Mastech Digital Inc (MHH) 2015 Q3 法說會逐字稿

Greetings and welcome to the Mastech third-quarter 2015 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Jennifer Ford Lacey, Manager of Legal Affairs. Thank you. You may begin.

Thank you, operator. And welcome to Mastech's third-quarter 2015 conference call. If you have not yet received a copy of our earnings announcement, it can be obtained from our website at www.Mastech.com.

With me on the call today are Kevin Horner, Mastech's Chief Executive Officer, and Jack Cronin, our Chief Financial Officer.

I would like to remind everyone that statements made during this call that are not historical fact are forward-looking statements. These forward-looking statements include our financial growth and liquidity projections as well as statements about our plans, strategies, intentions, and beliefs concerning our business, cash flows, costs, and the markets in which we operate. Without limiting the foregoing, the words believes, anticipates, plans, expects, and similar expressions are intended to identify certain forward-looking statements. These statements are based on information currently available to us and we assume no obligation to update these statements as circumstances change. There are risks and uncertainties that could cause actual events to differ materially from these forward-looking statements, including those listed in the Company's 2014 annual report on Form 10-K filed with the Securities and Exchange Commission and available on their website at www.SEC.gov.

Additionally, management has elected to provide non-GAAP financial measures to supplement our financial results presented on a GAAP basis. Specifically, we will provide non-GAAP net income and non-GAAP diluted earnings per share, which we believe will provide greater transparency with respect to the key metrics used by management in operating our business. Reconciliations of these non-GAAP financial measures to their comparable GAAP measures are included in our earnings announcement, which can be obtained from our website at www.Mastech.com.

As a reminder, we will not be providing guidance during this call, nor will we provide guidance in any subsequent one-on-one meetings or calls.

I will now turn the call over to Jack for a review of our third-quarter 2015 results.

thanks, Jen, and good morning. First off, I am pleased to inform everyone that our integration of the Hudson IT acquisition has progressed nicely during the third quarter. Today, we are functioning as one cohesive business with all back office and support functions firmly in place across the entire organization.

Additionally, Q3 2015 reflects the first full quarter of Hudson IT's operating results, which have benefited our year-over-year comparables. With that said, Q3 2015 revenues totaled $34.6 million compared to $28.6 million during the third quarter of 2014. Our entire revenue increase reflected the consolidation of the Hudson IT acquisition.

Activity levels were also higher than the previous quarter and reflected working Hudson's clients' needs for the fourth quarter full. Our average bill rate for the third quarter of 2015 was $74.87, which was approximately 2.4% higher than in the third quarter of 2014.

Gross profits for the third quarter of 2015 totaled $6.9 million or 19.9% of revenues compared to $5.2 million or 18.3% of revenues during the same period last year. Our gross profit dollar improvement largely reflected the additional revenue volumes. Our third-quarter 2015 gross margin percentage benefited from Hudson IT's strong retail client base, which generally carries higher margins than in the wholesale channel. However, it is important to note that when excluding the impact of Hudson IT's results on overall gross margins, we still had margin expansion of 40 basis points in Q3 2015 when compared to the corresponding quarter a year earlier. Higher margins on new assignments continue to drive this improvement in the current quarter.

GAAP net income for the third quarter of 2015 was $887,000, or $0.20 per diluted share, compared to $879,000, or $0.20 per diluted share, in the third quarter of 2014. Non-GAAP net income for the third quarter of 2015 was $1.1 million, or $0.25 per diluted share, compared to $956,000 or $0.21 per diluted share in the corresponding quarter of 2014.

Q3 SG&A expense items, not included in the non-GAAP financial measures, net of income tax benefits, were, one, amortization of acquired intangible assets; two, acquisition transaction costs; and three, stock-based compensation, all of which are detailed in our Q3 2015 earnings release.

Addressing our financial position, at September 30, 2015, we had $15.6 million of outstanding bank debt, net of cash balances on hand. Our effective interest rate on borrowings during the quarter was just under 3% per annum. Our borrowing availability at quarter end approximated $8.5 million.

Bank debt, net of cash, increased during the quarter by $2.2 million and reflected investments made in operating working capital of $3.5 million. You may recall that our acquisition of Hudson IT came exclusive of its historical working capital. In other words, the seller retained the working capital with the business. Thus, our Q3 2015 investment in operating working capital was largely attributable to the Hudson IT operations.

Our largest asset, accounts receivable, at September 30, 2015 remained of top quality. During the quarter, we successfully worked through client contract assignment matters related to our asset purchase of Hudson IT. Billing disruptions associated with these efforts had a minor impact on our days sales outstanding measurement, which increased by one day during the quarter to 53 days.

I will now turn the call over to Kevin for his comments.

Thanks, Jack, and good morning, all. As Jack mentioned, Q3 2015 is our first full quarter of Hudson IT's operating performance results consolidated into Mastech financials. I believe these consolidated results support the merits of our acquisition and clearly show the enhancements to our business in revenue, gross margin, and profitability.

Also, I continue to be pleased with the results of our initiative to improve gross margins by being more disciplined with respect to profit content on new assignments. Gross margins in the third quarter of 2015, excluding the benefits of Hudson's higher gross margin retail business, continued to improve and are now 40 basis points higher than the corresponding period last year.

What I wasn't pleased with was the decline in consultants on billing during the quarter. During the quarter, we experienced a lower than expected starts and higher than expected ends, which combined to impact our billable consultant base. Both our starts and end results have been influenced by a tightening of the supply of talented IT professionals.

Just to put some context around the marketplace for the call, TechServe Alliance reported earlier this month that they are now 4.99 million IT jobs in the United States. That is a high point for IT jobs in the history of IT jobs in the US. It is also a year-over-year increase of 195,000 IT jobs against the backdrop of less than 80,000 new IT graduates from colleges and universities in the same period. Additionally, that 5 million IT job number is roughly 1 million more IT jobs in the United States since the economic downturn in 2008 to 2010.

The bottom line for the market is there is virtually a full employment condition in the IT sector in the US economy. And this full employment condition has hit our business fairly hard this year, particularly in Q3. You have seen a higher than normal number of client hires of our consultants in 2015 as well as a higher than normal number of resignations where the employee is converting to a full-time hire somewhere else in the market.

We are continuing to adjust and train our recruiting workforce, including broadening the places our recruiters are searching for candidates and adding some US-based resource managers to assist our recruiting organization in quality candidate delivery. While we have not directly seen the payback from the investments that we have made in our recruiting organization over the past several quarters, I am confident that our recent actions, coupled with a larger scale recruiting organization, will provide the necessary skills and tools to be successful in the business longer-term.

Entering Q4, our focus will be squarely on improving our recruitment performance on the start side and addressing market driven ends issues with adjusted to client contracts and employee/employment agreements where possible.

Additionally, I am getting closer to filling our vacant Chief Revenue Officer position, which should occur in Q4 and which I believe we will have a positive influence on our prospects moving forward.

With acquisition integration largely compete complete in Q3, we will put all of our organizational efforts and energies in getting back to an organic growth focus for the combined business.

At this time, I would like to open it up for your questions.

Thank you. The floor is now open for questions. (Operator Instructions). David Polonitza, AB Value Management.

Good morning. Kevin, if you could just go over -- provide a little color with the merger and how the integration process went and your expectations versus reality now that you are about four months into combined company.

Actually, yes, that's a good question, Dave. Thanks for asking. I was concerned that we had a problem with the phone, so thanks for asking. And I will let Jack weigh in as well. I actually think we were prepared for the process to go -- if these are reasonable words -- less well than what it did. I think our consultant population moved over reasonably well. I think we ran into some, as I said already, some unexpected ends in the quarter, but that happened in both the legacy Mastech population as well as the Hudson population. So I don't believe there was anything abnormal there.

I think we have done a really good job of servicing the client base, so to my knowledge to date, we have had no client issues as a result of acquisition. And I believe our employee population, our sales and recruiting population, has transitioned reasonably well also.

So Dave, I would say the transition has really pretty well met our expectations. And I think you guys have already read through the financials of the acquisition I'm sure. We didn't over-leverage the Company in order to make acquisition. At least that is my view. I think it was a fairly conservative leverage point for the business.

So all told, when I look at the acquisition through the P&L, I am very, very pleased. And when I look at the acquisition through the balance sheet, I am very, very pleased. So I think it pretty well went the way it expected it to go.

We are in the middle of doing some of the basic logistics things that happen after an acquisition. So we have had to move some folks around from where our offices are located. We are in some new space in Chicago which is fundamentally a block from our old space. We are now into some new space in Tampa, which is a couple of blocks from our old space. And our folks in Orlando and in Boston are in their existing spaces. So, I don't think we impacted folks dramatically that way, either.

So all in all, Dave, I don't know if this is what you're looking for, but I am pretty pleased. I think the acquisition integration process that we followed is, at least at four months, I would say the process is repeatable.

Okay. Thanks. I had one more question here. So you had mentioned that there was a decline in consultants on billing in the quarter. Looking at your two business segments, whole-tail versus retail and really kind of the legacy Mastech versus what you acquired with Hudson, is there an area where the consultants on billing decline came from more -- was it more wholesale focused, retail? Just curious about that.

Yes. That is a really fair question as well. The decline was predominantly in the wholesale space, predominantly in the wholesale space.

Sure. And do you have the overall revenue breakdown between those two segments?

I do not, but, Jack, can you help me with that one?

I do have it. Give me a second. For the third quarter, the wholesale channel revenue was $21 million and the retail channel revenue was $13.4 million. And I know we had a couple hundred thousand of perm to make up the $34.6 million.

Okay. No, that is a good number. I guess that helped contribute in some fashion to your margin number, your gross margin number.

Yes. The perm revenue always does. Although, that is not higher than abnormal perm revenue or even the Mastech legacy business.

Oh, I meant the higher retail number as a percentage (multiple speakers).

oh, yes. Absolutely.

Absolutely.

Without a doubt.

And one final thing and I'll -- I don't know if there's other questions here. What is the role of your footprint in India in the retail business today or where you hope it will be at some point?

I can talk a bit about it today. Yes. I would say that we have -- that was part of the alignment that we did in the third quarter, was we were able to immediately work some MSP accounts that the Hudson business brought with it in the third quarter. So we turned those businesses on to the India-based recruiting model almost immediately after the acquisition. So there were several MSP/VMS clients that Hudson was really unable to work in their old model other than maybe to cherry pick a req here or there. And we were able to turn that on immediately.

Secondly, we were able to use our Indian-based recruiting team to cross-submit to Hudson requirements on the retail end of their business with their direct clients. And what I mean by that -- I think those of you who know the industry will understand that pretty readily. But, when a candidate -- when we find a candidate for a req in the legacy Mastech business that seems to fit skills, experience, and know-how required for the job, step two is to actually look if there are any other potential job requisitions in the company that might fit those same skills and submit that candidate to those as well, which we were able to do. And that netted us several placements in the Hudson retail business as well.

One other thing, and this is just -- when we formulated our purchase price of Hudson, our expectations were that we were going to get a company with $30 million of revenue, approximately $3 million of incremental EBITDA and 200 billable consultants. And that is pretty much what we got.

So moving forward, we are not going to break out what were Hudson revenues, what were legacy Mastech. We are just not going to do that. We got what we expected in the acquisition and we are going to win or lose as one company. It is not going to be Hudson is doing well or they are doing poorly and Mastech is doing better. Moving forward, it is one company and one company only.

Great. Thanks, guys. Pretty good numbers. I appreciate it.

Yes, we think so. We are pretty pleased with the top line and with the GM and with the profitability numbers. Thank you.

Howard Rosencrans, Value Advisory.

You mentioned the -- I didn't have a full chance to get on for all of the call. Did you mention specifically the CLB, where it was at the beginning of the quarter and the end of the quarter?

No, we didn't do that. But I will tell you that we were down in the quarter about 4.5%.

Okay. And that just speaks to the environment of there's just not enough availability of reasonably priced talent out there for you to work with to earn a decent margin. Does that capture it or please help me with that?

Yes. I actually think it speaks to a number of things. First, we had an abnormally high number of ends in the quarter where consultants were actually hired full-time either by the existing client or where consultants went and took a full-time job. So that was probably the single biggest driver.

The second driver for us was the July 4 week appeared to us like our customers didn't work. And so July was not only a very high end month for us, it was also a very low starts month for us as well. And we have been kind of beating the ground getting our customers back from that process.

I also think that the macroeconomic situation, as you have been hearing and seeing from the general economy, is also beginning to show itself, right? Whereas the IT industry is, in all respects, I would call it a full employment condition in the IT space. You are seeing a whole bunch of people miss on the top line this and we just are not seeing the growth in the general economy through the first three weeks of Q3 earnings announcements. So, I think there is some general economic stuff that is going on as well.

The staffing industry analysts revised their forecast for the IT segment growth for 2015. So at the beginning of the year, growth was expected in our segment to be about 7%. We are looking now -- they are looking now -- I shouldn't say we are. They are looking now at something that is probably closer to 5%, possibly 6%.

That is 5% or 6% for 2015? Is that what you are saying?

Yes, for 2015.

So with all of the slowdown coming in the back half of the year (multiple speakers).

The slowdown is coming at the back end. That is correct, Howard.

Right. So effectively, the back end has got to be growing 3% or 4% to bring the average for the full year.

At a much lower pace. That is correct.

Okay. So in essence, I guess the pure IT-ers or the guys who need bodies on an around the clock a basis have retained your employee or somebody else's on a full-time basis and the increment overload that would generally entail the temporary worker is diminished, and that is what you are seeing across yourselves and across the industry?

Well, I hesitate to speak for the entire industry. We definitely saw it and have seen it in 2015 in total, that we have had a much higher full-time hire rate of our consultants. In fact, I think our full-time hires for our consultants year to date in 2015 is higher through nine months than the entire year of 2014 or 2013 was. And it is indicative of the strengthening of the IT market and our customers not being able to get the talent they want. And so locking in some people on a full-time basis is obviously part of their talent strategy.

I guess, in part, my question speaks to the bidding process. You guys were I won't say the forerunner, but a very significant player, at least for your scale, in pursuing a different model predicated on shooting for a lower gross margin and doing it from a more automated process as the customers got more automated and just trying to work that model. Are you finding more of your competitors are now employing the same model and your win rate is diminished?

I don't know I would go that far. I can tell you we compete for recruiting talent in our centralized recruiting model at a much higher rate today than what we have ever seen. So maybe said a little differently, the offshore India-based recruiting model is beginning to mature and we compete for talent like crazy in that world.

We are making some investments in the US with some US-based recruiting as well as some US-based resource managers who can assist the offshore recruiters in making sure that they have real clarity around the job requisition and the skills the clients are looking for, and then making sure that we lock down candidates. Once we get agreement with a client that they want the candidate, we lock that candidate into that job. I have seen in 2015 -- I would venture to guess that the majority of our billing consultants that we are putting on new assignments have multiple job offers.

I believe -- let me try to parse that question a little more because -- or your answer, per se. That sort of addresses in my mind -- and please correct me if I am mistaken -- the sort of buy side of the equation because you are buying, per se, your employee and then you are selling them to the shop that has IT demand. So just take me through the other side of the equation as to what is happening on the sell side. Are more of your customers reaching an sort of automation level? Are more of your competitors going through the same automated sale of bodies, all adding up to a more challenged sale of your employees? Or is it really just an issue of an inadequate amount of bodies that you are able to capture on what I will term the buy side?

Yes, I can't speak to the entire $28 billion marketplace around how much more automated that market is on the customer side today as compared to 24 months ago. Listen, I do believe that the marketplace has continued to grow on the MSP/VMS side, that automation side. So from that perspective, is there more automation out there? Yes, I think there is.

And I think either SIA or TechServe could probably help us with some of the specific data around that. The last data that I saw was really about a year ago and it would suggest that over 80% of the Fortune 1000 were participating in MSP/VMS style hiring systems and practices for talent acquisition. And do I believe that number continues to grow? Yes, I do. I wouldn't suggest that it is now 90%, though, but I do believe it continues to grow.

Well, let me try to make this the last one, then, at least in this forum -- or two questions. What was your trend in the quarter on a month-by-month basis on the CLB? You mentioned that July 4 was particularly weak. Can you tell us where you ended on a year-to-year basis, what sort of -- ballpark, what sort of basis where you were at the end of July, the end of August, for those two months?

And then, my last question is the accretion that you saw in your -- or the year-to-year increase that you saw on a non-GAAP basis in your diluted earnings, does that reflect simply the accretion from the acquired business?

I am going to let Jack try that second one. And while he is thinking through that, let me hit the first one. Yes. Without tearing into the -- an incredible amount of detail, what I can tell you is at the end -- we have had net growth in the business of consultants on billing in the months of July and August. Excuse me, August and September. So August and September, the sum total of those two months was positive net growth and we had some fairly dramatic negative net growth in the month of July. That is a fair and accurate statement, correct, Jack?

That is fair and accurate.

So August and September were -- I don't know, how to did he characterize it? Meaningful net growth?

Modest increases.

Yes. Exactly.

Modest increases in CLB.

Yes.

And the accretion that you saw in the quarter, it sounds like it came from the acquisition. I know you are not going to talk about it that much it in the future on a broken out basis, but it seems pretty clear that it came from the acquisition.

Yes. And, again, all I can say is we expected -- when we acquired Hudson, we expected a $30 million increase in revenues from the Hudson acquisition and about a $3 million EBITDA, incremental EBITDA increase and 200 consultants. And that is what we got. So you bust that down by quarter and you can certainly do the math.

Right. Remind me quickly, that was a $30 million -- how much was the acquisition?

We paid $17 million and then funded it with working capital. But all of our financial valuations were based on getting a company that brought $30 million of revenue to the table and about $3 million of incremental EBITDA.

And 200 billing consultants.

And 200 billing consultants. And we are a little bit plus and a little bit minus in those three measurements, but just a hair plus and a hair minus in the difference. We got (multiple speakers).

Do you get sort of the full benefit from that? Did you -- the first quarter that they were on board, did you feel like you got the full benefit associated with --? You said they tracked exactly as you thought they would. I know, but maybe there was some transition going on. And did you feel like you got the full lift associated with that acquisition?

Yes. We feel like we got the full lift in Q3.

Is there a lot of seasonality that we are going to experience? I know we've talked about it in the past, but other factors have impacted the sort of the top/bottom line for the past year or so. Where do you see, I guess, the combined businesses from a seasonal perspective? What is going to be the best and what is going to be the weakest quarters?

Yes. All I will say moving forward is, in this business, December is always a tough month, just nature of the business. Contracts are ending and so on and so forth. Q1 is, generally speaking, a tough month on the cost side because you are re-pegging all of the taxes, insurance, et cetera, et cetera.

That is exactly right. I mean, the P&L is a downer in Q1. Consultant net growth is generally a downer in Q4.

Yes.

Great. Thank you for all your time.

(Operator Instructions). At this time, I would like to turn the floor back over to management for any additional or closing comments.

Just simply given that there are no further questions, I would like to thank you for joining the call today. We look forward to sharing our fourth-quarter 2015 results with you in the early February time frame. So thanks very much, folks, and everyone have a great day.

Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may disconnect your lines at this time and have a wonderful day.