DLH(DLHC) - 2023 Q2 - Quarterly Report

Part I — Financial Information Financial Statements The company's financial statements for the three and six months ended March 31, 2023, reflect a significant transformation following the acquisition of Grove Resource Solutions, LLC (GRSi), with decreased reported revenue and net income year-over-year due to a completed FEMA contract, while the balance sheet expanded substantially with increased goodwill, intangible assets, and debt, and cash flows were dominated by the acquisition Consolidated Statements of Operations For the three and six months ended March 31, 2023, revenue and net income declined significantly compared to the same periods in 2022, primarily driven by the conclusion of a major FEMA contract in the prior year, while the recent GRSi acquisition contributed new revenue but also led to higher operating costs, including a substantial increase in interest expense and amortization Consolidated Statements of Operations Highlights (in thousands, except per share amounts) | Metric | Three Months Ended Mar 31, 2023 | Three Months Ended Mar 31, 2022 | Six Months Ended Mar 31, 2023 | Six Months Ended Mar 31, 2022 | | :--- | :--- | :--- | :--- | :--- | | Revenue | $99,417 | $108,699 | $172,155 | $261,500 | | Income from operations | $5,951 | $10,254 | $9,872 | $21,473 | | Interest expense | $4,765 | $554 | $6,595 | $1,226 | | Net income | $805 | $7,178 | $2,352 | $14,982 | | Net income per share - diluted | $0.06 | $0.50 | $0.16 | $1.04 | Consolidated Balance Sheets As of March 31, 2023, the company's balance sheet shows a significant increase in total assets to $362.6 million from $169.0 million at September 30, 2022, primarily due to the GRSi acquisition, which added $72.7 million in goodwill and $92.2 million in net intangible assets, while total liabilities also rose sharply to $260.6 million from $77.0 million, driven by new long-term debt of $162.6 million incurred to finance the acquisition Consolidated Balance Sheet Highlights (in thousands) | Account | March 31, 2023 | September 30, 2022 | | :--- | :--- | :--- | | Total current assets | $70,671 | $43,602 | | Goodwill | $138,301 | $65,643 | | Intangible assets, net | $133,109 | $40,884 | | Total assets | $362,576 | $169,012 | | Total current liabilities | $79,064 | $38,541 | | Debt obligations - long-term | $162,636 | $20,416 | | Total liabilities | $260,636 | $76,952 | | Total shareholders' equity | $101,940 | $92,060 | Consolidated Statements of Cash Flows For the six months ended March 31, 2023, net cash provided by operating activities was $6.9 million, a significant improvement from the $14.8 million used in the prior-year period, while investing activities used $181.2 million almost entirely for the GRSi business acquisition, and financing activities provided $174.2 million, primarily from proceeds from new debt obligations ($168.0 million) and revolving credit ($32.6 million) used to fund the acquisition Six Months Ended March 31, Cash Flow Summary (in thousands) | Activity | 2023 | 2022 | | :--- | :--- | :--- | | Net cash provided by (used in) operating activities | $6,862 | $(14,815) | | Net cash used in investing activities | $(181,174) | $(89) | | Net cash provided by (used in) financing activities | $174,221 | $(8,788) | | Net change in cash | $(91) | $(23,692) | - The business acquisition, net of cash acquired, resulted in a cash outflow of $180.7 million[17] - The company received $168.0 million in proceeds from new debt obligations and $32.6 million from its revolving line of credit to finance the acquisition and other activities[17] Notes to Consolidated Financial Statements The notes detail the basis of accounting, significant policies, and key events during the period, with the most significant event being the acquisition of GRSi for $188.0 million, financed through new debt facilities and stock issuance, which substantially increased goodwill, intangible assets, and debt, while revenue is primarily from U.S. government contracts with a notable shift in customer mix due to the completion of a large FEMA contract and the addition of GRSi's business, and the company has also entered into new interest rate swaps to manage risk on its increased variable-rate debt Management's Discussion and Analysis of Financial Condition and Results of Operations Management attributes the year-over-year decline in revenue and operating income to the completion of a significant, short-term FEMA contract in fiscal 2022, while the acquisition of GRSi in December 2022 is a key strategic move, contributing new revenue streams and significantly increasing the company's backlog to $940.6 million, and after adjusting for the FEMA contract and acquisition costs, the company shows underlying growth in revenue and EBITDA, with solid liquidity supported by operating cash flow and a new, larger credit facility, despite the substantial increase in debt to fund the acquisition, and the company is actively managing interest rate risk on its new debt through swaps - The acquisition of GRSi on December 8, 2022, is a central theme, increasing revenue, operating costs, and interest expense[106][127] - The completion of FEMA task orders in the prior year, which contributed $39.8 million in revenue for the quarter ended March 31, 2022, is the primary reason for the year-over-year decline in reported revenue[128] - Total backlog increased significantly to $940.6 million at March 31, 2023, from $482.5 million at September 30, 2022, largely due to the GRSi acquisition[112] Business and Markets Overview DLH primarily serves U.S. federal agencies, with 99% of its revenue from this sector, and for the quarter ended March 31, 2023, the Department of Health and Human Services (HHS) and the Department of Veterans Affairs (VA) were the largest customers, accounting for 38.4% and 35.1% of revenue, respectively, while the acquisition of GRSi expanded capabilities and customer diversification, notably with the National Institutes of Health (NIH) and the U.S. Navy, and a key risk highlighted is that major VA CMOP contracts are currently operating under bridge contracts and are subject to recompete under a small business set-aside Revenue by Customer (Three Months Ended March 31) | Customer | 2023 Revenue % | 2022 Revenue % | | :--- | :--- | :--- | | Dept. of Health and Human Services | 38.4% | 25.4% | | Dept. of Veterans Affairs | 35.1% | 28.3% | | Dept. of Defense | 19.1% | 7.8% | | Dept. of Homeland Security | 0.1% | 36.8% | - Key VA contracts for pharmacy and logistics services, representing a combined $68.6 million in revenue for the six months ended March 31, 2023, are operating under bridge contracts through late 2023 and are expected to be recompeted as a service-disabled veteran owned small business (SDVOSB) set-aside[109][110] Results of Operations Comparing Q2 2023 to Q2 2022, revenue fell by $9.3 million to $99.4 million, primarily because prior-year results included $39.8 million from a completed FEMA contract, which was partially offset by a $32.6 million contribution from the newly acquired GRSi, while operating income decreased to $6.0 million from $10.3 million, impacted by the revenue mix change and increased G&A, depreciation, and amortization costs from the acquisition, and interest expense surged to $4.8 million from $0.6 million due to debt taken on to finance the GRSi purchase - For Q2 2023, revenue decreased by $9.3 million, due to the loss of $39.8 million from completed FEMA task orders, partially offset by a $32.6 million revenue contribution from the GRSi acquisition[128] - For the six months ended March 31, 2023, revenue decreased by $89.3 million, driven by the completion of FEMA task orders that contributed $130.9 million in the prior-year period, partially offset by a $39.5 million contribution from GRSi[136] - Interest expense for Q2 2023 increased to $4.8 million from $0.6 million in Q2 2022, primarily due to borrowing required to finance the GRSi acquisition[132] Non-GAAP Financial Measures The company provides non-GAAP metrics to illustrate underlying performance by excluding the impact of the short-term FEMA contract from 2022 and acquisition-related costs from 2023, showing that on an adjusted basis, Q2 2023 revenue grew 44.2% to $99.4 million from an adjusted $68.9 million in Q2 2022, and Adjusted EBITDA for Q2 2023 increased to $10.5 million (10.5% margin) from an adjusted $6.6 million (9.6% margin) in the prior year, demonstrating strong operational growth absent the one-time items Non-GAAP Reconciliation Highlights (in thousands) | Metric | Three Months Ended Mar 31, 2023 | Three Months Ended Mar 31, 2022 (Adjusted) | | :--- | :--- | :--- | | Adjusted Revenue | $99,417 | $68,935 | | Adjusted Operating Income | $5,951 | $4,729 | | Adjusted EBITDA | $10,486 | $6,610 | | Adjusted EBITDA Margin | 10.5% | 9.6% | - The adjustments remove the revenue and operating income from the FEMA task orders in fiscal 2022 and add back corporate development costs related to the GRSi acquisition in fiscal 2023 to provide a clearer comparison of ongoing operations[143][146][151] Liquidity and Capital Management As of March 31, 2023, the company's liquidity is sourced from operations and a $70.0 million secured revolving line of credit, of which $27.3 million was available, while the company's debt structure was significantly altered by the GRSi acquisition, with a new secured term loan of $182.9 million and a revolving credit balance of $21.3 million, and to mitigate interest rate risk on this new variable-rate debt, the company has executed floating-to-fixed interest rate swaps covering a notional amount of $112.2 million - The company has access to a $70.0 million secured revolving line of credit, with an outstanding balance of $21.3 million and available capacity of $27.3 million as of March 31, 2023[152] - The company executed an additional floating-to-fixed interest rate swap on January 31, 2023, with a notional amount of $96.0 million, bringing the total notional amount of all swaps to $112.2 million[157] Debt Obligations (in millions) | Facility | Balance as of Mar 31, 2023 | Interest Rate | | :--- | :--- | :--- | | Secured term loan | $182.9 | SOFR + 4.2% | | Secured revolving line of credit | $21.3 | SOFR + 4.2% | Critical Accounting Policies and Estimates Management highlights key accounting policies that require significant estimates and judgment, including revenue recognition for government contracts (using cost-based input and time-based output methods), valuation of goodwill and intangible assets (reviewed annually for impairment), and accounting for stock-based compensation (using a Monte Carlo method for valuation), as these policies are crucial for accurately reporting the company's financial position and results - Revenue is recognized over time as control transfers to the customer, using cost-based input and time-based output methods depending on the contract type (time and materials, cost reimbursable, or firm fixed price)[162][163] - Goodwill is reviewed for impairment at least annually, and the company concluded no impairment loss was warranted as of the reporting date[170] Quantitative and Qualitative Disclosures about Market Risk The company's primary market risk is interest rate risk associated with its variable-rate debt, which it manages using floating-to-fixed interest rate swaps, with $112.2 million in notional value of swaps in place as of March 31, 2023, fixing the rate on a significant portion of the debt, and the company estimates that a 1.0% increase in the SOFR would impact its annual interest expense by approximately $0.9 million on the unhedged portion of its debt - The company has executed floating-to-fixed interest rate swaps with a total notional amount of $112.2 million to mitigate risk on its variable-rate debt[175] - A hypothetical 1.0% increase in SOFR would increase the company's annual interest expense by approximately $0.9 million[176] Controls and Procedures Management, including the CEO and CFO, evaluated the company's disclosure controls and procedures and concluded they were effective as of March 31, 2023, and the company is currently in the process of integrating the internal controls of the recently acquired Grove Resource Solutions, LLC into its existing control environment - The CEO and CFO concluded that disclosure controls and procedures were effective at a reasonable assurance level as of the end of the reporting period[177] - The company is in the process of integrating the internal controls of the newly acquired Grove Resource Solutions, LLC[180] Part II — Other Information Legal Proceedings The company is subject to various claims and legal actions in the ordinary course of business but is not aware of any pending or threatened litigation that is reasonably likely to have a material adverse effect on its financial results or position - The Company is not aware of any pending or threatened litigation that it believes is reasonably likely to have a material adverse effect on its results of operations, financial position or cash flows[181] Risk Factors There have been no material changes from the risk factors previously disclosed in the company's Annual Report on Form 10-K for the fiscal year ended September 30, 2022, and the subsequent quarterly report - The company states that there have been no material changes from the risk factors described in its Annual Report on Form 10-K for the fiscal year ended September 30, 2022 and its Quarterly Report on Form 10-Q for the quarter ended December 31, 2022[182] Unregistered Sales of Equity Securities and Use of Proceeds The company did not issue any unregistered securities during the reporting period, except as previously reported - During the period, the Company did not issue any securities that were not registered under the Securities Act of 1933, as amended, except as has been reported in previous filings[183] Defaults Upon Senior Securities None - None[184] Mine Safety Disclosures Not applicable - Not applicable[185] Other Information None - None[186] Exhibits This section lists the exhibits filed with the report, including forms of restricted stock unit awards, CEO and CFO certifications, and iXBRL formatted financial data - Exhibits filed include forms for performance-based and time-based restricted stock unit awards, CEO/CFO certifications (31.1, 31.2, 32), and iXBRL data files (101.0, 104.0)[189]