DLH Holdings Corp. (DLHC) Q1 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Quarter 1 2015 DLH Holdings Corp. Earnings Conference Call. My name is Tracy, and I'll be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. And now I'd like to turn the call over to Casey Stegman, Investor Relations. Please proceed, Sir.

Thank you, Tracy. Good morning, everyone, and thank you for joining us for today's conference call. I'm Casey Stegman of Stonegate Inc., Investor Relations Adviser to DLH Holdings Corp. On the call with me today is Zach Parker, President and Chief Executive Officer of DLH; and Kathryn Johnbull, Chief Financial Officer. Earlier today, the company posted its earnings release, which outlines the topics that management intends to discuss today. Should you have missed that release, it can be found on the Investor page of DLH's corporate website at www.dlhcorp.com. As a part of today's call, we have provided a slide show presentation that can be accessed on the DLH website. Go to the Investor Relations tab towards the right side of the page and click on Presentations under the drop-down menu. We're also providing a simultaneous webcast of today's call with a replay available later today on our website. Please note that this conference call may contain certain forward-looking statements as defined by the federal securities laws. Statements in this call regarding DLH Holding Corp.'s business, which are not historical facts, are forward-looking statements that involve risks and uncertainties. While these statements reflect DLH's current views and outlook, they are subject to factors that could cause its future results to differ materially. These risks and uncertainties are discussed in detail in our documents filed with the SEC, specifically, the most recent reports on Form 10-Q and 10-K. 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 financial -- GAAP results is included in our earnings release and in the investor presentation on DLH's website. All comparisons throughout this call will be on a year-over-year basis unless stated otherwise. With that said, it's my pleasure to turn the call over to Zach Parker, President and Chief Executive Officer of DLH. Zach?

Thank you, Casey. Good morning, and welcome to our shareholders and other interested parties. We appreciate your participation in this conference call and those of you on webcast. As Casey indicated, earlier today, we posted our first quarter fiscal year 2015 financial results. We are very pleased with the -- our performance -- our operating performance in the first quarter of the fiscal 2015, as all key metrics were improved compared to the prior year period. Our results reflect our strategy to expand our business within our key customer base and in adjacent markets, principally in health care, with an emphasis on telehealth. We continue to have a strong backlog and a robust pipeline of qualified new business opportunities. We continue to deliver strong performance to our customers and value and their beneficiaries as well as, we believe, to our shareholders. In addition to our financial results, we have had a number of other positives during the first quarter, which I'd like to touch on now. As some of you may recall, in mid-November, we announced the addition of Dr. Elder Granger, U.S. Army Major General (retired) to our Board of Directors, an addition which we believe significantly strengthens our governance and leadership team. Dr. Granger's medical practitioner's awareness and substantial leadership experience will be invaluable, as we expand into the federal health care market. With regard to market expansion, we believe that our new business pipeline remains strong, with our addressable market being adequately funded in the years ahead. We continue to see strong bipartisan support for improving the health care of the U.S. veterans. The federal government omnibus spending bill was approved last month, which mitigates much of the procurement uncertainty for fiscal 2015. Funding for the Department of Veterans Affairs includes: a $65 billion of discretionary funding to provide needed care and other benefits to veterans and their families, an additional $400 million investment in high-priority capital projects and $138 million to address VA claims backlog and to improve efficiencies. Moreover, this week, the White House proposed a 2016 defense budget that includes $169 billion for the Department of Veterans Affairs. The VA budget includes $73 billion in discretionary funding, again, largely for health care and an increase of $5.2 billion above the 2015 enacted level. Also included is $1.2 billion to expand telehealth services, which is one of our strategic markets. In addition, there's a major funding commitment for health IT modernization within the VA, an area for which we anticipate participation. We've also seen the recent funding for Ebola vaccine trials and similar medical research and are encouraged by the opportunities that these challenges present for expansion of our business. We are proud of our working relationship with our principal customer, the Department of Veterans Affairs, who, all of the years, has expressed appreciation of our cost value performance and operational efficiencies. This was reinforced, again, with a fair amount of high customer satisfaction indices over the course of the last several months. Our competence in health and welfare, medical logistics, public health and pharmaceutical services will continue to serve us well in this business climate. We will invest in new business capture and in strategic health care market areas. This will deliver the type of growth and value that we believe our shareholders have come to expect from DLH. I will now like to turn the call over to our CFO, Kathryn Johnbull, who will provide a more detailed discussion of our financial results. After which, we'll begin our Q&A session. Kathryn?

Thank you, Zach, and good morning, everyone. We are pleased with our earnings and financial position that we reported to you today. Our first quarter results continued our trend of improving our key metrics, as we delivered growth in revenue, gross margins and adjusted EBITDA compared to the prior year period. Detailed financial results for the first quarter ended December 31, 2014, versus the prior year first quarter are as follows: revenues of $15.7 million increased $1.2 million or 8.3% over the prior year, with the increase due principally to a new business awarded throughout 2014 and expansion on current programs. Gross margin of $2.5 million increased by approximately $0.4 million or 19.9%. As a percentage of revenue, our gross margin rate of 16.2 improved by 1.6% over the prior year. Our margin growth is attributable to revenue growth, improved contract performance, continued cost controls and higher margins on new business. G&A expenses, which include general, administrative, operating and business development activities, were $2.3 million in the quarter, an increase of $0.2 million over the prior year first quarter. As a percent of revenue, G&A expenses were 14.4%, an increase of 0.4% over the prior year. On a non-GAAP basis, which excludes noncash stock and stock option expense, G&A expenses were 12.7% of revenue, an increase of 0.2% over the prior year first quarter. These expense increases are in line with our strategic plan to grow and manage our contract base. Income from operations was approximately $0.3 million, an increase of approximately $2 million over the prior year first quarter due to improved gross margins, offset by additional G&A expenses. Net income was approximately $0.1 million or $0.01 per basic and diluted share, essentially equal to the prior year period. Adjusted EBITDA is a non-GAAP measure that represents earnings from operations with noncash items such as taxes, stock and depreciation added back. This is a key measurement that our management team and directors use to evaluate the cash contribution attributable to our business operations. Adjusted EBITDA for the first quarter 2015 was approximately $0.6 million, an increase of approximately $250,000 or 80.3% over the prior year. This increase is due principally to increased revenue and gross margins. Moving on to the balance sheet. Our first quarter results reflect our trend of improving our surplus working capital. We closed at December 31 at approximately $1.1 million, an increase of $0.4 million compared to the year ended September 30. As the key contributor to this improvement is profitable operations, we expect that our working capital position will continue to improve throughout fiscal year 2015. At December 31, we had cash on hand of approximately $3.8 million, available loan reserves of approximately $2.6 million and no debt. We believe we have adequate liquidity resources to fund our operations and support our growth over the next 12 months in view of our existing cash position, availability under our credit facility, our funded backlog and our internal business plan for earnings and cash flow from operations. We are pleased with our first quarter results, and we believe we have implemented an operational model that can sustain this progress and can scale as the company grows. That concludes my discussion of the financial statements. With that, I would now like to turn the call over to our operator to open it for questions.

[Operator Instructions] And your first question comes from Howard Brous from Wunderlich Securities.

I have 3 questions. One, certainly in the last 3 quarters, I'm beginning to see a plateauing of revenue. Can you comment on that?

We sure can. Yes, we -- revenue has been, quarter-to-quarter, relatively flat. We think that, that is obviously indicative of the climate that was, as we addressed, was lacking a budget or an approved budget as we move into this new quarter, which of course began 1 October. We're confident that with the President submit and the Department of Defense and VA budgets, that for the first time in many years, they can see through 2016 with some budget uncertainties now eliminated. So we're anticipating that some of the new work opportunities that have been held up will start to move forward in the course of the next month or 2. So we're pretty encouraged by those budgetary changes and commitments now and that they will open up that dike a bit.

Just one comment. I wish you didn't have to pay income taxes this quarter. It would have been a lot better.

Well, of course, we won't be expending any cash for that. [indiscernible] to accrue tax results on profitable operations.

Right. I want to get back to the similar question I've been asking, generally, for the last several quarters, and that is a function of gross margins. And you've made good progress in gross margins. Can one, on a long-term basis, assume that, that line continues to get better? I'm not looking for a projection, you know that, because I know you won't give me one.

Sure, Howard. No, but it's a very fair question. And we commented on this quite a bit at the LD Micro-cap Conference, and so I don't mind mentioning it. The nature of the work that we have in that backlog of new business is substantially different in terms of its complexity for the government, particularly in health care. And with those nature of those contracts, they're a generally a higher-margin business than what has been the majority of our legacy business. So we expect that there'll be positive improvement as a result of the types of contracts that we start to add to our book of business.

Your next question comes from the line of Richard Greulich of REG Capital Advisors.

I have several questions. The loan agreement you have expires July of this year. Is there any reason to renew that at this point?

Certainly, we want that capacity to borrow. And because we do expect that growth through closing on new contracts, we'll require some use of cash.

Okay. The -- in the fourth quarter, the fourth fiscal quarter, when you recognized some of your deferred tax or your valuation allowance you reduced, like $4.6 million. Now to do that, you looked out over or -- at period of time in terms of possible profitability over that period of time, what was that time period that you looked at to allow you to come up with that $4.6 million number?

Well, it is the carryforward period for each of those losses generated. So generally speaking, tax losses in the U.S. have a 3-year carryback and a 20-year carryforward. And as you've been an investor for a long time, you may remember that many of those losses have about 10 years already burned on, right? So roughly speaking, it's a 10-year look-forward period.

But you didn't -- you only did a portion of it.

Yes, correct.

And so what -- I guess, what I was looking at is, what was the -- what went into that portion? In other words, like how do you derive at the $4.6 million as opposed to, let's say, $6.6 million?

Sure. Yes, well, it is by its nature being a financial accounting accrual, it's subject to lots of projections and lots of assumptions around how you're going to value it. And naturally, conservative views would prevail there that you've got to look at your current book of business, project out all of your contract base over its currently -- current period of performance, and then you've got to project your expected realization of renewals on those contracts. You've got to allow for the fact that there will be competitive pressure on these contracts and what that might do to the margins going forward, and then you've got to factor in new work. But that new work has got to have some degree of weighting to it to reflect the fact that it's obviously not in your current book of business. So it is a projection that we went through with a great deal of rigor and scheduled out across a 10-year term at that time. It is, as is the case with all key valuation exercises, that's subject to annual review and assessment in terms of assuring that the asset that we booked is realizable. And then if there's a major condition or major change in the condition of the business, such as adding substantial amounts of revenue beyond what was in our book of business and forecasted in last year's review, then it has to be updated to reflect the changes in the circumstance of business.

And Rich, let me just add one piece. And in that equation, as you well know, and part of what I think you may be looking for, is just to share with you that where there are those levers of looking at the adds -- the puts and takes as Kathryn described, we took a conservative approach with regard to the forecast piece, if that's what you're looking for.

Right. Right. Recognition standards are fairly conservative, so [indiscernible].

Right, exactly.

Yes, so I should not take that number, divide by 10 and say that's what you think you're going to earn.

I knew that's what you were trying to do [indiscernible].

Exactly right. That's right. That's right.

But nice try, though.

[indiscernible] over and then you have to look at how it's evolved over time.

And but I will share again, and some folks have heard this from me before, of course, we do not give guidance. But we are looking at, in the relatively near term working with Casey's organization, at some good ways of giving some future direction to give a little greater color to our pipeline for you and other investors so...

Now the last quarter in the conference call, you mentioned that you were looking for opportunities over the next 2 years to bid on around $400 million of multi-year businesses. You didn't mention that in this conference call. Is there any change in that, either up or down, from the addressable opportunities that you can bid on?

Good recall. Yes, those are still in the pipeline, and I didn't make this call. I appreciate you mentioned that. We still do have that amount. That number that is weighting now is a little less than that because we have submitted a couple of proposals since that time. One of those is -- and we do mention it in the -- which is unusual for us, we do mention it in our earnings presentation, and that is a large IDIQ for VA information technology going forward. So we do make some references at IDIQ, which basically will be one of those hunting license contracts over the next 5 years. We believe we have to have a -- it's very important to be a part of that opportunity to bid future opportunities, and so we some have submitted that one as well.

Is there a time line at which you would expect to hear one way or the other, whether you or part of that circle then or not?

For that particular one, I'll have to ask Denise. But I want to say that is the government's estimated sometime later -- late in this fiscal year. Is that right, Kathryn? Yes, okay.

Yes, okay. For the first time in a long time, you actually spent something on property. I guess, computer system?

Right, right. So that is a, as you said, a much-needed and very appropriate updating of our IT structure in corporate offices.

Okay. And you mentioned in the overview that there was recent government funding for Ebola vaccine and similar research. How does that tie into what you do?

What we are seeing is, in the federal space, largely attributed to some of the functions that we've provided for the VA and other clients over the last few years as pretty strong medical logistics company. As you know, we won some work that we're doing for the army, as well, in medical logistics, and we see that there's a pretty good potential for us in the near term to pursue work to provide medical logistics support in that arena and some other related infectious diseases, if you will. So we're looking at some opportunities now in that area. And we think that that infusion of new funding, which the President did plus up in the recent months, offers an opportunity for us as well. There will be...

I'm sorry. Would this be something where you will be a prime contractor in terms of any contracts that are let?

Yes, that is our preference. Our default position is to be a prime on those. It's going to be a function of which contract vehicles they use. There are some that we are currently partnered where we're a sub, but we are aware of some that we can prime and are planning to do so.

And last question, in the telehealth services funding work, I think that's your virtual pharmacy thinking. Can you give more detail on that?

Yes, I appreciate that question. This is a major strategic initiative for us. Kathryn and I, with our IT folks, just completed a meeting yesterday in looking at again standing up our infrastructure for telehealth to apply to -- to expand our business presence there as well. You'll hear more in Q2 about some of the revenue gains, because we had a couple of wins -- below-the-radar wins that will help us in the near-term quarters. But yes, there's -- that continues to be a very strategic market area for us. We believe that both in the VA and the Department of Defense, in particular, they have a lot of opportunities. And we also think it offers, long term, some potential crossover us -- for us into working potentially with the payers and the PBM community as well. So we have some really strategic sites to really evolve the business space of this company that we want to leverage the telehealth and virtual pharmacy capabilities.

[Operator Instructions] Your next question comes from the line of Benj Gallander of Contra the Heard.

I've been a shareholder since 2006, and since you guys have come in, things have certainly been doing much better.

Thank you very much, Benj. I know you probably have the perspective I have of Howard's question with regard to taxes. I'm glad we have a tax problem to report.

[indiscernible] that will continue. The very first person who asked the question mentioned revenue seemed to be topping up. And I mean, if you look at the bottom line, it seems to be -- it seems to be staying pretty much at the same level. I'm wondering if at this point, given the size of the company, it is relatively small. And I perceive there's a lot more value there. If it's not a good time to look at strategic alternatives and put the company up for sale, because as part of a larger organization, this would, I think, have a lot more value. And I think it could probably get about double the current stock price if you have the right people looking it over.

Well, you're actually right to ask that question. Because as you look at the transformation of this company and what we've had to do, and we have had to shift from, as you well know, first, putting our finger on the dike and then stabilizing the company, building the backlog in the book of business, demonstrate profitability, and now it's a point of growth. And there's various forms of that and there's, of course, the organic growth, which we have a very stable path for. We are seriously entertaining "not too distant future" opportunities with regard to acquisitive growth, and that is an acquisition, which, of course, could be a form of some combination of liquidity, could be some debt and things of that sort of nature. And there's also the potential of some type of merger or something of that nature that's -- as other companies are starting to contact our Board of Directors and ourselves about some possible unions to really infuse something dramatic into our entity and the strategic direction that we're going. So those are the sort of innovative things that we think now that we've demonstrated and you've ridden that ride with us up to this point. The 2015 and '16, we've had to say probably part of '17 as well, we are seriously looking at whether the disruptive changes that would benefit our shareholders, and we've not taken anything off of the table.

Right. That sounds good to me, indeed. I'd watch it if you look at a takeover. Because right now, the balance sheet is nice and clean. In terms of a merger, it would be great to see some cash on the table coming to shareholders. I still think the ideal might be that somebody comes and takes out the company, and it sounds like there's a few people who are kicking the tires and that's always a good thing. I'll just finish by saying, once again, I appreciate the work you've done, the turnaround you've done, and hopefully, maybe somebody will come in and take a bite.

You bet. Kathryn, did you want to clarify anything? I thought that was pretty straightforward.

No, I agree with that. But stating the obvious, I mean, in the meantime, the key for us is not to get distracted by those potential transactional things that might happen. And we do believe there's further opportunity inside the company, and we look forward to continuing to build the value of the company.

As there are no further questions coming at this time, I would like to turn the call over to Zach Parker for closing remarks.

Well, thank you, operator, and thank you, Kathryn. And we remain extremely indebted to our over 1,000 employees throughout the U.S., and I can't say enough about the -- their ability to deliver outstanding services to our clients and to us in DLH headquarters, so please join me in a salute to our team there. I'm also very proud that -- the fact that on Veterans Day, we ended our national window of service, which is a 2-month window from Patriot Day or 9/11 through Veterans Day, and which we really emphasize and push volunteerism and in-kind contributions to homeless veterans throughout all of our work site areas in several states as well as our headquarters in Atlanta. And I'm pleased to say that this year, our in-kind contributions to the homeless veteran and those need -- in need of major healings started approximate $0.25 million, which is a huge improvement for our second time. And we're really, really pleased for what we're able to give back to the community in such a positive way. And I want to thank you, all, again for participating in today's conference call and the questions. Should you have any additional questions, feel free to contact myself or Kathryn. We thank you for your interest and support and look forward to speaking with you again in May as we report our second quarter fiscal year 2015 results. Thank you, and have a great day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.