DLH Holdings Corp (DLHC) 2018 Q3 法說會逐字稿

Good morning, and welcome to the DLH Corporation Fiscal 2018 Third 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. 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 the company's outlook to 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 statement.

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.

Thank you, Chris, and good morning, everyone. Welcome to our fiscal 2018 third quarter conference call.

Starting with Slide 3, let me begin by providing a high-level overview of our financial performance and recent accomplishments. Revenue for the third quarter rose to $36.1 million, a recent high, up 23.5% over last year. Our growth this period was fueled by a surge in business activity across several key programs including Head Start, which was somewhat of an anomaly but reflected spending requirements as the government closes in on its fiscal year-end. By way of caution, we do not expect Q4 revenue to be at the same level.

While we're winning new contracts that build our base and -- our business base over time, individual quarters can be lumpy from a top line perspective due to characteristics of individual task orders and the overall timing of procurement activity.

Our gross margin was 23.1% for the quarter, also a recent high, and we posted net income of $0.13 per share versus $0.08 a year ago.

We also generated $4 million of cash from operations and further reduced our leverage during the quarter, leaving us with just $14 million of senior debt, as Kathryn will review in a moment.

Fiscal 2018 has been a -- had been a great deleveraging year as we've generated $8 million in cash from operations thus far. Overall, we continue to show strong operating performance, growing the business, expanding margins and generating solid financial results.

Turning to Slide 4. I want to take a moment to speak to our expectations for fiscal 2019, which is right around the corner. Obviously, our observations are just that, thoughts and views based on how we see the industry and on trends that appear imminent.

In this current environment, the future can, indeed, be difficult to predict, nevertheless, based on recent experience on the Capitol Hill, we anticipate that budget negotiations will result in a compromised spending bill similar to the past fiscal year. If that turns out to be accurate, we would be pleased.

DLH and our customers benefit from a strong bipartisan support across most of our programs beginning with the VA. We see continued prioritization of veterans programs, including programs that expand technology applications to enhance and improve speed of service.

That said, as discussed previously, the VA is evaluating the Rule of Two as it is applicable to our 9 CMOP pharmacy contracts having released the RFP, or request for proposal, as a small business set-aside solicitation this quarter. We, of course, have partnered in this phase and intend to remain a major player in this business going forward.

We cannot predict the date when this competition will be completed. However, in the meantime, the government continues to extend our services until the series of amendments and protests and evaluations and other changes are resolved and completed.

We are also encouraged that the VA has confirmed Robert Wilkie as secretary. We believe this will bring stability to an agency which has lacked a confirmed leader for quite some time. We'll keep you posted as this situation continues to evolve. Likewise, SAMHSA is under new leadership as well and we expect the Health and Human Services agency to continue to be a viable, strong customer and partner going forward.

Overall, as I said earlier, spending trends remain positive across our 2 targeted agencies and programs. Along with strong funding anticipated for fiscal 2013 (sic) [2019], our business is largely not impacted by economic issues related to such headlines as tariffs, inflation and geopolitical uncertainties.

Demand is directly correlated to the technology services that we provide in the health care space, particularly as we broaden our expertise in data analytics and behavioral health, and we are optimistic about our growth prospects heading into next year.

Now turning to Slide 5, I want to further discuss our new business pipeline as well as our M&A opportunities. In terms of our addressable market, we continue to look over -- look at over $400 million of qualified new business leads across the agencies that we target and, as I mentioned earlier, the fourth quarter is typically an active one for awards to be decided.

We have recently received 2 awards, one new business with the Navy and one new renewal -- one renewal of our current capacity building with the Center for Disease Control.

At the same time, we continue to invest for the future, which means adding staff for information technology, marketing and business development and, when appropriate, driving performance enhancements across the organizations so that we remain lean, nimble and profitable.

Our success depends on this attention to detail and how we run the company and dedicate ourselves to our customers. In that regard, we've been meeting with numerous constituents on the Hill lately at agencies, in Congress, military events, et cetera, to ensure our message and the DLH brand are top of mind as fiscal 2019 priorities are decided and funded.

As I've said a moment ago, I believe we are well positioned for solid performance in the year ahead based on the current outlook for our programs and the agencies we serve.

We also continue to be active in the M&A arena from the standpoint of looking at potential transactions. There remain many interesting opportunities out there, but we are steadfast in being thorough and careful when analyzing opportunities, companies and programs to ensure that any possible acquisition is accretive, synergistic and bolsters our existing capabilities.

So while we have nothing to report at present, we continue with our evaluations during the coming months and quarters and are optimistic that we can find a cultural fit opportunity out there.

Before turning the call over to Kathryn, I'd like to once again thank our hard-working team for all we've accomplished these past 2 years. We believe that the company is in very strong shape with a strong balance sheet, increasing growth trajectory and solid margins despite some recompete risk. I couldn't be more proud of what this says about our people and our enduring agency relationships.

We're committed to ensuring that DLH continues on its path of ongoing high performance no matter what the fiscal 2019 brings, and I'm confident we have the right staff, technology and strategy in place to make this a reality.

With that said, 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 report another quarter of solid financial results. Turning to Slide 6, we posted revenue for the 3 months ended June 30, 2018, of $36.1 million, representing an increase of $6.9 million or 23.5% over the prior year third quarter. The higher revenue reflected high activity levels on certain key programs, as Zach mentioned, and expansion of services on existing contract vehicles.

Such top line results represented strong performance for DLH, but we again caution that revenue trends can be lumpy quarter-to-quarter, particularly at the end of the government fiscal year.

Now moving to gross profit on Slide 7. This quarter, the company posted total gross profit of approximately $8.3 million versus $6.4 million last year with the 30.6% increase due to both higher revenue and margin expansion.

As a percent of sales, the third quarter gross margin was 23.1% versus 21.8% last year, generally reflecting program mix. As with revenue, gross margins can vary quarter-to-quarter due to the timing of activity levels across our many contracts.

Turning to Slide 8. Income from operations rose to $2.6 million for fiscal year 2018 third quarter from $1.8 million last year as higher gross profit was partially offset by an increase in G&A expenses. The increase in G&A primarily reflects the impact of business development activities and certain noncash equity grants.

We reported net income for the 3 months ended June 30, 2018 of approximately $1.6 million or $0.13 per diluted share versus net income of $0.9 million or $0.08 per share in the prior year period.

DLH recorded a $0.7 million tax provision for the current period versus $0.5 million in fiscal 2017, with effective tax rates benefiting in fiscal '18 from the prorated impact of the Tax Cuts and Jobs Act of 2017.

Turning to Slide 9. EBITDA for the 3 months ended June 30, 2018, was $3.2 million versus $2.3 million last year. EBITDA as a percent of revenue was 8.9% in the current quarter versus 7.7% in 2017. A reconciliation of GAAP net income to EBITDA is in our earnings statement.

Turning to Slide 10, you can see a snapshot of our balance sheet. At the end of the quarter, we had approximately $6.6 million cash on hand versus $4.9 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 balance -- our term loan had a balance of $14 million.

Our net debt to trailing EBITDA position now stands at just 0.72x trailing-12 month EBITDA, testimony to our company's extraordinary ability to generate and manage cash, as Zach mentioned.

That concludes my discussion of financial statements. And with that, I'll turn the call back to the operator to open for questions.

(Operator Instructions) The first question will come from Ken Herbert with Canaccord.

I just wanted to see if you could provide any more specifics around timing in the fourth quarter. And it sounded a little bit like there may have been some business pulled into the third quarter but -- from the fourth quarter, but how should we think about the strong revenue growth you saw in the third quarter and expectations, specifically for the fourth quarter around the top line? And then maybe, historically, you've got a -- at least last year, a very nice gross margin in the fourth quarter, as you saw good volume there, but do we see a similar strength in the gross margin in the fourth quarter as well?

Ken, good to chat with you. Appreciate the question. We are still looking at a good strong Q4 and, as we indicated, there are several factors that will contribute to a little bit of a variance as we get through the quarter. We do expect that the key drivers for the Head Start for the Q3 will not sustain through Q4, but we think that the top line will still be something very strong. I certainly think that it will probably be north of what we had in Q2. Kathryn, you want to add any color to that?

Exactly, right. I do think much of the surge that we completed in Q3 will naturally not recur into Q4. Though there's been growth and expansion on programs throughout Q3 that will help Q4. So I would place Q4 somewhere in between Q1 and Q2, not as strong as Q3. And just given the mix that, that revenue will drive from slightly more traditional gross margins, more in line with our 22%, maybe slightly north of 22% is our current expectation.

Okay, perfect. And Zach, I just wanted to follow-up on your comments around, obviously, fiscal '19, I know you've got some timing risk around some of the recompetes, but certainly, fundamentals and at least from a budget standpoint, appear to be favorable when you continue to, I think, put up certainly better top line numbers than I was expecting, which is very nice to see. Can you provide a little more detail on how you see maybe '19 shaping up? And some of the key sort of puts and takes from a contract standpoint as we start to look to frame the next fiscal year?

Yes. No, I appreciate that, Ken. We think that given that there's some stability now at the decision-making level within a few of our key targeted programs, a fair amount of -- we think a fair amount of the opportunities that we've had pending for some time had been -- we think -- and quite held up because of the lack of first budget and then now decision-makers. As we start to see more decision-makers being placed into some of these key organizations down to second and third levels in the agencies, we think we expect to see Q4 and the early part of Q1 of '19 to really release some of these awards. As we indicated, we've had a couple of small awards, recompete and a new business opportunity start to be uncorked. So we're hopeful that some of that logjam will get deployed. But we -- on the other front, we really are seeing a pretty strong budget. There will not be a sequestration in all respects of the prior years. We really expect to see some good movement on some of the awards. And we still remain optimistic that we'll get our fair share. We've traditionally done very well with our recompetitions and we're looking forward to continuing that trend as well.

Great. And if I could just finally -- you continue to make very good progress on deleveraging. As we move forward here, should we change our thinking at all around leverage levels you're comfortable with? Or maybe any change in how we should think about capital allocation as you continue to obviously work down the debt and shore up the balance sheet?

Sure. Well we're pretty consistent on how we want to really deploy capital. I think any major investment, of course, is, as we've talked about, Kathryn is leading our corporate development initiatives, and that would be where we would potentially look at using debt going forward on an acquisition. Besides that, I think, Kathryn, you can talk a little bit more specific.

Yes. Besides that, we continue to expect the operating needs of the business to be fairly light in terms of capital requirements. I mean, there -- naturally, as the new programs come on, there'll be a short-term consumption of cash. But very quickly, we expect the flow of cash flow on normal operations to be strong and really, as Zach said, protect our access to capital really for a special purpose and most likely that would be an acquisition.

(Operator Instructions) The next question will be from Ben Klieve with NOBLE Capital Markets.

First, kind of piggybacking off on one of Ken's questions here, you said the drivers -- the Head Start program will continue into Q4. But do you have any reason at this point to believe that the really strong performance you've seen through the first 3 quarters this year won't be continuing into next year?

Well, more so what we were going through with Ken was just the bell curve on the quarters within any given fiscal year, traditionally, and I put a big capital T on traditionally there because clients have their reasons for why they may layoff a particular program execution differently in any given period. But generally speaking, our peak periods are Q2 and Q3 because of the strength of the review cycle on that Head Start program in those periods. So that's why, if you tend to look at our revenue, layout's going to be strongest in Q2, Q3. Q1s are -- tends to be our softest quarter and Q4 tends to be better than Q1, stronger than Q1 but doesn't have the lift from some of the surge requirements that happen in Q2 and Q3. Now rolling forward to '19, as you said, we expect that a similar layout. Based on the data we know right now, we expect a similar layout of our programs in FY '19. But your bigger point, generally, the trend's positive from the current budget support and the sizing that the applicable adjustable targets in the market.

Okay, perfect, Kathryn. Turning to the pipeline, on the second quarter call, you described about $700 million of addressable leads and then this quarter, you described it as being down quite a bit, about $400 million. Can you talk about kind of how the pipeline has evolved this year? And help us understand kind of how successful you've seen in translating the pipeline into bookings?

Sure. So the number we've given, just to clarify again that we've given today is really a new business only, and we want to make sure it was clear does not include any of our recompetes in it. And from time to time, we specify -- we want to make sure we specify whether or not it does include recompetes. And the -- probably the biggest driver was a decision we had talked about once before in one of our, potentially, substantially impact opportunities, which we were not successful on, probably the biggest contributor. We had one relatively large one on an annual basis. The decision has been made and we believe that the protest activity has subsided. Aside from that, the addressable market has really expanded in some of our core areas, and we have -- as Kathryn indicated, we have reinvested in some additional business development resources because we see some opportunities in FY '19 starting to really surge, so we're starting to position ourselves for those as well.

Okay, perfect. So -- and I apologize if I was comparing apples and oranges here. So that $700 million in Q2 included recompetes and the $400 million that you talk about today did not include recompetes? Is that correct?

Correct. As well as I just said, one -- the potential significant award of which a decision was made to go another direction.

Right. Okay, perfect. And then on the M&A front, you've -- I certainly understand and appreciate the new [dictations] and wait for the right deal as opposed to moving too quickly here. But I'm curious over the last few quarters, you've certainly had the bandwidth to make a move if you saw the right opportunity. Have you -- are you any closer today than you have been over the last couple of calls? Have you had opportunities that progressed but kind of after a while didn't meet the final criteria? Or have you just really not seen much to even get that far down the negotiation path? What kind of -- what does the market really look like here over the last couple of quarters for you?

It actually has -- no, good question. And it actually has been a very healthy and a good market. We have actually done some very extensive reviews. We've been in very close discussions with some parties. And as best I can tell you at this stage, we remain very interested in an opportunity or 2 as well. So the market has been really good, and yes, it's not just list management for us. We've actually gotten into some pretty deep IOI discussions and even further.

At this time, there are no other callers in the question queue. So I'll turn the conference back over to Zach Parker for any closing remarks.

Good. Well, thank you for again, your continued interest and support in DLH. Again, we are pleased with our Q3 performance, but we look even more forward to giving you our full fiscal year and Q4 results later in the year. So thank you, again, and you all have a blessed day. Bye for now.

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