The Bowser Report Interviews DLH Holdings Management

| About: DLH Holdings (DLHC)
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DLH Holdings (NASDAQ:DLHC), formerly TeamStaff Inc, is a provider of defense, healthcare and logistics services to the Federal government. The company provides pharmaceutical delivery solutions, information technology solutions, logistics and technical services and other business needs to government agencies. Recently, the company has gone through a transformation, including rebranding itself and becoming a successful turnaround story.

On Wednesday, April 10, I had the opportunity to speak with Zach Parker (DLH's Director, President and Chief Executive Officer), Kathryn JohnBull (Treasurer, Principal Accounting Officer and Chief Financial Officer), and Adam Lowensteiner (Investor Relations representative). Below is our discussion:

Thomas: Could you begin by describing DLH's story as of late?

Zach: Just before I came on board, the shareholder community and the board of directors reached out to a couple of beltway firms to do a deep-dive analysis of the company and its targeted markets. The company had run through a long period of declining profitability even though the board and management felt like they were positioned around some good growth markets. One of those firms looked at the government side of the business, and another at the commercial side. As a result of their recommendations, the company elected to exit its commercially focused businesses, and to take a hard look at what was left on the government side of the house. The analysts then said these guys have great capabilities. They explained that the company has strong traction with current customers, but doesn't have an image or marketplace within that business area. Ultimately, they determined that with the right team in place, DLH could restore profitability and position the company for growth. Consequently, the board retained the government services business.

Thomas: So, the board and management have changed the course of the company?

Zach: Indeed. We sometimes refer to ourselves as a 40-year-old start-up company because we have made a significant change in what portions of our business we chose to exit and which we are going to invest in; what markets we are going to aggressively pursue and, of course, what leadership team and infrastructure are needed to in order to succeed.

Thomas: Was it one large factor or a number of small factors that pushed the board into leaving the commercial business behind and focus all of its capacities on government services?

Zach: It was number of things. The commercial market that the company was focusing on, which was a viable and healthy market back in the 2006 and 2007 time frame, had really kind of gone away. More importantly, TeamStaff hadn't really built any presence or brand equity with the customers it was targeting, and it would have taken a substantial investment to try and get there.

Kathryn: Also, they took into consideration that in the government space, while you're trying to build traction, you get relatively long-term contracts. You get a commitment from the customer for a 3 to 5 year contract, which you typically are not going to get in the commercial space. And, government contract terms are very well defined; the payment is good; the cash flow is good. So, in terms of picking the better prospect, government services won out.

Zach: That's a good point. Throughout my interview process I was looking for our brand equity within the government space, and I found that it was not very strong. The company had great performance capabilities and great references in terms of how well we were doing. So, we knew we had some great core competencies and that we delivered performance-wise, but just had not gotten the word out very well on who TeamStaff was in the government technical services space. So, we had great qualifications that we could build upon.

Thomas: Could you discuss more the qualifications that you refer to?

Zach: Those qualifications are, from a healthcare perspective, strong within the pharmaceutical market, particularly in the mail order component, and strong within supply chain and inventory management particularly within the healthcare segment. I feel that DLH can leverage those qualifications not only within the Veteran Affairs community, but through other agencies as well. I think that we could become very successful within adjacent markets; the Army in particular, the Navy, and other civilian agencies.

Thomas: What is the company looking towards as far as a growth plan is concerned?

Zach: We realize that DLH can't flip the switch in one quarter. So, management laid out a strategic plan -- a 3 to 5 year plan -- in late 2010 and early 2011. We very quickly made the decision that we were going to rebrand the company because the staffing company connotation was hurting us. We also looked to exit more short-term contracts to position DLH for more longer-term contracts. We believed that building a healthy contract backlog would allow the company to have the runway to carry out the rest of the strategy.

Thomas: Can you discuss more in depth the current backlog situation?

Zach: When you look at companies like ourselves for the overall financial health, you look at what do they have in terms of a backlog of contracts. Are they successful in winning long-term contracts that have really given them some good lift? In our case, with Veterans' Affairs, we were successful in winning 7 out of 7 bids -- each 5 year contracts. We went from a company that could only foresee about $10 million to $11 million in contract revenues per year to closing the latest fiscal year with $153 million in contract backlog, which is 3 times our annualized revenues. That allowed the company to attract the management team that we needed. It also allowed us to begin to knock down some high structural costs and to turn working capital towards strategic growth.

Thomas: How will this backlog contribute to overall growth?

Zach: Our goal is not just growth, but sustainable and profitable growth from contracts. The sustainable part is derived from the types of businesses that we are pursuing, which now gives us 3 to 5 years of business base. The profitable part comes from our ability to differentiate ourselves from some of the low-bidding competitors .

Thomas: What areas is DLH looking to expand into?

Zach: DLH is leveraging what it does in the pharmacy area and the medical professionals arena heavily into the Army. The Army seems to buy services similar to those that DLH offers. We have begun to establish our brand with the Army's decision makers in key locations. In the logistics and other technical services there are a couple of Navy contracts that will start to compete new business in DLH's area later this year, once the budget issues are resolved.

Thomas: When does the company expect to get involved with these upcoming contracts?

Zach: We expect to be bidding on these contracts within the next six months, with a few bids going out the door as we speak. But the funding won't come into play until early 2014.

Thomas: Speaking of funding, can you talk a little about the expected effects that DLH will face from sequestration?

Kathryn: Fortunately, our primary customer base is Veteran Affairs and there is bipartisan support for insulating that agency from any impacts of sequestration. So, for DLH's current book of business, we are very secure. Where the company really sees sequestration's effects is the clog that it creates around awarding new work. So, it will slow growth, but we expect that the company will still be able to grow year-over-year. While DLH is waiting out the congestion, we are all about establishing profitability within the current book of business and rightsizing operations. That is yielding very promising results. The company did post positive adjusted EBITDA by the skinniest of margins in the most recent quarter.

Thomas: So, you expect to continue to grow DLH margins?

Zach: That's correct. Part of it is that we are trying to be selective on the deals that the company pursues. We want to pursue deals where we can leverage DLH's value as much as we can, not having to get into those lower, margin-shrinking businesses that the government can drive bidders into. As such, the company won 3 IDIQ contracts with the Air Force in 2011. After we won those contracts, the Air Force came out and said that, as tasks are bid under those contracts, they are only to go with the low bidders, and they expect margins to be in the low single digits. So we are not bidding any of those jobs now. We aren't going to do much of that type of business. It would not be consistent with our strategic plan nor our communication to the shareholder community.

Thomas: In terms of bidding, DLH bids based on value?

Zach: Correct. The company has some tools that it has developed and we will continue to reinvest into the business. That is how we have been able to improve the margins.

Thomas: Do you have anything else that you would like to add?

Zach: We think this a very bright story. Every indication is that the company is still undervalued. The government services sector has been suppressed as far as stock valuations go, but clearly one of the things that DLH continues to emphasize is the health IT space, which is one of the highest valued components of the federal government. So, we see the business as protected by both sides of the aisle with solid funding for the future.

Kathryn: There has been a lot of news coverage lately about the unfortunate backlog benefits cases in Veterans' Benefits Administration, but it is important to understand that DLH does not currently operate within that space. DLH is on the Veterans' Health Administration side of the Department. So, while we are looking at this as possibly an opportunity to contribute to the benefits management solution, the company is not part of the problem. Also, in JD Powers' ranking of mail order pharmacy distributors -- where we currently provide support to the Department of Veterans' Affairs centers -- DLH has ranked at the top of the peer group year after year, including 2012.

Adam: One thing that I would like to add is that the management team has been a strong supporter of the stock in the open market. Most recently, both Zach and Kathryn purchased 50,000 shares each at $1. Throughout the turnaround process, the board of directors and management team have been key supporters of the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Companies discussed in this article may involve previous Bowser Companies of the Month. The discussions are the opinions of Thomas Rice and are not related to The Bowser Report's past, present or future recommendations.