DLH HOLDINGS CORP. Forward Looking and Cautionary Statements
You should read the following discussion in conjunction with the Consolidated Financial Statements and the notes to those statements included elsewhere in this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for the year endedSeptember 30, 2019 , and in other reports we have subsequently filed with theSEC . This Quarterly Report on Form 10-Q contains certain statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Certain statements contained in this Management's Discussion and Analysis are forward-looking statements that involve risks and uncertainties. Any statements that refer to expectations, projections or other characterizations of future events or circumstances or that are not statements of historical fact (including without limitation statements to the effect that the Company or its management "believes", "expects", "anticipates", "plans", "intends" and similar expressions) should be considered forward looking statements that involve risks and uncertainties which could cause actual events or DLH's actual results to differ materially from those indicated by the forward-looking statements. Forward-looking statements in this report include, among others, statements regarding benefits of the acquisition, estimates of future revenues, operating income, earnings, earnings per share, backlog, and cash flows. These statements reflect our belief and assumptions as to future events that may not prove to be accurate. Our actual results may differ materially from such forward-looking statements made in this report due to a variety of factors, including: the outbreak of the novel coronavirus ("COVID-19"), including the measures to reduce its spread, and its impact on the economy and demand for our services, are uncertain, cannot be predicted, and may precipitate or exacerbate other risks and uncertainties; the risk that we will not realize the anticipated benefits of an acquisition; the challenges of managing larger and more widespread operations resulting from the acquisition; contract awards in connection with re-competes for present business and/or competition for new business; compliance with new bank financial and other covenants; changes in client budgetary priorities; government contract procurement (such as bid protest, small business set asides, loss of work due to organizational conflicts of interest, etc.) and termination risks; the ability to successfully integrate the operations of future acquisitions; and other risks described in ourSEC filings. For a discussion of such risks and uncertainties which could cause actual results to differ from those contained in the forward-looking statements, see "Risk Factors" in the Company's periodic reports filed with theSEC , including our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2019 , as well as interim quarterly filings thereafter. The forward-looking statements contained herein are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry and business. Such forward-looking statements are made as of the date hereof and may become outdated over time. The Company does not assume any responsibility for updating forward-looking statements. 20 --------------------------------------------------------------------------------
Business and Markets Overview
We are a provider of technology-enabled business process outsourcing and program management solutions, primarily to improve and better deploy large-scale federal health and human service initiatives. DLH derives essentially all of its revenue from agencies of the Federal government, providing services to several agencies including theDepartment of Veteran Affairs ("VA"),Department of Health and Human Services ("HHS"), and theDepartment of Defense ("DoD"). Our business offerings are aligned to three market focus areas within the federal health services market space. •Defense and Veteran Health Solutions; •Human Services and Solutions; •Public Health and Life Sciences;
The following table summarizes the revenues by market for the nine months ended
(in thousands)
Nine Months Ended
June 30,
2020 2019
Revenue Percent of total Revenue Percent of total
revenue revenue
Defense/VA $ 75,353 48 % $ 70,026 66 %
Human Services and Solutions 31,563 20 % 29,421 28 %
Public Health/Life Sciences 51,579 32 % 6,761 6 %
Total revenue $ 158,495 100 % $ 106,208 100 %
Distribution of Services and Solutions in Our Markets
We operate primarily through prime contracts awarded by the government through competitive bidding processes. We have a diverse mix of contract vehicles with various agencies of the United States Government, which supports our overall corporate growth strategy. Our revenue is distributed to time and materials contracts (70%), cost reimbursable contracts (28%) and firm fixed price contracts (2%). We provide services under IDIQ and government wide acquisition contracts, such asGeneral Services Administration ("GSA") schedule contracts. We currently hold multiple GSA schedule contracts, under which we provide services that constitute a significant percentage of our total revenue. These Federal contract schedules are renewed on a recurring basis for a multi-year period.
Major Customers
Our two largest customers are HHS and theVA . The following table summarizes the revenues by customer for the nine months endedJune 30, 2020 and 2019, respectively: (in thousands) Nine Months Ended June 30, 2020 2019 Revenue Percent of total Revenue Percent of total revenue revenue Department of Veterans Affairs$ 74,402 47 %$ 68,563 65 % Department of Health and Human Services 73,263 46 % 34,987 33 % Customers with less than 10% share of total revenue 10,830 7 % 2,658 2 % Total revenue$ 158,495 100 %$ 106,208 100 % Major Contracts The revenue attributable to theVA was derived from 16 separate contracts covering the Company's performance of pharmacy and logistics services in support of theVA's consolidated mail outpatient pharmacy program. Nine contracts for pharmacy 21 --------------------------------------------------------------------------------
services, which represent revenues of approximately
As previously reported, a single renewal request for proposal ("RFP") had been
issued for the nine (9) pharmacy contracts that required the prime contractor be
a service-disabled veteran owned small business ("SDVOSB"), which would have
precluded us from bidding on the RFP as a prime contractor. We had joined a
SDVOSB team as a subcontractor to respond to this RFP. However, the government
has canceled the previously issued RFP for these contracts. The government has
neither indicated nor announced its future procurement strategy. Due to the time
required to conduct a procurement process, we expect these contracts to be
further extended.
The remaining seven contracts for logistics services, which represent
approximately $32.6 million and $29.0 million of revenues for the nine months
ended June 30, 2020 and 2019, have been extended through June 2021 . A renewal
RFP for the seven logistics contracts has been issued and provides for
evaluation and award of the contract based on the classification of the bidder,
with preference given to a SDVOSB prime contractor. The Company has joined a
SDVOSB team to respond to this RFP. We believe that these contracts will be
extended during the procurement process. The government has not provided any
updated guidance with respect to this procurement.
The Company's contract with HHS in support of its Head Start program generated
$26.8 million and $28.6 million of its revenue for the nine months ended
June 30, 2020 and 2019, respectively. This contract was awarded on a time and
materials basis and provided for a base period and four option periods for a
total term of five years through April 2020 . We have received a fully funded
contract extension through August 2020 . The customer issued an RFP during the
quarter. The Company submitted a proposal to the RFP. It is expected that the
government will announce an award determination during the next fiscal quarter.
We remain dependent upon the continuation of our relationships with the VA and
HHS. Our results of operations, cash flows, and financial condition would be
materially adversely affected if we were unable to continue our relationship
with either of these customers, if we were to lose any of our material current
contracts, or if the amount of services we provide to them was to be materially
reduced.
Backlog
Backlog represents total estimated contract value of predominantly multi-year
government contracts and will vary depending upon the timing of new/renewal
contract awards. Backlog is based upon customer commitments that the Company
believes to be firm over the remaining performance period of our contracts. The
value of multi-client, competitive Indefinite Delivery/Indefinite Quantity
("IDIQ") contract awards is included in backlog computation only when a task
order is awarded or if the contract is a single award IDIQ contract. While no
assurances can be given that existing contracts will result in earned revenue in
any future period, or at all, the Company's major customers have historically
exercised their contractual renewal options. At June 30, 2020 , our total backlog
was approximately $384.7 million compared to $414.1 million as of September 30,
2019 .
Backlog value is quantified from management's judgment and assumptions about the
volume of services based on past volume trends and current planning developed
with customers. Our backlog may consist of both funded and unfunded amounts
under existing contracts including option periods. At June 30, 2020 , our funded
backlog was approximately $95.5 million , and our unfunded backlog was $289.2
million .
Forward Looking Business Trends
COVID-19 Impact
We are exposed to and impacted by macroeconomic factors andU.S. government policies. Current general economic conditions are highly volatile due to the COVID-19 pandemic, resulting in both market size contractions due to economic slowdowns and government restrictions on movement. We have seen continued demand for the services we provide under our current contract portfolio as the services we provide are largely deemed essential. While the pandemic has had minor offsetting impacts due to social distancing and travel restrictions, we do not expect material impacts from COVID-19 in this fiscal year. The pandemic may cause reduced demand for certain services we provide, particularly if it results in a recessionary economic environment or the spending priorities of theU.S. government shift in ways adverse to our business focus. Our ability to continue to operate without any significant negative impacts will in part depend on our continued ability to protect our employees. We have endeavored to follow recommended actions of government and health authorities to protect our employees 22 -------------------------------------------------------------------------------- and were able to broadly maintain our operations. Further, we have partnered with our clients to adopt particular measures to protect our employees at distribution centers, and we expect to execute on a remainder of our contracts through remote and teleworking arrangements. We intend to continue to work with government authorities and implement our employee safety measures to ensure that we are able to continue our operations during the pandemic. However, uncertainty resulting from the pandemic could result in an unforeseen disruption to our operations (for example a closure of a key distribution facility) that may not be fully mitigated. Due to our ability to continue to perform under our contracts and our cash flow generation, we do not presently expect liquidity constraints related to COVID-19. We are presently in compliance with all covenants in our term loan and have access to a revolving line of credit to meet any short-term cash needs that cannot be funded by operations. Due to our reduction in term loan principal, we do not have a scheduled amortization payment untilSeptember 2023 . As such, mandatory demands on our cash flow remain low. Further, we have not observed any material impairments of our assets or a significant change in the fair value of our assets due to the COVID-19 pandemic.
For additional information on risk factors that could impact our results, please refer to "Risk Factors" in Part II, Item 1A of this Form 10-Q.
Federal budget outlook for 2021:
TheVA is requesting a total budget of$243.3 billion , an increase in fiscal 2021 of 10.2% above the fiscal 2020 budget. The budget increase focuses on several key veteran health initiatives to include telehealth and mental health. For these initiatives theVA has requested budgets of$1.3 and$10.3 billion , respectively. These requests represent an approximately 27% and 7% increase from fiscal 2020. We believe our capabilities and service delivery models are aligned with our customers growth initiatives
Over the past two government fiscal years, spending on health care initiatives has increased and is expected to increase in fiscal 2021 to$1.4 trillion . HHS is the principal federal department charged with protecting the health of all Americans and providing essential human services.
The
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Results of Operations for the three months ended
The following table summarizes, for the periods indicated, consolidated statements of income data expressed in dollars in thousands except for per share amounts, and as a percentage of revenue:
Three Months Ended
June 30, 2020 June 30, 2019 Change
Revenue $ 51,459 100.0 % $ 38,700 100.0 % $ 12,759
Cost of operations:
Contract costs 39,615 77.0 % 30,038 77.6 % 9,577
General and administrative costs 6,323 12.3 % 4,811 12.4 % 1,512
Acquisition costs - - % 1,247 3.2 % (1,247)
Depreciation and amortization 1,721 3.3 % 914 2.4 % 807
Total operating costs 47,659 92.6 % 37,010 95.6 % 10,649
Income from operations 3,800 7.4 % 1,690 4.4 % 2,110
Interest expense, net 813 1.6 % 562 1.5 % 251
Income before income taxes 2,987 5.8 % 1,128 2.9 % 1,859
Income tax expense 863 1.7 % 325 0.8 % 538
Net income $ 2,124 4.1 % $ 803 2.1 % 1,321
Net income per share - basic $ 0.17 $ 0.07 $ 0.10
Net income per share - diluted $ 0.16 $ 0.06 $ 0.10
Revenue
Revenue for the three months ended June 30, 2020 was $51.5 million , an increase
of $12.8 million or 33.0% over the prior year period. The increase in revenue is
due primarily to the inclusion of Social & Scientific Systems, Inc. ("S3") for
the full quarter in the current year.
Cost of Operations
Contract costs primarily include the costs associated with providing services to our customers. These costs are generally comprised of direct labor and associated fringe benefit costs, subcontract cost, other direct costs, and the related management and infrastructure costs. For the three months endedJune 30, 2020 , contract costs increased by approximately$9.6 million , principally due to the addition of S3. General and administrative costs are for those employees not directly providing services to our customers, to include but not limited to executive management, bid and proposal, accounting, and human resources. These costs increased as compared to the prior fiscal year period by$1.5 million primarily from the inclusion of S3 and increased business development costs, offset by increased operational leverage. For the three months endedJune 30, 2020 , depreciation and amortization costs were approximately$0.5 million and$1.2 million , respectively, as compared to approximately$0.3 million and$0.6 million for the prior fiscal year period. The increase of$0.8 million was principally due to the amortization of the acquired definite-lived intangible assets of S3.
Interest Expense, net
Interest expense, net, includes items such as, interest expense and amortization of deferred financing costs on debt obligations. For the three months endedJune 30, 2020 and 2019, interest expense was approximately$0.8 million and$0.6 million , respectively. The increase in interest expense was due to the borrowing required to finance the acquisition of S3. Income Tax Expense For the three months endedJune 30, 2020 and 2019, DLH recorded a$0.9 million and$0.3 million provision for tax expense, respectively. The effective tax rate for the three months endedJune 30, 2020 and 2019 was 29%. 24 --------------------------------------------------------------------------------
Results of Operations for the nine months ended
The following table summarizes, for the periods indicated, consolidated statements of income data expressed in dollars in thousands except for per share amounts, and as a percentage of revenue:
Nine Months Ended Change
Consolidated Statement of Income: June 30, 2020 June 30, 2019 $
Revenue $ 158,495 100.0 % $ 106,208 100.0 % $ 52,287
Cost of Operations:
Contract Costs 123,895 78.2 % 82,744 77.9 % 41,151
General and administrative expenses 18,497 11.7 % 13,462 12.7 % 5,035
Acquisition costs - - % 1,391 1.3 % (1,391)
Depreciation and amortization 5,340 3.4 % 2,037 1.9 % 3,303
Total operating costs 147,732 93.2 % 99,634 93.8 %
48,098
Income from operations 10,763 6.8 % 6,574 6.2 % 4,189 Interest 2,659 1.7 % 1,284 1.2 % 1,375 Income before income taxes 8,104 5.1 % 5,290 5.0 %
2,814
Income tax expense, net 2,352 1.5 % 1,532 1.4 % 820 Net income$ 5,752 3.6 %$ 3,758 3.5 %$ 1,994 Net income per share - basic$ 0.47 $ 0.31 $ 0.16 Net income per share - diluted$ 0.44 $ 0.29 $ 0.15 Revenue Revenue for the nine months endedJune 30, 2020 was$158.5 million , an increase of$52.3 million or 49.2% over the prior year period. The increase in revenue is due primarily to the inclusion of revenue from S3 for the full year, as well as increased volume in legacy contracts.
Cost of Operations
Contract costs primarily include the costs associated with providing services to our customers. These costs are generally comprised of direct labor and associated fringe benefit costs, subcontract cost, other direct costs, and the related management and infrastructure costs. For the nine months endedJune 30, 2020 , contract costs increased by approximately$41.2 million principally due to the addition of S3. General and administrative costs are for those employees not directly providing services to our customers, to include but not limited to executive management, bid and proposal, accounting, and human resources. These costs increased as compared to the same period in the prior fiscal year by$5.0 million primarily from the inclusion of S3. As a percent of revenue, general and administrative costs decreased due to improved operating leverage derived from an expanded business base. For the nine months endedJune 30, 2020 , depreciation and amortization costs were approximately$1.7 million and$3.6 million , respectively, as compared to approximately$0.5 million and$1.5 million for the prior fiscal year period. The increase of$3.3 million was principally due to the amortization of the acquired definite-lived intangible assets of S3.
Interest Expense, net
Interest expense, net, includes interest expense on the Company's term loan and amortization of deferred financing costs on debt obligations. For the nine months endedJune 30, 2020 and 2019, interest expense, net was approximately$2.7 million and$1.3 million , respectively. The increase in interest expense was due to the borrowing required to finance the acquisition of S3. 25 --------------------------------------------------------------------------------
Income Tax Expense
For the nine months endedJune 30, 2020 and 2019, DLH recorded a$2.4 million and$1.5 million provision for tax expense, respectively. The effective tax rate for the nine months endedJune 30, 2020 and 2019 was 29%.
Non-GAAP Financial Measures
The Company uses EBITDA as a supplemental non-GAAP measure of our performance.
DLH defines EBITDA as net income excluding (i) interest expense, (ii) provision
for or benefit from income taxes, if any, and (iii) depreciation and
amortization.
On a non-GAAP basis, Earnings Before Interest, Tax, Depreciation, and
Amortization ("EBITDA") for the three and nine months ended June 30, 2020 was
approximately $5.5 million and $16.1 million , respectively. The increase of
approximately $2.9 million and $7.5 million from the same periods in the prior
fiscal year was principally due to the contribution of S3, improved operating
leverage achieved through the expansion of the Company's business base, and
volume growth in legacy contracts.
Reconciliation of GAAP net income to EBITDA, a non-GAAP measure:
Three Months Ended Nine Months Ended
June 30, June 30,
2020 2019 2020 2019
Net income $ 2,124 $ 803 $ 5,752 $ 3,758
(i) Interest expense, net 813 562 2,659 1,284
(ii) Provision for taxes 863 325 2,352 1,532
(iii) Depreciation and amortization 1,721 914 5,340 2,037
EBITDA $ 5,521 $ 2,604 $ 16,103 $ 8,611
In fiscal 2019, the Company incurred $1.4 million of acquisition-related
expenses during the nine months ended June 30, 2019 for the acquisition of S3.
The Company is excluding acquisition-related expenses from this measure because
they were incurred as a result of a specific event, do not reflect the costs of
our operations, and can affect the period-over-period assessment of operating
results. In addition, we are including net income adjusted for the acquisition
of S3, in total and on a per share basis, presented on a tax-effected basis. We
are reporting this non-GAAP metric to demonstrate the impact of these events.
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--------------------------------------------------------------------------------Reconciliation of GAAP net income to net income adjusted for the effect of the acquisition costs, a non-GAAP measure:
Three Months Ended Nine Months Ended
June 30, June 30,
2020 2019 Change 2020 2019 Change
Net income $ 2,124 $ 803 $ 1,321 $ 5,752 $ 3,758 $ 1,994
Acquisition costs - 1,247 (1,247) - 1,391 (1,391)
Tax effect of excluding
acquisition costs - (362) 362 - (403) 403
Net income adjusted for
acquisition costs $ 2,124 $ 1,688 $ 436 $ 5,752 $ 4,746 $ 1,006
Net income per diluted share $ 0.16 $ 0.06
- 0.07 (0.07) - 0.08 (0.08)
Net income per diluted share
adjusted for acquisition costs $ 0.16 $ 0.13 These non-GAAP measures of performance are used by management to conduct and evaluate its business during its review of operating results for the periods presented. Management and the Company's Board utilize these non-GAAP measures to make decisions about the use of the Company's resources, analyze performance between periods, develop internal projections and measure management performance. We believe that these non-GAAP measures are useful to investors in evaluating the Company's ongoing operating and financial results and understanding how such results compare with the Company's historical performance.
Liquidity and capital management
As ofJune 30, 2020 , the Company's immediate sources of liquidity include cash generated from operations, accounts receivable, and access to its secured revolving line of credit facility. This credit facility provides us with access of up to$25 million , subject to certain conditions including eligible accounts receivable. As ofJune 30, 2020 we have$19.3 million of available borrowing capacity on the revolving line of credit and no balance outstanding as of such date. The Company's present operating liabilities are largely predictable and consist of vendor and payroll related obligations. Our current investment and financing obligations are adequately covered by cash generated from profitable operations and planned operating cash flow should be sufficient to support the Company's operations for twelve months from issuance of these consolidated financial statements.
A summary of the change in cash and cash equivalents is presented below:
Nine Months Ended
June 30,
2020 2019
Net cash provided by operating activities $ 10,707 $ 11,153
Net cash used in investing activities (152) (66,549)
Net cash (used in) provided by financing activities (11,687) 55,046
Net change in cash and cash equivalents $ (1,132) $ (350) For the nine months ended
Cash used in investing activities during the nine months endedJune 30, 2020 was$0.2 million , mainly for the purchase of capital assets. In the same period during the prior fiscal year, we entered a credit facility, which included a$70 million term loan, to finance the S3 acquisition. Cash used in financing activities was$12 million during the nine months endedJune 30, 2020 . We made net repayments under our credit facility of$11.5 million during the nine months endedJune 30, 2020 . In the same period during the prior fiscal year, we executed the acquisition of S3 and entered a$70 million term loan. 27 --------------------------------------------------------------------------------
Credit Facility
A summary of our secured loan facility for the period ended
Arrangement Loan Balance Interest* Maturity Date
Secured term loan $70 million (a) $ 44.5 million LIBOR* + 3.5% June 7, 2024
Secured revolving line of credit
million ceiling (b) $ - million LIBOR* + 3.5% June 7, 2024
*LIBOR rate as of
(a) Represents the principal amounts payable on our secured term loan. The$70.0 million secured term loan is secured by liens on substantially all of the assets of the Company. The principal of the term loan is payable in quarterly installments with the remaining balance due onJune 7, 2024 . OnSeptember 30, 2019 , we executed a floating-to-fixed interest rate swap withFirst National Bank ("FNB") as counter party. The notional amount in the floating-to-fixed interest rate swap is$36 million that matures in 2024. The remaining outstanding balance of our term loan is subject to interest rate fluctuations. (b) The secured revolving line of credit has a ceiling of up to$25.0 million and a maturity date ofJune 7, 2024 . The Company has accessed funds from the revolving credit facility during the quarter, but had no balance outstanding atJune 30, 2020 . The Term Loan and Revolving Credit Facility are secured by liens on substantially all of the assets of the Company. The provisions of the Term Loan and Revolving Credit Facility are fully described in Note 8 of the consolidated financial statements.
Contractual Obligations as of
Payments Due by Period
Contractual obligations Next 12 2-3 4-5 More than 5
(Amounts in thousands) Total Months Years Years Years
Debt Obligations $ 44,500 $ - $ - $ 44,500 $ -
Facility Leases 31,313 3,100 6,415 6,329 15,469
Equipment operating leases 100 34 44 22 -
Total Obligations $ 75,913 $ 3,134 $ 6,459 $ 50,851 $ 15,469 Off-Balance Sheet Arrangements
The Company did not have any material off-balance sheet arrangements subsequent to, or upon the filing of our consolidated financial statements in our Annual Report as defined underSEC rules.
Effects of Inflation
Inflation and changing prices have not had a material effect on DLH's net revenues and results of operations, as DLH expects to be able to modify its prices and cost structure to respond to inflation and changing prices.
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--------------------------------------------------------------------------------Significant Accounting Policies and Use of Estimates
Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted inthe United States of America . Preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosure of contingent liabilities. These assumptions, estimates and judgments are based on historical experience and assumptions that are believed to be reasonable at the time. Actual results could differ from such estimates. Critical policies and practices are important to the portrayal of a company's financial condition and results of operations, and may require management's subjective judgments about the effects of matters that are uncertain. See the information under Note 4 "Significant Accounting Policies" in this Quarterly Report on Form 10Q or Note 7 of the consolidated financial statements in DLH's Annual Report on Form 10-K for the year endedSeptember 30, 2019 , as well as the discussion under the caption "Critical Accounting Policies and Estimates" therein for a discussion of our critical accounting policies and estimates. DLH senior management has reviewed these critical accounting policies and related disclosures and determined that there were no significant changes in our critical accounting policies, or the estimates associated with those policies in the three months endedJune 30, 2020 .
New Accounting Pronouncements
A discussion of recently issued accounting pronouncements is described in Note 3 in the Notes to Consolidated Financial Statements elsewhere in this Quarterly Report, and we incorporate such discussion by reference.
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