DLH Holdings Corp. — FY2017 Form 10-K
Reporting period: Fiscal year ended September 30, 2017. The filing also reports fourth-quarter results; this is an annual report, not a standalone quarterly filing.
Business context
DLH provides healthcare, human services and related professional services to U.S. government agencies. It had more than 1,400 employees at over 30 U.S. locations. All revenue came from federal agencies; approximately 95% of the business base was prime contracts.
FY2017 revenue mix was approximately 62% defense and veteran health services, 34% human services and solutions, and 4% public health and life sciences. The VA accounted for 62% of revenue, down from 72% in FY2016; HHS accounted for 34%, up from 13%.
Financial performance and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $115.7 million | $85.6 million |
| Gross margin | $25.9 million; 22.3% | $17.8 million; 20.8% |
| Operating income | $6.6 million; 5.7% of revenue | $4.1 million; 4.7% |
| Income before taxes | $5.4 million | $2.4 million |
| Net income | $3.3 million | $3.4 million |
| Diluted EPS | $0.27 | $0.30 |
| Adjusted EBITDA (non-GAAP) | $9.0 million | $5.8 million |
| Cash from operations | $6.5 million | $6.0 million |
Revenue grew 35.1%, mainly from the full-year contribution of the May 2016 Danya International acquisition ($24.7 million) and $5.4 million of expansion on existing contract vehicles. Direct expenses rose 32.5%, slower than revenue, helping lift gross margin by 150 basis points. G&A increased 39.5%, reflecting the acquisition and investment in business development and management. Net income declined slightly despite higher pretax income, as FY2016 included a $0.9 million tax benefit from a partial release of the deferred-tax-asset valuation allowance; FY2017 recorded $2.1 million of tax expense.
Fourth-quarter FY2017 revenue was $30.4 million, gross margin $7.3 million, operating income $2.1 million and net income $1.0 million; diluted EPS was $0.08.
Cash and equivalents were $4.9 million at year-end, versus $3.4 million a year earlier. Current assets were $17.4 million and current liabilities $18.5 million. The company reported $6.5 million operating cash flow, $1.3 million cash used in investing, and $3.7 million cash used in financing, including $3.75 million of net debt repayments.
Term debt was $19.7 million gross ($18.7 million net of unamortized financing costs), with $3.6 million classified as current. The $10 million revolver had no balance outstanding; reported availability was $9.3 million after a $0.6 million standby letter of credit. The company stated that it complied with debt covenants and expected cash, available credit and planned operating cash flow to support operations for 12 months from the financial-statement date.
Material changes and unusual items
- Backlog fell to approximately $167 million from $233 million. Year-end backlog comprised about $74 million funded and $93 million unfunded; backlog includes estimates and options and is not assured revenue.
- The FY2016 acquisition drove much of the revenue increase. Final purchase accounting increased acquired intangible assets by a net $9.0 million and reduced goodwill correspondingly; no goodwill impairment was recorded in FY2017. Goodwill was approximately $26.0 million.
- FY2017 included $1.8 million of deferred tax expense, compared with a $1.1 million deferred tax benefit in FY2016. The company reported U.S. NOLs of approximately $31.5 million and state NOLs of $1.8 million, with expirations beginning in 2021.
- Congress had passed tax-reform legislation after year-end, but enactment terms were not final at filing. Management estimated that a proposed 20% corporate rate could reduce the $9.6 million net deferred tax asset by $3–4 million.
Outlook, risks and contingencies
Management identified federal health and human-services programs, technology-enabled delivery and selective acquisitions as growth priorities. It expected no material effect on the FY2018 existing business base from the continuing resolution then in place, but noted that funding delays could defer new awards. The filing provided no quantified company-specific revenue or earnings guidance.
Key risks include dependence on federal contracts and concentrated VA/HHS revenue; budget and appropriation changes; competitive bids, protests and contract renewals; possible cancellation or partial funding of contracts; and the possibility that backlog does not convert to revenue. Debt service and covenants, employee recruitment and benefit costs, cybersecurity and information-system disruption, and goodwill impairment are additional risks. Management reported no pending or threatened litigation it believed reasonably likely to materially affect results, financial position or cash flows.
Management concluded that disclosure controls and internal control over financial reporting were effective at the reasonable-assurance level. The independent auditor issued an unqualified opinion on the financial statements; the auditor did not attest to internal control over financial reporting.
Important facts for investors to verify
- How much of the $167 million backlog is funded, and what contract renewals, options or task orders support its conversion to revenue?
- Whether VA and HHS funding and contract awards sustain the business given the customer concentration and changing revenue mix.
- Whether gross-margin improvement is durable and whether G&A growth moderates after acquisition-related and business-development investment.
- Debt repayment, covenant headroom, revolver availability and sensitivity to the variable LIBOR-based borrowing rate.
- The enacted tax-law effect on the deferred tax asset, future tax expense and NOL utilization.
- Potential dilution from outstanding options and warrants, and the effect of director share grants issued after year-end.