DLH Holdings Corp. — FY2016 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended September 30, 2016; it is not a standalone quarterly filing. DLH provides healthcare, human services, and related technology-enabled services to U.S. government agencies. On May 3, 2016, it acquired Danya International, expanding its services and customer base. The company reported more than 1,400 employees across more than 30 U.S. locations.
All revenue came from federal agencies. The VA accounted for approximately 72% of FY2016 revenue, down from 95% in FY2015; HHS accounted for 13% after the Danya acquisition. Management describes the current business mix as approximately 55% defense and veterans’ health, 40% human services, and 5% public health and life sciences.
Financial performance and liquidity
| Metric | FY2016 | FY2015 |
|---|---|---|
| Revenue | $85.6 million | $65.3 million |
| Gross margin | $17.8 million; 20.8% | $11.7 million; 17.9% |
| Operating income | $4.1 million; 4.7% of revenue | $2.5 million; 3.8% of revenue |
| Income before taxes | $2.4 million | $3.2 million |
| Net income | $3.4 million; $0.34 basic and $0.30 diluted EPS | $8.7 million; $0.91 basic and $0.87 diluted EPS |
| Cash from operating activities | $6.0 million | $2.0 million |
| Cash and cash equivalents at year-end | $3.4 million | $5.6 million |
Revenue increased 31.0% year over year: $16.7 million was attributed to Danya from its acquisition date and $3.5 million to organic growth (5.4%). Direct expenses were 79.2% of revenue versus 82.1%, supporting higher gross margin. G&A rose 37.0% to $12.5 million, principally reflecting Danya and additional resources. D&A increased to $1.2 million, largely from acquired intangible amortization.
Despite higher operating income, net income declined because other income/expense shifted to $1.6 million of expense from $0.7 million of income, and the income tax benefit fell to $0.9 million from $5.5 million. FY2016 other expense included $0.8 million of acquisition costs, interest expense, and financing-cost amortization. Both periods’ tax benefits were principally related to releases of deferred-tax valuation allowances; the larger FY2015 benefit materially boosted prior-year net income. Adjusted EBITDA, a company-defined non-GAAP measure, was $5.8 million, up 90.6% from $3.0 million.
FY2016 cash flow included $32.7 million used in investing, principally for the Danya acquisition, and $24.6 million provided by financing. Cash declined by $2.1 million during the year. At September 30, 2016, gross term-loan principal was $23.4 million; the balance-sheet carrying amount was $22.2 million after unamortized issuance costs. The loan bears interest at LIBOR plus 3.0% (3.5% at year-end) and matures in 2021. The revolver had no outstanding balance, with $4.1 million unused capacity available based on eligible receivables; a $0.9 million standby letter of credit also used capacity. The $2.5 million related-party subordinated loan was repaid using rights-offering proceeds.
Working capital was negative $3.9 million. Management said cash, eligible receivables-based revolver availability, and planned operating cash flow should support operations for 12 months from the financial-statement date. DLH reported compliance with its debt covenants. Total backlog was approximately $233 million, comprising $95 million funded and $138 million unfunded; backlog is not a guarantee of future revenue.
FY2016 fourth quarter: Revenue was $27.1 million, gross margin $6.2 million, operating income $1.3 million, and net income $2.4 million, including a $1.6 million income-tax benefit. FY2015 fourth-quarter net income was $8.2 million, substantially influenced by a large tax benefit and favorable resolution of a legacy payroll-tax matter.
Outlook, risks, and unusual items
- Outlook: The filing provides no specific company revenue or earnings guidance. Management said the FY2017 continuing resolution was not expected to materially affect the current business base, but funding delays could postpone new awards. The resolution included full-year FY2017 VA funding and otherwise generally maintained FY2016 spending levels, with an across-the-board reduction.
- Growth strategy: DLH intended to pursue organic growth and consider further acquisitions or joint ventures. Management identified behavioral health, telehealth, health IT, program management, and human services as opportunity areas. Small-business set-asides on VA’s T4NG vehicle had affected planned expansion through that vehicle.
- Customer and contract concentration: Dependence on federal contracting, particularly the VA and HHS, exposes DLH to budget changes, procurement delays, contract competition, protests, non-renewals, and government termination rights. VA and HHS awards generally had one-to-four-year performance periods.
- Debt and acquisition risks: The secured loan includes financial covenants, restrictions, scheduled payments, and excess-cash-flow prepayments. Failure to meet covenants or integrate Danya effectively could adversely affect results and liquidity. Danya purchase-price allocations were provisional, and acquired goodwill and intangible assets are subject to valuation and impairment risk.
- Other risks and contingencies: The filing identifies staffing, subcontractor performance, government compliance audits, cybersecurity, insurance and workers’ compensation costs, and dependence on key personnel as risks. Management reported no known pending or threatened litigation expected to have a material adverse effect. No goodwill impairment was recorded in FY2016; up to $42.3 million of goodwill was on the balance sheet.
- Tax and capital matters: U.S. tax net operating losses were approximately $36 million and begin expiring in 2021. The filing warns future tax expense may be higher following valuation-allowance releases. A September 2016 rights offering raised approximately $2.5 million to repay the subordinated loan. DLH paid no common-stock dividend and stated no foreseeable plan to do so.
Important facts for investors to verify
- Reconcile acquisition-related growth and Danya’s contribution with subsequent reported revenue, margins, and cash generation.
- Track VA and HHS revenue concentration, contract renewals, funded backlog conversion, and the distinction between funded and unfunded backlog.
- Review debt amortization, covenant headroom, cash-flow prepayments, and actual borrowing availability under the receivables-based revolver.
- Assess the sustainability of operating cash flow and profitability after acquisition costs, acquired-intangible amortization, and tax benefits.
- Monitor final Danya purchase-price allocation, goodwill impairment indicators, and utilization of tax-loss carryforwards.