DLH Holdings Corp. (NASDAQ:DLHC) Q3 2023 Earnings Conference Call August 3, 2023 10:00 AM ET
Company Participants
Chris Witty – Investor Relations
Zach Parker – President and Chief Executive Officer
Kathryn JohnBull – Chief Financial Officer
Conference Call Participants
Joe Gomes – NOBLE Capital
Brian Kinstlinger – Alliance Global Partners
Operator
Good morning and welcome to the DLH Holdings Fiscal 2023 Third Quarter Earnings Conference Call. [Operator Instructions] Please also note that this event is being recorded today. I would now like to turn the conference over to Chris Witty, the Investor Relations Advisor. Please go ahead, sir.
Chris Witty
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.
Zach Parker
Thank you, Chris and good morning everyone. Welcome to our 2023 third quarter conference call. We continue to make good progress and remain on track for a strong end to fiscal 2023. These accomplishments are attributed to the great commitment and talent of our accomplished and distinguished employee base. They have weathered the pandemic storm and continue to deliver high-caliber solutions and services to our clients.
Let’s dive into the financial highlights on Slide 4. I’ll first provide a high-level overview of the quarter’s financial highlights. I am pleased to announce that the third quarter revenue surpassed the $100 million mark setting a new milestone for our ongoing operations that reflects our success, acquiring and integrating, growing organizations as well as importance of key programs and agencies that we serve. We anticipate being at or better than this run rate going forward, testimony of our new phase of growth – of our next phase of growth, which is built upon organic strength, a broader array of technology-enabled solutions and reflects strong demand for the company’s extensive capabilities by the federal government.
During this quarter, our reported operating income was $7.1 million and EBITDA rose to $11.4 million. We also managed to reduce our debt by over $8 million since the end of quarter 2, utilizing our strong cash flow to delever the balance sheet efficiently. Our reported EPS was $0.12 per diluted share and our backlog at quarter end was approximately $817.8 million. We are operating in a very active and attractive bid environment and anticipate winning our fair share of our new contracts in the coming quarters, supporting the accelerated growth going forward.
Turning to Slide 5. I want to give an update on some key developments for the company and its outlook. We recently announced that DLH had been awarded a contract to compete for Expanded Digital Transformation, Systems Engineering and Cybersecurity Services for the National Heart, Lung and Blood Institute, NHLBI. As part of this program, we will continue to provide advanced solutions and technology services to support this customer as a global leader in heart, lung and blood research and training and education as well. This multiple-award contract, indefinite delivery and definite quantity contract has an award ceiling of $85 million in a 5-year contract term.
Our integration of GRSi is also on track, and we are continuing to achieve, anticipate the anticipated enterprise results since the deal’s announcement. The transition of GRSi to key DLH business systems, such as our Enterprise Resource Planning, ERP and our Human Resource Information Systems – Human Resource Information Systems is complete leading to greater operational efficiencies across the board. Our expanded go-to-market strategy is evolving as the teams pull together and demonstrate the full range of the DLH enterprise capabilities to our customers.
And lastly, as you may recall, the Fiscal Responsibility Act of 2023 was enacted early in 2023. This increased the debt ceiling and allowed budget negotiations to begin for the next fiscal year. This includes providing initial funding targets for defense and non-defense agencies alike. Of course, there’s always a possibility that we’ll face another year that begin with a continuing resolution. But in any case, our programs and capabilities remain in high demand with strong bipartisan support.
We believe the outlook is positive for fiscal 2024 and numerous opportunities to grow our top line and continue to improve the company’s underlying results. As a reminder, DLH has access to many billion-dollar plus IDIQ contract vehicles that allow us to compete on more value-added agency work than ever before. Also, the White House fiscal 2024 preliminary budget called for historic investments in research, artificial intelligence and machine learning and digital transformation areas which would also boost our growth trajectory and bottom line performance. Our highly differentiated capabilities, broad area – a broad array of contracts and diversified suite of technology solutions make us a one-stop shop for advancing the government’s goals of tomorrow, and we look forward to what fiscal 2024 will bring.
With that, I’d like to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?
Kathryn JohnBull
Thank you, Zach and good morning everyone. We are pleased to report our third quarter results for fiscal 2023.
Turning to Slide 7. I wanted to once again begin by showing the adjusted results I’ll be speaking about today. While current year metrics require no adjustments, we are providing financial data for fiscal 2022 with and without the short-term FEMA contracts in Alaska that we’ve discussed in the past. A full reconciliation of this information is also included in the back of the presentation as well as in our press release and associated filings.
Slide 8 shows the details in graphic form. Adjusted revenue rose 43% to just over $102 million this quarter from $71.5 million last year. We’re obviously very pleased to have officially crossed the $100 million quarterly revenue threshold for the first time, excluding our prior FEMA-related work. Adjusted income from operations was $7.1 million for the quarter versus $6.5 million in the prior year period, an increase of 9%. As a percent of revenue, the company reported an operating margin of 7% in fiscal ‘23 versus 10.7% in fiscal ‘22, reflecting higher non-cash depreciation and amortization expense as a result of the GRSi acquisition.
Interest expense was $4.9 million in the fiscal third quarter of 2023 versus $0.5 million in the prior year period, reflecting higher debt outstanding due to the transaction – acquisition of GRSi. The effective interest rate for cash interest paid in the third quarter of 2023 was 8.64%. DLH recorded a provision of $0.5 million and $1.7 million, respectively, for tax expense during the third quarters of fiscal ‘23 and ‘22.
We reported net income in the third quarter of approximately $1.7 million or $0.12 per diluted share versus $4.9 million or $0.34 a share last year. Adjusted EBITDA for the 3 months ended June 30, 2023, was approximately $11.4 million versus $8.4 million in the prior year period, an increase of 36%. As a percentage of sales, adjusted EBITDA margin was 11.1% versus 11.7% in the prior year period reflecting the contribution of more broadly differentiated capabilities through which we expect to earn better returns over time.
The company generated $15 million in operating cash year-to-date versus $8.3 million on an adjusted basis in the prior year period. As we will discuss on Slide 10, we believe our ability to produce strong cash flow from operations will allow the company to reduce our debt, thereby reducing interest expense and providing meaningful earnings growth to our shareholders.
Slide 9 gives an overview of key metrics for the company in terms of year-over-year improvement. The acquisition of GRSi has bolstered our top line and EBITDA performance, although the impact of non-cash depreciation and amortization largely related to acquired intangibles offset some of that progress from a GAAP earnings perspective. Importantly, the company showed progress sequentially from the second quarter, and we remain on track for additional underlying improvement going forward. While non-cash depreciation and amortization expense will continue to be high, we are working hard to delever the balance sheet and reduce interest expense in tandem.
Interest will be reduced through both mandatory and voluntary repayments, and we are actively managing our paydown strategy. With approximately 60% of debt carrying a fixed interest rate – a fixed interest rates, near-term payments are all applied to our higher interest floating rate debt. Note that approximately $0.6 million of quarterly interest expense is non-cash being the amortization of the financing arrangement figures.
Slide 10 provides an update regarding our deployment of the company’s ongoing cash flow generation to pay down debt and strengthen the balance sheet, reducing interest expense, as I mentioned. We paid off approximately $8.5 million of floating rate debt in fiscal quarter three, ending the period with $195.8 million outstanding. This puts us squarely on track to meet our quarterly pay-down targets and reduced debt by approximately $22 million this fiscal year from the level of almost $208 million following the acquisition of GRSi. We are actively managing our working capital needs and utilizing the favorable tax attributes of our acquisitions, along with stock comp plans to minimize income tax payments. We continue to anticipate that our delevering strategy will leave us with between $185 million and $187 million of debt at fiscal year-end, and we expect to pay down even greater amounts in fiscal ‘24.
This concludes my discussion of the financial statements. With that, I would now like to turn the call over to our operator for questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] At this time, we will take our first question, which will come from Joe Gomes with NOBLE Capital. Please go ahead.
Joe Gomes
Good morning. Congrats on the earnings.
Kathryn JohnBull
Good morning, Joe.
Zach Parker
Thank you. Good morning, Joe.
Joe Gomes
So I wanted to just start off, Zach, you mentioned about the IDIQs as you guys have won recently and it looks – in some of your prepared remarks in the earnings release, you talked about some of the difficult environment. Just trying to get a better idea of how you see some of those bigger IDIQs? When are they really going to start putting out opportunities for you to bid on new awards?
Zach Parker
Great question, Joe. Those are always very material to our ability to drive that organic growth, as you will know. I’m actually pretty encouraged by the most – in particular, our most recent lines, the NHLBI contractors, one in which – it’s bringing new opportunities for new workforce, but we’re in a position of really leveraging a real strong track record that we’ve had with that particular customer, particularly within the competitive environment. While it is a multiple award contract, we have over the last 4, 5 years, exhibited a real, real strong ability to have a higher win rate in this community. So we’re hoping that with our valued enterprise capabilities that, that will continue.
We have been disappointed as you all know, with the government’s slowdown up until relatively recently as it relates to issuing new work on our previous IDIQs. I think I mentioned to you before, last time that our Defense Health Agency, Omnibus 4 IDIQ still has yet to issue the first request for a proposal. And we have been on standby with a real strong team for quite some time. That still continues to be the case, but we are starting to hear some – we’ve been very proactive on that, and we’re starting to hear that they are prepared, they’re getting closer and closer to prepared to issue a few of those. Similarly, we’ve had just slower than anticipated than government announced work on our – some of our other ones within NIH.
And then lastly, as you know, many of us across the industry, we’re anxiously looking for the government to resolve their process on the largest would be IDIQs, the CIO-SP4, it is where the biomedical research technology work is for largely health and human services agency is to be conducted, one that has been very strategic for DLH. We’re fortunate that in the heritage contract, the – our GRSi has some presence and some opportunities to pursue, but those will expand once CIO-SP4 before gets resolved. It has been delayed by I think, over 100 protests, largely by some of the small business partners. And that has slipped any opportunities for us to prime any of the unrestricted work that we’ve had our eyes on for a better part of the year. But the upside of that is we do think that, like I said, with the approval, getting beyond the Budget Control Act that should give some of our agency’s greater clarity and budget and the ability to issue some of the recurring work.
Joe Gomes
Okay. Great. Thanks for that update. And then on the VA, obviously, we’ve talked about this in the past. You’re on continuing work there, I think, through October on one of the contracts, in November on the other on the bridge contracts. Just wondering kind of an update, if any, on the VA process there?
Zach Parker
Yes. Still no definitive actions as you know, and for the benefit of the audience, we have been on – will effectively bridge contracts since November of 2016 for the – they have applied two strategies relative to the acquisition approach to date since 2016. And they have – based upon market conditions and other factors, they have continued to reevaluate that acquisition strategy. Proposals have been in since the beginning of the year, largely through services able, veteran and small businesses. We are continuing to participate there in a very meaningful way as well as we’re on standby should they elect to once again revisit that acquisition strategy and to reissue those in a unrestricted environment. So we are very committed to continuing to support our veterans in a distinguished way, delivering a high degree of customer satisfaction as we have for over a decade now represented by, of course, the J.D. Power Awards and other indicators of a high degree of customer satisfaction. So no new news there yet, Joe, and – but we were being optimistic that we’re going to have an opportunity to continue to impress the agency as we go forward.
Joe Gomes
Great. Thanks for that. I will back in queue.
Zach Parker
You bet. Thank you, Joe.
Operator
[Operator Instructions] Our next question will come from Brian Kinstlinger with Alliance Global Partners. Please go ahead.
Brian Kinstlinger
Great. Thanks. Only one question. With the challenges, at least in the short-term, you talked about in the government with awards and I don’t know if you call them delays. Can you talk on the other side of the bid-and-proposal equation, are big commissions as many as last year? Are you bidding on a lot more work? Just maybe talk about the proposal activity and from a quantitative perspective or qualitative perspective? Thanks.
Zach Parker
Yes. Great question, Brian. Yes, outside of the IDIQs, we have really targeted, as we’ve described before, a pretty healthy bid-and-proposal backlog. A number of those have started to come forward. Of course, earlier in the year, as you heard us describe the end of December time frame and January, quite a bit on the re-compete activity associated with the VA work. But subsequent to that, we’ve seen in the last several months really pick up with regard to some – a couple of our major bids. So we will be finding – you will be seeing that our BMP activity, which really will start G&A we’ll be pretty heavy during Q3 and certainly, as we move into the final stages of the fiscal year. So yes, we’re starting to see some of that pickup in the non-IDIQ arena which we’re hopeful is going to be more of a trend over the course of the rest of this fiscal year. It would not be uncommon for a number of these agencies to feel the pressure at the end of this fiscal year. They have been very restrained and particularly in our areas within health and human services. Very restrained in many cases, issuing contracts where they do have funding, right? A lot of that again was due to the uncertainty prior to the Fiscal Act being deployed. Kathryn, anything to add there?
Kathryn JohnBull
No, I think that’s right. Yes, slow start to the fiscal year, but encouraging recent trends.
Brian Kinstlinger
Great. Thanks so much.
Operator
And our next question will be a follow-up from Joe Gomes of NOBLE Capital. Please go ahead.
Joe Gomes
Thanks. Just on the HSS or HHS Head Start program. You had a great start to the year when you look year-over-year. And it looks – if I’m running the numbers correctly in the last couple of quarters, you’ve been below what you did the prior year. Is there anything specific going on with that program or is it just normal ebb and flow?
Kathryn JohnBull
I would think of this year as the more indicative. If the program from a good news perspective has returned to its normal cadence of being pretty front-loaded in our fiscal year Q1 and Q2 because that aligns to many of the grantees who are, if not sponsored by us inside of school are certainly affiliated and trying to align around the school system cycle. So ‘22 definitely was extremely backloaded because remember, we were all still working our way through Omicron in Q1 and Q2 of our fiscal ‘22. And so things got pretty backloaded. That’s what makes the comparison of organic revenue year-on-year for Q3 this year look a little lumpy because of some of the back end lift we got from head start this year as opposed to this year – last year, pardon me, as opposed to this year returning to the normal layout of the contract performance.
Joe Gomes
Okay, thanks, Kathryn. Appreciate it.
Zach Parker
You are welcome.
Operator
At this time, there are no further questions in the queue. So I’ll hand it back over to Mr. Zach Parker for any closing remarks.
Zach Parker
Well, thank you all for your continued interest and support in DLH. As you probably have heard, we’re really pretty excited about the company that we have become. As we – I can assure you that so have our human capital assets and we really, really are looking forward to closing strong and really entering FY ‘24 with the type of trends and expectations that we shared before. I might add that we are also going to be attending, if you look at our investor website attending a couple of investor conferences and I can provide some additional color around the business over the coming months. We look forward to engaging with you more in the near-term and certainly look forward to closing out Q4 with you as we enter in the latter part of the year. Thank you all for your time. Have a blessed and productive day. Bye for now.
Kathryn JohnBull
Thank you.
Operator
The conference has now concluded. Thank you very much for attending today’s presentation. You may now disconnect your lines.
