DLH Holdings Corp. (DLHC) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3 2017 DLH Holdings 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]. As a reminder, today’s conference call is being recorded. I would now like to turn the conference over to Chris Witty, Investor Relations. 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 third 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 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. Thank you for joining us to discuss our fiscal Third Quarter 2017 results. Last evening we issued our results for the quarter. Starting with Slide 4, I would like to go over some highlights of the quarter as well as some recent developments. But first let me begin by sharing how proud I am of our national network of employees and our management team. We're truly continuing to build a world-class organization that places high value on leveraging our expertise and diversity to deliver excellence to each of our customers while responding to a never changing set of priorities from our government, our clients and strategic partners. This quarter marks several important aspects of our transformation. These include number one, the one year point of our major acquisition of Danya and the start of the final phase of our related ERP financial system integration and testing, key milestones for the transformation of the Company. Second of all, the implementation of certain business process reengineering initiatives that will further strengthen our customer delivery services. And third, achieving a national recognition alongside one of our customer for Federal Health information technology innovation. This really serves to validate our actions with respect to strategic expansion of DHL in health IT arena and we find is a key milestone for acknowledging again the truly variable and expensive work being done by our leadership team. Fourth we also recently announced the appointment of a strong industry veteran Jim Alan to our board of directors, a tremendous addition to our Company. Jim has been in a leadership positions for years at some of the best known companies and organizations within our government services space. And he also brings a wealth of financials experience, strategic decision making expertise and really strong corporate development accruement to the Company [Technical Difficulty], Jim will prove to be invaluable as we grow the business, evaluate potential acquisitions and look to improve our long-term financial performance. His presence at DHL and on our board of directors elevates our position in the industry and our status as a leading provider of critical healthcare related government services to the Federal government. It is fitting he joins our board at this dynamic time in our Company's history as we leverage our stronger broader capabilities to go after some of the more attractive opportunity in those space. This past quarter was a very busy one in terms of bid and proposal activity and not surprisingly we encored at this new G&A expenses which really reflected higher investment and commitment to the organic growth profile of the Company and is right in line with our growth plan. These bids are being attractive, profitable and in line with our long-term strategic objectives and I’m proud of our employees both on the business development side, as well as operator at how they have come together in these recent few months in order to develop really strong proposals, great approaches and really reflective of the type of tempo that we expect to deliver sometime in the future. We are continuing to invest in our systems, our people and our bid and proposal activity to better the outlook for top-line growth and bottom-line results. Notwithstanding, we are also cognizant of some of the political and government headwinds that have continued to slow the award process. This quarter, we again posted strong gross margins of 21.8% and earnings of $0.08 per share. Revenue grew 17% year-over-year to $29.3 million, which includes 6% organic growth on top of the impact on last year’s acquisition. Overall, we are very pleased with our continued solid performance and while bidding on an active array of attractive opportunities we are also looking at additional bolt-on acquisitions that would strengthen our existing array of offerings and broaden our presence across the core markets that we serve. But we are not in a rush, instead we take a step-by-step approach to assessing any transactions that are brought before us, in terms of valuation, vision, culture and growth potential. We firmly believe that give in our current bid pipeline and existing award prospects, the outlook for DLH is positive and improving, we love our trajectory. We have some of the best people in the business working here and are confident that our credentials, strong customer relationships and growing reputation with service well in the quarter to come. With that, I would 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 solid financial growth. Turning to Slide 5 in our presentation, we posted revenue for the three months ended June 30th of $29.3 million, representing an increase of $4.3 million or 17% over the prior year’s third quarter. The higher revenue reflected the impact of our 2016 acquisitions, as well as additional growth from existing contract vehicles. Sales rose roughly 6% organically over the prior year period as Zach mentioned after we been successfully expand in business across the organization. Now moving to gross profit on Slide 6, this quarter, the Company posted total gross profit of $6.4 million, up approximately $0.9 million from that of last year, driven by the higher revenue. As a percentage of sales, our third quarter gross margin was 21.8 in both fiscal years. We continue to focus on more complex, higher value contracts that leverage our extended capabilities. Turning to Slide 7, income from operations was to $1.8 million for the fiscal 2017 third quarter versus $1.7 million last year. Our higher gross profit in 2017 was partially offset by an increase in G&A expenses tied to the heightened bid and proposal activity as Zach discussion, which we believe is crucial to accelerating top-line growth. We expect continued solid operating performance going forward. Below operating income, we had net other expenses of $0.3 million this quarter versus $0.4 million last year. Generally speaking, other income and expenses includes non-operational expenses including interests, amortization of differ financing cost and debt obligations and other miscellaneous non operational items. We reported net income for the three months ended June 30, 2017 of approximately $0.9 million or $0.08 per diluted share versus net income of $0.8 million or $0.07 per share in the prior year period. This reflects the increase in operating income I just spoke about, with our tax expense roughly equivalent year-over-year. Slide 8 shows the change in our adjusted EBITDA. On a non-GAAP basis, adjusted EBITDA for the three months ended June 30, 2017 increased 10% to approximately $2.3 million versus $2.1 million last year. In addition, adjusted EBITDA as a percent of revenue was 8% this quarter compared to 8.5% in the third quarter of fiscal 2016, reflecting the items previously discussed. Our definition of adjusted EBITDA, along with descriptions regarding its use and rational are in our earnings statement. Turning to Slide 9, you will find a snapshot of our balance sheet at the end of the third quarter. We had approximately $4.6 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 $20.6 million. We will continue to use cash generation to pay down debt when practical and deliver the balance sheet going forward. That concludes my discussion of the financial statements. With that, I would now like to turn the call to our operator to open the call for questions.

Thank you. [Operator Instructions] Our first question comes from Mark Jordan of Noble Capital Markets. Your line is now open.

Thank you and good morning everyone. First question relates to free cash flow generation. Obviously cash flow from ops was $4.9 million which is two times net income. I guess my basic question is this a normalized run rate in terms of cash generation for you, which would imply something like just EBITDA minus interest minus CapEx and is that type of run rate stable which would imply sort of a free cash flow nine months number in the $0.35 to $0.37 range?

We do think that the results year-to-date are pretty indicative, although I would caution that at given period its some of the function of course and some of the major collections come in. So as you know we have a set of contracts that are our primary contracts and it just so happen at the largest for those collected but 230 on June 30, so a couple hours later it could have flowed over into July 1, but that’s a point in time issue, but as a general practice we think the free cash flow results generated through June 30 are indicative of our norm.

Okay so normalize excluding transitory events and working capital needs that’s a good proxy for free cash flow generation.

Absolutely right and a key factor of course is that cap benefit also helps that free cash flow.

Absolutely. My next question relates around your pipeline, Zach what you referred to. Could you give us a little more of visibility as to what are the size of the bids which you have that are currently submitted, what you expect that might be adjudicated here through the balance of the calendar year and what opportunities do you expect to bid on in your fiscal 2018?

Sure. I appreciate the question. And let me first mention again that our pipeline is a fluid and living document, it evolves on a regular basis, in fact, we made a delivery of a substantial proposal just yesterday with a client. I will characterize our pipeline as while I continue to refer to it as healthy Mark, it still also reflects the [indiscernible] in the federal government. Many of our opportunities continue and war decision seem to continue to slip to the right or 70% of our value by the base we have done this year are still awaiting decisions on the government. And the climate is also affected by some actions from some of our industry competitors. We believe we have encountered four to five protests over the course of the last quarter plus that continue to slow the award process by the government. But having said that, we continue to focus on doing high value very strategic bids. We have benefited somewhat from really good timing by having a large search this last quarter. As we talked about before, our sales cycle if you will for a significant deals is generally 12 to 18 months we work it right. And the fact that this quarter reflects the 12 months of the addition of the Danya capabilities and qualification, as well as our ability to position the Company and the new company if will for some of these opportunities, we are in better shape to leverage or totality of our qualifications at this stage. So we are excited about notwithstanding, it did have an impact a little bit on our results, it’s the right kind of the impact if you ask me, because it really is strong endorsement and commitment to our organic growth. The pipeline as we look to 2018. I’m expecting that two or three of our very material bids or in fact not very likely, we are highly confident will slip to awards in FY 2018 period for us, of course that means after October 1st. Bids we put as an example yesterday, in the government space right now, you can’t expect them to make awards in that nature within 30 to 60 days. And it’s very common for us to expect that as we take work away from potentially other companies that there will be percentage of those that will contest the awards to us. So we think that still very healthy, some of those have been slipped to the right. We continue to maintain a good win rate, we have had some good small wins, it helped to see some of these major deals, so we think FY 2018 still looks very healthy for a growth trajectory.

Okay. One follow-up there, in your early comments you mentioned that there was some frustration of protest slowing down ramp of business that implies the two taken away business and therefore creating new business streams, could you quantify what you have one out there that you are waiting for the resolution of protest to realize revenue on.

We've had four deals that we bid, well let me phrase it, we have had one deal that we bid in our public health from life science, we bid business that was awarded to us, the incumbent protested, the government throughout the protest awarded to us again and incumbent protested government throughout the year protest. And once again they are on the third leg, so that’s our program reflects a program that in our model we had really anticipated we would be seeing net revenue in Q3, it is of course standing that and we remain optimistic that in revised approach that we will be successful, but in this kind of indicative of what we see in the space. We had another one, where it’s been protested prior to the award and we are seeing that it is sliding things also to the right, it certainly has impacted us by what we think has been at least one full quarter and given the political climate on the deal there is a chance of too will also spill over into next fiscal year. So we've had any number of programs now and fair amount of our new business revenue continues to slip to the right. It’s not terribly uncommon in our industry, protest is still great common part of the business in the industry, we know that going in, we often factor that in to our waterfalls, but when we get so close on some of these opinion awards there is a degree of frustration. But our folks remain vigorous in our approach and we think that further confirmations of our innovative approach is much was acknowledge this last quarter, nearly will help us to continue to have high win going probability on our pursuits.

So until the Federal Government penalizes unsuccessful protest, we will have live this for an extend period of time. Well, thank you very much.

You bet. Thank you. And by the way let me just add that the Federal Government does have some regulatory changes that are making their way through the hill, that are taken a stab and trying to reduce particularly further these protect, but try to reduce their amount of protest that can be down for programs and awards that are $25 million or above. So we will keep you posted on that as we think that will be a good thing, we're not a Company who does a lot of protesting, but we think that will a good thing for our industry as well our Company.

[Operator Instructions] And our next question comes from Jamaine Aggrey of Canaccord. Your line is open.

Hello this is Jamaine. Just a little bit on the bid pipeline growth, I know some things are slipping to the right given for the protest but in terms of with respect in gross margins on some of these bids, can you talk a little bit about that?

As we mentioned, I think previously we did shift our strategy in terms of the type of bids that we've perused, we're focused almost exclusively on awards that are what we called best value. So where you can have a value proposition that differentiates yourself from the lowest costs and lowest price award market. In addition with the acquisition of course we strategically want to make sure that we are consuming work that is higher degree of complexity, a larger profile and the professional sector and that will continue to drive as north on the gross margin perspective, much in the ranges that Kathryn has describe our objectives previously. And we see that our pipeline still reflects that. Kathryn do you want to add anything to that?

Well, that’s right. I mean very consistently that the avenues we are pursuing are going to be at the upper end of that range and more consistent with the professional content we talk about. So the upper end of our 20% to 23% range.

Sorry, I was on mute. Okay. And as far as we have seen obviously the lack of kind of healthcare reform has been coming through. I’m just kind of curious I suppose is that our positive or negative or no affects at all for you guys?

Our current book of business it’s no affect at all and our targeted future business very little effect and that’s, if you look at kind of the agencies where we are targeting, it really does not have much effect in the nature of the type of work we are going to be provide. We do pay very close attention to it. We think within the health and human services arena and under Tom Price that the CMS organization, we are heavy part of the Medicare and Medicaid evolution like this will be severally impacted and for the company that are heavy in that arena, they certainly have to pay very, very close attention. But for our current book of business, our current new business pipeline, we see that as neutral. And overall, you probably hear that what Kathryn and I shared, when we are at investor conferences that everything we have look at on the political landscape including that piece, we rate as neutral to positive across the board for DLH.

And lastly, could you just give us any update alternative head start program that’s part of 2017 or 2018 [Technical Difficulty]?

I’m sorry, you were breaking up a little bit on the first part. Can you repeat the question?

Hello. Is it better?

Yes. We got you Jamaine.

Sorry about that. So just wanted to get an update on the head start program that’s part of 2017, 2018 budget requests.

Yes. I think if I heard the question properly, just an update on head start program, which is one of our signature program with the acquisitions. Head start program is in very, very good shape. The good news is, they have got a leadership team that has deep, deep expertise experience in this arena and a high degree of confidence from this administration and the leaderships as well. We have had an opportunity to meet with them and there is always some degree of consternation as you change administrations and you look at new budgets come from both the President as well as the congressional community. I personally meet with a number of the folks involved with the Senate side of what we're going to see for budgets, but we feel real, real strong about the evolution of the program and the viability of it from a budget prospective as well. Leaving a head start and just to give kind of a general statement, across the board as you know we are a Federal Government contractor. I believe that there is a high probability that we will be operating on continuing resolution as we enter 1 October it really appears that the differences in the delta between the President submitted budget and where we know the House is on planned appropriations are far a party to have a substantial impact to the programs that we are working. So we think that would be a positive things for all of our recent feeds, the same applies for the VA, we expect that the VA budget will continue to be strong and potentially even flushed up and likewise in defense side of the house, health agencies and the DOD health agencies we think everything looks very, very strong in that arena. So the future looks bright for not only head start but a lot of the key programs as well.

And really and its natural for you to talk about the question on healthcare reform. While there is no direct impact to us, I think that is the marked on benefit, the focus and attention can now turn to budget and fund and really getting that settled as we head out of fiscal 2017 and into government fiscal 2018.

Okay, all right. Thank you. That was my last question.

Thank you. And your next question comes from [indiscernible]. Your line is open.

Hello Zack, Kathryn good morning. Just have two quick questions. I was looking at the financial in the press release for this quarter and I was comparing them to last quarter. And I saw that our cash is up $1 million from $3.1 million to $4.6 million and our debt is down by a $1 million, but yet the revenue stayed the same and gross margin pretty much stayed the same. So I was wondering where did that $2 million come from.

That’s the current collection effort we have going on.

So that’s what I felt, you kind of alluded to it there at the one of the earlier recent call questions. And the so account receivable went down then.

Its long operating events as we talked about earlier, you do get some transitory difference based on just the cut off issue. So that’s normal operating results.

All right thanks, and the next item is I saw that we added a new Board member Jim Allen and he has also been on the board of NCI since October of 2004 and per our press release was the Chair of the Audit Committee, but yet in according to the NCI's 10-Q in January of 2017 they disclosed that the former control embezzled $19.4 million circumventing controls and transferring money from his payroll account to his personal by creating fictional invoices and that created miss appropriation losses of many, many millions of dollars. And when I was looking at that I also notice that he is now the defendant in three different law suits that were filed in July. And I saw that Austin [indiscernible] is also on the board there. And I was wondering, how does this happen under their watchful guidance and eye of the audit committee. And then also how do we prevent it from our happening at our Company and do our Directors have director insurance to protect them in the event of these law suits?

Sure. Let me take them in a reverse order a little bit there. DNO insurance is something that we choose very, very seriously and so there is a full board and so the answer is yes. And Kathryn can elaborate if you care for any greater specificity there. NCI is a company that is in our space, we have watched them for several years as one of the peer type companies in our space, we have great deal of visibility to the challenges that they faced and as you might imagine, there was a great deal of diligence. They had a very, very powerful slate of candidates for consideration for the Board of Directors. The best I have seen in and quite a while. And for Jim to come out of that with the association that you referenced to, I think speaks wide for his reputation, his expertise in the market. That was a substantial amount of discussion with regard to that through his nomination process. We also received independent assessments with regard to capability potential there as well. And then Kathryn and I had an opportunity to meet and spend a fair amount of time with him last week and that probably was a 75% discussion. You might imagine, we probably have a board member now that is as keen and sensitive to test and controls as you will find in the industry today. I could tell you that we are expected to be [indiscernible] quite a while, but he just bring so much value and for him certainly some lessons learned in this space that all of the audit firms and all parties that were involved in this has learned some things with regard to what’s out there today. And this shows how vision and companies and audit partners need to be with regard to some very, very specific detailed transaction prospects in our industry. So we are really pleased that he is come out thus far with the assessment that he has and see as a tremendously valued asset.

So how would you validate that all your invoices are actually valid invoices?

Well of course there is a series of control that apply there. And so there is a [indiscernible] we do of that and separation duties and a number of controls that would prevent those kind of issues that you are point to in NCI.

Okay. All right.

And [Burt] (Ph) if you are interested in a little deeper dive let me just suggest that we have something offline and for Kathryn and of course Jim, he is tremendously a good communicator a good guy. We are happy to persuade any questions and concerns you may have in that regard. So feel free to may be - subsequently we can follow-up with you on that.

Thanks, we will do, will both of you be in Boston tomorrow?

Yes I was going to say in my closing that Kathryn and I shortly after this call heading out to Boston, we have got presentation and one-on-ones tomorrow, but I would say Thursday and Friday Kathryn and our team can be available for follow-ups.

Okay very good. Thanks so much.

Thank you. And there appear to be no additional questions in the queue. I would now like to turn the conference back over to Mr. Parker for any further remarks.

Great, well thank you again just for your help on today's call. We would like to extend our appreciation to all of you for participating on our call and webcast this morning. As Burt indicated Kathryn and I will be presenting at the Canaccord Genuity Growth Conference tomorrow. But later in the week, Kathryn and Chris and Tiffney can be made available for any follow-up that you may have and follow-up calls. With that, we thank you for again participating today and look forward to following up with you for our fourth quarter and year end results. Good bye for now.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone, have a great day.