DLH Holdings Corp. — Q1 FY2023 Form 10-Q
Reporting period: Three months ended December 31, 2022; unaudited. DLH provides technology-enabled health, public health, engineering, and program services, predominantly to U.S. federal agencies. Unless noted otherwise, amounts below are in U.S. dollars.
Financial performance
| Metric | Q1 FY2023 | Q1 FY2022 |
|---|---|---|
| Revenue | $72.7 million | $152.8 million |
| Operating income / margin | $3.9 million / 5.4% | $11.2 million / 7.3% |
| Net income | $1.5 million | $7.8 million |
| Diluted EPS | $0.11 | $0.55 |
| Adjusted EBITDA / margin on adjusted revenue | $7.2 million / 10.9% | $6.9 million / 11.1% |
| Operating cash flow | $8.0 million provided | $16.2 million used |
Reported revenue fell 52.4%, primarily because the prior-year quarter included $91.1 million from FEMA task orders supporting Alaska’s COVID-19 response; those orders ended in the following quarter. On DLH’s non-GAAP adjusted basis, excluding those task orders and GRSi’s post-acquisition contribution, revenue rose to $65.9 million from $61.7 million, adjusted operating income increased to $5.3 million from $4.9 million, and adjusted net income rose to $3.6 million from $3.1 million. These company-defined measures are not GAAP and may not be comparable with similarly titled measures at other companies.
Contract costs were $57.3 million; general and administrative costs were $7.4 million, including higher costs partly attributable to GRSi; and acquisition-related corporate development costs were $1.7 million. Depreciation and amortization was $2.4 million. Interest expense increased to $1.8 million from $0.7 million, largely reflecting acquisition financing. The effective tax rate was 26% in both periods.
Acquisition, balance sheet and liquidity
DLH acquired Grove Resource Solutions, LLC (GRSi) on December 8, 2022, for preliminary net consideration of $185.1 million. It financed the transaction principally with debt and issued approximately 527,000 shares valued at $7.0 million. GRSi contributed $6.9 million of revenue and $0.3 million of operating income after closing. Purchase accounting remains preliminary, including the valuation of acquired intangible assets; the recorded $73.6 million of acquisition goodwill may change. Management said it anticipates the acquisition will be accretive to earnings per share in fiscal 2024, subject to assumptions and integration execution.
At December 31, cash was $1.4 million and accounts receivable was $65.2 million. Current assets of $69.8 million were below current liabilities of $81.1 million. Debt obligations were $203.4 million in principal, reported net of financing costs as $194.4 million; the balance included $186.4 million on the term loan and $16.9 million drawn on the revolver. The term loan and revolver bear interest at SOFR plus 4.2% and mature in December 2027. The $70.0 million revolver had $31.2 million of unused capacity, subject to borrowing conditions. The company reported compliance with its loan covenants and stated that planned operating cash flow should support operations for 12 months from issuance of the statements.
Cash from operations was $8.0 million, while investing used $180.3 million, primarily for the acquisition. Financing provided $173.5 million, mainly from debt proceeds. The company said it intends to continue making debt prepayments subject to available cash. Reported debt service and cash availability are important given the low cash balance and acquisition-related leverage.
Business developments, outlook and risks
Backlog increased to approximately $942.7 million at December 31, 2022, including $164.0 million of funded backlog, from $482.5 million and $98.9 million, respectively, at September 30, 2022. Backlog includes estimated future revenue under existing contracts and options; it is not a guarantee of funded or realized revenue.
Revenue was concentrated in federal customers: VA represented 46.4%, HHS 37.5%, and DoD 14.1% of the quarter’s revenue. Two groups of VA pharmacy and logistics contracts were operating under bridge arrangements through October and November 2023, respectively. The VA had solicited replacement work with SDVOSB set-aside requirements; DLH expected it could continue significant work as a subcontractor if a qualifying partner won. Management highlighted reliance on VA and HHS relationships and the potential material effect of losing or reducing major contracts.
The filing provides no formal numerical revenue or earnings guidance. Management reported no material COVID-19 effect on Q1 revenue or operating income and said the FY2023 federal appropriations law did not prompt an expected significant operational change. Risks include federal budget reductions or delayed funding, contract recompetes and set-asides, acquisition integration and retention challenges, higher interest rates, increased debt service, covenant compliance, and failure to realize anticipated acquisition benefits. A subsequent interest-rate swap increased hedged notional to $112.2 million at a fixed 4.10% plus credit spread, with maturity in 2026; remaining debt remains exposed to floating rates. The company estimated a 1% increase in SOFR would raise annual interest expense by approximately $0.9 million. It reported no litigation believed reasonably likely to have a material adverse effect.
Key facts for investors to verify
- How GRSi’s final purchase-price allocation, integration costs, and operating contribution compare with management’s expectations, including the anticipated fiscal 2024 accretion.
- Whether the VA bridge contracts are replaced or extended, the impact of SDVOSB procurement outcomes, and the status of the HHS Head Start contract, which runs through April 2025.
- Whether backlog converts to funded work and revenue, especially given that only $164.0 million of the $942.7 million backlog was funded.
- Debt repayment, revolver availability, interest-rate exposure, and continued compliance with financial covenants.
- Whether reported results remain weak relative to the prior year after distinguishing the nonrecurring FEMA comparison and reviewing the company-defined adjusted measures.
- Final acquired-asset valuations and any resulting changes to goodwill, amortization, or impairment assessments.