PSDO is an information technology services company offering consulting, strategy, design, and implementation across three main areas: digital infrastructure (76% of revenue), cloud (15%), and security (9%). The company has increasingly focused on the cloud and security verticals due to the strong growth and demand for these technologies. It expects its business mix to continue shifting towards these markets.
Some examples of PSDO's services include advanced networking, Internet of Things (IoT), data center modernization, hybrid and multi-cloud, cyber risk management, enterprise mobility, and management of data from cameras, wearables, and sensors. Broadly speaking, the increasing potential and complexity of new, emerging technologies are creating more demand for these services.
In terms of customer base, the company focuses on the middle-market, large, and government organizations. Customers in the middle market are usually large enough to have significant technology needs, but, typically have less resources to develop and upgrade IT systems. Furthermore, the middle market is one of the fastest growing segments in the overall North American IT market. According to Gartner Research, this middle market segment is projected to grow from $226 billion in 2015 to $293 billion in 2020, representing a CAGR of 5.3%.
With over 7,000 customers, across a variety of industries, its base is diverse. In fact, in FY16, only 19% of its revenue came from its top 25 customers and no industry vertical represented more than 20% of its revenue. Its total sales outside the U.S. is only 2%, which does represent a significant opportunity for the company.
Taking a look at the financials, PSDO' revenue was up a modest 6% y/y to $1.5 billion. The increase in revenue resulted from a higher proportion of engineering and consulting services as part of it solutions, as well as from the Netech Acquisition, partly offset by changes in the timing of client engagements at the end of the periods. Breaking it down by vertical, digital infrastructure revenue grew 2.3%, cloud revenue grew 28.1%, and security revenue grew by 5.0%.
Gross margin is pretty thin, but, has remained quite stable. Total gross margin increased 40 basis points to 20.0% for the six months ended December 31, 2016, up from 19.6% of revenue for the six months ended December 31, 2015. Product gross margin was 20.0%, an increase of 50 basis points from 19.5%. The increase in gross margin percentage was due to higher margin product offerings attributable to increased sales of third party support services.
Despite the bump in revenue and gross margin, operating income fell by 13% y/y to $57.8 million. The cause is mostly tied to the 17% rise in Selling expenses and the 18% increase in general and administrative expense.
Using the $14/share offering price, PSDO's P/S looks very cheap at 0.4x annualized FY17 revenue. Given the mediocre topline growth, a premium valuation wouldn't be warranted. However, 0.4x revenue looks quite conservative, offering a pretty favorable risk/reward scenario in our view.