Earnings Call Transcript - DLHC Q3 2025

Operator, Operator

Good day, and welcome to the DLH Holdings Fiscal 2025 Third Quarter Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Mr. Chris Witty, Investor Relations Advisory. Please go ahead, sir.

Chris Witty, Investor Relations Advisory

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 2025 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 SEC. 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 C. Parker, President and CEO

Thank you, Chris, and welcome, everyone. Welcome to our third quarter conference call, and I'm pleased to have the opportunity to report on our financial results and provide an update about the current environment and an outlook. First and foremost, I'd like to begin by thanking our stellar employees for their steadfast dedication to our customers' missions. It has been a tumultuous period as we entered fiscal '26 for technical companies, solution companies like us. Yet our employees continue to rise to the occasion, leading with innovative and productive projects and solutions supporting our customers with excellent results. Their performance is why I'm so confident about the future of DLH. Now if you'll turn to Slide 4, I'll provide an overview of our Q3 results. Starting with revenue. Our anticipated erosion from our previously discussed unbundling and small business set asides from the prior administration is continuing on plan. I'm also pleased with how effectively our team has managed through this period, and Kathryn will give some added color to that a little bit later. The new administration has added layers of funding review and approval cycles that have slowed our revenue stream, and this is from work from our existing contracts. That being compounded by the effect of both of those two features has tremendously stalled the flow of new business growth for DLH. This, of course, will be reflective relative to prior quarters. Our pipeline conversion has been slowly impacted and slowed. RFP flow over the recent quarter too has been slowed. Our delivery of proposals and material proposals, that's things like over $25 million and over $100 million, much lower than anticipated and the same for contract awards. However, having said that, I've had an opportunity along with some of my industry colleagues to have met with appropriate influencers on the hill. And I really feel optimistic that anticipated changes will be productive and on their way soon. And I'll discuss this a little greater a little bit later. With respect to margin delivery, cash flow generation and debt paydown, we've made significant progress again this period. Our operating expenses continue to decrease as we scaled operations to meet the changing revenue volume and protect margin delivery while we prioritize our investments, continue to prioritize our investment in growth initiatives. We reduced debt by $9.4 million compared with Q2. Our debt at the close of the quarter was $142.3 million, and we are a year ahead of our mandatory debt payments. We expect to continue to aggressively deploy capital to pay down debt, manage our leverage and strengthen our balance sheet. The reconciliation bill, the fiscal 2025 budget bill and fiscal 2026 White House budget request combined to give greater clarity about the administration's spending priorities in the years ahead. This will help our customers. We are pleased that DLH's capabilities continue to align with the federal government's demand and believe that funding increases for our services in core areas of focus, which include technology integration, cybersecurity, artificial intelligence and machine learning, will continue to provide opportunities for the company's growth organically. I will speak to this in further depth on the following slide. The fusion of DLAs technology and research expertise is continuing to make mission-critical impact for our customers, and we see more opportunities in the near term. Solutions that we have developed and deployed through our internal R&D program, along with collaboration with military health agencies gives us reason to believe that our top technology programs seen by our government peers are well received. Such applications leveraging technology spend in AI, robotics, engineering, unmanned aircraft systems and automation demonstrates a crucial life-saving impact of the work carried out by our staff of data scientists, engineers, technologists, etc., to have such positive impact upon our citizens, our service members and our veterans. Our unique combination of advanced technology and world-class scientific expertise continues to provide tremendous value for our customers and targeted growth, and we firmly believe that our company's experience and expertise will continue to open new doors and expand our book of business as we go forward. Now let's turn to Slide 5 for a further review of the current federal spending outlook. As you can see, we continue to believe that our core competencies and capabilities align very well with the federal technology initiatives, and we expect that the current administration's priorities will lead to new business opportunities and contract wins for us in the medium and long term. The marketplace remains dynamic as the federal workforce is being reshaped. Procurements are being reshuffled based on the administration's priorities and certain departments and programs have undergone significant changes. Our strategic actions this year, focusing on operational agility, financial flexibility and technology differentiation have proven effective in these market conditions. This approach has allowed us to navigate industry challenges and strengthening our long-term position. We remain tremendously committed to our organic growth initiatives, and we are confident in our strategy to increase this revenue and margin delivery in the quarters to come given some anticipated changes by this administration. As mentioned before, recent weeks have brought increased clarity to the programs and initiatives that have been prioritized by the administration. Modernizing federal technology, maximizing efficiencies, integrating artificial intelligence and machine learning and bolstering cybersecurity while keeping America leading edge are consistent thought lines. The enacted budget for the remainder of fiscal '25 and the administration's fiscal 2026 budget and the One Big Beautiful Bill Act provided increased funding for each of these initiatives. I mentioned earlier that anticipated changes seem to support a positive outlook for DLH. This is largely attributed to some of the acquisition reforms that are in motion that will drive priority shifts in the way in which the client buys. And this administration is really committed to accelerating the speed of delivery on these types of new opportunities and contracts. We believe this provides significant opportunity for DLH. Our company has a strong legacy of making programs more efficient for customers through the integration of cutting-edge technologies, producing millions of dollars in cost savings to the government. Federal investment in AI and machine learning, systems integration, cloud computing, software development, research and development, data analytics and other advances have aligned with what we have been building over the last two to three years and continue to invest in for near-term opportunities. While we believe the upcoming quarters will have steady procurement activity, the realignment of the customer's contracting resources may cause contract awards to slip to future periods. To navigate the market dynamics, our goals are simple and threefold. First, we'll continue to delever the company. Second, we're going to do everything we can to protect our revenue base and focus on new business and organic growth with key opportunities that drive and deliver value for our business line. And finally, we're going to continue to preserve our margin delivery through proactive scaling initiatives. And as we move past these challenges created by short-term market dynamics, we believe the company is very well poised to once again become that growth enterprise that leverages its unique capabilities through differentiation and improves governance missions and the lives of those that it touches. With that, I'd now like to turn the call over to our Chief Financial Officer, Kathryn John. Kathryn?

Kathryn M. JohnBull, Chief Financial Officer

Thanks, Zach, and good morning, everyone. We're happy to have you join us for our third quarter results for fiscal 2025. Turning to Slide 7. I'd like to provide a high-level overview of some key financial metrics for the three months ended June 30, 2025. We reported revenue of $83.3 million in the third quarter versus $100.7 million in the prior year period. The change in revenue volume reflects contributions from recent contract awards offset by the expected conversion of certain VA and DoD programs to small business contractors, which accounts for decreases of $8.5 million and $3.2 million, respectively. Additionally, government efficiency initiatives narrowed the scope of some of our work, resulting in a $2.2 million decrease. As a reminder, we are under contract to manage five of the remaining CMOP locations through the end of October, while one location, Leavenworth, Kansas is expected to transition to a new contractor on August 31. This site represents approximately $10 million in annualized revenue. Award decisions for the remaining five sites could extend beyond our current period of performance as procurement strategies are shaped by the policies of the new administration. We reported EBITDA of $8.1 million for the third quarter versus $10 million last year, primarily due to the lower overall revenue. We have successfully navigated our key management priority of appropriately scaling operating costs to changes in business volume while preserving the resources necessary for growth. EBITDA as a percentage of revenue was 9.7% this year versus 10% in fiscal 2024. From a cash standpoint, we generated approximately $9.5 million of operating cash during the quarter, as Zach mentioned, due to increased collections of receivables and sound working capital management. We noted a reduction in days sales outstanding to 46 days from 52 days at the end of Q2. Year-to-date our operating cash flow was $12.5 million versus $14.9 million last year, and we again used Q3 cash generation to delever the company. As you can see on Slide 8, we reduced debt by $9.4 million during the quarter, ending the period with $142.3 million debt outstanding. At this point, we have made all mandatory term debt payments through June 30, 2026, a year ahead of schedule, and we remain on track to convert approximately 50% to 55% of EBITDA to pay down debt this fiscal year. Given our strong record of using cash flow to delever the company and strengthen the balance sheet, combined with the liquidity provided by our $50 million revolver, we continue to believe we have sufficient capital to pursue and support a busy pipeline of opportunities. We remain well ahead of our debt covenants supporting our positive outlook for the future. This concludes my discussion of the financial statements. With that, I would now like to turn the call over to our operator to open for questions.

Operator, Operator

And the first question will come from Joe Gomes with NOBLE Capital.

Zachary C. Parker, President and CEO

Joe, I think you're breaking up.

Kathryn M. JohnBull, Chief Financial Officer

Yes, you may have cut off just a bit.

Operator, Operator

It seems Mr. Gomes' line has disconnected. Mr. Gomes, if you are listening, you can press it as well to rejoin.

Zachary C. Parker, President and CEO

Operator, you indicated that he disconnected. Let's give him a moment.

Kathryn M. JohnBull, Chief Financial Officer

All right. Let's proceed and perhaps he'll join us.

Operator, Operator

Yes, Ma'am.

Zachary C. Parker, President and CEO

While we're waiting for Joe, I want to provide some additional context regarding a few points from the opening presentation. One notable aspect is the ongoing development of our small set-aside business, which was mainly initiated in the previous administration. A key focus for us has been our support for the VA mail order pharmacy programs, which, as Kathryn mentioned, continues to make progress down the small business set-aside path. We have been collaborating closely with our customer to ensure smooth transitions, although it has progressed more slowly than we had expected last year. Overall, we anticipate significant activity in this area for the remainder of the quarter, and we will keep you updated. Conversely, other contracts that we expected to be unbundled as we entered fiscal year '25 have largely remained on track. As I noted earlier, we were hoping to offset some of that with our new business opportunities and the anticipated RFPs from indications given by the government and our customers. However, I wanted to highlight that this has significantly slowed in the last quarter, largely due to administrative factors. One important point I didn’t mention is that there were numerous cuts within the government, primarily affecting the contract acquisition personnel. These are the individuals responsible for preparing RFPs, evaluating contractor proposals, and awarding contracts, and many of them have been let go due to administrative actions, creating shortages that hinder progress. I should mention that some of these positions are being reinstated through legal actions and initiatives from our agencies, and we have noticed this trend over the past month in some agencies. Thus, we are hopeful that stability will return significantly regarding the resources needed by the government to advance these solicitations and contracts. We remain optimistic that this return will positively influence our industry’s pipeline, especially in the areas we are concentrating on.

Operator, Operator

No sir, not at all.

Kathryn M. JohnBull, Chief Financial Officer

Yes, he has tried a couple of times to get back in.

Zachary C. Parker, President and CEO

Well, operator, if there are no further questions, I think we want to take this time to certainly thank those that have participated in our session today. We continue to feel strongly about the outlook of DLH. We think that we have a good grasp on the areas that are transitioning from the government. We've got a good level of engagement with the decision makers and influencers, and I feel very optimistic that as we exit '25, we'll have some good news in Q4 regarding the positioning for a very strong recovery in '26. With that, I'll turn it back over to the operator, and we look forward to seeing everyone again soon. Have a blessed day.

Operator, Operator

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