Earnings Call Transcript - DLHC Q4 2023

Chris Witty, Investor Relations Adviser

Good morning, and welcome to the DLH Holdings Corp. Fiscal 2023 Fourth Quarter Earnings Conference Call. All participants are in a listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Chris Witty, Investor Relations Adviser. Please go ahead.

Zach Parker, President and CEO

Thank you, Chris, and good morning, everyone. Welcome to our 2023 fourth quarter conference call. I am very pleased with the way that we have finished the year and with our strong position heading into fiscal 2024. But first, let me take a minute to once again thank our dedicated employees for their passion, commitment, and performance excellence that they have delivered in support of all of our customers' missions and to our corporation. This has been a transformative year for our company, and without the steadfast contribution of our team members at every level, DLH would not be the leading technology solutions and services provider that it is today. In all three channels—our digital transformation and cybersecurity, our science and research and development, and our systems engineering integration—all of our members have really shined. So thank you. Now turning to Slide 4. I'll first provide a high-level overview of the financial highlights for the quarter and the fiscal 2023. Fourth quarter revenue was $101.5 million, reflecting the impact of our acquisition as well as organic growth across our existing business. For the full year, revenue rose nearly $376 million from an adjusted $269 million in fiscal 2022, which, of course, excludes the short-term turnkey contract with FEMA to support Alaska's response to COVID-19. Given our sizable backlog, increased addressable market, and access to bid on various task orders through our several large contracts, we believe that the future continues to look bright for DLH. Adjusted operating income was $7.8 million for the quarter and $26.5 million for fiscal 2023, while adjusted EBITDA rose to $12.1 million for Q4 and $42.1 million for the year. In addition, we generated $31 million in cash from operations over the past 12 months and exited the quarter with approximately $179.4 million in debt, down from $207.6 million after our December '22 acquisition. As Kathryn will discuss further in a moment, we plan to continue using our company's strong cash flow generation to reduce debt in the coming year as we work towards further delevering our balance sheet. Our adjusted EPS was $0.16 per diluted share for the quarter and $0.55 for the full year, and our backlog as of September 30, 2023, was just under $705 million. We continue to operate in an active bid environment, even as the government works its way through the current continuing resolution circumstance. We remain very upbeat about the opportunities ahead and the path to accelerate top line growth moving forward organically. On that point, Slide 5 provides an update on certain key market conditions and metrics that have the potential to impact the Company in the quarters to come. First, the Company has worked diligently to align our business structure with our expanded capabilities and technology-based go-to-market strategy. Our highly credentialed staff are dedicated to providing the most advanced solutions that address the needs of each of our clients, positioning us to compete for more higher-value opportunities going forward. As customers continue utilizing professional services contractors, we can leverage our expertise, experience, and applications to further penetrate agencies and expand our book of business and accelerated growth. Second, the federal government remains committed to expanding the role of cybersecurity, given the crucial ongoing need to protect sensitive information and big data networks, as well as the personal records of millions of Americans. The use of cloud-based computing only increases cybersecurity's criticality and importance to protecting sensitive government systems and data. This aligns well with our intellectual property, secure data platforms, and technology-driven solutions. Third, as I mentioned a moment ago, the federal government continues to operate under a continuing resolution with certain agencies funded through January 19 and others through February 2. While this does at times restrict and hamper certain decision-making across some federal agencies, particularly with regard to awarding new contracts, it is not expected to materially impact DLH's current book of business nor the near-term outlook. Our wide array of programs and services provide a solid foundation for the Company's top line over the coming months. In addition, the core agencies we support—including the Department of Defense, Veteran Affairs, and Health and Human Services organizations—typically receive broad bipartisan support, which we anticipate will continue. The White House in its fiscal 2024 preliminary budget called for historic investments in research, artificial intelligence, machine learning, and digital transformation, which would all play very well to our growing and somewhat unique capabilities and increase the opportunity for further top line expansion along strong underlying performance. Lastly, our expanded capabilities and expertise provide the opportunity for us to bid on task orders from several new large IDIQ contracts that remain on the horizon. There's every indication that the government will continue to award a growing volume of work through these prescreened arrangements. Strategic contracts that are under consideration apply to us include our CBIIT contract, recently announced, the major CIO-SP4 supporting biomedical research coming from the National Institute of Health, OASIS, and several other large ceiling multiyear contract vehicles. These multiple award IDIQ contracts offer numerous opportunities for high-value work over the coming years that can substantially raise the revenue base of the Company and task orders as they are awarded. We are confident in our ability to win task orders on these vehicles, which we expect to impact the Company's growth trajectory for years to come. Given our advanced solutions, highly engaged customer relationships, and the unparalleled expertise of our amazing staff, we are very optimistic for FY '24 and beyond. 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 final results for fiscal 2023, and we believe these results demonstrate how our broad capabilities, employee expertise, and delivery execution produced consistently strong financial performance. Starting with Slide 7, we provide a high-level overview of our results for Q4 of FY '23 compared to the same quarter of FY '22 on both a GAAP and adjusted basis. The fiscal '23 adjusted EBITDA and adjusted operating income figures exclude the previously announced $7.7 million impairment charge related to real estate assets as we consolidated underutilized premises as part of an ongoing facility rationalization effort. Walking from operating to net income, interest expense was $4.8 million in the fiscal fourth quarter of '23, reflecting higher debt outstanding due to the acquisition and increased interest rates. DLH recorded a tax benefit of $2 million during the fourth quarter of fiscal '23 versus an expense of $0.8 million last year. As a result, we reported a net loss in the fourth quarter of approximately $2.6 million or $0.18 per diluted share. By comparison, the prior year fourth quarter adjusted results exclude $0.4 million of corporate development costs related to the December '22 acquisition from operating income. Interest expense was $0.5 million in the period, and we reported net income of $3.4 million or $0.24 a share. A full reconciliation of this information is included in the back of the presentation as well as in our press release and associated filings. Slide 8 shows these details in graphic form. Adjusted revenue rose 51% to roughly $102 million this quarter from $67 million last year, reflecting both organic and acquisition-related growth. Adjusted EBITDA for the three months ended September 30, '23, was approximately $12.1 million versus $7 million in the prior year period, an increase of 73%. As a percentage of sales, adjusted EBITDA margin was 11.9% versus 10.4% in the prior year period, reflecting higher value capabilities across a larger business base. While our fiscal '23 fourth quarter results are particularly strong due to the timing of certain expenses, we expect our EBITDA margin to remain at approximately 11% prospectively. After reducing adjusted EBITDA by depreciation and amortization expense of $4.3 million and $1.9 million for the respective quarters, adjusted income from operations was $7.8 million for quarter '23 versus $5.1 million in the prior year period, an increase of approximately 53%. As a percentage of revenue, the Company reported adjusted operating margin of 7.7% in fiscal '23 versus 7.5% in fiscal '22, with a richer mix of business offsetting the impact from higher noncash depreciation and amortization expense. The Company generated $31 million in operating cash for the full fiscal year versus $14.3 million on an adjusted basis in fiscal '22. As Zach mentioned, we anticipate continued strong cash flow generation going forward, allowing us to further delever the Company in the quarters to come. Turning to Slide 9, we give an overview of key metrics on a year-over-year basis, highlighting the significant improvement in adjusted EBITDA. While interest expense rose considerably due to the higher debt balance and elevated interest rates, our delevering strategy is clearly focused on eliminating debt, utilizing both mandatory and voluntary repayments as rapidly as possible, thus reducing our interest expense exposure. Note that approximately $0.6 million of quarterly interest expense is noncash amortization of financing arrangement fees. I'd like to emphasize that our adjusted operating income performance improved substantially, reflecting favorable contract margins on our current mix of programs and the impact of increased operating leverage; although these results were offset by noncash depreciation and amortization expense. The bottom line is that our acquisitions significantly opened new doors for the Company, elevated our presence in key agencies, and strengthened our margin profile over the long term. Slide 10 illustrates the successful deployment of our sizable cash flow generation to pay down debt and strengthen the Company's balance sheet over the past four quarters, along with an initial estimate for the year ahead. We paid off approximately $16.4 million of debt in Q4, ending the fiscal year with $179.4 million outstanding. In total, we've eliminated $28.2 million of debt since December '22, doing so by satisfying our mandatory payments of $14.3 million and making voluntary prepayments of $13.9 million. Approximately 60% of our debt carries a fixed interest rate, so all payments we make are against higher-interest floating rate debt. Notably, the Company's interest rate swaps maintained a relative 50-50 split between fixed and floating debt between fiscal '23, limiting our interest rate risk. As a result of our effective implementation of swap arrangements, our effective interest rate since the December '22 acquisition was approximately 8.7%. We continue to actively manage our working capital and cash flow requirements while simultaneously investing in the business and utilizing the favorable tax attributes of our acquisitions and our stock compensation plans to minimize cash tax payments. Our strategy to effectively manage cash flow to pay down debt is designed to reduce future interest expense obligations. Looking forward, we anticipate that our delevering strategy will leave us somewhere between $157 million or as low as $153 million of debt by the end of fiscal '24. Turning to Slide 11, we're poised for a new stage in our growth trajectory and development as a company. Our focus remains on expanding top line volume through high-quality franchise programs while continuing our delivery of strong margins. The transformation of DLH into a world-class technology provider illustrates the successful execution of our acquisitive and organic growth strategies and our commitment to generating long-term value for our shareholders. We stand ready to take DLH to the next level, delivering unique, innovative solutions across the federal health and cyber defense markets. This concludes my discussion of the financial statements, and with that, I would now like to turn the call over to our operator for questions.

Unidentified Analyst, Analyst

This is Justin filling in for Joe. So, I just wanted to start off with just looking at the IDIQ contract. Obviously, in the presentation, you guys have some priority IDIQs remaining pending. I just want to ask, is the Company starting to see this opportunity sort of bidding on new awards like as the environment has gotten better from what it was in the previous quarters?

Zach Parker, President and CEO

I didn't catch that. Could you repeat what you said before regarding the environment, Justin?

Unidentified Analyst, Analyst

I was saying has the environment gotten better from the previous quarter?

Zach Parker, President and CEO

Yes, we're seeing some signs of progress with our biggest pending opportunity, which we refer to as CIO-SP4. Over the past 1.5 years, we've identified around eight or nine opportunities that were planned for awards after the CLS, but delays have not worked in our favor. However, we are receiving indications that the government is making progress with the protest information. In fact, just in the last couple of weeks, we've heard encouraging news that they may be able to move forward and issue an award soon. This would be a positive development. While we've missed some opportunities, we're also strategically looking ahead and believe there are still several prospects that could lead to bookings in the early part of fiscal '24. So, we are hopeful regarding this significant opportunity. At the moment, we do not have a prime position in the unrestricted CIO-SP3.

Unidentified Analyst, Analyst

Can you provide us with an update on the VA contract? Last quarter, there wasn't much change, but you seemed a bit optimistic. Any information on that would be helpful.

Zach Parker, President and CEO

Yes, there has been very little activity so far. We remain the incumbent and are excited about the opportunity to work during this time while they are still making acquisition decisions. Our best estimate is that we do not anticipate a significant impact even if they move forward with their decisions. However, we have been closely collaborating and continue to deliver results. Our workforce is doing an excellent job of staying focused despite the acquisition matters.

Unidentified Analyst, Analyst

Great. And then last one, if I may. Last quarter in regards to the proposal backlog, you mentioned the non-IDIQ area was kind of trending positively. Can you kind of see that going into the new year?

Zach Parker, President and CEO

Yes. The biggest wildcard on that is really how agencies respond to that continuing resolution decision, the last one, of course, being February 1. There are some agencies that have been reluctant to put new contracts in place largely because of uncertainty about their full-year budget impact. But our leadership team has been really working hard to encourage those customers to issue those task orders on our current work, the National Cancer Institute. We're starting to see some signs that they may start to leverage the multiple award IDIQ we have there. We're also starting to see signs that the Defense Health Agency is moving forward. They've got in our minds a lot more budget certainty than some of the other agencies regarding the non-weapons systems. So, we're really optimistic that we'll see some more base flow come through over the next quarter, and we'll get our share. Thank you, Andrea, and thank you all for your participation and steadfast support of DLH. We're really, really pleased as we closed the year that we are so well positioned to now execute that next leg of our strategy with respect to both organic growth and performance excellence. So thank you for your participation. Of course, next calendar quarter, we will be having our annual meeting with shareholders. So, we look forward to having a deeper dive and some further engagement with you all. Thank you. Have a blessed day, and we'll chat with you soon. Bye for now.

Chris Witty, Investor Relations Adviser

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