DLH Holdings Corp (DLHC) 2018 Q2 法說會逐字稿

Good morning, and welcome to the DLH Fiscal Second Quarter Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Chris Witty, Investor Relations Adviser to DLH. Please go ahead.

Thank you, and good morning, everyone. On the call with me today is Zach Parker, President and CEO; and Kathryn JohnBull, Chief Financial Officer. The company's second 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 on a year-over-year basis unless otherwise stated.

President and CEO, Zach Parker, will speak next, 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.

Thanks, Chris, and top of the morning to everyone. Welcome to our fiscal 2018 second quarter conference call. Once again, the men and women that make up DLH Corporation have continued to shine and delivered a strong quarter of performance, excellence and efficiencies. We are indebted to our outstanding workforce.

Starting with Slide 3, let me begin by providing a high-level overview of our financial performance and recent accomplishments. Revenue for the second quarter rose to $34.4 million, the highest level ever and was up 15% over the comparable prior year period. Our growth reflects the enduring nature of our well-funded programs as well as demonstrating our ability to handle a temporary but meaningful surge in requirements as we reengineer one of our contracts. I'll speak to the overall outlook for such programs in a minute.

Our gross margin was 21.7% for the quarter, up slightly from last year. And we posted a net income of $0.10 per share versus $0.08 a year ago. We also generated $4.4 million of cash from operations and further reduced our leverage during the quarter, leaving us with just $14.9 million of senior debt, as Kathryn will review in greater detail in a moment.

Overall, we continue to post strong financial performance. We grew the business, expanded margins and generated solid operating results. This is a trend worth highlighting, as shown on Slide 4. Over the past 5 years, the company's annualized EBITDA has grown from around 400k to above $9 million. This is due to sound program and financial management, shrewd cost controls, steady top line growth and expanding margins.

We're very proud of this track record and what it says about the talent of our staff, the values of the services we provide and the long-standing importance of the agencies and programs we serve.

Cash flow has also been helped by our legacy deferred tax assets, and the company as a whole has benefited greatly from our acquisition of Danya just a couple of years ago. So the future looks very bright.

Turning to Slide 5, I'd like to talk for a moment about this year's recently enacted bipartisan budget in Washington, which has been positive for DLH in a number of ways.

First and most importantly, it continues to prioritize agencies and programs where we provide services. The budget includes strong support for the Veterans Administration, the Department of Defense and a variety of health care-related initiatives, along with greater funding to attack behavioral health and the opioid epidemic. We are pleased by the enhanced funding across these strategic areas and the visibility it provides to key programs going forward.

Health and Human Services now has an operating budget of $78 billion, some $10 billion above fiscal 2017. And total VA funding is $81.5 billion or $7.1 billion more than last year. In addition, the fact that we are no longer constrained by our continuing resolution, which means that decisions on contracts and task orders are happening on a more regular and, hence, rapid basis. This is obviously good for the entire industry, including us.

As you may recall, I said last quarter that federal civilian agency funding obligations were 28% below that of last year due to the ongoing CR, but this has now been reversed. The overall pace of awards is substantially higher, which we anticipate will continue heading into 2019. In addition, we are able to realize greater on-contract growth opportunities with our current clients.

Turning to Slide 6, I'd like to review the company's outlook more broadly, highlighting a number of positive trends. First, we operate within agencies that are continuing to demonstrate a solid position and well funding -- and good well-funded programs in the current budget, as I've just mentioned.

On a more granular basis, our specific areas and programs are seeing strong support on the hill. Spending on health care, technology and professional services is growing due to increased demand, and the 2018 budget included higher funding for such areas, particularly within the NIH, the ACF, the VA and SAMHSA. This correlates to a very healthy pipeline of new business opportunities for us.

In fact, we currently have over $700 million of addressable leads that we're pursuing. This remains quite healthy, leveraging our expertise in telehealth solutions, data analytics, medico-logistics and public health capacity-building, to name a few. Suffice it to say that our business development and proposal resources are clearly busy with an active bid and proposal environment. And we remain focused on the core agencies and capabilities that we provide. At the same time, we're always looking to increase the value of our services we offer and, in doing so, drive margin expansion.

And lastly, our outlook remains strong due to ongoing activity within the M&A space. We continue to look at a variety of attractive potential transactions that fit within our business model and can expand our capabilities across the sectors we serve. Now that a budget is in place in Washington, it provides greater clarity as to the contract environment, which also impacts deal flow in our space. We're looking for well-managed organizations with highly credentialed staff and strong margins. And we're optimistic about the potential for future acquisitions that can bolster our outlook going forward.

So we're in a very good position in terms of customer relationships, budget priorities and pipeline of opportunities. We're confident in the prospects for both organic and acquisition-fueled expansion as we continue to drive to boost our top line performance, achieve strong margins and use our prodigious cash flow to pay down debt and delever the company. Our balance sheet is strong and getting stronger, and the outlook of the company is better than ever before.

I'm proud that we can accomplish every day -- of what we can accomplish every day here, which speaks to the talent and perseverance of our hardworking workforce.

With that, I'd like to turn the call over to our Chief Financial Officer, Kathryn JohnBull, who will provide a more detailed discussion of our financial results. Kathryn?

Thank you, Zach, and good morning, everyone. We're pleased to share the results of another solid financial quarter.

Turning to Slide 7. We posted revenue for the 3 months ended March 31, 2018, of $34.4 million, representing an increase of $4.5 million or 15% over the prior year second quarter. The higher revenue was again due to growth across our existing contract vehicles along with new program awards and benefited, as Zach mentioned, from the timing of program deliverables. This quarterly revenue, while a record for DLH in this post-transformation period, will vary somewhat as program activity levels vary throughout the remainder of the year.

Now moving to gross profit on Slide 8. This quarter, the company posted total gross profit of approximately $7.4 million versus $6.4 million last year, with the 16.4% increase primarily due to the higher revenue. As a percent of sales, the second quarter gross margin was 21.7%, up slightly from last year's 21.4%, reflecting program mix and timing. We believe margins will continue to trend in the 21% to 22% range going forward, although we're targeting higher-value, higher-margin contracts that will positively impact profitability over the long term.

Turning to Slide 9. Income from operations rose 19.8% to $2.2 million for the fiscal 2018 second quarter from $1.8 million last year as higher gross profit was partially offset by an increase in G&A expense. This increase in G&A primarily reflects the impact of certain noncash equity grants and incentive compensation accruals.

We reported net income for the 3 months ended March 31, 2018, of approximately $1.3 million or $0.10 per diluted share versus net income of $1 million or $0.08 per share in the prior year period. DLH recorded a $0.6 million provision for income tax expense during the second quarters of both fiscal 2018 and 2017, though of course, '18 benefited from the reduced effective tax rate resulting from the tax law change in December.

Turning to Slide 10. EBITDA for the 3 months ended March 31, 2018, was approximately $2.8 million versus $2.4 million last year. EBITDA as a percent of revenue was 8% in both quarters. And 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 $3.6 million of cash on hand versus $4.9 million at the beginning of the fiscal year based on the timing of collections and debt repayments. We had nothing borrowed under our revolving credit facility at the end of the quarter, and our term loan had a balance of $14.9 million.

As a reminder, as we discussed last quarter, our loan agreement requires prepayments as a percentage of excess cash flow. And accordingly, we made an additional debt payment of $2.9 million on January 16. So now our net debt is $11.3 million, and our net debt-to-trailing EBITDA position is 1.21x, reflecting these debt reductions.

That concludes my discussion of the financial statements. And with that, I would now like to turn the call over to our operator to open the call for questions.

(Operator Instructions) Our first question is from Kenneth Herbert of Canaccord.

This is Perre on for Ken. Congrats on the strong sales growth this quarter. I was hoping you can provide more detail on sort of the drivers behind it. Sounds like a lot was existing, but anything around new business versus existing contracts? And maybe also, how much of that was better pricing versus any new scope?

Yes, no, good question there, Perre, and we appreciate your continued support. There actually were a variety of factors that contributed. You touched on some of them, including some additional program management increase on some of our contracts with the VA. The largest part of that is, as Kathryn indicated, we had some additional program requirements and deliverables on one of our key HHS programs that was a result of part of our business process reengineering. And we had an opportunity to surge, to provide those services and accomplished it very well. There's a combination of those factors and a couple of small new task orders as well.

Got it. And would you mind also sharing an update on the status of your VA contract recompete now in 2018? And also, how many primary contract vehicles are there for your legacy work with the VA?

Starting with the latter part of your question, Perre, we've got roughly 17 task orders, reflecting the majority of our book of business with the VA on the mail-order pharmacy side, just kind of our featured work. We have some portion of those that was attributed -- deals largely with the pharmaceutical piece that is up for renewal in this next round. We're currently on extensions, an option-year extension. There has not been a request for proposal period as yet, but we do anticipate that sometime this calendar year that we may be seeing recompetition in that particular book of business. That will represent probably somewhere in the neighborhood of 45% of our VA portion of work for that mail-order pharmacy business.

And last one for me for now. Would you also mind sharing an update on the status of the Head Start program? Maybe if you can touch on maybe revenue contribution this quarter versus same period last, year and also, if you could share anything on expectations around that, how we should think about it in terms of a full year run rate.

I'll leave the run rate to Kathryn, but the program is actually doing very well. As you may recall, we did undergo a major revision to the manner in which the work is to be conducted, bringing on a variety of new talented subject matter experts and delivering in a more favorable and modern IT process. Having said that, that has -- was the largest fuel to this quarter's growth. And that is, as we make that transition, the customer had -- still wanted us to make sure we satisfied ongoing demands as well as handling the surge requirements. So Head Start was a key driver to this program. And as I indicated earlier, it's a relatively temporary surge that was manifested largely this quarter. Kathryn, anything to add to that?

Right. So the Head Start program runs on a typical cycle, although it is a function of annual planning with the customer. But generally speaking, the Head Start program runs in a cycle that aligns with the school -- the K-12 school year. That's when most -- the peak of most of the activity happens in executing reviews and the other variable surge requirements of the programs. So generally speaking, our fiscal Q2 is the peak of the program delivery under that program. And that was the case last year. That's the case this year. What's a little different and why, even though it peaked in that same quarter in both periods, what's a little different in terms of fueling the revenue growth is, if you look at our trends in the quarters in last year, we established momentum in building -- expanding the business in Q3 and 4 and carried that forward into Q1 and then added a peak in activity of volume in Q2 that normally occurs from Head Start. So that's kind of the reason for that upward motion on the revenue line quarter-over-quarter. And because that is a peak period, it's our expectation that Q3 and 4 will be slightly softer as some of those programmatic surges have been executed within the current quarter.

The next question is from Ben Klieve of NOBLE Capital Markets.

A couple of questions for me. So first, I'm curious about these -- the margin profile of these surge-type activities you're referring to. Are you able to deliver higher margins from this type of work, given how quickly it comes up and how quickly you need to deliver? Or is the margin profile really in line with other work that you do over a more traditional time frame?

Yes, some of both. Some of it does command higher margins and healthy overall profile of the P&L, but some of it brings along with it travel and things that tend to be more of a pass-through nature. And so you get the net of all that, and it ended up being pretty consistent with prior year period, although it was up a little bit, just based on the volume contributed by the Head Start program compared to the overall volume.

Got you, okay. And I'm also curious about the status of ramping awards. You talked about a couple of smaller awards that contributed to growth as they were emerging. To what degree do you -- did you see growth this quarter driven by ramping awards? And on those awards, kind of where do they stand in getting towards the full run rate?

Yes. Well, no, good question. So some of the -- both the on-contract growth and the smaller task order IDIQ contracts, we think that some of that revenue will be better realized during Q3. They were kind of start-ups, on this case, early stages of Q2. So we do expect some of that work to be a driver there. I would say that a fair amount of the new work of our on-contract growth is in our -- on our lower-margin business, so we don't expect it to be terribly accretive with regard to EBITDA, but we do expect it to contribute to the top line.

Okay, got it. And I guess one more question from me. Curious about how you believe the lack of a VA secretary would impact your business development efforts. I know you don't believe that any -- that a lack of a secretary at the top will impact near-term operations, but I'm curious how long you think that an agency like the VA -- how long can that agency go without a secretary before it begins to impact business development efforts on kind of -- from a broad perspective?

Sure. Yes, no, I can tell you. I just spent the last 2 days with the leadership of the VA here in D.C. It is clearly evident that there's certainly some degree of impact from the loss of Secretary Shulkin and, of course, the amount of time it's going to take to get him reinstated. A number of major programs, particularly on the electronic health records and some of the major programs with Cerner and Leidos are going to be particularly impacted around the transition because uncertainties around their migration to the single platform will affect many of us, both DoD and the VA, as you well know. So there will be definitely some acquisition impact as well for major large programs. Having said that, I am really encouraged by the people that I see in the second-tier leadership that how keenly they remain focused on serving our veterans and are making great strides in trying to keep the distractions on the hill from having any impact on the service delivery. So we'll continue to see things, much like we have, where a continued support that remains very favorable to the VA will continue to get support both on the hill as well as within the agency. But make no mistake about it, there are some key programs relative to privatization, relative to the leveraging of a couple of the new acts that are going to be stunted with the absence of a secretary by all means.

Got you. Hope -- fingers crossed that they -- that, that gets resolved sooner rather than later for you guys and for everybody involved. So well, I think that does it for me.

(Operator Instructions) Your next question is from Jeff Rohrbaugh of AHSG Holdings.

This is a follow-up to your mail-order pharmacy discussion from the earlier question. So I've noticed that the VA seems to be focusing on setting aside contracts for service-disabled veteran-owned business. And is there a concern that the recompete for this contract could go down that route? And how would you partner or how would you go about recompeting that if that's the case?

Sure. Well, no, good question. As we stated several times that the impact of the Kingdomware decision just a couple of years ago has had a significant effect on moving more and more work to service-disabled, veteran-owned small businesses. As you may recall, we were awarded a couple of parts of the T4 Next Generation contract and effectively in 2016 ended up -- the latter part of 2016 really 0 booking any potential work out of that largely because of that strong commitment. We have had in the neighborhood of $60 million to $80 million of opportunities, which previously had been on our pipeline that we felt that were primable that over the course of the last 12 to 18 months, our business development representatives have briefed us that they will more likely go to small businesses. So it certainly is having an impact on our industry. It seems to be stabilizing a little bit, and we have, of course, continued to track that potential as a risk for us for our recompete. We obviously think that this is a critical mission, extremely critical mission to our veterans to keep health care on a daily basis without impacting in any way, shape or form. And every indication is that we will continue and provide those services in a great way. We do, however, have to be mindful of the fact that it is a bona fide risk and have to look at mitigating approaches to being able to continue to provide those services with a different model.

So you do have a plan in place if your mail-order pharmacy contract does go service veteran-owned small business, okay?

Yes.

(Operator Instructions) There are no other questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Zach Parker for closing remarks.

Well, I want to thank everyone for your attention and your time today, and we appreciate your interest and contributions to the success of the company. Kathryn and I and the rest of our team look forward to delivering on Q3, and we look forward to engaging with you all again at the appropriate time. Have a great and blessed day. Bye for now.

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