MASTECH DIGITAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

About this update from Mastech Digital, Inc

You should read the following discussion in conjunction with our audited consolidated financial statements and accompanying notes for the year ended December 31, 2021 , included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission ("SEC") on March 14, 2022 . This quarterly report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about future events, future performance, plans, strategies, expectations, prospects, competitive environment and regulations. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words, "may", "will", "expect", "anticipate", "believe", "estimate", "plan", "intend" or the negative of these terms or similar expressions in this quarterly report on Form 10-Q. We have based these forward-looking statements on our current views with respect to future events and financial performance. Our actual financial performance could differ materially from those projected in the forward-looking statements due to the inherent uncertainty of estimates, forecasts and projections and our financial performance may be better or worse than anticipated. Given these uncertainties, you should not put undue reliance on any forward-looking statements. All of the forward-looking statements are qualified in their entirety by reference to the factors discussed under "Risk Factors", "Forward-Looking Statements" and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2021 . Forward-looking statements represent our estimates and assumptions only as of the date that they were made. We do not undertake any duty to update forward-looking statements and the estimates and assumptions associated with them, after the date of this quarterly report on Form 10-Q, except to the extent required by applicable securities laws. Website Access to SEC Reports: The Company's website is www.mastechdigital.com . The Company's Annual Report on Form 10-K for the year ended December 31, 2021 , current reports on Form 8-K and all other reports filed with the SEC , are available free of charge on the Investors page. The website is updated as soon as reasonably practical after such reports are filed electronically with the SEC . Critical Accounting Policies Please refer to Note 1 "Summary of Significant Accounting Policies" of the Consolidated Financial Statements and "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" in our Annual Report on Form 10-K for the year ended December 31, 2021 for a more detailed discussion of our significant accounting policies and critical accounting estimates. There were no material changes to these critical accounting policies during the six months ended June 30, 2022 . Overview: We are a provider of Digital Transformation IT Services to mostly large and medium-sized organizations. Our portfolio of offerings includes data management and analytics services; other digital transformation services such as digital learning services; and IT staffing services. We operate in two reporting segments - Data and Analytics Services and IT Staffing Services. Our data and analytics services are marketed under the brand Mastech InfoTrellis and are delivered largely on a project basis with on-site and off-shore resources. These data and analytics capabilities and expertise were acquired through our acquisition of InfoTrellis and enhanced and expanded subsequent to the acquisition. In October 2020 , we acquired AmberLeaf Partners, Inc. ("AmberLeaf"), a Chicago -based customer experience consulting firm. This acquisition enhanced our capabilities in customer experience strategy and managed services offerings for a variety of Cloud-based enterprise applications across sales, marketing and customer services organizations. Our IT staffing business combines technical expertise with business process experience to deliver a broad range of staffing services in digital and mainstream technologies, as well as our other digital transformation services. Both business segments provide their services across various industry verticals, including: financial services; government; healthcare; manufacturing; retail; technology; telecommunications; and transportation. In our Data and Analytics Services segment, we evaluate our revenues and gross profits largely by service line. In our IT Staffing Services segment, we evaluate our revenues and gross profits largely by sales channel responsibility. This analysis within both our reporting segments is multi-purposed and includes technologies employed, client relationships, and geographic locations. 19 -------------------------------------------------------------------------------- Table of Contents Data and Analytics: We provide information regarding our new bookings in our Data and Analytics Services segment, which represents the estimated value of client engagements, including those acquired through acquisitions, as well as renewals, extensions and changes to existing contracts, because we believe doing so provides useful trend information regarding changes in the volume of our new business over time. New bookings can vary significantly quarter to quarter depending in part on the timing of the signing of a small number of large engagements. Among other factors, the types of services and solutions to be delivered, the duration of the engagement and the pace and level of client spending impact the timing of the conversion of new bookings to revenues. In addition, substantially all of our contracts are terminable by the client on short notice with little or no termination penalties. Information regarding our new bookings is not comparable to, nor should it be substituted for, an analysis of our revenues over time. New bookings involve estimates and judgments. There are no third-party standards or requirements governing the calculation of bookings. We do not update our new bookings for material subsequent terminations or reductions related to bookings originally provided in prior periods. Economic Trends and Outlook: Generally, our business outlook is highly correlated to general North American economic conditions. During periods of increasing employment and economic expansion, demand for our services tends to increase. Conversely, during periods of contracting employment and / or a slowing global economy, demand for our services tends to decline. As the economy slowed in 2007 and recessionary conditions emerged in 2008 and 2009, we experienced less demand for our IT staffing services. With economic expansion in 2010 through 2019, activity levels improved. However, as the recovery strengthened, we experience increased tightness in the supply-side (skilled IT professionals) of our businesses. These supply-side challenges pressured resource costs and to some extent gross margins. As we entered 2020, we were encouraged by continued growth in the domestic job markets and expanding U.S. and global economies. However, with the COVID-19 pandemic surfacing in the first quarter of 2020, we realized the economic growth would quickly turn into recessionary conditions, which had a material impact on activity levels in both of our business segments. This impact was reduced in 2021 as a result of the global roll-out of vaccination programs and signs of improving economic conditions. We are hopeful that COVID-19 related concerns will be less impactful on our business in 2022. The proliferation of COVID-19 variants, however, has caused some uncertainty and may continue to disrupt global markets during 2022. In addition, we are mindful of inflationary pressures and overall economic concerns regarding the potential for recessionary conditions in 2022 and beyond. In addition to tracking general economic conditions in the markets that we service, a large portion of our revenues is generated from a limited number of clients (see Item 1A, the Risk Factor entitled "Our revenues are highly concentrated, and the loss of a significant client would adversely affect our business and revenues" in our Annual Report on Form 10-K for the year ended December 31, 2021 ). Accordingly, our trends and outlook are additionally impacted by the prospects and well-being of these specific clients. This "account concentration" factor may result in our results of operations deviating from the prevailing economic trends from time to time. Within our IT Staffing Services segment, a larger portion of our revenues has come from strategic relationships with systems integrators and other staffing organizations. Additionally, many large end users of IT staffing services are employing managed service providers to manage their contractor spending. Both of these dynamics may pressure our IT staffing gross margins in the future. Recent growth in advanced technologies (social, cloud, analytics, mobility, automation) is providing opportunities within our IT Staffing Services segment. However, supply side challenges have proven to be acute with respect to many of these technologies. We believe these challenges will remain during 2022. Within our Data and Analytics Services segment many customers are satisfying their D&A needs using a holistic approach. This often results in the customer using one vendor partner rather than with multiple vendors. We have responded to this trend by establishing a service offering called "Center of Excellence" which bundles a customer's total requirements under a multi-year contract. This concept allows us to better understand the customer's longer-term strategy with respect to D&A and effectively address such needs. 20 -------------------------------------------------------------------------------- Table of Contents Results of Operations for the Three Months Ended June 30, 2022 as Compared to the Three Months Ended June 30, 2021 : Revenues: Revenues for the three months ended June 30, 2022 totaled $62.1 million compared to $53.7 million for the corresponding three month period in 2021. This 16% year-over-year revenue increase reflected a 26% organic increase in our Data and Analytics Services segment and a 14% organic increase in our IT Staffing Services segment. For the three months ended June 30, 2022 , the Company had one client that had revenues in excess of 10% of total revenues (CGI = 22.3%). For the three months ended June 30, 2021 , the Company had the same one client with revenues in excess of 10% of total revenues (CGI = 14.8%). The Company's top ten clients represented approximately 52% and 48% of total revenues for the three months ended June 30, 2022 and 2021, respectively. Below is a tabular presentation of revenues by reportable segment for the three months ended June 30, 2022 and 2021, respectively: Three Months Ended Three Months Ended Revenues (Amounts in millions) June 30, 2022 June 30, 2021 Data and Analytics Services $ 11.2 $ 9.0 IT Staffing Services 50.9 44.7 Total revenues $ 62.1 $ 53.7 Revenues from our Data and Analytics Services segment totaled $11.2 million in the second quarter ended June 30, 2022 , compared to $9.0 million in the corresponding period last year. The year-over-year improvement of 26% reflected an increase in backlog in the 2022 period compared to 2021. New bookings in the second quarter of 2022 totaled approximately $10 million compared to $15 million in the 2021 quarter. Revenues from our IT Staffing Services segment totaled $50.9 million in the three months ended June 30, 2022 compared to $44.7 million during the corresponding 2021 period. This 14% increase reflected higher demand and resulted in a higher level of billable consultants in the 2022 quarter compared to 2021. Billable consultants at June 30, 2022 totaled 1,344-consultants compared to totaled 1,251-consultants one-year earlier. Our average bill rate during the second quarter of 2022 was $80.15 per hour compared to $74.65 per hour in the corresponding 2021 quarter. The increase in average bill rate was due to higher rates on new assignments during the first half of 2022 and was reflective of the types of skill-sets that we deployed. Permanent placement / fee revenues were approximately $0.5 million during the 2022 quarter, which were $0.3 million higher than in the corresponding 2021 quarter. Gross Margins: Gross profits in the second quarter of 2022 totaled $16.7 million and exceeded the second quarter of 2021 gross profits by approximately $2.4 million . Gross profit as a percentage of revenue was 27.0% for the three-month period ended June 30, 2022 compared to 26.7% during the same period of 2021. This improvement in gross margins reflected higher margins in our IT Staffing Services segment. Below is a tabular presentation of gross margin by reporting segment for the three months ended June 30, 2022 and 2021, respectively: Three Months Ended Three Months Ended Gross Margin June 30, 2022 June 30, 2021 Data and Analytics Services 43.6 % 46.7 % IT Staffing Services 23.3 22.7 Total gross margin 27.0 % 26.7 % Gross margins from our Data and Analytics Services segment were 43.6% of revenues during the second quarter of 2022, which represented a decline of 310-basis points from a year ago. The margin decline reflected much lower utilization in the 2022 quarter due to a 22% increase in billable staff in anticipation of higher activity levels in the second half of 2022. Many of these resources were in training-programs during the second quarter, which negatively impacted utilization. Gross margins from our IT Staffing Services segment were 23.3% in the second quarter of 2022 compared to 22.7% during the corresponding quarter of 2021. This 60-basis point expansion was due higher permanent placement fees, higher revenues from our high-margin offshore staffing offering and better gross margins on new assignments secured during the last several quarters. 21 -------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative ("S,G&A") Expenses: Below is a tabular presentation of operating expenses by sales, operations, amortization of acquired intangible assets, the revaluation of contingent consideration and general and administrative categories for the three months ended June 30, 2022 and 2021, respectively: Three Months Ended Three Months Ended S,G&A Expenses (Amounts in millions) June 30, 2022 June 30, 2021 Data and Analytics Services Segment Sales and Marketing $ 1.8 $ 1.4 Operations 0.7 0.8 Amortization of Acquired Intangible Assets 0.6 0.6 Revaluation of Contingent Consideration - (2.0 ) General & Administrative 1.6 1.3 Subtotal Data and Analytics Services $ 4.7 $ 2.1 Three Months Ended Three Months Ended S,G&A Expenses (Amounts in millions) June 30, 2022 June 30, 2021 IT Staffing Services Segment Sales and Marketing $ 2.4 $ 1.9 Operations 2.9 2.2 Amortization of Acquired Intangible Assets 0.2 0.2 General & Administrative 3.0 2.6 Subtotal IT Staffing Services $ 8.5 $ 6.9 Total S,G&A Expenses $ 13.2 $ 9.0 S,G&A expenses for the three months ended June 30, 2022 totaled $13.2 million or 21.2% of total revenues, compared to $9.0 million or 16.8% of total revenues for the three months ended June 30, 2021 . Excluding the revaluation of contingent consideration in the 2021 period and the amortization of acquired intangible assets in both periods, S,G&A expense as a percentage of total revenues would have been 20.0% and 19.0%, respectively. Fluctuations within S,G&A expense components during the second quarter of 2022, compared to the second quarter of 2021, included the following: • Sales expense increased by $0.9 million in the 2022 period compared to the corresponding 2021 period. Approximately $0.4 million related to our Data and Analytics Services segment, which reflected additional staff and higher variable compensation. Sales expense in our IT Staffing segment increased by $0.5 million largely due to staff increases and higher variable compensation. • Operations expense increased $0.6 million in the 2022 period compared to the corresponding 2021 period. In our Data and Analytics Services segment operating expense declined by $0.1 million due to lower staff. In our IT Staffing Services segment operating expense increased by $0.7 million related to staff increases and higher variable expenses to support revenue growth. • Amortization of acquired intangible assets was $0.8 million in both the 2022 and 2021 periods. • Revaluation of contingent consideration totaled a credit of $2.0 million in the 2021 period and related to the AmberLeaf acquisition. No contingent consideration existed on the Company's balance sheet in 2022. • General and administrative expense increased by $0.7 million in the 2022 period compared to the corresponding 2021 period. General and administrative expense in our Data and Analytics Services segment increased by $0.3 million due to executive leadership staff increases. In our IT Staffing Services segment, general and administrative expense increased by $0.4 million due to higher compensation expense and increases in travel and facility expenses. Other Income / (Expense) Components: Other Income / (Expense) for the three months ended June 30, 2022 consisted of interest expense of ( $127,000 ) and foreign exchange gains of $195,000 . For the three months ended June 30, 2021 , Other Income / (Expense) consisted of interest expense of ( $159,000 ) and foreign exchange gains of $15,000 . The favorable foreign exchange gains reflected a stronger U.S. dollar in the 2022 quarter. 22 -------------------------------------------------------------------------------- Table of Contents Income Tax Expense: Income tax expense for the three months ended June 30, 2022 totaled $1.2 million , representing an effective tax rate on pre-tax income of 32.6% compared to $1.4 million for the three months ended June 30, 2021 , which represented a 27.7% effective tax rate on pre-tax income. The higher effective tax rate in the 2022 period was due to an increase in our tax valuation allowance related to foreign net operating losses ("NOL's) in Singapore , Ireland and the UK and additional tax expense associated with forfeited vested stock options. Results of Operations for the Six Months Ended June 30, 2022 as Compared to the Six Months Ended June 30, 2021 : Revenues: Revenues for the six months ended June 30, 2022 totaled $121.9 million compared to $103.4 million for the corresponding six month period in 2021. This 18% year-over-year revenue increase reflected a 21% increase in and Data and Analytics Services segment and a 17% increase in our IT Staffing Services segment. For the six months ended June 30, 2022 , the Company had one client that had revenues in excess of 10% of total revenues (CGI = 20.1%). For the six months ended June 30, 2021 , the Company had the same one client that had revenues in excess of 10% of total revenues (CGI = 14.9%). The Company's top ten clients represented approximately 52% and 48% of total revenues for the six months ended June 30, 2022 and 2021, respectively. Below is a tabular presentation of revenues by reportable segment for the six months ended June 30, 2022 and 2021, respectively: Six Months Ended Six Months Ended Revenues (Amounts in millions) June 30, 2022 June 30, 2021 Data and Analytics Services $ 21.4 $ 17.7 IT Staffing Services 100.5 85.7 Total revenues $ 121.9 $ 103.4 Revenues from our Data and Analytics Services segment totaled $21.4 million during the six months ended June 30, 2022 , compared to $17.7 million in the corresponding six-month period last year. The 21% year-over-year improvement reflected improved backlog in the 2022 period. Revenues from our IT Staffing Services segment totaled $100.5 million in the six months ended June 30, 2022 compared to $85.7 million during the corresponding 2021 period. This 17% increase reflected a higher level of billable consultants; an improved average bill rate ( $79.57 in 2022 versus $74.89 in 2021) and higher permanent placement revenues in the 2022 period versus 2021. Gross Margins: Gross profits in the six months ended June 30, 2022 totaled $32.7 million compared to $27.1 million in the corresponding period last year. Gross profit as a percentage of revenue was 26.8% for the six month period ended June 30, 2022 compared to 26.2% during the same period of 2021. This 60-basis point improvement largely reflected a favorable mix of revenues between our two operating segments and higher gross margins in our IT Staffing Services segment. Below is a tabular presentation of gross margin by reporting segment for the six months ended June 30, 2022 and 2021, respectively: Six Months Ended Six Months Ended Gross Margin June 30, 2022 June 30, 2021 Data and Analytics Services 44.3 % 46.2 % IT Staffing Services 23.1 22.1 Total gross margin 26.8 % 26.2 % 23 -------------------------------------------------------------------------------- Table of Contents Gross margins from our Data and Analytics Services segment were 44.3% of revenues during the six month period ended June 30, 2022 compared to 46.2% in the corresponding period of 2021. This gross margin decline reflects lower utilization during the first six months of 2022 primarily driven by 22% increase in billable staff in the second quarter of 2022 in anticipation of higher activity levels in the second half of 2022. Gross margins from our IT Staffing Services segment were 23.1% in the six months ended June 30, 2022 compared to 22.1% during the corresponding period of 2021. This 100-basis point expansion was due to better gross margins on new assignments secured during the last several quarters; higher permanent placement revenues and increased activity levels from our offshore staffing offering. Selling, General and Administrative ("S,G&A") Expenses: Below is a tabular presentation of operating expenses by sales, operations, amortization of acquired intangible assets, the revaluation of contingent consideration and general and administrative categories for the six months ended June 30, 2022 and 2021, respectively: Six Months Ended Six Months Ended S,G&A Expenses (Amounts in millions) June 30, 2022 June 30, 2021 Data and Analytics Services Segment Sales and Marketing $ 3.7 $ 3.2 Operations 1.3 1.6 Amortization of Acquired Intangible Assets 1.2 1.2 Revaluation of Contingent Consideration - (2.0 ) General & Administrative 2.7 2.3 Subtotal Data and Analytics Services $ 8.9 $ 6.3 Six Months Ended Six Months Ended S,G&A Expenses (Amounts in millions) June 30, 2022 June 30, 2021 IT Staffing Services Segment Sales and Marketing $ 4.9 $ 3.7 Operations 5.7 4.2 Amortization of Acquired Intangible Assets 0.4 0.4 General & Administrative 5.9 5.3 Subtotal IT Staffing Services $ 16.9 $ 13.6 Total S,G&A Expenses $ 25.8 $ 19.9 S,G&A expenses for the six months ended June 30, 2022 totaled $25.8 million or 21.2% of total revenues, compared to $19.9 million or 19.2% of total revenues for the six months ended June 30, 2021 . Excluding the revaluation of contingent consideration in the 2021 period and the amortization of acquired intangible assets in both periods, S,G,&A expense as a percentage of total revenues would have been 19.8% and 19.6%, respectively. Fluctuations within S,G&A expense components during the first six months of 2022, compared to the first six months of 2021, included the following: • Sales expense increased by $1.7 million in the 2022 period compared to the corresponding 2021 period. An increase of $0.5 million related to our Data and Analytics Services segment which reflected additional staff and higher variable compensation. Sales expense in our IT Staffing Services segment increased by $1.2 million due to staff increases, higher variable compensation and higher travel expenses. • Operations expense increased by $1.2 million in the 2022 period compared to the corresponding 2021 period. In our Data and Analytics Services segment operations expense decreased $0.3 million due to lower staff. Operations expense in our IT Staffing Services segment increased by $1.5 million largely related to staff increases and higher variable expense to support revenue growth. • Amortization of acquired intangible assets was $1.6 million in both the 2022 and 2021 periods. • Revaluation of contingent consideration totaled a credit of $2.0 million in the 2021 period and related to the AmberLeaf acquisition. No contingent consideration existed on the Company's balance sheet in 2022. 24 -------------------------------------------------------------------------------- Table of Contents • General and administrative expense increased by $1.0 million in the 2022 period compared to the corresponding 2021 period. General and administrative expense in our Data and Analytics Services segment increased by $0.4 million due to executive leadership staff increases and executive search fees. The increase in our IT Staffing Services segment of $0.6 million was due to higher compensation and increases in travel and facility expenses. Other Income / (Expense) Components: Other Income / (Expense) for the six months ended June 30, 2022 consisted of interest expense of ( $241,000 ) and foreign exchange gains of $249,000 . For the six months ended June 30, 2021 , Other Income / (Expense) consisted of interest expense of ( $354,000 ) and foreign exchange losses of ( $22,000 ). The lower level of interest expense was reflective of debt repayments and the favorable foreign exchange gains reflected a stronger U.S. dollar in the 2022 period. Income Tax Expense: Income tax expense for the six months ended June 30, 2022 totaled $2.1 million , representing an effective tax rate on pre-tax income of 30.5% compared to $1.9 million for the six months ended June 30, 2021 , which represented a 27.5% effective tax rate on pre-tax income. The higher effective tax rate in the 2022 period was largely due to an increase in our tax valuation allowance related to foreign net operating losses ("NOL's") in Singapore , Ireland and the UK and additional tax expense associated with forfeited vested stock options. Liquidity and Capital Resources: Financial Conditions and Liquidity: At June 30, 2022 , we had bank debt, net of cash balances on hand, of $4.2 million and approximately $36.8 million of borrowing capacity under our existing credit facility. Historically, we have funded our organic business needs with cash generated from operating activities. Controlling our operating working capital levels by closely managing our accounts receivable balance is an important element of cash generation. At June 30, 2022 , our accounts receivable "days sales outstanding" ("DSOs") measurement was 67-days, which was three days higher than our DSO measurement at March 31, 2022 , which is on the high-end of our targeted range and we would expect this number to come down over the next several quarters. We believe that cash provided by operating activities, cash balances on hand and current availability under our credit facility will be adequate to fund our business needs and debt service obligations over the next twelve months, exclusive of any acquisition activity. Cash flows provided by (used in) operating activities: Cash provided by operating activities for the six months ended June 30, 2022 totaled $1.9 million compared to cash provided by operating activities of $0.2 million during the six months ended June 30, 2021 . Elements of cash flow during the 2022 period were net income of $4.8 million , non-cash charges of $3.8 million and an increase in operating working capital levels of ( $6.7 million ). Elements of cash flow during the corresponding 2021 period were net income of $4.9 million , non-cash charges of $1.9 million and an increase in operating working capital levels of ( $6.6 million ). The operating working capital increases in both 2022 and 2021 were largely in support of our revenue growth. Cash flows (used in) investing activities: Cash (used in) investing activities for the six months ended June 30, 2022 was ( $693,000 ) compared to ( $525,000 ) for the six months ended June 30, 2021 . In 2022 capital expenditures and the recovery of office lease deposits accounted for investing activities. In 2021 capital expenditures and the payment of office lease deposits accounted for investing activities. Capital expenditures in the 2022 period increased from 2021 due to systems implementation expenditures. Cash flows provided by (used in) financing activities: Cash (used in) financing activities for the six months ended June 30, 2022 totaled ( $0.7 million ) and consisted of term loan debt repayments of ( $2.2 million ), partially offset by $1.5 million related to proceeds from the issuance of common shares and the exercise of stock options. Cash (used in) financing activities for the six months ended June 30, 2021 totaled ( $1.9 million ) and consisted of term loan repayments of ( $2.2 million ), partially offset by $0.3 million related to proceeds from the issuance of common shares and the exercise of stock options. 25 -------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements: We do not have any off-balance sheet arrangements. Inflation: We do not believe that inflation had a significant impact on our results of operations for the periods presented. On an ongoing basis, we attempt to minimize any effects of inflation on our operating results by controlling operating costs and, whenever possible, seeking to ensure that billing rates are adjusted periodically to reflect increases in costs due to inflation. However, high levels of inflation may result in an increase in our selling, general and administrative expenses, as well as a higher interest rate environment. Seasonality: Our operations are generally not affected by seasonal fluctuations. However, our consultants' billable hours are affected by national holidays and vacation policies. Accordingly, we generally have lower utilization rates and higher benefit costs during the fourth quarter. Additionally, assignment completions tend to be higher near the end of the calendar year, which largely impacts our revenue and gross profit performance during the subsequent quarter. Recently Issued Accounting Standards: Recent accounting pronouncements are described in Note 16 to the accompanying financial statements. © Edgar Online, source Glimpses

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