DLH Holdings (NASDAQ:DLHC) Q1 2020 Earnings Call

0:00 Good day and welcome to the DLH Holdings Corporation Fiscal 2020 First Quarter Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Mr. Chris Witte, Investor Relations Advisor. Please go ahead.

0:39 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 two of the presentation. This call may include forward-looking statements that relate to the company's outlook for fiscal 2020 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 10K and in our other filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements.

1:25 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.

1:50 Thanks, Chris, and good morning, everyone. Thank you for joining us to discuss our fiscal 20 first quarter performance. Last night, we released our results for the quarter, which indicates continued strong performance on almost all indicators. Turning to slide three, we have delivered significant financial improvement in both revenues and profitability. Our revenue of $52.2 million for the quarter reflects organic and acquired growth as our operating teams continue to earn the confidence of our customers, resulting in on-contract growth. This growth Offset, our typical seasonal soft Q1, as well as some erosion attributed to expiring legacy work that was set aside for small businesses.

2:35 Operating income rose to $3.1 million in quarter one, and we posted EBITDA of $5 million down slightly sequentially from the fourth quarter's record results. As I'll review further in a moment, we're actively bidding on an array of RFPs in an attractive market environment, are optimistic about the outlook going forward. At the same time, we paid the outstanding revolver balance of $1.8 million and an additional $3 million of senior debt in January. We plan to further reduce debt and improve the company's balance sheet this fiscal year, as Kathryn will discuss momentarily. Turning to slide four, we previously stated that we expected the full integration to be complete near the end of Calendar 2019, I'm happy to report that we have accomplished this goal.

3:31 Our ERP implementation was finalized in early January, and our business units are now operating together seamlessly, allowing for certain synergies as well as business development opportunities. All key decisions have been implemented, but some synergies, such as our planned facilities consolidation effort, will be realized later in the fiscal year. We will maintain our discipline in surgically reducing costs and streamlining our operations this fiscal year with an eye towards producing solid results and improved top-line growth. In addition, given our quarterly results may fluctuate due to project timing and government procurement policies, I wanted to say that generally speaking, the past six months in aggregate provide a pretty good benchmark for our performance going forward.

4:26 We posted over $106 million of revenue during this time, $6.5 million of operating income, and roughly $10 million of EBITDA, while we remain relentless in reducing our debt level with our designs on reinvesting in growth. Today, we have reduced our senior debt by some $17 million since last June's acquisition, and we believe this is smart use of operating cash flow going forward. Particularly as we invest in new business development and strengthening our solutions offerings in secure data analytics for our current and future customers that are concerned about cybersecurity. As noted in our 10-K, our VA CMOP recompetes remain unchanged, and at this stage we see no material impact to our financial performance this fiscal year. And we will address this in greater detail at our annual shareholders meeting next month along with greater visibility into our new business pipeline.

5:27 With that, I'd now like to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?

5:34 Thank you, Zach, and good morning, everyone. We're pleased to report a great start to fiscal 2020. Turning to slide five, we posted revenue for the three months ended December 31st of $52.2 million versus $33.8 million in the prior year's first quarter. The revenue variance year-over-year reflects the impact of our acquisition last June, approximately $17.3 million, and modest growth across our other operations. The first quarter is typically a seasonally light revenue period for us, as Zach mentioned, and we expect both year-over-year and sequential top-line growth in the second quarter. Turning to slide six, income from operations rose to $3.1 million for the fiscal 2020 first quarter.

6:23 compared to 2.6 million last year, reflecting operating margins of 6% and 7.6% respectively. The lower margin in fiscal 2020 was primarily due to increased depreciation and amortization expense, including the amortization of acquired intangibles from the S3 transaction, roughly 0.8 million per quarter. G&A rose to 5.9 million in the first quarter from 4.2 million last year, reflecting the addition of S3. G&A as a percent of revenue was slightly below 12% versus our typical range of 13 to 13.5%, largely due to the timing of planned business development expenses.

7:10 We continue to implement streamlining initiatives, largely as outcomes of the integration activities. and as Zach discussed, we're aggressively managing G&A going forward. We reported net income of approximately 1.6 million or 12 cents per diluted share versus 1.7 million or 13 cents a share last year. The company recorded a 0.6 million provision for tax expense this fiscal first quarter versus 0.7 million in fiscal 19. and interest expense was $0.9 million in fiscal 2020 versus $0.2 million last year. Naturally, the year-over-year increase in interest expense was due to higher outstanding debt balances from the acquisition. That said, we continue our actions to pay down debt and concurrently we entered into a floating to fixed rate interest rate swap.

8:05 Each of those factors contributed to this quarter's interest expense being $0.3 million lower than Q4's. Turning to slide seven, EBITDA for the three months ended December 31st, 2019 was 5 million versus 3.1 in the prior year period, reflecting the S3 acquisition and improved operating leverage across the enterprise. A reconciliation of gap net income to EBITDA is in our earnings statement at the back of this presentation. Slide eight illustrates our continued commitment to debt reduction, as Zach mentioned. Since the date of the transaction last June, we have consistently used the company's significant cash flow generation to reduce our debt, including an additional $3 million paid in January. We've now paid down $17 million of senior debt, and our next mandatory principal payment is not due until June 2022.

9:00 Pre-paying our debt not only strengthens our balance sheet and delivers the company, it reduces our interest expense, improving the bottom line. From a leverage perspective, we're about 2.6 times levered on pro forma LPM EBITDA. Remember, of course, that eight months now of that pro forma 12 months reflects actual results since the transaction is eight months old at this point. So obviously, we closed the deal at three and a half times levered. We're now sitting at a 2.6. We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys.

10:07 If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question will come from Joe Gomes of Noble Capital.

10:26 Good morning, Joe. Good morning. Nice quarter and thanks for taking my call. I know you talked real briefly, Zach, on CMOP, but I was wondering if you could maybe give us an update as of today on the three big contracts, CMOP, the logistics at the VA and the Head Start that are all either in the process of or potentially in the process of RFPing this year. Just where we kind of stand and anything else you could give us would be appreciated.

11:00 You bet. You bet. Be happy to. Thank you. And thank you for joining us again, Joe. Yeah, on the theme up front, you know, we kind of see it as no news is good news. We have continued to operate on extensions. Of course, these now, you know, all of these originated in November of 2016 for the heavily pharma one. And we have continued to receive, as recently as in the last month, SoSource Extensions for that work. You heard me state that for the foreseeable portion of this fiscal, I do not see any material impact. And that's largely just because of the acquisition cycle, right?

11:48 We're currently already into the second quarter. Typically, these contracts will require about a 90-day phase-in. So the likelihood of having any material impact upon this fiscal is relatively low. As you indicated, there are two of those CMOP ones. The second of the two is the one we refer to as the logistics CMOP work. That proposal, of course, also had been submitted, and every indication is that they will award these in series. And so, as such, that one will continue. We expect that one to continue to bridge for an even longer term into the next fiscal. For the Head Start, we compete.

12:39 Yep, you're spot on. That current contract will currently expire next quarter. It currently runs through May. And we are anticipating, we have not yet seen the release of an RFP. There's a decent likelihood that there may be a small bridge, but we have continued to start well early relative to the RFP and working our enhanced solutions offering, not taking things for granted, and certainly do not fall prey to incumbenitis. Helene and our team have continued to work that strategy and We're well prepared for the eventuality of that RFP, and we have a great deal of confidence in our prospects for renewing that work.

13:35 Thanks for that update. Just switching gears here on S3, last quarter you spoke about that you're looking at some pending awards and some task orders. But sequentially, you know, revenue for S3 declined. And I understand that sometimes you guys get those, for lack of a better term, one-off contracts on S3. But just wondering, you know, what's the status of some of those awards or task orders you're looking at? And if, you know, was that revenue decline, you know, really due just to the one-offs?

14:16 That's really the case. I mean, there were some special events in Q4 largely related to – materials used to support surveys, and those happen in a cycle, and so there was a bit of a surge from that in Q4. That's a one-time event.

14:35 Okay, great. And just, you know, if I'm looking at the numbers and margins, you know, you talked a little bit about the G&A. You know, gross profit margin kind of went down a little bit again, you know, sequentially, and wondering if Is that kind of a new normal, or is there something going on there, a mixed opportunity that you would see gross margins kind of rebounding in the rest of the year?

15:03 Yeah, I continue to think of our 12-month view of gross margin, if you will, to be at the upper end of our, you know, we had previously indicated an expectation of Thank you for joining us. Production-like and so less subject to the impact of holidays and time off around Thanksgiving and Christmas and all that. So it's normal in our first quarter that you'd see a little dip in direct labor just as people enjoy those holidays.

16:00 But from an overall expectation for the full year, I do expect us to be on the higher end of that range that we target and even slightly better than that.

16:10 Okay, great. And then one last one for me. Outside of the three big contracts, you know, is there much recompete risk this year with the rest of the business?

16:23 No, those are the three material ones that we see for this fiscal year. As you may recall, and we'll probably do a little, an update at the annual conference, at the annual meeting, but as you may recall, as we extended our backlog substantially, you know, post-acquisition, the overwhelming majority, we really had no individual contract that would represent materiality in terms of the next year or two, so... We feel real good about that aspect of our diversification in our broker business.

17:03 Great. Again, thanks for taking the questions. A great quarter.

17:07 Thank you very much.

17:08 Thank you, Bill. Again, if you have a question, please press star, then 1. The next question will come from Austin Moeller of Canaccord.

17:19 Hi, Zach. How are you guys?

17:21 We're well, my friend. How about yourself?

17:24 I'm doing just fine here. So the first question I have is for Zach. Just looking at the mix of revenues here, it looks like as part of the S3 acquisition that your public health and life sciences revenues have sort of doubled as a share. between this quarter and last. So I was just wondering about sort of what the bid pipeline looks like for S3 going forward and how you guys are sort of leveraging S3 as you go and make some of those bids.

18:04 Absolutely. Thank you for the question, Austin. And you're absolutely right. As you may recall, one of our key strategic objectives on our acquisitive side of growth was to balance our portfolio in those three market areas. And That's why we're particularly excited about S3 and what they did for us in the public health and life sciences arena. We continue to be real excited. We've had no disappointments in that regard in terms of how they've really bolstered our position here. And we'd like to anticipate an impact on the pipeline as well. It does help to reshape our pipeline and puts us in a stronger position in certain market areas where we were potentially going to have to lean more on subcontractors or other partners in the future, and we've accelerated that as well.

18:56 A couple of examples of that are one is we relatively recently were awarded an IDIQ that we expect a few people task orders this fiscal year and then more next year. And with the addition of some of the scientific research qualifications, clinical trials qualifications and the like, we were really a much better position for taking a lead role in some of those than we otherwise might have been. And then, as you may recall, we felt that there were one or two real key initiatives that really make that a one plus one equal three kind of opportunity for us with the addition of S3. You know, there are cases where adding a partner such as S3 would have been a subcontractor for us, and now it really makes a more robust offering for us to the client, and we're really excited about how it shapes that pipeline. Still a very competitive market.

19:56 We're seeing that the M&A world has changed the scale of some of our clients, And so, just to sort of ask about the whole coronavirus epidemic that's going on right now.

20:31 Given your guys' relationship with the CDC and now the NIH, of course, do you guys foresee contracts coming down to do research studies related to the coronavirus in the near term that you think could be accretive to revenues?

20:49 We do. We know that some of our customers in both of those areas, quite frankly, are looking at their roles and what they are doing, some things in-house right now. and talking with us and some of our peer companies with regard to potentially some new contracts in that arena. In some cases, our customers are still working in a somewhat competitive role with folks in the World Health Organization, so they're still trying to rationalize who's on first for a few of those things. Our recent IDIQ award happens to put us in a pretty good space with regard to the emergency response type of work such as this. We're really hopeful that we should see something in the not-too-distant future to support that.

21:43 Okay. That's good color there. And then my next question is for Kathryn. So just to sort of go back to the gross margin question, I mean, I understand that the operating margins were down just with the amortization associated with S3. But I'm just wondering, just given the mix shift towards public health, Does the 220 basis point decrease in gross margins year over year? Is that more of how we should think that will look during the quarter? That just has more to do with the vacations and just the seasonality of the quarter as you previously mentioned.

22:32 I do think that it's not unusual for Q1. Last year happened to be an exception just based again on the timing of some programmatic events, but It's not unusual for us that Q1 would be our lightest quarter gross margin-wise because of the fact that the volume in the lower end of our business, the CMOP work, tends to be constant throughout and indifferent to the fact that there are holidays and vacations. So that probably only means that we work on a weekend if there's a day during the week that we're closed. So that tends to be indifferent to The more differentiated contracts that generally command the higher margins, of course, are going to have some impact from the fact that people generally plan to have planned leads during that time. So you've got lower contribution from the higher margin direct labor from those contracts. So it's not unusual for us to have a little bit of softness in gross margins in Q1.

23:39 However, I again retain my expectation that for the year our gross margins will be more in that range of the higher end of our range, 20 to 22 percent. I think 22 is our new normal for a 12-month period. Notwithstanding that quarter to quarter, we're going to bump around a little bit. Does that help?

24:04 Yeah, I think that clears things up. So, yeah, that was everything I had. Thank you, guys.

24:10 Okay. Thank you for calling and joining us, Austin. Thank you, Austin.

24:14 Yeah. At this point, there appear to be no further questions in the queue, so I'll turn it over to Mr. Parker for any closing remarks.

24:24 Well, once again, thank you, everyone, for your interest and participation in the DLH evolution. I want to re-invite everyone to our annual meeting, which we recently released the information on. During that meeting, of course, we'll not have produced the subsequent quarter, but Kathryn and I look forward to providing added color around the current state of the business, some follow-up, a little greater detail regarding some potential synergies associated with integration. and then some additional information regarding what's happening on the market front with regard to our targeted agencies. So, again, thanks again for your attention and you all have a blessed day. Bye for now.

25:09 The conference is now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.