Earnings Call Transcript - DLHC Q2 2023

Operator, Operator

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

Chris Witty, Investor Relations Adviser

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, President and CEO

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 the $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 was $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, we 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 deleverage 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 came as a result of 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 its expertise toward 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 Cancer Institute. The estimated aggregate ceiling value of this multivendor blanket purchase agreement is $1.7 billion. We hope 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 warfare 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 wins 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 delighted to have her on board. She has already made a positive impact on our organization, and we look forward to her taking 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 the services that we provide. Our highly credentialed staff and innovative offerings align 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 learning, and digital transformation, which are all in our wheelhouse and bode 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, cybersecurity, 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, CFO

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 quarterly revenue threshold as Zach 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. As of the date of this call, we 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 closed 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, deleveraging 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.

Operator, Operator

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

Joseph Gomes, Analyst

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, President and CEO

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 contracts, which required the 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 from 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 in the latter part of last year, we're still just now starting to have a pretty heavy load of 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, Analyst

Okay. 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 were there some one-time items in that that drove that revenue increase on the pharmacy side?

Zachary Parker, President and CEO

Yes. Coming out of COVID, we've learned a lot about our veterans and their readiness to deal with some of the challenges we are addressing. The VA implemented several new regulations that will increase traffic to the mail-order pharmacy instead of allowing metro areas to pick up their needs at local VA hospitals. We believe this trend is on the rise. It may have stabilized now, and we expect it to remain steady moving forward. However, you have observed the changes brought about by the post-COVID regulatory environment for veterans.

Joseph Gomes, Analyst

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, President and CEO

Yes, there hasn't been any significant change since our last report. We have submitted the proposals for service-disabled veteran small businesses as required by the government. We are actively participating in that part of the acquisition strategy. Additionally, we remain ready and available in case they decide that pursuing that option is not in the best interest of the government, allowing us to continue providing those services through extensions of our current contracts, which are set to expire at the end of the fourth quarter of the calendar year. We will then assess the next acquisition strategy if adjustments are necessary. Since our last conversation, there have been no awards, and all proposals were submitted during the first quarter of the calendar year.

Joseph Gomes, Analyst

Okay. Katherine, could you explain the adjusted operating margin for this quarter? Last year it was about 6.8%. I'm curious about what changed. We anticipated that the GRSI segment would help improve operating margins, but it seems we took a step back this quarter.

Kathryn JohnBull, CFO

Yes. A key contributor to that is, of course, the noncash depreciation and amortization, which puts about 0.5 points 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, Analyst

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 of some of the major ones that you're looking at and give us a little bit more color or detail around that.

Zachary Parker, President and CEO

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. 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 felt 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, one of those, again, with our strategic interest in the National Cancer Institute. 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. The other opportunity, which we also announced, involves the defense health agency, Omnibus 4, which is for medical research for military health. 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 able to bid on that and potentially recognize that revenue early next fiscal year.

Joseph Gomes, Analyst

Great. Thanks for those updates. Really appreciate it, and I'll get back in queue.

Operator, Operator

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

Joseph Gomes, Analyst

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, President and CEO

Yes. Those are the areas that I am really, really most excited about. 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. There's some adjacencies in the nature of the work in the future. But things like precision medicine that depend very heavily on the computing power, 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 of our nation is really heavily focused on advancing the state of that business. We think we're really uniquely positioned for some of those cross-selling opportunities within the HHS arena. We also have some opportunities that we would not have been in a position to prime that support the readiness posture largely for our fleet in the Defense Health Agency. We think the combination 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 positions us in a differentiating way for several opportunities going forward. So I think what you'll see is a continued expansion of our support for military health in that regard as well as on the public Hill side for research with a heavy dependence on technology and innovation for the future.

Joseph Gomes, Analyst

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

Kathryn JohnBull, CFO

Yes, we have discussed that GRSI has a strong growth track record, and we are expecting low double-digit growth. We believe they are on an upward trend, and the volume of activity mentioned by Zach, particularly with key public health and national security customers, should facilitate continued support for that growth rate.

Joseph Gomes, Analyst

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 million for this year?

Kathryn JohnBull, CFO

Yes, I believe there will be pressure on interest expenses due to the continued rise in interest rates, including the recent increase. We have hedged a significant portion of this through our swap contract established in January. However, we still have some floating rate debt, which will be affected as well. This past quarter, we were disappointed with how contract payments were structured. We are pleased to report that we resolved that issue by this call, and we're satisfied with our position as of March 31. This is a multifaceted challenge. The pressure from rising interest rates will lead to increased interest expenses. There is also a noncash element related to amortization of deferred financing costs from an EBITDA standpoint. However, as you pointed out, the cash component of interest expenses will be slightly more than $14 million.

Zachary Parker, President and CEO

Anthony, back over to you.

Operator, 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, President and CEO

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, Operator

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