Mastech Digital, Inc. — Q3 2017 Form 10-Q
Period: Three and nine months ended September 30, 2017; unaudited. Unless noted otherwise, financial amounts are in U.S. dollars. Mastech provides IT staffing and digital transformation services. Following its July 13 acquisition of InfoTrellis, it reports Data and Analytics Services and IT Staffing Services segments.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $39.2m | $34.3m | $107.4m | $99.6m |
| Gross profit / margin | $8.8m / 22.5% | $6.9m / 20.1% | $22.1m / 20.6% | $19.9m / 20.0% |
| Operating income / margin | $0.2m / 0.5% | $1.6m / 4.7% | $1.6m / 1.5% | $3.4m / 3.4% |
| Net income (loss) | ($0.14m) | $0.92m | $0.76m | $1.88m |
| Diluted EPS | ($0.03) | $0.21 | $0.16 | $0.42 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | ($1.6m) | ($3.7m) |
Q3 revenue increased 14.5%, largely reflecting the acquired business; IT staffing revenue rose 2.6%. Nine-month revenue increased 7.8%, including approximately 4% organic growth in IT staffing. The acquired Data and Analytics segment contributed $4.1m of revenue from the acquisition date through quarter-end, at a 44.2% gross margin; IT staffing gross margin was 20.0% for Q3 and 19.6% for the nine-month period. Consolidated margin improved, but operating income and net income fell as SG&A, acquisition costs and interest expense increased.
Q3 SG&A was $8.6m, including $1.7m of acquisition transaction costs. Nine-month SG&A was $20.5m, including $2.0m of acquisition costs; acquired-intangible amortization was $1.0m for the nine-month period. The Q3 pre-tax loss was $0.24m, with a $0.10m tax benefit. Nine-month interest expense, net, was $0.65m.
Liquidity, debt and acquisition
- At September 30, cash was $3.2m, current assets $35.2m and current liabilities $16.1m (derived current ratio: approximately 2.2x).
- Debt was approximately $43.4m: $30.5m term loan and $12.9m net revolver borrowings. Net of cash, bank debt was approximately $40.3m. About $10m of revolver capacity remained available; the company reported compliance with credit-facility covenants.
- Operating cash use was $1.6m for the first nine months, reflecting working-capital investment, including increased receivables. Investing cash use was $35.6m, principally the InfoTrellis acquisition. Financing provided $39.5m, including debt borrowings and $6.0m from a private placement.
- InfoTrellis was acquired for $35.75m cash at closing, subject to a $0.93m working-capital adjustment, plus up to $19.25m of deferred, EBIT-contingent consideration. The recorded fair value of contingent consideration was $17.125m. Acquisition funding included a new $65m credit facility and a $6m stock placement to the company’s founders and majority shareholders.
Outlook, commentary and risks
- No specific financial guidance was provided. Management said demand and activity remained solid, while skilled IT-worker recruiting challenges continued; it believed cash, operating cash generation and available credit would be adequate for business needs and debt service over the next 12 months.
- Management cited Florida and Texas hurricanes and higher vacation time as factors lowering staffing utilization in Q3. Average IT staffing bill rates also declined: $72.54 per hour in Q3 2017 versus $75.29 a year earlier, and $73.90 versus $75.10 for the nine-month periods.
- Management generally expects lower utilization and higher benefit costs in Q4, and noted that MSP purchasing models may pressure staffing margins. Client concentration is material: CGI and Accenture each exceeded 10% of Q3 revenue; the top ten clients generated approximately 47% of Q3 and 48% of nine-month revenue.
- The acquisition adds integration and earnout uncertainty. Earnout amounts depend on specified EBIT targets, and the fair-value liability is remeasured each reporting period. The credit agreement pledges substantially all company assets and includes financial and other covenants.
- A 44-month interest-rate swap fixes the rate on a $15m notional amount; other borrowings remain exposed to variable rates. The company had no currency-hedging program. Management said legal proceedings were not expected to have a material adverse effect; no material change to previously disclosed risk factors was reported.
- Reported comparisons are affected by the acquisition and one-time costs. Unaudited pro forma results assuming InfoTrellis had been acquired at the start of each period show Q3 2017 revenue of $39.8m and net loss of $0.08m, versus revenue of $41.1m and net income of $2.6m in Q3 2016; nine-month revenue was $118.3m versus $117.9m, and net income was $1.5m versus $4.9m. These pro forma figures are not necessarily indicative of actual or future results.
- Disclosure controls were concluded effective, with the evaluation excluding controls related to the InfoTrellis acquisition. The filing says the new lease accounting standard was expected to materially affect financial condition and results; estimated lease obligations were approximately $3.0m.
Investor verification points
- Track InfoTrellis integration, segment growth and margins, and progress toward the EBIT thresholds governing up to $19.25m of deferred consideration.
- Reconcile reported results with acquisition transaction costs, acquired-intangible amortization and pro forma results; assess whether staffing bill rates and utilization stabilize.
- Monitor operating cash conversion, receivables and working capital, revolver availability, debt service and covenant headroom.
- Assess client concentration, recruiting capacity, hurricane or other disruption exposure, and Q4 seasonality.
- Review the detailed credit agreement, swap terms, earnout valuation assumptions and lease-accounting impact in the full filing and related exhibits.