What changed in this filing

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Item 7. Management’s Discussion and Analysis

2021-12-06 compared with 2020-12-07 · 94 added, 81 removed, 237 unchanged (42% of the section changed)

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We derive 99% of our revenue from agencies of the Federal government, providing services to several agencies including the Department of Veteran Affairs ("VA"), Department of Health and Human Services ("HHS"), and the Department of Defense ("DoD").

On September 30, 2020, we acquired Irving Burton Associates, LLC (“IBA”) for the base purchase price of $32.0 million in cash.

We funded the purchase price and the costs and expenses of the acquisition through funds received under our amended and restated credit agreement, as described in greater detail below.

IBA provides research, systems development, and other technology-enabled solutions to the DHA, the Telemedicine & Advanced Technology Research Center of the US Army’s Medical Research and Development Command, and other agencies within the DoD.

IBA maintains a top-secret facility clearance, and its defense contracts provide for a range of health IT services including digital transformation, data analytics, cybersecurity, and artificial intelligence

In recent years we have successfully completed acquisitions to increase future organic growth, diversify our customer base, and to expand into adjacent markets.

On June 7, 2019 we acquired Social & Scientific Systems, Inc.

("S3") and on September 30, 2020, we acquired Irving Burton Associates, LLC ("IBA").

Our business offerings are aligned to three market focus areas within the federal health services market space.

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We believe these business development priorities will position the Company to expand within top national priority programs and funded areas.

Federal budget outlook for fiscal 2021:

The President of the United States' broad agenda calls for increased military and, in certain cases, domestic spending, with reduced spending on foreign programs.

Most relevant to the Company’s targeted markets, the President advocates the lifting of sequestration caps in the defense sector;

increasing infrastructure spending in the United States;

and tightening controls on immigration.

Recent significant contract award activity

As previously announced, we were recently awarded two short-term task orders under a FEMA contract to provide support for states seeking temporary medical staffing support and COVID-19 related community testing, vaccination and therapy.

The ceiling value of these awards is approximately $107 million over base periods of three months, which will be largely earned in DLH's first quarter of fiscal year 2022.

Further, our customer has exercised the first of three one month contract options on the medical staffing task order, which has additional value of approximately $35 million.

This option is expected to be earned in DLH's second quarter of fiscal year 2022.

Additional options may be exercised, and would be expected to impact the second quarter financial performance.

We expect that our operating margin on these FEMA task orders will be approximately 5% of revenue.

The FEMA contracts provide for advance payments for the substantial staffing resources that are required to be deployed;

therefore, we do not expect these contracts to consume operating cash flow.

Federal budget outlook for fiscal year 2022:

The President’s budget proposal for fiscal year 2022 outlines many initiatives that include focusing on rebuilding and investing in our country’s physical infrastructure;

expanding access to early childhood education;

improving the affordability of child care and healthcare;

and enacting broad tax reform.

The budget also details additional proposals to expand economic opportunity, tackle the climate crisis, ensure strong national defense, and invest in public health infrastructure.

Specifically, the investment in public health infrastructure involves improving the nation’s readiness for future public health crises, expanding access to healthcare, and defeating diseases and epidemics such as, but not limited to, the opioid and HIV/AIDs epidemics.

We continue to carefully follow federal budget, legislative and contracting trends and activities and evolve our strategies to take these into consideration.

In July 2019, White House and Congressional budget negotiators reached an agreement on a two-year budget deal that would increase current spending caps by $320 billion and suspends the debt ceiling through mid-2021.

The budget allocates additional spending to defense and non-defense programs.

In late July 2019, Congress passed the Bipartisan Budget Act of 2019, which increased the caps for defense and non-defense spending for fiscal 2020 and 2021, established discretionary spending caps for fiscal 2020 and 2021, and suspended the national debt limit through July 2021.

On August 2, 2019, the President signed the measure into law.

Subsequently, in December 2019, Congress passed two appropriations bills totaling $1.4 trillion for the 2020 fiscal year;

on December 20, 2019, both bills were signed into law.

While Congress has not completed the final appropriation bills for the government’s 2022 fiscal year, the Company continues to believe that its key programs benefit from bipartisan support and does not expect a material impact on its current business base from budget negotiations.

If the appropriations bills are not timely enacted, government agencies operate under a continuing resolution ("CR"), which may negatively impact our business due to delays in new program starts, delays in contract award decisions, and other factors.

While we view the budget environment as stable under BBA 2019 and believe there is bipartisan support for continued investment in the areas of defense and national security, the government is currently operating under a CR which expires December 11, 2020.

On December 2, 2021, Congress passed and, on December 3, 2021, the President signed, a CR providing funds to the federal government through February 18, 2022.

When a CR expires, unless appropriations bills have been passed by Congress and signed by the President, or a new CR is passed and signed into law, the government must cease operations, or shutdown, except in certain emergency situations or when the law authorizes continued activity.

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Our customer's missions have received broad support from the legislative and executive branches of the federal government.

We expect that support to continue with the change of administration with amended and new priorities established by the President-Elect.

As such, we do not anticipate or expect any significant changes to our operations as a result of the recent elections.

As such, we do not anticipate or expect any significant changes to our operations.

Department of Veterans Affairs ("VA") health spending trends:

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Serving over nine million veterans each year, the VA operates the nation's largest integrated health care system, with more than 1,700 hospitals, clinics, community living centers, readjustment counseling centers, and other facilities.

The VA is requesting a budget increase in fiscal 2021 of 10.2% above the fiscal 2020 budget, an increase of $22.5 billion.

The budget increase focuses on several key veteran health issues to include several mental health initiatives.

We believe the fiscal 2021 budget request supports our identified growth opportunities.

The VA 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 the VA has requested budgets of $1.3 and $10.3 billion, respectively.

These requests represent an approximately 27% and 7% increase from fiscal 2020.

The VA is requesting a total of $269.9 billion for fiscal year 2022, a 10% increase above fiscal year 2021 enacted levels.

It includes $117.2 billion in discretionary funding, an increase of $9.7 billion, and $152.7 billion in mandatory funding, an increase of $14.9 billion from fiscal year 2021.

The VA research program is expected to allocate increased funding to advance the Department’s understanding of the impact of traumatic brain injury and toxic exposure(s) on long-term health outcomes, coronavirus related research and impacts, and precision oncology.

The budget also includes $2.6 billion (from all funding sources) for the total telehealth program.

The VA is continuing to expand this program because of its ability to leverage VA providers and to provide better services to veterans.

We believe our capabilities and service delivery models are aligned with our customers growth initiatives.

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HHS is the principal federal department charged with protecting the health of all Americans and providing essential human services.

Over the past two government fiscal years, spending on health care initiatives has increased and is increasing in fiscal 2020 to $1.3 trillion.

The budget will provide resources for efforts aimed to increase affordability of individual health insurance, decrease the price of prescription drugs, and combat the opioid crisis.

The Company has existing contracts with multiple agencies under HHS, and we are actively pursuing growth opportunities within this vital agency.

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 National Institutes of Health ("NIH"), a part of HHS, is asking for approximately $8.8 billion to fund new COVID-19 projects.

These projects will focus not only on vaccines and other treatments, but will also evaluate the societal impacts of the disease.

The fiscal year 2022 budget request proposes $131.8 billion in discretionary budget authority for HHS, an increase of $25 billion from the fiscal year 2021 appropriated amount, and $1.5 trillion in mandatory funding.

The budget includes $52 billion for the National Institutes of Health ("NIH"), an agency of HHS, an increase of $9 billion above fiscal year 2021 enacted, reflecting the Administration’s commitment to increasing investments in transformative biomedical research to advance the health of the nation and promote innovation.

The budget requests $37 million for Telehealth which is $3 million above fiscal year 2021 enacted, to promote health services and distance learning with telehealth technologies.

The budget also invests in programs that improve the health and well-being of young children and their families.

This includes $11.9 billion for the Office of Head Start.

We believe our capabilities and past performance are well aligned with the service sought under this budget increase.

Department of Defense ("DoD") health spending trends:

The Military Health System ("MHS") is one of the largest health care systems and a preeminent military medical enterprise, serving over 9 million beneficiaries.

As a part of the DoD, the Defense Health Agency manages a global health care network of military and civilian medical professionals, more than 400 military hospitals and clinics around the world, and supports the delivery of health services to MHS beneficiaries.

The funding and personnel to support the MHS’s mission is referred to as the Unified Medical Budget ("UMB").

The fiscal year 2022 UMB request for the Defense Health Program is $35.6 billion, an increase of $1.5 billion from the fiscal year 2021 appropriated amount.

Industry consolidation among federal government contractors:

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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 during fiscal 2020 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 the U.S.

While the pandemic has had minor offsetting impacts during fiscal 2021 due to social distancing and travel restrictions, we do not expect material adverse impacts from COVID-19 in the next fiscal year.

While we have been awarded contracts related to responding to the pandemic, such as awards to provide emergency medical services and community testing, vaccination and therapy services, 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 the U.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

and were able to broadly maintain our operations.

We have endeavored to follow recommended actions of government and health authorities to protect our employees and were able to broadly maintain our operations.

Additionally, we are complying with industry specific government directions that affect government contractors.

As such, we have mandated that all employees receive an approved COVID-19 vaccination or apply for and receive an approved vaccine exception.

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.

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The longer the duration of the pandemic, the more likely it is that it could have an adverse effect on our business, financial position, results of operations and/or cash flows.

However, we also believe that we are likely to see additional demand from federal agencies such as the CDC and the NIH for our services.

However, we also believe that we are likely to see additional demand from federal agencies such as the FEMA, CDC and the NIH for our services.

Due to our ability to continue to perform under our contracts and our cash flow generation, we do not presently expect material 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 .

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.

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General and administrative costs 25,054 10.2 % 24,195 11.6 % 859 (1.4) %

Acquisition costs 930 0.5 % 1,391 0.9 % (461) (0.4) %

Corporate development costs 1,088 0.4 % 930 0.5 % 158 (0.1) %

Depreciation and amortization 8,115 3.3 % 7,003 3.3 % 1,112 — %

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Net income per share - diluted $ 0.75 $ 0.54 $ 0.20

For the twelve months ended September 30, 2020 revenue was $209.2 million, an increase of $48.8 million or 30.4% over the prior year period.

The increase is primarily due to the inclusion of Social & Scientific Systems, Inc.

("S3"), acquired in June 2019, for the full year in fiscal 2020.

For the year ended September 30, 2021 revenue was $246.1 million, an increase of $36.9 million or 17.6% over the prior year period.

The increase is partially due to the inclusion of Irving Burton Associates, LLC.

("IBA"), acquired in September 2020, for the full year in fiscal year 2021.

IBA contributed $30.2 of revenue for fiscal year 2021.

The remaining net growth was due to contract expansion on existing contracts and new contracts awarded during the fiscal year.

Cost of Operations

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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 twelve months ended September 30, 2020, contract costs increased by approximately $39.0 million principally due to the growth in revenues.

General and administrative costs are for those employees not directly providing services to our customers, to include but not limited to executive management, bid & proposal, accounting, and human resources.

For the year ended September 30, 2021, contract costs increased by approximately $31.0 million consistent with the growth in revenues.

The increase in contract costs was due to the IBA acquisition, growth on existing contracts, and new contracts awarded during the fiscal year.

General and administrative costs are for those employees not directly providing services to our customers, including but not limited to executive management, bid and proposal, accounting, and human resources.

These costs increased as compared to the prior fiscal year by $0.9 million to approximately $25.1 million primarily from the growth in revenues.

Acquisition costs in 2020 were due to the IBA acquisition and include due diligence costs, such as legal and accounting fees.

As a percent of revenue, general and administrative costs decreased as we were able to increase operating leverage due to the acquisition and integration of IBA into the corporate structure.

Corporate development costs are incremental due diligence costs, such as legal and accounting fees.

Fiscal year 2021 costs were due to a transaction that was evaluated but was not executed.

Costs incurred in fiscal year 2020 were due to the IBA acquisition.

For the year ended September 30, 2021, depreciation and amortization costs were approximately $1.5 million and $6.6 million, respectively, as compared to approximately $2.2 million and $4.8 million for the prior fiscal year, an aggregate increase of $1.1 million.

The increase was principally due to the amortization of the acquired definite-lived intangible assets of S3.

The increase was principally due to the amortization of the acquired definite-lived intangible assets of IBA.

Interest Expense, net

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For the year ended September 30, 2021, interest expense, net, was $3.8 million compared to interest expense, net of $3.4 million in the prior year, an increase of approximately $0.3 million over the prior year period.

The increase in interest expense was due to the new credit facility used to finance the acquisition of S3.

The increase in interest expense was due to the $33.0 million increase to the senior term loan used to finance the acquisition of IBA.

Income Tax Expense

Income tax expense for fiscal year ended September 30, 2021 was $3.3 million, an increase of approximately $0.4 million from the prior fiscal year.

The effective tax rate for the fiscal years ending September 30, 2020 and 2019 was approximately 29%.

The effective tax rate was 24.5% and 29% for the fiscal years ending September 30, 2021 and 2020 respectively.

Non-GAAP Financial Measures for Fiscal 2021 and 2020

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On a non-GAAP basis, Earnings Before Interest Taxes Depreciation and Amortization (“EBITDA”) for the year ended September 30, 2021 was approximately $25.3 million, an increase of approximately $4.9 million, or 23.8%, over the prior fiscal year.

This increase was principally due to the contribution of S3 and effective management of general and administrative expenses.

For fiscal 2020 and fiscal 2019, our net income was impacted by transaction costs incurred as a result of the IBA and S3 acquisitions, respectively.

In fiscal 2020, we incurred $1.0 million of acquisition-related expenses and in fiscal 2019, we incurred $1.4 million of acquisition-related expenses.

We are excluding acquisition-related expenses from this measure because they were incurred as a result of specific events, do not reflect the costs of our operations, and can affect the period-over-period assessment of operating results.

This increase was principally due to the contribution of IBA and effective management of general and administrative expenses.

We incurred $1.1 million of corporate development costs for the year ended September 30, 2021, and $0.9 million in the fiscal year ended September 30, 2020.

We are excluding corporate development costs from this measure because they were incurred as a result of specific events, do not reflect the costs of our operations, and can affect the period-over-period assessment of operating results.

We are reporting this non-GAAP metric to demonstrate the impact of these events.

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By providing this non-GAAP measure as a supplement to GAAP information, we believe this enhances investors understanding of our business and results of operations .

Reconciliation of GAAP net income to EBITDA, a non-GAAP measure:

(in thousands)

Reconciliation of GAAP net income to EBITDA, a non-GAAP measure (in thousands):

September 30,

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EBITDA $ 25,338 $ 20,464 $ 4,874

Reconciliation of GAAP net income to net income adjusted for the effect of the acquisition costs, a non-GAAP measure:

(in thousands)

Reconciliation of GAAP net income to net income adjusted for the effect of the corporate development costs, a non-GAAP measure (in thousands except for per share amounts):

September 30,

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Net income $ 10,145 $ 7,114 $ 3,031

Acquisition costs 930 1,391 (461)

Tax effect of excluding acquisition costs (270) (403) 133

Net income adjusted for acquisition costs $ 7,774 $ 6,312 $ 1,462

Corporate development costs 1,088 930 158

Tax effect of excluding corporate development costs (267) (270) 3

Net income adjusted for corporate development costs $ 10,966 $ 7,774 $ 3,192

Net income per diluted share $ 0.75 $ 0.54 $ 0.21

Impact of acquisition costs, net 0.05 $ 0.08 (0.03)

Net income per diluted share adjusted for acquisition costs $ 0.59 $ 0.49 $ 0.10

Impact of corporate development costs, net 0.06 0.05 0.01

Net income per diluted share adjusted for corporate development costs $ 0.81 $ 0.59 $ 0.22

Liquidity and Capital Management

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Cash flows from operations totaled approximately $45.7 million and $19.5 million for the years ended September 30, 2021 and 2020, respectively.

The increase in cash from operations was principally due to higher profitability.

We used $32.8 million and $67.5 million of cash in investing activities during fiscal 2020 and fiscal 2019, respectively.

The cash utilized in each respective fiscal year was predominantly due to acquisitions, IBA in fiscal 2020 and S3 in fiscal 2019.

Cash provided by financing activities during the fiscal years ended September 30, 2020 and 2019 was approximately $12.9 million and $44.9 million, respectively.

The activity in each fiscal year was primarily the sourcing of capital to fund acquisitions and early repayment of principal on our senior term loan.

We entered into a $95 million credit facility entered on June 7, 2019 which included a $70.0 million term loan.

The increase in cash from operations was principally due to improved collections on key contracts and an advance payment to fund deployment of emergency medical resources under the FEMA contract awarded in late September.

We used less than $0.1 million and $32.8 million of cash in investing activities during fiscal years 2021 and 2020, respectively.

The cash utilized was predominantly due to capital expenditures in fiscal year 2021 and the IBA acquisition in fiscal year 2020.

Cash used in and provided by financing activities during the fiscal years ended September 30, 2021 and 2020 was approximately $22.9 million and $12.9 million, respectively.

The activity in each fiscal year was primarily the sourcing of capital to fund the IBA acquisition and early repayment of principal on our senior term loan.

We entered into a $95 million credit facility on June 7, 2019 which included a $70.0 million term loan.

We amended and restated the credit facility on September 30, 2020 in connection with our acquisition of IBA.

During the year ended September 30, 2021, we had repayments of approximately $23.3 million under our credit facility.

We amended and restated the credit facility on September 30, 2020 to acquire IBA.

We expect to continue to use operating cash flow to pay outstanding debt.

A summary of the change in cash and cash equivalents is presented below:

A summary of the change in cash and cash equivalents is presented below (in thousands):

September 30,

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Net cash used in investing activities (44) (32,830)

Net cash provided by financing activities 12,946 44,880

Net cash (used in) provided by financing activities (22,927) 12,946

Net change in cash and cash equivalents $ 22,694 $ (433)

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As of September 30, 2020, our LIBOR rate is subject to a minimum floor of 0.5%.

The floor affects interest payments for the periods after September 30, 2020.

The floor affects interest payments for periods after September 30, 2020.

(a) Represents the principal amounts payable on our secured term loan.

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The quarterly payments are in equal installments.

During the year ended September 30, 2021, the Company made voluntary prepayments of $16.3 million, bringing the total amount paid on the secured term loan to $23.3 million.

As of September 30, 2021, we have satisfied mandatory principal amortization until December 31, 2023.

In addition to quarterly payments of the outstanding indebtedness, the loan agreement also requires annual payments of a percentage of excess cash flow, as defined in the loan agreement.

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In addition, the Company must make additional mandatory prepayment of amounts outstanding based on proceeds received from asset sales and sales of certain equity securities or other indebtedness.

Due to the voluntary prepayment of term debt, there was no excess cash flow payment required.

For additional information regarding the schedule of future payment obligations, please refer to Note 11 Commitments and Contingencies .

On September 30, 2019, we executed a floating-to-fixed interest rate swap with First National Bank ("FNB") as counter party.

The notional amount in the floating-to-fixed interest rate swap is $36 million;

the remaining outstanding balance of our term loan is subject to interest rate fluctuations and the minimum LIBOR floor.

On September 30, 2019, we executed a floating-to-fixed interest rate swap, maturing in 2024, with First National Bank ("FNB") as counter party.

The notional amount in the floating-to-fixed interest rate swap is $22.8 million at the end of fiscal year 2021 and $28.8 million at the end of fiscal year 2020.

The remaining outstanding balance of our term loan is subject to interest rate fluctuations and the minimum LIBOR floor of 50 bps.

On the notional amount, the Company pays a fixed rate of 1.61%, plus applicable credit spread.

As a result, for the year ended September 30, 2020, interest expense increased by less than $0.2 million.

As a result, for the year ended September 30, 2021, interest expense increased by approximately $0.4 million.

(b) The secured revolving line of credit has a ceiling of up to $25.0 million.

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Payments Due By Period

Contractual obligations Next 12 2-3 4-5 More than 5

Next 12 2-3 4-5 More than 5

(Amounts in thousands) Total Months Years Years Years

Debt Obligations $ 46,750 $ — $ 8,250 $ 38,500 $ —

Facility leases 31,002 3,317 6,710 6,291 14,684

Facility Operating Leases 27,701 3,418 6,507 6,285 11,491

Equipment Operating Leases 218 83 135 — —

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Inflation and changing prices have not had a material impact on the Company’s net revenues, results of operations, and cash flows as inflation has generally been limited.

However, the Company has been able to modify its prices and cost structure to respond to inflation and changing prices as needed and expects to be able to do so in future periods.

However, we are subject to current inflation pressures which may increase the cost of labor, subcontractors and other direct costs.

The Company has been able to modify its prices and cost structure to respond to inflation and changing prices as needed and expects to be able to do so in future periods.

Critical Accounting Policies and Estimates

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The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.

Significant estimates include valuation of goodwill and intangible assets, interest rate swaps, stock-based compensation, right-of-use assets and lease liabilities, valuation allowances established against deferred tax assets, measurement of loss development on workers' compensation claims.

Significant estimates include valuation of goodwill and intangible assets, interest rate swaps, stock-based compensation, right-of-use assets and lease liabilities, valuation allowances established against deferred tax assets, and measurement of loss development on workers' compensation claims.

In addition, the Company estimates overhead charges and allocates such charges throughout the year.

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For services contracts, we satisfy our performance obligations as services are rendered.

We use a cost-based input method to measure progress.

We use cost-based input and time-based output methods to measure progress.

For time-and-materials contracts, revenue is recognized to the extent of billable rates times hours delivered plus materials and other reimbursable costs incurred.

Revenue for cost-reimbursable contracts is recorded as reimbursable costs are incurred, including an estimated share of the applicable contractual fees earned.

For firm-fixed-price contracts, the consideration received for our performance is set at a predetermined price.

Revenue for our firm-fixed-price contracts is recognized over time using a straight-line measure of progress or using the percentage-of-completion method whereby progress toward completion is based on a comparison of actual costs incurred to total estimated costs to be incurred over the contract term.

Contract costs are expensed as incurred.

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This guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized.

The Company believes it has adequate sources of taxable income to fully utilize its net operating loss carryforwards before their expiration.

The Company recorded no valuation allowance as of September 30, 2020 and September 30, 2019, respectively.

The Company has fully utilized its net operating loss carryforwards.

Stock-based Equity Compensation

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis