MHH

Business Context and Reporting Period

Company: Mastech Holdings, Inc. (Mastech Digital, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2010
Business Overview: Mastech provides IT and specialized healthcare staffing services. The company operates as a single reportable segment with four sales channels: Wholesale IT, Retail IT, Specialized Healthcare, and Permanent Placements. In January 2010, the company acquired Curastat, Inc. to expand its healthcare staffing capabilities and divested its brokerage operations unit (GFS).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Trends:
  • Quarterly: Revenue increased 9.4% year-over-year (YoY) to $18.9 million, driven by a 67-consultant increase in billable IT headcount and the inclusion of the Curastat acquisition.
  • Year-to-Date (YTD): Revenue decreased 7.2% YoY to $51.5 million. This decline is attributed to the divestiture of the brokerage operations unit and lower average IT billable consultant levels in the first half of the year, despite a 95-consultant increase in headcount by period end.
• Profitability: Gross margins improved to 19.3% (Q3) and 19.6% (YTD) compared to 18.4% and 18.8% in the prior year periods. Improvements were driven by a favorable mix of higher-margin integrator clients, lower bench costs, and the removal of lower-margin brokerage operations.
• Expenses: Selling, General, and Administrative (SG&A) expenses increased as a percentage of revenue (17.5% in Q3 vs. 14.3% prior year) due to investments in sales and recruiting organizations for both IT and healthcare sectors.
• Cash Flow: Operating cash flow turned negative at ($132,000) for the nine months ended September 30, 2010, compared to positive $3.7 million in the prior year. This was primarily due to a $1.6 million increase in accounts receivable and unbilled receivables as the company expanded revenue.

Outlook, Risks, and Management Commentary

• Outlook: Management notes encouraging improvements in business activity levels during the first nine months of 2010 but cites the weak U.S. job market and high unemployment as ongoing concerns. The company expects cash from operations and existing balances to be adequate for 2010 business needs, excluding acquisitions.
• Strategic Shifts: The company is seeing a shift toward the Wholesale IT channel (system integrators), which offers higher volume but lower margins. Additionally, the increasing use of Managed Service Providers (MSPs) in the Retail channel is putting pressure on gross margins.
• Liquidity: As of September 30, 2010, the company held $5.9 million in cash and had access to a $10 million revolving credit facility with a borrowing base of $7.5 million.
• Risks:
  • Client Concentration: Two clients (IBM and TEK Systems) accounted for approximately 30% of revenue in Q3 2010. The top ten clients represented 56% of YTD revenue.
  • Economic Sensitivity: Business performance is highly correlated with general U.S. economic conditions and employment levels.
  • Legal: The company is involved in various lawsuits and administrative proceedings, though management does not expect a material adverse effect.

Investor Verification Checklist

• Client Concentration: Verify the stability of relationships with IBM and TEK Systems, which collectively represent nearly one-third of quarterly revenue.
• Working Capital Management: Monitor the Days Sales Outstanding (DSO), which increased to 49 days from 47 days the prior quarter, and its impact on future operating cash flow.
• Margin Sustainability: Assess whether the improved gross margins can be sustained given the strategic shift toward lower-margin wholesale channels and the prevalence of MSPs.
• Acquisition Integration: Review the performance of the Curastat, Inc. acquisition (purchased Jan 2010) to ensure it meets the EBITDA targets required for the contingent earn-out payment.
• Debt Covenants: Confirm compliance with the revolving credit facility terms, noting the current borrowing base of $7.5 million against total debt of $125,000.