Mastech Holdings' (MHH) CEO Kevin Horner on Q4 2015 Results - Earnings Call Transcript

| About: Mastech Holdings, (MHH)

Mastech Holdings, Inc. (NYSEMKT:MHH)

Q4 2015 Earnings Conference Call

February 03, 2016 09:00 AM ET

Executives

Jennifer Ford Lacey – Manager-Legal Affairs

Jack Cronin – Chief Financial Officer

Kevin Horner – Chief Executive Officer

Analysts

David Polonitza – AB Value Management

Louis Mosher – Mayfax Investors

Operator

Greetings and welcome to the Mastech Q4 2015 Earnings Call. At this time, all participants are in a listen-only mode. A brief 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, Ms. Jennifer Ford Lacey, Manager of Legal Affairs for Mastech Holdings. Thank you, Ms. Lacey. You may begin.

Jennifer Ford Lacey

Thank you, operator, and welcome to Mastech’s fourth 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 facts 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 data, 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 fourth quarter and full year 2015 results.

Jack Cronin

Thanks, Jen, and good morning. First off, I’d like to remain everyone that our June 2015 acquisition of Hudson IT is reflected in our financial results effective as of the acquisition date and accordingly has benefited our year-over-year comparables. With that backdrop, revenues for the fourth quarter of 2015 totaled $32.5 million, compared to $28.5 million in the fourth quarter of 2014. This 14% year-over-year increase in revenues was entirely attributable to our Hudson IT acquisition.

Activity levels during the quarter were slightly below the previous quarter and included some holiday related weakness in the latter part of December. Despite solid overall demand, we had a net decline in our billable consultant base of 47 consultants during the quarter. This reflected a combination of a higher level of assignment ends, which historically occur in fourth quarter, and a disappointing start performance, which Kevin will talk more about in his prepared comments.

Gross profit for the fourth quarter of 2015 totaled $6.7 million or 20.6% of revenues compared to $5.2 million or 18.3% of revenues during the same period last year. Our growth profit dollar increase reflected non-organic revenues in the 2015 quarter. Additionally, fourth quarter 2015 was positively impacted by approximately a $100,000 of lower benefit cost due to the favorable claims experience related to our self-insured healthcare program.

Our year-over-year gross margin comparables benefited from Hudson IT’s strong retail client base, which generally carries higher gross margins than in our wholesale channel. Additionally, our gross margins on new starts continue to trend up in Q4, and this coupled with a lower benefit cost further contributed to our overall gross margin improvement during the quarter.

SG&A expenses were $4.5 million in the fourth quarter of 2015, and represented 13.8% of total revenues compared to $3.9 million in the fourth quarter of 2014. The increase in SG&A expenses in the 2015 quarter, compared to the corresponding quarter of 2014, reflected SG&A expenses related to the Hudson IT operations. This should be noted that third quarter 2015 SG&A expenses or previous quarter, totaled $5.3 million or 15.5% of total revenues and represented a first full quarter to include all the SG&A expense associated with the Hudson IT operations.

Our lower SG&A expenses of approximately $800,000 in Q4 2015 compared to Q3 2015 was due to the following items. One, lower staff salary expense of approximately a $100,000 due to non-regrettable employee attrition and higher vacation time off. Two, lower variable compensation expense of approximately $400,000. This is a combination of lower sales commissions, management incentives and stock-based compensation.

Three, lower travel and marketing expenses of approximately $200,000. And four, an elimination of $100,000 of transaction – excuse me, transition service costs, associated with the Hudson IT acquisition that we incurred in Q3 2015. These SG&A expense reductions played a significant role in driving our GAAP and non-GAAP net income in the fourth quarter of 2015.

To that point, GAAP net income for the fourth quarter of 2015 was $1.3 million or $0.29 per diluted share, compared to $782,000 or $0.18 per diluted share in the fourth quarter of 2014. Non-GAAP net income for the fourth quarter of 2015 was $1.4 million or $0.31 per diluted share, compared to $804,000 or $0.18 per diluted share in the corresponding 2014 quarter. Fourth quarter SG&A expense items not included in the non-GAAP financial measures, net of tax benefits, or amortization of acquired intangibles and stock-based compensation expense and they are detailed in our Q4 earnings release, which is available in our website.

Addressing our full year results 2015 revenues totaled $123.5 million and represented a 9% increase over 2014 revenues of $113.5 million. This increase reflected our June 2015 acquisition of Hudson IT. Organically, revenues decreased by approximately 5% in 2015 due to the decline in our billable consultant base. Gross profits in 2015 were $23.8 million compared to $20.8 million in 2014. Gross margins as of percent of revenues were 19.3% in 2015, compared to 18.3% in 2014. Both the higher gross profit dollars and gross margin percentage are largely attributable to the Hudson IT acquisition.

GAAP net income for the full year 2015 totaled $2.8 million or $0.62 per diluted share, compared to $3.4 million or $0.77 per diluted share in 2014. Non-GAAP net income for 2015, totaled $3.8 million or $0.85 per diluted share, compared to $3.6 million or $0.81 per diluted share for the full year 2014.

Full year SG&A expense items not included in non-GAAP financial measures, net of tax benefits or the amortization of acquired intangible assets, stock-based compensation expense, acquisition transaction cost and severance cost. Again, a detailed reconciliation of our non-GAAP measures compared to their comparable GAAP measures are included in our earnings release and available on our website.

At December 31, 2015 we had $11.7 million of outstanding bank debt, net of cash balances on hand. Our borrowing availability at year end 2015 was approximately $11 million under our existing revolving credit line. During Q4, 2015 net bank debt declined by $3.8 million.

Lastly, our cash receivable balance at December 31, 2015 remains at top quality. With client contract assignment matters related to our asset purchase of Hudson IT largely behind us, our day sales outstanding measurement, is starting to return to pre-acquisition levels.

I’ll now turn the call over to Kevin for his comment.

Kevin Horner

Thanks, Jack, and good morning all. First, I would like to comment on our fourth quarter performance, and then I will give you my perspective on the full year of 2015 and where I see Mastech headed into 2016. With respect to the fourth quarter, I would summarize Jack’s detailed comments in the following way.

Number one, our Hudson IT acquisition is providing the kind of results that we hoped for, when we acquired the business in June of 2015. Thus far, I’m very happy with this transaction. Number two, gross margins continue to expand beyond the impact related to the acquisition, which pleases me. Albeit, we had some help during the quarter from our self-insured healthcare program. Three, we’ve done a good job in managing our SG&A expenses in Q4, from eliminating marginal producers to encouraging the use of vacations during this slow holiday season, to tightening up on travel, marketing and supported by expenditures.

Our fourth quarter SG&A expense performance also shows the positive impact of having a leveraged compensation structure in place. With lower commissions, management incentives and stock-based compensation expense responding to a lower than expected growth rate for the business. However, despite a solid earnings performance in fourth quarter of 2015, our consultants ongoing continue to decline, which was disappointing for me.

Well, historically, the fourth quarter is a high project dense quarter. And we generally come to expect some COD deterioration. My disappointment was squarely on the start side of our business. We need to do better turning demand into new starts in 2016. We’ll talk a little bit about our plans around that in a minute.

Adjusting my performance for the full year, most of my fourth quarter views applied to the entire year. We closed some exciting acquisition with plenty of potential. The market is still cooperating and we are adequate demand for our services. We’ve a low cost operating model, which has proven to be effective. But again, like the fourth quarter we struggled to convert demand opportunities into new business, average which were consistent with our performance from 2011 to 2014.

Let’s talk a little bit about our focus for improvements in 2016. Our focus is back to basic strategy. Within offshore recruiting organization, we have implemented smaller client centric teams, each with an experienced leader accountable for the performance of his or her team. The smaller teams have daily quality candidates and middle targets. And we simply do not go home until we get our daily targets. If January is a measure, we’re probably up about 25% or 30% submittal rates as compared to Q4. So I’m very pleased with the initial action on there.

Number two, we got our resource managers to our onshore delivery organizations and those RM’s are working with our clients to clarify job requisitions technically to confirm those technical needs with the recruiting organization and to evaluate the candidates who are being submitted from both technical fit and client culture fit.

Number three, within our sales organization we have added additional experienced comp executives plus we are reestablishing relationships and several clients who changed MSP that would be managed service providers in the second half of 2015. As you know in the MSP world, relationships with both the customer hiring manager and the MSPs sourcing coordinators or sourcing context are crucial.

Number four, we have several interesting growth opportunities in 2016 and I’d like to highlight just a couple of them today. We added a new client in 2015. There is a large user of contract IT resources. In the two – two quarters we have been serving them. We have moved into their top tier vendors and we stand to grow with them in 2016 as well.

Two, we have one of our integrator partners, again, a top five customer of ours, who is challenging us to double our starts per month with them in the first half of 2016. We’ve added recruiting capability and we’ve added sales in our own capability to serve better count.

Three, we have one of our direct customers again in top five customers, has offered us the opportunity to significantly grow our exclusive business with them beginning in January 2016. Historically, this customer isn’t MSP customer with little hiring manager contact. So we expect to leverage those new relationships that we are building there as well.

To summarize, from aspect 2016 will be all about our organically increasing consultants on billing with our clients or how to is about the basic strategy focused on two things which are simple to say but much tougher to do. One, a much higher level of quality candidates of middle activity from our recruiting organizations, and two, a much higher level of sales activity penetrating our existing clients developing new or re-establishing – existing relationships with contacts within both customers and where applicable [ph] the customers MSP.

At this time I’d like to open it up for your questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Louis Mosher with Mayfax Investors. Please proceed with your question.

Louis Mosher

Yes, good morning. I just tried to verify that the new acquisition is not a seasonal business. I know you included it for just part of the year. And I wonder if this business will continue to grow as – it has apparently done during the time you’ve had the company?

Kevin Horner

Actually we expect it to continue to grow. And the customers of that business are somewhat seasonal in many of our contracts in that business, run through the end of the year. So 12/31/2015 was a big end time for that part of our business as well. So, if there is any seasonality in the business, it’s high growth in the first two to three quarters with some trailing in the fourth. Is that a fair way to describe the business, Jack? It leaves us much as we’ve seen so far and what the team can tell us about how the business is historically performed.

Jack Cronin

Yes, that’s been their historical trend.

Kevin Horner

Yes.

Louis Mosher

Thank you.

Operator

Our next question comes from the line of David Polonitza with AB Value Management. Please proceed with your question.

David Polonitza

Hi, guys. Thank you very much for the call this morning. Just have two quick questions. One, if you could just comment about the sustainability going forward of the operating margin. Obviously, it’s a good number compared to historical margins of the company. And the second one is the breakdown of the wholesale verse retail revenue, and if there was any permanent placement during the quarter?

Kevin Horner

Yes, I’ll let Jack think through the perm question and let me try the first one. David, what we believe that the operating margin or the relationship of our SG&A costs to our revenue at 13.8% is absolutely sustainable right now. There will be times when we – in a quarter where we will add salespeople or add some recruiters. And generally the performance is trailing those ads, right. But generally speaking, I don’t see any reason why we won’t be – why that margin – those ratios won’t continue. Jack, do you agree with that on the operating margin side? I don’t see any reason that you won’t.

Jack Cronin

From a gross margin perspective, I think they’re sustainable. Yes, we had $100,000 favorable cost settlement because of good claim experience on our self-insured program. If that’s going to happen each quarter, yes, I would doubt that.

Kevin Horner

Yes.

Jack Cronin

But margins – but again our perm placement activity was down in Q4. So maybe those two offset a bit, but certainly gross margins in the low-20%s are hardly that sustainable. So the operating margins – if you look at the cost savings that we had in Q4 versus Q3, and both of those quarters have all of the SG&A expense associated with the Hudson acquisition, the Hudson operations. We had $800,000 of cost or expense improvements. Some of which are, in a way one-time, by the sales commissions, the management incentives and the stock-based compensation, hopefully…

Kevin Horner

But one-time related to revenue.

Jack Cronin

One-time related costs.

Kevin Horner

No, but as revenue increases. That ratio of SG&A to revenue will continue to stay where it is.

Jack Cronin

I think maybe in the long – over the long haul, those operating margins would hold.

Kevin Horner

Yes.

Jack Cronin

But in the shorter-term, I would suspect they’re going to decline a bit.

Kevin Horner

You mean like…

Jack Cronin

Q1.

Kevin Horner

Q4 to Q1?

Jack Cronin

Yes.

Kevin Horner

That’s a fair statement, Jack. Yes, that’s absolutely fair. So I stand corrected. That is fair. Dave did we catch you? That we get…

David Polonitza

No. Yes, and just you have the numbers in front of you in terms of the wholesale versus retail breakdown on the revenue base?

Jack Cronin

Yes, I get it. Give me a sec. Yes, for fourth quarter we had approximately $19 million of wholesale and $13 million of retail. So we’re looking at retails around 40%, and wholesale around 60%. And prior to the Hudson acquisition that number was dramatically different. The retail channel was more like 25%. So one of the advantages, yes, that Hudson did was it moved up our revenues spread in retail.

David Polonitza

Thanks, appreciate it.

Kevin Horner

Thanks, Dave.

Operator

[Operator Instructions] There are no further questions at this time. I would like to turn the floor back over to you Mr. Horner, for closing comments.

Kevin Horner

Given there are no further questions, I’d like to thank you for joining our call today and we look forward to sharing our first quarter 2016 results with you in late April. Thanks, all.

Operator

This does concludes today’s teleconference. You may disconnect your lines at this time. And thank you for your participation.

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