DLHC - NASDAQ

Good day, and welcome to the DLH Holdings Fiscal 2026 First 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.

Thank you, and good morning, everyone. On the call with me today is

Thank you, Chris, and good morning, everyone. Welcome to our first quarter conference call. I am pleased for the opportunity to report our financial results and provide color regarding the current environment and outlook. Now turning to Slide 4, I'll provide an overview of our achievements and outlook. The first quarter was marked by the longest government shutdown in our nation's history, followed by a short-term funding gap at the end of January. However, the recently enacted budget provides increased funding capacity and improved visibility for our clients for the remainder of the fiscal year across our markets. we expect that to be a positive impact. Notably, key federal health agencies received funding increases compared to the fiscal 2025 levels, reversing in part previously disclosed funding reductions to our current and addressable markets. We believe this improved clarity and stability meaningfully support the company's organic growth initiatives. This budget stability comes at an opportune time for DLH as we continue to see improving demand across our core markets. Defense and Intelligence customers are emphasizing rapid delivery, cost efficiency digital modernization and advanced technology integration through the application of command, control, communications, computers, cyber defense and combat systems with intelligence, surveillance and recognizant known as C6ISR expertise. At the same time, federal health agencies continue to prioritize system interoperability, cybersecurity, including 0 trust applications, cloud migration and AI adoption, which positions DLH competitively well for modernization-driven awards. These are areas that leverage our strengths, our capabilities and our innovative proprietary tools as discussed previously to enhance productivity on current work while elevating our competitive position on organic growth opportunities. While revenue was down year-over-year, largely due to our previously discussed program transitions to small business set-aside contracts, such as the [indiscernible] and head start. We are seeing improved visibility and are encouraged by the midterm outlook. More importantly, we delivered sequential improvement in adjusted EBITDA margin from the fourth quarter, as Kathryn will discuss in more detail shortly. We remain firmly focused on expanding efficiencies and margins and improving overall returns as the year progresses and award decisions are made. We also continue to execute on our commitment to deleveraging the balance sheet. As is typical in the first quarter, Debt increased modestly, driven primarily by the timing of labor and payroll tax repayments around holidays. That said, we remain on track with our debt reduction plans for fiscal 2026. We Overall, we remain well positioned to succeed over the coming years, including competing effectively for high organic value opportunities within a healthy and expensive addressable market. Our differentiated technology application capabilities, tools and workforce alignment exceptionally well position us for 3 strategic within our 3 strategic pillars that those are digital transformation and cybersecurity, science, research and development and systems engineering and integration. Importantly, the improved clarity around the fiscal '26 budget, combined with our broad portfolio of contract vehicles, bodes well for DLH's long-term growth outlook. We remain committed to continued investment in the talent, tools and technologies required to meet the evolving complex needs of our customers across each of our core markets. our customers leverage our capabilities to access leading edge processing speeds digital sandbox environments, tailored integrations with cot products and technologies, advanced data science and actionable visualizations and dashboards that support mission-critical decision making. While the government services market has experienced meaningful disruption this year, driven by delays in contract solicitations and awards and previously uncertain budget visibility. We have continued to use this period to transform DLH in a positive way. Today, we are technology, engineering and scientific solutions provider that is extremely well positioned to compete for the opportunities of the future. As we work to enhance our organic profile, we will remain disciplined in reducing our indirect costs and managing our capital deployment. The management team and I are confident that DLH is on track to exit fiscal 2026 in a much stronger position than we began, and we are encouraged by what lies ahead. Before I close, I would like to recognize the performance of our deep and highly credentialed workforce. In a challenging environment, we lean on the passion, ingenuity and expertise of our staff to succeed. This past quarter, you once again surmounted extraordinary challenges in support of our customers. As always, thank you to everyone at DLH for your commitment to excellence demonstrated each day. With that, I'd now like to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?

Thank you,

[Operator Instructions] The first question today comes from Joe Gomes with Noble Capital.

So Kathryn, just you said about $18 million of the delta in the revenue decline was from CMOP and head start, and that would leave about $4 million still unaccounted for what was the other $4 million? Where did that get lost?

Yes. It's what we have referred to as the Knicks and the nibbles of the [indiscernible] initiatives that happened in the early part of fiscal '25 somewhat after December, but in Q2 of fiscal '25. Also, the wrap-up of that little that single international project that we had that completed in January of '25 yes, USAID project. So it is a sundry of smaller impacts that were not strategic and not related to the small business set aside.

And Joe, those as Kathryn indicated, they're a little bit smaller because those were the effect of unbundling contracts, right, so that they were able to make more work available also to small businesses or other contract vehicles that have been in existence.

Okay. And on the spot, I know we, we had 4 contracts in the end of last year and 1 they had recently awarded somebody else. I think 2 more were out for bid. Any update on the 2 that were out, have they been awarded any timing as to when they might transition and anything new on the last remaining location.

Well, we're looking at we believe we'll be, we're really in the wind-down phase across the board for the CMOP work. The VA has gotten more a little battle rhythm set for being able to do some of the transitions, complete their evaluations a little more timely fashion and to move into a transition phase we have been leading very aggressively and supportive of making those transitions, the specifics on the contract coverage. I'll turn it over to Kathryn.

Yes. No, I think that's the right way to think about it. As we indicated as early as the first quarter of we certainly expected the completion of the CMOP work to be near term. And as

Okay. And when you talk about the cost reductions that you've taken so far. One, was there any cost to those? And where would that show up on the income statement? And two, is that inclusive of the expected losses? Or you need to do additional cost out once all 3 of those contracts transition?

Let me kick it off and I'll let Kathryn hand on the specifics. So when we exited '24, we kind of laid out, at least internally and with our Board a game plan around this reset, right? The reset of the decline in business that we have been communicating that would result from CMOP and some of the unbundling and bundling of other contracts and small business set asides, while at the same time, we're anticipating more bid opportunities and wins throughout '25. So we had looked at what we kind of call them V curve and managing that for exiting '24 and throughout '25. The delays, obviously, as Kathryn indicated, in the opportunity bid opportunities during '25 due to all the challenges we've discussed had really necessitated that we made sure we had a plan that was flexible and would be phased for indirect reduction. We have implemented 2 major components of that indirect reduction. It's very important for us to maintain a competitive indirect cost profile to be able to compete organically, and that's been a key driver for us. While we've been managing the phaseout of these contracts, including those that still continue for CMOP. So we've had a management plan to make sure we can do those indirect reductions. At the same time, I would tell you, we've been implementing new measures to drive efficiencies of playing some of the tools we do for our customers, AI, ML and things of that nature to drive efficiencies in executing not only for our customers but also for our enterprise. And we're going to continue to look at deploying that. We've got a project or 2 that has some of that running out through this the remainder of this fiscal year where we can enhance and augment the caliber of services by our folks using some of these tools. We think those efficiencies will also help us in the long run. Kathryn, do you want to answer a couple of the specifics on the timing and G&A impact.

Yes. To your question, Joe, about whether the cost of those reductions is factored in and where does it show up? That is reflected in our Q1 results, both the impact of the reduction in cost as well as the cost of achieving those reductions is all reflected in the Q1 financials. And also then considered as part of the crosswalk from standard EBITDA to adjusted EBITDA. In other words, that adjustment reflects as if those reductions had taken place at the beginning of the quarter. I'm sure you can appreciate that those have to be thought through and take some implementation time and so, therefore, happened midway in the quarter. In terms of addressing the change in volume of CMOP specifically, that's part of the overall program, and we have scaled costs related to supporting CMOP as CMOP has made its journey downward. But we do, of course, still carry some costs for running the remaining locations, but we will scale it in the appropriate time frame, along with the changes in revenue volume, just as we do the volume of business for the entire enterprise.

Okay. And 1 more for me. I mean it sounds we might be starting to see some positivity here on the pipeline and bidding activity just wondering,

You bet, Joe. And we are planning on giving a deep color as we have historically from time to time on that pipeline during our upcoming annual meeting with the shareholders. But to your point, yes, we've a little bit of each, right? So we've had in terms of the major IDIQs and the MAC IDIQs, the most recent news, of course, is [indiscernible] has been canceled. And as we have stated before, we saw that as a very attractive and viable vehicle for us with a number of opportunities that we had anticipated being able to bid in '25 that would allow us to start to generate some revenue around this time period. A number of those some of those jobs some of our customers have moved to other vehicles already anticipating that CIOS [indiscernible] was not going to be viable. And so we've had a couple of erosions to our pipeline attributed to work moving to a vehicle, which we could not prime. That's had some impact. And while at the same time, I'd have to say the biggest key has been customers given the budget uncertainty, et cetera, have continued to do kind of like some of our customers, bridge work instead of extending the existing incumbents instead of having a competition. And that's where we're thinking that now that they have stability, some visibility in their budget for some time. That they'll be able to move on with it and get some of those procurements. So we still just have not had a large volume of bid opportunities. We had 1 bid opportunity for the entire month of January. And that's just really, really trickling. And that one is a small one. So we have our needle-mover deals, which we invest a lot in, and we really push to drive a high wind profitability. And we have some of those that come from some of these MAC IDIQs. Some many of those are much smaller. But we're really feeling pretty encouraged that a number of the major needle movers for us. now we'll start to get some stability. We're still actively working to make sure that some of those that were earmarked for CIOS before and success predecessor [indiscernible], that we're well positioned on the GSA schedules and Oasis of which we think will be 2 of those where it would allow us to prime. But when they've moved a couple have moved to some vehicles where we were not prime is very disappointing. Some of the customers just had not had the influence as they thought they would have with the acquisition shop, but we're continuing to monitor that very closely.

But getting that certainty, the key takeaway, as you set it up, Joe, is we view that as positive that to get certainty even if the even if it isn't the way we would have done it, it's really distracting from a resource perspective and not cost effective to be trying to support and straddle all possible pads. So for us, just give us an answer, give us clarity, we can pivot and get ourselves organized to address that way. And so as

Yes. And I want to add, John, to that, Joe, is that we're seeing a major movement by a number of our customers, including Department of War to leverage more commercial best practice vehicles and approaches. We've referred to OTAs, other transaction authorities as something that has been viable and certainly, we demonstrated during COVID to be a viable means to get some of these bids out faster. What you're going to see is what we are seeing is a number of these vehicles start with a pilot that is a much smaller dollar value for the award and then you move from pilot to true execution. And so the revenue profile and the value of the awarded contract will shift a little bit but we're preparing for that. We've been well prepared for that. We've made some down select on a couple of those already. But we're going to see in the industry, a pretty heavy move towards not using our traditional RFP contracting model that just takes so long for the government to get this in place. And this administration is really, really keen to cut through those delays and to use more commercial best practices. So stay tuned on that. We'll talk a little bit around that as well during our upcoming annual meeting on the acquisition environment and our pipeline.

[Operator Instructions] The next question comes from Bert Osterweis with Osterweis business consultation.

Good morning,

Sure. No, great question. First of all, we probably should have a clarification of that because while we do work with the Defense Health Agency, the Department of War, in particularly in the C5 ISR arena, C6ISR arena, we are in the federal government space, we really referred to the civilian agencies that are still federal government, right? And those include customers like the National Institute of Health, the Center for Disease Control, ASPR would include DHS and other agencies, they're still federal clients. Now and so that's really what we're referring to on the macro for us that we have civilian agencies and then those that are aligned with defense. The other point, though, that raise is commercial work. And we do have a small book of business, a small bit of business with commercial. We're doing some of that work through partnerships with universities. And we do believe that there's an incubator area that lends itself for us to be able to work with more commercial companies. It's not going to be a major portion of our business. Kathryn and I have long stood and held the position that if we're going to try to move into that market in a meaningful way, it would be led probably with an acquisition. But we do have some adjacencies where we've been doing work, leveraging relationships with the federal government that have led us to doing some work usually grant funded with the commercial community. And within our public health and scientific research organization, we are looking to perhaps try to pull a little more of that business in-house.

I was thinking biotech firms and things like that.

It is biotech. You're actually you're right spot on. It is in that arena that we have been doing some of that work. We've had some talent on our staff on [indiscernible] and Christian staff that have worked with the biotech and biopharma community. And we're looking to see if we can parlay that as well. We've just brought on a new resource that has tremendous reputation and experiences with FDA and as such, it also worked closely with the biotech community. So we're taking a fresh look at that as a potential account for us right now, it's just targeted opportunities, specific opportunities, but it could develop into an account by year's end.

Those commercial enterprises need to access that government approval queue and it's often an inscrutable protracted process for them, and so they're happy to opportunistically leverage our capability to help steer them through that. But as I said, that would be in the course of relationship building and opportunistic avenues, but not really something that we're going to we're prepared to invest a lot of money in pursuing commercial opportunities.

The other part of that, to your point, Burt, is we need to make sure that even though the 99% of our book of business is with the federal government, we need to be able to operate at speed like commercial companies or truly commercial companies. We have and we believe that the administration is removing some of those barriers on allowing companies and customers that have interest and capabilities to be able to move at speed consistent with commercial companies. And so again, we're taking a look at leveraging some of these OTA type vehicles and our ability to leverage what has been our heritage, and that's to be able to be far more agile than a lot of our large tier companies to be able to be tremendously responsive and operate more like a commercially aligned company. . So please look for more of that. That often will mean our pipeline will look a little bit different with speed and smaller start-up sort of programs a little bit less 5-year booked values, but they offer the same organic growth profiles and trajectories that we have had otherwise, just a more rapid deployment and we've developed some of our tools so we can do rapid prototyping and that's going to help us in a number of areas where clients want to build a little test a little and then make a longer commitment. And we think we're well positioned with some of our digital sandbox opportunities and our cyclone platforms to demonstrate and move quickly from prototype to development and deployment.

One last question. Is there anything in our government contract, which prohibits us from going after civilian contracts?

No, nothing that precludes it at all. It is a very different regulated environment. From time to time, you'll see things like you hear this administration talk about most favored nation kind of rates, in some cases, in our world, we have to look at where the best, best what I'm going to look for, Kathryn the rate schedules that we offered a couple but no regulatory formalized regulatory constraints.

It's really just a function more so of it. It's a distinctly different kind of sales model. And so you have to kind of weigh out your options for investing in that kind of a sales force, if you will, commercial sales force versus the model that makes sense in the government context. But there are some specific boutique opportunities that we're aware of and that we're leveraging. .

At this point, there are no further questions in queue. I would like to turn the conference back to Mr. Parker for any closing remarks.

Once again, I want to thank everyone for participating in our call today and for being good stewards of the DLH equity stakes. We are really, really committed, remain committed to giving you good visibility into the future and look forward to seeing and chatting with you all at the upcoming annual meeting. With that, everyone, have a blessed day, and we'll connect again soon. Bye for now. .