Greetings. Welcome to Mastech Digital, Inc. First Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. It is now my pleasure to introduce your host, Jennifer Ford Lacey, Manager of Legal Affairs for Mastech Digital, Inc. Thank you, Ms. Ford Lacey. You may begin.

Thank you, operator. And welcome to Mastech Digital's first quarter 2020 conference call. If you have not yet received a copy of our earnings announcement, it can be obtained from our website at www.mastechdigital.com. With me on the call today are Vivek Gupta, Mastech Digital'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 2019 annual report on Form 10-K filed with the Securities and Exchange Commission and available on its website at www.sec.gov. Additionally, management has elected to provide certain 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 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.mastechdigital.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 first quarter 2020 results.

Thanks, Jen. And good morning, everyone. Let me begin by acknowledging our current environment. Obviously, the COVID-19 pandemic is having a profound impact on the global economy and on people's lives. Companies are being faced with unprecedented challenges, and Mastech Digital is no exception. While our business and financial results will be adversely impacted by the economic and other conditions arising from COVID-19, the extent of this impact will largely depend on the duration of shelter-in-place and other government mandates, as well as the pace of the expected economic recovery. We're fortunate to enter this difficult period in a strong liquidity and cash position. This, combined with our business model, leads us to believe that we won't experience some of the severe liquidity challenges that many other companies are facing as this pandemic plays out. With that backdrop, let me now turn to our first quarter 2020 financial results. Revenue for Q1 2020 totaled $50.4 million and represented a 12% increase compared to $45.2 million in the first quarter of 2019. Our Data and Analytics Services segment contributed $7.4 million of revenue during Q1 2020, which exceeded last year's Q1 revenue results by 28%. Activity levels in this segment held up well, given the state of the global economy, and we did secure a significant multiyear, multimillion-dollar order with a blue-chip customer in the financial services industry in March. While our pipeline of opportunities is strong, we are seeing some clients pushing projects out into the second half of the year. Year-over-year revenue growth from our IT Staffing Services segment was 9% in the first quarter of 2020. However, we are seeing lower demand for our Staffing Services, particularly with clients in hard-hit industries such as travel, energy, and manufacturing. Gross profit for the first quarter of 2020 totaled $12.7 million compared to $10.8 million in the same period last year. Our gross margins for Q1 2020 were 25.2% of revenues compared to 24% in the first quarter of 2019. This is our second consecutive quarter of breaking the 25% gross margin barrier. Our Data and Analytics Services segment had gross margins of 47.1% in Q1 2020, an increase of 160 basis points from a year earlier. Our IT Staffing Services segment had first quarter 2020 gross margins of 21.5%, an increase of 70 basis points from the 2019 first quarter. Higher margins from new assignments in both segments were largely responsible for this improvement. SG&A expenses were $10.2 million in the first quarter of 2020 compared to $9 million in the first quarter of 2019. This $1.2 million increase in SG&A expenses represented investments of $900,000 in our Data and Analytics Services segment, principally in the areas of global sales and delivery, and $300,000 in our IT Staffing Services segment, largely due to higher staff-related expenses. As we entered 2020, we had planned to continue investing in both of our business segments. However, given the current environment, we will delay much of these planned expenditures until we start to see a meaningful recovery in economic conditions. GAAP net income for the first quarter of 2020 was $1.9 million or $0.16 per diluted share compared to $1 million or $0.09 per diluted share in the first quarter of 2019. Non-GAAP net income for Q1 2020 was $2.7 million or $0.23 per diluted share compared to $1.6 million or $0.15 per diluted share in the corresponding quarter of 2019. First quarter SG&A expense items not included in non-GAAP financial measures, net of tax benefits, for the amortization of acquired intangible assets and stock-based compensation and are detailed in our first-quarter earnings release, which is available on our website. Addressing our financial position, at March 31, 2020, we had $19.6 million of outstanding debt, net of cash balances on hand and borrowing availability of over $15 million under our existing revolving credit line. During the quarter, we reduced debt by $3.4 million, lowering our debt-to-equity ratio to 0.45 compared to 1.1 a year ago. I'll now turn the call over to Vivek for his comments.

Good morning, everyone. Thank you, Jack, for the detailed financial review of our operating results for the first quarter of 2020. Let me begin by saying that Mastech Digital is navigating today's challenges from a position of relative strength following record performances in so many critical areas in 2019. The entire organization is working incredibly hard to serve our customers during these difficult times. We were quick to mobilize our workforce to a remote work-from-home model to mitigate the health risks to our employees and to continue to provide uninterrupted service to our customers. Our ability to do so was made possible by our solid technology platforms across our global environment, which we have been investing in quite heavily over the last several years. Ironically, while the world has been going through this unprecedented crisis, we have delivered one of our best quarterly results on many parameters in the first quarter of 2020, including revenue growth in both business segments. Having said that, we did see some adverse impact of COVID-19 during the month of March and continue to see both our businesses being impacted thus far in the second quarter. However, with visibility being substantially limited on one hand and with the continued existence of new opportunities on the other, I'm unable to quantify for you the exact impact on our Q2 financial results. But what I can tell you is that we are very confident that, A, the fundamentals of the company remain strong; B, the high demand for our services will return as the global economy recovers; and C, we are well-positioned to withstand these economic headwinds until it does. Meanwhile, during this crisis, we are prudently adjusting our cost structure in ways that will allow us to maintain our top-notch talent that we have artfully secured over the years. With proven track records in both of our businesses, we're mindful of avoiding any short-term decision that may hinder our ability for a speedy and prosperous recovery. Lastly, I'm happy to tell you that both morale and confidence levels are high across our entire organization, despite today's daunting environment. Without getting too granular, many of the austerity measures that we have undertaken have been received well by the organization with understanding and even appreciation. Major crises tend to bring people together, as can be seen across the world today. At Mastech Digital, I see a similar resolve in our dedicated associates to successfully get through this crisis and an eagerness to get back to building upon our accomplishments and successes of 2019. I will now open the session for your questions.

Thank you. Our first question is from Josh Vogel from Sidoti & Company.

Thank you. Good morning, Vivek and Jack. I hope you and your families are doing well. Really nice results for Q1 despite the onset of the pandemic. I do have a bunch of questions for you. I guess the first one, just looking at the tax rate in Q1, it was 17%. It's much lower than the 26%, 27% rate you've reported over the prior couple of quarters. Can you tell us why? And is this the new tax rate we should expect going forward?

All right, Josh. Thank you for your question. I'm going to ask Jack to answer that.

Hi, Josh. Yeah, the tax rate was down in Q1 of 2020, and it was actually down to about 17%. Our normal tax rate is generally around the 26% level. For Q1, we did get some benefit because we had a lot of stock exercises, which generated – in accounting lingo – excess tax benefits. That occurs when the gains from the exercises of stock options exceed the fair value of the options as determined at the grant date, which is the 123R expense. So, the difference between the two actually creates higher deductions for a company when they do their tax returns. Those additional tax deductions are booked as reductions in our tax provision. So, you should still expect the 26% going forward, but there's always an opportunity for this situation to resurface. It's just part of the elements that impact our provision.

Okay, that's helpful. Thank you. So – shifting – looking at the interest expense, it obviously dropped pretty significantly compared to the prior year. I know you've been paying down debt at a good clip. Were there any changes to your effective interest rate? What was it? And has that dropped with the Fed's moves in Q1?

Jack?

Yeah. Just give me a second here. So, our effective interest rate on our term loan today is a little over 4%. Our effective interest rate on our revolver is a little over 3%. So, if you would blend those percentages – I think our average interest rate today is around 3.5%. In the first quarter of 2019, our effective interest rate was 5.5%. So, yeah, it has been dropping. It has been dropping due to a combination of the Fed cuts and then also the impact of a diminishing term loan balance, which carries the higher interest rate. So, that's definitely helping our overall interest. But probably the bigger factor is our debt repayments, which have been really good over the last 12 months.

Okay, great. On the liquidity position, I know you mentioned that you had more than $15 million available to you on the existing revolver. I was just wondering if you had access to any other potential vehicles. And also, are you potentially partaking in any of the government programs?

Yeah. Jack, will you take this one too?

Yeah. The $15 million of availability, we believe that is more than enough to get us through this situation and return to normal times. We do have a $10 million accordion feature in our PNC credit facility that we can draw on. But we don't expect that we're going to need to draw on that. But it is nice to have in case the unexpected occurs. As far as – you're talking about the tax – or the stimulus tax, right?

Yes.

Yeah. The one provision that we did take advantage of was a provision that allows you to defer the employer portion of FICA taxes. Again, this is only a deferral. It's not going to directly impact our P&L. It won't lower our SG&A expenses. But, indirectly, it will have a pretty nice effect on interest expense because we are going to have a nice cash savings through the deferral. The payments on the deferral, which we expect to accumulate to about $5 million by the end of the year, don't have to be paid back until the end of 2021 and the other half at the end of 2022. So, it's a nice benefit. But that's the only provision that we took advantage of.

Okay, great. That's helpful. So, shifting gears, you mentioned that you were putting some planned investments on hold, adjusting the cost structure. Can you remind me how much you intended to spend on these investments before COVID-19 versus today's plan? And also, was this mostly all personnel? I know, Vivek, you had a comment on, you had invested in the technology. So, is this a blend of personnel and technology? And then, I guess, are you concerned that if you do put some of these investments on hold, are you concerned that this will impact your speed of recovery when the economic conditions improve?

Good questions, Josh. So, I don't think I have the exact numbers as to how much we were planning to invest, and out of that, how much we have done already. But I can say it's a pretty significant amount that was yet to be invested. Coming to the larger point, when we've taken these austerity measures, we've been guided by four main principles. We should minimize the essential expenditure, which has to be done anyway, but minimize it to the extent that is possible. Then eliminate or defer discretionary spend and all investments for future growth, but more importantly, protect all our A and B players. We don't want to cut ourselves deeply enough that it hinders our ability to scale quickly because we think that when things start recovering, the economy starts recovering, demand will come back fairly quickly. We should be ready and able to scale at that point in time. So, we have not deliberately taken any action that compromises that. So, does that answer your question, Josh?

Yes, definitely. And just one more and I'll hop back in the queue. So, if we look at the APAC region as a model for recovery and maybe the three-month or so lag that we're seeing in the US – I know you're not giving guidance – but any sort of directional commentary. If we could think about the revenue cadence and what it could look like within both Data and Analytics and IT Staffing over the balance of the year, if assuming that we get back to a new normal in say, June or July, I was just curious about any comments you had on that. Thank you.

Okay. Let me try and answer it slightly differently as to what has been the impact so far in both the businesses. On the Data and Analytics side, the demand is still there. The pipeline is still looking robust, and that includes Asia-Pac, Europe, and North America. The one thing that's happening is that decisions are getting deferred or delayed into the later part of the year. So, the scaling up that we were hoping or planning for to happen quite rapidly beginning maybe in the very first half of the year itself is going to get delayed. On the other side, the IT Staffing business, demand has definitely come down. Some of the clients who are in those heavily hit industries have actually come up with early ends, customers who are in industries, as Jack mentioned, like transportation, energy, manufacturing. That's how it happened so far. But again, like I said a little while ago, we expect that when things ease up, when things start settling down, economies start recovering, we feel that the staffing demand will come back very quickly. We are hoping that the Data and Analytics decisions will start getting pulled up a little closer rather than further out into the year. Does that make sense?

Yeah, definitely. Thank you again. I'll hop back in the queue.

And our next question is from Howard Rosencrans from VA. Please proceed with your question.

Hi, guys. I hope you and your families are all safe and healthy, as are all your employees and theirs. I wanted to ask you about – just follow-up on the last question. I'm not sure I fully understood your answer and you have had that $20 million plus order. So, would you provide a little more color on the prior answer in the context of the two separate businesses? The IT business, I believe you're saying that there's a – that you're seeing pushouts and earlier terminations, and I'm not sure exactly on the clarity of the Data Analytics piece. And really to get a little more color on that large, large order that you got in – I believe it was December. Thank you.

Okay. Hi, Howard. Nice to hear your voice. Thank you for the question. So, as you know, Howard, we have two business segments, the Data Analytics and the IT Staffing Services business. The Data Analytics business is the one that secured $23 million of business in December. And these were three multimillion-dollar, multiyear contracts. Happy to say those contracts are going strong, and we are delivering upon them month after month. In fact, in this quarter, in the month of March, we added a fourth one, which is also of similar size and quality, a multiyear, multimillion-dollar contract. That has also started executing. So, the point I was trying to make on Data Analytics is not that any of those have been affected. I'm saying that the business, we were hoping to scale the business beyond where it is right now to higher levels. That part of scaling is getting delayed because the pipeline is still there, except that the customers' decisions are getting pushed out further into the future. What we were hoping to achieve in the first half of the year probably is going to happen in the second half, and what we were hoping to achieve in the second half of 2020 will probably happen in early 2021. So, that's as far as the Data and Analytics segment is concerned. The IT Staffing business, we have about 1,100 plus of our associates billing for clients on different parts of North America, primarily the US, and that's the piece where I was saying that we have seen demand for that staffing has reduced somewhat, and some of the folks that were billing in that 1,100 plus were early – we saw some early terminations from the customer side, and we are talking about a few percentage points out of the 1,100, were from customers who have been badly affected, like airlines, cruise industry, and so on and so forth. So, that's the distinction I was trying to make between the two businesses. Does that answer your question, Howard?

It's certainly very helpful. I appreciate the color. So, in terms of the Data Analytics, that business remains steady and you can basically deliver off backlog for the next few years. And you also picked up another contract in March, so that you could also deliver over the next few years. Am I understanding that correctly?

Yes. As I've mentioned, there is limited visibility and things are changing by the week, by the hour right now. But as of today, we are comfortable that these multiyear deals that we have signed will continue, and we'll be able to execute upon them over the next few years.

Do the customers have the ability to stop? Would either be canceled with a fairly limited penalty or would you expect that sort of activity to follow on that, or can they only defer without any meaningful cancellation fee?

Well, Howard, the contracts are worded in a way that both sides have the option of giving notice to each other, stopping the contract, or putting it on hold, if need be. But the conversations that we are having with the customers, we are not seeing any indication of that happening at this point in time.

Okay. Thank you. Thank you both. Wishing one and all continued safety and health. Thanks so much.

Thank you, Howard.

And our next question is from Lisa Thompson from Zacks Research.

Good morning.

Hi, Lisa.

The first question I had is, could you just decode this cryptic adjusting cost structure to allow us to retain top-notch talent? Does that mean you gave people raises? Like, what does that mean?

Well, Lisa, there is actually a bunch of things that we have done. We've tried not to impact the top-notch talent. That's been one of the principles when we've been coming up with our austerity plan. We want to protect all our A and B players. Among the things that we have done, we've put a hiring freeze. We've delayed joining dates of people who were already in the hiring process. We've actually delayed compensation increases, which are typically done around this time – springtime – effective 1st of April. We've put all our marketing initiatives on hold or minimized them, including participation in a lot of conferences and some of our internal events. Travel has reduced dramatically. We've also eliminated a bunch of bottom C players, which is anyway an annual feature, which we do around springtime after we complete our annual appraisals. We are looking at better utilization of paid time off, and we have been negotiating or renegotiating with our suppliers and partners in the spirit of collaboration. Because of the current situation, they have a reduced need, especially when people are working from home. Of course, we've also benefited from the unintended consequence of the global working from home. We've saved some on infrastructure and operational costs because people are not going to work in office locations. There is a whole long list of things that we've looked at, and we continue to find ways to keep our SG&A under control and not impact the key players that we have and not lose them. Does that answer your question, Lisa?

Yes. That's much more clear. Thank you. So, does that mean that one should expect SG&A to be down sequentially for June and the rest of the year?

Well, definitely, the SG&A should be down in Q2. Again, to what extent? It's a work in progress. Depending on how things pick up in the future quarters, if business starts picking up, the SG&A will pick up as well. But if, unfortunately, the economies remain where they are and they don't pick up in a hurry, then we will keep our SG&A down.

Okay. And do you have the exact number of how many billable consultants you had for the quarter?

I don't have the exact number as of March 31, but it was upwards of 1,100. And these are...

It was exactly 1,100.

The billable on IT Staffing side. And then, of course, we have billable people on the Data Analytics side, and that would be closer to 175 or so. So, if you add the two, that's roughly 1,300 people billing in the last quarter.

Okay. So, based on what's happened so far, since we're at the end of April, how much has that number come down due to cancellations? Are we talking hundreds or tens of people? Just vaguely. Because it sounds kind of scary when you don't quantify it.

Yeah. So, I can give you a sense. I think we had – and, Jack, if you have the exact number, you can mention. But in the region of 50 to 60 in Q1. We lost that many people billing. So, we're talking about a few percentage points on 1,100. We're not talking about tens and twenties of percent of the 1,100.

Okay. So, I guess, that means then revenues in Staffing will be down sequentially. Does that also apply to Data Analytics? Or because of your new contracts, could that number be up sequentially?

I don't think we have that feel for, at this point in time, whether this number will remain the same or go down for Data Analytics. But on the IT Staffing side, sequentially, yes, it will be a little down.

Okay. All right, great. This is much clearer as to what's going on. Thank you so much. Wait, one more question. As far as recruiting and things, has anything changed in the visa situation for yourself?

Actually, at this point in time, the situation has not changed for us. Of course, the whole recruiting process has changed because of people working from home, but I think as we don't bring people over from overseas for billing purposes – we hire locally within the US – so, as of now, it hasn't changed.

Okay, great. Thank you so much. That's all my questions.

Our next question is from Josh Vogel from Sidoti & Company.

Hey. Just following up on that last question. Can you give any thoughts or comments around the recent legislation that's going to limit immigration into the US and what impact that could potentially have on your base of the H1B visa holders?

So, Josh, right now, what we understand is immigration has been put on hold, which is bringing fresh people from overseas into this country. But the current legislation as of today does not impact the people who are already here. Now things can change; something can come out in the next week, two weeks, we don't know. But that's where we are at this point in time.

Okay. And just last one, given everything going on, we've seen kind of like a reset in some market valuations. I was just curious about your appetite to make deals and what the pipeline looks like.

So, if you're talking about making deals as in M&A, then right now, we are obviously – this is not the time to do that. We are still open-minded. We are looking at what the options out there are. But I don't think we will be aggressively pursuing it until we are out of this current economic crisis.

Okay. I'm sorry. If I could just sneak in one last one. When you talked about the clients within the hard-hit industries like transportation, energy, manufacturing, could you quantify what percent of revenue comes from those sectors? And then maybe what percent would you say comes from the essential businesses where maybe you'd see less of an impact?

Actually, we've been fortunate. The total amount of business that comes from the transportation – travel and transportation segment is actually very small. It's probably 2% or 3%. Manufacturing is a little bit more. Energy – and then, retail is one which I hadn't mentioned – is one more. So, we actually don't have any major concentration in any one or two industry segments, although financial services and health care are probably the larger ones. But we are fairly well spread out. What's happened is, while some of these industries have been hit very badly, a couple of them have actually seen an uptick. But, of course, net-net, when you balance everything out, it's more negative than positive. We don't have any serious industry concentration, which kind of exaggerates the risk for us.

Hey, Josh. In our annual report, we do break down our industry verticals. So, under our description of businesses, you will find our top five industry verticals. So, that might help you.

Okay, great. Thanks again for taking all my questions. And stay safe out there, guys.

Thank you, Josh. We appreciate your questions.

And our next question is from Howard Rosencrans from VA. Please proceed with your question.

Hi again. I just wanted to follow-up a little more on the visa situation and the ability to get employees, et cetera. So, I apologize if this is a historic question. I felt like I had a deeper understanding of this. Your employees, you're hiring within the United States, but they are already employees that have come, I believe, predominantly from India and they have achieved their status where you – and/or in some cases, you're working with them to garner that status for the – the employer has to sign on to give them that status as H1B. I'm just trying to get clarity on that, so I can better understand. Thank you.

So, Howard, it's like this. We hire potential employees from within the US. Almost half or so of that are US citizens and Green Card holders who have been here. Many could be of Indian origin, and a lot of them are not. Then, we have another pool which is the pool of H1B candidates. They are people who have come here on H1B, and they've been working – they've come on other company's H1Bs and they are now looking for better opportunities. We help them find those opportunities, and there we have to do what is called a transfer, an H1B transfer to the new jobs that we are able to find. When we were talking a little earlier about immigration being put on hold, at the moment, it's fresh people coming in from India and other countries into this country on H1Bs. For us that does not immediately impact us because we are hiring people from within the pool that is already here in the US. Does that answer your question? Or am I missing some key points?

No, no, no. I think that does. So, it's sort of if you needed people further out, it would impact your hiring capability. It doesn't impact your ability now, particularly since there's a lot lower demand for consultants or for employees. I think that's fair to say, right?

Yes. Actually, that's true. The demand was far more than supply when we were looking at things in January, February timeframe. Today, because the demand has come down, the supply is more. So, in some ways, it makes it easier for our recruiters to find the right talent for those positions, which are still open and customers are looking for them.

And could you give us some color as to the first few weeks of April as to what you're seeing, if you're comparing it on a year-to-year basis versus last year? How deep are the cuts down? You commented that you were down, I don't know, about 50 or 60 people year-end to the end of Q1. I believe that was the timeframe you quoted. Although on the same vein, I would assume that you had a pickup during the quarter because you had – because your revenues in both segments increased. So, I would assume that you actually went from, let's say – there's probably a 10% cut in March from peak to quarter-end. And just trying to understand – is that fair to say? And what has been the additional cut in the first few weeks of April? Thank you.

Okay. So, April is not over yet. So, we don't have the final numbers of what it looks like. But in some ways, the trend has been continuing. What happened in March has happened in April as well. But coming back to your comment about the headcount, what happened in the first quarter, yeah, we did lose some people. But in some ways, it got compensated by new starts that we got for better bill rates and, in some places, even better gross margins. Also, the entire cut did not happen on the very first day of the quarter. It happened over a period of the quarter. So, it did not fully impact the revenues for that. But that reduction is definitely going to have a carryover impact into the second quarter that we are in. So, I can't give you a precise number for April, but the reductions have been sort of continuing in the way it started in March.

Okay. Do you know what your peak employee count this year was? You comment that 1,100 of the regular IT guys at the end of the quarter. Do you know what your peak was and approximately when it occurred?

I'll have to look at my records. But as I said, it is above 1,100. Whether it was 1,125 or 1,104 or 1,140, I wouldn't know immediately, but we can get that information.

Okay. You guys are very gracious, and I thank you. In light of what's transpiring, it sounds like you're doing very well. Hats off to you in that regard. It certainly seems like you have a lot of talented people and you're picking up share. So, congrats on the way you're getting through. Thank you.

Thanks, Howard. Appreciate it.

And we have reached the end of the question-and-answer session. And I will now turn the call back over to Vivek Gupta for closing remarks.

Thank you, operator. If there are no further questions, I would like to thank you for joining our call today. We look forward to sharing our second-quarter 2020 results with you in late July. Until then, please stay safe. Thank you.

And this concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.