Earnings Call Transcript - DLHC Q1 2021

Operator, Operator

Good day and welcome to the Fiscal 2021 First Quarter Earnings Conference Call. All participants will be in a 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 Chris Witty, Investor Relations Advisor. Please go ahead.

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, CEO

Thank you, Chris, and good morning everyone. And welcome to our first quarter conference call. Let me begin with the recognition of the excellent and courageous work done by our DLH employees worldwide in executing the mission of our customers. Many of our employees largely attended the workplace on a daily basis, braving the challenges imposed by the pandemic. We are truly indebted to the service of our folks, as well as the close control and safety provisions provided by our customers for those working at our customer sites, and by our leadership team and our COVID-19 task force for those of our employees that work in our existing facilities. We began fiscal 2021 with solid results. As I indicated last time, I remain very optimistic about the year ahead. Starting with Slide 3, I'll first provide a high-level overview of our financial performance and some color around the outlook for the balance of fiscal 2021. As I indicated, the year started off strong, and I am pleased to say with revenue of $57.9 million and operating margins of 6.3%. The company's top line benefited from almost $7 million in contribution from IBA, as Kathryn will review in a moment. While overall profitability increased even as some of the pandemic-related headwinds continued, due to ongoing travel restrictions as noted in the past, certain programs saw less activity and of course the subsequent billings. But we believe that such challenges should lessen in quarters to come. We posted net income of $1.8 million or $0.13 per share, and our backlog was $665 million at the end of the quarter, providing strong revenue visibility. Most importantly, we're seeing a very active proposal bid environment. And as I’ll describe more in a moment, we're pleased with the wide array of opportunities that have been open to us this fiscal year. Overall, I think the company performed well in Q1, and we're on a path towards sustained solid performance throughout the fiscal year. A quick brief note also that we ended the quarter with the majority of our transition and integration requirements associated with the IBA acquisition satisfied. Now turning to Slide 4, I'd like to update our investors on DLH’s business outlook following the recent political changes in Washington. As we said last quarter, the outcome of the election was not expected to materially impact the overall stability of our end markets or demand for the services we provide. We continue to maintain strong alliances with customers that are well supported on both sides of the aisle, as well as the White House. However, at this juncture, we anticipate that the new administration's spending priorities may result in even greater opportunities for us to grow long-term due to the ongoing focus on improving technology associated with healthcare solutions. These include the Department of Defense, Defense Health Agency, the Veterans Administration, and several agencies within the Health and Human Services agencies. What is different is our company can now provide an even broader and deeper range of services than ever before, as we continue to integrate our acquisitions, develop unique value propositions, leveraging tools and technologies to differentiate us as we look to grow our opportunities organically. We continue to drive key technology enhancements and modernizations to support the fight against COVID-19. We've been using the depth of our credentials and expertise to continue to address a large number of opportunities associated with the pandemic, bringing together core service offerings in a way that transcends anything that we've been able to do in the past. Furthermore, the federal government, including the key agencies that we serve, continue to increase their focus on digital transformation, artificial intelligence, and the move to a secure cloud environment. The pace of bidding activity has clearly picked up, in part due to the fact that we actually had a budget signed at the end of the calendar year as opposed to continuing to operate on continuing resolutions. We also believe that this solidly positions us to pursue more contracts over the course of the next 12 to 18 months, most of which will be new business opportunities. In addition to the COVID-19 pandemic, opportunities for us to pursue are largely in our public health and life sciences arena. But we also find opportunities within the DoD and veteran arena as well. These opportunities should help us continue our track record of growing the top line and, most importantly, supporting the nation's fight against this virus. Some of our recent awards in this arena are already positively impacting the outlook for fiscal 2021. We anticipate pursuing additional contracts dealing with both the vaccine rollout, therapeutics, telehealth applications, and, of course, clinical trials for the safety and efficacy of investigational therapeutics. All in all, I remain upbeat about the coming years and the performance of DLH during these challenging and uncertain times. With that, I'd like to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?

Kathryn JohnBull, CFO

Thank you, Zach and good morning everyone. We're pleased to start the year with continued positive results. Turning to Slide 6, we posted revenue for the three months ended December 31, 2020, of $57.9 million versus $52.2 million in the prior year’s first quarter. The revenue variance reflects the impact of roughly $7 million in sales tied to the acquisition of IBA, as Zach mentioned, offset in part by a reduction in organic revenue due principally to restrictions on pass-through travel within the current COVID environment. These expenses were not incurred and therefore not billed to the government. Revenue delivery from labor was stable year-to-year, albeit with a somewhat different distribution among programs. We anticipate revenue to grow organically during fiscal 2021 as a whole due to an expansion of current programs, expected new business wins, and general task order timing. Turning to Slide 7. Income from operations was $3.6 million for the fiscal 2021 first quarter versus $3.1 million last year. Operating margins improved to 6.3% from 6% in fiscal 2020, reflecting improved operating leverage. We reported net income of approximately $1.8 million or $0.13 per diluted share versus $1.6 million or $0.12 of share last year. DLH recorded a provision of $0.7 million and $0.6 million per tax expense during the fiscal 2021 first quarter and fiscal 2020 first quarter respectively. Interest expense in the current year quarter increased to $1.1 million versus $0.9 million for the three months ended December 31, 2019, due to higher outstanding debt levels resulting from the acquisition of IBA. Turning to Slide 8, EBITDA for the first quarter of fiscal 2021 was $5.7 million versus $5 million in the prior year period. As a percent of sales, EBITDA rose to 9.8% this quarter versus 9.5% last year. A reconciliation of GAAP net income to EBITDA is provided in our earning statement and at the back of this presentation. Slide 9 gives an updated snapshot of our debt position at the end of the first quarter. As of December 31, we had $77.4 million of debt outstanding under our credit facility versus $70 million at the start of the fiscal year. This position largely stems from our use of $8.5 million of operating cash during the quarter versus $2.9 million last year, reflecting a significant growth in receivables. This was due to two key drivers: first, the impact of the continuing resolution on the fiscal 2021 federal budget, which was not signed until December 27; and second, a transition in key contract payment offices causing a delay in collections. These two big drivers have since been resolved, and we anticipate returning strong cash flow in the second quarter, leading to a resumption of our deleveraging efforts. As noted on the slide, we continue to see debt levels of between $50 million and $52 million at the end of fiscal 2021 and a substantially lower leverage ratio in tandem. 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. Please go ahead.

Joe Gomes, Analyst

Good morning, Zach and Kathryn nice quarter and thanks for taking my questions. I wanted to start out with you talked about the top line and how the lack of travel pass-through, but also on some of the compliance programs? And I’m wondering if you might give us a little more color on how much on the compliance programs it was in the quarter that was not received? And on those programs once we hopefully get back to normal sooner than later? Would you make that revenue up or is that revenue gone due to COVID and not doing those compliance programs at those times?

Zach Parker, CEO

Right, great question, Joe, and no you're absolutely right. We continue, as we discussed briefly at the latter part of last year, the impact of COVID-induced restrictions for travel. The overwhelming majority, actually north of 90% of our compliance related reductions are associated with compliance and surveillance that we do that actually requires onsite visits. I can tell you that in terms of the go-forward, we're working closely with our customers to leverage new methodologies to still get the job done that is less dependent upon having large numbers of people in specific facilities. Many of our compliance programs have to do with children and programs such as Head Start, and our support to the Department of Homeland Security. The best of these groups have been, in many cases, closed and have been very, very restrictive with regard to access. We have been working and postulating some alternative means to execute the mission in a reduced travel mode and are working closely with our customers to start to implement those. So, we think we're going to start to get some of that revenue, less, of course, the specific travel-related component, and we should start to see some of those gains, we think by second quarter. Having said that, the last part of your question, we will probably not recover; current indications are that we’ll probably not accelerate those that have slipped over the course of the last two quarters and to try to get through them during this fiscal year. So, all indications are that for that particular work, I do not expect it to be reflected by September 30 this year.

Joe Gomes, Analyst

Okay, thanks for that Zach. And then you talked about the large number of opportunities associated with the pandemic, especially in the public health arena. I was wondering, if you could give us even a little bit more color because you combine that with you're seeing an expanded pace of proposal activity. What type of contracts are? Is there any way you can give some type of detail or color on the amount of bidding and has it - what’s the timing of some of those; any additional detail or color on that would be appreciated?

Zach Parker, CEO

Yes, there are a couple of forms of that. First and foremost, when we really began to step up our support largely in the technology side of NAID, our nation took it as an approach to really apply all hands on deck, right. That was manifested not only by us and other contractors but also the active participants of the CDC and NIH, both of our principal customers, have said we are supporting the pandemic response. So, we've been working with them to ensure that we can appropriately align our workforce for the added bandwidth. In many cases, the customer is using non-traditional means because of the urgency of getting the range of clinical trials and evaluations done in a relatively short timeframe. So, in many cases, we've been drafting white papers that would allow our customer to not have to go through the normal competitive channels and expand some of the work on some of our existing contracts. We're starting to see quite a bit of bid activity that is associated with expanding work on some of our existing contracts, both IDIQ and some standalone scope increases awarded in the last couple of quarters. So that's exciting for us. One, it reflects an acknowledgment of the quality and caliber of the work that we have been doing as we continue to look at various types of vaccines and therapeutics. They are asking us to expand our footprint and increase our market share in that arena. So, the jury is still out; we've had a number of proposals submitted in the course of the last several weeks - not a few months - but there is a sense of urgency from the federal government to get these in place and in motion. So, we're really leaning in on those. The majority of those are in our public health and life science arena, quite a bit of it from an epidemiology and clinical trials network standpoint from Jeanine Christian's operation, which we call PHSR, public health and scientific research, the cornerstone of the S3 acquisition. However, we are also seeing some expansion in veterans' needs in that arena. We are working very hard to expand our bandwidth to support a greater demand for veterans' response to COVID-19. Part of that was also a tribute to the fact that they're trying to restrict physical presence by our veterans in a number of the medical centers, and so some of that work is flowing into the mail-order component, and we're going to see some of that increase in our VAC mark direction as well. So, it's a pretty broad range. The ones that we think are, those are two areas that we think are probably the most material for upside over the course of this fiscal.

Joe Gomes, Analyst

Thank you for that. And just one more from me and I'll get back in queue. Kind of a two-part question, obviously, you mentioned the increase in accounts receivable, part of that from the continuing resolution, part of it from the transition in key contract payment offices. So question one, can you give us a little more information on this transition and the key contract payment offices; what does that actually mean? And two, we're now a month into the second quarter. Are your collections keeping up with what your internal forecasts are in order to get back to being able to pay down debt and get a more normalized cash flow situation? Thank you.

Kathryn JohnBull, CFO

Yes, let me grab that one.

Zach Parker, CEO

Let me kick it off real quick. And then Kathryn will certainly add the colors. I just wanted to give the context. As you heard Kathryn mentioned earlier, the two key dates: one is that we closed our IBA acquisition on September 30, which happens to be the last day of the prior fiscal year. Most of that activity from the government standpoint starts up on the first week with a brand new fiscal year, which happens to be our Q1, consistent with the government. Substantial portion of that transition is impacted not only by the start-up of new customer sets and new paying offices for us associated with that transition. As Kathryn also indicated, there is always a reluctance associated with funding when you're on a continuing resolution, moving towards the pending approved budget. During Q1, there were three changes to the date of implementing the approved budget at the end of December, and that caused a fair amount of paralysis with some of our customers and their paying office, and we don't expect those to continue on a regular basis. Kathryn, over to you to add additional color.

Kathryn JohnBull, CFO

Yes, no, that's absolutely right. Historically for us, our first quarter is always our softest quarter in terms of collections. Just that this year sort of outdid itself in terms of the volume of cash consumed because of the factors Zach mentioned. So, it's typical for the government to have a lot of use or lose time that once they get through their big government year-end work at September 30, there's a lot of time now in training time and all that. So, that causes Q1 to be softer in general, and then we had a couple of exacerbating factors this quarter. However, to your second question in terms of whether we're on pace, we know we are definitely on pace; as we indicated, we expect to return to a normal pace of collections and really drain that backlog from Q1 and then deliver normal cash flow in Q2. So we're setting up for a strong Q2 in terms of cash delivery.

Operator, Operator

The next question comes from Ken Herbert with Canaccord. Please go ahead.

Ken Herbert, Analyst

Yes, well, Kathryn, I just wanted to first to follow up on that last comment. It sounds like you're still expecting roughly sort of $25 million in deleveraging this fiscal year. And how should we think about the pace of that through the second quarter through the fourth quarter?

Kathryn JohnBull, CFO

Yes, it'll likely follow our historical trends. We'll have a strong Q2 because we'll be clearing that backlog from Q1, but historically for us our normal pattern is it builds through the year in Q4. That's typically our strongest quarter because our government partners' working environments inverse of the Q1 effect, where they have a lot of out of office time either on building their use or lose leave or doing their annual training. Conversely, heading into their own fiscal year end, they clear the decks and resolve their issues. So, the extent there's anything pending that usually tends to gush through Q4. We expect strong Q2, kind of an average Q3, and a strong Q4. Also, the expectation is that we expect that level at the end of the year would be between $50 million and $52 million.

Ken Herbert, Analyst

And as we just to think maybe get to a finer point on the first quarter traveling compliance issues. Was that about in the quarter about a $2 million headwind, or is it possible to sort of quantify how we should think about that from a top-line standpoint?

Kathryn JohnBull, CFO

Yes, that's a pretty good sizing of it as we talked about in our Q4 call. We expected that to slide out of Q4 and into Q2 and Q3, as Zach indicated. We are pleased with the progress we've been able to make in converting some of those compliance events to a virtual environment. In the case of our current first quarter, we were able to offset that significantly with revenue delivery from the Defense and VA market on the C-MAP programs, as Zach mentioned, due to the higher volume there. So the actual revenue delivery from labor was pretty well in line year-to-year notwithstanding the headwinds on the compliance programs.

Ken Herbert, Analyst

Okay, that's helpful. And then just finally on that point you had, I think you reported about 60% of your sales in the quarter were from Defense and VA markets. And I know this includes maybe the majority if not all of IBA. But as you look at this market, it clearly looks like you're seeing some growth in the Defense and VA besides just IBA especially in the quarter. Can you parse that out a little bit and maybe which particular contracts or is that run rate then with these sort of that organic growth in that business? Is that sustainable in second, third and fourth quarter, or how should we think about that for the fiscal year?

Zach Parker, CEO

Yes, Ken. I think there are a couple of things in play here. First, you're right that north of 95% of the IBA business is on the defense side. That was strategically exactly where we were looking to start to balance out the portfolio as you may recall to get ourselves into a stronger three-legged stool of our market focus areas. You're spot on there. We're also seeing growth in some of those key programs. Helene and Helene Fisher, who heads our MSS Machines Services or Solutions operating unit is where the IBA acquisition landed in the company. We did retain the leadership in terms of that acquisition, and Mary Dowdall and her team have been doing an excellent job of positioning us to have growth, excuse me, growth in some of the key programs. We are doing some COVID related work for the Defense Health Agency customers there as well. It’s difficult to forecast how much of that is surge versus sustained at this time, but we do expect to see some Q3 and Q4 plus ups in our labor-intensive work there. I think Kathryn properly categorized what we’re seeing, and Kathryn will properly categorize what we're seeing in the VA, but that was an intentional part for us to start rounding out that portion of our market focus.

Kathryn JohnBull, CFO

As you can see in our disclosure around our major contracts and major customers, the contribution from those core VA programs grew from 46% of revenue last year to 48% this year, notwithstanding that overall revenue grew pretty significantly. So, you can see that the volume of top line delivery from that set of programs has grown pretty substantially. Notably, the redirection of workload from the MTFs or the military treatment facilities over to the same up. Now time will tell whether that business model - whether that part of the incremental value - volume sustains for us. It seems reasonable that it would because it's a very cost-effective way of delivering that service. However, veteran health delivery has an element of visually being person-attending in military treatment facilities. The best bet is to continue the excellent program delivery. The customer sees the value-add and getting it done cost-effectively. That gives you a sense of where some of the growth in that market segment is coming from.

Ken Herbert, Analyst

No, that's very helpful. It sounds like you've got some nice runway in that business and just finally, Kathryn, as you do - or Zach, you do start to catch up or ideally see loosening of travel restrictions and maybe more compliance opportunities through technology or in-person as we go through your fiscal year. I imagine those businesses are or those revenues are probably margin dilutive to other parts of the business. As you do start to see that ramp, is that the case and would that perhaps negatively impact margins in the remainder of the fiscal year? To what extent could that be a factor for the margins?

Zach Parker, CEO

Sure, yes. First of all, part of what we're doing to get through this year is again virtualizing a substantial amount of some of those compliance programs so that we can continue to deliver some value to the grantees and to the program office without really a crystal ball as to when normalcy will come back. This does have an effect; a lot of our compliance programs leverage a lot of the technology tools we develop with a new completely modernized system. That nets out into some cost savings and cost efficiencies related to how we execute and deliver those services. The combination of these still has some pressure on our overall margin basis throughout the rest of the year as we start to stabilize the virtual approach. Throughout the rest of this year, we are looking at some additional analytics and potential expansion on the analytics throughout this fiscal year that may also help us to offer some of that margin erosion on the compliance side. As Kathryn indicated, we're not expecting to recover obviously the travel and the non-labor component of what has been lost in our first quarter of this fiscal as well as the last fiscal.

Operator, Operator

The next question comes from Bert with Business Consulting. Please go ahead.

Unidentified Analyst, Analyst

Hi, good morning Zach and Kathryn. Happy New Year and thanks again for another great quarter.

Zach Parker, CEO

Thank you.

Kathryn JohnBull, CFO

Great to hear from you. Happy New Year.

Unidentified Analyst, Analyst

Yes. I could hear your voices. I was pleased to see your form force in December. I was tickled pink and giddy as a schoolgirl to learn that I could now start trading options on my favorite security. That has happened recently. Nobody mentioned that. That's a big deal.

Zach Parker, CEO

Yes, it did.

Unidentified Analyst, Analyst

And I'm interested in learning more about the CMOP expiration extension and also that exclusion which would have prevented us from our re-compete?

Zach Parker, CEO

Yes, no, great points. Thank you again for your continued support and engagement in the business. You've been with us for quite a while and hopefully, we're answering e-mails for you as well. Regarding CMOP, of course, it is one of our longer and strong heritage businesses, and the VA work is as strong as it gets when it comes to protection under various threats for funding. We expect that to continue. As relates to our prognosis for the extensions, as you may remember, we have two primary channels for delivering those services. One is heavily on the pharmaceutical side, and the other on medical logistics. Both programs fell under solicitations a couple of years and they were slated to be small business set-asides, as a preferred option for the pharmacy when it is exclusively a small business set-aside. As they went through their evaluation process, the government made the decision that it was not in their best interest to continue with that path. So, they canceled that one, which has resulted in us receiving sole-source extensions. We continue to operate on those extensions. They range from six months to three month options. We’ll continue in that mode until such time that the VA re-establishes and gets an approved new acquisition approach. As of today, we have no knowledge that has been solidified as yet the acquisition plan. This bodes well for your additional sole-source extensions. We feel quite optimistic that that will go at least through the end of the fiscal year. If a solicitation comes out, that normal path allows industry partners to get another couple of few months in the bid process. We will certainly notify when if and when that occurs as it is a material contract to us, and then that starts the evaluation cycle on the part of the government again, which generally ranges from six months evaluation process to a couple of years. We will keep you posted on that but expect to operate with extensions and bridges through the end of this fiscal year if we’re successful.

Unidentified Analyst, Analyst

Thanks so much. You mentioned that it was material; how material is it? Is it 40% or 50% of revenue?

Zach Parker, CEO

Yes, we're doing north of about $100 million for that customer. It’s been a very significant material contract even with our expansions with organic growth in two acquisitions that we've had over the last year plus.

Operator, Operator

The next question comes from Jeff Bronchick with Cove Street Capital. Please go ahead.

Jeff Bronchick, Analyst

So just a quick question. Let’s assume this COVID thing goes away in 2021. When you look at ‘22 maybe looking back, would you say that over the two-year period, there is X amount of revenues that you've benefited from as you've helped your customers deal with just motivating and getting prepped through the COVID issues? Or would you expect a drop off or would you say no, it’s the opposite? We’ve actually lost more revenue because we couldn't execute on either current or potential plans?

Zach Parker, CEO

Right, thank you, Jeff. For those of you enjoying 80-degree weather right now, I’m not sure that gives you any extra bonus points. And the means to boot, no, that's a great question; I can tell you that the way we are viewing it right now is largely drawn upon the history of some of our other pandemics and emerging infectious diseases. What we hope to see is that over the course of the years, whether it's two years or three years, the nature of the trials, studies, evaluations, and health communications will evolve. We wouldn't expect to see much of a drop-off. There is certainly some surge associated with getting the networks in place and dealing with a very large population of subjects experiencing the infection and the disease itself. But often, there will be sustaining studies around these effects, sometimes environmental effects, and many cases looking for various types of therapeutics. Just like many chronic as well as infectious diseases, there is a tail associated with evaluating it and ensuring we understand its implications. So we’re hopeful to see it as something sustainable. It may change; of course, the margin basis of that may change as well, but we don’t see it as having a substantial drop-off as we enter FY 2022.

Operator, Operator

At this time, there are no other callers in the queue. So I would like to turn the conference back over to Mr. Parker for any closing remarks.

Zach Parker, CEO

All right, well I just want to say again thank you all. We think we’re continuing to build this platform consistent with the strategies that you heard us lay out several years ago. We're really excited about the continued transition and collaboration amongst our team to be able to help drive this one plus one plus one into a five, six and seven equation. We are truly committed to executing the strategy where we focus and build our pipeline on complex and mission-critical work. We think that helps us as administrations change, budgets shift, and deal with some potential long-term headwinds associated with budget debt issues at the federal government and so forth. So stay tuned, we're continuing to provide additional color. We are having our next month our annual meeting of the shareholders, and as our custom, we’ll give a deeper dive into our new business pipeline, our targeted agencies as we start to see that we can open our aperture further and how well we continue to do on the win rate. So stay tuned. We look forward to seeing you all soon and thank you very much for your participation today. Have a blessed day.

Operator, Operator

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