Mastech Holdings, Inc. (Mastech Digital) — Q3 2015 Form 10-Q
Business context and period: The filing covers the quarter and nine months ended September 30, 2015. Mastech provides IT staffing services and reports one operating segment. Results include Hudson IT from its June 15, 2015 acquisition date.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $34.6 million | $28.6 million | $90.9 million | $85.0 million |
| Gross profit / margin | $6.9 million / 19.9% | $5.2 million / 18.3% | $17.1 million / 18.8% | $15.6 million / 18.3% |
| Operating income | $1.5 million | $1.4 million | $2.5 million | $4.3 million |
| Net income | $0.9 million | $0.9 million | $1.5 million | $2.6 million |
| Diluted EPS | $0.20 | $0.20 | $0.33 | $0.59 |
Q3 revenue rose 21%, primarily from Hudson IT; excluding the acquisition, revenue declined about 5%. Nine-month revenue rose 7%, but declined 3% excluding Hudson IT. Q3 gross margin improved 160 basis points; nine-month gross margin improved 50 basis points, reflecting higher-margin retail business and, in Q3, improved assignment margins. SG&A rose to $5.4 million in Q3 from $3.8 million, and to $14.6 million year to date from $11.3 million. Higher costs included Hudson IT’s branch operating model, technology and business-development investment, acquisition costs, acquired-intangible amortization, and $305,000 of nine-month severance expense. Nine-month operating income and net income fell despite revenue growth.
Cash flow, debt and liquidity
Operating cash flow was negative $1.0 million for the first nine months, versus positive $2.8 million in 2014, primarily due to a $3.2 million increase in operating working capital; accounts receivable and unbilled receivables used $4.9 million of cash. Investing cash flow was negative $17.1 million, including $17.0 million for Hudson IT. Financing cash flow was positive $16.2 million, largely from acquisition-related borrowings. Cash fell to $0.7 million from $2.6 million at year-end 2014.
At September 30, gross bank debt was approximately $16.3 million (including $8.5 million under the term loan and $7.8 million under the revolver); net of cash, debt was $15.6 million. Available revolving capacity was approximately $8.5 million. Current assets were $21.8 million and current liabilities $10.7 million. The company reported compliance with its credit facility covenants and believes cash, operating cash flow and available credit will fund its needs and debt service for the next 12 months. Receivables days sales outstanding were 53 days, one day higher than the prior quarter.
Material developments, outlook and risks
- Hudson IT acquisition: Completed for $17.0 million in cash and assumed net liabilities; funded with $2.0 million of cash, a $9.0 million term loan and approximately $6.0 million of revolver borrowing. Hudson contributed $7.5 million of Q3 revenue and about $0.4 million of Q3 net income. The purchase allocation included $8.4 million of goodwill and $8.6 million of identifiable intangibles.
- Business trends: Management cited solid market activity but continuing scarcity of skilled IT professionals, lower new assignment wins, and more consultants hired directly by clients, all pressuring organic billable headcount growth. Billable consultants totaled 893 at quarter-end versus 761 a year earlier, including 206 acquired and an organic decline of 74; Q3 average bill rate increased about 2% to $74.87.
- Channel and customer mix: Acquisition-driven retail growth improved channel balance and reduced customer concentration. Top ten clients accounted for 47% of Q3 revenue versus 60% a year earlier; wholesale revenue declined amid fewer integrator project assignments. Management noted that managed-service-provider cost pressures may weigh on margins.
- Outlook: No quantified revenue or earnings guidance was provided. Management said business demand is tied to U.S. economic conditions and warned that fourth-quarter holidays, vacation and year-end assignment completions can affect utilization, costs and subsequent-quarter results.
- Other matters: The company had ordinary-course lawsuits and administrative proceedings; management did not expect a material adverse effect. No material change to previously disclosed risk factors was reported. The company used foreign-currency forwards and an interest-rate swap to hedge exposures; estimated hedge losses of approximately $0.1 million were expected to be reclassified to earnings within 12 months.
Important facts for investors to verify
- Whether Hudson IT integration and its higher-cost branch model deliver the expected growth and operating efficiencies.
- Whether working-capital use, receivables growth and low cash balances improve as acquisition-related billing and collections normalize.
- Debt repayment capacity, revolver availability, covenant compliance and the effect of variable borrowing rates.
- Organic consultant counts, assignment wins, client hiring trends, bill rates and gross margins by channel.
- Acquisition-related intangible amortization, transaction and severance costs, and future goodwill or intangible-asset impairment risks.