DLH Holdings Corp. Q1 FY2024 Earnings Call

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 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. 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.

Thank you, Chris, and good morning, everyone. Welcome to our 2024 first quarter conference call. Once again, thanks to the dedication, collaboration, and innovation of our talented DLH workforce, we're on track for another year of solid performance here at DLH. Their dedication to our customers' vital missions, combined with the organization's overriding commitment to performance excellence and improved results, continues to drive value for our DLH shareholders. We rely on our people to set very high standards of excellence each year as we continue to build a world-class provider of emerging technology-enabled solutions and services. They continue to rise to the challenge, and we are very proud of their accomplishments. Now turning to Slide 4. I'll provide an overview of the quarter's financial results. We reported first quarter revenue of $97.9 million and EBITDA of $11.1 million, while generating operating cash of $5.1 million during the period. We also continue to delever the company as Kathryn will review momentarily, by paying off another $5 million of debt, ending the quarter with only $174.4 million of total debt outstanding. With our organic growth, which has endured federal budget continuing resolution headwinds due to the timing of new budget decisions, we continue to see some delays in business development opportunities. However, we remain confident in our ability to generate new business through our robust growth channels, both existing and new award contracts. Turning to Slide 5. Let me summarize a few key industry and environmental factors currently influencing our position in the market. First, as I just noted, the federal government is still operating under a continuing resolution, which typically slows down decision-making both on current IDIQ contracts and potential new business opportunities. The most recent resolutions keep the government running through March 1, with some departments funded through March 8. As a reminder, this is the third set of stop-gap measures that Congress has passed since September. And as a result, our clients have limited budget certainty, which is restricting their ability to make new awards. That said, we remain cautiously optimistic that both the recent and near-term progress could result in funding flow for our major agencies through the remainder of fiscal '24, paving the way for efficient contract implementation and awards. We continue to build upon a strong pipeline of high-value opportunities across our broad customer base as well as key large multi-award IDIQ platforms, opening additional channels for the company. Our enhanced technical capabilities, highly credentialed workforce, and science and technology platforms are ready to meet the evolving demands of our customers and to provide innovative value propositions. Our ability to attract and retain industry-leading talent is critical to providing uninterrupted support for our clients' missions. DLH employees solve challenging complex problems, and their program execution results are unmatched in delivering customer satisfaction. So it's truly an honor to receive a Great Place to Work certification, an award entirely based on what current employees say about their workforce. This achievement is significant to customers, partners, and prospective new hires alike that DLH creates an outstanding employee environment. Now turning to Slide 6. We have provided an overview of our business base to illustrate the diverse set of customers we support. This broad customer base, which spans agencies within the federal military and civilian markets, offers many opportunities to deliver our differentiated services to an array of new and existing customers. Building a portfolio of work that supports mission-critical programs that have traditionally received broad bipartisan support is a long-standing strategic goal of our corporate and business development organization. 45% of our current business portfolio lies within the Department of Health and Human Services. Key clients under this umbrella include the Agency for Children and Families, the Centers for Disease Control and Prevention, and, of course, the National Institutes of Health. Our capabilities in research and development, systems integration, and big data analytics have allowed DLH to provide unmatched value to our HHS clients and penetrate new programs across the board. The VA comprises approximately 35% of our revenue via the Veterans Health Administration. This includes our long-standing CMOP operations. We have a long history of supporting the VA, and we currently are looking forward to expanding our services inside the agency to deliver for those who truly deserve our nation's excellence. Thirdly, defense agencies comprise roughly 17% of DLH revenue, including the work across a broad array of programs in the Defense Health Agency and the military services. This book of business is poised to see substantial growth over the coming years as the DoD looks to invest in health IT, digital transformation, data analytics, cybersecurity, AI-enabled research, and numerous health-related platforms. Given that our client relationships span decades, we can leverage this intimacy to shape customized solutions and expand our contract portfolio to new business development opportunities as well as growth on existing programs. As government agencies continue to expand their commitment to cybersecurity, data analytics, IT modernization, artificial intelligence, and more, all directly aligned with our strengths, our company's addressable markets continue to grow. Our innovative offerings remain in the sweet spot of agency technology upgrade initiatives, as evidenced by the White House and Federal Agency strategic plans. By integrating our highly differentiated digital transformation capabilities with research domain expertise, this serves as a relatively unique platform to address a broader range of solutions than ever before, helping our clients reach higher and perform even better every day. With that, I'd now like to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?

Thank you, Zach, and good morning, everyone. We're pleased to report our first quarter results for fiscal 2024. Turning to Slide 8. I'd like to provide a high-level overview of some key financial metrics for the three months ended December 31, 2023, compared to the prior year period. We reported revenue of $97.9 million in the first quarter versus $72.7 million in the prior year period, reflecting the addition of our strategic acquisition in December 2022. We reported EBITDA of $11.1 million for the first quarter versus $8.1 million last year, as adjusted for corporate development costs supporting that acquisition, and generated cash from operations of $5.1 million compared to $8 million in fiscal 2023, with the variance primarily related to vendor payment timing. This does not negatively impact our expectations for cash flow generation this year nor a planned debt reduction. Speaking of which, if you'll turn to Slide 9, 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 $5 million of our higher interest rate floating rate debt in the first quarter, ending the period with $174.4 million of total debt outstanding. As a reminder, approximately $6 million of quarterly interest expense is non-cash amortization of financing arrangement fees. Our cash generation ability reflects our focus on efficient and timely cash collections, resulting in days sales outstanding of 51 days for the period versus the industry peer group average of 61 days. We remain on track to reduce debt to between $153 million and $157 million at the end of the fiscal year, resulting in a debt leverage ratio of below 3.5 times EBITDA by the end of the fiscal year. We will continue utilizing the favorable tax attributes of our acquisitions, along with stock compensation deductions to minimize cash and income tax payments going forward. This concludes my discussion of the financial statements. And with that, I would like to turn the call over to our operator to open for questions.

And today's first question comes from Joe Gomes with NOBLE Capital. Please go ahead.

Good morning, and thanks for taking my questions.

Good morning, Joe. Thanks for joining us.

I wanted to start off with the revenue line and kind of get a feel for what you guys were expecting going into the quarter. It's a little lighter than what we had expected. I understand that the continuing resolution can represent a headwind for you guys. But I just kind of wanted to get a little better feel for what you were expecting going into the quarter? And what you think this means for the rest of the year?

Yes. That's a great question, Joe. I would say it did turn out a little softer than what we had expected, largely due to certain customer sets that are really being throttled by the budget uncertainty. As you well know, we have a few very large $100 million contracts that involve intramural and extramural scientific research around health challenges. And we've just seen that for consecutive quarters, several quarters now, that without budget certainty, there's been some reluctance to do some of the funding. So it's trailed what we were really expecting for this year. And then a couple of anomalies have just had some seasonal impacts.

Right, right. That's it. As Zach said, there has been some slowness in turning new orders as he indicated, although as you might expect, Q1 is historically a softer, lighter quarter just based on where it falls in the calendar and the impact of lead time around the holidays. So from that perspective, from our planning perspective, it's pretty in line, though we do see some slowness in the orders that we expected to give us some lift exiting the quarter and coming into Q2.

Thank you for that. The VA contracts have been extended into February, but this extension seems to be shorter than usual, as they are typically longer than two months. Does this provide any insight into what the VA might be planning in the near future? Or do you think these contracts will just continue to be extended as we've seen in the past?

Yes. As you well know, when we started out on what we referred to as bridge contracts, we were usually going at what we would call six months that were really kind of a pairing of two, three months bundled together, et cetera. And it is customary for the acquisition community and the federal government to, as you get further along in these kind of extensions and you have procurements on the table right now, to shorten the cycles in the event that they are able to make some progress on the awards. Having said that, though, we think there's nothing to really read into that. We still are really strongly believing that we see no material impact to FY '24's plan and results just based upon the timing and the potential evolution of the acquisition chain.

Okay. Great. And then on HHS. This quarter we didn't need to break that out in the Q. I'm just wondering how that big contract performed in the first quarter compared to last year?

Yes, very consistently because we've returned to a normal operating cadence as opposed to the variation that happened during the COVID challenges. We do have comparable results year-to-year from that program.

Okay. Great. And then one last one for me and I'll drop back in queue. There was a nice drop in SG&A as a percent of revenues cap, and I was just wondering, is that sustainable? Is that a good number to use going forward? Or do you think that cost will begin to edge back up over the rest of the year?

I do think that it's going to be a function of the timing of business development costs. Given the congestion around RFPs getting issued, our G&A costs incurred in the quarter were a little lighter than we expected. So we get both good and the bad side of that coin, I guess, if you want to think about it that way. But we'd be happy to spend that money for the long-term value that it delivers in the company and our growth strategy. But I think I don't see that as our delivering a permanent reduction in SG&A costs to scale yet until we get on that track of that front-end investment in business development and the yield on the back end in the form of awards. That helps for modeling your outlook.

Okay, great. Thanks for taking the questions. I'll get back in queue.

Thank you, Joe.

Our next question comes from Brian Kinstlinger with Alliance Global Partners.

Hi, good morning, guys. Thanks for taking my questions.

Hi, Brian. Thanks for joining.

Hi, Kathryn. Can you discuss the trends in bookings and proposal submissions? I joined the call late, but I’d like to know if they have been strengthening, weakening, or remaining stable, even if just at a high level. This will help us understand the market conditions.

Yes. I missed the first part. You said that bookings and what was the other...

Proposal submissions?

Yes, I think, as Kathryn mentioned, the data contributing to the softer SG&A indicates a slightly shorter than expected proposal development period. There are several government programs that have been delayed. One significant program we've discussed is a large multiple award IDIQ contract, referred to as the CIO-SP4, which will provide us with opportunities to bid on various contracts. We believe the government is close to resolving the protests they've faced over the past year, and we expect to see an award possibly by the end of Q2. This would create bidding opportunities for us in Q3 and Q4. Some of these will be long-term opportunities, while others may have quicker turnarounds, and we are ready to handle both as they arise. However, I must express some disappointment that we haven't had the chance to bid on these opportunities yet, as the bookings continue to be delayed. That said, we are still working on developing value propositions and believe we will secure wins on some of our existing IDIQ contracts, provided that funding is available.

So I'm curious, in past coverage where I've covered some of the more defense-related IT guys, the win rates were around 25% to 30%, 30% would be excellent. I'm not sure it is similar for DLHC or not. But if it is, I'm wondering, are you casting a wide enough web outside of your existing book of business to drive growth? And if not, what can you do to increase that web to drive stronger growth?

You have been a great support for us. As a result of some capabilities that were acquired at the end of last calendar year and key investments and hires we've made, we've been very active in the last quarter to broaden our addressable market. Some agencies that previously seemed too distant are now within our reach. We've expanded our pipeline development in areas integrating stronger cybersecurity or improved health IT qualifications, and our new business pipeline is beginning to reflect that. We expect these opportunities to materialize in this fiscal year and anticipate a strong exit with the potential to secure some awards. We typically observe a win rate of around 30% in our industry, and our new business has been performing exceptionally well. We hope for a much higher rate, close to 100% on recompetes we decide to pursue. A 30% win rate is a top industry standard, while 20% is still respectable. We categorize our bids into three areas: multiple award IDIQs, which usually come in with zero bookings but offer significant potential for organic growth; small to medium-sized bids, which have been our strength in previous phases, generally ranging from $10 million to $50 million; and medium to larger opportunities over $50 million, akin to a recent $600 million or $700 million win. Now, we feel equipped to pursue some of those larger opportunities ourselves, rather than having to partner, and we're actively integrating these into our pipeline.

And that's really the opportunity for productive use of that delay time. No one desires the delays that the industry is experiencing, but for us, particularly probably more so than most, it's an opportunity to really have the client call plans working and really raise awareness and really, to your point, open the aperture, not even that far adjacent from where we've been, but more so really for people who don't necessarily think of DLH and certain capability sets because they haven't seen us there yet, but really having them understand how we have resident in the company that the breadth of capabilities that can really respond to new things and really giving those proof points and building awareness before the bid opportunities come out. So you never run out of ideas of how to raise profile and build awareness. So in some respects, we're, I think, making the best use of that delay time to really continue to improve our position for when the opportunity to bid comes in.

And that pipeline shaping activity will be, in part, reflecting the answer that Kathryn gave to Joe earlier, right? So we're doubling down on the positioning opportunities, whether the RFPs come out or not from the customer, which would lead to investment on the SG&A side. So you'll see we would expect that the next quarter's results will be more reflective of that portfolio expansion.

Great. My last question is about the GRSi transaction. I'm curious if you can share any numbers or a high-level overview. Looking at their 2023 revenue, did it grow compared to 2022? Did it decline, or is it about the same? I'm also interested to know if you've assessed where you hoped to be in terms of revenue contribution from the IT side. Are you meeting your expectations, or has it been more affected by the broader market, leaving you a bit behind your plan?

Sure, we're addressing that question. Yes, regarding the transition from '22 to '23 and beyond, the acquisition has met our expectations by enhancing our competencies, capabilities, and channels for growth in expanding markets. It has been very strong in that respect. Furthermore, when we completed the acquisition on December 8, we noted that there was still a significant portion of contracts we considered small business set asides. There was some uncertainty about retaining that work within GRSi. Typically, we would expect to retain about 49% to 50% of any arrangements with small business partners. The schedule and timing of these contracts have varied from our original expectations. While Kathryn and I anticipated the erosion in that market area, the company is effectively positioning itself. We have succeeded in securing a few contracts that we weren't overly optimistic about, but overall, these factors will have a net negative impact on revenue. We expected some erosion in small business set aside work since our capabilities enable us to compete successfully in the unrestricted market. Kathryn, would you like to elaborate on this?

Yes, that's correct. The strong EBITDA contributors have been secured and continue to perform well. There has been some decline in the lower-end work, but it’s important to note that this is from a numerical standpoint and not a reflection of the quality of the work or the clients being served. Regarding growth, GRSi has also been significantly impacted by delays in decisions related to the large IDIQ, specifically CIO-SP4. As you may recall, GRSi holds a schedule on CIO-SP3. Unlike heritage DLH, which lacked the technical capabilities to compete for CIO-SP3 but was preparing to be competitive for CIO-SP4, GRSi had prior involvement with CIO-SP3 but has outgrown its small business status. They have maintained their existing work, but opportunities to leverage their expanded talent in larger-scale operations are currently on hold. The growth strategy for GRSi faces some challenges that the entire industry is experiencing. However, in terms of their relevance to our future and their ability to contribute to our market initiatives, they are meeting our expectations.

Yes. Let me add to that. Our strategy was not solely focused on those qualifications. We have been very active in fostering collaboration throughout the business. We believe in the concept of one plus one equaling three. Therefore, we were not merely assessing their existing capabilities. What excites us the most is the synergy created by pursuing these opportunities based on our extensive NIH experience, which is significantly rooted in the science and security aspects of the business, alongside the IT components acquired. When combining these, we bring together some of the world's leading epidemiologists and research scientists with the technological capabilities associated with the acquisition. We are witnessing innovations and opportunities to present past performance references that are not commonly available in the competitive landscape. We are enthusiastic about the synergy and the possibilities it has unlocked, particularly regarding value propositions and cross-agency sales.

Okay. Thanks so much for your time. Thank you.

Well, thank you all. We really appreciate your continued support and interest in DLH. We ask you to look forward to a couple of dates in the future. And we'll meet you again in the not-too-distant future. First of all, will be March 14, where we will have our Annual Shareholders Meeting. We would actually physically be in New York. So come on by. Kathryn and I and our Board of Directors would love to see you there. And also stay tuned. We will be participating in an Emerging Technology Investor conference, large and small caps at the Alliance Global Partners events on February 7. You can read the details on our website. We will be disclosing a little bit more color around some of the technology evolution that the company has gone through and how we see that being a key part of driving value. So thank you very much, and we look forward to hearing and seeing you soon. With that, have a blessed day. Bye for now.

Take care.

Thank you. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.