NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 30, 2022
1. Basis of Presentation
The accompanying consolidated financial statements include the accounts of DLH Holdings Corp. and its wholly-owned subsidiaries (together with its subsidiaries, "DLH" or the "Company" and also referred to as "we," "us" and "our"). All significant intercompany balances and transactions have been eliminated in consolidation. The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, these statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.
In management's opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the period ended June 30, 2022 are not necessarily indicative of the results that may be expected for the year ending September 30, 2022 or any future period. Amounts as of and for the periods ended June 30, 2022 and June 30, 2021 are unaudited. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended September 30, 2021 filed with the Securities and Exchange Commission on December 6, 2021.
2. Business Overview
The Company is a full-service provider of technology-enabled health and human services, providing solutions to three market focus areas: Defense and Veterans' Health Solutions, Human Solutions and Services, and Public Health and Life Sciences. The Company delivers domain-specific expertise, industry best-practices and innovations to customers across these markets leveraging seven core competencies: secure data analytics, clinical trials and laboratory services, case management, performance evaluation, system modernization, operational logistics and readiness, and strategic digital communications. The Company manages its operations from its principal executive offices in Atlanta, Georgia, and we have a complementary headquarters office in Silver Spring, Maryland. The Company employs over 2,400 skilled employees working in more than 30 locations throughout the United States and one location overseas.
At present, the Company derives 99% of its revenue from agencies of the Federal government, primarily as a prime contractor but also as a subcontractor to other Federal prime contractors.
A major customer is defined as a customer from whom we derive at least 10% of our revenues. Our largest customers are the Department of Veteran Affairs ("VA"), the Department of Health and Human Services ("HHS"), the Department of Homeland Security ("DHS"), and the Department of Defense ("DoD"). Our contracts with the state of Alaska were task orders awarded under our Federal Emergency Management Agency ("FEMA") contract vehicle within DHS. The following table summarizes the revenues by customer for the nine months ended June 30, 2022 and 2021, respectively:
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | |
| | | | Nine Months Ended |
| | | | June 30, |
| | | | | | 2022 | | 2021 |
| (in thousands) | | | | | | Revenue | Percent of total revenue | | Revenue | Percent of total revenue |
| | | | | | | | | | |
| Department of Homeland Security | | | | | | $ | 126,397 | | 38.6 | % | | $ | 523 | | 0.3 | % |
| Department of Veterans Affairs | | | | | | 92,270 | | 28.1 | % | | 83,010 | | 45.9 | % |
| Department of Health and Human Services | | | | | | 78,452 | | 23.9 | % | | 66,748 | | 36.9 | % |
| Department of Defense | | | | | | 25,227 | | 7.7 | % | | 22,103 | | 12.2 | % |
| Other customers with less than 10% share of total revenue | | | | | | 5,594 | | 1.7 | % | | 8,529 | | 4.7 | % |
| Total Revenue | | | | | | $ | 327,940 | | 100.0 | % | | $ | 180,913 | | 100.0 | % |
3. New Accounting Pronouncements
In March 2020 and January 2021, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” and ASU No. 2021-01, “Reference Rate Reform (Topic 848): Scope,” respectively (collectively, “Topic 848”). Topic 848 provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued because of reference rate reform. The optional expedients and exceptions provided by Topic 848 can be applied for all entities as of March 12, 2020 through December 31, 2022. The Company is currently assessing the impact of electing this standard on its consolidated financial statements and related disclosures and does not expect the impact to be material.
4. Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include valuation of goodwill and intangible assets, interest rate swaps, stock-based compensation, right-of-use assets and lease liabilities, valuation allowances established against accounts receivable and deferred tax assets, and measurement of loss development on workers’ compensation claims. We evaluate these estimates and judgments on an ongoing basis and base our estimates on historical experience, current and expected future outcomes, third-party evaluations and various other assumptions that we believe are reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities as well as identifying and assessing the accounting treatment with respect to commitments and contingencies. We revise material accounting estimates if changes occur, such as more experience is acquired, additional information is obtained, or there is new information on which an estimate was or can be based. Actual results could differ from those estimates. In particular, a material reduction in the fair value of goodwill could have a material adverse effect on the Company’s financial position and results of operations. We account for the effect of a change in accounting estimate during the period in which the change occurs.
Fair Value of Financial Instruments
The carrying amounts of the Company's cash, accounts receivable, accrued expenses, and accounts payable approximate fair value due to the short-term nature of these instruments. The face values of the Company's debt instruments approximated fair value because the underlying interest rates approximate market rates that the Company could obtain for similar instruments at the balance sheet dates.
Long-lived Assets
Our long-lived assets include equipment and improvements, intangible assets, right-of-use assets, and goodwill. The Company continues to review long-lived assets for possible impairment or loss of value at least annually, or more frequently upon the occurrence of an event or when circumstances indicate that a reporting unit's carrying amount is greater than its fair value.
Equipment and improvements are recorded at cost. Depreciation and amortization are provided using the straight-line method over the estimated useful asset lives (3 to 7 years) and the shorter of the initial lease term or estimated useful life for leasehold improvements. Maintenance and repair costs are expensed as incurred.
Intangible assets (other than goodwill) are originally recorded at fair value and are amortized on a straight-line basis over their estimated useful lives of 10 years.
Right-of-use assets are measured at the present value of future minimum lease payments, including all probable renewals, plus lease payments made to the lessor before or at lease commencement and indirect costs paid, less incentives received. Our right-of-use assets include long-term leases for facilities and equipment and are amortized over their respective lease terms.
Goodwill
At September 30, 2021, we performed a goodwill impairment evaluation on the year-end carrying value of approximately $65.6 million. We performed a qualitative assessment of factors to determine whether it was necessary to perform the goodwill impairment test. Based on the results of the work performed, the Company has concluded that no impairment loss was warranted at September 30, 2021. For the nine months ended June 30, 2022, the Company determined that no change in business conditions occurred which would have a material adverse effect on the valuation of goodwill. Our assessment incorporated effects of the COVID-19 pandemic, which is not expected to have a meaningful impact on our financial results. Notwithstanding this evaluation, factors including non-renewal of a major contract or other substantial changes in business conditions could have a material adverse effect on the valuation of goodwill in future periods and the resulting charge could be material to future periods’ results of operations.
Income Taxes
The Company accounts for income taxes in accordance with the asset and liability method, whereby deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reflected on the consolidated balance sheets when it is determined that it is more likely than not that the asset will be realized. This guidance also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized. We account for uncertain tax positions by recognizing the financial statement effects of a tax position only when, based upon the technical merits, it is "more-likely-than-not" that the position will be sustained upon examination. We had no uncertain tax positions at either June 30, 2022 or September 30, 2021. We report interest and penalties as a component of income tax expense. During the three and nine months ended June 30, 2022 and June 30, 2021, we recognized no interest and no penalties related to income taxes.
Stock-based Equity Compensation
The Company uses the fair value-based method for stock-based equity compensation. Options issued are designated as either an incentive stock option or a non-statutory stock option. No option may be granted with a term of more than 10 years from the date of grant. Option awards may depend on achievement of certain performance measures determined by the Compensation Committee of our Board. Shares issued upon option exercise are newly issued common shares. All awards to employees and non-employees are recorded at fair value on the date of the grant and expensed over the period of vesting. The Company uses Monte Carlo binomial option pricing models, as appropriate to estimate the fair value of each stock option at the date of grant. Any consideration paid by the option holders to purchase shares is credited to common stock.
Cash
We maintain cash balances of $1.1 million and $24.1 million at June 30, 2022 and September 30, 2021, respectively, at financial institutions that are insured by the Federal Deposit Insurance Corporation up to $250,000. Deposits held with financial institutions may exceed the $250,000 limit.
Earnings Per Share
Basic earnings per share is calculated by dividing income available to common shareholders by the weighted average number of common stock outstanding and restricted stock grants that vested or are likely to vest during the period. Diluted earnings per share is calculated by dividing income available to common shareholders by the weighted average number of basic common shares outstanding, adjusted to reflect potentially dilutive securities. Diluted earnings per share is calculated using the treasury stock method.
Preferred Stock
Our certificate of incorporation authorizes the issuance of "blank check" preferred stock with designations, rights and preferences as may be determined from time to time by our board of directors up to an aggregate of 5,000,000 shares of preferred stock. As of June 30, 2022 and September 30, 2021, the Company had not issued any preferred stock.
Interest Rate Swap
The Company uses derivative financial instruments to manage interest rate risk associated with its variable-rate debt. The Company's objective in using these interest rate derivatives is to manage its exposure to interest rate movements and reduce volatility of interest expense. The gains and losses due to changes in the fair value of the interest rate swap agreements completely offset changes in the fair value of the hedged portion of the underlying debt. Offsetting changes in fair value of both the interest rate swaps and the hedged portion of the underlying debt both are recognized in interest expense in the Consolidated Statements of Operations. The Company does not hold or issue any derivative instruments for trading or speculative purposes.
Risks & Uncertainties
Management continues to evaluate the impact of the COVID-19 pandemic on the Company, primarily through the introduction of additional regulations and restrictions. While it is reasonably possible that the virus could have a negative effect on the Company's financial position and the results of its operations, we expect that impact to be largely mitigated by the nature of our work and our ability to modify performance to accommodate those restrictions.
5. Revenue Recognition
We recognize revenue over time when there is a continuous transfer of control to our customer. For our U.S. government contracts, this continuous transfer of control to the customer is supported by clauses in the contract that allow the U.S. government to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. When control is transferred over time, revenue is recognized based on the extent of progress towards completion of the performance obligation. For services contracts, we satisfy our performance obligations as services are rendered. We use cost-based input and time-based output methods to measure progress.
Contract costs include labor, material, and allocable indirect expenses. For time-and-material contracts, we bill the customer per labor hour and per material, and revenue is recognized in the amount invoiced since the amount corresponds directly to the value of our performance to date. We consider control to transfer when we have a present right to payment. Essentially, all of our contracts satisfy their performance obligations over time. Contracts are often modified to account for changes in contract specifications and requirements. Contract modifications impact performance obligations when the modification either creates new or changes the existing enforceable rights and obligations. The effect of a contract modification on the transaction price and our measure of progress for the performance obligation to which it relates is recognized as an adjustment to revenue and profit cumulatively. Furthermore, a significant change in one or more estimates could affect the profitability of our contracts. We recognize adjustments in estimated profit on contracts in the period identified.
For time-and-materials contracts, revenue is recognized to the extent of billable rates times hours delivered plus materials and other reimbursable costs incurred. Revenue for cost-reimbursable contracts is recorded as reimbursable costs are incurred, including an estimated share of the applicable contractual fees earned. For firm-fixed-price contracts, the consideration received for our performance is set at a predetermined price. Revenue for our firm-fixed-price contracts is recognized over time using a straight-line measure of progress or using the percentage-of-completion method whereby progress toward completion is based on a comparison of actual costs incurred to total estimated costs to be incurred over the contract term. Contract costs are expensed as incurred. Estimated losses are recognized when identified.
Contract assets - Amounts are invoiced as work progresses in accordance with agreed-upon contractual terms. In part, revenue recognition occurs before we have the right to bill, resulting in contract assets. These contract assets are reported within receivables on our consolidated balance sheets and are invoiced in accordance with payment terms defined in each contract. Period end balances will vary from period to period due to agreed-upon contractual terms.
Contract liabilities - Amounts are a result of billings in excess of costs incurred.
The following table summarizes the contract balances recognized on the Company's consolidated balance sheets (in thousands):
| | | | | | | | | | | | | | | | | | |
| | | | |
| | | | June 30, | | September 30, |
| | Ref | | 2022 | | 2021 |
| | | | | | |
| Contract assets | | | | $ | 8,467 | | | $ | 7,307 | |
| Contract liabilities | | (a) | | $ | 200 | | | $ | 22,473 | |
Ref (a): Contract liabilities are primarily due to contract start-up funding provided under a contract awarded at the end of fiscal year 2021, for which all performance obligations were completed by March 31, 2022.
Disaggregation of revenue from contracts with customers
We disaggregate our revenue from contracts with customers by customer, contract type, as well as whether the Company acts as prime contractor or subcontractor. We believe these categories best depict how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors. The following tables present our revenue disaggregated by these categories:
Revenue by customer (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | |
| | Three Months Ended | | Nine Months Ended |
| | June 30, | | June 30, |
| Ref | 2022 | | 2021 | | 2022 | | 2021 |
| Department of Homeland Security | (a) | $ | (4,908) | | | $ | 184 | | | $ | 126,397 | | | $ | 523 | |
| Department of Veterans Affairs | | 33,344 | | | 27,496 | | | 92,270 | | | 83,010 | |
| Department of Health and Human Services | | 27,741 | | | 23,245 | | | 78,452 | | | 66,748 | |
| Department of Defense | | 8,272 | | | 7,601 | | | 25,227 | | | 22,103 | |
| Other | | 1,991 | | | 3,029 | | | 5,594 | | | 8,529 | |
| Total Revenue | | $ | 66,440 | | | $ | 61,555 | | | $ | 327,940 | | | $ | 180,913 | |
Ref (a): The results for the three months ended June 30, 2022 include final closeout activities related to the short-term FEMA COVID support contracts and the related agreements between DLH and its subcontractors. Reconciliation of estimated pass-through travel and accommodation expenses to the final reimbursable expenses resulted in a reduction to expenses, and a corresponding reduction to revenue, previously accrued and pending payment. This reduction reflected the value of in-kind expenses furnished by the State in support of the contract.
Revenue by contract type (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | |
| | Three Months Ended | | Nine Months Ended |
| | June 30, | | June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Time and Materials | | $ | 44,672 | | | $ | 46,790 | | | $ | 263,072 | | | $ | 137,492 | |
| Cost Reimbursable | | 11,979 | | | 12,070 | | | 34,364 | | | 35,796 | |
| Firm Fixed Price | | 9,789 | | | 2,695 | | | 30,504 | | | 7,625 | |
| Total Revenue | | $ | 66,440 | | | $ | 61,555 | | | $ | 327,940 | | | $ | 180,913 | |
Revenue by whether the Company acts as a prime contractor or a subcontractor (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | |
| | Three Months Ended | | Nine Months Ended |
| | June 30, | | June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Prime Contractor | | $ | 58,743 | | | $ | 53,407 | | | $ | 304,862 | | | $ | 159,059 | |
| Subcontractor | | 7,697 | | | 8,148 | | | 23,078 | | | 21,854 | |
| Total Revenue | | $ | 66,440 | | | $ | 61,555 | | | $ | 327,940 | | | $ | 180,913 | |
6. Leases
We have leases for facilities and office equipment. Our lease liabilities are recognized as the present value of the future minimum lease payments over the lease term. Our right-of-use assets are recognized as the present value of the future minimum lease payments over the lease term plus lease payments made to the lessor before or at lease commencement less unamortized lease incentives and the balance remaining in deferred rent liability under ASC 840. Our lease payments consist of fixed and in-substance fixed amounts attributable to the use of the underlying asset over the lease term. Variable lease payments that do not depend on an index rate or are not in-substance fixed payments are excluded in the measurement of right-of-use assets and lease liabilities and are expensed in the period incurred. The incremental borrowing rate on our credit facility was used in determining the present value of future minimum lease payments. Some of our lease agreements include options to extend the lease term or terminate the lease. These options are accounted for in our right-of-use assets and lease liabilities when it is reasonably certain that the Company will extend the lease term or terminate the lease. The Company does not have any finance leases. As of June 30, 2022, operating leases for facilities and equipment have remaining lease terms of 0.4 to 8.8 years.
The following table summarizes lease balances in our consolidated balance sheets at June 30, 2022 and September 30, 2021 (in thousands):
| | | | | | | | | | | |
| June 30, | | September 30, |
| 2022 | | 2021 |
| Operating lease right-of-use assets | $ | 17,429 | | | $ | 19,919 | |
| | | |
| Operating lease liabilities, current | $ | 2,227 | | | $ | 2,261 | |
| Operating lease liabilities - long-term | 17,028 | | | 19,374 | |
| Total operating lease liabilities | $ | 19,255 | | | $ | 21,635 | |
The Company subleases a portion of one of its leased facilities. The sublease is classified as an operating lease with respect to the underlying asset. The sublease term is 5 years and includes two additional 1-year term extension options.
For the three and nine months ended June 30, 2022 and 2021, total lease costs for our operating leases are as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| | | |
| Three Months Ended | | Nine Months Ended |
| June 30, | | June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| Operating | $ | 869 | | | $ | 903 | | | $ | 2,684 | | | $ | 2,763 | |
| Short-term | 33 | | | 18 | | | 85 | | | 88 | |
| Variable | 44 | | | 40 | | | 89 | | | 70 | |
| Sublease income | (69) | | | (46) | | | (188) | | | (233) | |
| Total lease costs | $ | 877 | | | $ | 915 | | | $ | 2,670 | | | $ | 2,688 | |
The Company's future minimum lease payments as of June 30, 2022 are as follows:
| | | | | |
| For the Fiscal Year Ending September 30, | (in thousands) |
| 2022 (remaining) | $ | 845 | |
| 2023 | 3,299 | |
| 2024 | 3,156 | |
| 2025 | 2,995 | |
| 2026 | 3,092 | |
| Thereafter | 11,000 | |
| Total future lease payments | 24,387 | |
| Less: imputed interest | (5,132) | |
| Present value of future minimum lease payments | 19,255 | |
| Less: current portion of operating lease liabilities | (2,227) | |
| Long-term operating lease liabilities | $ | 17,028 | |
At June 30, 2022, the weighted-average remaining lease term and weighted-average discount rate are 7.7 years and 6.01%, respectively. The calculation of the weighted-average discount rate was determined based on borrowing terms from our senior credit facility.
Other information related to our leases is as follows:
| | | | | | | | | | | | | | | | | | | | | | |
| | | | | | Nine Months Ended | |
| | | | | | June 30, | | |
| | | | | | | | 2022 | | 2021 | | |
| Cash paid for amounts included in the measurement of lease liabilities | | | | | | | | $ | 2,566 | | | $ | 2,483 | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
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7. Supporting Financial Information
Accounts receivable
| | | | | | | | | | | | | | | |
| | | (in thousands) |
| | | June 30, | | September 30, |
| | | 2022 | | 2021 |
| Billed receivables | | | $ | 41,870 | | | $ | 26,140 | |
| Contract assets | | | 8,467 | | | 7,307 | |
| Total accounts receivable | | | $ | 50,337 | | | $ | 33,447 | |
| | | | | |
| | | | | |
Accounts receivable are non-interest bearing, unsecured and carried at net realizable value. We evaluate our receivables on a quarterly basis and determine whether an allowance is appropriate based on specific collection issues. No allowance for doubtful accounts was deemed necessary at either June 30, 2022 or September 30, 2021.
Other current assets
| | | | | | | | | | | | | | | |
| | | (in thousands) |
| | | June 30, | | September 30, |
| | | 2022 | | 2021 |
| Prepaid insurance and benefits | | | $ | 1,019 | | | $ | 655 | |
| Other receivables | | | 1,021 | | | 995 | |
| Prepaid licenses and other expenses | | | 2,377 | | | 2,615 | |
| Other current assets | | | $ | 4,417 | | | $ | 4,265 | |
Equipment and improvements, net
| | | | | | | | | | | | | | | | | |
| | | (in thousands) |
| | | June 30, | | September 30, |
| Ref | | 2022 | | 2021 |
| Furniture and equipment | | | $ | 958 | | | $ | 958 | |
| Computer equipment | | | 1,484 | | | 1,262 | |
| Computer software | | | 4,375 | | | 4,353 | |
| Leasehold improvements | | | 1,595 | | | 1,595 | |
| Total equipment and improvements | | | 8,412 | | | 8,168 | |
| Less: accumulated depreciation and amortization | (a) | | (7,057) | | | (6,256) | |
| Equipment and improvements, net | | | $ | 1,355 | | | $ | 1,912 | |
Ref (a): Depreciation expense was $0.2 million and $0.4 million for the three months ended June 30, 2022 and 2021, respectively, and $0.8 million and $1.2 million, for the nine months ended June 30, 2022 and 2021, respectively.
Intangible assets
| | | | | | | | | | | | | | | | | |
| | | (in thousands) |
| | | June 30, | | September 30, |
| Ref | | 2022 | | 2021 |
| Intangible assets | (a) | | | | |
| Customer contracts and related customer relationships | | | $ | 62,281 | | | $ | 62,281 | |
| Covenants not to compete | | | 522 | | | 522 | |
| Trade name | | | 3,051 | | | 3,051 | |
| | | | | |
| Total intangible assets | | | 65,854 | | | 65,854 | |
| Less: accumulated amortization | | | | | |
| Customer contracts and related customer relationships | | | (22,049) | | | (17,378) | |
| Covenants not to compete | | | (303) | | | (264) | |
| Trade name | | | (972) | | | (743) | |
| Total accumulated amortization | | | (23,324) | | | (18,385) | |
| Intangible assets, net | | | $ | 42,530 | | | $ | 47,469 | |
Ref (a): Intangible assets (other than goodwill) are subject to amortization. These intangible assets are amortized on a straight-line basis over their estimated useful lives of 10 years. The total amount of amortization expense was $1.6 million for the three months ended June 30, 2022 and 2021 and $4.9 million for the nine months ended June 30, 2022 and 2021.
| | | | | | |
| Estimated amortization expense for the following fiscal years ending September 30: | | (in thousands) |
| 2022 (remaining) | | $ | 1,646 | |
| 2023 | | 6,585 | |
| 2024 | | 6,585 | |
| 2025 | | 6,585 | |
| 2026 | | 5,851 | |
| Thereafter | | 15,278 | |
| | |
| Total amortization expense | | $ | 42,530 | |
| | |
| | |
Accounts payable, accrued expenses, and other current liabilities
| | | | | | | | | | | | | |
| | | (in thousands) |
| | | June 30, | | September 30, |
| | | 2022 | | 2021 |
| Accounts payable | | | $ | 18,614 | | | $ | 16,684 | |
| Accrued benefits | | | 4,172 | | | 2,916 | |
| Accrued bonus and incentive compensation | | | 2,600 | | | 2,381 | |
| Accrued workers' compensation insurance | | | 4,877 | | | 7,014 | |
| Other accrued expenses | | | 4,835 | | | 3,722 | |
| Accounts payable, accrued expenses, and other current liabilities | | | $ | 35,098 | | | $ | 32,717 | |
Debt obligations
| | | | | | | | | | | | | | | | | | |
| | | | (in thousands) |
| | | | June 30, | | September 30, |
| | Ref | | 2022 | | 2021 |
| | | | | | |
| Bank term loan | | | | $ | 28,500 | | | $ | 46,750 | |
| Less: unamortized deferred financing costs | | | | (1,717) | | | (2,114) | |
| | | | | | |
| | | | | | |
| Long-term portion of bank debt obligations, net of deferred financing costs | | (a) | | $ | 26,783 | | | $ | 44,636 | |
Ref (a): As of June 30, 2022 and September 30, 2021, we had no outstanding balance on our revolving line of credit and have satisfied mandatory principal payments covering the following twelve months.
Interest income (expense)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | |
| | | Three Months Ended | | Nine Months Ended |
| | | | June 30, | | June 30, |
| (in thousands) | Ref | | 2022 | | 2021 | | 2022 | | 2021 |
| Interest expense | (a) | | $ | (334) | | | $ | (696) | | | $ | (1,242) | | | $ | (2,367) | |
| Amortization of deferred financing costs | (b) | | (178) | | | (197) | | | (497) | | | (610) | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| Interest expense, net | | | $ | (512) | | | $ | (893) | | | $ | (1,739) | | | $ | (2,977) | |
Ref (a): Interest expense on borrowing
Ref (b): Amortization of expenses related to term loan and revolving line of credit
8. Credit Facilities
A summary of our loan facility as of June 30, 2022, is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | ($ in thousands) |
| | As of June 30, 2022 |
| Lender | | Arrangement | | Loan Balance | | Interest | | Maturity Date |
| First National Bank of Pennsylvania ("FNB") | | Secured term loan (a) | | $ | 28,500 | | | LIBOR* + 2.5% | | 09/30/2025 |
| First National Bank of Pennsylvania ("FNB") | | Secured revolving line of credit (b) | | $ | — | | | LIBOR* + 2.5% | | 09/30/2025 |
*LIBOR rate as of June 30, 2022 was 1.06%. As of June 30, 2022, our LIBOR rate is subject to a minimum floor of 0.5%.
(a) Represents the principal amounts payable on our term loan, which is secured by liens on substantially all of the assets of the Company. The principal of the term loan is payable in quarterly installments with the remaining balance due on September 30, 2025.
The Credit Agreement requires compliance with a number of financial covenants and contains restrictions on our ability to engage in certain transactions. Among other matters, we must comply with limitations on the following: granting liens; incurring other indebtedness; maintenance of assets; investments in other entities and extensions of credit; mergers and consolidations; and changes in nature of business. The loan agreement also requires us to comply with certain quarterly financial covenants including: (i) a minimum fixed charge coverage ratio of at least 1.25 to 1.00, and (ii) a Funded Indebtedness to Adjusted EBITDA ratio not exceeding the ratio of 3.75:1.0 to 2.75:1.0 through maturity. Adjusted EBITDA ratio is calculated by dividing the Company's total interest-bearing debt by net income adjusted to exclude (i) interest and other expenses, (ii) provision for or benefit from income taxes, if any, (iii) depreciation and amortization, and (iv) non-recurring charges, losses or expenses to include transaction and non-cash equity expense. The term loan has an interest rate spread range from 2.5% to 4.5% depending on the funded indebtedness to adjusted EBITDA ratio. We are in compliance with all loan covenants and restrictions.
We are required to pay quarterly amortization payments, which commenced in December 2020. The annual amortization amounts are $7.0 million each for fiscal years 2021 and 2022, $8.75 million each for fiscal years 2023 through 2025, with the remaining unpaid loan balance due at maturity in September 2025. The quarterly payments are equal installments. The Company made voluntary prepayments of term debt of $9.0 million during the quarter ended June 30, 2022 bringing the total amount paid on the secured term loan to $41.5 million. We have satisfied mandatory principal amortization until loan maturity on September 30, 2025.
In addition to quarterly payments of the outstanding indebtedness, the loan agreement also requires annual payments of a percentage of excess cash flow, as defined in the loan agreement. The loan agreement states that an excess cash flow recapture payment must be made equal to (a) 75% of the excess cash flow for the immediately preceding fiscal year in which indebtedness to consolidated EBITDA ratio is greater than or equal to 2.50:1.0; (b) 50% of the excess cash flow for the immediately preceding fiscal year in which the funded indebtedness to consolidated EBITDA Ratio is less than 2.50:1.0 but greater than or equal to 1.5:1.0; or (c) 0% of the excess cash flow for the immediately preceding fiscal year in which the funded indebtedness to consolidated EBITDA Ratio is less than 1.5:1.0. In addition, the Company must make additional mandatory prepayment of amounts outstanding based on proceeds received from asset sales and sales of certain equity securities or other indebtedness. For additional information regarding the schedule of future payment obligations, please refer to Note 11. Commitments and Contingencies.
On September 30, 2019, we executed a floating-to-fixed interest rate swap with First National Bank ("FNB") as counter party. The notional amount in the floating-to-fixed interest rate swap as of June 30, 2022 is $22.8 million and matures in 2024. The remaining outstanding balance of our term loan is subject to interest rate fluctuations. On the notional amount, the Company pays a base fixed rate of 1.61%, plus applicable credit spread. As a result, for the nine months ended June 30, 2022, interest expense has been increased by approximately $0.2 million.
(b) The secured revolving line of credit has a ceiling of up to $25.0 million; as of June 30, 2022 we had unused borrowing capacity of $23.0 million, which is net of outstanding letters of credit. Borrowing on the line of credit is secured by liens on substantially all of the assets of the Company. The Company accessed funds from the revolving credit facility during the quarter, but had no outstanding balance at June 30, 2022.
The Company's total borrowing availability, based on eligible accounts receivables at June 30, 2022, was $25.0 million. As part of the revolving credit facility, the lenders agreed to a sublimit of $5 million for letters of credit for the account of the Company, subject to applicable procedures.
The revolving line of credit has a maturity date of September 30, 2025 and is subject to loan covenants as described above. The Company is fully compliant with those covenants.
9. Stock-Based Compensation and Equity Grants
Stock-based compensation expense
Options issued under equity incentive plans were designated as either incentive stock or non-statutory stock options. No option is granted with a term of more than 10 years from the date of grant. Exercisability of option awards may depend on achievement of certain performance measures determined by the Compensation Committee of our Board. Shares issued upon option exercise are newly issued shares. As of June 30, 2022, there were 1.4 million options available for grant.
Stock-based compensation expense, shown in the table below, is recorded in general and administrative expenses included in our Consolidated Statements of Operations:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | |
| | | Three Months Ended | | Nine Months Ended |
| | Ref | | June 30, | | June 30, |
| (in thousands) | | | 2022 | | 2021 | | 2022 | | 2021 |
| DLH employees | (a) | | $ | 481 | | | $ | 356 | | | $ | 1,466 | | | $ | 968 | |
| Non-employee directors | (b) | | 162 | | | 117 | | | 486 | | | 349 | |
| Total stock option expense | | | $ | 643 | | | $ | 473 | | | $ | 1,952 | | | $ | 1,317 | |
Ref (a): Included in this amount are equity grants of restricted stock units to Named Executive Officers ("NEO"), which were issued in accordance with the DLH long-term incentive compensation policy in this fiscal year, and stock option grants to NEO and non-NEO company employees. The restricted stock units totaled 161,485 restricted stock units issued and outstanding at June 30, 2022.
Ref (b): Equity grants of restricted stock units were made in accordance with DLH compensation policy for non-employee directors and a total of 53,510 restricted stock units were issued and outstanding at June 30, 2022.
Unrecognized stock-based compensation expense (in thousands)
| | | | | | | | | | | | | |
| | | | | |
| | | | June 30, | | |
| | Ref | | 2022 | | |
| Unrecognized expense for DLH employees | (a) | | $ | 5,498 | | | |
| Unrecognized expense for non-employee directors | | | 162 | | | |
| Total unrecognized expense | | | $ | 5,660 | | | |
Ref (a): The remaining compensation expense is recognized as the requisite service is rendered. The compensation expense for that portion of awards has been based on the grant-date fair value of those awards as calculated for recognition purposes under applicable guidance. For options that vest based on the Company's common stock achieving and maintaining defined market prices, the Company values the awards with a Monte Carlo binomial model that utilizes various probability factors and other criterion in establishing fair value of the grant. The related compensation expense is recognized over the derived service period determined in the valuation. On a weighted average basis, this expense is expected to be recognized within the next 4.15 years.
Stock option activity for the nine months ended June 30, 2022
The aggregate intrinsic value in the table below represents the total pretax intrinsic value (i.e., the difference between the Company’s closing stock price on the last trading day of the period and the exercise price, times the number of shares) that would have been received by the option holders had all option holders exercised their in the money options on those dates. This amount will change based on the fair market value of the Company’s stock.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | (in years) | | |
| | | | | | | | | | Weighted | | |
| | | | | | | | Weighted | | Average | | (in thousands) |
| | | | | | (in thousands) | | Average | | Remaining | | Aggregate |
| | | | | | Number of | | Exercise | | Contractual | | Intrinsic |
| | | | | | Shares | | Price | | Term | | Value |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| Options outstanding, September 30, 2021 | | | | | | 2,374 | | | $ | 5.60 | | | 5.60 | | $ | 15,899 | |
| Exercised | | | | | | (224) | | | $ | 2.67 | | | — | | | — | |
| Granted | | | | | | 250 | | | $ | 16.01 | | | — | | | $ | — | |
| | | | | | | | | | | | |
| Options outstanding, June 30, 2022 | | | | | | 2,400 | | | $ | 6.96 | | | 5.68 | | $ | 20,052 | |
Stock options shares outstanding, vested and unvested for the periods ended (in thousands):
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | |
| | | Number of Shares | | |
| | | June 30, | | September 30, | | |
| Ref | | 2022 | | 2021 | | | | |
| Vested and exercisable | (a) | | 2,150 | | | 1,662 | | | | | |
| Unvested | (b) | | 250 | | | 712 | | | | | |
| Options outstanding | | | 2,400 | | | 2,374 | | | | | |
Ref (a): Weighted average exercise price of vested and exercisable shares was $5.91 and $3.91 at June 30, 2022 and September 30, 2021, respectively. Aggregate intrinsic value was approximately $20.1 million and $13.9 million at June 30, 2022 and September 30, 2021, respectively. Weighted average contractual term remaining was 5.2 years and 4.0 years at June 30, 2022 and September 30, 2021, respectively.
Ref (b): Certain awards vest upon satisfaction of certain performance criteria.
10. Earnings Per Share
Basic earnings per share is calculated by dividing income available to common shareholders by the weighted average number of common shares outstanding and restricted stock grants that vested or are likely to vest during the period. Diluted earnings per share is calculated by dividing income available to common shareholders by the weighted average number of basic common shares outstanding, adjusted to reflect potentially dilutive securities. Diluted earnings per share is calculated using the treasury stock method.
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | (In thousands) |
| | Three Months Ended | | Nine Months Ended |
| | June 30, | | June 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
| Numerator: | | | | | | | | |
| Net income | | $ | 4,864 | | | $ | 2,880 | | | $ | 19,846 | | | $ | 7,261 | |
| Denominator: | | | | | | | | |
| Denominator for basic net income per share - weighted-average outstanding shares | | 12,812 | | | 12,545 | | | 12,779 | | | 12,529 | |
| Effect of dilutive securities: | | | | | | | | |
| Stock options and restricted stock | | 1,423 | | | 1,110 | | | 1,426 | | | 1,165 | |
| Denominator for diluted net income per share - weighted-average outstanding shares | | 14,235 | | | 13,655 | | | 14,205 | | | 13,694 | |
| | | | | | | | |
| Net income per share - basic | | $ | 0.38 | | | $ | 0.23 | | | $ | 1.55 | | | $ | 0.58 | |
| Net income per share - diluted | | $ | 0.34 | | | $ | 0.21 | | | $ | 1.40 | | | $ | 0.54 | |
11. Commitments and Contingencies
Contractual obligations as of June 30, 2022 (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Payments Due Per Fiscal Year |
| | | (Remaining) | | | | | |
| | Total | 2022 | 2023 | 2024 | 2025 | 2026 | Thereafter |
| Debt obligations | | $ | 28,500 | | $ | — | | $ | — | | $ | — | | $ | 28,500 | | $ | — | | $ | — | |
| Facility operating leases | | 24,231 | | 824 | | 3,216 | | 3,104 | | 2,995 | | 3,092 | | 11,000 | |
| Equipment operating leases | | 156 | | 21 | | 83 | | 52 | | — | | — | | — | |
| Total contractual obligations | | $ | 52,887 | | $ | 845 | | $ | 3,299 | | $ | 3,156 | | $ | 31,495 | | $ | 3,092 | | $ | 11,000 | |
Worker's Compensation
We accrue worker's compensation expense based on claims submitted, applying actuarial loss development factors to estimate the costs incurred but not yet recorded. Our accrued liability for claims development as of June 30, 2022 and September 30, 2021 was $4.9 million and $7.0 million, respectively.
Legal Proceedings
As a commercial enterprise and employer, the Company is subject to various claims and legal actions in the ordinary course of business. These matters can include professional liability, workers’ compensation, tax, payroll and employee-related matters, other commercial disputes arising in the course of its business, and inquiries and investigations by governmental agencies regarding our employment practices or other matters. 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.
12. Related Party Transactions
The Company has determined that as of June 30, 2022 and September 30, 2021 and for the three and nine months ended June 30, 2022 there were no significant related party transactions that have occurred which require disclosure through the date that these consolidated financial statements were issued.