DLH Holdings Corp (DLHC) 2021 Q2 法說會逐字稿

Good day, and welcome to the DLH Holdings Fiscal 2021 Second Quarter Earnings Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Chris Witty, Investor Relations Adviser. Please go ahead.

Thank you, and good morning, everyone. On the call with me today is Zach Parker, President and Chief Executive; 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 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.

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 to 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 '21. The second quarter was certainly one of accomplishment with revenue rising 12% to a new record $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. And then of course, 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 5-year period. With that in tow, we will have a backlog in and around $800 million, its highest level ever for the company. And 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. Again, first of all, I want to expand on the comment I made a moment ago about the CMOP and our recent award. As many of you likely already know, we have served this program under the VA for over 2 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 proposals from large business -- only 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. And last year, we processed over 120 million prescriptions from 7 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. And we are thrilled to continue to provide prescriptions, 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 5 years. So we look forward to that acquisition beginning.

On another front, as you know, as the country continues to make progress with COVID-19 vaccinations and of course various states move towards reopenings 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 time frame.

As you may recall, our digital transformation team under Helene Fisher's operation had implemented a new system that reduced costs, increased efficiencies through a major business process reengineering effort. While that achievement reduced our Head Start-related revenue once implemented entering the fiscal year, we did not anticipate further reduction due to COVID-induced reduction 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 qualify and pursue a strong set of growth opportunities from strategically small opportunities to very large opportunities. Unfortunately, like -- much 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, the Office of Management and Budget, OMB, has recently issued some new directives to these federal agencies intended to improve these time lines and to also drive greater accountability into the contract procurement process. We welcome those changes to help accelerate our organic growth prospects.

While both parties -- 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 or heightened interest within the mergers and acquisitions front. There is 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 continuing to build. And I think the global pandemic has only accelerated the trend towards some of the network modernization, ensuring convenience and security for individuals performing critical work under the fluid [global] environment.

While the economy is improving and the impact from COVID-19 subsiding, 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 the numerous opportunities and decide what strategically aligns with the company that is something that we would value. We always thought that the corporate culture was a key part of any transaction. We will continue this in the future and 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 opportunity 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. And I couldn't be more proud of the team that 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 now to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?

Thank you, Zach, and good morning, everyone. We're pleased to continue posting positive results this year.

Turning to Slide 6. We posted record revenue for the 3 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 revenue 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 and as Zach mentioned, we believe it will continue to do so in the quarters to come.

Turning to Slide 7. 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 $1 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 3 months ended March 31, 2020, due to higher outstanding debt levels reflecting the acquisition of IBA.

Turning to Slide 8. 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 9 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 in part largely reflecting transition 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 Instructions) Our first question comes from Brian Kinstlinger with Alliance Global Partners.

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?

Great question, Brian. I'll take the second part and pass the 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 few years. And 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 hanging out, for instance, in the lobbies or in the areas where they're providing those deliveries have led to an increase in the mail order process.

So what remains to be seen is how, if at all, any of that will be ratcheted back in the [out years]. Every indication is that they're here to stay, that the quality and the productivity at which the mail order system is delivering the services relative to the in-house has proven to be of tremendous value for the VA and our veterans. And we expect that with the new leadership, they're going to continue to go down this path. So we think the upside is a good bet that we'll continue to build on that. And as we continue to have a larger group of veterans living and meeting the demands, we expect it to grow as opposed to plateau.

So we're looking forward to that. At the same time, the VA is expanding its facilities. We're looking to expand the workforce over the next quarter or so. Kevin Wilson, who leads that effort for us, has been assembling a really, really good team to make sure that we can be responsive and still grow in some challenging workplace environments. So doing a tremendous job. And these are people that, if you think about it every day, they go into a regional distribution center that has 200 or 300 folks going to work in a major assembly line sort of environment. So they really take on that risk associated with large groups, but they've managed it very well. They had very, very, very low rate of infection. And we look to that to continue. With regard to the numbers that we quoted on...

Sure. Yes. Yes. Perfect. So for the period and 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 to in the CMOP part of the business as well as in the COVID support parts of the business and other places, but those are the 2 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'll be some recovery of that. Of course, the customers got to work through exactly how they'll reschedule those programs and those site visits. But from that perspective, we see the pause on those site inspections as beginning to ease in the second half of the year.

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

There were -- for this particular one, on 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. There will be a little bit of a mix 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 -- some of the costs that will ease because we've implemented a number of things historically that did not need to be implemented in the next year or 2. So a little bit of softening in that regard, but nothing material.

Great. And my last question is several -- and 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 process. Is DLH experiencing the same on their submissions and their contracts that are now going through the procurement cycle?

Yes. No, great question. And the answer is absolutely yes. We -- as I've mentioned briefly in my comments -- 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. And the trouble is, as you've pointed out, my peers are experiencing the same as I am, where -- while our CMOP has been on -- some of our contracts have been on (inaudible) extension 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.

So yes, the acquisition community is very upfront about the fact that they have -- on the government side, they have lost a lot of talent to help move these contracts and these procurements along. They've been working to incentivize, bringing in new blood because they lost a lot through attrition and retirement and just have not been able to make that up in a very cost-effective way.

But they're addressing it. And when I mentioned the OMB has put into place some new initiatives, one in particular is focused on what they call PALT, which is an acronym for Procurement Administrative Lead Time. So they're raising accountability and focus on that effort, so that they can get these procurements in place and contracted in a timely fashion.

But it has been brutal for us. It has been the #1 headwind towards stunting our organic growth through business opportunities because we just can't wait to get the proposal submitted. We think we've built some really tremendous solutions. We've added our capabilities through M&A, but we've got -- most of our programs that we have that are north of $100 million in new business continue to slip to the right for, what we call, single-award contract.

So 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 '22 and hopefully still some at the end of FY '21.

The next question comes from Chris Bliska with NOBLE Capital.

I'm sitting in for Joe Gomes. And let's see -- a couple of questions that we had have already been addressed. But Kathryn, maybe you can answer one about accounts receivable. There was some improvement in the quarter. Are you satisfied with those results or were you expecting more? And the timing on getting the accounts receivable down further, please?

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. So 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 all of their requirements. But they're -- I'm expecting by the time we complete our process of addressing changing customer needs, they've had some transition in their own place of contact and people responsible for managing things. And I do see roughly $3 million that I think will be kind of -- if you want to consider a permanent transition just because of some additional layers that the customers have added as we recompeted some of these contracts.

So as compared to last year and on a steady state revenue, I think I'll end up with about $3 million level of AR higher. But all that in the context of I'm currently sitting at around 60 days sales outstanding. My -- I see a path to getting closer to 50, so that should free up some pretty strong operating cash flow and get us back in a realm of what I consider to be appropriate for our business.

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, time line, please?

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 have 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. And there's some public information out there with regard to what their particular position is on the protests.

The norm -- I should probably say there really is no norm in 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, right? It's usually -- the type of adjudication involved here is usually relatively timely. And of course, we're -- in the federal government space, that still could be 90 days, 120 days for resolution. So that's about how we're mapping this one right now.

I can tell you that in the meantime, the contracting officer has notified us their intent to and put into place an extension to take us out through pretty close to the end of the fiscal year in the August, September time frame, so that they can get this adjudicated. And then we would begin the phase-in period of that contract.

And i would just add in context, of course, the protest cycle is, as unfortunately these days, kind of a normal part of the awards and procurement cycle. So we don't view it as anything particularly significant.

Okay. Great. 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 the revenue decline in the Head Start business?

Yes. There've been a couple of major factors, right? And I touched on the fact that we had, late last fiscal, started the new contract. An exciting part of the completion -- one of the most attractive features of that operation for us was the ability to design from rearchitecting, 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 were not just modernizing it and transforming for the sake of transformation, but to drive efficiencies. And so in our new bid that we won, announced at $150 million, that was about $30 million to $35 million over 5 years, more cost effective than before. We believe that great success in executing digital transformation efforts should result in benefits to the ultimate customer and the users.

And we have done so by implementing all these new mobile friendly technologies, substantially reducing what was labor-intensive before by implementing new methods of digital visualization and things of that nature. So it -- so we understood that. That, of course, was in our plan as we went forward and was again, arguably, $5 million, $6 million more cost effective on an annual basis. But we did not factor in COVID...

Right, didn't see that one coming.

In 2020. And of course still rearing its ugly head on our revenue now. So we do expect that the haircut that we've experienced over the recent couple of quarters, Helene is working very closely with the government leadership. There has been turnover -- recent turnover with the new administration at the top. They're getting their arms around. We've got outstanding new leadership in place, we believe -- a leadership that has great intimate understanding of the program -- having come up through the program and she sees the benefit of implementing our new system. So we're optimistic that by this fall -- I'd love to see it be sooner, but some time by this fall that most of the states -- we're in all 50 states. And as states start to allow more mobility and access, we expect to start to realize that revenue back again certainly by our first option year period before it comes to completion.

And Chris, just echoing that and reinforcing part of what Zach referred to, that cost effectiveness in a recompete cycle is an important part of our value proposition as we implement technology enablement. So as Zach said, that was completely expected. But as you're looking at like for like, period to period, remember that the COVID restrictions really came in at the very tail end of Q2 last year. So Q2 last year is essentially kind of normal, but for the impact of the value delivered in the technology enablement.

So it's a little -- It makes period-to-period comparisons a little bit challenging, a little bit difficult. But in terms of the soundness of the program, we do expect that, however, unexpected and undesirable, this pause has been in terms of the long-term view of the program, we're greatly encouraged. You hear it almost every day in the headlines about the need to really reinforce and help to recover some of the education gap that happened during this year of everybody being at home. And we think that Head Start provides a great channel for doing that. So our commitment and our enthusiasm for the program is as strong now as it's ever been.

But that doesn't mean we're not looking forward to the backlog starting to clear and really starting to pick back up the normal momentum.

(Operator Instructions) There appears to be no callers in the queue. I would like to turn the conference back over to Mr. Parker for any closing remarks.

Thank you. And let me just say thank you again to the full -- to our shareholders and the current investors and interested parties. We again remain very, very excited about the future of the company. We really believe that we've got just a great trajectory with opportunities to continue to deliver not only sound performance for our current clients but also to build that client base.

We're also excited about having entered this fiscal year with a very balanced portfolio, and that portfolio covers all 3 of our market focus areas identified in our 10-Q. We're really excited that as we look both organically and acquisitively that 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.

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