DLH - Q3 2024

Transcript

Operator (participant)

Good day, and welcome to the DLH Holdings Corp.'s Fiscal 2024 Third Quarter Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Chris Witty, Investor Relations Advisor. Please go ahead.

Chris Witty (Investor Relations Advisor)

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 three of the presentation. This call may include forward-looking statements that relate to the company's outlook for fiscal 2024 and beyond. These statements are subject to various risks and uncertainties, which could cause actual results and events to differ materially from such 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 will be referencing both GAAP and non-GAAP financial measures. A reconciliation of our non-GAAP results for our reported GAAP results is included in the 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, and good morning, everyone. Welcome to our third quarter conference call as we remained on track for a solid year as we enter the last three months of fiscal 2024. First, let me take a moment to thank our incredible workforce for their dedication and commitment to our ongoing success. Our sophisticated, highly credentialed staff continue to offer a broad array of high technology services and solutions on behalf of our customers' vital missions. We would not be where we are today as a company if it weren't for these outstanding employees, and we appreciate what you do and what you stand for each and every day. Now, turning to slide 4, I will provide an overview of our financial results.

We reported third quarter revenue of $100.7 million and EBITDA of $10.0 million, while generating operating cash flow of $4.6 million during the period. That translated to $14.9 million of cash flow year to date. This once again illustrates the company's ability to generate cash and to pay down debt, which now stands at $166.5 million. Kathryn will review this further in a moment. Overall, it was a solid quarter with no major surprises as we continue to position the company for the future, deleveraging our balance sheet and investing in new business development activities for the future. Turning to slide five, I'd like to give an update on our near-term outlook as we approach the end of fiscal 2024. We're quite upbeat about the current award environment.

We have several new business opportunities that we anticipate from across our core markets under government evaluation and/or anticipated requests for proposals. That hopefully should translate into award decisions in the near term and potentially early in 2025. We believe the potential for new program wins in the future is high, which should bolster our top-line growth trajectory in the quarters to come. While third quarter revenue was negatively affected by the transition of some small business set-aside work, we see continued strong demand for our services in several of our core markets. The small business transition impact on Q3 sales offset the fact that many of our new key markets, such as public health, enterprise IT management programs, grew nicely year-over-year.

We're optimistic that such trends will continue, given the overwhelming bipartisan support for the majority of our programs, combined with our strong agency relationships and the company's wider range of advanced solutions and digital transformation capabilities. As in the past, we expect our solutions and services will continue to hold broad partisan support in the quarters to come, regardless of the changes in Congress or the White House. While one CMOP site already awarded is now set to transition soon, the other seven have been reset in terms of the bidding process, with funding on the current contract expected to be extended through at least October 31st.

The award timing of the other seven contracts remains uncertain, but we do anticipate the award of, the award value process to be lengthy due to the complex nature of the critical services represented by these awards. In short, essentially, during the last quarter, the government restarted a new solicitation that allows new bidders to enter the competitive environment. These solicitations, however, still remain small, disadvantaged, veteran-owned businesses, and will again, we will consider our participation given the changes to these procurements. Enhancing our highly credentialed workforce's presence and contributions as thought leaders is a significant element of our growth strategy. DLH expects to continue to hold leadership roles across the communities of practice, raising the company's profiles in the markets in which we bid for new work.

In the past quarter alone, our experts and thought leaders have published and presented leading research in the fields of public health, readiness, and other technical services, demonstrating our company's innovative approaches to tackling some of the globe's most pressing challenges. Overall, we remain upbeat about the opportunities at our doorstep and the contract activity as the government's year-end comes to a close. We're proud of the breadth and depth of our offerings, our expanded capabilities, and the more advanced are now more advanced than ever, and the highly credentialed nature of the company's workforce. Together, our people, our combined capabilities, our new and expanded processes and past performance bring unmatched systems and solutions to the agencies we serve. With that, I'd now like to turn the call over to our Chief Financial Officer, Kathryn Johnbull. Kathryn?

Kathryn Johnbull (CFO)

Thank you, Zach, and good morning, everyone. We're pleased to report our third quarter results for fiscal 2024. Turning to slide seven, I'd like to provide a high-level overview of some key financial metrics for the three months ended June 30th, 2024. We reported revenue of $100.7 million in the third quarter, versus $102.2 million in the prior year period, reflecting growth across several priority markets, offset by the conversion of some programs to small business set-aside contracts. We continue to see expansion within our public health and enterprise IT management businesses and are excited by the level of opportunities presented within the current bid environment, as Zach discussed.

We reported EBITDA of $10 million for the third quarter versus $11.4 million last year, and the company has generated operating cash of $14.9 million year to date. Our EBITDA was lower than last year, largely due to a higher than normal contribution from non-labor pass-through revenue, which inherently carries lower margins. Now, if you turn to slide eight, I'll provide an update regarding our deployment of the company's cash to reduce debt, strengthen the balance sheet, and lower interest expense. We paid off approximately $4.3 million of our higher interest floating rate debt during the quarter, ending the period with $166.5 million of total debt outstanding.

Due to updated forecasts and working capital changes, we now anticipate that our debt will be reduced to between $157 million and $160 million at the end of Q4, slightly higher than prior projections. But still leaving us on track to start fiscal 2025 with a debt leverage ratio of below 3.3x-3.5x. We will continue utilizing the favorable tax attributes of our acquisitions, along with stock compensation plans, to minimize cash income tax payments going forward. In addition, if interest rates come down as anticipated, we will utilize that excess cash to accelerate our debt reduction next year. This concludes my discussion of the financial statements. With that, I would now 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 one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then two. Our first question. Our first question comes from Joe Gomes with Noble Capital Markets. Please go ahead.

Speaker 5

Good morning, guys. It's Josh filling in for Joe.

Kathryn Johnbull (CFO)

Hey, Josh.

Zach Parker (President and CEO)

Good morning, Josh.

Speaker 5

All right, so, you know, my first question is, you know, revenue kind of came in lower than we expected, you know. Can you guys just kind of provide just a little bit more color on that kind of soft business award runoff? You know, it seems to have a larger impact than I think we expected. You know, how much more of it should we expect, and kind of, you know, how is that kind of recompete process as a subcontractor looking for those?

Zach Parker (President and CEO)

Yeah. No, great question, Josh, and we're happy to provide that added color. I think it's very important to have the context of what we see, what we've seen this quarter and what we see coming down the pipeline. First of all, we still remain really, really strong with our ability to, where we're competing in terms of our win rate for our existing business, right? And so our capabilities to retain work from a competitive standpoint, we still remain strong. So that's not what's driving this. As you may recall, we do have a fair amount of business booked in our business that we've retained for a better part of a year and a half, that the that was.

You know, awarded to us previously as a small business set-aside, at least in terms of the, the companies that came, the contracts that came to us through acquisitions. And while we paid no, value for those in our, in our acquisition for those, small business set-aside contracts, some of them have continued to, extend and still be in our book of business and are starting to roll off, now. And so we, we had, you know, some of our work, that has, either come to an end and we cannot bid it and would not bid it as a small business set-aside. And there's still some, addition that we expect in the, in the coming quarters.

Those, again, are, you know, sans the CMOP, and obviously, we gave a separate commentary there as well. Now, having said that, we do still anticipate that there, you know, the government's commitment to small business set-asides will have some varying impact on on some of those legacy contracts, and we'll be certainly keeping you advised. We are, you know, working with our customers to try to continue to maintain those in an unrestricted environment, and we'll keep you posted on that. But we do see probably a quarter or two of some meaningful cleanup, what we call a reset of our capabilities contracts, our strong capabilities contracts, that where the government has committed to going small business set-aside.

Some of those we're gonna bid and be a, you know, a partner, a subcontractor partner, where we might be able to retain, you know, up to 49% or so. But some of those we're just allowing to run off because they were non-strategic. So, we'll give you some added color on that, near term as well, in terms of sizing. But we do, again, anticipate several of those to run out between, you know, Q3, Q4, and maybe a trickle into Q1. Kathryn, anything to add there?

Kathryn Johnbull (CFO)

Yeah, I think it is, as Zach indicated in his comments, this is not unexpected, and as we've talked about a number of times, the business is built roughly 85% or 85%, percent-ish, on, you know, recurring business that just rolls forward through the term of the contract. And then it's got, you know, some business that—some part of the business that comes to us via acquisitions that, you know, we understand at the time we do the deal, it's not strategic to the business and/or as Zach indicated, one in the current quarter, some that we knew were, the acquired company had one as a small business and wouldn't be eligible in the recompete to be the prime. So nothing about that surprises us.

That's why we bubble around at approximately $100 million, and we're gonna have some of that variability period to period. Additionally, there's some special projects work we do from time to time, that it's turnkey in nature and comes and goes as the work wraps up. So nothing about delivering at the $100 million mark surprises us, but there is gonna be that little bit of variability quarter to quarter. The real change in trajectory is going to be when a major event happens, such as a big contract award, which we talk about frequently, and we're happy to share more about on this call, and/or a disruptive event like transition of CMOP, which we also will cover in more detail.

I think you had a part-- that was part of your question, Josh.

Speaker 5

Yeah, and so, you know, that's kind of a good segue as well, because, you know, you guys mentioned obviously the CMOP you know, the CMOP contract as well. You know, can you kinda just give me a little bit more color? It's like, you know, do you guys have really any indication of, like, how the VA is really moving along with these contracts?

Zach Parker (President and CEO)

Yes.

Speaker 5

You know, kind of what's you guys' confidence level in kind of recompeting for the, those CMOP contracts that you want to recompete for?

Zach Parker (President and CEO)

Yeah, I think a great question again. You know, we've kept the community abreast with the VA's attention for some time. And just for recap, you know, our current contracts ended in November 2016. And since then, the VA has been having, you know, three or four attempts to try to get them awarded, and you know, competing and revising the competition strategy or acquisition strategy and revising it again. And of course, we're at the current state, which we shared with you, where most of the bids that had been submitted were submitted in the early part of 2023. And of those eight bids, only one, the Chelmsford one, the smaller of all of them, has been awarded to date.

We, having said that, it has morphed just about every other year, since then, and that's why we want to give some color. What the VA did, in May timeframe, maybe even spilled over into June-

Kathryn Johnbull (CFO)

Mm-hmm.

Zach Parker (President and CEO)

Is they came out with a modification again, that reopened the competition to any new bidders, service-disabled veteran-owned small businesses. So it's like a restart of all, except, Chelmsford. Those proposals, none of those proposals have been submitted by any of the competitors, yet. It, best estimate is that by the end of, end of August, maybe the first part of September, the government will have received all of those proposals. And we have, you know, we know, we have, pivoted as the government's modifications, have pivoted with regard to our approach. And, for those in which we are still engaged with a, small business partner, we do have a, you know, a, a good, probability of win.

But, yeah, but I do want to be clear that, they have moved the nature of the work with their solicitations, with the most recent modifications, to clearly signaling what they're looking for is the equivalent of a temporary staffing company, right? Small, and in this case, limiting it to, SDVOSBs. Where we have built the business in, both in terms of organically winning, you know, 17 of those contracts, as well as, executing tremendous performance excellence, up to and including, you know, JD Power Awards for the VA for 10 consecutive years. It was when they, their solicitation and their contracts had us focus on, on, performance, not, yeah, not just staffing.

Those performance metrics involve solutions and analytics, Lean Six Sigma standards for quality, exacting standards for productivity, and we invested a lot to maintain that degree of service for the VA. In the last two years, they have the modifications as well as you've seen in our discussions every quarter. They stopped giving even the one-year bridges, right? Which says you can't invest a year's worth of tools, et cetera. They continue to signal moving the work to where it was back in 2000, prior to 2012, and that's kind of what we call a butts-in-seats contract. So, our appetite for the current versions that I'll just share with you is not the same, right? It doesn't allow you to differentiate.

It's you know when you move to that kind of environment, it becomes almost a low-cost shootout. And so I won't go into any details because this is still competition sensitive, but that transition that the new contracting folks in the last couple of years at the VA have made makes it you know a different type of acquisition. So we'll leave it at that. But you know obviously we're not excited about that, but we do have you know strong qualifications that we think differentiate us in particular areas, in particular sites and locations, and we're leaning into those.

Speaker 5

Yeah, thank you for the color on that. And just kind of, you know, looking at, you know, your income statement, you know, we're kind of, what I'm kind of seeing is, you know, your gross margin was kind of down about 200 basis points from the last year and really just about 300 basis points sequentially. You know, can you guys just kind of describe what's really kind of driving that decrease?

Kathryn Johnbull (CFO)

Yeah, Josh, that's really a function of, as we mentioned, in this particular quarter, the contribution of lower margin pass-through costs was more significant than it was in the prior period. So those types of costs are inherently generate tighter margins, and therefore, it's going to deliver an aggregate lower gross margin.

Speaker 5

Okay, great. Thank you guys so much for answering my questions. I'll hop back in the queue.

Zach Parker (President and CEO)

Yeah.

Kathryn Johnbull (CFO)

Appreciate it, Josh.

Operator (participant)

Again, if you have a question, please press star and then one. Our next question comes from Brian Kinstlinger, with Alliance Global. Please go ahead.

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

Hi, good morning. Thanks for taking my questions.

Kathryn Johnbull (CFO)

Hey, Brian.

Zach Parker (President and CEO)

Hi, Brian.

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

How are you? When you look at the $100 million in quarterly revenue you just reported, can you quantify how much of that revenue is related to small businesses contract?

Zach Parker (President and CEO)

Let's see, of the revenue reported for the quarter. We'll probably need to come back to you to give you a specific number.

Kathryn Johnbull (CFO)

Yeah, it's not a material portion of the total $100 million. To the point, most of those items that we anticipated would convert, that is largely behind us. Not completely, but largely.

Zach Parker (President and CEO)

Right. Excluding CMOP.

Kathryn Johnbull (CFO)

Excluding CMOP.

Zach Parker (President and CEO)

Right.

Kathryn Johnbull (CFO)

No, but two flavors of small business.

Zach Parker (President and CEO)

Right.

Kathryn Johnbull (CFO)

The flavor that was inherently pent up that we, the acquired company previously won it as a small business. By the way, it's not the acquisition that caused them to be ineligible to recompete for that work. They had already outgrown the small business status prior to the acquisition. So there's that layer, and then, as Zach said, there's, of course, things that are not presently small business, like CMOP, that are moving to that kind of vehicle. That's a different layer.

Zach Parker (President and CEO)

And I would tell you that we, Josh, the other added color on that one is we've actually anticipated, as did the customer, that several of these would have been decided, you know, probably two to three quarters prior, right? Things have seemed to be, the government seems to be pretty slow in getting some of these award decisions, much like on CMOP. It kind of works to our favor in some regards, but in some cases, you know, when we diligence the deal, you know, some of these award decisions that were going small business were slated for, you know, earlier in 2023, and they just started to hit this past quarter. So good news, bad news, I guess, in that regard.

Kathryn Johnbull (CFO)

Yeah, that's the other side of that coin-

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

So to be clear, when you say insignificant, Kathryn, you're saying less than 5% of revenue? That's what I think of as insignificant, even smaller.

Kathryn Johnbull (CFO)

Yeah, I think.

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

Is actual small business contracts.

Kathryn Johnbull (CFO)

That's a fair way to think about it.

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

Okay. The second part of the question, I guess, would be: how much of that $100 million of revenue are contracts where you expect, today, they're full and open to move to small business, even including CMOP?

Zach Parker (President and CEO)

Well, there's still, you know, those things that are in our current book of business, I think you're referring to.

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

Yep.

Zach Parker (President and CEO)

You know, I'd say there's some risk still in that book, right? Book of business.

Kathryn Johnbull (CFO)

Yeah.

Zach Parker (President and CEO)

Right? In a couple of areas, largely attributed to two things. Number one is accelerate across the industry, right? All of our folks are seeing. In January of this year, the White House and OMB issued a directive to all federal agencies to go through the quote-unquote, "Rule of Two process" for a number of these IDIQ multiple award contracts and consider setting aside some of that work for small businesses. Now, while there are no enabling regulations that have been issued by and introduced into the federal regulations, some agencies take it as guidance, particularly since OMB did not provide the usual exclusion language that agency contracting officers can use. So we've seen some of that happen to some of our competitors over the last six months.

We have not been hit by that yet, but we have been in close discussions with some of our customers that they're considering it, right? And so we do have some of that quantified. We've got that framed as some erosion risk for us in sometime in 2025. And of course, we're trying to work, you know. The good news is, we, you know, we're clearly still seeing indications that the government is gonna be releasing some of these RFPs so that we can organically grow our way out of a little bit of that transition. We have-

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

Mm-hmm.

Zach Parker (President and CEO)

As we indicated, we have some things we have very high win probabilities for. We'd like those to have been awarded by now, or at least solicited by now, but we're hearing still good things and seeing good behaviors from the customers that those should be coming in at a time to help us offset that small business erosion.

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

So that is a great transition to my next question. You've highlighted some large pending adjudications that you believe could help drive this return to growth. I know it's not something typically you provide, but I think it would be helpful for investors if you could quantify total proposals outstanding that are pending adjudication.

Zach Parker (President and CEO)

Yeah, we periodically do provide our pipeline and some metrics around that. So we will, we'll make sure we do get that to you shortly. In short, I can tell you, though, that we have north of two dozen opportunities that could materially affect the strong growth by mid FY 2025. And, you know, with good anticipated organic win probability, it should help us exit 2025 in just outstanding position relative to the erosion, small business erosion, including CMOP, that we anticipate.

Some of those, I will say that, as Kathryn and I diligenced that quite a bit, you know, there's a mix of work that is in our digital transformation and cybersecurity arena that is typically a lot higher margin basis than some of the work in our systems engineering and logistics. That mix will have an effect, depending upon which ones come out first. It'll have an effect on either dilution or expansion of our gross margins in those contracts, and of course, ultimately impacting our EBITDA. So we're monitoring that pretty closely, just because we're now capable of bidding much larger contracts that are north of $100 million over five years, and with the high tech quals.

We'd like to see those come out, you know, similar to similar time, timeline as some of the lower margin work, but still very strategic. So we'll keep you posted on that. We'll give you that color pretty soon with regard to our pipeline. But some of those, again, like I said, we'll try to add more color than just the numbers and kind of give you an idea of that which is in our DTC, digital transformation and the higher health research and technology arena.

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

Okay. Last question I've got, it's followed up by a question I asked last quarter. Can you talk about the progress you're making on increasing your proposal submission engine? This seems more important than ever, obviously, given the roll-offs you're experiencing.

Zach Parker (President and CEO)

Yeah, that's probably the area I'm most excited about, my friend.

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

Mm-hmm.

Zach Parker (President and CEO)

I'll tell you, we have, I think, you know, we have briefed the community, certainly the shareholders, about a year or so ago, that we're making some major changes, major improvements, into elevating both our ability to go after large contracts and to do so with high win probability. There were several key factors to this process, which we kind of walked through, I think in our shareholder call. But our ability to derive, you know, winning value propositions and technology solutions has elevated substantially, which it needed. As you may recall, we were generally operating with entities that were in the, you know, $60 million, $70 million, $80 million range as an operating unit. Accordingly, we're looking at, you know, generally smaller deals.

But we've augmented them now. We've kind of revamped our full approach to the business development, expanding it now with the capabilities that we now have in hand. You've probably seen some press releases around some of the caliber of expertise that we've brought in with regard to, cybersecurity, data analytics, data fusion, AI, ML. These are sort of tools that, while we had, performance capability and we were able to execute with the customer, we didn't really have that on our bench. It didn't exist with any of the acquisitions, and it strongly now complements, the more strategic, shaping assets, that we had along. So a number of these bids before didn't have the value of our strategic advisory, capabilities.

And we have seen substantial improvement in our process for positioning and building the type of intimacy needed to have a real, real strong win rate. So we're real optimistic about that. You know, we've got teams that are as good as, if not better than, most of the organizations in our industry, just because we've come from most of those organizations. So we're really excited about the elevation of both the aperture in terms of now we're going after things that our teams were not going after. So we think the size is great, but our positioning to elevate our win probabilities and our value propositions, we've got a lot more committed there as well.

Real excited about what's to come on the organic growth front.

Brian Kinstlinger (Director of Research and Senior Technology Analyst)

Great. Thanks so much.

Zach Parker (President and CEO)

You bet.

Operator (participant)

It appears there are no further questions in the queue. This concludes our question and answer session. I would like to turn the conference back over to Mr. Parker for any closing remarks.

Zach Parker (President and CEO)

Well, I'd like to thank you all again for your participation, your continued interest, and a very probative conversation. We're, you know, I think it's really important to really make sure that we set the expectations around what we see in the coming quarters. And at the same time, we really, really wanna lean into looking at the longer trajectory from a, you know, from a forecasting perspective. And we're really optimistic that despite the small business set-aside impacts to some of our work that is, you know, becoming less differentiating.

Kathryn Johnbull (CFO)

Right.

Zach Parker (President and CEO)

We're tremendously excited about the quality of the new business pipeline and our ability to prosecute it. So we'll come out of this upcoming period much stronger as we go forward. So thank you again, and we'll continue to, to keep you posted. I think the next time we get together, of course, we'll be at or around the election time period, and we'll give a little more color around you know, that, as we, as we approach Q4 and Q1. So thank you all and have a blessed day. Bye for now.

Operator (participant)

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.