DLH Holdings Corp. ($DLHC)

Good day, and welcome to the DLH Holdings Fiscal 2026 Second Quarter Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Chris Witty, Investor Relations Adviser. Please go ahead, Chris.

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 2026 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 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.

Thank you, Chris, and good morning, everyone. Welcome to our second quarter conference call. I am pleased for the opportunity to report our financial results and provide color regarding the current environment and our outlook. As I begin, I would like to recognize the performance of our highly skilled workforce. Our people are our #1 asset as a company, and we lean on the passion, creativity and expertise of our staff in order to succeed. This past quarter, we once again demonstrated the innovative thinking required to support our customers' critical missions and delivered excellence across the way. We continue to thank everyone at DLH for this execution. Now turning to Slide 4. I'll provide an overview of the federal marketplace achievements and financial performance. The fiscal 2026 budget cycle is now complete, and the 2027 outlook is coming into focus. We believe that the current federal funding environment is favorable to DLH. Clients across our markets have increased funding capacity and improved budget visibility, allowing for a steadily improving procurement environment. Key federal health agencies received FY '26 funding increases compared to the FY '26 -- FY '25 levels, reversing in part the previously proposed funding reductions outlined by the President's request for fiscal 2026. Agencies in the defense and intelligence market have received significant budget increases that align particularly well with our capabilities. These are supported on both sides of the aisle, and we expect to be a healthy profile for us in the years to come. We believe that the improved clarity and stability, which has emerged in the recent months, meaningfully expands the company's addressable market and supports the company's strategic organic growth initiatives. Last year and throughout the shutdown in our fiscal year Q1, budget uncertainty and large reductions to the federal agency contracting departments significantly slowed procurement activity across the government. As such, numerous key deals and strategic large procurements that we were expecting in FY '25 are just now coming up for bid. We are encouraged by the increase in bidding activities and are experiencing a busy second half of the fiscal year responding to procurement requests. We expect certain award decisions over the coming months, subject to customer time lines and procurement processes. DLH continues to maintain a healthy pipeline of opportunities, which will leverage our world-class workforce, advanced capabilities, and our recently developed commercial technology differentiators to elevate our win probabilities in this pipeline. Notably, the President's recently released fiscal 2027 budget request calls for historic spending increases in the defense and intelligence sector. The administration proposes that this investment be partially offset by unspecified reductions in federal health spending. As always, the President budget request is an initial step in the multi-phase federal budget cycle. We will remain engaged with the Hill, our customers, and influential industry groups as this process advances. Additionally, the current administration has taken several actions intended to simplify contracting and to accelerate the time required to complete transactions. We find this as very healthy for our industry. In addition to nontraditional contract arrangements that we discussed at our recent shareholder meeting, there have been executive orders to streamline the regulatory environment in contracting and to rebalance the risk/reward trade-off, moving away from some of their cost reimbursement contracts to fixed price arrangements with performance metrics. The changes aligned very well with DLH's strategy and our heritage. We welcome this needed shift by our government. Our defense and intelligence customers continue to prioritize prototyping, rapid delivery, cost efficiency, digital modernization, and the integration of advanced technologies, particularly as they relate to health and C4ISR systems. These align very well with our DLH Cyclone and DLH Nexus Labs digital sandbox investments that are cloud secure. In parallel, federal health agencies remain focused on interoperability, cybersecurity, including Zero Trust architectures, cloud migration and AI adoption. Collectively, these priorities position DLH very strong to grow organically from these initiatives. It is always gratifying when DLH innovation and performance excellence is acknowledged by our industry. In recent months, DLH supported projects in automation, artificial intelligence, scientific research, data science and information technology were recognized by customer and industry organizations for outstanding program performance and significant technology achievements. We are proud of these accomplishments as they illustrate the thought leadership, ingenuity, and passion of our employees in advancing the missions of our customers. While revenue was down year-over-year, largely due to the previously discussed program transitions to small business set aside contracts, these include the VA CMOP and Head Start, we remain committed to maximizing shareholder value. Through strong project management delivered margins and implemented cost scaling initiatives, we delivered an adjusted EBITDA margin of 9.0%. As Kathryn will discuss in more detail shortly, we continue to delever our commitment to the balance sheet. Total debt was reduced to $132.7 million, aligned with our debt reduction plans for fiscal '26. In late-breaking news, we were awarded a 2-year sole source extension of one of our contracts to provide world-class clinical research support services to the National Institute of Health. We truly appreciate the opportunity to continue this tremendous support in this critical public health mission that has been a primary focus area for DLH for decades. Overall, we remain well positioned to succeed over the coming years and are excited to buy for the high-value organic growth opportunities that our company was assembled to compete for. Our differentiated suite of data science and AI/ML technology applications, our outstanding capabilities and workforce alignment exceptionally aligns exceptionally well to position us for work within our 3 strategic pillars: science, research and development, digital transformation and cybersecurity, and systems engineering and integration. As government acquisition strategies evolve, we remain prepared and proactive, leveraging speed, innovation and agility to compete on multiple fronts in an accelerated acquisition landscape. With that, I'd now like to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?

Thank you, Zach, and good morning, everyone. Thanks for joining our reporting on our second quarter results for fiscal 2026. Turning to Slide 6. I'd like to first provide a high-level overview of some key financial metrics for the 3 months ended March 31, 2026. We reported revenue of $59.3 million in the second quarter versus $89.2 million in the prior year period, reflecting contributions from expansion on existing contracts, offset by the impact of conversion of certain programs to small business set aside contracts as discussed in the past and certain government efficiency initiatives. In total, the revenue contraction was mostly due to small business set aside initiatives, primarily from CMOP and Head Start with approximately a $24 million increase in the quarter-over-quarter results. The remaining change was due to year-over-year contract completions and government efficiency initiatives. We reported adjusted EBITDA of $5.3 million for the quarter compared to $9.4 million in the prior year period, with the decrease primarily driven by the change in revenue volumes. Adjusted EBITDA margin was 9% for the quarter, adjusting for the timing and incremental cost impact of our cost scaling initiatives implemented in the second quarter. From a free cash flow standpoint, we generated approximately $3.8 million during the quarter. In comparison to the prior year period, the prior year reflects the results of significant working capital build stemming from the transition of a CMOP location that restricted cash collections early in fiscal '25. Now turning to Slide 7. I'll wrap up with a summary of our debt reduction efforts, which remain a key focus area for DLH. Debt reduced during the quarter to $132.7 million, a reduction from $136.6 million at the end of the previous quarter. This marks the resumption of our deleveraging trend after the typical seasonal uptick we experienced in the first quarter. We expect to convert approximately 50% to 55% of EBITDA generated during fiscal 2026 to reduce debt by year-end. We remain well ahead of our mandatory repayment schedule and in full compliance with all financial covenants. With that, I would now like to turn the call over to our operator to open up for questions.

[Operator Instructions] Our first question comes from Joe Gomes with NOBLE Capital.

I just want to start out on the VA CMOP. Do we have anything left there? How much longer do you think that's going to run through? I know we were hoping it would end, I think, in this fiscal third quarter of this year, but maybe a little just update on where we stand on that.

Yes, I think we're still on plan with regard to that reduction. The VA and our team have been working collaboratively towards standing down the final couple of operations. Kathryn, do you have any greater specificity for that?

Sure. Yes. Our expectation is that we will wrap up the transition of those contracts just before Memorial Day.

Is that behind us?

Yes, sir.

Obviously, it served us well. We remain committed, Joe, to supporting our nation veterans. We've still got irons in the fire for transitioning to different types of work for the VA. But yes, once again, as the -- once the VA changed that acquisition process, not only to small business set aside, but changed it from being a solutions and tech-derived execution to just butts in the seats. We withdrew all of our joint venture bids and approached it accordingly, so we're -- it's bittersweet. As you know, we had a couple of decades of support in that arena, but we wish the small business community well.

Exactly. Agreed. And then Zach, you talked about how there's been multiple delayed procurements. There's some going through the pipeline now coming -- just now coming up for bids. You're hoping hear something here in the next couple of months. I guess kind of the concern here is, obviously, every September 30, we go into a threatened government shutdown, the contingency budget, all that, which then seems to always delay contracts. What's your comfort level of actually seeing some of these contracts be awarded in a timely manner versus getting caught back up in the whole contingency budget issue? And then if you might be able to provide us a little more color on that, the nice late-breaking news of the new award that you received.

You bet, Joe. First of all, on the -- I'll cover the market, what we see in the market and I'll ask Kathryn to address the extensions. Yes, we're always very mindful of what the headwinds could be as we've come to know continuing resolutions and shut down risk quite well over the years, recent years, and certainly with this administration. We're also encouraged by some multiyear funding initiatives that have gone forward. They have already been approved that we anticipate continuing to move forward in selected agencies. Particularly, we still find good strength and support on both sides for defense and intelligence budgets as well as critical health care programs. So we're really pretty comfortable in that arena. More importantly, Joe, in the last quarter, we have seen actually multiple RFPs that we have been signaling were coming. And so fortunately, these have gotten under the wire before the September crisis, the usual September crisis. And I think that was also attributed to some of the budget visibility once they got the budget passed, customers have had some pent-up demands for moving along on some of these procurements. We think that the fact that we've had 3 or 4 of the more material ones come through already. We have submitted bids. We're hopeful that the decision process will also move forward in the coming quarter. Often for the very material bids, it's often they see a protest or something of that nature that might delay the actual award and start of work. But we believe that we've got -- some that we're very well positioned that we should have decisions by this fiscal year. With regard to the contract extensions, Kathryn, over to you.

Sure. Yes. So it is -- as we mentioned, it's the continuation of a key contract we've been working in support of the NIH for a number of decades. It would have gone through a normal recompete cycle at the completion of its 10-year period of performance here shortly, but the NIH has decided to -- or made the case to extend it for under a sole-source bridge for 2 years. So any time, of course, an important part of your portfolio gets an extension and gives you additional revenue visibility, that's always very welcomed, and that's work that's really reflects, as Zach mentioned earlier, just as we value a strong presence and continue to have interest in veterans' health, of course, public health is a key dimension of our portfolio and market-facing strategy for addressing every aspect of federal health care delivery. And so this part of our portfolio of contracts in that public health sector is very critical to us. So we're pleased and honored to be able to continue to provide that support and to get the revenue -- the additional revenue visibility in the short run.

And then on the cost scaling or the rightsizing, are we where we need to be for the current and the expected near term revenue production? Or do you think there might even be more cost scaling that needs to occur here?

I think we've done the significant actions. We have -- we always have some strategies we're working through, and those would continue to be as leases come due, for example, continuing to evaluate our footprint in our real estate, those kind of activities. So we continue to evaluate and assure that our cost structure remains competitive and allows our rates to stay competitive for bidding on new work. But we think that we've accomplished the material reductions that are necessary to rightsize the business.

[Operator Instructions]

Hearing none, do we want to reopen it for Joe. Operator?

He is not back in the queue. Joe, if you need to requeue.

Just give Joe just a second as he did put himself back in the queue. That will move forward. All righty. Well, with that, I'd like to thank everyone for your participation throughout this call today...

Joe Gomes is on the call.

Okay. Joe, anything else?

Yes. Maybe a little more. Zach, you talked about some of the potential of reprioritizing federal health spending. Given what we've seen here in the past couple of years, it's just -- it's been a challenging time for DLH, And losing, obviously, the CMOP business and the Head Start and to potentially see reprioritizing federal health spending, it just throws up additional challenges for the company. And maybe you can give us a little more your thoughts and color and how you're going to go about this, addressing that.

You bet. No, great question again, Joe. Yes, I think the best way we characterize it is, as you well know, we advertised, communicated, try to be very transparent with regard to what largely was fueled by the Biden administration's commitment to move not only the VA, but a number of other agency contracts to small business. We anticipated that erosion started in '24 and certainly matured in '25. And as you indicated earlier, we expect to have the final pieces of the headline set aside for us, which was the VA CMOP finally running out this year. But having said that, we are also well positioned, and we're very optimistic that the RFPs and solicitations that had been earmarked for FY '24 aligned with our establishment of our differentiators in data science and data analytics. We're going to be fueled by RFPs in FY '25. Unfortunately, as we indicated earlier, it was -- all of those basically stalled, not all of them, but the overwhelming majority of those basically stalled. And so we had a flat -- relatively flat bid cycles for the major new business deals that are just now coming around. A few of those evolved and a few of those have evolved from the government deciding to move towards some grants. The DOGE effect certainly impacted a lot of our clients where they did not have the acquisition officials to issue those RFPs. They've begun to stabilize that over the course of the last 6 months. And again, we're starting to see both in the defense and intel side and in the public health arena, those solicitations come back. So we've got a few we're anticipating in the next few months. We've got a pretty healthy revenue potential for some that are recently submitted. So we're just optimistic that, that trend will continue. We're not expecting to have a series of the major DOGE government cuts, major doge program cuts, budget cuts followed by historical shutdowns in the coming months. And the global challenges, both including the war in the Gulf are going to certainly keep a strong commitment of funding and rapid development initiatives for the defense and defense health arena as well. So we right now do see good optimism that the flatness in terms of opportunities for us to compete in '25 is starting to break, and that's good for us. What we thought was going to be a pretty quick B curve turned out to become a little more bathtub, but we are starting to see the opportunities hit now and certainly feel that we'll be able to compete favorably for our share.

Much appreciated. I'm looking forward to starting to see some wins be put up on the board here after, as you said, a challenging period here. Nothing to really do with you guys, it's the government itself, but it'd be nice to start to see the engine start back up again and be moving strongly going forward.

We are absolutely -- we can't wait.

100%.

This concludes our question-and-answer session. I would like to turn the conference back over to Zach Parker for any closing remarks.

Well, again, I want to thank you all for, again, your participation, your interest in DLH. We remain committed to driving that shareholder value. We are looking forward to chatting with you in the coming quarters. And we ask that everyone have a blessed day, and we'll talk again soon. Bye for now.

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