DLH Holdings Corp. (DLHC) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the DLH Fiscal Fourth Quarter Conference Call. Following management's prepared remarks we will hold a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded today December 8, 2016. I would now like to turn the conference over to the moderator Chris Witty.

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 fourth quarter press 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 2017 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 risks factors contained in the Company’s Annual report on Form 10-K for the fiscal year ended September 30, 2016 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 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. All comparisons throughout this call will be on a year-over-year basis unless otherwise stated. As shown on Slide 3, President and CEO Zach Parker will speak next followed by CFO, Kathryn Johnbull. With that, I now like to turn the call over to Zach. Please go ahead, Zach?

Good morning to everyone. Welcome to the fiscal fourth quarter conference call of 2016. Our fourth quarter results reflect major accomplishments during the fiscal year. First and foremost is a high degree of customer satisfaction on all of our major programs. This we attribute to the strong caliber of our employees throughout the country, now in excess of 1,400 and our management team. We also have had positive effect of how well our integration has gone from five of the twelve months. We’ve retained this 100% of all of our key managers during this transition period. And this is critical to the further transformation of DLH. Our employees across both of our operating years have kept their focus on delivering performance excellence to our customers. This will always yield better results for our stakeholders. Starting with Slide 4, let me review some of our major highlights of the past quarter. Bolstered by our acquisition of Danya in May, Q4 revenue rose 50% year-over-year to just over 27 million. This includes organic growth of 4.4% across our legacy business within DLH which is indicative of steady inroads we've made across a number of key government agencies where we see many opportunities for even further expansion. Our gross margin rose 310 basis points to 23% which was also an increase sequentially from the third quarter’s 21.8%. We believe that our improved mix of business and value added services should support similar gross margins going forward in tandem with a higher percentage of our overall business that comes from the more complex, technical and unique skill sets that come with our acquisition. We posted EPS of $0.20 for the quarter and at the same time further reduced the Company's debt to strengthen our balance sheet. This includes completing a small equity offering which was oversubscribed to eliminate the outstanding bridge loan from our acquisition. We ended the quarter and our fiscal year well positioned for higher growth and improved returns going forward with 233 million in our contract backlog and an active pipeline of bid opportunities worth some 510 million, a testimony to our focus on new business development. Now turning the Slide 5, I want to take a moment to just reflect on what we've accomplished this year. Not only have we bolstered the Company's position covering a core set of healthcare related consulting, management and technology services across what we consider solid federal agencies but we have enhanced our growth trajectory within the company. As we continue to transform the company, we have increased revenue by more than 50% expanded our knowledge base business and its associated margins and improved the outlook for the bottom line financial performance of the company. Our portfolio is now more broadly diversified. It includes new customer agencies, workforce credentials which includes strengthening our trades and skill based augmented talent with a high-end academic and professional credentials. This is critical to providing the next generation of telehealth and other IT enhanced services for the government, its employees and our veterans. As I mentioned earlier, I'm pleased with the integration efforts underway. We see this not only as a means to effect a smooth transition of our new workforce but rather an opportunity to transform the company and to take us to new levels on every front. Accordingly, we have positioned one of our senior executives Mr. Fred Vago, currently the President of Danya to lead our integration and transformation efforts. This was effective 1, October. Fred is overseeing major infrastructure initiatives including our ERP or enterprise resource planning of systems, our IT systems migration, and management governance policies and procedures efforts. These will be completed during calendar 2017 and are expected to deliver further infrastructure synergies to the business. In addition, while we pay for the acquisition with debt, we are well on our way to reducing the company's leverage through robust cash generation and efficiently managing the operations even as we invest for the future. We have strengthened our array of capabilities that are suitable for numerous contract opportunities and we are actively seeking and bidding on such vehicles to grow our business within key agencies. We're also leveraging our deep domain experience to expand in areas that complement our current business. We know our track record is excellent but we cannot rest on our laurels. To grow we must always be looking for new opportunities, which is exactly what we're doing. Turning to Slide 6, I want to speak for a moment about the market and the overall outlook for government services. We ended the year with a record revenue of 85.6 million and a gross margin of 20.8% but we believe the future looks even more promising for DLH. We’ll continue to be focused on organic growth driven by our talented workforce, strong management and existing agency relationships, while at the same time occasionally looking at bolt on acquisitions to further strengthen and enhance our business and improve our company's outlook. In the near term, we fully expect to see a continuing resolution from congress until the new administration gets up to speed. But the Department of Veteran Affairs already has its appropriations approved for fiscal 2017 and the National Defense Authorization Act or NDAA recently passed the House and is awaiting action from the Senate. In any event, we believe the net effect of the transition to a new administration while it could slow some new contract awards in the coming year, we expect these trends to be very favorable for the government services market. In fact, we believe it's possible that the next administration may bring new opportunities for companies such as DLH. The demand for veterans and military health care services will continue to remain strong and many analysts also anticipate more moving towards higher outsourcing of certain government work. Given the ongoing need for health IT services, the possible demand for increased consulting and the likely focus on improved government efficiency will be active and in this challenging and changing budget environment as well. Whatever the case, we are prepared to serve the administration, its agencies and their beneficiaries in the same professional manner of achieving performance excellence as we have always done. So I'm optimistic about the overall demand environment for DLH going forward. Lastly before turning the call over to Kathryn, let me just thank our employees, our customers and our investors for a great fiscal 2016. I’ve spend a good deal of time meeting with our customers, talking with our employees and listening to our investor community in terms of how we make a DLH a better company for everyone. From our investors, we've heard that people are pleased with the higher operating results and growth outlook as evidenced by the fact that our recent small offering was well oversubscribed. I think most shareholders also want us to remain focused on the core markets we serve and deploy cash today to delever the company as expeditiously as possible. We now stand as a unique provider of technology enabled solutions to manage, monitor and to support large scale healthcare and human services programs across the federal government. Our customer base has four of the largest federal health agencies including the VA, and Health and Human Services. Our new business pipeline again now exceeds 500 million leveraging our expanded capabilities in core competencies across the enterprise. I’d never felt more confident about the company's future. With that I’d like to turn the call over to Kathryn, our Chief Financial Officer. Kathryn who will be providing a more detailed discussion of our financial results. Thank you Kathryn.

Thanks Zach and good morning everyone. We are pleased to report another quarter of improved financial results as we turned the corner on fiscal 2016. Turning to Slide 7, revenue for the three months ended September 30, 2016 was 27.1 million representing an increase of 10.1 million or 60% over the prior year’s fourth quarter. Higher revenue was primarily due to the inclusion of Danya as well as from additional growth across our existing contract vehicle. Revenue expanded 4.4% organically over 2015 and we believe there's plenty of room for further expansion going forward. Given our strong position at HHS, DoD, VA and the CDC along with potential new opportunities for outsourcing across the federal government. We feel optimistic about the outlook for fiscal ’17 as Zach mentioned. Now moving to gross profit on Slide 8, this quarter the company posted total gross profit of approximately 6.2 million, an increase of 2.8 or 84% versus 2015. This was driven by our higher overall revenue as well as improved contract performance. As a percent of sales, third quarter gross margin, sorry pardon me, fourth quarter gross margin was 23%, an increase of 310 basis points over the comparable period last year. As we said last quarter such margin expansion is due to the contribution from Danya along with an improved mix of more complex higher value contract combined with effective cost management on our current business - on our legacy business base. The company remains dedicated to managing expenses and continuing to post solid gross margins. Turning to Slide 9, income from operations was 1.3 million for the fiscal 2016 fourth quarter, an increase of approximately 38% over the prior-year period. Within operating income, our G&A expenses were approximately 4.1 million this quarter versus 2.4 million a year ago. This increase was primarily due to the addition of Danya combined with incremental cost tied to program management, integration advisory services and new business development. G&A as a percent of revenue was approximately 15.2% this year compared with 14.2% last year. We also have higher depreciation and amortization due to 0.7 million of intangible amortization tied to Danya acquisition. Below operating income, we had net other expenses which totaled 0.5 million this quarter versus a positive other income of 1.5 million last year, which primarily derived from the favorable closure of a legacy payroll tax issue. Generally speaking other income and expenses include non-operational acquisition expenses, interest expense, amortization of deferred debt cost and other miscellaneous non-operational items. We reported net income for the three months ended September 30. 2016 of approximately $2.4 million or $0.20 per diluted share versus $8.2 million or $0.82 per share in the prior-year period. The decrease was primarily attributable to non- operational items including principally the decrease in the amount of tax benefit reflected from our net operating loss carryforwards and last year’s favorable impact from the closure of that legacy payroll tax issue as I just mentioned. Slide 10 shows the change in adjusted EBITDA. On a non-GAAP basis adjusted EBITDA for the three month ended September 30, 2016 was approximately 2.2 million, an improvement of 1.2 million or 114% over the prior-year period. In addition, adjusted EBITDA as a percent of revenue was 8.1% compared to 6.1% in the fourth quarter of fiscal 2015 reflecting the stronger returns from our revenue as discussed previously. Our definition of adjusted EBITDA along with descriptions regarding its use and rationale is in our earnings statement. We certainly understand that the substantial non-operating items on our financials for the quarter and for the year make it challenging to compare EPS period to period. In addition to the major tax adjustments related to recognizing the value of our tax net operating losses, there was that one-time benefit from resolution of the payroll tax issue in ’15. There were also acquisition expenses in FY16 and of course there's the, the non-cash amortization of the intangible from the Danya acquisition. So to assist in comparing operating results for period to period, we've included income from operations per share in our earnings release. The main message we offer you is that FY16 represents what we believe to be the new normal for DLH, following our transformational acquisitions. And these results are indicative of what should be expected going forward. Turning to slide 11, here's a high level overview of changes in our cash position for the fiscal year. We began ’16 with roughly 5.6 million in cash and during the year generated 6 million from operations. Through debt and equity, we raised approximately 24.6 million of funds, net of repayment and during the year, of course, paid off 32.7 million primarily for the Danya acquisition, leaving us with 3.4 million as we start fiscal ’17. We remain dedicated to reducing debt going forward and de-levering the company. Our senior debt has already been brought down from -- to 23.4 million from the 30 million at closing of Danya in early May and we have approximately 5 million available under our $10 million revolving credit facility. I'm also pleased that during the quarter, we successfully raised 2.65 million to repay the subordinated debt held by Wynnefield Capital. DLH now has 11.1 million shares outstanding and the offering, the rights offering demonstrated a high level of interest in the company in its future, given the strong level of over subscription requests. Additionally, given our substantial net operating losses that we discussed previously that’s reflected through the tax benefit line, we do not anticipate being required to outlay significant cash for tax payments in the near future, which allows us to maintain our cash to support working capital needs of the company, for growth and to continue to service the outstanding debt. Before handing the call over for questions, I wanted to alert our listeners to some upcoming investor events, as shown on slide 12. We'll be presenting at the Noble Financial Growth Conference at the end of January, after which we’ll report FY17’s Q1 results on February 8. We will then host our annual shareholders meeting on February 9. We encourage our investors to participate in these activities to the extent possible. Now, let me just summarize where we stand heading in to ’17 as shown on slide 13. We believe as Zach indicated earlier that DLH is in the best shape ever in terms of its capabilities and outlook. With Danya integrated and performing as planned, we’ve strengthened our core competencies and brought some excellent employees into our organization, which we can leverage to win new business across the various agencies we serve. We believe that demand for innovative healthcare services and solutions will continue to grow across the federal sector, no matter what happens with the new administration. Given the ongoing demographic trends and requirements for health IT services and higher VA support. At the same time, we’ve paid down debt and provided improved financial flexibility to support our growth going forward and we’ll continue to be disciplined when it comes to de-levering the company. Given our existing agency contract vehicles and the solid relationships we've built over time. DLH is extremely well positioned for the opportunities of tomorrow. And we're pleased by the support shown by our employees and our investors as we enter this next phase of growth. That concludes my discussion of the financial statements. And with that, I would now like to turn the call over to our operator to open for questions.

[Operator Instructions] And our first question comes from Mark Jordan of Noble Financial. Your line is now open.

Good morning. Kathryn, a question relative to future tax payments. Was the tax benefits you realized here in the fourth quarter, the final release of evaluation reserve and that therefore, if that's the case, therefore, you'll be showing a standard say 38% tax rate moving forward, but not paying any taxes, just accreting down the tax benefits on your balance sheet?

Exactly right, Mark. Exactly right. We fully realize benefit of those NOLs and going forward, our tax provision will look very standard at the standard high 39, high 38%, 39%.

Okay. Could you talk about what your re-compete events were this past year and what re-competes are scheduled for this upcoming year?

Sure, by this year, with regard to FY16, we had really a re-compete free year with one small exception, we had some small work, small amount of work at CDC with our new business that was successfully re-competed, not at a material level for financials. With regard to FY17, we anticipate that before the end of the year, we may be in re-compete one of our two large CMOP contracts at current time, we would forecast that to start the solicitation process somewhere around mid-year. So we would not expect to see very much impact from re-competes during the calendar, or during the fiscal ’17 period.

Okay. The pipeline that you characterized 510 [ph] million, I assume that that's the aggregate value of the multi-year opportunities. If you were to look at it on average, what would that 510 be with regards to sort of annual revenue potential. And when will those be adjudicated?

Mark, it’s a very good question. Right now, we believe it's pretty heavy, when I say front loaded with deals that would drive the revenue largely in ’18, more so than ’17, even though we've got a significant amount pending that was bid in the middle of this year, right around the time, shortly after we completed the acquisition. I got to tell you though that there's really kind of a bimodal view as I look at our pipeline. We've got a few very major opportunities those that will be transformational on individual award merit and then large number, they are good steady growth opportunities for the company. So the average quite frankly is really not terribly indicative. In fact, I use more of the median because of that, as we look at the average, it’s just not, it’s not very reflective of anywhere near 30% or 40% of the potential revenue stream. So we are going to give more color, as Kathryn indicated on our annual shareholders meeting in February, a lot deeper dive into the characteristics of that pipeline. We would expect, despite a continuing resolution, would expect that some degree of those will have already been decided by the government.

Okay. Final question from me. Could you talk a little bit about the integration expenses that were recorded in the fourth quarter and when do you expect the combined companies to be wanting on a normal efficient basis?

So the acquisition or the integration expenses in the fourth quarter were largely around, we did engage a third-party advisor that was really, gave us what we viewed as a very healthy quick start on getting people, pulling people together, getting organized and really driving the mindset of moving towards what we call DLH 3.0. So, let's not necessarily run into any either of the existing approaches that either the two sides of the business were using, but rather explore what’s the best for the consolidated business and drive towards that. So that was a pretty intense exercise through late July and the better part of August and early September. We have now transitioned that as Zach mentioned earlier in his comments to an internal resource, so we got a quick injection of focus, if you will. And now, we’re driving to implementation. So, many other things have from time dependencies that are a function of, for example, some things around benefits plans and payroll tax reporting and all that that drives around calendar years or planned years and all that. But however, there are phases that the identification and the planning for the integration exercises has occurred. Sales cycle through according to that schedule that makes that applies depending on, if there is some external constraint, but the key punch line to that is, we expect those integration changes to be implemented fully as we wrap up FY17. And in fact, we are from our own planning well ahead of what we expected in terms of the amount of those integration activities that we've already accomplished.

[Operator Instructions] And our next question comes from Matt Genie, private investor. Your line is now open.

Hi. Thanks for taking my question. So in your previous conference calls, you gave guidance for next year, for about 120 million in revenue, 23% to 24% gross margins, 13.5% of that for G&A and about 10% operating margin. Have those forecasts changed or is that still roughly what you guys expect?

Well, actually, Matt, this is Zach. I appreciate the question. We actually do not give guidance. I think what you may be referring to as during a couple of investor conferences and quite frankly Kathryn and I are updating you right now, we do give, it’s not even a pro forma, but we do give an indication of what we think the major financials and company value would look like as we continue down on long range strategic plan. That strategic plan does include as Kathryn indicated earlier, substantial component of organic growth, but what's more important, just as important is the nature and the caliber of that growth in terms of the type of margin delivery you have on the business. We do that kind of looking at not necessarily annual milestones, but sized milestones. So we would take a look at what does the company's profile look like at 100 million, 120 million and then 300 million as an example. So we did that at the IDS Conference, posted that and we have a couple of things in that regard. So we are going to have an update on that as we go to the Noble conference in the end of January as well as our annual shareholder meeting in February, but I do want to be clear that we do not give guidance and we’ll continue that practice.

Okay. Well, let me ask a different question then. So this quarter, the other income was about 2 million in annualized run rate. Can you give us any information on how much of that was interest expense versus how much of that was still expense and sort of corresponding where you'd expect those numbers to come next year?

Yes. So within the current quarter, there were no deal expenses included because as the deal closed in Q3. So that is a pretty, the current quarter activity is a pretty good indication of the annual, on an annualized basis. It includes both interest as well as amortization of the deferred debt costs. So it’s effectively all of that, different flavors of interest and of course that's going to vary depending on the level of debt.

Okay. And one last question, what do you expect your tax rate to be once you burn NOLs and also what's the delta on that from any kind of recent election results?

Right, right. We’re cutting that tax rate, right. So assuming that can get through, I think everybody would benefit from that, but yet, so the tax rate is closed in, in our current financials we think is the effective rate that we expect going forward. So it's in the 39% range.

Thank you. [Operator Instructions] And I’m showing no further questions at this time. I’d like to turn the conference back over to management for closing remarks.

Well, we want to thank you all again for your interest and participation in DLH. We do plan on closing to continue to invest in the, not only the growth of the business, but operational excellence. We’re going to continue to enhance the posture of our leadership team and we think all of these investments as a result of the transformation of DLH 3.0 will certainly yield more positive results and position us even more favorably with new clients and our future shareholders. With that, on behalf of the DLH leadership team, Kathryn and I would like to wish you all a merry Christmas and Happy Hanukkah and Kwanzaa and a bright and prosperous New Year. Have a blessed day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Have a great day everyone.