DLH Holdings Corp. annual report, FY2011

Business context and reporting period

TeamStaff, Inc. (the operating business now called DLH Solutions, Inc.) filed this Form 10-K for the fiscal year ended September 30, 2011, including fourth-quarter results. The parent proposed changing its name to DLH Holdings Corp.; shareholder approval was still pending. The company focused on federal-government healthcare, logistics and technical services, and contingency/staff augmentation. The former commercial staffing business had been sold in 2010.

Financial performance and position

Revenue rose 2.6%. Gross margin improved as direct expenses declined to 85.9% of revenue from 88.2%, which management attributed largely to better project management and lower workers’ compensation costs. SG&A was $7.425 million, approximately flat year over year. The $2.583 million non-cash trademark impairment contributed to the annual loss; the company reported EBITDA of $(1.527) million, an improvement from $(2.878) million.

In Q4 FY 2011, revenue was $10.325 million and gross profit was $1.559 million; operating and net losses were each $3.592 million and $3.660 million, respectively. The quarter included the $2.6 million trademark write-off, about $0.6 million of strategic legal fees, and substantial stock-option expense.

At September 30, 2011, total assets were $21.917 million, total liabilities $16.363 million, shareholders’ equity $5.554 million, and working-capital deficit approximately $3.6 million. The company had $11.112 million in accounts receivable, including a $9.3 million unbilled DVA receivable relating to retroactive contract billings. Bank borrowings were $0.740 million, with $0.316 million available under a receivables-based facility capped at $3.0 million. The balance sheet also included $0.711 million in notes payable and $0.350 million principal of convertible debentures (reported net of discounts).

Material changes versus the prior period

• Contract backlog increased to approximately $160 million from approximately $11 million at September 30, 2010, following 10 competitive contract awards. Backlog includes estimated multiyear commitments and options; it is not a guarantee of future revenue.
• The company secured a DVA pharmaceutical-services agreement with a stated maximum value of approximately $145 million over up to five years, plus a DVA medical-services award of up to approximately $10 million. Work on the pharmaceutical agreement began November 1, 2011.
• The DVA remained highly concentrated: it represented 94% of FY 2011 revenue, versus 95% in FY 2010. The federal government accounted for 100% of FY 2011 revenue.
• The company raised capital from directors, management, and its largest shareholder, and increased its secured credit facility. It also settled a legacy acquisition dispute using cash and shares, while retaining a recorded contingent obligation.
• Following the strategic rebranding, the company wrote off the $2.583 million carrying value of the TeamStaff trademark. Goodwill of $8.595 million was not impaired.

Outlook, risks, contingencies, and unusual items

Management expected available cash, operating cash flow, collections of receivables, credit availability, and cost measures to support operations for 12 months from the financial-statement date. That assessment was conditional, including on timely collection of the DVA receivable and the expected nonpayment or non-cash settlement of certain liabilities. Management cautioned that a shortfall could require spending cuts, supplier-payment extensions, asset sales, or additional financing. The filing provides no numerical earnings or revenue guidance.

• Customer and contract concentration: Loss, nonrenewal, delayed funding, or reduced scope of DVA work could materially harm results. Other DVA contracts representing close to a further 50% of FY 2011 revenue were due to expire December 31, 2011, with no solicitations yet issued at filing time.
• Liquidity and financing: Operating cash use, a working-capital deficit, limited unused borrowing availability, lender control over cash receipts, covenant/default provisions, and possible need for further capital create material financing risk. Additional equity or convertible financing could dilute shareholders.
• Receivable and billing uncertainty: The $9.3 million unbilled DVA receivable arose from retroactive billing adjustments recognized in 2008. Management expected resolution and collection in the first half of FY 2012, but the timing and outcome were uncertain; potential additional indirect costs and fees were estimated at $0.4–$0.6 million, subject to government approval.
• Other liabilities and contingencies: A $1.3 million payroll-tax liability remained under discussion with the IRS and Social Security Administration. The RS Staffing settlement carried a recorded $0.711 million obligation, with maximum remaining contingent exposure stated as up to $0.750 million. Management reported no litigation it believed likely to have a material adverse effect.
• Other risks: Federal budget and procurement changes, contract protests, government audits, competition and margin pressure, employee and malpractice claims, and potential goodwill impairment. The company had $8.595 million of goodwill; impairment testing found fair value exceeded carrying value by more than 100%, but depended on forecasts and assumptions.
• Unusual income item: FY 2011 included a $0.270 million gain from Florida escheated funds associated with former operations; it was nonrecurring.

The independent auditor issued an unqualified opinion on the financial statements. Management concluded disclosure controls and internal control over financial reporting were effective at the reasonable-assurance level; the auditor did not provide an internal-control attestation.

Important facts for investors to verify

• Whether the DVA agreements commenced as expected, were funded at anticipated levels, and replaced or extended the expiring contracts; compare actual revenue and concentration with the stated contract maximums.
• Collection, approval, and final settlement of the $9.3 million unbilled DVA receivable and any related additional fees.
• Subsequent cash generation, facility availability, covenant compliance, and the company’s ability to meet near-term obligations without further financing.
• Final IRS/payroll-tax resolution and settlement-guarantee payments, including whether the recorded amounts prove adequate.
• Actual revenue conversion from the reported backlog and task-order awards, particularly because IDIQ vehicles and options do not assure work or funding.
• Potential dilution from outstanding options, warrants, and convertible debentures, and the status of the proposed parent-company name change.