Mastech Digital, Inc. — 2016 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2016; filed March 24, 2017. Although the request refers to 2016 Q4, this is an annual report covering the full year, with quarterly results also disclosed. Mastech provides U.S.-focused IT staffing and digital transformation services, including Salesforce.com, SAP HANA and digital learning. It has one reportable segment.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Revenue | $132.0 million | $123.5 million |
| Gross profit / gross margin | $26.3 million / 19.9% | $23.8 million / 19.3% |
| Operating income | $4.5 million | $4.7 million |
| Net income | $2.5 million | $2.8 million |
| Diluted EPS | $0.56 | $0.62 |
| Cash from operating activities | $2.3 million | $3.0 million |
| Cash and cash equivalents at year-end | $0.8 million | $0.8 million |
| Bank debt at year-end | $9.9 million | $12.5 million |
| Operating working capital | $11.7 million | $9.9 million |
2016 revenue rose 7%, primarily reflecting a higher average consultant base, including a full year of Hudson IT, acquired in June 2015. Average hourly bill rate increased about 1% to $75.35. Gross margin improved 0.6 percentage points, while SG&A rose to $21.8 million, or 16.5% of revenue, from $19.1 million, or 15.5%. Interest expense increased to $462,000, mainly due to acquisition-related borrowing. The effective tax rate was 37.3%.
At December 31, 2016, the company reported $12 million of available borrowing capacity under its credit facility and $9.1 million of debt net of cash. It repaid $2.6 million of debt during the year. Management said operating cash flow, cash on hand and facility availability should fund organic needs over the next 12 months. DSO increased to 58 days from 53, principally after payment terms were extended for two large clients.
Fourth quarter: Revenue was $32.4 million versus $32.5 million in Q4 2015; gross profit was $6.4 million versus $6.7 million; net income was $640,000 versus $1.3 million. The filing attributes lower retail-channel gross margin performance in Q4 2016 partly to lower utilization.
Material changes versus prior periods
- Retail-channel revenue increased 29% to $52.2 million, reflecting the Hudson IT acquisition; wholesale revenue declined 4% to $79.4 million. Retail represented 40% of revenue and wholesale 60%.
- The billable consultant base reached 881 at year-end, up 35 consultants, or about 4%, organically during 2016. Approximately 20% of revenue came from digital technologies.
- Top-ten clients accounted for 44% of revenue, down from 51% in 2015. No single client exceeded 10% in 2016.
- Cash from operations declined to $2.3 million from $3.0 million, with working-capital investment contributing to the reduction. Investing cash outflow fell sharply after the prior-year Hudson IT acquisition expenditure.
- The company incurred $780,000 of severance costs in 2016, related to changes in the CEO and the Vice President of Technology and CIO. Goodwill and intangible-asset impairment testing found no impairment; estimated fair value exceeded carrying value by less than 20%.
Outlook, risks and contingencies
Management viewed job-market growth and an expanding U.S. economy as supportive heading into 2017, while warning that limited availability of skilled IT professionals would remain a recruiting challenge. It expected working-capital needs to rise if revenue grew and anticipated DSO remaining near year-end 2016 levels. No numerical revenue or earnings guidance was provided.
- Key risks include U.S. economic weakness, competition and pricing pressure, recruiting and retention constraints, and potential changes to H-1B immigration rules. About 43% of the workforce held company-sponsored H-1B permits.
- Most client contracts can be terminated without penalty. Client concentration and continued use of managed service providers may affect revenue, margins and direct client relationships; MSP arrangements have pressured margins.
- Revenue is entirely U.S.-generated, while recruitment operations in India create currency, operating and geopolitical exposure. The company chose not to hedge the Indian rupee in 2016.
- Debt is secured by substantially all company assets. The company reported compliance with credit-facility covenants at year-end. Operating-lease commitments totaled approximately $3.3 million.
- Management believed ongoing lawsuits and administrative proceedings would not materially affect financial position, results or cash flows. The filing reports no off-balance-sheet arrangements.
- The independent auditor issued an unqualified opinion on the financial statements. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor did not attest to internal-control effectiveness.
Important facts for investors to verify
- Whether organic consultant growth and recruiting capacity can sustain revenue growth despite tight skilled-labor supply.
- Whether retail-channel expansion can offset wholesale weakness without a sustained increase in operating costs.
- Whether operating cash generation improves as DSO and working-capital investment evolve, and how quickly debt is repaid.
- How client concentration, MSP pricing, and contract termination rights affect future margins and revenue stability.
- Whether goodwill and acquired intangible asset valuations remain supportable; the reported fair-value cushion was less than 20%.
- The potential effects of immigration-policy changes, Indian rupee movements, and the adoption of new lease accounting on the company’s financial position.