DLH - Q2 2023

Transcript

Operator (participant)

Good morning, and welcome to the DLH Holdings Corp's fiscal 2023 second quarter earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal 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 your telephone keypad. To withdraw your question, please press Star then two. Please note this event is being recorded. I would now like to turn the call over to Chris Witty, Investor Relations Advisor. Please go ahead.

Chris Witty (Managing Director Investor Relations)

Thank you. 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 3 of the presentation.

This call may include forward-looking statements that relate to the company's outlook for fiscal 2023 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 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.

Zach Parker (President and CEO)

Thank you, Chris. Good morning to everyone. Welcome to our 2023 second quarter conference call. We continue to make good progress since last quarter. We are also remaining on track for a strong fiscal year despite the macroeconomic headwinds in the business.

We owe a debt of gratitude for the outstanding performance by our workforce that remains committed to our clients' missions in delivering differentiated value on our programs. Beginning with slide 4, I'll first provide a high-level overview of our quarter's financial highlights.

With GRSI, our most recent acquisition under our belt, the second quarter revenue essentially reached $100 million, reflecting our first full quarter of operations post-closing. Of course, we have surpassed the $100 million mark before, during the first two quarters of last year due to the large short-term COVID-related FEMA contracts that we had, including Alaska.

This year's milestone reflects the ongoing business space that we expect to build upon going forward. The company has substantially expanded our technology-enabled solutions profile, particularly in the areas of health IT, digital transformation, and cyber. This is, of course, consistent with our growth strategy that we have articulated over the years.

Our recent couple of quarters have been very active with regard to proposal development and program shaping for future organic growth, leveraging these competencies. Our reported operating income of $6.0 million, while EBITDA rose to $10.5 million.

Our improving EBITDA margins reflect a strategy of expanding our business through highly differentiated services. We ended the quarter with roughly $204 million in debt, but after the end of the quarter, paid down an additional $8 million.

Katherine will review that in greater detail in a few moments. We will continue to use the company's operating cash flow to delever the balance sheet as quickly as possible, consistent with our history. Our reported EPS was $0.06 per diluted share. Our backlog at quarter end was nearly $941 million. Turning to slide 5, I wanted to briefly provide an overview of some recent developments, including two important contract awards.

The first gave us a seat on a highly coveted contract vehicle to provide technical solutions and support to the National Cancer Institute Center for Biomedical Informatics and Information Technology. This program will allow DLH to continue to build its expertise to the national imperative of scientific research for cancer causes and treatments.

It's a great opportunity to apply our advanced IT solutions and expand our business base with the National Cancer Institute. The estimated aggregate ceiling value of this multi-vendor blanket purchase agreement is $1.7 billion, and we hope to see the opportunity to compete on multiple task orders in the not-too-distant future.

Also, after the end of the quarter, we won a contract to expand our Naval Information Warfare business. Through this award, valued at roughly $15 million, we will continue to provide turnkey management solutions for information systems and cybersecurity, leveraging advanced logistics and artificial intelligence to assist in capacity planning and architecture modernization.

Such wins and our significant pipeline of future opportunities underscore the strength of our advanced innovative offerings and the value that we have built through our long-term growth strategy, including the acquisition of GRSI. In addition, we continue to strengthen our governance and board of directors, recently adding Judy Bormann, former Chief Financial Officer for ManTech, to the company's board of directors at our annual meeting in March.

Given her nearly unmatched expertise and experience and strong track record within our industry, we are truly delighted to have her on board. She has already made a positive impact on our organization, and we look forward to her playing a key role in our continued success.

DLH is built to compete favorably in the government services market as a technology provider, underscored by our advanced capabilities, bolstered again through our most recent couple of acquisitions and the demand for services that we provide. Our highly credentialed staff and innovative offerings are in line with the major government priorities for fiscal 2023 and beyond.

In fact, the White House's fiscal 2024 preliminary budget calls for historic investments in research, artificial intelligence, machine learning, and digital transformation, which are all in our wheelhouse and bode well for future top-line performance. We believe we're at the beginning of an exciting new chapter in DLH's evolution, where we're combining technology leadership with our long-standing mission support and scientific research credentials.

We have strengthened our position across many of these areas, building on our existing track record of innovation, cloud computing, enterprise IT, systems engineering and integration, cyber and secure data analytics across a host of government agencies and programs.

Now more than ever, our highly differentiated capabilities and strong customer relationships are paving the way for greater overlap between the government's needs and that which we can provide.

Once again, we owe this success to our dedicated professional workforce who rise to the challenge every day of delivering on our clients' expectations, and in doing so, accelerating the company's organic growth trajectory. With that, I'd like to turn the call over to our Chief Financial Officer, Katherine John. Katherine.

Kathryn JohnBull (CFO)

Thank you, Zach, and good morning, everyone. We're pleased to report our 2nd quarter results for fiscal 2023, which includes a full period of our latest acquisition, GRSI. As a reminder, we closed this transaction on December 8, 2022. Turning to slide 7, I wanted to begin by showing the adjusted results I'll be speaking about today.

While the GAAP 2023 numbers, including revenue, operating income, and cash from operations, require no adjustments, the remaining operating measures presented show adjusted results for fiscal 2022, adjusted to exclude the short-term FEMA contracts in Alaska, which, as we've discussed in the past, were a one-off in nature, covering specific COVID-related services last year.

A full reconciliation for this information is included in the back of this presentation, as well as in our press release and associated filings. Slide 8 shows these details in graphic form. Adjusted revenue rose 44% to just over $99 million from $69 million last year, as the impact of our acquisition of GRSI largely offset a slight decline in our legacy programs in the quarter, reflecting contract timing. GRSI added approximately $32.6 million of revenue during the quarter.

We anticipate organic growth across our business for fiscal 2023 and are happy to have essentially met the $100 million quarterly revenue threshold, as Zach previously mentioned. Adjusted income from operations was $6 million for the quarter versus $4.7 million in the prior year period, an increase of 27%. As a % of revenue, the company reported an operating margin of 5.9% in fiscal 2023 versus 9.4% in fiscal 2022, reflecting higher non-cash depreciation and amortization expense as a result of the GRSI acquisition.

Interest expense was $4.8 million in the fiscal second quarter of 2023 versus $0.6 million in the prior year period, reflecting higher debt outstanding due to the GRSI transaction. DLH recorded a provision of $0.4 million and $2.5 million, respectively, for tax expense during the second quarters of fiscal 2023 and fiscal 2022.

We reported net income in the second quarter of $0.8 million or $0.06 per diluted share versus $7.2 million or $0.50 a share last year. Adjusted EBITDA for the three months ended March 31st, 2023 was approximately $10.5 million versus $6.6 million in the prior year period, an increase of 59%.

Improving adjusted EBITDA margins of 10.5% versus 9.6% in the prior year period reflect the contribution of more highly differentiated capabilities through which we expect to earn better returns. The company generated $6.9 million in operating cash year to date versus $5.8 million on an adjusted basis in the prior year period.

Slide 9 provides an update regarding our plan to use the company's substantial cash flow generation to pay down debt and strengthen the balance sheet, reducing interest expense in tandem. While timing on certain receivables did not grant us the opportunity to extinguish debt during the quarter, we did so soon thereafter. As of the date of this call, have $196.5 million of debt outstanding.

This puts us squarely on track to meet our quarterly debt paydown targets and to reduce debt by approximately $20 million in this fiscal year. As a reminder, when we closed the GRSI transaction, the company had almost $208 million of debt outstanding.

We've built a strong track record and a reputation for being able to rapidly turn cash generation into debt reduction, delevering the balance sheet, that is not expected to change this year. We continue to anticipate that our debt will be between $180 million and $190 million at fiscal year-end. This concludes my discussion of the financial statements. I would like to turn the call over to our operator to open for questions.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star then on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question will come from Joe Gomes with Noble Capital. You may now go ahead.

Joe Gomes (Senior Research Analyst)

Good morning. Thanks for taking my questions.

Kathryn JohnBull (CFO)

Hey, Joe.

Zach Parker (President and CEO)

Good morning, Joe.

Joe Gomes (Senior Research Analyst)

I wanted to start off with, you know, the top line was a little light versus our expectations, and thought maybe we could just drill down a little bit more to that. You mentioned that the legacy business was down, I think, about $2 million in the quarter. Business gets moved to the right. Some things didn't come in that you thought might have come in? Just trying to get a little better handle on that top line.

Zach Parker (President and CEO)

Yeah. Yeah. Great, great question there, Joe. You actually hit it spot on. Both our on contract, existing contract growth, as well as new business opportunities have continued to slip to the right.

As you may recall, some of our on-contract growth, of course, were on some of our existing task order IDIQ contracts, which require the government to get those programs, you know, through the acquisition process. We've seen that that has continued to slip to the right a little more so than we expected, and seems to be largely attributed to internal government delays. We see no long-term impact to that just being slipping to the right. The same for our new business pipeline.

Even some of our acquisitions or contract awards that we had, the latter part of last year. We're still just now starting to have a pretty heavy load of bidding activity. For those to turn into proposal or to actual contract awards, is just, again, running through that same cycle, slipping what we think will be more Q3, Q4 prospects.

Joe Gomes (Senior Research Analyst)

Okay. Thank you on that. Did notice a nice increase in VA pharmacy revenues, year-over-year. I think they increased by about $3 million. Was there anything behind that, just doing more business with them, or was there some one-time items in that that drove that revenue increase on the pharmacy side?

Zach Parker (President and CEO)

Yeah, Joe. You know, coming out of COVID, we've learned a lot about our veterans and their readiness to deal with some of the challenges that were imposed by COVID. Quite frankly, the VA put into effect a fair amount more regulations that will drive more traffic to the mail order pharmacy as opposed to allowing veterans to come in and pick up their meds at local VA hospitals. We're gonna continue to.

We think that trend is, which has increased. It's probably leveled off now. It'll probably remain stable as we go forward, but you have seen a lift that was kind of a post-COVID regulatory environment change for our veterans.

Joe Gomes (Senior Research Analyst)

Okay. And sticking with the VA for a second, can you provide us with any update on the contracts there and the VA, you know, potentially looking to rebid out those contracts?

Zach Parker (President and CEO)

Yeah, nothing's really changed since our last report. We, as you know, we have submitted. The government did require the submission of SDVOSB proposals, service-disabled veteran-owned small businesses. You know, we are continuing to participate in that portion of the acquisition strategy.

We also remain, we remain ready and available that should they, you know, determine that that is not in the best interest of government, then we'll be able to continue to provide those services through extensions of our current contract, which currently run out through, you know, the fourth quarter calendar year. We'll evaluate what their next acquisition strategy if it is subject to change. No awards since we last spoke, and all of those proposals went in during the first quarter calendar.

Joe Gomes (Senior Research Analyst)

Okay. Kathryn, maybe, you could talk a little bit, you know, if I look at the adjusted operating margin for this quarter, 6%. Last year was about 6.8%. Just wondering what happened there. GRSI was, you know, expected to help drive operating margins up higher, we kind of took a little bit step backward in this quarter.

Kathryn JohnBull (CFO)

A key contributor to that is, of course, the non-cash D&A, which puts about half the point of pressure on that. Otherwise, it's really just a function of the relative revenue contribution from the various streams of revenue that we have, just the blend of the revenue. Nothing I would say that indicates that we wouldn't expect to get the relative contribution from the acquisition that we expected, more so just the particular mix that we had in the quarter.

Joe Gomes (Senior Research Analyst)

Okay. Fair enough. Then 1 more from me, and I'll let someone else ask 2 questions. Zach, you talked about the significant pipeline of opportunities. I was wondering if you might kind of point out 1 or 2, some of the major ones that you're looking at and give us a little bit more color or detail around that?

Zach Parker (President and CEO)

Sure. As you know, we don't get into too much that on the competition sensitive side, but, you know, we did mention a year or so ago that there was a major acquisition that would open up a lot of bids, we were within also NIH, National Institutes of Health customer. We refer to that contract as CIO-SP4.

While it has taken a while, it was really delayed a lot due to the large number of protests, very often due to smaller businesses, but to some extent, large businesses as well. That acquisition has moved really pretty close to having been finalized, but the government has continued to have delays in the final award.

That's one that, of course, we had felt that there's a fair amount of pent-up opportunities for us to be able to bid. Beyond that is we also announced 2 other awards that we had that were multiple award IDIQs. One of those, again, with our strategic interest in the National Cancer Institute.

Those procurements, those task orders are just now starting to break. We've actually bid 1 or 2, and we expect another 4 or 5 before the end of this fiscal year. The other opportunity which we also announced, the Defense Health Agencies, we call it OMNIBUS IV, but it's for medical research for military health.

That one also, while it has been awarded, the government has yet to release any request for task order proposals. We do still remain hopeful that we'll see some this fiscal year in time to at least be booked perhaps by this year. That revenue, you know, given that we're already in May, that revenue now looks like it'll probably be more likely FY 2024 early start.

Joe Gomes (Senior Research Analyst)

Great. Thanks for those updates. Really appreciate it, and I'll get back in queue.

Zach Parker (President and CEO)

You bet.

Operator (participant)

Again, if you have a question, please press star and one. Our next question will be follow-ups from Joe Gomes with Noble Capital. You may now go ahead.

Zach Parker (President and CEO)

Joe, are you still there?

Joe Gomes (Senior Research Analyst)

Yes, sir.

Zach Parker (President and CEO)

You might be muted, Joe.

Joe Gomes (Senior Research Analyst)

Nope.

Kathryn JohnBull (CFO)

Coming back around here.

Joe Gomes (Senior Research Analyst)

Yeah. If no one else is gonna ask some, I'll ask some more. You know, one of the key items, you know, with the GRSI acquisition was cross-selling opportunities.

Zach Parker (President and CEO)

Yeah.

Joe Gomes (Senior Research Analyst)

wanted to speak about some of those.

Zach Parker (President and CEO)

Yeah. Those are the areas that David and I, David Apple and I are really, really most excited about. You know, well, you know, there's some major programs that, you know, some of our existing but major targeted agencies, including the National Institutes of Health, the Center for Disease Control.

You know, programs and agencies where we currently have a business base, but there's some adjacencies in the nature of the work that's in the future. Things like precision medicine that depends very heavily on not only the computing power, but secure data environments, as well as extensive support from biomedical research talent.

You know, that really combines the benefits of what we have been building, both in our heritage business and the tremendous bolstering that we've gotten from the addition of GRSI.

These are key programs that the future, that our nation is really heavily focused on advancing the state of that business, and we think we're really, really uniquely positioned for some of those. The majority of those cross-selling opportunities we think are within the HHS arena. We also have some opportunities that we would not have been in a position to prime that supports the readiness posture of largely our fleet and the Defense Health Agency. We think the combinations of

Of cross-selling, with some of the engineering and technical capabilities from GRSI, along with the health technology related business that came with the IBA acquisition, really position us in a differentiating way for several opportunities going forward. I think what you'll see a continued expansion of our support for military veterans in that regard, as well as on the public health side of the house for research with a heavy dependence upon technology and innovation for the future.

Joe Gomes (Senior Research Analyst)

Okay, great. Then switching back to GRSI for a moment. I know they did $32.6 million of revenue in the quarter.

Kathryn JohnBull (CFO)

Mm-hmm.

Joe Gomes (Senior Research Analyst)

If you annualize that it comes out to about $130 million. On your initial projections, you were talking about $140 million at GRSI. Should we expect that to see maybe that increase on a quarterly basis to get closer to that 140 run rate?

Kathryn JohnBull (CFO)

Yeah. Well, definitely. You know, as we've discussed, GRSI has a strong track record of growth, and we've set that expectation of low double digits. We do think that they are moving upward. Just the volume of activity that Zach's talked about in the presence of it with those key public health and national security NIWC customers, we believe provides the channel to continue to support that level of growth.

Joe Gomes (Senior Research Analyst)

Great. One last one for me, I think to you, Kathryn, again, interest expense was, you know, $4.9. Again, you know.

Kathryn JohnBull (CFO)

Uh-huh.

Joe Gomes (Senior Research Analyst)

You projected I think about a $14 million increase, with GRSI debt. Are you still comfortable with that number? Do you think maybe some of these higher rates out there will increase that number a little bit above the 14 for this year?

Kathryn JohnBull (CFO)

Yeah. I do think there's certainly gonna be pressure on it as a result of interest rates continuing to grow, including the increase yesterday. You know, we've obviously hedged a major portion of that with our swap contract we put in place in January. Still, we do have some floating rate debt, and that's gonna be subject to impact from that.

As well as in the quarter in particular, as we mentioned, we had some... You know, we were disappointed in the way that the contract payments laid out. You know, it... We're happy to report we cleared that congestion by this call, you know, obviously we're happy with where we ended up on March 31st. You know, it's multi-pronged, of course.

Pressure on the interest rate is gonna result in higher interest expense. There's a non-cash component of that, too, that we might wanna put a finer point on in terms of, you know, from an EBITDA perspective, the amortization of deferred financing costs as a non-cash component. Nonetheless, as you suggest, the cash component of interest expense, I think is gonna be a bit stouter than $14 million.

Joe Gomes (Senior Research Analyst)

Okay, great. That's it for me. Thank you.

Kathryn JohnBull (CFO)

Thank you, Joe. Anthony, back over to you.

Operator (participant)

Okay. It appears there are no further questions. I'd like to turn it back over to Mr. Parker for any closing remarks.

Zach Parker (President and CEO)

All right. Well, thank you. Again, thanks everyone for joining us and your continued interest in DLH. As Kathryn and I conveyed earlier, we remain very, very excited about this new chapter, and we feel very, very well positioned to continue to execute our strategy for both organic growth, and building the value proposition as we go forward. Thank you all, and we'll look forward to chatting with you next quarter. Bye for now.