DLH Holdings Corp. (DLHC) Q4 2017 Earnings Report, Transcript and Summary

Good day, and welcome to the DLH Fiscal 2017 Quarter Four Earnings Conference Call. All participants will be in a listen only mode [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Chris Witty, Moderator and Investor Relations Adviser. Please go ahead, sir.

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 fiscal 2018 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 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 made on a year-over-year basis unless otherwise stated. As shown on slide three, President and CEO, Zach Parker, will speak first; followed by CFO, Kathryn JohnBull. With that, I'd now like to turn the call over to Zach. Please go ahead, Zach.

Thank you, Chris, and good morning to everyone. Welcome to our 2017 fiscal fourth quarter and year-end conference call. Please note that Q4 reflects the first period in which the full impact of our 2016 acquisition can be compared to the prior year quarter on an apples-to-apples basis. Starting with Slide 4, let me begin by providing a high-level overview of the recent performance and some particular accomplishments. First of all, I am quite pleased to announce that our revenue topped 30 million this past quarter, which is the first and the highest level ever since our transformation into a dedicated government services provider many years ago. Sales rose 12% year-over-year, a major achievement in our industry. The bottom line is that our uniquely talented workforce continue to provide strong performance this quarter driving the organic growth, while revenue can still be lumpy at times quarter-over-quarter, it was nice to finally break the $30 million mark and exit fiscal 2017 at 120 million annual run-rate. Our gross margin was 23.9% for the quarter, and 22.3% for fiscal 2017. This is up substantially from fiscal 2016 and we generated 6.5 million in operating cash flow for the 12 months just ended. Couple that with our deleveraging activities this year and you'll find that we have continued to bolster our balance sheet. Accordingly, we have strengthened our posture with regard to potential acquisitions consistent with our strategic plan. At the same time, our new business development pipeline has never been healthier with over $1 billion in qualified opportunities across the strategically-targeted agencies over the next -- expected to deliver over the next 18 months. And I'll speak more to that in a moment. But first, please turn to Slide 5, which simply encapsulates the progress that DLH has made over the past 5 years. Not only have we grown the company into a major government healthcare solutions services provider approaching $120 million in revenue, but our profitability, EBITDA and cash flow have expanded even more rapidly. And while we are periodically compared to much larger companies in our space, such as Maximus, CACI or Agility, the fact is that while smaller, our profitability, cash flow and balance sheet metrics compare quite favorably against our peer groups and benchmark companies. Many of these peers carry much higher debt and leverage ratios. While we have consistently delevered the company since our transformative acquisition last year, we are pleased with the progress we're making. So we are in an enviable position to be able to both invest in the business and pursue additional growth opportunities, organic and acquisitive, as they continue to present themselves throughout the years. I credit the entire leadership team here for strengthening the company into the organization that it is today, one respected by our peers and admired by our clients. Now turning to Slide 6, I want to provide you some color with regard to our thoughts on fiscal 2018. Obviously, we do not yet have the full picture on the federal budget. And since there is none, we will continue to leverage our engagement on the Hill, but we are very optimistic about the quarters to come. Given our current pipeline and the request for proposal environment for contracts up for award, we anticipate a healthy level of wins leading to growth in fiscal 2018 and '19. Anticipated spending looks to be strong at the key federal agencies that we serve today. These include the Department of Veteran Affairs, Health and Human Services Agency, the Defense Health Agency and its related service components and the Homeland Security Organization. Programs related to health services and medical readiness programs, in particular, appear to be set for future growth from the congressional budgets. That said, we are not looking to just maintain our share of the current business. Indeed, we are looking to expand our presence while having our innovative solutions to address -- having more innovative solutions to address the more complex challenges for these customers. Accordingly, in FY '18, we will be focusing on further differentiating ourselves through technology insertion and expanded data analytics. This will ensure that top line growth will align strategically with enhancing shareholder value as well as achieving excellent operating performance and customer service -- and customer satisfaction. Overall, it remains a very exciting time for us as we build upon the transformative actions of the last 18 months. So while volatility continues to be the new normal in Washington these days, our active engagements to track what's happening on the Hill and at the Office of Management and Budget, confirms that our addressable markets remain very strong for the future of DLH. In addition, as I mentioned earlier, we continue to assess the market for attractive and strategic bolt-on acquisitions. M&A activity in the GovCon space remains robust with strong valuations. Potential acquisition targets for us, we need to serve our target markets, broaden our core competencies and move us up the food chain, while we continue to bring great customer relationships, high caliber staff and provide appropriate returns. We look at companies of all sizes, but often pass on opportunities that we do not view as being the right strategic or cultural fit for DLH. Nevertheless, our strong balance sheet allows us the flexibility to be in the market and take advantage of opportunities when they exist to strengthen the future of our results. As we turn the corner on 2018, I am proud of everything that our team has accomplished these past 12 to 18 months and appreciate the support of our Board of Directors, my staff and our shareholders in helping to reach these goals. We're upbeat about the coming quarters and believe opportunities are bound to elevate our game and to take DLH to the next level, as we leverage our capabilities to grow the business, maintain solid margins and pursue strategic acquisitions to position us into an even greater provider of healthcare solutions for federal agencies. With that, I would now like to turn the call over to our Chief Financial Officer, Kathryn JohnBull, who'll 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 sound financial results. Turning to slide seven, we posted revenue for the three months ended September 30, 2017, of 30.4 million, representing an increase of 3.3 million or 12% over the prior year's fourth quarter. This was the first quarter with a clean year-over-year comparison not impacted by our 2016 acquisition as Zach mentioned. The higher revenue was entirely due to growth across our existing contract vehicles and by new awards. We're very pleased with this performance. And while quarters can still be impacted by the timing of program volumes, we're happy to report our first period with revenues above 30 million. Now moving to gross profit on slide eight. This quarter, the company posted total gross profit of approximately 7.3 million versus 6.2 million last year, driven by higher revenue as well as improved program profitability. As a percent of sales, our fourth quarter gross margin was 23.9%, an increase of 90 basis points over the comparable period last year. We continue to focus on more complex, higher value contracts, while keeping a lid on expenses. Turning to Slide 9. Income from operations rose to 2.1 million for the fiscal 2017 fourth quarter from 1.3 million last year. Higher gross profit was partially offset by an increase in D&A and G&A expenses tied to the timing of incentive compensation accruals, and our ongoing business development efforts, as we seek out new opportunities and pursue higher top line growth. We reported net income for the three months ended September 30, 2017, of approximately $1 million or $0.08 per diluted share versus net income of 2.4 million or $0.20 per share in the prior year period. Note, however, that the fiscal 2016 fourth quarter included a tax benefit of $1.6 million, while this year, the DLH had a tax provision of $0.8 million. It's also important to mention that due to our substantial deferred tax asset position, our Q4 tax provision this year was noncash in nature. The company's cash flow will continue to be positively impacted by utilizing tax net operating losses for an estimated 6 to 7 years in the future. Slide 10 shows the change in our adjusted EBITDA. On a non-GAAP basis, adjusted EBITDA for the 3 months ended September 30, 2017, was approximately $2.7 million, up 22% versus last year. In addition, adjusted EBITDA as a percent of revenue was 8.8% this quarter compared to 8.1% in the fourth quarter of fiscal 2016. Our definition of adjusted EBITDA, along with descriptions regarding its use and rationale, are in our earnings statement. Turning to Slide 11. You can see a snapshot of our balance sheet at the end of the quarter. We had approximately $4.9 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 loan had a balance of $19.7 million. We generated $6.5 million of operating cash flow in fiscal 2017, and due to our improving financial position and lower debt, we ended the year with a net debt-to-adjusted EBITDA position of 1.6x versus 3.5x in fiscal 2016. We'll continue to use cash generation to pay down debt and delever the balance sheet going forward, providing financial flexibility for various growth initiatives as well as potential additional acquisitions as Zach mentioned. That concludes my discussion of the financial statements. With that, I would now like to turn the call over to our operator to open for questions.

[Operator Instructions] The first question comes from Ben Klieve with NOBLE Capital Markets.

So a few questions. Kathryn, this one maybe more for you. I'm wondering if you can quantify the one-time incentive compensation or BD expenses that you saw this quarter? And then, I believe I heard this correctly that, that was entirely baked in the SG&A, none of that fell under the gross profit line.

Correct. That's all in SG&A. And the quarter -- the impact for the quarter was roughly $600,000.

And then -- another comment you made regarding the organic growth. You discussed that it came from both new contracts and expansion of existing contracts. I'm wondering if you can kind of elaborate on that a bit. I mean, to what degree is that growth driven by the pipeline delivering in the past and now turning to revenue? Or how much of that is just tied to expansion of the existing contracts? And can you provide any comments regarding that pipeline delivery? Any awards that you can maybe highlight that would suggest the -- how well that pipeline is really delivering?

Thank you very much, Ben. Let me comment on a few of those. First of all, with regard to the current revenues, a function of the awards, we have, as Kathryn indicated, there are both new contracts as well as wherever we can, it's to our advantage in many cases if we can influence a customer to use our existing contracts, it certainly helps from a competitive standpoint and saves a substantial investment in terms of business development and BMP or bid & proposal funding. So we did have some work, which customer was able to award to us. Those range -- they vary in terms of their size and magnitude over the recent year to two -- year to 18 months or so over the last couple of years. Some customers have larger ones than others. In fact, the largest ones we had was on order of 35 million over 5 million that has a ramp-up scale to it, and we were fortunate to have had the customer award that to us through existing vehicles and, of course, save some money, increased our win probability, and of course, it has netted out with positive contribution to our revenue stream. We've also had a string of very small, but strategic to us, wins in the health promotion, disease prevention arena periods throughout the year. And we just can't give you a quantitative assessment of those, but those have been also contributors. And then, we continue to try to make sure that we incentivize our operating personnel on current performance to grow our current contracts. So all three of those had a contribution. I'm not in a position right now to give you kind of a weighted contribution. We can certainly maybe talk about some things downstream in that regard, but each of those are going to continue to be part of our toolkit for business development on a go-forward basis and it just really makes sense. With regard to the future pipeline, yes, we regularly monitor and evaluate the health of that pipeline. And as I indicated, it's north of 1 billion. As we closed the fiscal year, that number was right at 1.3 billion and what we call qualified opportunities from the new business perspective and that are also signature meaningful awards. We generally don't track things below $1 million here and there at our corporate level, but best manage within our operating units. I'll just give you a few additional metrics. We think our sweet spot is right around the $50 million to $65 million, $70 million type of contracts. Of that pipeline I just gave you, the medium value is 58 million. Our average value, however, is 87 million. And I think I've mentioned at the end of the last year that we have one or two very significant opportunities pending that kind of skew the average. So that'll give you a little bit of a metric around there. We are still awaiting award for those transformative operations. The customer has continued to down select and whittle the potential field of our awardees and we've been very optimistic that we still have a real good shot for those. Of course, those were things that in this sales cycle were bid over 12 months ago. So those are still in that pipeline.

Two other questions, I guess. One, how do you gauge your level of recompete risk as you enter fiscal '18 here?

We've continued to have 100% win rate over the last six plus years, in fact since I've been with the company. We have had growth on all of our current customer sets and we have yet to lose a competitive recompete. So we work very hard in those. We invest as much attention into changing our value proposition for our customers. As you know, we've talked about before some of our VA works coming up. And we think, over the next year, for recompete, if you haven't heard, our customer just recently was awarded the J.D. Power Award for the VA, in this particular case, across as compared against all the commercial mail-order pharmacies. And we think our partnership in that relationship has been a very positive one and we feel very confident about our recompete potential.

Perfect. And then last one for me and I'll jump back in queue. Regarding CapEx, did you make your final payments in last year P system in Q4 and expect CapEx to be back to the more normalized levels in '18? Or is it still going to be a bit elevated from kind of the normal range next year?

Yes, there's a little carryover into our Q1, but not materially and we are on track to wrap that project on time, in budget and then we're back to, as you said, the very, very low level of sustaining CapEx requiring for services business.

[Operator Instructions] The next question comes from Ken Herbert with Canaccord.

This is actually Jamaine calling in for Ken. Just a few kind of broader questions, couple broader questions. You talked about the current RFP line remains robust. Could you talk a little bit in terms of for 2018, in terms of any expectations that you may have in terms of hearing back one on some of the contracts that you're bidding for?

Of course, everything begins with getting a budget, right? So -- and we're not unique in that decisions around programs are in some cases going to be associated with the timeliness of the budget. But let me throw it back over to Zach to reinforce what we talked about in terms of the things we're pursuing.

Kathryn is spot on. We do expect that there will be a continuing resolution regarding that bidding on a shutdown. If there is a shutdown, however, we do believe that we have some material highly mission-critical programs. So we expect minimal risk there. But with regard to the awards, we have continued to see that the federal government is still lacking resources in the acquisition committee for contract awards. That has continued to slow the process. We have also seen a slowdown in the award process, particularly impacting us as a result of protests -- protests in various stages of the acquisition process. The Hill does have some initiatives moving forward. There are some regulations that will try to curb the frivolous and less viable protests and hopefully that will allow our government contract officials to improve their administrative lead times for awards. Now having said that, without going to that crystal ball that Kathryn was referring to, we do think that a number of these key opportunities for us have aged to the standpoint that the likelihood of award is substantially higher over the course of the next three or four quarters than they were before. So we're pretty optimistic that these, once the budgets are set into place, will translate into relatively early FY '18 awards.

And then just lastly, in terms of some of the bolt-on acquisitions that you kind of looking at the kind of complement your capabilities, have you in the last few quarters or so seen kind of a rise in terms of some of the valuations, in terms of the companies that you're looking at? And do you guys have kind of a top line where you wouldn't go above in terms of a valuation perspective?

Good question. Good question, Jamaine. Yes, let me start and I'll turn it over to Kathryn, who also runs our corporate development initiatives. But first of all, we have seen pretty consistent deal flow this year. I think in the GovCon space, somewhere on an order of 90 to 100 deals of services solutions kinds of providers are arenas what we're going to close their calendar year with. That's pretty consistent with the track record we've seen over the recent years. But the market still seems to have hilled if not improved with regard to its attractiveness in a lot of areas. And we think that has led to some enhanced valuations from what we've seen over the last year. We continue to get and see pretty good steady diet of deal flow and opportunities. With that, let me turn it over to Kathryn.

Well, I think, that's right. The areas that we are targeting are highly sought-after areas, and the targets that are meaningful to us are targets that other people would like to have as well. And so it is, obviously, a competitive process, but we have a pretty well-defined, I think, a very rigorous process for establishing what's reasonable value, and living within that expectation but we do go into these deals to win. And so, for the right deal, that is going to complement our business and allow us to move the ball forward more quickly, we're definitely positioned to be very competitive.

Let me add also that we continue to maintain relationships. In fact, Kathryn had a very comprehensive meeting yesterday with our bankers and it's the third and really we're making sure that we continue to expand our toolkit of options so that we have a pretty good shot at offsetting sometimes the advantage that some of the large companies have with cash offers, where it's pretty clear for material things for us. We're still going to leverage debt to do the deal. But we are laying that ground work to make sure we mitigate that competitive risk. We still don't plan to do much overpaying for things that don't fit strategically. We have made no pursue decisions quite a bit also this last year.

[Operator Instructions] At this time, we have no further questions. So this will conclude our question-and-answer session. I would like to turn the conference back over to Zach Parker, President and CEO, for any closing remarks.

Thank you, Rachel. And I would just like to thank you all again for joining us and for your interest and participation in DLH's success. I would encourage you to stay tuned for additional information as we will be participating in some upcoming investor conferences and we'll, of course, provide some additional color and detail into aspects of the business at that time. And lastly, if I don't -- neither Kathryn or I hear from you all in the very near term, we wish you all a very Merry Christmas, Happy Hanukkah, Happy Kwanzaa and just a joyous holiday season. Thank you, and have a blessed day. Bye for now.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.