DLH Holdings Corp. (DLHC) Q3 2019 Earnings Report, Transcript and Summary

Good day everyone and welcome to the DLH Holdings Incorporated Fiscal Third Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please also note, today's event is being recorded. At this time, I'd like to turn the conference call over to Mr. Chris Witty, Investor Relations Advisor. Sir, please go ahead.

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 two of the presentation. This call may include forward-looking statements that relate to the company's outlook for fiscal 2019 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'll 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 the DLH 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 now like to turn the call over to Zach. Please go ahead, Zach.

Thank you, Chris and good morning everyone. Welcome to our fiscal 2019 third quarter conference call. Starting with slide three, let me begin by providing a high-level overview of our financial performance and some color on the outlook for fiscal 2019. Of course, the biggest news of the quarter was surely our acquisition of Social & Scientific Systems, which was completed on June 7th. We hosted a special conference call on July 2nd to discuss the -- this very consequential event for the company and I will review some highlights in a moment. Suffice it to say that our acquisition of SSS builds our platform, expands our customer base, strengthens our backlog, and solidifies our long-term growth trajectory. So, we're truly excited. Revenue for the third quarter was $38.7 million, up from $36.1 million last year, with the increase primarily due to contribution from SSS. Our standing business was down slightly year-over-year due to workload volume timing, as Kathryn will discuss a little bit later. The operating income was $1.1 million, impacted by the $1.2 million of transaction expense incurred in the period for the SSS acquisition. We posted net income of $0.13 per diluted share excluding the impact of closing cost and generated $4.4 million of operating cash during the period. We already used this cash to begin paying down the term debt that financed our SSS transaction, and we will continue working, once again, to delever the company's balance sheet going forward. Turning to slide four, let me briefly review some key aspects of the SSS transaction. We view our acquisition of Social & Scientific Systems as a game-changer for DLH as it brings both new and complementary skill sets to the company. Most notably is its mature and robust secure data analytics platform, as President, Kevin Beverly, had the vision to invest in the development of this industry-leading platform that is quickly becoming a major requirement for conducting work with federal agencies. This feature substantially accelerates our maturity and ability to compete as a prime contractor in our targeted growth areas. We will have more on that in the coming days. Also as a leader in public health and life sciences market, SSS boasts many of the same core capabilities as DLH, serving a complex, diverse set of programs with highly credentialed, nationally recognized staff. The company now operating as a single business unit within DLH will continue to be run by President, Kevin Beverly, overseeing some 400 highly qualified employees. The unit provides solutions in clinical and biomedical research, epidemiology, health policy, and program evaluation to several agencies and their operating divisions. Thus, as a standalone addition to our portfolio, this acquisition will drive a bright future for the company and will certainly enhance shareholder value in the long run. Strategically, the acquisition accomplishes three things for DLH from our current state. First, it improves of our portfolio balance and substantially increases our Public Health and Life Sciences capabilities. These complement our DoD and VA and Human Services and Solutions offerings. Second, it reduces the impact of our potential re-compete risk that we've continued to address associated with the VA's Kingdomware requirements. As we've discussed in the past, the Kingdomware ruling in 2016 has impacted certain of our contracts, such as our CMOP. While we continue to see no impact in fiscal 2019 due to this issue, we're continuing to work diligently to mitigate how it affects our base of business going forward, and there's really no new information to announce at this particular time. A key feature of the business is that it brings over $300 million of contract backlog. In particular, it does so in a way that no one contract represents over 10% of its revenue stream. This diversification is important and has remained important to our growth -- long-term strategy. The third thing that the transaction achieves for DLH is greater scale. As contracts continue to consolidate with -- as well as our industry and a growing focus on key, large IDIQ awards, higher value is placed on being able to provide broader and deeper capabilities. This acquisition strengthens our portfolio and our bandwidth, thus, improving our overall industry competitiveness and win probabilities. Slide five illustrates what SSS adds to DLH in terms of its programs and services. As such, you can see from this slide that the company brings, again, focus on clinical research, epidemiology, policy analysis, program management, data analytics, and health IT solutions. With over 40 years in business serving core customers, such as the National Institutes of Health, SSS is a recognized technology-enabled health research organization that is fundamentally grounded in research and the scientific method. It also collects, manages and analyzes large scale data in support of clinical public initiatives and decisions. It is an excellent fit for our health-focused organization and brings highly credentialed staff and new business development opportunities. And it clearly expands the third leg of our organization as I indicated with regard to Public Health and Life Sciences, as shown on slide six. In short, Kathryn and I have said over the period of the year that we have remained very selective with regard to M&A opportunities. We're both excited to have acquired such a strong, strategic and cultural fit where our values and our mission focus are so well aligned. With the acquisition complete, we've bolstered our presence in this new key segment, which now represents approximately 35% of our business going forward. As you may recall, prior to the acquisition, our presence here was relatively small, less than 5% of the company's distributed revenue. Now, annualized sales are anticipated being in a neighborhood of $70 million across a multitude of contracts, covering disease prevention, clinical trials, epidemiology studies, statistical data analysis, biological research and the like. And this is the perfect time to be increasing our market presence due to the numerous ongoing healthcare issues facing our nation. As discussed last quarter, the opioid epidemic and resurgence of measles will likely translate into expanded funding for NIH and CDC in the coming years. The recent budget submission by the Department of Health and Human Services demonstrates focus on several important initiatives that are key to our current business as well as our targeted agency growth. The expanded DLH enterprise brings expertise, resources, and unique technology applications to advance and address such prices going forward. In addition, this newly strengthened focus area complements the two other markets that we serve very well. We see the outlook for all of our target markets to be strong and growing. The recently passed Bipartisan Budget Act of 2019 bodes well for fiscal 2020 and beyond. Initial parameters include a 9% increase for the Veterans Administration, 5% growth at the Department of Defense and a 4.4% increase at Health and Human Services, with even higher growth at particular agencies that we are targeting. These include, Center for Disease Control, National Institutes of Health, SAMHSA, and ACF. The budget not only supports expansion across nearly every aspect of our core markets, it provides plenty of visibility into growth opportunities over the coming 18 months, and later, we'll address the pipeline aspects accordingly. As we look to leverage our capabilities and win new business, we'll also continue working to improve our customer approach, streamline administrative expenses and solidify our margins. The SSS secure data analytics platform will certainly bolster our go-to-market strategy across the board from defense healthcare programs, VA, Life Sciences, and other agencies as well. Slide seven summarizes the financial and strategic benefits of the acquisition, starting with the highly visible revenue stream that I've already discussed as well as a total backlog now of roughly $345 million. Since the SSS business is primarily tied to research and data analytics, the contract durations tend to be a little larger in certain areas where we have longitudinal studies that generally run for 10-year periods. These provide greater visibility and stability for our book of business. We expect to generate solid free cash flow, enabling both our debt service and additional prepayments, as Kathryn will review in a minute, and we, once again, delever the company. Our free cash flow is supported by the tax deductible purchase price as well as our the prior DLH tax shield and capital requirements at DLH, which remain minimal, such as the strength of our business model, which leverages a large existing customer base and growing professional capabilities to bolster our long-term financial outlook. We're confident that our revenue growth will continue to be driven by a solid execution against recurring customer requirements, cross-selling opportunities, and an unsaturated client market base -- addressable market base. Before turning the call to Kathryn, let me just add that the integration of SSS is well underway. A great team led by our existing leadership team, including Kevin Beverly, is already in place. We've reactivated certain integration process controls that were based upon our successful 2016 experience and we're identifying appropriate synergies. In the months to come, we'll complete the ERP integration, our IT standardization and asset rationalization as necessary. The bottom-line is that we have a great deal of germane experience from successfully integrating our acquisition of Danya. And we'll take a disciplined approach to maximize our capabilities and eliminate redundancies where possible. This process is designed to keep us agile and make us even more customer-centric, safeguarding our margins. We'll continue to leverage our value-added technology applications within the healthcare space to go after more complex, larger opportunities in data analytics, and health IT. We're increasing our budget commitment to new business development and have strengthened the company fitting into the fiscal 2019. With that, I'd like to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?

Thank you, Zach and good morning everyone. We're pleased to report another quarter of solid financial results. Turning to slide eight. We posted revenue for the three months ended June 30th, 2019, of $38.7 million versus $31.6 million in the prior year's third quarter. The revenue variance year-over-year reflects the impact of our acquisition of SSS, completed on June 7th, slightly offset by lower revenue within our legacy operations, impacted by workload timing on key contracts. As discussed during our transaction-related conference call on June -- on July 2nd, we anticipate that SSS will contribute approximately $65 million to topline results annually going forward. Now, moving to operating income on slide nine, this quarter, the company posted total operating income of approximately $1.7 million versus $2.6 million last year. Excluding the $1.2 million of acquisition-related transaction expenses in the current quarter, operating income was $2.9 million compared to $2.6 million last year. As Zach mentioned, we will continue looking for further efficiencies as we integrate SSS into our operations. We reported net income of approximately $1.8 million -- sorry, $0.8 million or $0.06 per diluted share versus $1.6 million or $0.13 a share last year. As detailed in our earnings release filed last night, excluding the impact of the transaction expenses, diluted EPS for the quarter was $0.13 on a non-GAAP basis. Turning to slide 10, EBITDA for the three months ended June 30th, 2019 was $2.6 million versus $3.2 million in the prior year period. Of course, the current period EBITDA results also reflect the -- absorbing the $1.2 million of transaction expenses previously discussed. A reconciliation of GAAP net income to EBITDA is in our earnings statement and the back of this presentation. Slide 11 shows a summary of our balance sheet at the end of the quarter. We had approximately $6 million of cash on hand versus $6.4 million at the beginning of our fiscal year. To finance the acquisition of SSS, we entered into a new $70 million term loan, which was part of a $95 million credit facility. The balance was a $25 million revolving line of credit, which is available to us to support growth throughout the five-year term. Since our acquisition on June 7th, we've made $6.5 million of voluntary prepayments on the term loan, $3.9 million on June 30th, and more recently, $2.6 million on July 31st, such that we have now satisfied all term payment obligations through fiscal 2019 and fiscal 2020. We were able to fund the debt payments through $4.4 million of cash from operations during the third quarter, and obviously, ongoing cash from operations in the current quarter. We plan to continue utilizing cash to, once again, delever the company and strengthen our balance sheet, while integrating our latest acquisition. This concludes my discussion of the financial statements. With that, I would now like to turn the call back over to our operator to open the call for questions.

Ladies and gentlemen, we'll now begin the question-and-answer session. [Operator Instructions] And our first question today comes from Joe Gomes from NOBLE Capital. Please go ahead with your question.

Good morning.

Good morning Joe.

Just on the cash generation in the quarter. You had $4.4 million that was down a little bit from the second quarter. Just wondering if you can, kind of, reconcile what was occurring there that there was less cash generated in the quarter.

Really, just a function of timing -- of items that actually moved from Q1 into Q2 and made Q2 appear a bit stronger. $4.4 million for our third quarter represents well against $11.2 million for the year as a whole.

Okay. And you talked about -- in the press release, you called out gross margins that they strengthened and they went, obviously, 25.6% in the most recent quarter from 23.1% the previous year. How much of that was due, if any, to SSS versus the base business?

It really is a function of contributions from both sides of the business. As you know, the margins on the base business have continued to nudge up. And then the model from SSS is a bit -- because of the professional -- highly credentialed nature of the business, tends to a bit stronger than historical business. They had to be careful about over-focusing on gross margin, of course, since it's -- fundamentally, it's -- as we shared on our July 2nd call, this is largely cost-reimbursable business due to its research nature. So, in the net, we think it's pretty consistent in terms of its operating margin and EBITDA delivery to the standing book of business that we previously had. Does that help?

Okay. Yes, it does. Thank you. I just was trying to find on the base if the base was still showing some improvement on gross margin. It sounds like it is, which is great.

Yes.

Yes, it is, continues to do so. Yes. And we're -- as we look at integration going forward; please don't think of it just as an integration that ties only to SSS piece. We're looking, again, at the entire platform with -- as Kathryn and I have always said, we're looking at building for a $350 million entity with strategic directions around what you've been seeing here, and so we're going to be very mindful of that as we continue our evolution. We would also anticipate that a substantial portion of the addressable market that SSS enhances for us is in the T&M, time and materials and fixed-price environment as well. And we hope to have some benefits from that as well.

Okay. And one last one. In the 10-Q, you have a page in there, on the pro forma for the quarter would have been revenues of about $51 million and a little loss. Is that the representative at least for the next quarter as you continue to integrate the business? Is that -- are those good numbers going forward for that fourth quarter?

We do think so. We think that is pretty representative of the sustaining business. But for -- of course, you have to adjust for things like the transaction expenses.

Right.

And timing.

Okay, that's it from me for now. Thank you.

Great. Appreciate it Joe.

[Operator Instructions] Our next question comes from Austin Moldow from Canaccord. Please go ahead with your question.

Good morning guys. This is Austin on for Ken.

Good morning Austin. How are you?

Hi Austin. You guys are a little swamped today. So, thank you for taking time out with your big conference about to kick-off.

Thank you. Thank you. So, my first question is just, so given your expanding footprint in Life Sciences after the SSS acquisition, does the visibility of the Bipartisan Budget Act, which you guys have highlighted on -- for the key agencies that are your customers, has mid-single-digit, high single-digit growth over the next two years. Does -- just the volume of contracts in the backlog, does that make the sort of the lumpiness of the contract opportunities of those short-term research studies more smooth than traditionally just because you have a higher volume of those contracts?

Sure. Thank you for your question, again, Austin. And we do think that the act is a positive. We generally -- for the market, we'll look at these acts and these budget submissions from either a negative, neutral or positive, and we do think it is a positive for us. But it is not necessarily a positive due to the lumpiness. And in fact, we think it may fund some new starts there, some programs that are emerging challenges that we're facing that Congress wants to be able to address and we may find opportunities within NIH and CDC to be able to address those. Often, some of those emerging disease issues will result in six months scientific study or even a two-year scientific study, but they're usually relatively turnkey. So, we do expect to have a visibility into number of those and may still have some -- we would prefer to not have to compete for those and have the customer be able to find ways of leveraging our current book of contracts and IDIQs to do so. So, we think it'd be a net positive for us, but not one that would eliminate some of the nature of the way in which they contract those.

Okay. And then my second question is just, last quarter, I asked you guys just about what the general progress is of implementing SSS' data analytics platform across your other business units. And so I was just wondering, sort of, just a progress report of what the updates are on that? And what kind of synergies may have even been realized so far?

You already sound like my straight man now. As you know, we think that was an under-advertised, understated real value out of the platform that's been built by Kevin and his leadership team over the years. I can tell you that we are -- we have had two sessions already where we've brought the entire enterprise together of our leadership and our growth-oriented folks from -- on business development. And we're starting to look at that in a very, very disciplined and deep way. I should also add that as we talked about during the diligence phase, we did have some external partners do some due diligence for us and looking at what that pro forma pipeline might be. We've prequalified some 14 opportunities over the course of the next six to 24 months in the recent week and are starting to apply force on target how we can -- to see where we can leverage that secure data analytics platform. With regard to integration, though, we are pretty convinced that it is fully capable of taking on the heritage business near-term. So, we're not looking at making much change there. And if we haven't stated before, Kevin Beverly is going to talk a little bit more at your conference on this. We're in the stages of getting certifications, independent certifications from the government done over the course of this -- the rest of this calendar year. So, we're going to be very careful to make sure that we focus on passing each of those certifications as we look to leverage it as a tool across the enterprise. So, stay tuned on that, but we're really excited that there's a good strong upside there.

Okay, great. Yes, I'm definitely looking forward to it. I look forward to seeing you guys at the conference.

You bet. We -- Kathryn and I both see your position in Boston as we speak.

Fantastic. Thank you.

And ladies and gentlemen, at this point, there are no further questions in the queue. I'd like to turn the conference call back over to Mr. Parker for any closing remarks.

I just want to, again, say thank you to all of you who've continued to follow and track and support DLH. We look forward to communicating to you further. We will be adding additional color around the opportunity and the acquisition this week at Canaccord Growth Conference this week. But also stay tuned for other communications from press releases for additional capabilities and expansion of our business. With that, we thank you, again, and look forward to communicating to you. Have a great and blessed rest of the day. Bye for now.

And ladies and gentlemen, that does conclude today's conference call. We thank you for joining today's presentation. You may now disconnect your lines.