DLH Holdings Corp. (DLHC) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the DLH Fiscal First Quarter Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today February 8, 2017. 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 CEO; and Kathryn Johnbull, Chief Financial Officer. The Company's first quarter press release and PowerPoint presentations 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 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. All comparisons throughout the 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?

Thank you, Chris, and good morning and good afternoon everyone. Welcome to our fiscal first quarter conference call. Starting with Slide 4, I'm delighted to go over some of the recent highlights for the company including our financial performance. Once again we [lead] by our acquisition last year, our total revenue rose substantially this quarter to 26 million which also reflects organic revenue growth of approximately 5%. We continue to pursue a healthy new business pipeline of opportunities across our target market as I will review in a few moments. And we are pleased to be achieving organic growth such as this on a steady basis. At the same time, we again posted strong gross margins of 22.3% this quarter up 470 basis points year-over-year underscoring our improved positioning with higher value added contract vehicles. EPS of 0.03 was greatly improved versus a loss last year although lower sequentially from fourth quarter as Kathryn will review momentarily. In addition, we announced in December that we had hired Helene Fisher to run part of our operations along with Kevin Wilson. Helene is been a great fit from day one. She's in charge of our mission systems and solutions operating unit where we contain a great deal of our civilian agency business and brings an unparalleled depth of experience from her prior work experience at many quality organizations within the federal government contracting industry. Her management skills and extensive experience with technology enabled health services make her an ideal person to energize and expand our civilian focused operations. All in all I feel very good about where we stand at the start of fiscal 2017 including the potential impact from changes taking place in Washington. On that note, please turn to Slide 5. While still in the early days, we view the new administration is neutral to positive for our markets and business and we do not anticipate any substantial erosion to our new business pipeline of opportunities. We view the federal hiring freeze as a no risk to us and we have a great reputation with our customers for contracts currently in place. Indeed if there's an increased commitment to compliance and driving down costs this falls squarely within our wheelhouse. In addition, the Veterans Administration is being considered for increased focus and potential higher spending. In the incoming secretary, hails [indiscernible] from the Veteran Health Administration were DLH is one of the top medical service providers today. Overall, the key areas where we operate are ones that are expected to benefit from the additional growth over the coming years and we believe we're well positioned to provide the expertise and assurances necessary for leaders to look - to continue to look to improve healthcare support and manage cost-effectively. Near-term as shown on Slide 6, DLH is working to complete our integration activities during fiscal 2017 and drive enhanced value across our book of business. We're pursuing a number of ongoing initiatives including enterprise resource planning integration, and are doubling down on streamlining cost and leveraging our IT infrastructure, so that everything operates on the same effective platform. The leadership team is extremely focused on driving synergies throughout the organization to bring strong results to our customers, and our shareholders alike. We anticipate that this will all lead to a more stable, improved operating results and over time our top line growth. Turning to Slide 7, we'll continue to pursue those opportunities that best fit our strategic plan in core competencies and expertise. For organic growth, our sales cycle today is still roughly 18 to 24 months and programs in the $30 to $120 million range of our sweet spot but occasionally we go for major deal substantially larger and looking at some of those right now. We believe there are plenty of areas where we can strengthen our position and broaden our business base leveraging the total enterprise and pursuing penetration opportunities within agencies that are adjacent to those that we serve today. From an acquisition standpoint conversely there remains a healthy deal flow in today's marketplace and we will consider target opportunities that we believe would potentially benefit DLH and bring added benefits to our organization. We’re not just looking for scale, our focus here will remain on selectively considering enterprises that share the same strategic objectives, the same focus areas in targeted customers, and a good cultural fit. Most importantly those that can add unique differentiating capabilities to DLH and strengthen our positioning in our market pursuits. Before turning the call over to Kathryn, I want to thank once again our incredible staff across the country for everything they do in the results that we have achieved together. We see additional top line growth potential for 2017 and beyond, leveraging our core competencies, business development initiatives, and new business opportunities that present themselves within the current administration. We will continue to focus on performance excellence and operationally delivering to our current customers in a manner that will continue to yield results such as the JD Power award and additional certifications. Our balance sheet remains solid. Our focus on the bottom line results are unwavering and our confidence had never been stronger that we are uniquely positioned to serve and thrive from the health and welfare needs of our nation. With that, I'd now like to turn the call over to our Chief Financial Officer, Kathryn Johnbull who will provide a more detailed discussion of our financial results. Kathryn?

Thank you, Zach and good morning everyone. We are pleased to report another quarter of sound financial results as we began fiscal 2017. Turning to Slide 8, we posted revenue for the three months ended December 31, 2016 of $26.1 million representing an increase of $10.5 million or 58% over the prior year first quarter. The higher revenue was primarily due to the inclusion of Danya, as well as from additional growth across our existing contract vehicles. Revenue expanded approximately 5% organically over the prior year period as Zach mentioned reflecting business development efforts across the entire enterprise. Now moving to growth profit on Slide 9, this quarter the company posted total gross profit of approximately $5.8 million nearly double that of last year driven by higher revenue, as well as improved program profitability. As a percent of sales, our first quarter growth margin was 22.3%, an increase of 470 basis points over the comparable period last year. As we said before, this performance represents a focus on more contracts, higher value contract, combined with effective cost management. The gross margin rate was up slightly versus the Q4 of FY '16 rate of 23%, although still well within our expected gross margin range of 20% to 23%. Turning to Slide 10, income from operations was 0.9 million for the fiscal 2017 first quarter versus 0.4 million last year. Higher gross profit was partially offset by an increase in depreciation and amortization and G&A expenses tied to the inclusion of Danya along with incremental expenses to manage and grow DLH. As compared to Q4, our first quarter results absorbed the impact of non-cash stock compensation expense and yearly audit fees that totaled in aggregate approximately 0.7 million of cost. Below operating income, we had net other expenses of 0.4 million this quarter versus 0.6 million last year. Generally speaking other income and expense includes non-operational expenses such as interest expense, amortization of differed financing cost on debt obligation, and other miscellaneous non-operational items. In the prior year period other expenses included acquisition related expenses. We reported net income for the three months ended December 31, 2016 of approximately 0.3 million or $0.03 per diluted share versus a net loss of 0.1 million or $0.01 per share loss in the prior year period. This reflects the higher operating income I just spoke about and a decrease in the other expenses net of a higher provision for taxes. Slide 11 shows the change in our adjusted EBITDA. On a non-GAAP basis adjusted EBITDA for the three months ended December 31, 2016 was approximately $1.6 million more than double last year's $0.7 million. In addition, adjusted EBITDA as a percent of revenue was 6% this quarter compared to 4.4 in the first quarter of fiscal 2016 reflecting the items previously discussed. Our definition of adjusted EBITDA along with descriptions regarding its use and rationale are in our earnings statement. Turning the Slide 12, you can see a snapshot of our balance sheet at the end of the quarter. We had approximately $2.5 million of cash on hand versus $3.4 million at the beginning of the fiscal year primarily reflecting $1 million of cash used during the quarter to pay down on our senior debt. We had nothing borrowed under our revolving credit facility at the end of the quarter and our term loan had a balance of $22.5 million. This compares to $30 million when we acquire Danya and $23.4 million at the beginning of the fiscal year. We’ll continue to use cash generation to pay down debt and continue to de-lever the balance sheet going forward. That 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.

[Operator Instructions] Your first question comes from the line of Mark Jordan with Noble Capital Market. Your line is now open.

Good morning, Zach and Kathryn. Question on amortization. In the quarter on the adjusted EBITDA table you show depreciation, amortization of roughly $200,000 but in the 10-K on Page F10, you have I believe estimated intangible amortization of about $2.375 million for the year, could you explain the discrepancy between those two numbers.

Sure, and it will be a lot easier to follow that in detail when we file the Q tomorrow but as you'll recall from the K we were developing our forecast of annual amortization based on a preliminary purchase price allocation and during the quarter we've now completed that exercise. So, you will see an update to how that amortization lays out when we file the Q tomorrow.

Okay, I guess, I have something to look forward to.

Thanks Mark.

Again looking at G&A, fourth quarter was $4.1 first quarter was $4.7 million obviously you are in the throes of integration of the businesses. Could you give us a little bit of guidance on how you see G&A evolving through the year and what would be in your view sort of a normalized run rate versus the number that's inflated due to again some of your restructuring and strengthening activities?

Yes, remember that Q1 has some anomalies that are non-recurring because they happen every Q1 but they are connected to the closing of the fiscal year. So, in Q1 we get absorbed the impact of the annual stock compensation grant to our Board of Directors any other non-cash stock compensation which for the quarter was just under a $0.5 million and then it also absorbs the bulk of annual audit fees. So, those can tend to, some of them can tend to file in Q4 or but are largely absorbed by Q1 because that’s the audit activities performed. So those are non-recurring items but they are items that tend to cluster in Q1 and really account for the overwhelming majority of the variation from Q4 to Q1.

And you are spot on also Mark with regard to business activity right now that won’t be sustained long term with regard to integration. I think we've provided some highlights to some of the activity we're doing there, and sometimes that required bringing in some resources and in some cases you’ve pulling some of our directory sources to support it. But we don’t expect those to be sustaining long term, we do see a path of getting back to our norm of percentage of G&A to the book of business so, nothing trending in that regard.

Okay. Relative to gross margin obviously very positive impact with the 470 basis point improvement year-over-year driven by the acquisition. Moving forward though, we would assume that you would see higher revenues as the year evolves, is there the opportunity for further gross margin improvement as the year evolves and would this be in the range of say 50 to 100 basis points by the end of the fiscal year in terms of normalized run rate.

Sure, and we don’t delve too deeply into the specific characteristics of our new business pipeline but we are very focused around is the nature of organic growth opportunities are going to continue to move us north on the gross margin business and the acquisition completed certainly gives us a lift to the direction of which we are heading but we clearly will continue to move north. There is an opportunity too for the right fit business that maybe consistent with the kind of mix we have today but strategically we are primarily aligned with the type of deals that are going to continue to drive our gross margin in the north. Kathryn, do you want to add anything to that?

That is exactly right, that is the crux of where the business development activity is being focused and so that will continue to improve the aggregate deposit gross margins.

Final question from me. I believe on your year-end call you implied that at a goal for fiscal 2017 was to have an adjusted EBITDA margin in the range of 8%, is my memory right and is that a correct statement?

Obviously we don’t give guidance, I'm trying to think what that might have been. We do often give color around what the business in certain stages of our strategic plan, what the appropriate metrics would be when we are certain stages of our execution of our plan. And we have been really pretty consistent if you look at some of what we posted as to when we are $100 million company, and if we stay on plan with regard to the quality and calibre of sort of work what that would deliver in terms of both top line and margin bases as would and net that out at EBITDA. But I don’t recall that we have given anything externally with the specific number on EBITDA. So as again it's probably interpreted with someone assuming when we would hit some of those profiles. Kathryn, can you recall anything else that we have mentioned with - may have been a pro forma thing you think we might be thinking about it?

Certainly if you look at the results for fiscal 2016, the adjusted EBITDA delivered over the course of the 12 months was in high 6s and so obviously moving up from the slightly under 5 with the prior year so reflecting the blend of Danya and obviously for 2017 we will have the benefit of that transaction for the full year. So, we do expect to start to push up against it but as Zach said, we are not prepared to from a guidance perspective say that's where we will end up. But certainly we do expected - to really back to your earlier question about gross margin as those gross margin rates continue to improve and we scale the G&A infrastructure, we do expect the preponderance of that gross margin improvement to fall at the bottom line it will improve adjusted EBITDA return.

And the linkage to your earlier question or comment Mark is very keen, that's that the integration activities that we are doing today are to ensure that we can scale in a very effective way and still be able to manage that growth in a way that moves us north on both the EBITDA and the percentage of SG&A. So those investments today this quarter, next quarter, Kathryn's team is working towards integration testing at around July of this calendar year and so we fully expect to exit 2017 with much of our IT and ERP infrastructure completed.

Thank you very much.

Our next question comes from the line of Bill Sutherland with The Benchmark Company. Your line is now open.

Thank you. Hi, good morning to both of you. So the new business pipeline think at year end or at least at the time of the call maybe I'm not sure which was $510 million, is that right?

Yes correct.

So I guess there is no update on that number?

In terms of what color we have in the annual shareholders presentation probably not much more than but suffice it to say and of course the pipeline is a moving number but it is still very healthy with regard to the type of deals that we had before. The government has of course not made many decisions on some of those things that we need to pursuit motor, as well as those things that we had already submitted for evaluation. So we haven't had much movement of that number. We have qualified some new opportunities that are really right for us, much of which is in the early FY18 award schedule for us so that will take that number a little bit north. We've had one or two that - as we look at the government's commitment to small businesses on the VA side particularly in the technology side for the contract that we won last year, VA next-generation T4 contract with the kingdom where supreme court decision we're really zeroing that out of our plans. So we've moved a little bit out but we by enlarge are still looking at the north of the 0.5 billion as a strong pipeline over the course of this near-term period.

And your historical win rate is and I think north of 35% just we can think about?

Yes, we have been pretty fortunate on the recomplete side, of course it’s been 100% and with the new business work that we prime has been north of 35%. And then of course it varies a little bit depending on – when we are supposition which is not our norm that occasion where subcontracted to small business working appropriate type of opportunity.

And just to make sure I’m clear on this, so when you look at the award timing of this pipeline, it falls just proportionally in the FY18 and it doesn’t go beyond that 18 does it?

The majority of our hits we see is in FY18. We generally our business development folks do work generally 24 months out where we're qualified and there's occasionally some deals we have to start partnerships or something little bit beyond that but the majority of what we have is in our qualified pipeline is inside of 24 months.

And then last one on the pipeline. Is the next roughly aligned with kind of your mix with revenue across the agencies?

So the mix in the pipeline is really going to reflect, yes more so in the health and human services side just because that’s where we see the bulk of a near-term opportunity although to your point that shouldn't be interpreted as lack of opportunities and it depends in VA space. But the majority of the opportunities we're tracking in the pipeline are in health and human services space?

Great. And then last, there is a lot of consternation obviously about what federal spending across - and so maybe it would helpful if you guys go through the logic steps that you apply to why you think your business - where you’re going at is look so defensible?

Very good question and Kathryn I just came back from a noble conference [indiscernible] and of course you know that front and sooner given the headlines and the changes in the administration. So very good question. Let me talk a little bit about that and our approach. So we go through a process every month in fact - every twice a month where we review our business development leaders will bring before the leadership team reviewing our major strategic new business opportunities. And two of the key factors upfront for us to commit to something that’s going to have a – this kind of long sales cycles 12 to 18 months in many cases, as how solid do we know they are on the hill and how strong is the program with regard to the operational organization whether it be civilian or department of defense. We have quite a bit of connectivity at net personally on the course of the last six months with major decision makers across these organizations both in health and human services, their CIOs, their directors throughout several of their sub agencies and similarly General Armstrong will pair me up with the right decision makers on the military in the DoD side. But we do a lot of detailed homework we have - had representation as we saw fit to have active representation on the transition teams for the new administration and so we do keep great insight as to where they are going, what are they thinking and then of course the way in which this transition occurs you move from the transition teams to the - ultimately to the [indiscernible] teams which our folks are going to be helping to populate this positions. So we are very, very active there. Three or four of us are also very active on some trade association organizations that are working day-to-day with the staffers of each of our targeted agency. So we can verify and validate their budgets and then we also have a market, business intelligence resource who is tracking appropriations, and funding in the areas that we look at. So it’s a really pretty comprehensive approach to verify when we make a qualify pursue decision that it will be stable. Now of course these headwinds in this administration could very well move and make changes a lot faster than we've seen before but in our world to be able to net effect on a funded program you really have to go through not only the budget but more importantly the appropriation. So, we track those appropriations on a regular basis and we would generally see things that may be a headwind usually at least one budget cycle there. So but we are staying tuned because as you've probably seen already, this administration is showing a bias reaction and we need to make sure that we have the ability to be able to navigate our new business pipeline accordingly.

Right. And so everything you hear suggests that where you work in HSS and CDC and I’m forgetting the other key agency. It just feels to you like even in the new administration those are programs that either, potentially get even more focus, more appropriation or at least aren't the cross hitter potentially.

Sure, so the VA is - both side of the aisle are very, very strong which supports for the VA. They have been historically - the Bush Administration in fact both Bush Administrations plus up the budget that was submitted to them. President Obama did the same and everything we've heard from the Trump Administration, the leaders and what we know about the Mr. Shelton, the new VA says no one is going to move off of taking care of their healthcare initiatives for the veterans. On the HHS side, there is different forms of risk and our belief is a high degree of risk in the CMS side of the house and why because ACA and what's going to happen with the exchange could radically change in relatively short time period. Now you can't change laws and implement funding changes quite a bit but there are those that are addressing the expiration of contracts that are in CMS and what that may hold for the next round of budgets. Now fortunately for us that is not one of our targeted agencies within the health in human services arena. We are largely focused around the organizations much like where we have core competencies today and our role largely there and the - being the agent to ensure the appropriateness of the funding, the delivery of the quality and caliber of services and reporting that to Congress is something that's going to continue to - we believe continue to be an increase focus if anything else. So, we’re very careful of looking at across these organizations. We've posted I think some literature recently with regard to where our targeted agencies are and how addressable those budgets are but we are keeping it very keen eye to that. We feel very - strong the monitoring and evaluation and compliance business that across several agencies but we are constantly managing that risk and rebalancing our new business pipeline accordingly.

Great, thanks for all the color Zack. Thanks again.

Our next question comes from the line of Ken Herbert with Canaccord. Your line is now open.

Hi good morning, Zach and Kathryn. Just wanted to first ask can you talk Kathryn just briefly about sort of where you like to be from a leverage standpoint and some of your thinking specifically in 2017 and 2018 assuming the current business what range you are comfortable with and maybe some timing as we think about how you move towards that?

Sure. So in the absence of further transaction our plans for capital are to support growth of course through organic growth and to continue to delever, so we are certainly - we completely extinguish the revolvers and with the very modest borrowing cost on the term debt, we will extinguish it according to schedule, there are provisions if you remember when we described that loan agreement there are provisions for excess cash flow sweeps and that would apply however given the adjusted - the ratios of adjusted funded debt to adjusted EBITDA that where those kick in, we will probably not be I don’t project us to require to make any excess cash flow sweeps. So because I think we’re going to naturally delever enough that will be in a good place. So from our perspective we're going to accumulate cash to continue to support growth of the business either organically or acquisitively and manage our debt down for the schedule.

Okay, that's helpful and then obviously it is fair to say if you were to potentially win new business maybe even Zach beyond your sweet spot that you talked about earlier and any sort of associated investments to support that across the organization, I mean there is no limitations on your ability to sort of absorb the new business or a higher level of business maybe than beyond what you typically described as your sweet spot, is that the right way to think about it?

It really is obviously it is the one that maybe a swing for the Finch sort of a deal, there will be some stress usually these kinds of deals are 30 to 60 day phase in and then you got 30 day ramp up before you submit those invoices and Kathryn is constantly monitoring as one of the things we do as we look at the nature of the deals but we do look at our ability and what we have within existing resources to be able to execute that without putting too much on the business and I would tell you that there is no shortage of folks out there ready to help us but that is not a problem because we are continuing to be out there in space right now. So we feel there is high degree of capabilities for us to manage the majority of each of our larger deals enhance ourselves but we certainly Kathryn can talk to what additional leverage are should we need to look at externally?

Sure, we definitely have access to our revolver for $10 million and those - growth through organic contract growth of course brings with borrowing base that allows us to access that revolver. So that is the strategy of course and the good thing for us is that as we have contracts that come online we don’t whether this transition period and there are of course a flow timeframe required to get cash flowing on it you create an invoice and get through that first invoicing cycle and convert it to cash, you are talking 60 days but we don’t have extraordinary capital requirements in growing the business and so the cash flow requirements are generally just working capital and receivables that tends to convert very quickly. So we feel that we have the capacity to grow both through those sweet spot opportunities as well as a couple of outliers if we are able to bring them in the door. So we think we are well positioned for that.

That's great. And then just finally I wanted to follow up on the gross margin discussion earlier, I mean I think it has been really helpful that you have laid out specifically I think what you are able to do here in 2017 and beyond sounds like incremental acquisitions or maybe new contract wins clearly help move the margin to the until the right but in the absence of significant new contract wins, can you just talk about a couple of the items that you think are where you have got more significant opportunity to drive gross margin improvement with the business as it is today because I know you're clearly - you talked about the integration, you have talked about other value creation and synergy opportunities but maybe what are couple of the key things we should think about or any milestones this year that we should keep in mind as you look at gross margin expansion absent incremental contract wins which could certainly help push that up further?

Yes, that’s a very good question and one I’m excited to talk about because one of things that we were able to demonstrate in turnaround early on was ability to drive the very effective and more higher productivity with regard to our program management. And as you might imagine we’re going through the integration stage right now but we hosted an event in August to post deal to really place a strong focus around program management effective transitions. Today we have a team Kathryn has a team of probably 20 or so of our folks working through some ERP tools that will allow us to more effectively manage the business that we've acquired that they not had before. So we expect the natural evolution as we start to increase our aperture around those things where we can drive added margin into the business that we’ll be able to take advantage of that. Activities that we've got the scheduled beyond this week in fact will also be managed by both Kevin Wilson and Helene Fisher for enhanced program management, not only leveraging our tools but the type of contract management, skill sets that we are able to deliver in the last couple of years to drive up margins as well. So we're not taking the foot off of that pedal, we do expect there is ways of making sure that we're fully leveraging all of the federal acquisition regulated capabilities to service our customers in a most efficient way and to deliver both to the shareholders and our ultimate customers.

Great. Thank you very much.

Your next question comes from Jeff Rohrbaugh with AHSG Holdings. Your line is now open.

Good morning. Had a question about your outpatient pharmacy program. I believe I read somewhere that that was or will be re-competed just wondering what your - if that's the contract you are now, what your plan is for that?

I'm not sure what is what you may have read but I can certainly give you latest yard. We're referring to the program we finally refer to a [indiscernible] which is a consolidated mail out outpatient program with the VA and we've got a couple of large BPAs if you will within. The norm historically - this is a customer says that we've been doing business with over a decade, the norm for those contracts are generally one year with four options years, and the history is on the average has been about additional two years before the next acquisition cycle matures. So we’re not - while we are being prepared, we've started to work our strategies and activities we’re going to do to make sure that when the time comes for that to compete will be ready but the Good Money says that we won't see that at all this fiscal year and possibly sometime next year which would be again just consistent with what we're seeing in the VA acquisition community, not only for our business base but across the board. So it's not imminent that something that we take very seriously and we’re comparing for to be successful in the retention.

Okay. Thank you.

I’m showing no further questions in queue at this time. I’d like to turn the call back to Mr. Parker for closing remarks.

Well once again I just want to thank everyone for participating in our Q1 results descriptions and we're excited about being prepared to come back for you in Q2 and to continue to share the story. So I welcome you to stay tuned. We're also going to do as much as we can on disclosures around an investor conference or two in the course of this fiscal year. So we'd ask you please stay apprised, we're going to give that color throughout the rest of the year. So with that, we thank you all for your participation. Have a blessed day. Bye for now.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.