Mastech Digital, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Mastech provides IT staffing and digital transformation services and reports one operating segment. In September 2016, it changed its name from Mastech Holdings, Inc. as part of a rebranding; its ticker remained MHH.
Financial performance
Amounts are in U.S. dollars; financial statement amounts below are in millions except per-share data.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $34.263 | $34.565 | $99.606 | $90.930 |
| Gross profit | $6.897 | $6.879 | $19.899 | $17.081 |
| Gross margin | 20.1% | 19.9% | 20.0% | 18.8% |
| Operating income | $1.594 | $1.523 | $3.393 | $2.470 |
| Net income | $0.924 | $0.887 | $1.880 | $1.464 |
| Diluted EPS | $0.21 | $0.20 | $0.42 | $0.33 |
- Q3 revenue decreased about 1%; gross profit was nearly flat. Gross margin improved 20 basis points. Q3 diluted EPS rose to $0.21 from $0.20.
- Nine-month revenue rose about 10%, primarily reflecting the June 2015 Hudson IT acquisition; management said organic revenue declined 6%, largely due to fewer billable consultants. Nine-month gross profit increased about 16%, and gross margin improved 120 basis points.
- For the nine months, SG&A was $16.5 million (16.6% of revenue), versus $14.6 million (16.1%). Excluding severance and acquisition transaction costs, management reported SG&A at 15.8% of revenue in 2016 versus 15.0% in 2015.
Cash flow, balance sheet and debt
- Operating cash flow was negative $3.712 million for the first nine months, compared with negative $0.975 million in 2015. Management attributed the 2016 outflow chiefly to a $6.8 million increase in operating working capital, including receivables and amended payment terms for major clients.
- Investing cash outflow was $0.067 million, mainly capital expenditures. Financing cash inflow was $3.669 million, including $4.874 million of net revolving-credit borrowings and $1.350 million of term-loan repayments. Cash declined $0.110 million to $0.738 million.
- At September 30, cash was $0.738 million; accounts receivable was $20.877 million and unbilled receivables were $3.512 million. Total current assets were $26.130 million and current liabilities $10.596 million.
- Total debt was approximately $16.062 million: $9.3 million drawn on the revolver and $6.8 million on the term loan. Net debt, after cash, was approximately $15.3 million. The company reported $7.7 million of unused revolver capacity and compliance with credit-facility covenants. It classified the revolver balance as long-term.
- Management said cash, operating cash flow and available credit should meet business needs and debt service for the next 12 months, excluding potential acquisitions. DSOs improved to 58 days from 59 days a quarter earlier.
Changes, outlook and risks
- Hudson IT contributed $7.9 million of Q3 revenue and $22.2 million for the nine-month period in 2016. Its acquisition increased retail-channel revenue and helped improve the year-to-date channel mix and margins. Nine-month wholesale revenue fell 6%, while retail revenue increased 47%, with the retail increase attributed to the acquisition.
- Management described activity as solid during the first nine months, but said tight supply of skilled IT professionals continued to constrain recruiting and assignment wins. At September 30, billable consultant headcount was 884 versus 893 a year earlier; Q3 average bill rate was $75.15 per hour versus $74.87.
- The company reported $0.780 million of nine-month 2016 pre-tax severance costs related to executive leadership changes; none was incurred in Q3. The comparable 2015 nine-month period included $0.305 million of severance and $0.624 million of acquisition transaction costs.
- No specific financial guidance was provided. Management cautioned that results depend on U.S. economic conditions, client prospects, skilled-labor availability and channel mix. Wholesale work generally carries lower margins; increased use of managed service providers may pressure margins. One client, CGI, accounted for 11.0% of Q3 revenue; the top ten clients accounted for 45%.
- The company had no currency hedges outstanding in 2016 and noted exposure to exchange-rate changes associated with its India recruitment operations. An interest-rate swap fixed the rate on a $5 million notional amount of term debt; its reported fair-value liability was $48,000.
- Management said ordinary-course legal matters were not expected to have a material adverse effect. No material risk-factor changes were reported. Management judged disclosure controls effective. The company expected the new lease accounting standard to materially affect consolidated financial condition and results of operations; lease commitments were approximately $3.5 million.
Key facts for investors to verify
- Whether the organic revenue decline, consultant headcount trend and recruiting constraints persisted after quarter-end.
- Whether receivables and working-capital needs continued to weigh on operating cash flow, and how collection trends developed.
- Revolver availability, borrowing-base capacity, debt balances and covenant compliance, particularly given the negative year-to-date operating cash flow.
- How sustainable the gross-margin improvement is, including the effects of channel mix, MSP pricing and wholesale revenue trends.
- The impact of Hudson IT operating costs and the one-time executive severance charges on ongoing profitability.