MASTECH DIGITAL, INC. This Management's Discussion and Analysis should be read in conjunction with our Consolidated Financial Statements and accompanying Notes included in this Annual Report on Form 10-K.
This Management's Discussion and Analysis contains forward-looking statements that involve risks, uncertainties, and assumptions as described under the heading "Forward-Looking Statements" included in Part I of this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated by these forward-looking statements as a result of many factors, including those discussed under "Item 1A. Risk Factors" and elsewhere in this Annual Report on Form 10-K.
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 on a global
basis under the brand Mastech InfoTrellis and are delivered largely on a project
basis with on-site and off-shore resources. These capabilities and expertise
were acquired through our acquisition of InfoTrellis and enhanced and expanded
subsequent to the acquisition. In
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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.
Economic Trends and Outlook
Generally, our business outlook is highly correlated to general North American
economic conditions, particularly with respect to our IT Staffing Services
segment. 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
economic conditions strengthened, we experienced 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
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"). 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 MSP's 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 in 2023.
Results of Operations
We operate in two reporting segments - Data and Analytics Services and IT
Staffing Services. The 2020 results of operations for our Data and Analytics
Services segment include the operating results of AmberLeaf from the
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Below is a tabular presentation of revenues and gross profit margins by segment for the periods discussed:
Revenues & Gross Margin by Segment
(Revenues in millions)
Years Ended December 31,
Revenues 2022 2021 2020
Data and Analytics Services $ 40.6 $ 38.3 $ 30.2
IT Staffing Services 201.6 183.7 163.9
Total Revenues $ 242.2 $ 222.0 $ 194.1
Gross Margin %
Data and Analytics Services 41.5 % 48.4 % 50.5 %
IT Staffing Services 23.0 % 22.3 % 22.1 %
Total Gross Margin % 26.1 % 26.8 % 26.6 %
Below is a tabular presentation of operating expenses by sales and marketing operations, amortization of acquired intangible assets, acquisition transaction expenses, revaluation of contingent consideration and general and administrative categories for the periods discussed:
Selling, General & Administrative ("S,G&A") Expense Details
(Amounts in millions)
Years Ended December 31,
2022 2021 2020
Data and Analytics Services Segment
Sales and Marketing $ 5.9 $ 6.2 $ 4.9
Operations 2.3 2.6 1.9
Amortization of Acquired Intangible Assets 2.3 2.5 2.1 Acquisition Transaction Expenses
- 0.1 0.6
Revaluation of Contingent Consideration - (2.9 ) -
Cyber-security Breach 0.4 - -
Severance Expense 1.0 - -
General & Administrative 5.4 4.5 3.0
Subtotal Data and Analytics Services
IT Staffing Services Segment Sales and Marketing$ 9.5 $ 7.8 $ 7.1 Operations 11.0 9.1 8.1 Amortization of Acquired Intangible Assets 0.7 0.7 0.7 General & Administrative 12.5 11.2 9.7 Subtotal IT Staffing Services$ 33.7 $ 28.8 $ 25.6 Total S,G&A Expenses$ 51.0 $ 41.8 $ 38.1 29
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Table of Contents 2022 Compared to 2021 Revenues
Revenues for the year ended
In both 2022 and 2021, we had one client that exceeded 10% of total revenues (CGI = 22.2% in 2022 and 15.0% in 2021, respectively). Our top ten clients represented 53% of total revenues in 2022 compared to 48% of total revenues in 2021.
Gross Margin
Gross profit increased to
Selling, General and Administrative ("S,G&A") Expenses
S,G&A expenses in 2022 totaled
Fluctuations within S,G&A expense components during 2022 compared to 2021 included the following:
• Sales expense was $1.4 million higher in 2022 compared to the previous
year. In the Data and Analytics Services segment sales expense decreased
by $0.3 million due to lower variable compensation expense in 2022. IT
staffing sales expense increased by $1.7 million and largely related to
higher compensation, marketing and business travel expenses.
• Operations expense increased by $1.6 million compared to 2021. In our
Data and Analytics Services segment operations expense decreased by
$0.3 million due to lower staff headcount. Operations expense in our IT
Staffing Services segment increased by $1.9 million in 2022, largely due
to higher recruitment staff and higher compensation and other variable
expenses - both reflective of higher activity levels in the first half of
2022.
• Amortization of acquired intangible assets was $3.0 million in 2022
versus $3.2 million in 2021. The decline reflected certain intangible
assets being fully amortization in 2022.
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• Acquisition transaction expense was $0 in 2022 and $0.1 million in 2021.
The 2021 expense was related to an acquisition opportunity that was
halted by us.
• The revaluation of a contingent consideration liability totaled a credit
of $2.9 million in 2021 related to the AmberLeaf acquisition. No
contingent consideration revaluations occurred in 2022.
• Reserves for a cyber-security breach and severance expenses totaled
$0.4 million and $1.0 million , respectively in 2022. There were no
reserves in 2021 for these items.
• General & administrative expenses increased by $2.2 million in 2022
compared to 2021. Our Data and Analytics Services segment was responsible
for $0.9 million of this increase due to higher executive leadership
staff headcount and higher compensation expense. The IT Staffing Services
segment had higher general and administrative expenses in 2022 of
$1.3 million compared to 2021 due to higher compensation expense and
increases in travel and facility expenses.
Other Income / (Expense) Components
In 2022, other income / (expense) consisted of interest expense of (
Income Tax Expense
Income tax expense for 2022 was
2021 Compared to 2020 Revenues
Revenues for the year ended
In both 2021 and 2020, we had one client that exceeded 10% of total revenues (CGI = 15.0% in both periods, respectively). Our top ten clients represented 48% of total revenues in 2021 compared to 47% of total revenues in 2020.
Gross Margin
Gross profit increased to
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improvement in our gross margin percentage largely reflected a favorable mix of revenues between our Data and Analytics Services and IT Staffing segments. In our Data and Analytics Services segment, gross margins declined by 210-basis points from a record 50.5% in 2020. This decrease in margins reflected a lower margin profile in our acquired AmberLeaf business. Gross margins in our IT Staffing Services segment were 22.3% in 2021 compared to 22.1% in 2020. This 20-basis point improvement was largely due to better margins on new assignments and higher permanent placement revenues in 2021.
Selling, General and Administrative ("S,G&A") Expenses
S,G&A expenses in 2021 totaled
Fluctuations within S,G&A expense components during 2021 compared to 2020 included the following:
• Sales expense was $2.0 million higher in 2021 compared to the previous
year. In the Data and Analytics Services segment sales expense increased
by $1.3 million in 2021 due to investments made in the sales organization
of $0.7 million and $0.6 million related to the consolidation of
AmberLeaf's sales expense. IT staffing sales expense increased by
$0.7 million due to austerity measures implemented in the 2020 period,
which were unwound in 2021.
• Operations expense increased by $1.7 million compared to 2020.
Approximately $0.7 million reflected investments made to the delivery
organization of our Data and Analytics Services segment - including an
upgraded and expanded facility in Chennai, India . Operations expense in
the IT Staffing Services segment increased by $1.0 million in 2021,
largely due to higher recruitment staff headcount and other variable
expenses - both reflective of higher activity levels in the current year.
• Amortization of acquired intangible assets was $3.2 million in 2021
versus $2.8 million in 2020. The increase related to amortization
associated with the AmberLeaf acquisition.
• Acquisition transaction expense was $0.1 million in 2021 and $0.6 million
in 2020. The 2021 expense was related to an acquisition opportunity that
was halted by us. The 2020 acquisition transaction expenses related to
the AmberLeaf acquisition.
• The revaluation of a contingent consideration liability totaled a credit
of $2.9 million in 2021 related to the AmberLeaf acquisition. No
contingent consideration revaluations occurred in 2020.
• General & administrative expenses increased by $3.0 million in 2021
compared to 2020. Our Data and Analytics Services segment was responsible
for $1.5 million of this increase due to higher executive leadership and
stock-based compensation expenses, as well as the consolidation of a full
year of AmberLeaf in 2021. The IT Staffing Services segment had higher
general and administrative expenses in 2021 of $1.5 million compared to
the austerity-impacted levels of 2020 due to higher stock-based
compensation expense, additional administrative staff and the unwinding
of austerity measures from 2020.
Other Income / (Expense) Components
In 2021, other income / (expense) consisted of interest expense of (
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Income Tax Expense
Income tax expense for 2021 was
Liquidity and Capital Resources
Financial Conditions and Liquidity
At
Historically, we have funded our business needs with cash generation from operating activities. In the data and analytics services and IT staffing services industries, investment in operating working capital levels (defined as current assets excluding cash and cash equivalents minus current liabilities, excluding short-term borrowings) is a significant use of cash. Controlling our operating working capital levels by closely managing our accounts receivable balance is an important element of cash preservation. Our accounts receivable "days sales outstanding" measurement ("DSO") was 59-days at year-end 2022 compared to 61-days at year-end 2021. The slight improvement in the DSO measurement in 2022 was due to a lower DSO measurement in our solution-based data and analytics business.
Cash provided by operating activities, our cash and cash equivalent balances on
hand at
Below is a tabular presentation of cash flow activities for the periods discussed:
Years Ended December 31 ,
Cash Flows Activities 2022 2021 2020
(Amounts in millions)
Operating activities
Operating Activities
Cash provided by (used in) operating activities for the years ended
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We would expect operating working capital levels to increase should revenue grow
in 2023. Accordingly, an increase in operating working capital would result in a
reduction in cash generated from operating activities. We believe DSO's will
remain at current levels or increase marginally should data and analytics
revenues grow disproportionately to total revenues. Additionally, the
Investing Activities
Cash (used in) investing activities for the years ended
Financing Activities
In 2022, cash (used in) financing activities totaled (
2022 Cyber-security Breach
During the third quarter 2022, we experienced a cyber-security breach involving
a single employee email account and which indirectly impacted two Mastech
InfoTrellis clients. Our IT team identified the point of entry, decommissioned
the affected laptop and email address, and changed email logins and passcodes
for this email account. As a result of this incident, we engaged external
advisors to validate our findings and remedial action steps. As part of this
engagement, these advisors are assisting us with a forensic analysis to
determine whether any personally identifiable information ("PII") was
compromised as a result of this breach. For any such PII data determined to have
been compromised, these advisors will be assisting us in determining the
appropriate compliance steps required with respect to that PII data. We have
accrued a pre-tax loss reserve of
Employment-Related Claims Against the Company
As disclosed in Note 9 "Commitment and Contingencies" to the Notes to the
Consolidated Financial Statements, included in Item 8 herein, a former employee
who resigned has asserted various employment-related claims against the
Company. We dispute such allegations and will incur additional SG&A expenses
during 2023 to defend our position that such claims are without merit. Estimated
professional services fees related to this matter during the first quarter of
2023 will approximate
"Shelf" Registration Statement
In 2020, we put into place an effective shelf registration statement that allows us to offer and sell common stock, preferred stock, debt and other securities, either individually or in combination, up to a total dollar amount
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of
Other than the factors discussed in this section and the potential further impacts of the pandemic on our business, we are not aware of any other trends, demands or commitments that would materially affect liquidity or our financial resources.
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, although economic uncertainty, including
the concerns of our clients and other companies with respect to inflationary
conditions in
In addition, refer to "Item 1A. Risk factors" in this annual report on Form 10-K for a discussion about risks that inflation directly or indirectly may pose to our business.
Seasonality
Our operations are generally not affected by seasonal fluctuations. However, our consultants' billable hours are affected by national holidays and vacation patterns. Accordingly, we typically 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.
Critical Accounting Policies and Estimates
Certain accounting policies are particularly important to the portrayal of our financial position, results of operations and cash flows and require the application of significant judgment by management, and as a result, are subject to an inherent degree of uncertainty. In applying these policies, our management uses judgment to determine the appropriate assumptions to be used in the determination of certain estimates. These estimates are based on our historical experience, terms of existing contracts, observances of industry trends and other available information from outside sources, as appropriate. The following explains our most critical accounting policies. See the Notes to the Consolidated Financial Statements, contained in Item 8, of this Annual Report on Form 10-K for a complete description of our significant accounting policies.
Revenue Recognition
The Company recognizes revenue on time-and-material contracts over time as services are performed and expenses are incurred. Time-and-material contracts typically bill at an agreed-upon hourly rate, plus out-of-pocket expense reimbursement. Out-of-pocket expense reimbursement amounts vary by assignment, but
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historically on average represent less than 2% of the total contract revenues. Revenue is earned on a per transaction or labor hour basis, as that amount directly corresponds to the value of the Company's performance. Revenue recognition is negatively impacted by holidays and consultant vacation and sick days.
The Company recognizes revenue on fixed price contracts over time as services are rendered and uses a cost-based input method to measure progress. Determining a measure of progress requires management to make judgments that affect the timing of revenue recognized. Under the cost-based input method, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenues, including estimated fees or profits, are recorded proportionally as costs are incurred. Incurred cost represents work performed, which corresponds with, and thereby best depicts, the transfer of control to the client. The Company has determined that the cost-based input method provides a faithful depiction of the transfer of goods or services to the customer. Estimated losses are recognized immediately in the period in which current estimates indicate a loss. We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which may be refundable.
The Company's time-and-material and fixed price revenue streams are recognized over time as the customer receives and consumes the benefits of the Company's performance as the work is performed.
In certain situations related to client direct hire assignments, where the Company's fee is contingent upon the hired resources' continued employment with the client, revenue is not fully recognized until such employment conditions are satisfied.
Accounts Receivable and Allowance for Uncollectible Accounts
The Company extends credit to clients based upon management's assessment of their creditworthiness. A substantial portion of the Company's revenue, and the resulting accounts receivable, are from Fortune 1000 companies, major systems integrators and other staffing organizations. The Company does not generally charge interest on delinquent accounts receivable.
Unbilled receivables represent amounts recognized as revenues based on services performed and, in accordance with the terms of the client contract, will be invoiced in a subsequent period.
Accounts receivable are reviewed periodically to determine the probability of loss. The Company records an allowance for uncollectible accounts when it is probable that the related receivable balance will not be collected based on historical collection experience, client-specific collection issues, and other matters the Company identifies in its collection monitoring.
Identifiable intangible assets are recorded at fair value as of the closing date
when acquired in a business combination. Identifiable intangible assets related
to acquisitions consisted of client relationships, covenants not-to-compete,
trade names and technology, which are being amortized using the straight-line
method over their estimated useful lives ranging from three years to twelve
years, as more fully described in Note 3 "Business Combinations" and Note 4
"
Excess purchase price over the fair value of net tangible assets and
identifiable intangible assets acquired are recorded as goodwill.
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We review goodwill and intangible assets for impairment annually as of
In conducting our annual impairment testing, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (more than 50%) that the estimated fair value of a reporting unit is less than its carrying amount. If not, no further goodwill impairment testing is required. If it is more likely than not that a reporting unit's fair value is less than its carrying amount, we are then required to perform a quantitative impairment test. We also may elect not to perform the qualitative assessment, and instead, proceed directly to the quantitative impairment test.
Leases
Leases Right-of-use ("ROU") assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. Since most of the Company's leases do not have an implicit borrowing rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Our leases may include options allowing us in our sole discretion to extend or terminate the lease, and when it is reasonably certain that we will exercise those options, we will include those periods in our lease term. Variable costs, such as payments for insurance and tax payments, are expensed when the obligation for those payments is incurred.
Business Combinations
The Company accounts for acquisitions in accordance with guidance found in ASC 805, Business Combinations ("ASC 805"). This guidance requires consideration given (including contingent consideration), assets acquired and liabilities assumed to be valued at their fair market values at the acquisition date. The guidance further provides that: (1) in-process research and development will be recorded at fair value as an indefinite-lived intangible asset; (2) acquisition-related transaction costs will generally be expensed as incurred; (3) restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and (4) changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will effect income tax expense.
ASC 805 requires that any excess purchase price over fair value of assets acquired (including identifiable intangibles) and liabilities assumed be recognized as goodwill. Additionally, any excess fair value of acquired net assets over acquisition consideration results in a bargain purchase gain. Prior to recording a gain, the acquiring entity must reassess whether all acquired assets and assumed liabilities have been identified and must perform re-measurements to verify that the consideration paid, assets acquired and liabilities assumed have all been properly valued.
The AmberLeaf financial results are included in the Company's Consolidated
Financial Statements from the
Stock-Based Compensation
Effective
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appreciation rights, performance shares or stock awards. The Plan is administered by the Compensation Committee of the Board of Directors. Stock options are granted at an exercise price equal to the closing share price of the Company's common stock at the grant date and generally vest over a three to five-year period.
In
The Company accounts for stock-based compensation expense in accordance with ASC Topic 718 "Share-based Payments" which requires us to measure all share-based payments based on their estimated fair value and recognize compensation expense over the requisite service period. The fair value of our stock options and shares issued under the Company's Stock Purchase Plan is determined at the date of grant using the Black-Scholes option pricing model.
Income Taxes
The Company records an estimated liability for income and other taxes based on what management determines will likely be paid in the various tax jurisdictions in which we operate. Management uses its best judgment in the determination of these amounts. However, the liabilities ultimately realized and paid are dependent on various matters, including the resolution of the tax audits in the various affected tax jurisdictions, and may differ from the amounts recorded. An adjustment to the estimated liability would be recorded through income in the period in which it becomes probable that the amount of the actual liability differs from the amount recorded.
Management determines the Company's income tax provision using the asset and
liability method. Under this method, deferred income taxes are provided for the
temporary differences between the financial reporting basis and the tax basis of
the Company's assets and liabilities. The Company measures deferred tax assets
and liabilities using enacted tax rates in effect for the year in which we
expect to recover or settle the temporary differences. The effect of a change in
tax rates on deferred taxes is recognized in the period that the change is
enacted. The Company evaluates its deferred tax assets and records a valuation
allowance when, in management's opinion, it is more likely than not that some
portion or all of the deferred tax assets will not be realized. As of
The Tax Cuts and Jobs Act of 2017 created a new requirement that certain income
earned by foreign subsidiaries, known as global intangible low-tax income
("GILTI"), must be included in the gross income of their
The Company accounts for uncertain tax positions in accordance with ASC Topic
740-10, "Accounting for Uncertainty in Income Taxes". Accordingly, the Company
has reported a liability for unrecognized tax benefits resulting from uncertain
tax positions taken, or expected to be taken, in a tax return. As of
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Contingent Consideration Liability
In connection with the AmberLeaf acquisition, the Company had an obligation to
pay consideration that was contingent upon the achievement of specified revenue
growth and EBITA margin objectives. As of the acquisition date, the Company
recorded a contingent consideration liability of
We re-measured this liability and recorded changes in the fair value when it was more likely than not that the future payments had changed. Increases or decreases in the fair value of contingent consideration can result from changes in timing and amounts of revenue and earnings estimates.
No contingent consideration revaluation was recorded in 2022 and 2020. In 2021,
the Company revalued the contingent consideration liability related to the
AmberLeaf acquisition after determining that relevant conditions for payment of
such liability were likely not to be satisfied. The revaluation resulted in a
Derivative Instruments and Hedging Activities - Interest Rate Swap Contracts
Concurrent with the Company's borrowings on
With respect to derivatives designated as hedges, the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking such transactions. The Company evaluates hedge effectiveness at the time a contract is entered into and on an ongoing basis. If a swap contract is deemed ineffective, the change in the fair value of the derivative is recorded in the Consolidated Statement of Operations as interest expense.
During the year 2022, we had no derivative instruments and hedging activities.
Foreign Currency Translation
The reporting currency of the Company and its subsidiaries is the
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Recently Issued Accounting Standards
Recent accounting pronouncements are described in Note 1 to the Consolidated Financial Statements contained in Item 8, herein.
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