The protests can you give any more detail about that? Who's protesting and what the argument is and when it will be decided, timeline please?

Zach Parker, President and CEO

Yes. Just a little bit of color. Obviously, these are very procurement-sensitive information, so I really can't give you much more than what is public. The protests of this nature are made public through a few channels. There has been only one company that has protested. It is a service-disabled veteran-owned small business, which means they are in that first tier for priority for the award. There is some public information out there regarding their position on the protests. There really is no norm for what to expect on the timing of these. My personal assessment is based upon the nature of this one. It is not one that usually results in a long protracted protest period. Of course, in the federal government space, that could still be 90 days, 120 days for resolution. The contracting officer has notified us of their intent to extend to take us through close to the end of the fiscal year that's August-September timeframe so they can get this adjudicated. After that, we would begin the phase-in period of that contract.

Chris Bliska, Analyst

Okay. Thanks so much.

Kathryn JohnBull, Chief Financial Officer

I would just add in context, of course the protest cycle is, unfortunately these days, a normal part of the awards and procurement cycle, so we don’t view it as anything particularly significant.

Chris Bliska, Analyst

Okay. Great. Thank you. Last question then on the Head Start program, the revenue decline there was that all related to travel reimbursement, or are there other reasons for that revenue decline in the Head Start business?

Zach Parker, President and CEO

Yes. There've been a couple of major factors. Right? I touched on the fact that we had late last fiscal started the new contract. One of the most attractive features of that operation for us was the ability to design from re-architecting, fully testing, and integrating a completely new IT modernization process. We completely transformed both the operations and protocols for executing the business and it was really a full-fledged digital transformation effort under the previous contract. With the new key objectives of that modernization, we did not see COVID-19 impacts coming. We are optimistic that by this fall, we will start to realize that revenue back again. Certainly by our first option period before it completes.

Kathryn JohnBull, Chief Financial Officer

And Chris just echoing that and reinforcing part of what Zach referred to. The cost-effectiveness and recompete cycle is an important part of our value proposition. The restrictions we faced have made period-to-period comparisons challenging, but we do expect that, however unexpected and undesirable this pause has been, we are committed and enthusiastic about our program.

Chris Bliska, Analyst

Right. Thank you. That makes sense. Thank you very much. Those are my questions.

Zach Parker, President and CEO

You bet. Thank you. And say hello to Bill for us. I am sorry, Joe.

Operator, Operator

There appear to be no callers in the queue. I would like to turn the conference back over to Mr. Parker for any closing remarks.

Zach Parker, President and CEO

Thank you. I want to say thank you to our shareholders, current investors, and interested parties. We remain very excited about the future of the company. We believe that we've got a great trajectory with opportunities to continue delivering sound performance for our current clients, but also to build that client base. We're excited that at the end of this fiscal year, we will have a very balanced portfolio that covers all three of our marketing-focused areas identified in our 10-Q. As we look both organically and acquisitively, we can continue to be very selective with high probabilities of success and we look forward to delivering on that in the near future. So thank you for your participation and have a blessed day. Bye for now.

Operator, Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.