DLH Holdings Corp. — Q2 FY2018 Form 10-Q
Business context and reporting period. The quarter ended March 31, 2018; the six-month period is the first half of fiscal 2018. DLH provides technology-enabled health, readiness, and human-services programs to U.S. government agencies. All revenue is federal-government revenue; the VA and HHS represented approximately 63% and 33% of first-half revenue, respectively.
Financial performance
- Quarter: Revenue was $34.4 million, up 15.0% year over year, primarily from higher workload on existing contracts. Gross profit was $7.4 million, with a 21.7% gross margin. Operating income was $2.2 million; net income was $1.3 million, or $0.11 basic and $0.10 diluted per share.
- Six months: Revenue was $64.6 million, up 15.4%. Gross profit was $14.0 million and gross margin was 21.6%. Operating income was $3.4 million. GAAP net loss was $1.5 million, or $0.13 per share, mainly because of a $3.4 million discrete tax charge related to the Tax Cuts and Jobs Act. Excluding that charge, the company reported non-GAAP net income of $1.8 million, or $0.14 per diluted share.
- Costs and margins: Quarterly gross margin improved from 21.4% to 21.7%; first-half gross margin was slightly lower than the prior-year 21.8%. First-half G&A was $9.6 million, or 14.8% of revenue, versus 15.6%. Management said the current business supports a 20%–22% gross-margin range.
- Cash flow: First-half operating cash flow was $4.0 million, versus $2.5 million a year earlier. Capital spending was $0.6 million; debt repayments were $4.8 million. Cash declined $1.3 million to $3.6 million.
- Liquidity and debt: At March 31, cash was $3.6 million and current assets were $16.9 million against current liabilities of $18.2 million. Term-loan principal was $14.9 million, bearing interest at LIBOR plus 3.0%; the company reported covenant compliance. The $10 million revolver was undrawn, with $9.4 million of unused availability after a $0.6 million standby letter of credit. On May 10, 2018, its maturity was extended to May 1, 2021.
- Other metrics: Non-GAAP EBITDA was $2.8 million for the quarter and $4.4 million for the six months, up 15.5% and 26.8%, respectively. The company completed implementation of a new ERP system during the quarter.
Changes, outlook, and risks
- Revenue growth and higher gross profit lifted operating income in both the quarter and first half. First-half GAAP earnings nevertheless shifted from $1.3 million of income to a $1.5 million loss because the enacted tax-rate change reduced the carrying value of deferred tax assets; the reported deferred tax asset fell to $5.5 million.
- Management said planned operating cash flow should support operations for 12 months from issuance of the statements. It viewed the FY2018 federal budget as more stable after the Bipartisan Budget Act and did not expect budget uncertainty to materially affect the current business base during FY2018. These are management expectations, not earnings guidance.
- Key exposure is customer and contract concentration: VA and HHS together contributed about 96% of first-half revenue, and the company said losing either relationship could materially harm results, cash flows, and financial condition. Contract performance periods cited were approximately six months to two years; actual work volumes are not assured.
- Other risks include federal procurement and budget changes, VA small-business set-asides that may limit prime-contract opportunities, and contract renewal or recompete outcomes. Management reported no pending or threatened litigation it believed likely to have a material adverse effect and no material change to previously disclosed risk factors.
- The company made a $2.9 million excess-cash-flow debt payment in January and did not expect further such payments. It reported no off-balance-sheet arrangements. The new revenue-recognition standard was scheduled for adoption beginning October 1, 2018; management was evaluating its effects.
Investor verification points
- Confirm the composition and nonrecurring nature of the $3.4 million tax-related deferred-tax-asset write-down and the assumptions behind the non-GAAP adjusted earnings presentation.
- Review VA and HHS contract awards, workload levels, renewal/recompete timing, and the effect of small-business set-asides on future revenue.
- Track operating cash conversion, receivables and unbilled receivables, revolver availability, debt repayments, and compliance with loan covenants.
- Assess whether gross margins remain within management’s stated 20%–22% range and whether revenue growth continues to come from existing contract workload.
- Verify the effects of the May 2018 revolver extension and the company’s implementation of the new ERP system on liquidity and reporting controls.