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Edited Transcript of DLHC earnings conference call or presentation 8-May-19 3:00pm GMT

Q2 2019 DLH Holdings Corp Earnings Call

Somerset May 20, 2019 (Thomson StreetEvents) -- Edited Transcript of DLH Holdings Corp earnings conference call or presentation Wednesday, May 8, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Chris Witty

DLH Holdings Corp. - MD IR

* Kathryn M. JohnBull

DLH Holdings Corp. - CFO & Treasurer

* Zachary C. Parker

DLH Holdings Corp. - President, CEO & Director

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Conference Call Participants

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* Austin William Moldow

Canaccord Genuity Limited, Research Division - Associate

* Joseph Anthony Gomes

NOBLE Capital Markets, Inc., Research Division - Senior Generalist Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the DLH 2019 Fiscal Q2 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would like to now turn the conference over to Chris Witty, Investor Relations Adviser. Please go ahead.

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Chris Witty, DLH Holdings Corp. - MD IR [2]

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Thank you, and good morning, everyone. On the call with me today is Zach Parker, President and Chief Executive Officer; and Kathryn JohnBull, Chief Financial Officer. The company's earnings release and PowerPoint presentation are available on our website under the Investor page. I would now like to provide a brief safe harbor statement, which is also shown on Slide 2 of the presentation. This call may include forward-looking statements that relate to the company's outlook for fiscal 2019 and beyond. These forward-looking statements are subject to various risks and uncertainties that could cause actual results and events to differ materially from these statements.

Please refer to the risk factors contained in the company's annual report on Form 10-K and in our other filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statements.

On today's call, we will be referencing both GAAP and non-GAAP financial measures. A reconciliation of our non-GAAP results to our reported GAAP results is included in our earnings release and in the investor presentation on DLH's website. President and CEO, Zach Parker, will speak next followed by CFO, Kathryn JohnBull, after which we'll open it up for questions.

With that, I'd now like to turn the call over to Zach. Please go ahead, Zach.

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Zachary C. Parker, DLH Holdings Corp. - President, CEO & Director [3]

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Thank you, Chris, and good morning, everyone. Thank you for joining us to discuss our fiscal year 2019 second quarter results, driven by our talented DLH employees and partners as well. It is through their unwavering commitment to performance excellence and the highest standards of integrity that we were able to deliver these results. Last night, we posted our Q2 earnings report reflecting strong profitability, robust cash flow, along with an enhanced balance sheet.

Starting with Slide 3. Let me begin by providing a high-level overview of our financial performance and some color on the outlook for fiscal 2019.

Revenue for the second quarter was $33.8 million, down slightly from $34.4 million in 2018, largely reflecting variations in seasonality and work demands in some of our key programs. Our gross margin was 23.9% for the fiscal 2019 second quarter versus 21.7% last year, as gross profit rose to $8.1 million from $7.4 million in 2018. We posted net income of $0.10 per diluted share, the same as last year, and generated $8.5 million of operating cash during the period, a significant achievement that speaks to the underlying nature of our business.

With such strong cash flow, we were able to completely payoff our senior debt in the quarter, leaving us with a very strong balance sheet, bolstering our position to deploy capital for strategic growth.

Turning to Slide 4. Let me provide an update on our macro environment. As a reminder, the key agencies that we serve were fully funded for 2019 without being impacted by any government shutdown and we're currently optimistic about the outlook for next year's budget. While Washington often seems dysfunctional, the core markets that we serve: Public Health Care, Veterans, and the Military, are areas that continue to enjoy broad bipartisan support. We are pleased to see that the government 2020 Budget request continues to reflect a strong commitment to the programs that we serve today as well as those that we have targeted for organic and acquisitive growth in the future. Accordingly, we are confident that our programs remain well positioned to be fully funded going forward.

And looking at our 3 market focus areas; the Defense and Veterans space, we believe there are very strong opportunities for growth due to the increased emphasis on behavioral health and readiness, areas that leverage our vast experience serving the Armed Forces as well as our core capabilities.

In addition, the Veterans Administration is moving towards use of greater amounts of data analytics to improve responsiveness and care for its 20 million retirees and DLH is bidding on several programs where Big Data and cloud computing can be used to more accurately and timely provide service to those in need. At the same time, our mail-order pharmacy work continues unabated during the current prolonged solicitation period, with no impact expected during the remainder of this fiscal 2019.

Within Human Services and Solutions market, we also see many positive trends that should benefit DLH in the quarters to come. For example, we believe the administration for children and families, part of the Health and Human Services organization, offers growth opportunities during the second half of 2019 and early portion of 2020. DLH was also recently awarded an expanded contract servicing family members under the Department of Homeland Security in which we will expand our monitoring and evaluation and associated analytics and reporting capabilities.

And within the Public Health and Life Sciences sector, an area in which we have been strategically looking to expand, we see a greater role for companies, such as DLH, due to the current health care crisis facing the nation. The opioid crisis, as well as the more recent resurgence of previously eradicated diseases like measles, make it likely that HHS will expand research funding for CDC and other sub-agencies to tackle these challenges in the future.

In short, our forward indicators look bright for the company, given our strong re-compete win rate at nearly 100%; our new business win rate, which is fueling organic growth; and a healthy new business pipeline with quality opportunities in each of our 3 market focus areas, this combined with, of course, a strong balance sheet.

Our strategy of identifying attractive programs across our target agencies remains unchanged as we look to strengthen our capabilities of value-added technology solutions within the health care and human services space. We're steadfastly going after more complex work in data analytics, health IT, research and web-enabled applications that leverage our highly credentialed staffs and ensure attractive margins, while connecting us better with our clients.

This applies to both our organic and acquisitive growth posture. We continue to be impressed with the caliber of acquisition prospects on the horizon, and we'll remain selective to ensure that opportunities present a good strategic and cultural fit to ensure that we drive enhanced value over the long haul.

In closing, at this midyear point, we are upbeat about the remainder of 2019 and are already looking forward to the opportunities ahead of us.

With that, I'd like to turn the call over to our Chief Financial Officer, Kathryn JohnBull. Kathryn?

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Kathryn M. JohnBull, DLH Holdings Corp. - CFO & Treasurer [4]

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Thank you, Zach, and good morning, everyone. We're pleased to report another quarter of solid financial results.

Turning to Slide 5. We posted revenue for the 3 months ended March 31, 2019, of $33.8 million versus $34.4 million in the prior year second quarter. The revenue variance year-over-year reflects normal variation in service delivery, which Zach indicated earlier, as some lumpiness remains in quarter-to-quarter spending patterns. Last year, second quarter was unusually strong, due to the timing of performance of certain contract obligations. But overall, our contract performance is consistent with expectations for fiscal 2019.

Now moving to gross profit on Slide 6. The company posted total gross profit of approximately $8.1 million versus $7.4 million last year, with the 8.4% increase due to margin expansion. As a percentage of sales, second quarter gross margin was 23.9% in 2019 versus 21.7% last year, reflecting improved program mix.

Turning to Slide 7. Income from operations rose slightly to $2.3 million for the fiscal 2019 second quarter from $2.2 million last year, reflecting the higher gross profit I just mentioned, offset by an increase in G&A expenses. We reported net income of approximately $1.3 million or $0.10 per diluted share for the second quarter of both fiscals. Net income for the second quarter of fiscal 2019 was reduced by a noncash charge of $0.4 million, stemming from the early retirement of our term loan. The company recorded a $0.5 million tax provision for this fiscal second quarter versus $0.6 million in fiscal 2018.

Turning to Slide 8. EBITDA for the 3 months ended March 31, 2019, was $2.9 million versus $2.8 million in the prior year period. EBITDA as a percent of revenue was $8.5 million in fiscal 2019 versus 8% in 2018, reflecting the factors I discussed and largely linked to the improved gross profit. A reconciliation of GAAP net income to EBITDA is in our earnings statement and in the back of this presentation.

Slide 9 shows a summary of our balance sheet at the end of the quarter. We had approximately $5.5 million of cash on hand versus $6.4 million at the beginning of our fiscal year. We had nothing borrowed on our revolving credit facility at the end of the quarter, and our remaining term loan balance of $7.4 billion was paid off during the quarter, as Zach mentioned. Our balance sheet is in great shape, reflecting the company's solid cash flow. We generated approximately $8.5 million in cash from operations during the quarter.

This concludes my discussion of the financial statements. With that, I would now like to turn the call over to our operator to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Joe Gomes with NOBLE Capital.

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Joseph Anthony Gomes, NOBLE Capital Markets, Inc., Research Division - Senior Generalist Analyst [2]

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As I was looking over the Q and everything, it looks like the revenue in HHS was down about $1 million year-over-year. And all that you guys are saying is -- it's just due to seasonality and timing or is there anything else going on there?

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Zachary C. Parker, DLH Holdings Corp. - President, CEO & Director [3]

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No, it actually is a function of just some variability that we have in the business, mostly seasonal. Some of that, however, from EBITDA quarter-to-quarter was not -- some of it was disproportionate in the early part of the quarter versus the latter part of the quarter. So no real -- no contractual or level of effort changes at all.

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Kathryn M. JohnBull, DLH Holdings Corp. - CFO & Treasurer [4]

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I think you came on board, Joe, after our Q2 last year, but I do remember our discussing last year that some of the service events, some of the monitoring site visits and things that we -- the normal program scheduling issues in fiscal '18 slid more -- clustered more into Q2 than we had -- we would have wanted -- would have expected or would have planned. So our Q1 was light and our Q2 was really caught up on the program service delivery. In this year, that -- the spread of those events has been much more even and normalized. And so from our perspective, it's the same program operating at the same cadence and delivering the same quality of service, but just a little more evenly distributed.

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Joseph Anthony Gomes, NOBLE Capital Markets, Inc., Research Division - Senior Generalist Analyst [5]

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Okay. Okay. That makes sense. And on the G&A, it was a little bit higher than normal and you guys discussed that it was due to some increased corporate development cost. And I was wondering if you might be able to give us a little more color on what those corporate development costs are? And do you see that elevated level going forward through rest of the year, do you think it will come back down to a more normal run rate?

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Zachary C. Parker, DLH Holdings Corp. - President, CEO & Director [6]

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Well, Joe, it's really a function of response and reaction to things that, as I described earlier, that reach certain degrees of interest with us on the acquisition side. And, of course, that varies as a function of the deal flow and the opportunities that present themselves. I do think, though, that we'll probably see a little bit of cessation in that over the second half of the year. It's certainly is nothing that it is a standard operating pace for us. As I indicated, we've seen this year -- this calendar year, we've seen some targets that we really took a really strong -- a lot stronger look at, some of which we've passed and some of which we've maintained some interest. So it will be a bit of a moving target, but we do think it is higher than we would expect to sustain over the long term. Kathryn, anything to add?

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Kathryn M. JohnBull, DLH Holdings Corp. - CFO & Treasurer [7]

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I think that's appropriate, which -- of course, we -- as Zach mentioned, we are continuously in review mode on potential targets of opportunities and we do the initial work internally and with a set of fixed resources. So when we incur some incremental costs that we think it's something that's appropriate to insert a little additional external expertise on and get some additional advisory support, so that's what that represents.

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Joseph Anthony Gomes, NOBLE Capital Markets, Inc., Research Division - Senior Generalist Analyst [8]

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Okay. And you guys talked about the new business pipeline. I think it's roughly $600 million of qualified opportunity. What's the timing that you guys are looking at for some of these opportunities to come to fruition?

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Zachary C. Parker, DLH Holdings Corp. - President, CEO & Director [9]

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It's -- we've seen things slide to the right. We have had the more substantive portions of the qualified opportunities left are opportunities that we would have anticipated a request for proposal actually probably last quarter during Q1, but government has, much like our VA work, extended and have had some delays in getting those request for proposals on The Street. We have reason to be encouraged that 1 or 2 of those we expect to see certainly before this quarter is out. And the government is sending indication that Q4 is very likely to see a fair amount of those coming out. We think, obviously, the break in the government contracting side of the house during the sequestration -- during the freeze, obviously, impacted the acquisitions committee to get some things finished, but we are encouraged that we will see some of those materialize this fiscal year. And, obviously, they will drive the revenue stream for 2020 and we won't rule out that late '19, we might see some evidence as well.

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Joseph Anthony Gomes, NOBLE Capital Markets, Inc., Research Division - Senior Generalist Analyst [10]

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That will be great. And just last one for me. I know you guys have talked about the M&A opportunities for a while and I know from some of my other companies that I have cover, it seems that valuations continue to increase, and just trying to get if you can provide any more detail or color on what you guys are seeing, I mean, is it -- you haven't pulled the trigger yet because valuation seemed to then continue to increase or just haven't seen the appropriate fit? What's the stumbling block, I guess, as to why we haven't seen anything come to fruition yet?

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Zachary C. Parker, DLH Holdings Corp. - President, CEO & Director [11]

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Well, I will pass it over to Kathryn, of course, who heads our corporate development initiatives. But I can tell you that for us it's the attractiveness of the deal. We remain selective. We don't -- have not been looking to add scale for the sake of scale or things of that nature. And we've passed on probably 6 or 7 deals that got our interest, got our attention, but just did not really seem to be the very, very strong fit once we got a look under the hood. Having said that, we're still finding good quality deals that are there. We think the valuations are still reflective of things that within our sweet spot are very addressable by us. And Kathryn and our team have put together a pretty good package to make sure that we can -- and obviously, we can delever to make sure we can take care of that. We've got a strong support from the capital community, so we're really locked and loaded and ready to make sure we can move out when we find the right strategic and cultural fit. Kathryn?

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Kathryn M. JohnBull, DLH Holdings Corp. - CFO & Treasurer [12]

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Right. I don't think we expect to continue to be -- we don't feel left out of the process, if you want to think about it that way. We think we've done the necessary work to position ourselves well, both from a capital perspective and from a readiness to absorb another transaction. We, again, may be predating you a little bit, Joe, but as we've talked on some earlier calls, we did the work post the Danya acquisition of evaluating how to integrate the companies and position not just for absorbing that transaction, but really preparing to manage a $300 million to $500 million book of business and so we're -- we feel like we're ready in that regard. And now it's a matter of finding the right target. And as Zach suggested, we've seen a number of targets that in the trade-off, we think we can compete with anyone on valuation, but there is a trade-off point where you figure out is the investment worth what you're -- with what you would have to offer to be competitive. So when we've elected to leave a process, it's been because we have made that decision. We think the valuations certainly are strong right now across the areas that we're interested in. So we'd love to be able to pick up something less expensively, but in the long run, we think it's more important to pick up something that's going to add significant shareholder value and open up some new markets for us and strengthen the company. So to that particular target that we identify, we will compete with the best of them in terms of valuation and we're ready for that.

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Operator [13]

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(Operator Instructions) The next question comes from Ken Herbert with Canaccord.

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Austin William Moldow, Canaccord Genuity Limited, Research Division - Associate [14]

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This is Austin on for Ken. So just a couple of questions here. So you posted very good gross margins in the quarter. How should we think about gross margins for the full year and is there any specific reason that they might step back down?

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Kathryn M. JohnBull, DLH Holdings Corp. - CFO & Treasurer [15]

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Sure. It's best to think of gross margins as a range. And in the past, we've traditionally talked about our gross margin ranges somewhere between the high-teens and very low 20, at the end of roughly 18% to 22%. If you go back 12 months, that's kind of where we -- that was our expectation. We, of course, are always looking for measures to continue to improve that and there are several factors that impact it. One is going to be, of course, the particular mix of revenues you have in a particular time. So if you have a high volume of service delivery that requires a lot of travel, that's going to maybe add to the top line, but compress the margins a bit since the markups you get on that tend to be less generous. On the other hand, if you are able to continue to build internal capabilities, and therefore, have less reliance on some contractors, that's going to work towards improving your margins. And if you have improving -- and one of things we called out as particular driver is favorable trends on our management of employee benefits and taking some of the risk out of some of the benefit arrangements, so that's helped to improve gross margin. So my outlook now for gross margins tends to be in the, I would say, 21% to 24% range. And it's going to pop up and down, so I wouldn't necessarily carry the 20 -- just under 24% we delivered this quarter, carry that out in the forecast, but I would say, if you came somewhere in the middle of that range, that's probably a reasonable expectation on average over a period of time.

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Austin William Moldow, Canaccord Genuity Limited, Research Division - Associate [16]

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Okay. Got it. That makes sense. And then do you guys have any update on the VA logistics contracts and how you think that contract might look or what the timing of the potential order process might be?

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Zachary C. Parker, DLH Holdings Corp. - President, CEO & Director [17]

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Which contract was that again, you say again?

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Austin William Moldow, Canaccord Genuity Limited, Research Division - Associate [18]

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The VA logistics contract.

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Zachary C. Parker, DLH Holdings Corp. - President, CEO & Director [19]

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Yes. The VA logistics contract will be done in -- at least historically is indicated that it will be done in a series with the pharmaceutical one. So the client will continue to issue sole source bridges to us again, much like they have for the last 2.5 years on the pharma, until the pharmacy one is completed, in place, through its 90-day transition period. And then they will probably be able to start the acquisition process. And, of course, it's always subject to change, but every indication, both historically and the vibes that we're getting, indicates that it will be done accordingly. So we wouldn't expect to see anything on The Street before late 2020 or early 2021, perhaps. Let me also add a little color around your gross margin question. We currently enjoy a large book of our business that is in the T&M and fixed price arena. We do have a small portion of cost reimbursable business, which came in with Danya. As we look at some of these opportunities that we're bidding in our current pipeline, some of them have a larger portion of cost reimbursable contracts and while that certainly reduces the risk for us and offers really strong capabilities, it will probably tend to drive a little bit of that margin growth that we've continued to see and that we've certainly forecast for this year. So we'll manage expectations. I think it will be important as we do hit some of our larger organic wins, and even on the acquisition side, to make sure we characterize the contract types so that their impact on that gross margin percentage could be anticipated next and modeled.

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Austin William Moldow, Canaccord Genuity Limited, Research Division - Associate [20]

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Okay. Great. Great color on that. And just one last question. Can you guys provide an update on the Head Start program and how you guys are seeing opportunities in continuing to expand the contract?

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Zachary C. Parker, DLH Holdings Corp. - President, CEO & Director [21]

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Sure. I can tell you that they are doing a tremendous job on their team. The historic has transitioned to some new leadership. The new Director and our leadership team have been working very closely with their Program Manager and at the core of the program to really drive some really great benefits to their constituency and we're really, really excited about the work that Helene and Roe and our team are putting into place there. We do expect that sometime within this year, the government will start to look at reacquisition for that. We have been really driving a lot of increased value-added technology solutions to that program and really expect to compete very, very, very well. As we go forward, we welcome it. But we've really got a really, really exciting story that we will tell. We may very well tell a little bit more about it at some upcoming investor conferences because we're just really excited about where the program is heading, how Congress and the appropriate committees are seeing it on the hill and, of course, how our folks are really leaning in to deliver great value for the client.

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Operator [22]

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

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Zachary C. Parker, DLH Holdings Corp. - President, CEO & Director [23]

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Well, I want to just thank everyone, again, for your participation and interest in DLH. We really appreciate your strong commitment to the company and ask that you stay tuned. In the coming months, Kathryn and I will be on roadshow with a couple of very reputable industry conference events, investor conference events, and we'll provide some additional color around key metrics that we've addressed today. So thank you, again, and you all have a blessed day. Bye for now.

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Operator [24]

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