DLH Holdings Corp. Q4 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. 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 the 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 very much, Chris, and welcome to everyone here for joining us on the fourth quarter communication. I'd like to take a moment to once again express our appreciation for the tremendous commitment that our workforce has given during this quarter to be able to deliver great results. It happens to be a very, very strong end of the year. And we are truly blessed to have a strongly committed team of scientists, technologists, and subject matter experts delivering every day for our customers, and we really appreciate that. In addition, we're going to cover a number of things on today's call as we want to really give some highlights around our differentiating capabilities. Our troops have really done a tremendous job, and I know we'll continue to do so in the quarters to come. Now turning to Slide 4, I'll provide an overview of our financial results. We reported fourth quarter revenue of $96.4 million, and for the full year, revenue increased to nearly $396 million, surpassing our previous record results. Our EBITDA for the fourth quarter was $10.7 million and $42 million for the fiscal year. We generated operating cash of $12.5 million during the period, equating to $27.4 million of operating cash flow for the fiscal year. This cash-generating ability allowed us to pay down debt by $11.9 million in the fourth quarter, ending the fiscal year with $154.6 million in total debt outstanding. Kathryn will review our results further in a moment. If you would turn to Slide 5, I'd like to give you an update on our near-term outlook as we move into a new year and soon a new administration. We are very pleased to announce a new $76 million contract award with the United States Navy at the tail end of the quarter. This highly competitive award was won through a procurement process unseating a long-term incumbent. Under this contract, we will provide critical systems engineering and integrated logistics support to support our fleet's C5ISR missions. Wins such as this illustrate the newly positioned DLH organic growth posture as we go forward. With a focus on leveraging our technology-enabled solutions and implementing strategically new business development capabilities to win contracts from across our client base. Turning to broader industry trends, we are operating, of course, under another continuing resolution, which, when combined with an election year and the changing priorities of the new presidential administration, is expected to have a substantial reshaping of the federal government procurement landscape. Changes developed by traditional cabinet secretaries as well as other advisory organizations, such as the Department of Government Efficiency (DOGE), will likely emerge in our fiscal '25 second and third quarters. As we remain very close to the administration's transition team, it's important that we keep focused on how we see it impacting our addressable market, as DLH. I'm happy to tell you that at this stage, despite many headlines, we see it as neutral to slightly positive over the long haul with regard to our addressable market and growth forecast. To support our growth plan for fiscal '25, we recently amended our credit facility to provide flexibility while navigating small business conversion headwinds that we've talked about previously, most notably regarding our CMOP portfolio. We're operating under new task orders that currently extend our services into the second quarter of fiscal 2025 as the VA continues to try to work through its procurement process. We continue to expect that the VA will conclude these procurements and make award decisions within fiscal 2025. In our last discussion during the previous quarter, we indicated that we are evaluating our CMOP proposal strategy in response to new amendments to the procurement process that were issued by the VA. In short, we have not continued our joint venture bids in response to all of those VA acquisition changes. We believe those changes will further dilute the performance standards required, which typically results in low bidder awards. However, we have selectively participated in some sites as a value-added subcontractor. Turning to Slide 6, let me provide further detail into how we see the future of the company evolving. Over eight years ago, Kathryn and I began communicating and implementing an acquisition strategy designed to deliver on our strategy, which was to expand into specific technology and scientific capabilities and to diversify into selected markets beyond the VA. The DLH you see today is the result of that strategy successfully unfolding to assemble a dynamic science-and-technology-based enterprise with a broad set of capabilities and customers to create an enterprise that is greater than the sum of its parts. We are now taking that organization for organic growth, and we're excited about the added business development engines that we have put into place. We were intentional about building a company capable of addressing the full range of our targeted customers' requirements in a way that offers an agile, best practice-based, high-tech solution to compete favorably in the organic space. We think about our differentiating capabilities in three primary components: digital transformation and cybersecurity, science research and development, and systems engineering and integration. We refer to those as DTC, SRD, and SE&I. The main reason for having built this capability over the years has been to strengthen these service offerings in relation to key agencies that have demonstrated strategically a strong interest in those capabilities. These happen to be the channels in which we provide our strong capabilities in artificial intelligence, machine learning, robotics engineering, telehealth tools and technologies, modeling and simulation, specialized engineering, and the like. These are the powerful capabilities that we're able to leverage in developing winning solutions, much like on the recent award. With these fully assembled capabilities, we're pursuing a nearly $4 billion pipeline of new business opportunities for which we have substantially elevated win probabilities. As our investors know, we already have a seat at the table for many relevant future task orders through existing long-term IDIQ contract vehicles, and we are continuing to seek more. We're also using our organic growth engine to go after larger, broader contracts that resemble our most recent win with the Navy. These services are in high demand because the federal government is looking to drive efficiencies. They're also looking to partner with organizations like us, a company that in its DNA has been rooted in driving efficiencies, delivering best value, and reducing costs to our clients. These require more complex answers: how to get things done, how to do things differently and more efficiently, leveraging tools such as AI and machine learning and supportive data analytics, how to leverage digital transformation, cloud-based secure computing to improve systems performance, and to pursue capabilities such as achieving precision medicine in the future. We also look at how to ensure that their networks are safe from cybersecurity attacks and how to tackle the health care challenges of today and tomorrow. Our highly credentialed staff, including our health IT professionals, a world-class team of experts, deliver these mission-critical solutions and services to our customers every day. The DLH team is recognized as thought leaders within the health and defense markets more and more, where we're pursuing major organic growth opportunities. This is where we are, and we are looking forward to the future. Given our expanded capabilities and focus on these end markets, I believe we are at a precipice of a new day at DLH, which will take us to much higher levels and stronger values as we achieve top-line growth and operating performance. This is clearly an exciting time as we navigate through some of these administrative and other near-term challenges. We appreciate all of our investors who have joined us through this journey, and we're even more excited about continuing the successful strategy unfolding that we have shared with you over the last decade. We're excited about what the future holds for shareholder value with DLH. With that, I'd 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 fourth-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 September 30, 2024. We reported revenue of $96.4 million in the fourth quarter, reflecting the conversion of contracts to small business set-aside programs, including the first CMOP site, as we discussed last quarter. While we continue to see expansion and wins across our health IT and readiness customers, as Zach discussed, we believe that future periods will be impacted by additional small business transitions. We reported adjusted EBITDA of $10.7 million for the fourth quarter versus $12.1 million last year. Adjusted EBITDA was down due to the overall sales level in the mix of business, including a higher proportion of revenue derived from non-labor costs, which inherently produce a lower margin. If you'll turn to Slide 9, I'll review some key financial metrics for the full fiscal year. Revenue rose 5.3% to just under $396 million, primarily reflecting the impact from our acquisition in December 2022, along with growth in our HHS portfolio, partially offset by the small business conversions we've discussed. Adjusted EBITDA is roughly flat year-over-year at $42 million, and the company generated operating cash of $27.4 million for the full fiscal year, down from $31 million in 2023. The decrease year-over-year was primarily due to the payment of lease liabilities established as part of the December 2022 acquisition, partially offset by a decrease in day sales outstanding to 45 days. Slide 10 provides an update on our deployment of the company's cash to reduce debt, strengthen the balance sheet, and lower cash interest expense. We paid off approximately $11.9 million of our higher interest floating rate debt during the quarter, ending the period with $154.6 million of total debt outstanding. As a result, we satisfied all mandatory amortization payments through fiscal 2025. We plan to continue using cash from operations to reduce debt going forward. In addition, our amended credit facility will provide greater financial covenant flexibility as we navigate the conversion of certain contracts to small business contractors. Now turning to Slide 11, I'd like to review our go-forward growth strategy following up on what Zach discussed earlier. As Zach mentioned, we have a robust pipeline of qualified opportunities estimated to be worth over $4 billion across our core technology and readiness capabilities, which positions us for expansion and improved operating performance in the years to come. That said, while timing is still uncertain due to the changing landscape of government decision makers, we are confident in our ability to capture new business awards and grow meaningfully organically. This process takes time to complete, but nevertheless is moving forward, and we expect that many key decisions will be made in fiscal 2025. As Zach mentioned earlier, we began this journey many years ago with our first acquisition in fiscal 2016 as we sought to build a diversified technology-powered company. We continue to expand our capabilities by bringing in more companies into the DLH enterprise through our acquisition program. We ended fiscal 2024 with revenue of $396 million, of which approximately $140 million was from our CMOP portfolio, leaving roughly $256 million delivered from our technology-powered solutions and services. Our EBITDA margin was 10.6%, with approximately equal contributions from both components. While not providing guidance, we believe that in the near term, by targeting growth vehicles and programs within our core technology sectors, we can drive our technology powered solutions portfolio to $300 million in annualized revenue. In that scenario, we would expect our EBITDA margin to be around 9% as we maintain our investment in strategic solutioning and business development initiatives to deliver organic growth. We believe that the 9% margin delivery is a transitional balance between our historical and future margins of over 10%, that is necessary to maintain our ability to grow in the longer term. Over the longer term, we envision further growth in our technology powered solutions. In a scenario that encompasses a $500 million annual revenue run rate, we would anticipate EBITDA margins to expand as we leverage economies of scale and improve our overall operating structure. Again, we're not providing guidance but rather offering insight to investors on our future focus on the health IT and readiness portfolio we've assembled. In future discussions, we expect to continue providing this bifurcated view of the enterprise for clarity to the investor community. In closing, I share Zach's enthusiasm about the future of DLH as we continue to execute our growth strategy and support the critical missions of our customers. This concludes my discussion of the financial statements, and with that, I would now like to turn the call over to our operator to open for questions. Thank you.

Thank you. Good morning, Zach and Kathryn.

Good morning, Joe.

Hey, Joe.

I know this is a bit retrospective, but I wanted to discuss the CMOP. It appears that for fiscal 2025, the first and second quarters should be somewhat similar to the fourth quarter run rate. However, after the second quarter, when the contract extension concludes, there will likely be a significant decline. I was curious about what percentage of the $140 million CMOP from the past fiscal year you are pursuing as a subcontractor.

Yes. Thanks. Great first question there, Joe. Yes, I think you're not far off. Our best estimate is that Q1 and Q2 will be relatively similar to Q4. Obviously, there will be some variances. It is our current expectation and communications with the VA that they are anticipating executing on some of the other awards downstream. We're looking at material aspects to be reflected in the second half of the year for FY '25, which coincides with the time period provided there's not too much delay or paralysis associated with the continuing resolution and the award of new contracts with the ramp-up hopefully of some decisions to be made on the bids and proposals that we have in place now. Regarding our commitments on the bids, it's still a very procurement-sensitive environment. So we're really not providing much color there. I can tell you we are not bidding on all of them. There are several we are not bidding on. We have elected to participate with small business partners on a few, and we'll leave it at that.

Okay, thank you for that. In the quarter, you continue to do a great job on the SG&A side, down about $8.5 million. Is that a good run rate, or do you think there's more that can be taken out on the SG&A, obviously putting aside the whole CMOP part of it?

I think our SG&A rate will run around. It will probably as we indicated in our discussion on Slide 11 in the deck, we will feel some growth as a percent of top line as that top line as CMOP exits the top line. But we expect to scale the business appropriately. If you think about gross margin running at 20% to 21% and EBITDA of 9%, that implies SG&A of somewhere between 11% and 12%. We understand the importance of scaling SG&A costs where we can reasonably, but we need to balance that with our ability to execute and deliver on our organic growth strategy.

Okay. On the defense presence that you guys have, obviously, we are having a new administration come in here in another month. Same thing on the DOGE. Could you give us a little more color detail on the opportunities that this opens up for you guys and how that fits into some of your core strengths, especially on the DOGE going forward?

Yes, great question. Yes, and I've had the pleasure of sitting down multiple times with folks on the transition team working with a variety of agencies and also the DOGE Commission. What we like about it in terms of our heritage and DNA is we've been a company that if you look at the example of the CMOP over the course of when we took it over, the number one driving aspect for growth for us was that we were driving efficiencies into the business that they had not accomplished before. These efficiencies led the VA to achieve record levels of service while delivering their pharmaceutical services with the highest standards of customer satisfaction. Our culture has been that way all along. Every time we brought in new members through acquisitions and organic growth, that has also been a cultural imperative to ensure alignment. I can tell you that on all the contracts we execute, we are looking to drive best practices in a way that delivers efficiencies and cost savings, even at the expense of revenue. We're looking forward to having a dialogue with the new administration to explore opportunities as they seek to accelerate efficiencies.

Great. One more if I may, and I'll turn it over. Kathryn, I know it's a very fluid situation here, but do you have any goal for debt reduction for fiscal 2025 that you care to share with us?

I expect to continue at a very healthy EBITDA conversion rate. My internal target is 55% of that. It will depend on the timing of when CMOP exits the portfolio, but whatever EBITDA we deliver, I do expect us to convert that smartly to pay down debt.

Thank you.

Thank you, Joe.

Good morning, Zach and Kathryn. Congratulations on a solid quarter and year end. I had a question on the intangible assets number on the balance sheet. I noticed it went down a bit this quarter from last quarter. Am I correct in assuming that it contains a component representing a discounted future cash flow pipeline of contracts that we've won but haven't yet executed on? If so, how much did the new Navy contract pump that number up? If not, where does that appear on the balance sheet?

The balance sheet is really a function of what exists at the time of the acquisition. Purchase accounting requires you to value the business you acquired. It allows you to establish an asset for awarded contracts. It doesn't allow you to value your pipeline of potential future opportunities, which is considered inherent in goodwill. The intangible related to the backlog of all acquired companies is footnoted out for us in the 10-K. Those amortize over average useful lives of the contracts at the time of the acquisition, typically between 7 and 10 years.

So that Navy contract would appear that some component of it would have bumped the intangible assets?

No.

Since that was not a contract that the acquired company had at the time we bought them, it's not a part of that valuation.

Okay. I got you. Thanks so much. Have a happy holiday.

Yes, thank you.

Thank you, Burt.

Same to you Burt, you and yours. Maybe we'll see you March 13 when we have our annual shareholder meeting.

Absolutely. Thanks for joining us.

Hi, Zach. Hi, Kathryn. Good morning.

Hey, Ross.

The only question I had was around just setting aside CMOP. My understanding is that you faced a headwind of small business set-asides in other parts of the business as well. Is there a known amount or horizon of that transition or is it an ongoing process?

Yes, great question, Ross. Yes, indeed, there was a component that was inherent and we disclosed to some extent. Every one of our acquisitions had a portion of their business that was subject to small business set-aside. Some of those had a year of life, some of them two years of life before they came around. We've had some material impacts from that over the last year, where very large contracts have transitioned to small business set-aside. We model these and have had some pretty significant effects. We're finding the government trying to unbundle or break apart contracts, and we're modeling when those risks are anticipated to occur. We do see erosion from the continuing small business set-aside work, both planned from acquisitions and in response to the executive order. At the same time, our new business pipeline position is as good as it's ever been. We successfully won 100% of all our prime eligible recompetes in fiscal '24 and are hoping the government will make more decisions soon.

What we are describing is the philosophy and direction provided by the outgoing administration. We are watching carefully what the new administration will set forward as their goals. Our job is to define a set of capabilities and markets that provide robust enough pipeline to offset some of the ebbs and flows based on changes in philosophy and strategy for our customers. We are excited about our ability to execute against that $4 billion pipeline.

That's very helpful. Yes, great point, Kathryn. Everything could change come January. Just a quick follow-up on that. Is it fair to think about fiscal 2024 as facing that headwind and not seeing as much ramp as you might have otherwise hoped?

Yes, that's a great question. Our new business pipeline is at a record for a couple of reasons. We've gotten really good at identifying and positioning for some high-quality opportunities that reflect the totality of our capabilities. However, we would love to see more decisions, so there are things we anticipated that have slipped. It's largely due to budget instability, which comes with continuing resolutions where customers can't make decisions, which has impacted our ability to see more ramp.

Thanks for joining us, Ross.

This concludes our question-and-answer session. I would like to turn the conference back over to Zach Parker, President and CEO for any closing remarks.

Thank you. Once again, I want to thank you all for participating today and for your continued support and interest in DLH. We are really excited about what the future holds. We appreciate your continued interest and will keep you posted on the impact of the administration changes and the continued evolution of DLH. A major part of that will be our descriptions of the business as we approach our annual meeting for the shareholders, which is scheduled for March 13. We look forward to engaging with you as we continue to keep you abreast of both Q1 and the implementation of the strategy. Thank you again, and have a blessed day. Bye for now.

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