DLH Holdings Corp. (DLHC) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the DLH Holdings Corp. 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] I would now like to turn the call over to Chris Witty, Investor Relations Advisor. Please go ahead.

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 second 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 risk 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 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.

Thanks, Chris, and good morning to everyone. Welcome to our fiscal 2017 Second Quarter Conference Call. Starting with Slide 4, it gives me great pleasure to once again review some of the recent highlights of the company, including our financial performance. Total revenue grew 77% to $29.9 million just shy of breaking the $30 million revenue barrier. Our sales reflected organic revenue growth of approximately 7%, once again illustrating the strength of the markets we serve and the demand for our professional services. Our gross margin rose 240 basis points year-over-year to 21.4%. And we posted earnings of $0.08 per share, a significant increase over 2016 and indicative of what we expect going forward. Helene Fisher, President of our Mission Services and Solutions operating unit has already had a great impact on our civilian focused operations and is focusing on current and adjacent customers for growth. We have an active and very strong pipeline of new business opportunities. This includes additional DoD and VA opportunities for Kevin Wilson’s Health and Logistics Services operating unit. I believe the outlook for 2017 and 2018 is very promising. On that note, please turn to Slide 5. We said last quarter that we felt the current administration would likely be neutral to positive with regard to our business and the agencies we serve and we still continue to believe this. I had an opportunity to meet with the number of folks on the transition team and on the Hill. And we’ve been more bullish than before about the value placed on high-quality, cost effective services that we deliver. The recent bipartisan budget we assume Congress, not only provides additional spending for defense and our veterans, it also includes investments in other areas, such as health, research and development, education and infrastructure. So while the budget only takes us through the end of this fiscal year of 2017, and further debates about budget priorities and reconciliation is anticipated. It aligns well with our programs and our markets. We believe it bodes well as a blueprint for the future spending trends that will likely continue requiring a bipartisan approach. Indeed, the National Defense Authorization Act in the early fiscal 2018 federal priorities track with our long-range strategic plan and new business development initiatives across the defense and veterans landscape. The bottom line is that we look forward to working within the priorities of the new administration as spending priorities are reconciled. In terms of our recent awards, you may have noticed that we’ve won a recompete contract covering the Navy substance abuse contract for clinical preceptorship program. And 2 additional indefinite delivery indefinite quantity or IDIQ contracts with the substance abuse and mental health services administration, referred to as SAMHSA. Programs like these leverage our strengths in behavioral health, Big Data and health informatics, further establishing the company as potential top provider of technology-enabled management solutions supporting large-scale federal health programs. We also believe that continued focus and budget commitment to programs, such as the opioid epidemic, will continue to infuse business with that customers that. So we feel great that we are beginning to become pretty well positioned to support that business. Turning to Slide 6, I wanted to talk briefly about the current outlook for both organic and acquisitive fueled growth. As I mentioned a moment ago, we believe the potential for new contracts and top line organic growth expansion is still at the high point and very strong relative to the past. Certainly, there are some headwinds with regard to budget and transition team delays, but as evidenced by our new business pipeline, we believe that the market is right for additional organic growth plus the potential for bolt-on acquisitions that could enhance our existing agency business and expand the company into our adjacent markets. Lastly, before turning the call over to Kathryn, I’ll wrap up by highlighting our ability to execute on our growth strategy as shown on Slide 7. Late last year, we said that we focus on further integrating our business in fiscal 2017 and position the company for higher top line growth and we’ve done just that. We’re on track with regard to all key integration milestones and are looking at new business development initiatives that are expected to positively impact the quarters to come. We also recently became ISO 9000 certified after a lengthy process that began in 2016. ISO 9001, which is one of the most widely used management tools for standardization and quality improvement establishes quality standards to help companies, such as ourself, ensure that we meet our exceed or customers’ requirements. I’m really proud of this particular distinction. I want to thank Kevin Wilson and his team for their immense efforts in achieving this. To our shareholders, we appreciate your continued interest in our business and support for the future. We believe we’re on track with higher growth, stronger margins and numerous new contracts to pursue and potential bolt-on acquisitions to explore. I’m confident that in 2017 we will put DLH on sound footing for solid bottom-line performance for years to come. With that, I’d 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’re pleased to report another quarter of strong financial growth. Turning to Slide 8, we posted revenue for the 3 months ended March 31 of $29.9 million, representing an increase of $13 million or 77% over the prior year second quarter. The higher revenue was principally due to the inclusion of the acquisition as well as from additional growth across our existing contract vehicles. Revenue expanded approximately 7% organically over the prior year period, as Zach mentioned, reflecting business expansion efforts across the entire enterprise. Now moving to gross profit on Slide 9, this quarter, the company posted total gross profit of $6.4 million, roughly double that of last year, driven by higher revenue as well as improved program profitability. As a percentage of sales, our first quarter gross margin was 21.4%, an increase of 240 basis points over the comparable period from last year. We continue to focus on more complex, higher value-added contracts that leverage our extended capabilities. Turning to Slide 10, income from operations rose to $1.8 million for the fiscal 2017 second quarter from $0.7 million last year. Higher gross profit was partially offset by an increase in DNA and G&A, expenses tied to the inclusion of the acquisitions, along with incremental expenses to manage and grow DLH. We expect our strong operating profit performance to continue going forward. The low operating income, we had net other expenses of $0.3 million this quarter versus $0.1 million last quarter. Generally speaking, other expenses include non-operational items, such as interest, amortization or deferred financing cost on debt obligations and other miscellaneous items. We reported net income for the 3 months ended March 31 of approximately $1 million or $0.08 per diluted share versus net income of $0.3 million or $0.03 per share in the prior year period. This reflects the increase in operating income I just spoke about, 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 3 months ended March 31 was approximately $2.5 million, more than triple last year’s $0.7 million. In addition, adjusted EBITDA as a percent of revenue was 8.2% this quarter compared to 4.3% in the second quarter of fiscal 2016, reflecting the increasing value add nature of the work that we’re pursuing. Our definition of adjusted EBITDA, along with descriptions related to its use and rational are in our earnings statement. Turning to Slide 12, you can see a snapshot of our balance sheet at the end of the quarter. We had approximately $3.1 million of cash on hand versus $3.4 million at the beginning of the fiscal year. We had nothing borrowed under our revolving credit facility at the end of the quarter and our term loans had a balance of $21.6 million compared to $23.4 million at the beginning of the fiscal year. We’ll continue to use cash generation to pay down debt and deliver the balance sheet going forward. In addition to the financial capacity provided by our cash balance and ongoing access to our revolving credit facility, we recently filed an S-3 to provide a shelf registration of our securities. While the company has no current plans to issue securities under the registration statement, we believe it provides additional flexibility that is prudent to a range at this time. Any ability to utilize the shelf is to have been declared effective by the SEC. That concludes my discussion of the financial statements. And with that, I would now like to return the call to our operator, to open the call for questions.

Thank you. [Operator Instructions] Our first question is from Ken Herbert with Canaccord. Your line is now open.

Good morning, Ken.

Hi, good morning. Hi, good morning, Zach and Kathryn. How are you?

Great, thanks.

[Indiscernible]

Just wanted to first ask about the organic growth in the quarter. Nice growth. As we think about your bid pipeline and the opportunities, is a 7% or sort of high-single digit organic growth a realistic expectation for the top line for sort of the back half of 2017 and into 2018?

I don’t think it’s for – certainly not other question to look here. We – the characteristics of our pipeline for the remainder of this year is little bit unique for us right now because we do have some steady-state opportunities that are sweet spot range that would continue along that path. And we do have an opportunity or 2 that are substantially larger, so it kind of distorts, if you will, trying to work an average. In fact, median is probably a better number. But yes, we think that, if you look at our industry these days, most of our peer and competitive companies, mid-single digits is pretty solid for right now, and we think that mid-single digits right now is a good growth curve for us.

Okay. That’s helpful. I know you typically don’t provide it, but if you think about the backlog, where you think about the bid pipeline, either way, maybe your backlog of opportunities, is there any quantification you can provide around maybe how much you’ve seen that grow, maybe sort of how much that – how much the funnel has perhaps expanded? I know obviously you’ve been clearly focused on business development and it seems to be paying off in terms of the backlog and the potential pipeline there, but anything just to help understand the magnitude of that? Or maybe some of the quantification around how that has grown?

Yes, we’ll do that. We typically have a – we report quarterly, which our Board of Directors with the characteristics of quality and quantity of our new business pipeline. I would refer to the values, in particularly, what’s meaningful for us are those that are qualified opportunities, which means it been through some degree of rigor from either John Armstrong or Denise Ciotti with regard to their business development team bringing the opportunities to the leadership team, and then for the degree of positioning and up to and including bidding jobs. So we’ll be able to give you some color, I think, around both those that we have that already submitted a waiting award with some quantitative numbers there. And in those that we have in our qualified new business pipeline that really looks out to about 24 months to 36 months for potential growth in that. Kathryn and I, we’ll make a note to make sure we can get something that we can put up and post publicly maybe at our upcoming investor conference to get out on the wires. That’s a good point, Ken.

Okay. Yes, thanks.

And with regard to post-acquisition, we kind of get a little bit distort because we’re emerging – kind of emerge 2 different companies and what the BD resourcing and the pipelines would look like. We took a number of things out of the pipeline that were no longer core that would drive the kind of margin expansion that is consistent with our strategy. And at the same time, started to bring along things that were – where the synergies of the 2 companies made us a qualified prime. So we’re at the point now where we’ve got some maturity now within our integrated pipeline. It’s hard time for us to give you some color around that. So we’ll make a note and get something on the wires for that.

Yes, that would be helpful. Thank you. And then just a final question around the recompete within VA coming up here in the next 6 months to 12 months on those 2 contracts there. Can you provide any update? And then specifically, obviously, we’ve now got a fiscal 2017 budget. I think there is a little more confidence around maybe some of the step-ups, specifically within VA and DoD in fiscal 2018 as we move closer to that. Has that changed maybe some of your opportunity? And then specifically around your specific recompete strategy or timing or anything else there would be helpful? Thank you.

Yes, what we – as I mentioned before, we generally start to work the recompete strategy as a year or year or so and a half – 1.5-year or so out and nothing has really changed there. We’ve been – Kevin Wilson and his team on our Mail Order Pharmacy work has been really positioning ourselves well for our solutions that we’re going to offer on recompete. However, as we stated before, we generally see these opportunities within the – within a number of the acquisition communities and VA is no different that often get extended beyond their – the current scope. So we still have yet to receive anything with regard to the solicitation on those. It would not be unusual for us to see 6 years or 7 years out of the 5-year contract with most of the acquisition entities that we’re dealing with. So as we get close around, they will probably bring some color, not much because we think this public communications are – some of the things we discussed are competition sensitive, but certainly, from the standpoint of risk management, we’ll get enough out there as for you to manage. Kathryn, anything you want to add to that?

Well, I would just reinforce that, from our perspective of what’s important to strategize and to plan for innovation in the recompete, we, of course, believe that part of what differentiates us is that we’re innovating throughout the life of the contract. And so operating those contracts within a Six Sigma environment and the ISO credential, as Zach mentioned earlier, was applicable to an implement – to an instance of the CMOP facility. So we’ve continued to extend the reach of our quality and delivery of high-quality, cost-effective solutions. So if you do that, as you go, there is not a – there’s nothing magical that has to happen in order to position you for the recompete, but on the other hand, of course, as you’re suggesting, we do have to strategize to make sure that we don’t become complacent on that. So that’s really where we are in terms of shaping up on the recompete for the CMOP work. And we do think the ongoing commitment as we’ve consistently seen, it’s a very strongly bipartisan-supported agency, and we think the ongoing support for veterans and the increasing allocation of budget support for the veterans administration, we believe that continues to offer opportunities to – as we demonstrate additional credentials and capabilities, we’re well positioned for those.

Yes, and we have a – we continue even with the acquisition and with our – the addition of our mission services and solutions operating unit, Danya folks, we continue to have just a tremendously good track record, of course, with regard to our recompete, some of which we addressed more recently. But we – there is a disease in our space that we’ve referred to often as incumbentitis, right? Where you’re the incumbent and sometimes you get a little too complacent, and you’re not servicing your customer and continually improving a passion. We’ve started that initiative under Kevin’s leadership and with our executive leadership team and make sure we continue to move, as Kathryn indicated, in a way that’s driving value that will just be described in our upcoming proposal, whenever they get to that point rather than creating anything from scratch. So we’re very confident that with the ways in which they’ve been evaluated, our customers have been evaluated by the outside entities and our partnership within that – we’re going to make sure we continue to drive better value to them, and we’re optimistic that, that will bode well for our recompete probabilities.

Thank you. I can’t imagine you get completion to take anything for granted. Thank you very much and nice quarter.

Thank you.

Thank you.

[Operator Instructions] Our next question is from Ben Klieve with Noble Capital Markets. Your line is now open.

All right, thank you. Hi, Kathryn. Hi, Zach. Thanks for taking my question Zach. Couple of questions. First of all, regarding potential M&A activity, Zach, you stated that growth is clearly your highest priority, but I’m wondering kind of what you’re looking at beyond that from a finance perspective? I mean, is it fair to say that your focus on kind of more complex value-add opportunities in your pipeline would reflect the fact that you’re looking for something – looking for opportunities that can have that capability and so you’re looking for a more higher-margin acquisition? Or do you think kind of a lower- margin opportunity that has really solid free cash flow generation would be attractive as well? Just kind of put some thoughts there.

It’s a very good question, Ben. And you really spot on for where we are and coming out of our transition. And let me also mention before answering the specifics on the question that we are – given that we are a substantially different company right now, we are going through the period of – over the next month or so, we’ll be beginning a long-range strategic plan reset, right? So our Chief of Staff, Fred Vago, is working and has already started working with our entire leadership team. We’ve got a 2-day session offsite that we’re going to be working to update the strategic plan. We’ll be hopefully ready to give you some color around that at or around the Q3 time frame. But with regard to where we are right now in mapping out the strategy, yes, our strategy has been, with regard to growth, has had – it does have a few legs to it. First of all, we continue to excel on the performance of our existing customer base. We don’t want to erode any of our business. We have some very good legacy heritage business that we want to protect. Kim’s question with regard to our VA Mail Order Pharmacy is a good example of that, right? As many of you know, couple of years ago, low-single digits on the margin side was kind of what we’re reporting, and we’re substantially higher than that now. And the characteristics of our growth platform and that’s, again, why we had to focus on reshaping of our pipeline, consistent with just a few things: one is, yes, more complex, higher-level professional business in our space that generally nets a greater expansion into the margin basis as well as when it contributes for the value of the G&A that’s generated within the company; number two, we want to make sure that it has the right kind of bandwidth to be meaningful and that we had material additions to our business. In some cases, there could be very small opportunities that are strategic that we bid because there is a nice new capability that will need with regard to maybe a health IT solution that we want to point towards the National Institute of Health or package what we’re doing for Fort Detrick in the health, medical research and development arena. But we can add another component to our offering to provide a more value solution and expanding into some of these adjacent markets. In other cases, to your point, we may find that we could really leverage some of our lowering business to expand the base. That is generally not our core focus. We generally believe that there is – the addressable market is very healthy for us to drive higher value. That’s why you may have remembered, may recall it a year or so ago, we were discussing the absence of our – of low priced technically accepted – acceptable opportunities in our pipeline. Many companies started to lower their price structure. We just did not want to pursue that arena. It has a number of characteristics and influences on businesses. Kathryn and I have both managed organizations where that’s front and center and done very well. But it’s not consistent with the strategic direction of our company. So we do want to continue to maintain everything that we have today, expand in every area where we have today, but the nature of the work is going to really move us north with regard to the government food chain, which drives higher margins. In the valuation scheme of things, we think that there is a larger portion of health IT opportunities today in our new business pipeline. We certainly get – we’re buoyed in that arena with the acquisition of Danya before where we have now some really strong IT calls in the health space. And so you’ll see more and more of that look and feel, we think, in the new business pipeline for the future.

Very good. Thank you. That’s very helpful. One other question I have regarding – is regarding organic growth. And I guess, this quarter, was there anything that had an outside impact? And you both referred to just kind of general strength broadly across the market. But – was it truly a very diversified organic growth? Or was there anything that had any meaningful impact on that this quarter?

It was really pervasive throughout the business, and so – it’s really a function of customer demand and some of our revenue is volume dependent. And so – so that was – as we’re supporting the work of the customer operations day in, day out, you’re going to experience that. As Zach mentioned, our expectation is more probably closer to the middle – mid-single digits as opposed to trending up almost to the higher single digits, but we do think that by being a valued business partner with your customers, they have growing demand and most of our agencies do, you’ll be there throughout that and you’ll experience the benefit of that.

Yes. And we have a number of contracts that are these IDIQs where the customer competes in very small quick-turn task orders. And Helene’s organization, early in the year, we had a number of wins in that regard that are relatively small, but they certainly will add few mineral here business, and we’re going to continue. Again, not – we’re not always swinging for the fences, right? So lots of singles and doubles and those will be major contributors to our – continuing with that growth curve that Kathryn alluded to. So those wins, by the way, are the ones out on the – down in Atlanta area were largely with the center for disease control.

Very good. Well, thank you both for taking my questions and I’ll jump back in.

[Operator Instructions] And I’m showing no further questions. I would now like to turn the call back to management for any further remarks.

All right. Thank you, again, Ayela, and thank you, all. We really appreciate your continued interest and support to the company. We look forward to chatting with you near-term at our fiscal 2017 third quarter presentation. Please also stay tuned as Kathryn and I are taking some additional information out on to the road. So please pay attention to our calendar of events as we will be participating in some additional Investor Relations – investor conferences and some non-deal roadshows, and we’ll provide additional color between now and quarterly report out. So thanks, again, everyone, and have a blessed day. Bye for now.

Ladies and gentlemen, thank you for participating in today’s conference. You may all disconnect. Everyone, have a good day.