DLH Holdings Corp (DLHC) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2017 DLH Holdings Earnings Conference Call. (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 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 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 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'd now like to turn the call over to Zach. Please go ahead, Zach.

Thank you, Chris, and good morning, 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'd 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 are 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 an ever-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 1-year point of our major acquisition, Danya, and the start of the final phase of our related ERP financial system integration and testing, key milestone 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 customers for a federal health information technology innovation. This really serves to validate our actions with respect to strategic expansion of DLH in health IT arena, and we find is a key milestone for acknowledging, again, the truly valuable and extensive work being done by our leadership team. Fourth, we also recently announced the appointment of a strong industry veteran, Jim Allen, to our Board of Directors, a tremendous addition to our company. Jim has been in leadership positions for years with some of the best-known companies and organizations within our government services space, and he also brings a wealth of financial experience, strategic decision-making expertise and really strong corporate development acumen to the company. Zach and I are excited about Jim's addition. 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 DLH and on our Board of Directors elevates our position in the industry and our status as a leading provider of critical health care-related government services to the federal government. It is fitting that 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 opportunities in this space.

This past quarter was a very busy one in terms of bid and proposal activity, and not surprisingly, we incurred additional G&A expenses, which really reflected higher investment and commitment to the organic growth profile of the company and was right in line with our growth plan. These bids are deemed 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 our operators at how they've come together these recent few months in order to develop really strong proposals, great approaches and are really reflective of the type of tempo that we expect to deliver sometime in the future.

We are continuing invest in our system, our people and our bid and proposal activity. The better we outlook for the top line -- to better the outlook for top line growth and bottom line results. Notwithstanding, we're 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 from last year's acquisitions.

Overall, we're 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 will 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 of taking a -- 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 given 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 will serve us well in the quarters to come.

With that, I'd 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 solid financial results.

Turning to Slide 5 in our presentation. We posted revenue for the 3 month ended June 30 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 the existing contract vehicles. Sales rose roughly 6% organically over the prior year period, as Zach mentioned, as we successfully expanded 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 percent of sales, our third quarter gross margin was 21.8% in this fiscal year. We continue to focus on more complex, higher-value contracts that leverage our expanded capabilities.

Turning to Slide 7. Income from operations was $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 that Zach discussed, 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 nonoperational expenses, including interest, amortization of deferred financing cost on debt obligations and other miscellaneous nonoperational items.

We reported net income for the 3 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 3 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 rationale, are in our earnings statement.

Turning to Slide 9. You'll 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 our 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'll continue to use cash generation to pay down debt, when practical, and delever 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) And our first question comes from Mark Jordan of NOBLE Capital Markets.

First question is -- relates to free cash flow generation. Obviously, cash flow from ops was $4.9 million, which was 2x 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 9 months number in that $0.35 to $0.37 range?

We do think that the results year-to-date are pretty indicative. Although I would caution that at any given period it's going to be a function, of course, of when some of the major collections coming in. And so as you know, we have a set of contracts that are our primary contracts and just so happens that the largest of those collected $230 on June 30. So, yes, a couple of hours later, it could have flowed over into July 1. But on a -- that's a point in time issue. But as a general practice, we think that free cash flow results generated through June 30 are indicative of our norm.

Okay. So normalized excluding transitory events in working capital needs that it -- that's a good proxy for free cash flow?

Absolutely right, Yes. And the key factor, of course, is that tax benefit also helps that free cash flow.

Absolutely. My next question relates around your pipeline, Zach, which you referred to. Could you give us a little more of a visibility as to what are the size of the bids that you have that are currently submitted? What do 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 '18?

Sure, and 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 for us 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 trade wins in the federal government. Many of our opportunities continue -- awards this season continue to slip to the right, over 70% of our value and of the bids we've done this year are still awaiting decisions on the government, And the climate is also affected by some action from some of our industry competitors, and we've encountered 4 to 5 protests over the course of the last quarter plus they continue to slow the award process by the government. But having said that, we continue to focus on growing high-value, very strategic bids. The -- and we've benefited somewhat from a really good timing by having a large surge this last quarter. As we talked about before, our sales cycle, as you will, for me -- for significant deals is generally 12 to 18 months if we work it right. And the fact that this quarter reflects the 12 months of the addition of the Danya capabilities and qualifications as well as our delays position the company and the new company, if you will, for some of these opportunities, we're in better shape to leverage the totality of our qualifications at this stage. So we're excited about -- notwithstanding, it did have an impact loaded on the results. It's the right kind of impact if you ask me because it really is a strong endorsement and commitment to our organic growth.

The pipeline, as we look to '18, I'm expecting that 2 or 3 of our very material bids have very -- in fact, not very likely here. Highly confident will slip to awards in FY '18 and for us, of course, that means after October 1st. Bid that we put in as an example yesterday will -- in the government space right now, you can't expect them to make awards in that nature within 30 to 60 days. And it is very common for us to expect that as we take work away from potentially other companies that there will be a percentage of those that will contest the awards to us. So we think that it is still very healthy, some of those have been slipped to the right. We continue to maintain a good, win rate. We've had some good small wins that helped to seed us for some of these major deals so we think FY '18 still looks very healthy for a growth trajectory.

Okay. One follow-up were in your early comments, you mentioned that there was some frustration, of protest slowing down the ramp of business. That implies that you have taken away business, and therefore, creating new business streams. Could you quantify what you have won out there that you're waiting for the resolution of protests to realize revenue on?

I can, yes. We've had 4 deals that we bid. One of them is -- let me rephrase that. One deal that we bid in our public health and life sciences bid business that was awarded to us. The incumbent protested, the government, throughout the protest awarded to us again. The incumbent protested government throughout the protest. And then once again, you're on the third leg. So that's a program that reflects the program that in our model, we had really anticipated we'd be seeing that revenue in Q3. It is, of course, stunning, that. And we remain optimistic that in the revised approach that we would be successful. But it is kind of indicative of what we see in the space. We've had another one where we -- 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 1 full quarter. And given the political climate on the hill, there's a chance that, that 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. Protests are still very common part of the business in the industry, we know that going in. We often factor that into our waterfalls. But when we get so close on some of these and pending awards so there is a degree of frustration. But our folks remain vigorous in our approach, and we think that further confirmations of our innovative approaches, much as was acknowledged this last quarter, really will help us to continue to have a high win probability on our pursuits.

I guess, until the federal government penalize unsuccessful protests, we'll have to live this for an extended period of time.

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 taking a stab at trying to reduce, particularly frivolous protest to try to reduce the amount of protest that can be done for (inaudible) and awards that are $25 million. So we'll keep you posted on that. That's, we can tell, a good thing. We're not a company who does a lot of protesting. Though, we think that'll be a good thing for our industry as well as our company.

(Operator Instructions) Our next question comes from [Jemaine Agri] of Canaccord.

This is [Jemaine]. Just a little bit on the bid pipeline growth. I know some things are slipping to the right (inaudible) for the protest. But in terms of what you're expecting in gross margins on some of these bids, if you could talk a little bit about that?

Yes, as we mentioned -- I know previously we did shift our strategy in terms of the type of bids that we have pursued. We're focused, almost exclusively, on awards that are, what we call, best value, so where you can have a value proposition that differentiates yourself from the lowest-cost, lowest-priced award market. As -- in addition with the acquisition, of course, we strategically want to make sure that we're pursuing work that is a higher degree of complexity, a larger profile in the professional sector and that will continue to drive us north on the gross margin perspective, much in the ranges that Kathryn has described, that 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 items we're pursuing are going to be at the upper end of that range and more consistent with the professional content we talked about. So it's the upper end of our 20% to 23%.

Okay. And as far as we've seen obviously the lack of kind of healthcare reform that has been coming through, I'm just kind of curious with regards to your thoughts. Is that a positive? A negative? Or no effects at all for you guys?

In our current book of business, it's no effect at all. And in our targeted future business, a very little effect, right? And that's -- if you look at kind of the agencies that we're targeting, it really does not have much effect in the nature of the type of work we're going to be providing. We do pay close -- pay very close attention to it. We think within the Health and Human Services arena under Tom Price that the CMS organization, where heavy part of Medicare/Medicaid evolution exists will be severely impacted. And for the companies that are heavily 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're at investor conferences is that everything we've looked 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 on kind of the Head Start programs as part of 2017 and 2018 budget request?

I'm sorry, you're breaking up a little bit on the first part, can you repeat the question?

So just want to get updates on the Head Start program as part of 2017 and 2018 budget request.

Yes, I think if I heard the question properly just an update on our Head Start program, which is one of our signature programs with the acquisition. Head Start program is in very, very good shape. They've got -- the good news is, they've got a leadership team that has deep, deep expertise and experience in this arena and a high degree of confidence from this administration and the leadership's as well. I've had the opportunity to meet with them and there's always some degree of consternation as you change administrations and you look at new budgets coming from both the President as well as the congressional community. We have -- I personally met with a number of the folks involved with the (inaudible) side of what we're going to see for budgets, but we feel really, really strong about the evolution of the program and the viability of it from a budget perspective as well. There are -- we -- leaving Headstart and just to give kind of a general statement, across the board, as you know, we're a federal government contractor. We actually believe -- I believe that there's a high probability that we'll be operating on a continuing resolution as we enter 1 October. It really appears that the differences in the delta between the President's submitted budget and really the houses on its planned appropriations are too far apart to have a substantial impact to the programs that we are working. So we think that it would be a positive things for all of our recompetes, the same applies for the VA. We expect that the VA budget will continue to be strong and potentially even plussed up. And likewise, in the Defense side of the House, DoD and health -- (inaudible) DoD's health agencies, we think everything looks very, very strong in that arena. So the future looks bright for not only Head Start but our -- other key programs as well.

And really and as much as you talked about the pressure on healthcare reform, I think that while there's no direct impact to us, I think that is the knock-on benefit that just the focus and attention can now turn to budget and funding and really getting that settled as we head out of fiscal '17 and into government fiscal '18.

And our next question comes from Burton Osterweis of Osterweis Business Consulting.

I just have 2 quick questions. I was looking at the financials 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 $1 million. So I -- 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?

Despite the current collection efforts we have going on...

Yes, so that's what I thought we -- you kind of alluded to at there -- at the last -- one of the earlier recent call questions. And so there was still accounts payable -- accounts receivable went down then?

Yes, there is -- it's normal operating events, as we've talked about earlier, as you do get some transitory differences based on just the cutoff issues. So that's -- there's -- that's normal operating results.

All right. And the next item is I saw that we added a new board member, Jim Allen, and he's also been on the board of NCI since October of 2004 and he was even -- per our press release was the Chair of the Audit Committee. And but -- yet -- and according to the NCI's 10-Q, in January of 2017, they disclosed that the controller embezzled -- the former controller embezzled $19.4 million by circumventing controls and transferring money from his payroll account to his personal by creating fictional invoices and that created misappropriation losses of many, many millions of dollars. And when I was looking at that I also noticed that he is now the defendant in 3 different lawsuits that were filed in July and I saw that Austin Yerks 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 happening at our company? And do our directors have director insurance to protect them in the event of these lawsuits?

Sure. Let me take them in reverse order a little bit there. Our D&O insurance is something that we treat very, very seriously and so does our 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. We had a very, very a powerful slate of candidates for consideration for the Board of Directors, the best I've seen in quite a while. And for Jim to come out of that with the association that you make reference to, I think, speaks volumes for his reputation, his expertise in the market. There was a substantial amount of discussion with regard to that through his nomination process. We also received and -- sought and received independent assessments with regards to any culpability potentially 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 75% of the discussion. He is -- 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 can tell you that we're expecting to be prodded and probed (inaudible) for quite a while but he is -- he just brings so much value and to -- for him, certainly some lessons learned in this space that all of the audit firms and all parties that were involved in this had learned some things with regard to what's out there today. And this shows how vigilant companies and audit partners need be with regards to some very, very specific detailed transaction prospects in our industry. So we're really pleased that he's come out of it thus far with the assessment that he has, and see him as a tremendously valued asset. (inaudible)

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

Well, there's -- of course, there is a series of controls that apply there. And so there is depth of review of that and separation of duties and a number of controls that would prevent those kind of issues that you're pointing to in NCI.

And, Burt, if you are interested in a little deeper dive, let me just suggest that we have something off-line and with Kathryn and, of course, Jim. He is a tremendously good communicator, good guy. We will be happy to assuage any questions and concerns you may have in that regard. So feel free to maybe (inaudible) and we can follow up with you on that?

Will do. Will both of you be in Boston tomorrow?

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

And there appear to be no additional questions in the queue. I'd like to turn the conference back over to Mr. Parker for any closing remarks.

Great. Well, thank you, Candace, for your help on today's call. We'd like to extend our appreciation to all of you for participating on our call and our 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 Tiffany can be made available for any follow-up that you may have in 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. Goodbye 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.