DLH Holdings Corp (DLHC) 2018 Q1 法說會逐字稿

Good morning, and welcome to the DLH Holdings Fiscal 2018 First Quarter Conference Call. (Operator Instructions) Please note, today's event is being recorded. I would now like to turn the conference over to Chris Witty, today's moderator. Please go ahead.

Thank you, and good morning, everyone. On my call with me today is Zach Parker, President and Chief Executive Officer; and Kathryn JohnBull, Chief Financial Officer.

The company's first quarter press release and the 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 on a year-over-year basis unless otherwise stated.

As shown on Slide 3, President and CEO, Zach Parker will speak first; followed by CFO, Kathryn JohnBull, after which we'll open it up for questions. With that, I'd now like to turn the call over to Zach. Please go ahead, Zach.

Thank you, Chris, and good morning, everyone. Welcome to our Fiscal 2018 First Quarter Conference Call.

Starting with Slide #4. Let me begin by providing a high-level overview of our recent performance and some particular accomplishments. Revenue for the first quarter once again surpassed $30 million, and more importantly, rose nearly 16% over prior year comparable period. This organic growth not only underscores the value of our services and the stability of our contracts, but it is rather impressive, given the ongoing budget stalemates in Washington that have led the Congress to adopt a string of continuing resolutions.

In fact, most of our programs are fully funded with limited downside risk even during government shutdowns, a testimony to their enduring nature and the critical mission criticality to these agencies, which include Department of Veteran Affairs, HHS and the Department of Defense. This aspect of our business, unlike some of our competitors, should reassure our investors during a time when there is no easy matter of trying to figure out the forecast when the government -- when Congress will decide on a budget.

Our gross margin was 21.6% for the quarter, down slightly from last year due to our program mix, but will still be within our target range. And our bottom line results were impacted by a onetime noncash charge recorded due to the recently enacted Tax Act, which Kathryn will review in greater detail in a moment.

It remains a very busy time for DLH in terms of our bidding proposal activity, although some awards have been delayed due to the ongoing continuing resolution. We expect that once the budget priorities are finalized, the remainder of fiscal '18 will be a period of higher-than-normal contract selection for government agencies. The current environment has particularly impacted the federal civilian agency contract awards, where we have found that funding obligations are down 26% below that of the last year's first quarter. We again look forward to greater activity in the coming quarters and anticipate winning our fair share of these new business proposals.

At the same time, we continue to look at potential acquisitions that fit within our strategic business model as we strengthen the company's balance sheet. Such transactions must, of course, meet not only our strategic objectives, but obviously to be accretive to our earnings. We're encouraged by the level of deal flow activity in our space and the government contracting space. And we believe that well-aligned opportunities will present themselves in the foreseeable future as well.

Now turning to Slide 5. I'd like to review for a moment just what sets us apart from other companies that compete in the government services space. Unlike some contractors, we are solely focused on health-related solutions and services. This is an important distinction for new and old investors alike, as it really forms the basis for why we're bullish on the future of the company. This is our area of expertise with a very strong addressable market, which yields plenty of upside potential.

And within this space, we have years of experience providing unique technology-enabled solutions and are very proud of the track record that we've dealt within the agencies that we serve. In fact, roughly 90% of our contracts represent work we've been doing for over 15 years. We have a strong reputation for quality and helped our clients win numerous awards for customer service and innovation. It's no surprise that we have nearly 100% recompete rate as a prime contractor. We look for ways to deliver cost effective solutions, and in doing so, prove our value proposition, which is why customers are so loyal and appreciative of what we do.

That's what in part sets us apart and is one of our competitive advantages as well as a foundation of our business development efforts as we go forward. We definitely see plenty of room for revenue growth in the markets we serve even as we move up the value change towards more technology-driven services.

Moving to Slide 6. I want to discuss some work that we're currently performing that represents the type of work consistent with the direction of DLH. One of our contracts with USAMMA, The United States Army Medical Material Agency, integrates many of the innovative capabilities that our highly credentialed staff provide today, all within the health IT arena. We provide advanced research and development, test and evaluation for next-generation medical systems and devices to be used in the theater. This will help the Army through the use of data analytics and additional capability to determine and assess the readiness posture of the troops in the field.

Program management is combined with biomedical engineering, test planning, readiness in logistics and systems analysis. This is a great example of leveraging multiple dimensions of our core competencies and new technologies to grow our base of business as we see more and more opportunities to expand such applications in other agencies. As we continue to move up the value chain to higher margins, our stickiness with contracts and clients will continue to drive to the full breadth and leverage our capabilities within these organizations.

Before turning the call over to Kathryn, let me just reiterate that as current results clearly illustrate, DLH has a unique base of business in the government space that we believe will remain, for the most part, nearly fully funded even if Congress cannot come up with a decision regarding the near-term spending priorities. We're confident that we can weather the storm if there is one.

Having said that, make no mistake, if a prolonged shutdown is considered likely, we have contingency plans in place and will take every precaution necessary to ensure that our services are rendered professionally while protecting our shareholders and our employees. Notwithstanding the political environment of budget negotiations, we remain very upbeat about the future of our technology-enabled solutions and the programs that we serve.

We still continue to prioritize business development efforts, focusing on a wide array of new programs of various sizes that emphasize our higher value core competencies. The most exciting programs for us are those that leverage our analytics capabilities within the health IT space and programs such as the one I reviewed earlier that are moving more and more towards leveraging DLH expertise.

How we execute today on such programs will help drive growth in these applications going forward, and the future looks bright, very bright in my opinion. We appreciate our long-term shareholders who have come to value the DLH growth story. In addition, we recently attended the Noble conference in Florida and met with many new potential investors who came away with a better understanding of what we do, how we're different and expressed substantial interest. We look forward to seeing our shareholders at the company's upcoming annual meeting in a couple of days on February 8.

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, Zack, and good morning, everyone. We're pleased to report another quarter of sound financial results.

Turning to Slide 7. We posted revenue for the 3 months ended December 31, 2017, of $30.2 million, representing an increase of $4.1 million or 15.7% over the prior year's first quarter. The higher revenue was once again due to growth across our existing contract vehicles along with strategic new small program awards. This is the second consecutive quarter of revenue surpassing $30 million, as Zach mentioned. And although we expect to see some lumpiness quarter-to-quarter going forward due to tax quarter timing and program delivery schedules. However, we expect the second quarter to be a very positive one, regardless of whether there is a government shutdown or a continuing resolution due to the nature of our programs and their funded status.

Now moving to gross profit on Slide 8. This quarter, the company posted total gross profit of approximately $6.5 million versus $5.8 million last year, driven by the higher revenue. As a percentage of sales, the first quarter gross margin was 21.6%, down slightly from last year's 22.3%, reflecting program mix and timing. We continue to focus on more complex, higher-value contracts, as Zach discussed, while keeping a lid on expenses.

Turning to Slide 9. Income from operations rose to $1.1 million for the fiscal 2018 first quarter from $0.9 million last year, as higher gross profit was partially offset by an increase in D&A as well as G&A expenses. The increase in G&A primarily reflects the impact of certain noncash equity grants. We reported a net loss for the 3 months ended December 31, 2017, of approximately $2.9 million or $0.24 per diluted share versus net income of $0.3 million or $0.03 per share in the prior year period. Note that in the fiscal '18 first quarter, we recorded a one-time charge of $3.4 million for the revaluation of our net deferred tax assets due to the Tax Act enabled in December.

Excluding this, net income in the first quarter of 2018 would have been $0.5 million or $0.04 per diluted share. The tax provisions in both years were noncash in nature, as we continue to have tax net operating losses that are expected to last another 6 to 7 years. Offsetting the charge that we took in the first quarter somewhat is the benefit we will derive from the Tax Act's lower rates beginning next quarter.

Slide 10 shows the year-over-year change in EBITDA. Beginning with the first quarter in fiscal 2018, we have commenced reporting EBITDA rather than adjusted EBITDA as a key non-GAAP financial measure of our business. We believe this change will improve the transparency of the information reported and provide useful information for investors to compare our results to those of our peers.

Non-GAAP measures from prior periods have been recast to conform to this change in our reporting. It is important to note that our GAAP results in presentation of GAAP metrics, of course, do not change, and this has no effect on our business nor how we manage our business. On a non-GAAP basis, EBITDA for the 3 months ended December 31, 2017, was approximately $1.7 million versus $1.1 million last year. In addition, EBITDA as a percent of revenue was 5.5% this quarter compared to 4.2% in the first quarter of fiscal 2017. A reconciliation of GAAP net income to EBITDA is 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 $3.2 million of cash on hand versus

$4.9 million at the beginning of the fiscal year based on the timing of key collections and of incentive comp payments for the prior fiscal year that were paid in December. We had nothing borrowed under our revolving credit facility at the end of the quarter, and our term loan had a balance of $18.8 million. Our net debt to trailing EBITDA position is now 1.73x and as we continue to delever the balance sheet to enhance our financial flexibility.

Note that our loan agreement requires prepayments as a percentage of excess cash flow. And accordingly, we've made an additional debt payment of $2.9 million on January 16, 2018, so within this current -- second quarter. Thus we anticipate our leverage ratio should be below 1.5x trailing EBITDA at the end of Q2.

This concludes my discussion of the financial statement. With that, I would now like to turn the call over to our operator to open the call for questions.

(Operator Instructions) Today's first question comes from Ken Herbert of Canaccord Genuity.

This is Jamaine calling in for Ken. Just a couple of quick questions. You mentioned there are your contracts you're looking to focus on leveraging your IT and your kind of own company expertise. Just looking forward in terms of contracts or competition that you're looking at. I mean, is there -- could you give a percentage in terms of how many of those contracts are focused on leveraging your IT expertise versus kind of typical contracts that you guys have bid on in the past?

Yes -- no, I appreciate that. Congratulations again to all the Eagles fans on the call. We had a good time with you guys as well. With regard to our new business pipeline, Jamaine, we've been really shaping that portfolio over the last 6 months to ensure that the majority of the deals are going to be those that -- where we can leverage IT, and particularly, information and data analytics. Kathryn and I made a substantial investment commitment for this annual operating plan to upgrade our resources and capabilities in that arena. And our business development folks are doing pretty good job of making sure we're shaping the new business pipeline to that regard. I would -- with that pipeline in front of me, I would estimate that approximately 50% of our pipeline today is heavily leveraged around technology solutions. So we're really getting there. And this, of course, will be driven largely by the shot in the arm that we have with the acquisition in mid-2016.

First half of '18, what was -- how many -- how much of the contracts would you say are up due for renewal in the first half of the year?

All of what I was describing for you is new business. So we're -- and I would say that the work that is up for renewal near term is that work, which is really not leveraging a high amount of analytics and technology to drive the higher margins.

Okay. And then lastly, just for a -- and I don't know if you've just given any guidance on this. But as far as you guys are estimating for taxes for the full year, is that something that you've disclosed or have a window in terms of what you think the tax rate will be for the full quarter -- or full year rather?

Sorry, can you repeat it again, Jamaine? I...

Sorry. Can you hear me? Is this better? I'm sorry (inaudible)?

We can adjust a little bit.

Is this better?

Yes.

It's better. Thank you.

Okay. Yes, just wanted to see if you guys are -- could give any window in terms of what you believe the tax rate will come in for the year?

Oh, the tax rate. Yes, so of course, there's the big bulge in the tax rate related to the discrete item that we talked about in Q1. And so you have to set that on the side. That's $3.4 million that's not really associated to operations of the business. The ongoing tax rate of the company, though, on current operations is a blend of the old tax system through December 31 and the new system from January 1 onward. And so that blends out at around 24.5% for us.

(Operator Instructions) Today's next question comes from Ben Klieve of NOBLE Capital Markets.

So a few questions first, bit of a follow-up here regarding Jamaine's question regarding the pipeline. Zach, you said that roughly half of pipeline is tied to kind of technology-enabled solutions. I'm curious how that roughly 50% number has evolved since the Danya acquisition? And then when you look at the addressable market, where do see that figure growing to? And do you think that figure would be relatively stable in the future? Or do you think that -- the kind of tax solutions will expand beyond that 50% number?

I appreciate the call and the question. Let me start with the latter portion. No, we don't expect it to be stable. We're driving to try to get that number upwards of 60% to 75% hopefully within the next 12 months. Our pipeline is qualified and pursued deals. We expect to hover around $1.5 billion for opportunities over the next 2 to 3 years. And so we have been making that shift and are focusing on that -- in that type of business. And we're finding that, that addressable market really covers a range of our target agencies. So we feel pretty excited about that. With regard to the first part of it, yes, that initiative in the middle of '16, of course, with the acquisition of Danya. And Danya brought with it a major shot in the arm of real good system integration and IT qualifications that we started to put into our capabilities portfolio that we did not have prior to that acquisition. So there were some things we took out of our new business pipeline as a result of that and -- because we are relatively limited in terms of the resources we can commit to that organic component and then started to bring in the types of deals and now the type of resources that are effective at creating the right value proposition leveraging these new capabilities. So it's been an evolution. And the sales cycle of our business for major deals is generally 18, 24 months. And of course, that deal closed in May. And as we started portfolio reshaping, we're starting to hit that stride in '18.

Perfect. And kind of along the same lines with the investments in technology, you referred to increased investment in your SPOT-m technology. 2 questions regarding that. One, I'm curious if you have an idea of the scale of that investment? And then second of all, what does the technology kind of lack today or what opportunities do you think are out there that you're hoping to address?

Yes, on the first part, I don't want to put too much detail around Kathryn's comment. But we took into this annual operating plan just north of $1 million to invest into expanding our analytics, informatics capabilities. And it's not just for new business. We have existing clients within HHS and the VA, where we think we can continue to enhance our capabilities. This is important, because whether it's our recompetes or new business opportunities, the competitive landscape is also changing. We're finding a lot of our peer competitive companies are sharpening their capabilities there too. So that component, that leg of SPOT-m, we think, is very important for us to continue to invest in. With regard to -- I'm sorry, could you repeat the first part of that, the other part of that, Ben?

Yes. And I was just curious kind of where the investment in this technology, what are you -- what do you think the investment will address? What -- how will this help you expand your pipeline or win awards that are already in the pipeline? What's the mission of this investment?

Well, we're pretty guarded with what we put on the public space with regard to that, because quite frankly, some of our peers have access to the data that we're going to share today. But I can tell you that when you look across the agencies, whether it be Department of Defense, a very large number of vis-ins within veterans health agency. And then 2 or 3 claimants major claimants within HHS, Health & Human Services agencies, you'll find that the analytics, the capabilities around driving better decisions, the capabilities around driving more effective use of Big Data is becoming more and more important. So we're combining some strategic partnerships with some of the best-of-breed tools and software and as well as leveraging some strong partnerships on taking more of our solutions to the cloud in a FedRAMP-certified environment so that we can really leverage on the best practices, leverage today in a major way. That really helps us to reduce the cost of the actual proposed solutions, particularly over the long haul, particularly as we have those as more of an in-house investment. So we think we're pretty far along and feel pretty comfortable with that expansion.

But you had the right too, Ben, when -- as you said at the outset, it's really just technology enablement of business process delivery. So to be clear, we're not talking about becoming a software house or even a large-scale systems implementer or integrator. But rather we're talking about technology enablement to the solution we deliver in a way that allows us to be, of course, more cost effective. It's great in terms of value demonstration to the customer, but also become more key to the customers' operations. And so if we show with bodies that arrive on the customer system, that makes us a pretty undifferentiated provider, Whereas, if we're bringing a technology enabled solution we're accessing, of course, these are major agencies we mentioned that we're working for. They have very massive system implementations and investments of their own. But where we really leverage that is (inaudible) to really interface to that to really deliver better value, faster, lower-cost, higher-quality and/or combination of all those things in the delivery of our services for their benefit. So that's really the dimension of technology enablement that we're talking about.

Got you. I'd like to transition to the really impressive organic growth numbers, 16% on the quarter, that's -- congrats on that, first of all. Curious, was there any kind of a onetime lumpy bit of revenue that came in or was this all just kind of normalized operations that contribute to that impressive growth figure?

No real one-time event. It was -- we've continued to have organic growth in a number of our programs. There's some seasonality that affected. And you may remember also the last -- we briefed last year that one of our headline programs with the Office of Head Start had a -- we had a revision in the manner in which we provide some of those services. And so there was some variation that did carry over into Q1 to help that. And then the new work, which we had, with the exception of some small ones out of Center for Disease Control, we've been able to have the customer put those on some of our existing IDIQ or BPA contracts as opposed to competing them in the open arena. So we'll continue to try to use that. That's much more cost effective use of our BMP dollars to help drive their business. Doesn't quite get us the press releases or the headlines we'd like, but we think double-digit growth is still a very, very strong position that we want to drive our business development resources towards as we go forward.

Yes, absolutely. Okay. And last question from me for that growth figure. Are you able to kind of quantify the level of growth that you saw the quarter from kind of the non-VA pharmacy and head start programs?

Not in position to give you any real numbers dividing those. Those will continue to be our largest customer book of business. Certainly, 90% of our revenue -- north of 90% of our revenue comes from those clients. And I've got to tell you our adjacent markets are still -- we find substantial addressable opportunities with each of those agencies as well. So we expect that to continue for the foreseeable future. So we'll continue to expand within HHS and Head Start. And I would also say that all of the growth that we've encountered in this last year-over-year comparison is within those agencies. We came out of our long-range strategic plan mid-year with quite a bit of good outside assessment with regard to other markets, other federal agencies, commercial state and local options, et cetera. But at the end of the day, it became real clear that we've got a real, real good addressable market. We continue to sharpen. As Kathryn indicated, our value propositions, we feel that taking our share will help us drive a substantially increased shareholder value over the near term.

And our next question comes from Nelson Obus of Wynnefield Capital.

Hey, Kathryn, I just wanted to go over a couple of accounting things here. So in the press release, you say that you -- on a non-GAAP basis, your EBITDA in the quarter was $1.7 million versus $1.1 million. That's very clear. Then I think you said that -- first of all, I assume a non-GAAP basis means adjusted GAAP, right?

Right.

What I'm really getting at is you've done something, which is a little different than what most companies do. Everybody is gravitating to adjusted EBITDA, and you're going back to EBITDA, which I think is probably a noble thing to do, because things get thrown into adjusted that are a little questionable for shareholders. But can you just -- from an accounting perspective, when you go from where you are now to pure EBITDA, what are the things that fall out of the calculation?

Yes, well, of course, the most significant of those is going to be that major tax charge in the quarter. So that accounts for $3.7 million of the adjustment from the loss reported, which again just is a GAAP loss, it's not operational, it's not a cash loss, it's just reflecting the fact that the tax rate at which those NOLs were carried out have to be valued under the new tax law. So a charge of $3.4 million related to that and then regular taxes, of course, which get added back, is another $0.3 million. Then we had, of course, interest expense on our declining debt of a few hundred thousand and then depreciation and amortization largely of the acquired intangibles of the Danya acquisition, because of course, we're a very CapEx-lean company. So our natural depreciation on fixed assets is a couple of pennies put together. But there is a noncash charge related to amortizing our acquired intangibles.

But I don't think -- I may have misunderstood. In other words, what you just did was you took EBITDA and adjusted it for a cleaner number from operations, correct?

Correct.

Did I misunderstand you that now you're not -- you're going to go away from adjusted EBITDA and back to the more standard calculation? You got me really confused here.

You're absolutely right about that.

So let me de-confuse you a little bit now. We were very intentional as we look to going into this new year for us, at whether or not adjusted EBITDA still serves our purpose. And as you well know, we're as a transitioning company, the materiality of some of the things that were noncash over the last several years are not as material to us anymore. And therefore, we think from an analyst perspective, cleaner is better. Adjusted EBITDA always has some connotations as to really what are various companies doing. And we believe -- and there's pros and cons. But we do believe that moving to and we'll continue to stay in a straight EBITDA model right now, reflects the status of the company where we are today, and more importantly, where we expect to be over the next couple of years, such that some of the items that were material and sending misinformation to the analysts 2 years ago are no longer in that status for us. So yes, it was an intentional change for us. Appreciate your observation there that we're moving away from adjusted EBITDA for the long haul and believe that we are now a company that EBITDA serves our analysts in a much better fashion.

Well, then let me play devil's advocate here. Okay? Certainly, one thing that goes out is comp, which I -- when you go from adjusted to EBITDA, you take out compensation, which I think is great. But I have to say this to you, this is a company that is probably not done making acquisitions. So if you're going to EBITDA from adjusted EBITDA for a foreseeable future and then you're making acquisition, you're going to be right back in the rough of explaining such things related to a deal that are not recurring. And -- I mean, I'm trying to be friendly here. But for a company that pays down debt as rapidly as you have and generates a whole lot of free cash flow, it seems inevitable another Danya will creep up and then EBITDA might not be -- in fact, I would go for so far as to say would be misleading as opposed to adjusted EBITDA, because it wouldn't reflect -- EBITDA would not reflect those transitional nonrecurring expenses. So I hope you see where I'm going. It just seems like an unusual move for a company with your kind of free cash flow and your stated desire to continue to look for value-added acquisitions for the shareholders.

Ergo, Nelson, to your point, I did indicate that there's some tradeoff for us, and that's one of them. And as you noted it is our incentive comp that has really been that blip historically. And now that does transition over to being more those costs associated with acquisitions. That is still consistent with part of our strategy. And we did have a good fair, a good debate around is now the right time for that. And Kathryn, you want to add any other color to that?

No, I think that's right. I guess, the difference is that while we do expect those acquisition expenses episodically as we identify targets down the road, we think that we can supplement reporting as appropriate for those intervals when necessary. But on a sustaining basis, providing EBITDA, which puts us -- takes away the step of analysts having to compare, understand how do you do adjusted EBITDA versus how does this peer do adjusted EBITDA, taking that issue off the table, we thought, was appropriate.

And congratulations there.

Well, let me make 2 points. Number one, I think that supplementary information will be very helpful. And number two, you and the board should recognize that the reasoning that you've got into this whole rigmarole with me is because you generate too much free cash, and that allows you to make acquisitions. And it's called a high-quality problem, but so the supplementary information I think is important, and there was no doubt in my mind that Eagles would blow them out.

Still basking in the glow.

Well, I tell you if there's any gamblers there, I took the money line on Eagles.

I'm sure there are some. Well, thank you, Nelson. We appreciate the feedback and the question.

And ladies and gentlemen, I see no further questions in the queue. So at this time, I'd like to turn the call back over to Mr. Parker for any closing remarks.

Well, again, thank you, everyone. We really appreciate your intention and contributions to the success of DLH. As Kathryn and I wrap up, we'd certainly invite any that are in and around the Atlanta area later this week to please join us for the annual meeting of the shareholders and stay tuned. We look forward to chatting with everyone for our second quarter of fiscal '18. Have a blessed day.

Thank you, sir. Today's conference has now concluded. And we thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.