NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
March 31, 2023
1. Basis of Presentation and Principles of Consolidation
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 United States 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 March 31, 2023 are not necessarily indicative of the results that may be expected for the year ending September 30, 2023 or any future period. Amounts as of and for the three and six months ended March 31, 2023 and March 31, 2022 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, 2022 filed with the Securities and Exchange Commission on December 5, 2022.
2. Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. The most significant of these estimates and assumptions relate to estimating revenues and costs including overhead and its allocation, estimating progress toward the completion of performance obligations, assessing fair value of acquired assets and liabilities accounted for through business acquisitions, valuing and determining the amortization periods for long-lived intangible assets, interest rate swaps, stock-based compensation, right-of-use assets and leases liabilities, and 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.
Revenue
The Company's revenues from contracts with customers are derived from offerings that include technology-enabled business process outsourcing, program management solutions, and public health research and analytics, substantially within the U.S. government and its agencies. The Company has various types of contracts including time-and-materials contracts, cost-reimbursable contracts, and firm-fixed-price contracts.
We consider a contract with a customer to exist when there is a commitment by both parties (customer and Company), payment terms are determinable, there is commercial substance, and collectability is probably in accordance with Accounting Standards Codification ("ASC") No. 606, Revenue from Contracts with Customers ("Topic 606").
We recognize revenue over time when there is a continuous transfer of control to our customer as performance obligations are satisfied. For our U.S. government contracts, this continuous transfer of control to the customer is transferred over time and revenue is recognized based on the extent of progress toward completion of the performance obligation. We consider control to transfer when we have a right to payment. In some instances, the Company commences providing services prior to formal approval to begin work from the customer. The Company considers these factors, the risks associated with commencing work, and legal enforceability in determining whether a contract exists under Topic 606.
Contract modification can occur throughout the life of the contract and can affect the transaction price, extend the period of performance, adjust funding, or create new performance obligations. We review each modification to assess the impact of these
contract changes to determine if it should be treated as part of the original performance obligation or as a separate contract. 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 service contracts, we satisfy our performance obligations as services are rendered. We use cost-based input and time-based output methods to measure progress based on the contract type.
•Time and material - We bill the customer per labor hour and per material, and revenue is recognized in the amount invoiced as the amount corresponds directly to the value of our performance to date. Revenue is recognized to the extent of billable rates times hours delivered plus materials and other reimbursable costs incurred.
•Cost reimbursable - We record reimbursable costs as incurred, including an estimated share of the contractual fee earned.
•Firm fixed price - We recognize revenue over time using a straight-line measure of progress
Contract costs generally include direct costs such as labor, materials, subcontract costs, and indirect costs identifiable with or allocable to a specific contract. Costs are expensed as incurred and include an estimate of the contractual fees earned. Contract costs incurred for U.S. government contracts, including indirect costs, are subject to audit and adjustment by various government audit agencies. Historically, our adjustments have not been material.
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 Accounts receivable, net 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 or prepayment for services to be rendered.
Fair Value of Financial Instruments
The carrying amounts of the Company's cash and cash equivalents, accounts receivable, contract assets, contract liabilities, accrued expenses, and accounts payable approximate fair value due to the short-term nature of these instruments. The fair values of the Company's debt instruments approximate 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. Maintenance and repair costs are expensed as incurred.
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.
Lease Liabilities
The Company has 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 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 secured term loan is 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.
Goodwill
The Company reviews goodwill for impairment on an annual basis and on a quarterly basis the company assesses the impact of any macroeconomic changes that may impact the business conditions to determine if these changes have any adverse impact to goodwill. 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. The Company determined that no change in business conditions occurred which would have a material adverse effect on the valuation of goodwill.
Provision for 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 March 31, 2023 or September 30, 2022. We report interest and penalties as a component of provision for income taxes. During the three and six months ended March 31, 2023 and March 31, 2022, we recognized no interest and no penalties related to income taxes.
Stock-based Compensation
The Company uses the fair value-based method for stock-based 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 a Monte Carlo method 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.
Compensation expense for the portion of equity awards for which the requisite service has not been rendered 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 method that utilizes various probability factors and other criterion in establishing fair value of the grant. The related compensation expense is recognized over the service period.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. We maintain cash balances at financial institutions that are insured by the Federal Deposit Insurance Corporation ("FDIC") up to $250,000.
Accounts Receivable
Receivables include amounts billed and currently due from customers where the right to consideration is unconditional and amounts unbilled. Both billed and unbilled amounts are non-interest bearing, unsecured, and recognized at an estimated realizable value that includes costs and fees, and are generally expected to be billed and received within a single year. 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 March 31, 2023 or September 30, 2022.
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.
Treasury Stock
The Company periodically purchases its own common stock that is traded on public markets as part of announced stock repurchase programs. The repurchased common stock is classified as treasury stock on the consolidated balance sheets and held at cost. As of March 31, 2023 and September 30, 2022, the Company did not hold any treasury stock.
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 March 31, 2023 and September 30, 2022, the Company has not issued any preferred stock.
Interest Rate Swap
The Company uses derivative financial instruments to manage interest rate risk associated with its variable 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 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 evaluates the impact of global markets and economic factors on our industry and the potential for adverse effects on the Company's consolidated financial position and its operations. As of the date of these consolidated financial statements, there was no indication of any global or economic impacts to our industry.
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. In December 2022, FASB issued ASU 2022-06 "Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848" which defers the end date for electing the relief provided in Topic 848 from
December 31, 2022 to December 31, 2024. In the first quarter of fiscal 2023, the Company adopted the optional expedients and exceptions provided in Topic 848. The adoption did not have a material impact on the Company’s consolidated financial statements.
4. Business Combination
Acquisition of Grove Resource Solutions, LLC
On December 8, 2022, the Company acquired 100% of the equity interests of Grove Resource Solution, LLC ("GRSi") for a purchase price of $188.0 million, inclusive of the working capital adjustment completed and paid during this fiscal quarter. The acquisition was financed through a combination of:
•borrowings of $181.5 million under the Company’s amended and restated credit facility; and
•common stock issued of approximately 0.5 million shares, which were valued at $6.5 million in the aggregate, based on the shares issued to the previous owners as determined by the equity purchase agreement and the stock price on the acquisition date.
The acquisition of GRSi was consistent with the Company’s growth strategy, as it provided contract diversification, addition of key capabilities and increased presence in the military health market. The estimated goodwill derived from this transaction is primarily due to these attributes.
The Company has used the acquisition method of accounting for this transaction, whereby the assets acquired and liabilities assumed are recognized based upon their estimated fair values at the acquisition date.
The purchase price for GRSi was $188.0 million adjusted to reflect acquired cash, assumed liabilities and net working capital adjustments.
The Purchase Agreement contains customary representations, warranties and covenants by the parties. Subject to certain limitations and conditions, the seller and the equity holders of the seller do not have indemnity obligation for damages resulting from breaches or inaccuracies of the representations, warranties, and covenants of the seller, GRSI and the equity holders as set forth in the Purchase Agreement. The Purchase Agreement also provided for the establishment of an escrow account in order to satisfy (i) any downward adjustment of the purchase price base on GRSI's net working capital at the closing and (ii) certain specified indemnification obligations of the seller and equity holders that may arise following the closing. The escrow account is funded by an aggregate amount of approximately $4.3 million and the stock consideration. A representations and warranties insurance policy has been purchased by the Company in connection with the Purchase Agreement, under which the Company may seek recourse for breaches of the representations and warranties of the seller, GRSI and the equity holders. The representations and warranties insurance policy is subject to certain customary exclusions and a deductible.
In accordance with ASU 2017-01, the Company evaluated the transaction as an acquisition of a business. The Company has assessed the acquisition price to the fair value of the assets and liabilities of GRSi at the acquisition date. Based on the unaudited financial statements of GRSi on December 8, 2022, we accounted for the total acquisition consideration and allocation of fair value of the related assets and liabilities as follows (in thousands):
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Purchase price for GRSi | | $ | 187,997 | |
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Purchase price allocation: | | |
Cash | | 747 | |
Accounts receivable | | 25,468 | |
Other current assets | | 1,354 | |
Accounts payable and accrued expenses | | (2,449) | |
Payroll liabilities | | (7,826) | |
Other current liabilities | | (325) | |
Equipment and improvements, net | | 463 | |
Other long-term assets and liabilities | | (781) | |
Intangible assets | | 98,688 | |
Total identifiable net assets acquired | | 115,339 | |
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Goodwill | | $ | 72,658 | |
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All operating units are aggregated into a single reportable segment. The acquisition of GRSi did not create an additional reportable segment as all operations report to a single Chief Operating Decision Maker (CODM), serve a similar customer base, and provide similar services within a common regulatory environment. The goodwill represents intellectual capital and the acquired workforce, of which both do not qualify as a separate intangible asset.
During the three months ended March 31, 2023, following the completion of the acquisition, GRSi contributed approximately $32.6 million of revenue and $2.0 million of income from operations.
The following table presents certain results for the three and six months ended March 31, 2023 and 2022 as though the acquisition of GRSi had occurred on October 1, 2021. The unaudited pro forma information is presented for informational purposes only and is not necessarily indicative of our results if the acquisition had taken place on that date. The pro forma information was prepared by combining our reported historical results with the historical results of GRSi for the pre-acquisition periods. In addition, the reported historical amounts were adjusted for the following items, net of associated tax effects:
•The impact of recording GRSi's intangible asset amortization.
•The impact of interest expense for the new credit facility.
•The removal of legacy GRSi director's fees.
•The removal of transaction costs for the acquisition incurred by GRSi.
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| | | (in thousands) | | (in thousands) |
| | | Three Months Ended | | Six Months Ended |
| | | March 31, | | March 31, |
Pro forma results | | | 2023 | | 2022 | | 2023 | | 2022 |
Revenue | | | $ | 99,417 | | | $ | 134,615 | | | $ | 199,240 | | | $ | 313,469 | |
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Net income (loss) | | | 805 | | | 4,001 | | | 2,945 | | | 10,852 | |
| | | | | | | | | |
Number of shares outstanding - basic | | | 13,759 | | | 12,778 | | | 13,530 | | | 12,763 | |
Number of shares outstanding - diluted | | | 14,600 | | | 14,442 | | | 14,447 | | | 14,368 | |
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Basic earnings per share (loss) | | | $0.06 | | $0.31 | | $0.22 | | $0.85 |
Diluted earnings per share (loss) | | | $0.06 | | $0.28 | | $0.20 | | $0.76 |
5. Revenue Recognition
The following table summarizes the contract balances recognized on the Company's consolidated balance sheets as follows (in thousands):
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| | | | March 31, | | September 30, |
| | | | 2023 | | 2022 |
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Contract assets | | | | $ | 19,907 | | | $ | 7,682 | |
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Contract assets are included presented as part of the accounts receivables on the consolidated balances sheets. Contract liabilities are presented as deferred revenue, which had a $0 balance for the as of March 31, 2023 and September 30, 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 series of tables present our revenue disaggregated by these categories:
Revenue by customer for the three and six months ended March 31, 2023 and 2022 as follows (in thousands):
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| | Three Months Ended | | Six Months Ended |
| | March 31, | | March 31, |
| | 2023 | | 2022 | | 2023 | | 2022 |
Department of Veterans Affairs | | $ | 34,883 | | | $ | 30,733 | | | $ | 68,591 | | | $ | 58,926 | |
Department of Health and Human Services | | 38,204 | | | 27,584 | | | 65,509 | | | 50,710 | |
Department of Defense | | 18,972 | | | 8,460 | | | 29,235 | | | 16,955 | |
Department of Homeland Security | | 126 | | | 39,978 | | | 293 | | | 131,306 | |
Other | | 7,232 | | | 1,944 | | | 8,527 | | | 3,603 | |
Total | | $ | 99,417 | | | $ | 108,699 | | | $ | 172,155 | | | $ | 261,500 | |
Revenue by contract type for the three and six months ended March 31, 2023 and 2022 as follows (in thousands):
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| | Three Months Ended | | Six Months Ended |
| | March 31, | | March 31, |
| | 2023 | | 2022 | | 2023 | | 2022 |
Time and Materials | | $ | 53,803 | | | $ | 85,860 | | | $ | 102,794 | | | $ | 218,400 | |
Cost Reimbursable | | 17,260 | | | 12,275 | | | 29,840 | | | 22,385 | |
Firm Fixed Price | | 28,354 | | | 10,564 | | | 39,521 | | | 20,715 | |
Total | | $ | 99,417 | | | $ | 108,699 | | | $ | 172,155 | | | $ | 261,500 | |
Revenue by whether the Company acts as a prime contractor or a subcontractor for the three and six months ended March 31, 2023 and 2022 as follows (in thousands):
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| | Three Months Ended | | Six Months Ended |
| | March 31, | | March 31, |
| | 2023 | | 2022 | | 2023 | | 2022 |
Prime Contractor | | $ | 93,826 | | | $ | 100,012 | | | $ | 161,807 | | | $ | 246,119 | |
Subcontractor | | 5,591 | | | 8,687 | | | 10,348 | | | 15,381 | |
Total | | $ | 99,417 | | | $ | 108,699 | | | $ | 172,155 | | | $ | 261,500 | |
6. Leases
The following table summarizes lease balances presented on our consolidated balance sheets as follows (in thousands):
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| March 31, | | September 30, |
| 2023 | | 2022 |
Operating lease right-of-use assets | $ | 18,754 | | | $ | 16,851 | |
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Operating lease liabilities, current | $ | 3,452 | | | $ | 2,235 | |
Operating lease liabilities - long-term | 17,337 | | | 16,461 | |
Total operating lease liabilities | $ | 20,789 | | | $ | 18,696 | |
As of March 31, 2023, operating leases for facilities and equipment have remaining lease terms of less than 1 to 7.9 years.
For the three and six months ended March 31, 2023 and 2022, total lease costs for our operating leases as follows (in thousands):
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| Three Months Ended | | Six Months Ended |
| March 31, | | March 31, |
| 2023 | | 2022 | | 2023 | | 2022 |
Operating | $ | 1,098 | | | $ | 863 | | | $ | 2,045 | | | $ | 1,815 | |
Short-term | 27 | | | 25 | | | 70 | | | 52 | |
Variable | 32 | | | 27 | | | 63 | | | 45 | |
Sublease income (a) | (71) | | | (50) | | | (142) | | | (119) | |
Total lease costs | $ | 1,086 | | | $ | 865 | | | $ | 2,036 | | | $ | 1,793 | |
(a) 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.
The Company's future minimum lease payments as of March 31, 2023 as follows (in thousands):
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For the Fiscal Year Ending September 30, | |
2023 (remaining) | $ | 2,324 | |
2024 | 4,611 | |
2025 | 3,928 | |
2026 | 3,700 | |
2027 | 2,627 | |
Thereafter | 8,672 | |
Total future lease payments | 25,862 | |
Less: imputed interest | (5,073) | |
Present value of future minimum lease payments | 20,789 | |
Less: current portion of operating lease liabilities | (3,452) | |
Long-term operating lease liabilities | $ | 17,337 | |
At March 31, 2023, the weighted-average remaining lease term and weighted-average discount rate are 6.4 years and 6.4% respectively. The calculation of the weighted-average discount rate was determined based on borrowing terms from our secured term loan.
Other information related to our leases for the six months ended March 31, 2023 and 2022 as follows (in thousands):
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| 2023 | | 2022 | |
Cash paid for amounts included in the measurement of lease liabilities | 2,171 | | | $ | 1,729 | | |
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Lease liabilities arising from obtaining right-of-use assets | 3,541 | | | $ | — | | |
7. Supporting Financial Information
Accounts receivable
The following table summarizes accounts receivable presented on our consolidated balance sheets as follows (in thousands):
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| | | March 31, | | September 30, |
| | | 2023 | | 2022 |
Billed receivables | | | $ | 47,114 | | | $ | 32,814 | |
Contract assets | | | 19,907 | | | 7,682 | |
Allowance for doubtful accounts | | | — | | | — | |
Accounts receivable | | | $ | 67,021 | | | $ | 40,496 | |
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Other current assets
The following table summarizes other current assets presented on our consolidated balance sheets as follows (in thousands):
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| | | March 31, | | September 30, |
| | | 2023 | | 2022 |
Prepaid insurance and benefits | | | $ | 2,060 | | | $ | 737 | |
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Prepaid licenses and other expenses | | | 297 | | | $ | 1196 | |
Other receivables | | | 1,156 | | | 945 | |
Other current assets | | | $ | 3,513 | | | $ | 2,878 | |
Equipment and improvements, net
The following table summarizes equipment and improvements, net presented on our consolidated balance sheets as follows (in thousands):
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| | | March 31, | | September 30, |
| | | 2023 | | 2022 |
Furniture and equipment | | | $ | 877 | | | $ | 893 | |
Computer equipment | | | 5,006 | | | 2,316 | |
Computer software | | | 1,733 | | | 4,407 | |
Leasehold improvements | | | 1,880 | | | 1,614 | |
Total equipment and improvements | | | 9,496 | | | 9,230 | |
Less: accumulated depreciation and amortization | | | (7,938) | | | (7,526) | |
Equipment and improvements, net | | | $ | 1,558 | | | $ | 1,704 | |
Depreciation expense was $0.2 million and $0.2 million for the three months ended March 31, 2023 and 2022, respectively. Depreciation expense was $0.4 million and $0.6 million for the six months ended March 31, 2023 and 2022, respectively.
Intangible assets
The following table summarizes intangible assets, net presented on our consolidated balance sheets as follows (in thousands):
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| | | March 31, | | September 30, |
| | | 2023 | | 2022 |
Intangible assets | | | | | |
Customer contracts and related customer relationships | | | $ | 113,622 | | | $ | 47,044 | |
Covenants not to compete | | | 637 | | | 522 | |
Trade name | | | 13,034 | | | 3,051 | |
Backlog | | | 37,249 | | | 15,237 | |
Total intangible assets | | | 164,542 | | | 65,854 | |
Less: accumulated amortization | | | | | |
Customer contracts and related customer relationships | | | (24,186) | | | (19,731) | |
Covenants not to compete | | | (346) | | | (316) | |
Trade name | | | (1,525) | | | (1,048) | |
Backlog | | | (5,376) | | | (3,875) | |
Total accumulated amortization | | | (31,433) | | | (24,970) | |
Intangible assets, net | | | $ | 133,109 | | | $ | 40,884 | |
Amortization expense was $4.3 million and $1.6 million for the three months ended March 31, 2023 and 2022, respectively. Amortization expense was $6.5 million and $3.3 million for the six months ended March 31, 2023 and 2022, respectively.
As of March 31, 2023, the estimated amortization expense per fiscal year as follows (in thousands):
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2023 (remaining) | | $ | 8,193 | |
2024 | | 16,386 | |
2025 | | 16,386 | |
2026 | | 15,652 | |
2027 | | 14,624 | |
Thereafter | | 61,868 | |
Total amortization expense | | $ | 133,109 | |
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Goodwill
The change in the carrying amount of goodwill as follows presented on our consolidated balance sheets as follows (in thousands):
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| | |
Balance at September 30, 2022 | | $ | 65,643 | |
Increase from GRSi acquisition (a) | | 72,658 | |
Balance at March 31, 2023 | | $ | 138,301 | |
Ref (a) The Company has completed its valuation assessment of the GRSi acquisition. Please refer to Note 4 for more information.
Accounts payable and accrued liabilities
The following table summarizes accounts payable and accrued liabilities presented on our consolidated balance sheets as follows (in thousands):
| | | | | | | | | | | | | |
| | | |
| | | March 31, | | September 30, |
| | | 2023 | | 2022 |
Accounts payable | | | $ | 14,182 | | | $ | 11,886 | |
Accrued benefits | | | 4,341 | | | 3,857 | |
Accrued bonus and incentive compensation | | | 1,897 | | | 3,625 | |
Accrued workers' compensation insurance | | | 2,602 | | | 4,880 | |
Other accrued expenses | | | 2,044 | | | 2,614 | |
Accounts payable and accrued liabilities | | | $ | 25,066 | | | $ | 26,862 | |
Debt obligations
The following table summarizes debt obligations presented on our consolidated balance sheets as follows (in thousands):
| | | | | | | | | | | | | | | | |
| | | | |
| | | | March 31, | | September 30, |
| | | | 2023 | | 2022 |
Secured revolving line of credit | | | | $ | 21,330 | | | $ | — | |
Secured term loan | | | | 182,875 | | | 22,000 | |
Less: unamortized deferred financing costs | | | | (8,302) | | | (1,584) | |
Net bank debt obligations | | | | 195,903 | | | 20,416 | |
Less: current portion of debt obligations, net of deferred financing costs | | | | (33,267) | | | — | |
Long-term portion of debt obligations, net of deferred financing costs | | | | $ | 162,636 | | | $ | 20,416 | |
Interest expense
The following table summarizes interest expense presented on our consolidated statements of operations for the three and six months ended March 31, 2023 and 2022 as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | Three Months Ended | | Six Months Ended |
| | | March 31, | | March 31, |
| | | 2023 | | 2022 | | 2023 | | 2022 |
Interest expense (a) | | | $ | 4,160 | | | $ | 386 | | | $ | 5,714 | | | $ | 907 | |
Amortization of deferred financing costs (b) | | | 605 | | | 168 | | | 881 | | | 319 | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
Interest expense | | | $ | 4,765 | | | $ | 554 | | | $ | 6,595 | | | $ | 1,226 | |
(a) Interest expense on borrowing.
(b) Amortization of expenses related to secured term loan and secured revolving line of credit.
8. Credit Facilities
A summary of our credit facilities as of March 31, 2023 and September 30, 2022 is as follows (in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
March 31, 2023 | | September 30, 2022 | | |
Arrangement | | Loan Balance | | Interest | | Arrangement | | Loan Balance | | Interest | | |
Secured term loan (a) due December 8, 2027 | | $ | 182.9 | | | SOFR* + 4.2% | | Secured term loan due September 30, 2025 | | $ | 22.0 | | | LIBOR + 2.5% | | |
Secured revolving line of credit (b) due December 8, 2027 | | $ | 21.3 | | | SOFR* + 4.2% | | Secured Revolving line of Credit due September 20, 2025 | | $ | — | | | LIBOR + 2.5% | | |
*Secured Overnight Financing Rate ("SOFR") as of March 31, 2023 was 4.81%.
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 March 31, 2023 is $16.2 million, matures in 2024, and the fixed rate is 1.61%. On January 31, 2023, we executed an additional floating-to-fixed interest rate swap with FNB; the notional amount as of March 31, 2023 is $96.0 million, it matures in January 2026, and the fixed rate is 4.1%. The total floating-to-fixed swap balance as of March 31, 2023 is $112.2 million. As a result of entering these agreements, for the six months ended March 31, 2023, interest expense has been decreased by approximately $0.3 million.
(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 December 8, 2027.
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 total leverage ratio not exceeding the ratio of 4.50:1.0 to 2.00:1.0 through maturity. The total leverage 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-cash charges, losses or expenses, including stock-based compensation, and (v) non-recurring charges, losses or expenses to include transaction and non-cash equity expense. We are in compliance with all loan covenants and restrictions.
We are required to pay quarterly amortization payments, which commenced in December 2022. The annual amortization amounts are $14.3 million each for fiscal years 2023 and 2024, $19.0 million each for fiscal years 2025 and 2026, and $23.8 million for fiscal year 2027, with the remaining unpaid loan balance due at maturity in December 2027. The quarterly payments are equal installments. The Company made a mandatory prepayment of $3.6 million during the quarter ended March 31, 2023 bringing the outstanding principal balance on the secured term loan to $182.9 million. We have satisfied mandatory principal amortization until March 31, 2023.
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 the total leverage 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 total leverage 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 total leverage 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 indebtedness. For additional information regarding the schedule of future payment obligations, please refer to Note 11. Commitments and Contingencies.
(b) The secured revolving line of credit has a ceiling of up to $70.0 million; as of March 31, 2023 we had unused borrowing capacity of $27.3 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 an outstanding balance at March 31, 2023 of $21.3 million
The Company's total borrowing availability, based on eligible accounts receivable at March 31, 2023, was $70.0 million. As part of the revolving credit facility, the lenders agreed to a sublimit of $10.0 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 December 8, 2027 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 March 31, 2023, there were 0.8 million shares available for grant under the 2016 Omnibus Equity Incentive Plan.
Stock-based compensation expense, shown in the table below, is recorded in general and administrative expenses included in our consolidated statements of operations for the three and six months ended March 31, 2023 and 2022 as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | (in thousands) | | (in thousands) |
| | | Three Months Ended | | Six Months Ended |
| | | March 31, | | March 31, |
| | | 2023 | | 2022 | | 2023 | | 2022 |
DLH employees (a) | | | $ | 621 | | | $ | 647 | | | $ | 993 | | | $ | 985 | |
Non-employee directors (b) | | | 179 | | | 162 | | | 359 | | | 324 | |
Total stock option expense | | | $ | 800 | | | $ | 809 | | | $ | 1,352 | | | $ | 1,309 | |
(a) Included in this amount are equity grants of restricted stock units ("RSU") to Executive Officers, which were issued in accordance with the DLH long-term incentive compensation policy in this fiscal year, and stock option grants to employees during prior fiscal years. The RSUs totaled 337,578 and 161,485 issued and outstanding at March 31, 2023 and 2022, respectively. During the three months ended March 31, 2023, 197,174 RSUs were granted to Executive Officers. Of the RSUs granted, 141,892 have performance-based vesting criteria and the remaining 55,282 have service-based vesting criteria. Utilizing a volatility of 50% along with assumptions of a 3-year term and the performance vesting criteria results in an indicated range of value, the RSUs granted during the quarter ended March 31, 2023, as follows using the Monte Carlo Method.
| | | | | | | | | | | | | | | | |
| | | | | | Volatility |
| | | | | | 50% |
| | | | | | |
| | | | | | Calculated |
Grant Date | | Performance Vesting Base | Performance Vesting Criteria | | (Years) | Fair Value |
January 27, 2023 | | Revenue | Revenue increase at the end of the performance period as compared to the year ended September 30, 2022 | | 3 | $ | 3.51 | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
January 27, 2023 | | Stock price | Stock price is at least $33.21 per share average for the 30 days prior to the end of the performance period | | 3 | $ | 2.92 | |
Notes: | | | | | | |
Results based on 100,000 simulations | | | |
(b) Equity grants of RSUs were made in accordance with DLH compensation policy for non-employee directors and a total of 50,367 and 53,510 restricted stock units were issued and outstanding at March 31, 2023 and 2022, respectively. These grants have service-based vesting criteria and vest at the end of this fiscal year.
Unrecognized stock-based compensation expense
Unrecognized stock-based compensation expense is presented in the table below for the three months ended March 31, 2023 and 2022 as follows (in thousands):
| | | | | | | | | | | | | | | |
| | | | | |
| | | | | |
| | | 2023 | | 2022 |
Unrecognized expense for DLH employees (a) | | | $ | 8,575 | | | $ | 5,982 | |
Unrecognized expense for non-employee directors | | | 359 | | | 324 | |
Total unrecognized expense | | | $ | 8,934 | | | $ | 6,306 | |
(a) On a weighted average basis, the unrecognized expense for the three months ended March 31, 2023 is expected to be recognized within the next 4.1 years.
Stock option activity for the six months ended March 31, 2023
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, 2022 | | | | | | 2,392 | | | $ | 7.05 | | | 5.40 | | $ | 13,566 | |
Granted (a) | | | | | | 400 | | | 11.66 | | | — | | | — | |
Exercised | | | | | | (286) | | | 1.84 | | | — | | | — | |
| | | | | | | | | | | | |
Cancelled | | | | | | (40) | | | 10.12 | | | — | | | — | |
Options outstanding, March 31, 2023 | | | | | | 2,466 | | | $ | 8.35 | | | 6.20 | | $ | 9,071 | |
Ref (a): Utilizing a volatility of 50% along with assumptions of a 10-year term and the aforementioned 10-day stock price threshold results in an indicated range of value of the Options granted during the quarter ended March 31, 2023, as follows using the Monte Carlo Method.
| | | | | | | | | | | | | | | | | | | |
| | | | | | | Volatility |
| | | | | | | 50% |
| | | | Vesting | | Expected | |
| | Strike | Stock | Threshold | | Term | Calculated |
Grant Date | | Price | Price | Price | | (Years) | Fair Value |
January 26, 2023 | | $ | 11.66 | | $ | 11.66 | | $ | 15.00 | | | 10 | $ | 7.41 | |
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| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Notes: | | | | | | | |
Results based on 100,000 simulations | | | | |
Stock options shares outstanding, vested and unvested for the periods ended as follows (shares in thousands):
| | | | | | | | | | | | | | | | | | | |
| | | | | | | |
| | | March 31, | | September 30, | | |
| | | 2023 | | 2022 | | | | |
Vested and exercisable (a) | | | 1,841 | | | 2,117 | | | | | |
Unvested (b) | | | 625 | | | 275 | | | | | |
Options outstanding | | | 2,466 | | | 2,392 | | | | | |
(a) The weighted average exercise price of vested and exercisable shares was $6.67 and $5.86 at March 31, 2023 and September 30, 2022, respectively. Aggregate intrinsic value was approximately $9.1 million and $13.6 million at March 31, 2023 and September 30, 2022, respectively. The weighted average contractual term remaining was 5.1 years and 4.9 years at March 31, 2023 and September 30, 2022, respectively.
(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.
Earnings per share information is presented in the table below for the three and six months ended March 31, 2023 and 2022 as follows (in thousands except for per share amounts):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | (In thousands) |
| | Three Months Ended | | Six Months Ended |
| | March 31, | | March 31, |
| | 2023 | | 2022 | | 2023 | | 2022 |
Numerator: | | | | | | | | |
Net income | | $ | 805 | | | $ | 7,178 | | | $ | 2,352 | | | $ | 14,982 | |
Denominator: | | | | | | | | |
Denominator for basic net income per share - weighted-average outstanding shares | | 13,759 | | | 12,778 | | | 13,530 | | | 12,763 | |
Effect of dilutive securities: | | | | | | | | |
Stock options and restricted stock | | 841 | | | 1,664 | | | 917 | | | 1,605 | |
Denominator for diluted net income per share - weighted-average outstanding shares | | 14,600 | | | 14,442 | | | 14,447 | | | 14,368 | |
| | | | | | | | |
Net income per share - basic | | $ | 0.06 | | | $ | 0.56 | | | $ | 0.17 | | | $ | 1.17 | |
Net income per share - diluted | | $ | 0.06 | | | $ | 0.50 | | | $ | 0.16 | | | $ | 1.04 | |
11. Commitments and Contingencies
Contractual obligations as of March 31, 2023 are as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Payments Due Per Fiscal Year |
| | | (Remaining) | | | | | |
| | Total | 2023 | 2024 | 2025 | 2026 | 2027 | Thereafter |
Debt obligations | | $ | 204,205 | | $ | 17,804 | | $ | 24,901 | | $ | 19,000 | | $ | 19,000 | | $ | 23,750 | | $ | 99,750 | |
Facility operating leases | | 25,770 | | 2,283 | | 4,560 | | 3,928 | | 3,700 | | 2,627 | | 8,672 | |
Equipment operating leases | | 92 | | 42 | | 50 | | — | | — | | — | | — | |
Total contractual obligations | | $ | 230,067 | | $ | 20,129 | | $ | 29,511 | | $ | 22,928 | | $ | 22,700 | | $ | 26,377 | | $ | 108,422 | |
Workers' Compensation
We accrue workers' 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 March 31, 2023 and September 30, 2022 was $2.6 million and $4.9 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 for the three and six months ended March 31, 2023 there were no significant related party transactions that have occurred which require disclosure through the date that these consolidated financial statements were issued.