DLH Holdings' (DLHC) CEO Zach Parker on Q3 2016 Results - Earnings Call Transcript

| About: DLH Holdings (DLHC)

DLH Holdings Corp. (NASDAQ:DLHC)

Q3 2016 Results Earnings Conference Call

August 04, 2016 11:00 AM ET

Executives

Chris Witty - MD, IR

Zach Parker - President and CEO

Kathryn Johnbull - CFO

Analysts

Howard Brous - Wunderlich Securities

Ben Klieve - Noble Financial

Marlon Dorsey - MWD Associates

Operator

Good day, ladies and gentlemen. And welcome to the DLH Fiscal 2016 Third Quarter Earnings Call. At this time, all participants are in listen-only mode. Later, we will conduct the question-and-answer session, and instruction will be given at that time. [Operator Instructions] As a reminder, this call is being recorded.

I would now like to turn the call over to Chris Witty, You may begin.

Chris Witty

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 two of the presentation.

This call may include forward-looking statements that relate to the Company’s outlook for 2016 and beyond. These forward-looking statements are as subject to various risks and uncertainties that could cause actual results and events to differ materially from these statements. Please refer to the risks factors contained in the Company’s Annual report on Form 10-K for the fiscal year ended September 30, 2015 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 stated otherwise.

With that, I now turn the call over to Zach Parker, President and CEO. Please go ahead, Zach?

Zach Parker

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

Starting with slide three, I’d like to review some major highlights of this past quarter. It was certainly a busy time for us having just acquired Danya in May of this year, and we’ve been focused on integrating our two organizations to realize the true goals of this game-changing transaction for DLH. And I’ll get little more into that in a moment.

Suffice it to say that in a rather short time period, we pulled together as a team and achieved very solid results across a variety of metrics. We posted nearly 50% revenue expansion year-over-year including 5% organic growth along with much stronger margins and operating income. This performance in Q3 reflects not only the addition of Danya and its contract vehicles but also the dedication and hard work of all of our individuals in both organizations to continue to achieve performance excellence, thus raising our value with our customers and to accelerate our federal market penetration and expand margins.

We are taking on more complex value added opportunities that naturally set us apart from the competition and bringing the higher returns in tandem. Since our acquisition of Danya we have reassessed and reshaped our new business pipeline with the eye towards strategically expanding our presence in the federal marketplace and to seek out new program opportunities. I can say that the outlook looks brighter than ever.

I’m sure our listeners already know that we are leaders in providing systems and services for improved healthcare management across a wide range of applications for our customers. Our web-based open architecture technology has proven to be a very key differentiator as we pursue new contract vehicles to bolster growth going forward. Currently, roughly 54% of our business supports active duty military personnel and our veterans, with the remainder serving various health and human services agencies, both are key markets for DLH.

We’ve already won several contracts this year in medical research and medical device testing, as discussed last year, and we expect additional wins going forward. Similarly, we believe the VA is in an area that will continue to support higher growth and enjoy bipartisan support on the hill with the context of current budget priorities. We see DLH as uniquely positioned for stronger top line performance, given these trends and our current backlog as well as existing relationships within these agencies.

At the same time, we’re lifting the lid on costs -- sorry, keeping a lid on costs and investing in growth in the business. Since acquiring Danya, we have reduced our debt by some $4.5 million, utilizing our operating cash flow as Kathryn will review in a moment. We have also filed a registration statement for our rights offering, which is expected to eliminate the $2.5 million bridge loan provided by Winfield, leaving us with an even stronger balance sheet.

Now, let me provide a few more details on our Danya integration, as shown on slide four. We acquired the company just three months ago and since that time, the leadership team and I have been incredibly focused on integrating and leveraging Danya’s core capabilities into the existing organization. Danya brought unique benefits to DLH in terms of both expertise and program vehicles, particularly with customers within the Health and Human Services Agency, the Depart of Homeland Securities and the United States Navy. We continue to believe that the acquisition will bolster our efforts to enter new territory with these clients and other DoD agencies, particularly those that are healthcare related information systems that allow us to improve health outcomes.

Danya strengthens our ability to offer healthcare and human services programs across the continuum of care and case management. Within Health and Human Services alone, via contracts such as with the Office of Head Start, Danya’s monitoring and evaluation systems are helping to ensure education and health readiness of millions of children across the nation. From an integration standpoint, we’ve had multiple groups within the Company in charge of different aspects of this undertaking from sales and marketing to finance and accounting, operations, human resources and other back office management functions. And I can say with certainty that everyone has done a terrific job, bringing all aspects of these entities together.

We’ve reshaped our business development team to an account management and agency focused operation aligned with our strategic growth goals. This has been very important. We will provide more color around the strategic growth game plan at the upcoming Annual Canaccord Genuity Growth Conference in Boston later this month. We have since issued a press release with further details regarding that conference.

Thus far, we’re very pleased with how everything is proceeding in terms of servicing our customers and targeting key clients and new business opportunities, which have turned out to be very substantial. At the same time, we’ve addressed the back office integration where beneficial of finance, accounting, human resources, purchasing and other administrative functions. And Kathryn’s team has done a tremendous job analyzing all areas of the combined organization for ways to further streamline our processes and efficiencies. We’ve already provided the street with pro forma financials which benefit both our investors as well as our internal performance benchmarking. We’re also looking at our office footprint to see if any savings income from further consolidation of spaces, among many of which -- although many of our employees are taking advantage of our telecommute policies.

Most importantly, when all is said and done our customers have not seen any disruptions at all from this transaction. We want all of our existing clients to know that the excellent service they’ve been receiving is not going to change and we don’t want any hiccups in terms of client interface of any nature whether it would be for services, sales or billing. So, we are very happy with all that has taken place thus far and feel confident that this transformational acquisition will continue to prove to be an excellent strategic fit within DLH. Then this transaction accelerates our expansion into key federal agencies and drives shareholder value through the use of more complex, higher-margin mission critical programs and services, again a key part of our growth game plan.

I believe that the new DLH is in great shape to further top line growth and performance improvement, heading into 2017.

I now would 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?

Kathryn Johnbull

Thank you, Zach and good morning, everyone. We’re pleased to report another quarter of improved financial results.

Turning to slide five, our third quarter was one that as Zach mentioned, underscored our commitment to growth, higher margins, solid cash flow and a strengthened balance sheet. With Danya now under our belt, we’ve seen the improved operating performance we anticipated and we are looking at an increased number of potential RFP opportunities, all while maintaining cost discipline, paying down debt and ensuring that DLH has the financial flexibility to invest in the future and pursue our strategic growth plans.

Now, let me get into the details, starting with slide six. Revenue for the three months ended June 30th was $25 million, which represents an increase of $8.2 million or 49% over the prior year period. The higher revenue was primarily due to the inclusion of Danya from the May 3rd acquisition date forward, as well as from growth across our existing contract vehicles. Revenue expanded 5% organically over 2015 and our backlog remains solid. As Zach mentioned, we are uniquely positioned for further growth across a number of important agencies including Health and Human Services, DoD and the VA. We believe these agencies provide a firm foundation for further top line expansion and will enable us to broaden the number of contract vehicles we serve.

Now turning to gross profit on slide seven. This quarter, the Company posted total gross profit of approximately $5.5 million, an increase of $2.4 million or 80% versus 2015. This reflects both our higher revenue and improved contract performance. As a percent of our revenue, our third quarter gross margin was 21.8%, which was an increase of 370 basis points over the comparable period last year. This significant margin expansion was due to the contribution from Danya, as well as reflecting a mix of more complex high-value contracts and effective cost management. The Company continues to focus on internal productivity measures to control expenses and expand gross margins.

Turning to slide eight, income from operations was $1.7 million for the fiscal 2016 third quarter, an increase of approximately $0.9 million or 119% over the prior year period. The improvement here again reflects the inclusion of Danya as well as expansion across a number of our existing licensing programs. Within operating income, our G&A expenses were approximately $3.4 million this quarter versus $2.3 million a year ago. This 49% increase was largely due to the addition of Danya. However, G&A as a percent of revenue was approximately 13.5% this year, essentially unchanged from the third quarter last year. We continue to keep a lid on overhead expenses even while investing for the future and seeing a substantial growth in the Company’s base of business.

Below operating income, we had net other expenses which totaled $0.4 million this quarter including non-operational acquisition expenses, interest expense and amortization of deferred financing costs on debt obligations.

We reported net income for the three months ended June 30th of approximately $0.8 million or $0.07 per diluted share, an increase of approximately $0.3 million or $0.03 per share versus the prior year period. This increase was due primarily to the operating contributions from Danya offset by acquisition expenses, interest and the amortization of deferred financing costs. For the third quarter, DLH recorded a $0.5 million provision for taxes compared to taxes of $0.3 million in 2015.

Now turning to slide nine, I’d like to review our adjusted EBITDA. On a non-GAAP basis, adjusted EBITDA for the three months ended June 30, 2016 was approximately $2.1 million, an improvement of approximately $1.3 million or 153% over the prior year period. In addition, adjusted EBITDA as a percent of revenue was 8.5% compared to 5% in the third quarter of fiscal 2015, resulting from the items I previously described. Our definition of adjusted EBITDA along with descriptions regarding their use and rationale are in our earnings statement.

Slide 10 shows our liquidity position, and here again, we’re very pleased with where things stand. We ended the quarter with $2.8 million in cash on hand and approximately $6 million available under our $10 million revolving credit facility, having nearly paid off our $5 million revolver draw that we made to fund the Danya acquisition. In the coming weeks and quarters, we expect to continue building working capital in support of planned growth.

So, once again, we’re very pleased with the results of our operations and progress made to-date in integrating Danya into the DLH family. But certainly, we’re not going to rest on our laurels we’re committed to doing everything possible to utilize the new larger organizations to expand our business base, secure new contracts, and accelerate growth going forward. At the same time, we remain focused on strengthening the balance sheet and driving cash flow to reduce our leverage.

We believe the future looks brighter than ever; and with the approach for fiscal 2017, we will have a more nimble innovative Company, well-positioned to take advantage of federal funding trends and budget priorities as the new administration takes office. We feel confident that our credentials, capabilities and relationships will deliver improved results into next year and beyond.

So, 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.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Howard Brous of Wunderlich Securities. Your line is open.

Howard Brous

Zach, Kathryn, congratulations on a great quarter, particularly in paying down as much as the debt that you did; no question that’s really heroic. Couple of questions, one, backlog, you mentioned backlog; I didn’t see it in release. What is the backlog as of today?

Kathryn Johnbull

Well, formally update backlog on an annual basis, but obviously our backlog has historically been very strong. And with the addition of Danya, as we just closed, at the transaction date, we had a backlog of consolidated in excess of $300 million. So, thinking about that in terms of the multiple of annual sales, you can see that we’re 2 to 3 times annual revenues.

Howard Brous

I have a one tangential question and let me get to the some other weekly data. [Ph] Medical device testing, can you be a little bit more specific about what that is?

Zach Parker

Yes, would be happy to. We are in support right now to -- it’s really all services, but the medical logistics community is kind of centered around an army organization referred to as USAMMA, which is based Fort Detrick, Maryland. The role we provide there is provide research and development as well as test and evaluation of next generation medical devices that are going to be used primarily in theatre. So, think of it in terms of enhancing the readiness posture of our troops that are in Afghanistan, in various places throughout that particular AOR where those fight. So, our role is one where we of course have to sign non-disclosures because we cannot be one of those product vendors but we on behalf of the army will move the technology readiness level throughout the acquisition cycle, so that we are testing some and many fall out and do not move further but will help those product vendors and think tanks to move certain items all the way through up to including being able to fill them in theatre. So, it’s a very, very high-end type of work and one that we find very socially redeeming.

Howard Brous

Thank you. That’s extremely important. G&A for 2017, can I expect some improvement over what we’ve seen certainly in this quarter, as a percentage of sales?

Kathryn Johnbull

Well, I think 13% of sales is a pretty competitive number already but definitely and as you know from our trend, we certainly look at G&A, not so much with the view of driving down that percent but more so with a view of redistributing the G&A costs away from fixed infrastructure kind of things and away towards business development, which also goes in G&A. So from our perspective, a dollar spent is best in growing the business. And so we work as aggressively as we can to really allocate the distribution in G&A costs.

Howard Brous

So, let me sort of ask it little bit differently. Looking at the gross margins, can I expect an expansion of gross margins for 2017 and if you will, 2018?

Zach Parker

Well, I can tell you that that is certainly consistent with our strategic plan. And of course we’ve been very successful over the course of last couple of years in moving that north. As we are developing -- you heard me mention it a little bit earlier, we’re reshaping substantially our new business pipeline. And we will be providing more color later this month in Boston at the Canaccord Genuity Conference. But we are targeting and particularly those type of opportunities and those partnerships with certain clients that will allow us to continue to move up that margin profile. So that is certainly the majority of our new business pipeline, as we enjoy that where we’re focused around and that’s continuing to build on that higher margin business, which basically comes as a function of our ability to leverage our tools and technologies as part of our service offerings.

Howard Brous

Last question, when is the Q going to be out?

Kathryn Johnbull

Early next week, I am targeting Tuesday.

Operator

[Operator Instructions] Our next question comes from Mark Jordan of Noble Financial. Your line is open.

Ben Klieve

Actually this is Ben Klieve with Noble stepping in for Mark right now, but good morning to you both. I have a couple of questions that I actually build out off of Howard’s points. First of all, regarding margins, I know before the -- or I guess after Danya acquisition that you’d targeted margin improvement from Danya’s historic operations. And I am just wondering how much further improvement just from the Danya perspective do you think there is in terms of both, growth and EBITDA margin going forward?

Zach Parker

Part of what -- part of that is going to be a result of our completing our implementation of the integration to work. We can see what we, as Kathryn alluded to a few items that we think we’re able to have some takeouts and operate a little more efficiently. As you might imagine, of course consistent with our industry, as companies evolve from a small business as they have over the recent years to moving into the mid-tier company environment, there needs to be certain types of shifts with types of costs and types of services and structures to be more competitive. And we’re actually actively involved in that, and we’ll know more about that as we start to move towards completion of several of our integrations.

But having said that, most of us including Kathryn, and I’ve had lot of experience in this business and certainly understand where the benchmark and our peers are. And we feel very, very confident that we will be able to continue the trajectory of moving that largest book of business right now and to continue to move down a more favorable path with regard to what we can take out of it. Kathryn, do you want to add anything?

Kathryn Johnbull

Well, that’s right. I mean, we’ve consistently said that our target is to be at the gross margin level in the 20 to 25ish range is our near term target. And we saw our self getting there by continuing to improve the heritage business which we think we have pretty much going out of that; we’ve sort of gotten that optimized. But also adding in acquisitions that were more in those value -- higher value margin deliveries, and then finally of course the pursuing business development opportunities that were more consistent with that margin target as well. So, you are seeing the impact from both -- all of those factors so far. But we view the incremental revenue growth we are going to have obviously more consistent with that goal. So, we expect over time that composite margins continue to move up closer to the mid 20s I would say, somewhere in the 23% to 24% is where we are targeting in the short run.

Ben Klieve

Got it, perfect. Thanks Kathryn. And then, my second and final question is regards to debt level. I’d like to first of all agree with Howard that the debt right now -- and it’s pretty impressive to seek that this quickly. And just kind of curious what you forecast for near-term debt reduction besides the -- beyond the elimination of the bridge loan. I mean, where can we really forecast debt levels going into next fiscal year?

Kathryn Johnbull

Well, yes. So, don’t program [ph] $4.5 million every quarter. Yes.

Ben Klieve

Fair enough.

Kathryn Johnbull

But of course, we would now, post the quarter close, we completely extinguish the revolver. So, anything we did on the term debt and debt reduction here would be early repayments, which as we are in growth mode, we would be careful about doing. But there are provisions of our loan agreement that mostly get out outside of fiscal 2017, do have provisions for excess cash flow suite. And it is a -- one of the benefits of this business is that it’s extremely cash flow positive. So, I do expect those excess cash flow suites to kick in. And so beyond the schedule, the term -- loan reductions of about $3.8 million a year, I do expect that we will have some excess cash flow suites kicking in. And we’re certainly not expecting that it’s going to take us the entire five-year term to extinguish that term debt.

Zach Parker

And we are very committed to extinguishing as early as practical. I can tell you that Kathryn and I met just last week with the leadership within our bank with the folks and the spirit of partnership to continue and the type of growth that we are doing both organically and particularly acquisitively is still something as part of our strategic plan. And we are going to do we need to do on the books to make sure that we can continue to leverage every aspect of our assets.

Operator

Our next question comes from Marlon Dorsey of MWD Associates. Your line is open.

Marlon Dorsey

First of all, congratulations on the successful acquisition of Danya and your positive trend line for the last quarter here. And Zach, I guess my question is you had mentioned about rights offering as far as paying down the debt, if I’m not mistaken, and I just wanted to get some idea of what the price would be and what effect do you anticipate that offering to have on your price, going forward?

Zach Parker

Great question, Marlon. I appreciate that. Let me give -- provide though that we do not give -- of course our expertise is not the market and the stock price, and so obviously we don’t give advice in that regard. But we will certainly comment with regard to what we believe we’ll see. First of all, the price is set at $3.73; that represents parity between our current shareholders and what we had for the seller or the new shareholders at the time of closing, as part of the deal. We are committed both contractually and spirit to accomplishing that at that level. And it is the equivalent of this equity being put in at closing which of course was our goal that was always impacted somewhat by timing. But to answer your question,, in the long run, we have seen and it’s been purposeful for us that most DLH investors, in particular institutions, had bought based upon fundamentals and results, which is you all are observing today. Our trajectory we think has reflected that. And as we continue to post AR, our Qs and news, we expect that the trajectory that we’ve been on up late, will certainly bear out and the price should reflect that. So, we’re really quite optimistic in that regard.

Marlon Dorsey

And I guess I got a second question, and you had mentioned that. I think the VA is 50% of your business. And do you anticipate that to change going forward in a positive way, maybe due to the Danya acquisition or will you be looking more towards the private market to expand? Can you touch on that a little bit?

Zach Parker

I’d be happy to. We are still laser focused on federal government space. And while there from time to time become some commercial opportunities and to a lesser some state and local, we’re really built to compete favorably in the federal space. The VA and DoD are, as you indicated, north of 50% of our business base today. We have really, really great traction with those customers. As you know, our mail order pharmacy customer for instance is -- which has been a really good partnership for us, has continued to exhibit strong performance success with the veterans achieving JD Power awards for customer satisfaction again in the recent years.

We think we can build up on that. There is still a fair amount of business that we consider addressable within the VHA or the Veterans Health Administration as well as the Veterans Benefits Administration, much of which tracks very closely to some of the goals we’ve acquired in Danya and some of the qualifications that we have recently built within DLH Solutions. So we’re’ really excited that there is a great opportunity to expand our business with the VA and DoD, more so into the higher margin type of business than the trades business that has been part of our heritage business. So, we’re going to continue to move in that direction. And then of course Danya opens the door substantially across the HHS family of agencies including the Central for Disease Control. And we think that our public health and life sciences market focus area offers really great opportunities too. So, we’ve got some of diversification within the federal space which comes with Danya but we’re going think -- pretty much stay laser focused around on the federal agencies.

Operator

[Operator Instructions] Our next question is a follow-up from Howard Brous from Wunderlich Securities. Your line is open.

Howard Brous

In following up the August 26, 2015 overview in Chicago, one of those things that I kept referring to still do is not just the Danya acquisition but obviously using the stock, hopefully higher prices as the Company performs, there are then avenues or areas of interest on our ongoing basis. Is that a fair statements to make?

Zach Parker

That is a fair statement. Yes, sir.

Howard Brous

As would obviously circle around the existing areas or was that the still government area but so focused in -- or concentrated in the DoD or VA?

Zach Parker

Sure. As you saw on the [Multiple Speakers]

Kathryn Johnbull

Yes. In federal government and in healthcare, right, so not -- certainly to include VA and DoD but not limited to those.

Zach Parker

Right. As I think I know which one you are referring to on our growth game plan, we did -- we were pretty specific with regard to the agencies we wanted to expand in, because notice HHS and CDC, we’re on that agenda as couple of years ago. Danya really accelerates our expansion in that area substantially. So, it is wholly consistent with that strategic plan on our growth, it’s a very-very nice package. It accelerates us not only in terms of getting into that agency but in a big way really accelerates our strategic plan with regard to the type of financials that we expect to come with that as well. But that is -- but we are not abandoning that Howard. That strategy is still very germane. And to first part of your question, we are -- Kathryn is entertaining some limited deal flow every month of opportunities. We are going to continue to look at them and at the right time, we think we’re certainly going to be ready to reload.

Operator

Our next question comes from [Burton Osterweis of Osterweis Business]. [Ph] Your line is open.

Unidentified Analyst

I had three questions, I’ll just read them off quickly. The first one is can you please tell me what’s the interest rate and terms are of that $25 million loan? And then also, when we might be able to purchase through the rights offering, when that will be ready? And then, the third question is kind more strategic question on after the debt is down, would we be any closer to issuing [indiscernible] or we would be looking to make the next acquisition.

Kathryn Johnbull

Let me go through those in order. So, the terms of the $25 million term debt are, it’s LIBOR plus 3, so that runs around [Indiscernible]. As for typical covenants including a couple of financial covenants, and those are discussed in greater detail in the 8-K, but it’s a funded debt to EBITDA and then a fixed charge coverage ratio, so very traditional covenants, which of course we’re fully compliant. Repayment schedule is 15% amortization in years one through -- each of years one through four and then a balloon at the end. So, I think a very generous amortization schedule, although, as I mentioned earlier, there is an excess cash flow suite tied to it as well. So, does that give you what you need on the term debt?

Unidentified Analyst

Yes, thanks.

Kathryn Johnbull

The rights offering, the expectation is that when we do that and as you probably saw file a preliminary S3 on July 1st and we expect to update that within the next week, and it’ll go effective.

Unidentified Analyst

Okay, thank you.

Kathryn Johnbull

Okay. And then, finally, in terms of once the debt is paid off, which is next, of course our interest is in growing the Company. And so from that perspective, we are certainly bias towards capital preservation to support that growth.

Unidentified Analyst

Is it possible that issuing next dividend would raise cost compressions [ph] to have more purchasing power?

Zach Parker

Yes.

Kathryn Johnbull

Quite possibly, so. And obviously that’s a matter that we do review in tandem with the Board. So, we’re looking at that as an alternative, but you clearly are getting the flavor of growth, capital requirements for growth as well.

Operator

There are no further questions. At this time, I’d like to turn the call back over to Zach Parker, President and CEO, for closing remarks.

Zach Parker

I just want to again thank everyone for participating. We’re really pleased with the results of our operations and the progress we’ve made on integrating Danya into the DLH family. We certainly won’t rest on our laurels, we are as you heard, very committed to doing everything possible to utilize new larger organization to expand our business base, secure new contracts and accelerate the growth going forward. At the same time, we remain focused on strengthening the balance sheet and driving cash flow to reduce our leverage going forward.

We believe the future looks brighter than ever, and with the approach that we’ve taken for fiscal 2017, we will be even more nimble, innovative Company, well-positioned to take advantage of the federal spending trends and budget priorities as the new administration takes office. We feel very confident that our credentials, capabilities, and relationships will deliver improved results into the next year and beyond.

That concludes my discussion of the financial statements. And with that, we’ll look forward to hearing from you for our next Q4. Bye for now.

Operator

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.

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