DLH Holdings Corp. — Form 10-Q, Quarter Ended June 30, 2016
Business context and reporting period
DLH provides healthcare, human-services, and related technology services to U.S. government agencies. The filing covers the fiscal third quarter and first nine months of fiscal 2016. On May 3, 2016, DLH acquired Danya International, a provider of technology-enabled program management, consulting, and digital communications services. Danya’s results are included from the acquisition date.
Financial results and liquidity
| Metric | Three months ended June 30 | Nine months ended June 30 |
|---|---|---|
| Revenue, 2016 / 2015 | $25.0M / $16.8M | $58.5M / $48.4M |
| Gross margin, 2016 / 2015 | $5.5M / $3.0M; 21.8% / 18.1% of revenue | $11.6M / $8.3M; 19.8% / 17.2% of revenue |
| Operating income, 2016 / 2015 | $1.7M / $0.8M | $2.7M / $1.5M |
| Net income, 2016 / 2015 | $0.8M / $0.4M | $1.0M / $0.5M |
| Diluted EPS, 2016 / 2015 | $0.07 / $0.04 | $0.09 / $0.05 |
Revenue grew 48.9% in the quarter and 20.9% year to date, primarily reflecting Danya and growth on existing contracts. Management cited improved contract performance, cost management, and Danya’s contribution for higher gross margins. Adjusted EBITDA, a non-GAAP measure, was $2.1M for the quarter and $3.6M year to date, versus $0.8M and $2.0M, respectively.
For the nine months, operating cash flow was $3.4M. Investing cash flow was negative $32.7M, mainly due to the acquisition; financing cash flow was positive $26.6M. Cash declined $2.7M to $2.8M. At June 30, current assets were $12.4M and current liabilities $16.0M, producing a $3.6M working-capital deficit. Debt obligations had a $26.5M carrying value, including $24.2M net bank debt and $2.3M net subordinated debt. Revolver availability was $4.3M, subject to eligible receivables and facility conditions.
Material changes, outlook, and risks
- Danya was purchased for a preliminary $38.75M. Consideration included $30.0M in senior borrowings, $2.5M in subordinated debt, $2.5M in DLH shares, and cash. Purchase-price allocation remained provisional; reported goodwill and other intangibles increased substantially. Danya contributed approximately $7.3M revenue and $0.9M operating income after acquisition.
- Management said cash, eligible revolver capacity, and expected operating cash flow should support operations for 12 months from the financial-statement date. No specific earnings or revenue guidance was provided. DLH reported compliance with its debt covenants; the facilities include financial tests, restrictions, and excess-cash-flow prepayment requirements.
- All revenue is from federal agencies. The VA accounted for about 83% of nine-month revenue, down from 95% a year earlier; HHS represented 13%, following Danya. The VA pharmacy mail-order contract was expected to recompete for a new five-year term beginning in November 2016. Losing or materially reducing major VA or HHS work could harm results, cash flow, and financial condition.
- Wynnefield-affiliated entities, then beneficial owners of approximately 45% of DLH, provided the $2.5M subordinated loan and received warrants. The loan may mature early following an equity financing of at least $2.5M; a rights offering was underway. The filing also reports a consulting agreement with Danya’s former owner at $10,000 per month.
- Management reported no material litigation expected to adversely affect the company and stated that disclosure controls were effective. Integration of Danya into internal controls was ongoing.
Investor verification points
- Track the VA contract recompete, renewal timing, and any changes in customer concentration or contract revenue.
- Review Danya’s post-acquisition performance, integration, final purchase-price allocation, and goodwill/intangible-asset valuation.
- Monitor working capital, operating cash conversion, revolver availability, debt amortization, covenant compliance, and any required excess-cash-flow payments.
- Confirm the status and terms of the rights offering and any resulting early repayment of related-party subordinated debt.
- Reconcile reported GAAP results with Adjusted EBITDA and its exclusions, including acquisition costs, interest, and equity compensation.