DLH Holdings Corp. (NASDAQ:DLHC) Q2 2023 Earnings Call Transcript May 6, 2023

Operator: Good morning, and welcome to the DLH Holdings Corp’s Fiscal 2023 Second Quarter Earnings Conference Call. . This is call is now being recorded. I would now like to turn the conference to Chris Witty, Investor Relations Adviser. Please go ahead.

Chris Witty: 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 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 will 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.

Zachary Parker: Thank you, Chris, and good morning to everyone. Welcome to our 2023 second quarter conference call. We continue to make good progress since last quarter, and we are also remaining on track for a strong fiscal year despite the macroeconomic headwinds in the business. We have a debt of gratitude for the outstanding performance by our workforce that remains committed to our clients’ missions and 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 on the 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 100 million mark before during the first 2 quarters of last year due to a large short-term COVID-related FEMA contracts that we had, including the last year. But this year’s milestone reflects the ongoing business base 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 side. 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 $2.5 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. Kathryn will review that in greater detail in a few moments. And 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 and 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 2 important contract awards. The first game as a ceded 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 it’s 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 — continue to expand our business base with the National Cancer Institute. The estimated aggregate ceiling value of this multivendor blanket purchase agreement is $1.7 billion. And we hope to see competing 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 National Information Warfare business, Naval Information mortar 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 wallings 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 Bjornaas, 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’re pretty delighted to have to onboard. She has already made a positive impact on our organization, and we look forward to her coming 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 credential staff and innovative offerings are in line with the major government priorities for fiscal ’23 and beyond. In fact, the White House’s fiscal 2024 preliminary budget calls for historic investments in research, artificial intelligence, machine levy and digital transformation, which are all in our wheelhouse and bond 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 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 rises 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, Kathryn John. Kathryn?

Kathryn JohnBull: Thank you, Zach, and good morning, everyone. We’re pleased to report our second 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 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 the 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 revenue — quarterly revenue threshold as Zack 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 percent of revenue, the company reported an operating margin of 5.9% in fiscal 2023 versus 9.4% in fiscal 2022, reflecting higher noncash 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 quarter of fiscal 2023 and fiscal ’22. -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 3 months ended March 31, 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 general. While timing on certain receivables did not grant us the opportunity to extinguish debt during the quarter, we did so soon thereafter. And 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 close 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, and 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. With that, I would like to turn the call over to our operator to open for questions.

Q&A Session

Operator: . Our first question will come from Joe Gomes with Noble Capital.

Joseph Gomes: So I want to start off with the top line was a little light versus our expectations. And probably, maybe you could just drill down a little bit more to that. You mentioned the legacy business was down, I think, about $2 million in the quarter. So business gets moved to the right or just 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.

Zachary Parker: Yes. Great question, Joe. And 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, for some of our existing task order IDIQ contract, which required a government to get those programs through the acquisition process. We’ve seen that continue to slip to the right, a little more so than we expected and seems to be largely attributed to internal government delays. But we see no long-term impact of that, just things 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 the bidding activity.

And for those who turn into proposals to actual contract awards is just, again, running through that same cycle slipping to what we think will be more Q3, Q4 prospects.

Joseph Gomes: Okay. that I did notice a net 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 onetime items in that, that drove that revenue increase on the pharmacy side?

Zachary Parker: Yes. Joe, coming out of COVID, we’ve learned a lot about our veterans and their readiness to deal with some of the challenges that we are coselling quite frankly, the VA put into effect of a fair amount of more regulations that will drive more traffic to the mail-order pharmacy as opposed to allowing metros to come in and pick up demands at local via hospitals. So we’re going to continue to — we think that trend is — which has increased. It’s probably level off now, it probably remain stable as we go forward. But you have seen the left that was kind of post COVID regulatory environment change for venture.

Joseph Gomes: Okay. And thinking with the VA for a second, can you provide us with an update on the contracts there and the VA potentially looking to rebid out those contracts?

Zachary Parker: Yes, 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 small businesses. And we are continuing to participate in that portion of the acquisition strategy. We also remain — as before, we remain ready and available that should they determine that, that is not in the best interest of government that we’ll be able to continue to provide those services through extensions of our current contract, which currently run out to the fourth quarter calendar year, and then we’ll evaluate what the next acquisition strategy if it’s subject to change. But no awards since we last spoke and all of those proposals went in during first quarter calendar.

Joseph Gomes: Okay. And Katherine, maybe you could talk a little bit — if I look at the adjusted operating margin for this quarter last year about 6.8%. Just wondering what happened there. GRSI side was expected to help drive operating margins up higher and we kind of took a little bit step backward in this quarter.

Kathryn JohnBull: Yes. A key contributor to that is, of course, the noncash D&A, which is about — puts about 0.5 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. So 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.

Joseph Gomes: Okay. Fair enough. And then one more for me, and I’ll let someone else ask a couple of 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.

Zachary Parker: Sure. I’ll get into too much on the competition sensitive side. But we did mention a year or so ago that there was a major acquisition that would open up a lot of bids within also NIH mission to a health customer, and we refer to that contract as CIO Sp4. And while it has taken a while, it was really delayed a lot due to a 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. But 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, as we also announced 2 other awards that we had that were multiple IDIQs and one of those, again, with our strategic interest in the National Case Institute.

And 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. And the other opportunity, which we also announced the defense health agencies, we — Omnibus 4, but is for medical research for military kind of health. And 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 perhaps by this year, that revenue — given that we’re already in bank, the revenue now was like will probably be more likely FY ’24 early start.

Joseph Gomes: Great. Thanks for those updates. Really appreciate it, and I’ll get back in queue.

Operator: . Our next question will be a follow-up from Joe Gomes with Noble Capital.

Joseph Gomes: Yes. No one else is going to ask them. I’ll ask some more. One of the key items with the GRSI acquisition was cross-selling opportunities? And Zach, I wonder if you could speak about some of those.

Zachary Parker: Yes. Those are the areas that David happen I’m really, really most excited about. And well, there are some major programs that some of our existing major targeted agencies, including the National Institute of Health, the Syneron disease control programs and agencies where we currently have a business base, but there’s some adjacencies in the nature of the work is in the future. But things like precision medicine that depends very heavily on the computing power, but secure data environments as well as extensive support from biomedical research talent 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 was cross-selling opportunities, we think, are within the HHS arena. We also have some opportunities that would not have been in — we would not have been in a position to prime that supports the readiness posture largely our fleet in the Defense Health Agency. And we think the combinations 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.

So I think what you’ll see a continued expansion of our support for military metros in that regard as well as in the public Hill side of the house for research with a heavy dependence bond technology and innovation for the future.

Joseph Gomes: Okay. Great. And then went back to the GRS for a moment they did $32.6 million of revenue in the quarter. implies that it comes out to about $130 million. And on your initial chance you were talking about $140 million at GRSI. Should we expect that to see maybe that increase on a quarterly basis to get back to get closer to that $150 million run rate?

Kathryn JohnBull: Yes. Definitely, we — as we’ve discussed, the GSRI has a strong track record of growth, and we’ve set that expectation of low double digits. So we do think that they are moving upward and just the volume of activity that Zack talked about in the presence of with those key public health and national security NIWC customers, we believe provides the channel to continue to support that level of growth.

Joseph Gomes: Great. Thank you, Kathryn, again, interest expense was $4.9 million. Again, you projected, I think, about a $14 million increase with GRSI debt. Are you still comfortable with that number? Or 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: Yes. I do think there’s certainly going to be pressure on it as a result of continuing to — interest rates continuing to grow, including that increase yesterday. We’ve obviously hedged a major portion of that with our swap contract we put in place in January. But still, we do have some floating rate debt, and that’s going to be subject to impact from that as well as in the quarter, in particular, as we mentioned, we had some — we were disappointed in the way that the contract payments laid out. We’re happy to report we clear that congestion by this call, but obviously, we’re happy with where we ended up on March 31. So it’s multipronged, of course, pressure on the interest rates is going to result in higher interest expense.

And there’s a noncash component of that, too, that we might want to put a finer point on in terms of — from an EBITDA perspective, the amortization of deferred financing costs is a noncash component. But nonetheless, as you suggest, the cash component of interest expense, I think, is going to be a bit sounder than $14 million.

Zachary Parker: Anthony, back over to you.

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

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

Operator: The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.