Earnings Call Transcript - DLHC Q3 2022

Operator, Operator

Good day, and welcome to the DLH Holdings Corp. Fiscal 2022 Third Quarter Earnings Conference Call. I would now like to turn the conference over to Chris Witty, Investor Relations Advisor.

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, CFO. 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. And with that, I’d now like to turn the call over to Zach Parker.

Zach Parker, President and CEO

Thank you, Chris, and good morning, everyone. Welcome to our fiscal 2022 third quarter conference call. I am pleased to report another solid quarter, especially as we conclude our two major COVID-19 pandemic response programs with FEMA and the NIH Infectious Disease Clinical Trials for Therapeutics. Both programs showcased DLH’s capacity to respond swiftly to national threats by utilizing our emergency preparedness and global clinical research network. Starting with Slide 3, I’ll provide a high-level overview of the quarter, beginning with the top-line results. Revenue increased nearly 8% year-over-year to $66.4 million, indicating strong demand across many of our programs and services. We are satisfied with the recent award activity and the numerous ongoing opportunities as we near the end of 2022 and prepare to enter FY ‘23. I will discuss our outlook in a moment. We achieved an operating income of $7.1 million, or 10.7% of sales, an increase of 44% year-over-year, and recorded EBITDA of $9.0 million compared to $7.0 million in the third quarter of fiscal 2021. Earnings per share rose nearly 50% to $0.34, and we reduced our debt by an additional $9 million during the quarter, concluding the period with $28.5 million in outstanding debt. Our backlog entering Q4 was a solid $510 million, positioning us for continued strong performance. Turning to Slide 4, I want to highlight how DLH brings innovation and value to its clients. I am very proud of the contributions from DLH employees to our customers' critical missions. One of our projects recently received a Federal Health IT Innovation Award for our work with the Defense Medical Logistics Support Program, where we successfully integrated several supply chain management systems for the Defense Health Agency. This accomplishment demonstrates our experts' ability to innovate using emerging and established technologies. Additionally, the DoD ESSENCE biosurveillance program played a vital role in identifying the initial cases of Monkeypox, showcasing our partnership’s expertise in detecting health threats that could affect military readiness. Within the Veteran Affairs program, our CMOP contract recently set all-time daily production records to meet the medical needs of our nation’s veterans, reflecting our commitment to serving them for nearly 25 years. DLH was also awarded a small but strategic contract for on-site clinical monitoring for an outpatient anti-coronavirus immunoglobulin study at eight international research sites, utilizing an NIAID-funded global clinical trials network. This significant work enhances our efforts to address evolving health threats. As previously mentioned, our Infinibyte Cloud solution received full FedRAMP authorization earlier this year, strengthening our data analytics, cloud migration, and platform-as-a-service offerings for current and future clients. These examples highlight our talented experts' differentiation and the tools we use to serve our government, military, and service members across the nation. Slide 5 outlines the various avenues supporting our future expansion, which position us for sustained growth. Some of our turnkey programs are nearing completion, including much of our COVID-19 work for various agencies. This experience and unique capabilities can be leveraged across other infectious disease research. Overall, our focus aligns with the Federal Government’s spending priorities, and recent awards create opportunities for accelerating top-line growth. Alongside recompetes, we’re pursuing several new contracts that could enhance our growth, including multiple award contracts with ceilings of $10 billion for health-related R&D support to the Department of Defense, particularly the Defense Health Agency and the Medical Research and Development Command, leveraging our expertise in medical simulation and infectious disease research. We were also selected for another multiple award IDIQ contract with a ceiling of $320 million for supporting the National Cancer Institute with clinical support and study management, aligning with our strategic objective to expand our presence within HHS and NIH. While the maximum value of these awards is substantial, our potential relies on actual task orders awarded over time. We are building a strong pursuit team with experienced personnel and are excited to contribute to critical research for years to come. We are eager to re-compete for work we’ve held since 1986 with the National Institute of Environmental Health Sciences for high-standard statistical analysis and toxicology research, continuing our support for the National Toxicology Program and the Division of Intramural Research. We are also pleased to support the National Institute of Diabetes, Digestive and Kidney Diseases in expanding chronic disease research. As we approach the end of the government’s fiscal year, agency budget adjustments typically present further growth opportunities. These opportunities often arise from contracts finalized quickly through various procurement initiatives. Following September 30, our service outlook remains positive, indicating strong demand as we transition into fiscal ‘23 and beyond. Our innovative healthcare research and technology applications have strong bipartisan support. While it's early to predict the fiscal ‘23 budget, we are optimistic about our portfolio, reputation, and standing within the agencies we serve, given the ongoing need for diagnostic analytics to tackle national health challenges. We anticipate a continuing resolution, and believe that budget stability and our focused priorities will lead to further growth. Additionally, we have a strong pipeline of potential M&A opportunities that could enhance our market position and provide new avenues for strategic expansion. As Kathryn will explain, our balance sheet remains robust and largely delevered. We are confident that our future will follow our established formula of strategic growth and solid performance, rewarding our shareholders and clients with stable returns and ongoing excellence. I believe the best is yet to come for DLH, and we are eager to lead this initiative. Now, I would like to turn the call over to our Chief Financial Officer, Kathryn JohnBull.

Kathryn JohnBull, CFO

Thank you, Zach, and good morning, everyone. We’re pleased to report another quarter of solid results. Turning to Slide 7. We posted revenue of $66.4 million for the three months ended June 30, 2022, versus $61.6 million in the prior year’s fiscal third quarter. The 8% increase year-over-year reflects expansion across many of our existing programs. We believe that our recent awards and our evolving capabilities will continue to support growth in fiscal 2023 and beyond. Moving to Slide 8. Income from operations was $7.1 million for the quarter versus $4.9 million in the prior year period. And as a percent of revenue, the company reported an operating margin of 10.7% in fiscal 2022 versus 8% in fiscal ‘21. Income from operations improved due to higher revenue, improved program mix, and effective management of fringe benefit costs. Interest expense was $0.5 million in the fiscal third quarter of 2022 versus $0.9 million in the prior year period, reflecting lower debt outstanding. DLH recorded a provision for taxes of $1.7 million and $1.2 million during the third quarters of fiscal 2022 and fiscal 2021 respectively. We reported net income in the third quarter of approximately $4.9 million or $0.34 per diluted share versus $2.9 million or $0.21 a share last year. As a percent of revenue, net income was 7.3% for the third quarter of fiscal 2022 versus 4.7% for the prior year period. Turning to Slide 9. EBITDA for the three months ended June 30, 2022, was approximately $9 million versus $7 million in the prior year period or 13.5% and 11.3% of revenue respectively. The improvement in EBITDA is derived from the same factors as for operating income, of course, higher revenue with improved program mix and effective management of benefits costs. A reconciliation of GAAP net income to EBITDA is provided in our earnings statement and at the back of this presentation. Slide 10 gives an updated snapshot of our debt position at the end of Q3. As of June 30, we had approximately $28.5 million of debt outstanding under our credit facilities versus $46.8 million at the end of fiscal 2021. And our leverage ratio remains under 1% at 0.7x EBITDA. During the quarter, the company paid off all remaining debt from the 2019 Social & Scientific Systems acquisition. The $70 million 5-year term loan from that acquisition was retired in 35 months. We continue to 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 future transactions. We anticipate being under $25 million of debt by the end of our fiscal year. 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.

Operator, Operator

The first question comes from Joe Gomes with NOBLE Capital.

Joe Gomes, Analyst

Congratulations on the quarter, Zach and Kathryn. I wanted to go through the business reconciliation with the FEMA results mentioned in the presentation. I want to ensure I'm understanding this correctly. In this quarter, FEMA had a negative impact of around $5 million on revenue. It appears from the reconciliation that the ongoing business generated approximately $71.6 million in revenue, reflecting a 16% increase compared to the same quarter last year. Am I interpreting this correctly, or are there other one-time items affecting that calculation?

Zach Parker, President and CEO

And your arithmetic is correct. It is an adjustment, but it does net out at about 16%. Kathryn, anything to add?

Kathryn JohnBull, CFO

On the sustaining.

Zach Parker, President and CEO

On the sustaining, that’s correct.

Joe Gomes, Analyst

So you’re underselling what you actually did in the quarter. I mean, that’s just fantastic increase from the first quarter on the sustaining business. You did about a 7% increase, the second quarter at 12% and now we’re talking 16%. I mean, just showing significant growth on the sustaining business.

Zach Parker, President and CEO

We appreciate your input. As you know, this is part of our history and our standard practice. We are beginning to see the benefits of many of the strategic initiatives we've implemented. I can say that it takes teamwork, and our operators and business development team are really coming together. We also have a strong portfolio of customers and clients who have managed to maintain their budget stability amidst the challenges posed by COVID-19. We are starting to see signs of recovery reflected in our results.

Kathryn JohnBull, CFO

However, let me point out that while we experience strong market support and increasing demand for our services as we expand our offerings, there is some seasonality in our business. We had a very strong return in Q3, partly due to this seasonality, especially concerning the Head Start program, and as Zach mentioned, the conclusion of the large COVID therapeutics trial program. Generally, we can expect our performance to be in the high-60s to low-70s. There may be some fluctuations from quarter to quarter due to these seasonal effects, but overall, we are achieving new heights and progressing positively.

Joe Gomes, Analyst

The CFO always has to put a brake on the good news. So you mentioned the FedRAMP authorization for the Infinibyte Cloud. Zach, maybe give us a little more color or detail of what that could mean? What’s the potential market out there for that product? And when do you think you start to see the fruits of that being harvested?

Zach Parker, President and CEO

Great question, Joe. We’re starting to see a lot more attention coming from the agencies, particularly the federal agencies that we serve that are requiring that contractors have FedRAMP-level secure systems if you’re going to move forward in handling large sensitive data, not only in the healthcare arena, where it’s very, very sensitive health records being managed, but also from just cyber risk and general cyber risks across the industry. So we think that by having the FedRAMP certification, it will certainly give us a differentiating capability where there will be less competition because of those that do not have it. We’re also taking a look to see if we can help position this platform to be the solution for some of the smaller businesses that do not have the ability to invest and develop this capability, yet they still want to maintain either existing work or be able to pursue work in a cost-effective way in a cloud environment for big data analytics. So we think we’re going to start to build a pipeline specific to the FedRAMP certification requirements for those agencies that treat cybersecurity and security against these kinds of systems as a priority in the way they evaluate.

Joe Gomes, Analyst

And on the IDIQs, I know it’s all dependent upon the specific task orders and then competing to win those task orders. Any feel for when those task orders might start coming out or any type of ramp on that? Is this something that you think you see a lot here in the next couple of quarters or is it more over a longer period of time?

Kathryn JohnBull, CFO

There is a long duration for the large Omnibus task order IDIQ, which spans 10 years. Typically, the initial work will involve transitioning tasks from the expiring predecessor IDIQ. Omnibus 4 follows Omnibus 3, so the first items in line will likely be existing work. However, there are also new needs and customer opportunities. We do not anticipate an immediate shift to new work, but we are focused on identifying market opportunities through the recompete of current work and expanding the scope under those IDIQs. For the epidemiological aspect with NIH, we expect a closer timeline for work authorization, following the same pattern of transitioning existing work from the aggregated programs under that IDIQ. Additionally, we are already receiving feedback from that customer regarding new scopes and work expected to be put out for competition. The competitive landscape is limited to five companies, making us quite optimistic about the near-term opportunities from that IDIQ.

Joe Gomes, Analyst

I just will once again talk about the VA contracts. I think they’re good through the fall of this year. Any update on those contracts?

Zach Parker, President and CEO

Yes, Joe. We know that, as we have stated before, the VA will set their acquisition strategy, get their team in place to do the procurements. They’ve provided some indications that they have started to address how that’s going to come out. But given the history of what we have seen historically, we’re pretty optimistic that we’ll probably be looking at a year’s worth of extension so that they can get a set of RFPs out on the street, get proposals submitted, get the valuations done, and to move towards a final award decision. Historically, that generally has been easily a 12-month cycle, and we’ll see how it goes in the future. So we’re pretty optimistic that we’ll see something beyond this fall, given that we’re getting ready to approach a new fiscal year.

Joe Gomes, Analyst

And on those, the previous one they talked about a small veteran-owned business. Any more or any indication of whether they’re just going to open it up to everybody or do you think any indication that they would be looking once again to award it to a veteran-owned business first?

Zach Parker, President and CEO

There is always a preference for small businesses. However, after soliciting both contracts in this environment, they have concluded that it is not in the best interest of the government to have this critical work performed by the small business community. That said, acquisition strategies can change, and there are signs that they are exploring other options. We are prepared and believe we are well positioned to continue providing our services in an unrestricted and prime setting. If that is not the case, we will consider other approaches. We remain optimistic about staying in this competition, ideally as a prime contractor in an unrestricted environment, but we won’t know until these procurement cycles occur.

Joe Gomes, Analyst

And hopefully, the fact that you’re handling record levels of orders and you’ve done such a great job on this in the past plays in your favor on that?

Zach Parker, President and CEO

Yes, there are many dynamics at play.

Joe Gomes, Analyst

Go ahead, Zach. I’m sorry.

Zach Parker, President and CEO

Well, I was just going to say that there are many factors at play. Even though we have experienced short periods of less than a year, we have chosen to invest in next-generation methods to fulfill the CMOP mission. I believe our customers recognize this. The productivity and production records we are achieving demonstrate our shared dedication to quality and performance, continuing our legacy as one of the top performers as rated by J.D. Power. We are excited about the potential future and will keep investing to be the best provider for our veterans.

Joe Gomes, Analyst

I have one final question. Regarding the debt paydown, you all are doing an impressive job. If things keep going as they are, I expect you will be nearly debt-free by the end of the next fiscal year. However, this typically seems to be when the company announces an acquisition. So, I'm curious about the current state of your M&A pipeline. What multiples are you seeing in the market? Are you more comfortable with these multiples, or have they decreased given the changes in the economy? Any additional information on potential M&A activity would be appreciated.

Kathryn JohnBull, CFO

I appreciate that question. As we anticipated and indicated in our call a few quarters ago, the first part of the year was quite calm as all the investment banks recovered from their exceptional performance in 2021. However, volume has started to increase nicely, and we have a strong and active pipeline of opportunities that we are diligently pursuing and assessing. I’m encouraged to see activity picking up again, providing us the chance to enhance our offerings and strengthen our position in the market with additional technology capabilities. Regarding multiples, they seem to be softening slightly compared to 2020 and 2021, but not to the extent that we’re likely to find the same bargains we saw in 2015 and 2016. I believe we are still a bit away from that. However, we are seeing slight improvements in margins as people consider overall economic indicators and adjust their multiple expectations. Nonetheless, from my perspective, it remains a highly competitive and somewhat volatile market.

Operator, Operator

Our next question comes from Brian Kinstlinger with Alliance Global Partners.

Brian Kinstlinger, Analyst

You talked about a few new programs. Can you first comment on your ability to hire professionals to meet new project requirements? And then in this inflationary period, maybe compare compensation for either new hires or comparable to a year ago?

Zach Parker, President and CEO

No, great question. As you probably know and heard me talk about before, I think that one of the more unique challenges that we’re facing over the last year and in the near-term future is the threat of the great resignation and the ability to find and retain top talent. We under the leadership of our relatively newly hired Chief Human Resource Officer, Maliek Ferebee, we’ve really focused heavily on the ability to retain our workforce as well as to be able to attract workforce given the threats that we’re seeing out there. We’ve started to have some good traction. We’ve put in some new measures, implemented some new measures over the last quarter or two. We’re starting to see some of that pay off. We are actually doing I think better than most of the industry from my engagements with the rest of my GovCon folks. But we’ve still got a lot of work ahead. It’s a different environment today to be able to attract and retain top talent. And there’s a bit of scarcity of resources in that regard because a lot of the newer generations are looking more at the gig work environment and we’ve got to find ways to attract them into our places. So it is a threat. It’s one that I’m really pleased to say that with our new leadership and approaches across our operating units, we’re holding our own and feeling that I think we’ve weathered some of those storms. Some of that also was exacerbated by COVID-19, particularly in programs such as some of ours where you have to go into facilities and have to come to work in an environment that had different degrees of risk and many regulatory requirements in our space. A number of our agencies required that you had to get vaccinated and certainly less than 100% of our workforce was amenable to that. We kind of reflect the national demographic. So we’re going to continue to apply force on target for this threat. It is front and center for us. And I’m pleased to say that early results are positive.

Brian Kinstlinger, Analyst

16% organic growth is solid. I’m curious, as a follow-up though, has the challenges in hiring and retaining curtailed in any way revenue? Meaning, you couldn’t fill certain positions so maybe certain revenue is not ramping as you expected? And then also, what is your voluntary attrition rate?

Zach Parker, President and CEO

We don't publish a rolling voluntary attrition rate, but I can share that industry norms indicate around 17% attrition for the professional workforce in government contracting. In sectors like professional services and consulting, turnover has almost doubled in the past year and a half to two years. Some Tier 1 companies report turnover exceeding 40% in their professional workforce. However, we are performing better and maintaining our turnover below 20% in that area. In production and manufacturing environments, we also exceed industry standards. We have faced challenges over the past year and a half due to COVID and the great resignation, which affected our revenue delivery. Addressing this is a top priority in our human capital management. Our managers recently participated in sessions focused on innovative recruitment methods, utilizing social media to engage candidates more effectively than traditional recruiting practices. This is essential for enhancing our revenue, meeting client demands, and fulfilling resource needs to meet the specific requirements of our VA customers. We are optimistic that our efforts to fill these positions will lead to increased revenue.

Kathryn JohnBull, CFO

I would like to add that the competition for talent has always been intense for us, even before the pandemic, as we have worked to navigate and compete with well-known companies. The professionals on our team come from public health and scientific research backgrounds, which has made them even more in demand now. What sets us apart is our absolute focus on increasing the proportion of work delivered by our direct team rather than relying on subcontractors. This is an important metric for our company, and we are making good progress in this area despite the talent competition. We are building capabilities and engaging in work that our employees are passionate about, allowing them to take on an entrepreneurial role in serving clients. We have the advantage of gaining momentum, and people are excited about it. However, we cannot lose sight of the importance of making the employment environment competitive and appealing for the talent we are vying for.

Brian Kinstlinger, Analyst

I’m curious, we’ve had a short period of time where we’ve had budgets in place before maybe what’s coming, continuing resolution. But can you talk about, from a high level at least, the bookings trends over the last nine months compared to the previous nine months? And how do you think that will be impacted by a continuing resolution?

Zach Parker, President and CEO

No, great question. I believe CR has been our default for the past decade. While there is some stagnation in Congress that complicates things for us, especially in the federal government sector, we are beginning to see some progress. As you noted, we’ve recently identified some bookings. I can tell you that we are now experiencing more proposal development activity than we have in quite some time for several strategic initiatives that have taken a couple of years. Therefore, we are optimistic that in the areas we’re focusing on, it’s not universal in our industry, but certainly in our targeted areas, new programs and some evolving recurring programs are starting to emerge. The leading indicators suggest that the pipeline of these opportunities will be quite robust and positively impact 2023 and fiscal year 2024.

Brian Kinstlinger, Analyst

I guess lastly, as I look at your businesses between the VA, Health and Human Services and DoD, as you look at your pipeline of opportunities, is there one that sticks out of where you see the biggest growth opportunity or is it pretty evenly split across the board?

Zach Parker, President and CEO

That's a great question. As Kathryn and I mentioned earlier in the quarter, we are broadening our growth strategy. HHS, DoD, and VA will remain important customers for us, and we believe there are significant expansion opportunities within these agencies. Additionally, we are strategically focusing on utilizing the skills we developed during our last five-year plan. We now have strong digital transformation capabilities that encompass areas such as cybersecurity, security, data analytics, and advanced systems engineering, which includes modeling and simulation. We can apply these skills not only within the existing agencies but also in other Civil and DoD sectors that aren't solely focused on health. We expect these areas to present further leverage points for us. Key differentiators, including our global clinical research network and our FedRAMP platform-as-a-service solutions, will play essential roles in maximizing the investments we've made to strengthen these capabilities, along with enhancing our technology-enabled approaches for these customers. We continue to believe there are ample opportunities for expansion within NIH and the HHS realm. We've previously indicated that cancer presents a promising growth area for us, and the recent DCEG win is a step in that direction. We also see potential in the behavioral health sector, particularly in light of the challenges that have arisen from COVID-19, including issues related to depression, suicide prevention, substance abuse, and concerns related to TBI and PTSD on the battlefield. We plan to continue investing in these areas and exploring how we can leverage our C4ISR capabilities from the workforce we acquired at Fort Detrick. We're excited about diversifying our portfolio now that we have a solid foundation to build on, allowing us to deepen and broaden our target market capabilities.

Operator, Operator

At this time, there appears to be no further callers in queue. So I’ll turn it back to Mr. Parker for any closing remarks.

Zach Parker, President and CEO

Well, thank you very much. And I would just like to thank you all for your attention and your continued interest in DLH and our quarter 3 results. We look forward to chatting with you again next at our fourth quarter report out, and subsequently, our annual report to the shareholders. So thank you very much. Have a blessed day. Bye for now.

Operator, Operator

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