Earnings Call Transcript - DLHC Q1 2022

Operator, Operator

Good morning and welcome to The DLH Holdings Fiscal 2022 First Quarter Earnings 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 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 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. With that, I'd like to now turn the call over to Zach. Please go ahead, Zach.

Zach Parker, CEO

Thank you, Chris, and good morning, everyone. Welcome to our fiscal year 2022, first quarter conference call and Happy New Year. As we hope you will agree, fiscal 2022 is off to a great start at DLH. I want to first give credit to our tremendous committed leadership team and workforce for keeping focused on the missions of our customers. None of us would have predicted two years ago that we would be discussing great results despite the challenges of the pandemic. Beginning with Slide 3, I'll first provide a high-level overview of the quarter, which represented outstanding results for the company. Driven by our recent short-term contracts with FEMA, providing pandemic-related assistance in Alaska, revenue rose to $152.8 million in Q1. Even excluding the $91.1 million of FEMA-related work, we saw a revenue growth of 7% year-over-year as our programs remained strong and in high demand despite an ongoing continuing resolution in Washington. We posted operating income of $11.2 million, which equates to 7.3% of sales, including the impact of our lower-margin Alaska contracts. First-quarter earnings were $0.55 per share or $0.22 without the FEMA work, reflecting the value of our technology offerings and highly credentialed staff. A reconciliation of the numbers is in the back of this presentation. We also paid down an additional $3.9 million of our term debt loan this quarter, further strengthening the balance sheet and closed out December with a backlog of $633.6 million. Turning to Slide 4, I'd like to give an update on our markets, applications, and advanced capabilities. We continue to serve the federal arenas that will define the next decade of public and military health investment. We've built a strong and growing position across a number of enhanced emerging technology offerings. Demand for our services in existing and adjacent markets continues to expand due to an increased emphasis across the board on advanced data analytics and digital transformation. DLH is an established provider of innovative solutions for medical assistance and diagnostics, including Telehealth and Pharmaceutical Systems. With our scientific and research capabilities, we can help the federal government effectively assess and respond to current and future health challenges across the nation. At the same time, our advanced capabilities in digital transformation include experience in IT infrastructure and modernization, cloud-based solutions, and continuous software development, all with a healthcare focus. We possess robust capabilities in data analytics and cyber-security, providing large-scale management services that leverage technology with highly credentialed subject matter experts. These focus areas, in total, are expected to benefit from the high demand going forward. DLH believes we have the right people, proper expertise, and customer relationships in place to drive growth in the quarters and years to come. In closing, the company is stepping up to the next level in terms of its offerings and the breadth of innovative solutions that we bring to bear. While the FEMA business will come to a close in quarter two, DLH is well-positioned to have a highly successful year with a strong balance sheet, long-standing partnerships with key agencies, and an exciting array of technology applications. Although we are mindful that the federal budgetary uncertainties need to be resolved in the near future, we are well on our way to another year of solid organic growth and customer expansion and continue looking at possible acquisition opportunities that can further accelerate our top-line growth going forward. With that, I'd now like to turn the call over to our Chief Financial Officer, Kathryn Johnbull. Kathryn.

Kathryn Johnbull, CFO

Zach, and good morning, everyone. We're pleased to report such a great start to fiscal 2022. Turning to Slide 6, we posted revenue of $152.8 million for the three months ended December 31st, 2021, versus $57.9 million in the prior year's first quarter. The growth reflects the impact of approximately $91.1 million in revenue tied to the Alaska FEMA contracts as Zach discussed, along with a 7% revenue increase across the other parts of our business. The majority of the Alaska contracts have been fulfilled such that we see approximately $30 million of additional revenue during Q2 and none thereafter. If additional revenue is awarded based on pandemic needs in the region, we will inform our investors. Turning to Slide 7, income from operations was $11.2 million for the fiscal 2022 first quarter, versus $3.6 million last year, again reflecting the additional short-term FEMA business. Operating margins improved to 7.3% from 6.3% in fiscal 2021, with the current year results including the impact from lower-margin Alaska work but reflecting a larger contribution of time and materials programs in the remaining business, which generally yield stronger returns than cost-reimbursable contracts. Interest expense was $0.7 million in the first fiscal quarter of 2022, versus $1.1 million in the prior year period, reflecting lower debt outstanding. DLH recorded a provision of $2.7 million and $0.7 million for tax expense during the first quarters of fiscal 2022 and fiscal 2021, respectively. We reported net income in the first quarter of approximately $7.8 million or $0.55 per diluted share versus $1.8 million or $0.13 per share last year. Excluding the Alaska business, non-GAAP earnings for the first fiscal quarter of 2022 were $3.1 million or $0.22 per diluted share. A reconciliation of all these results is included in the back of this presentation. Turning to Slide 8. EBITDA for the first quarter of fiscal 2022 was $13.2 million versus $5.7 million in the prior-year period due to the reasons I discussed above. As a percent of sales, EBITDA rose to 8.6% this quarter versus 9.8% last year. But excluding $6.3 million related to our Alaska business, EBITDA for our ongoing contract portfolio was approximately $6.8 million or 11.1% as a percent of revenue in the fiscal 2022 first quarter. A reconciliation of GAAP net income to EBITDA is provided in our earnings 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 31st, we had approximately $42.9 million of debt outstanding under our credit facilities versus $46.8 million at the end of fiscal 2021. We have satisfied all mandatory principal payments on the loan facility through March 31st, 2024, but we will continue to reduce debt when feasible to strengthen the balance sheet going forward. This concludes my discussion of the financial statements. With that, I would now like to turn the call over to our Operator for questions.

Operator, Operator

We will now begin the question-and-answer session. At this time, we will pause momentarily to assemble our roster. Our first question today comes from Brian Kinstlinger with Alliance Global Partners. Please go ahead.

Brian Kinstlinger, Analyst

Hey, great. Thanks. Great first quarter here. Did I hear right that excluding the FEMA contracts, your EBITDA margin was 11% versus 8% a year ago? And if that's right, can you just describe factors that drove that to get some of its mix, but I also figure you're paying your people more in this market? So just maybe go through the dynamics if I did hear that right.

Kathryn Johnbull, CFO

Yes. You did hear that right, Brian. And by the way, good morning. Thanks for joining us. EBITDA as a percent of revenue for the three months last year was 9.8% and 11.1% this three months, excluding Alaska. The improvement comes from a couple of things as you suggested. The contract mix where we had a healthier proportion of the revenue delivered from time and materials largely and a little bit of fixed fee for service contracts, whilst last year, a stronger portion of the mix was from cost-reimbursable work. But secondarily, the operating leverage we've got on our indirect expenses improved as the revenue base grew as well. And so the two of those together yielded that strong EBITDA performance for the quarter.

Brian Kinstlinger, Analyst

Okay. And then can you talk about your pipeline? Are there any other short or long-term contracts that are COVID-related? Of course, not including the existing Alaska or CDC contracts you have where you're doing research on the long-term impacts. I'm just wondering, is there a pipeline of similar contracts or are those slowly subsiding as Omicron seems to be getting a little bit better?

Zach Parker, CEO

A great question, Brian. And again, thank you for your participation. The answer is yes to both. We are in discussions on short-term impact certainly as Omicron starts to subside a bit. There is a look at potential additional variants and what sort of therapeutics we believe might be more relevant as COVID continues to evolve, while at the same time, we are seeing that the government is starting to think about longer-term research projects associated with it as well. There's a little bit of both. The biggest challenge has been for all of us in government contracting is the government acquisition folks being able to get those contracts out. As you might imagine, in a continuing resolution environment, it's very difficult to get new contracts out. Sometimes we're using more novel contracts, certainly for large buys, things like OTAs, but we're hopeful that the discussions we are hearing and the customers' interest will turn into solicitations.

Brian Kinstlinger, Analyst

Great. I have two more. The first one is as it relates to challenges in recruiting talent. Has that challenge subsided at all? And secondarily, has it caused any lost revenue, meaning have you been able to fill and fully staff all your contracts?

Zach Parker, CEO

We have seen some erosion as the rest of the nation has. As you know, the great resignation has placed a real challenge for the labor market across the field. And we're seeing some of that. We're experiencing some of that on some of our contracts; not only due to a smaller labor base but also from time to time COVID-induced absences. So we're continuing to manage that. As you know, we have stepped up our investment in human capital management within the business. That involves both retention and attracting new talent. We have seen a small impact thus far through Q1 of what we're seeing across the nation.

Brian Kinstlinger, Analyst

Great. Lastly, if you can just talk about your M&A pipeline? And as you look, what are management's priorities in terms of what you hope a target will bring DLH?

Zach Parker, CEO

Let me just kick off by saying we are opening our aperture in that regard. Strategically, Kathryn and I have felt that, as you may be reading, the conclusion of this last fiscal year really represents having satisfied our strategic plan, particularly the first phase of our strategic acquisitions plan. We're looking at expanding our opportunities in the M&A arena. Kathryn has led some activity over the recent month or so and can talk about the pipeline more specifically. Kathryn.

Kathryn Johnbull, CFO

The pipeline we expect to continue to be quite healthy. There is quite a bit of activity out there and our focus, as we've indicated, is that we closed our first phase of our acquisition strategy, which was principally focused on market presence in our target markets. The beneficial effect has been improvements to our technology capabilities as well. From a perspective of our Phase II acquisition strategy, we're going to shift those priorities. We think we've got good coverage in the relevant markets. However, as Zach indicated, there are definitely adjacent markets that we continue to keep an eye on. Our primary emphasis from an acquisition strategy perspective is adding capabilities and extending our reach in relevant technologies that benefit our current customers and any potential future ones. Digital transformation, artificial intelligence, machine learning, the things that are really relevant, modeling simulation; those things are applicable across the set of markets that we currently play in and those that are near adjacent. That's really going to be the primary lens through which we evaluate competitive acquisition opportunities.

Brian Kinstlinger, Analyst

Great, thanks so much, guys. Nice quarter.

Kathryn Johnbull, CFO

Thank you for joining, Brian.

Operator, Operator

Our next question comes from Joe Gomes, with Noble Capital. Please go ahead.

Joe Gomes, Analyst

Thanks. Good morning. Congratulations on a great quarter.

Zach Parker, CEO

Thank you, Joe, and good morning to you, my friend.

Kathryn Johnbull, CFO

Hey, Joe. Great to hear from you.

Joe Gomes, Analyst

So if we could just take a step back for a second on FEMA, just want to drill down on that just for a second here. You got the two initial contracts; they were $107 million valued up to then you did the $35 million extension, so that's a $142 million. You did $91 million in the quarter, so that leaves it let's call it 50-ish from the headline and you're saying that in the second quarter you're thinking $30 million and then that's it. What happened to the other $20 million? Is that just not being filled or is there something else there?

Kathryn Johnbull, CFO

Yeah, I think the awarded values really function as an estimate at a point in time and as we all know, COVID is a fast-moving environment. From our perspective, and our current visibility on the program and the needs from the customer, in terms of the support we're providing, we expect to deliver an additional $30 million, though they have funded or earmarked more than that in the event that they have additional surges, or other variants or other things that could happen. We can only share with you the visibility based on the trend line as we see it today.

Joe Gomes, Analyst

Right.

Kathryn Johnbull, CFO

That varies. We'll have to provide a further update.

Zach Parker, CEO

As probably worth noting also, Joe, that the way this program is working through FEMA, is that the states actually draw upon federal money that has been obligated for this effort and is contingent. The states are actually working off of, as Kathryn indicated, predictions, and contingencies as well. This could operate in either direction, as Kathryn indicated. Right now, we're seeing with the cessation of Omicron that there's new indication and particularly in Alaska, that it will be accelerating. But we'll all stay tuned and we certainly hope that remains the case.

Joe Gomes, Analyst

Okay, great. And our next continuing resolution seems to be dragging on a little bit longer than normal here. From your perspective or from your looking at the potential programs that you were hoping to be awarded, what ones are most at risk of continuing to be pushed to the right? And does this have, as this continues to go on, an impact on your two big VA contracts, which are currently operating under bridges? I would think that if the continued resolution is extended, then for you guys, you will see just those two contracts also extended out another year. I wonder if you might just share your thoughts on that.

Zach Parker, CEO

Sure. With regard to the continuing resolution, first of all, we have rated this from a company standpoint neutral to slightly positive. Largely because the agencies that we serve are very, very strong with their mission, and our budget stability is very strong, accordingly. Both sides of the aisle are committed to the type of programs that we have in place supporting veterans, military, and the underserved community. However, 12 of the last 13 budgets we've had to deal with CRs, and we're seeing frustration largely on the civilian side of the house. The DOD community and our DHA business have been pretty good at spending against the budget. While in recent years, the civilian agencies have had challenges executing and getting the full budgetary spend. We have continued to see two or three major programs slip to the right, new business opportunities for us. Usually, you find that when there is a case where there's some evolving scope in the work and it could be perceived as new. We can only be hopeful that a couple of those requests for proposals will come out in the near term. We are getting good body language, good vibes from those customers, that we should see something this fiscal year for a couple of our major programs. But we're on our third year and a couple of cases for things slipping to the right. Of course, our CMOP contracts as you referred to with the VA, they're on their fifth year but so is source bridges. Our first one expired in November of 2016. We're optimistic that we're going to continue on that business with the CR. These are missions that we tackle every day and every week to ensure that we get the appropriate services and products to our veterans. Our clients remain just as vigorous. We remain very optimistic that we will continue with DBA support, and we're hopeful that we'll see some of our larger programs that have slipped to the right start to come back this fiscal year.

Joe Gomes, Analyst

Okay. Thank you for that color, Zach. And then maybe you could give us a little more detail on what drove the 7% excluding Alaska revenue increase. I noticed in your revenues that Health and Human Services were up almost 15% year-over-year to $20.31 million. What are the factors driving that type of revenue increase?

Kathryn Johnbull, CFO

Yes, it is. In general, expansion on current contracts as well as some of the awards we had laid in fiscal 2021, like the CDC DHAP program that we announced last August, as well as a bit of starting to return to, I hesitate to call it normal, but maybe I'd put air quotes around the word normal, return to activities in our headstart program. So those things that are both expanding on current programs as well as starting to return to some of the more normal operating patterns, as well as the awards that we had late in fiscal 2021.

Joe Gomes, Analyst

Okay. Great. And anything new that you can share with us on InfiniByte? It's something you've talked about a lot in the past, and how is that rolling out here? Are you hitting internal plans that you had for that? Maybe you could just give us a little more detail on that product.

Zach Parker, CEO

Yeah, no, I appreciate that. It's still a very exciting part of our toolkit for us as we may have shared earlier. Just relatively recently we added to resources to really focus on the good market for that program. On the government side, there's been some slippage from some of the Secure Data Analytics contracts and the Cloud Based Hosting contracts. Things such as CMMC etc. that were to be incorporated in the contracts are being redefined by the government regarding some of those cyber security requirements. In the meantime, we're looking to try to take InfiniByte for a spin and not wait passively for that. We have started to build a pretty good pipeline there. Our current customers, of course, that we've been hosting for quite some time are really getting some tremendous benefits. We're also looking at very soon completing an audit that should get our system fully certified externally. Kathryn, do you want to add anything to that?

Kathryn Johnbull, CFO

I think that's exactly right. We're in that final phase of going from being on the market to being fully federally certified through GSA.

Joe Gomes, Analyst

Okay. Great. Thanks for the update. And one last one for me if I may. Kathryn, this is more for you. I know there's been a backlog through the last two years on the accounts receivable this time of the year. They were always running a little behind, and you had to use some of your magic with all eventually come in. Just trying to understand where we are today on the accounts receivable and are you comfortable where they are? Are you seeing some extensions on payments in this type of environment? Anything there would be great. Thank you.

Kathryn Johnbull, CFO

Sure, we continue the pattern that we've seen in the last couple of years. First, our first quarter, which ends right around the year-end holidays, and particularly this year with the way the calendar fell, I think people exited a little bit earlier than they normally do for their Christmas and New Year holidays. As per that trend, we did have a peak in Q1, but as per our usual trend, that's already clearing, and we've had a very healthy January, and it looks like a good start to February based on this morning's collection. I expect our full-year trend to be in line with our normal strong cash generation that we generally deliver. The only variable for us this year is that we've moved from being able to shield our earnings with our net operating losses. We fully consumed those during fiscal '21, so we will be tax paying in fiscal 22, but that old saying 'you have to be making money to pay taxes.' So we are among the tax-paying population now, but we still expect our net return free cash flow to be very strong.

Zach Parker, CEO

Kind of strange to be excited about having to pay taxes.

Joe Gomes, Analyst

Zach, Kathryn, thank you very much again. Great quarter. Looking forward to seeing how the rest of the year plays out. Thank you.

Zach Parker, CEO

Thank you, Joe.

Kathryn Johnbull, CFO

Thanks for joining us.

Operator, Operator

The next question today comes from Victor Hernandez with Hernandez Capital. Please go ahead.

Victor Hernandez, Analyst

Thank you. Congratulations on a great quarter. I had, I think, a simple question. On the statement of cash flows that you released, you had a line for deferred revenue. I wanted to see if you could give any details of what that line represents and what the impact would be on the full year.

Kathryn Johnbull, CFO

Sure. Thank you for joining, Victor. Welcome. The deferred revenue and the use of cash for performance of deferred revenue reflect the fact that right before the end of the last fiscal year, we collected a very large advance payment from the state of Alaska for these FEMA contracts that we've discussed on this call. Q1's results just reflect the fact that we had to perform the obligations that we received the advance payment for. We consumed that advance payment in the quarter, and we'll fully deliver against that by the time the program executes in Q2.

Victor Hernandez, Analyst

Excellent. Thank you.

Zach Parker, CEO

You bet.

Kathryn Johnbull, CFO

Thanks for joining.

Operator, Operator

At this time, there are no further questions in the question queue. I would like to turn the conference over to Mr. Parker for any closing remarks.

Zach Parker, CEO

Well, thank you. I'd like to express my appreciation for those of you who are engaged both live and via the website and also for those of you who will be checking it out offline. We look forward to sharing additional information with you at our annual meeting of shareholders, which is scheduled for March the 10th. We're scheduled to be in New York, provided that the pandemic allows us. We will look forward to meeting with not only you all but with our Board of Directors at that session and we'll give you additional color around the strategy in the business. Thank you all for joining us today. Have a blessed day.

Operator, Operator

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