Greetings and welcome to the Mastech Digital Inc. Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jennifer Lacey, Manager of Legal Affairs for Mastech Digital Inc. Thank you. You may begin.

Thank you, operator, and welcome to Mastech Digital's third quarter 2022 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 the 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 2021 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 the key metrics used by management in operating the 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 Vivek for his comments on several recent noteworthy events.

Thanks, Jennifer. Good morning, everyone. First, let me address the press release that was issued last night related to a change in leadership in our data and analytics services business segment. Ganeshan Venkateshwaran resigned yesterday from the company as the CEO of the Data and Analytics Services Segment. Our Board accepted his resignation with immediate effect. I will serve as the Chief Executive of the DNA Services business until Ganeshan’s successor is in place. Secondly, as mentioned in this morning's third quarter earnings release, we experienced a cybersecurity breach involving a single employee email account, which indirectly impacted two Mastech Info Trellis clients. Our IT team identified the point of entry, decommissioned the affected laptop and email address, and changed logins and passcodes for this email account. To be doubly sure and as good business practice, we also engaged external advisors to validate our findings and remedial action steps. As part of this engagement, these experts are assisting us with forensic analysis to determine whether any personally identifiable information, also known as PII, was compromised as a result of this breach. For any PII data determined to have been compromised, these advisers will be assisting us in determining the appropriate compliance steps required with respect to such PII data. We have accrued a pre-tax loss reserve of $450,000 in the third quarter of 2022 related to this event, which reserve includes the costs of engaging our external advisers, as well as an estimate of other potential losses relating to the breach. Finally, in the third quarter of 2022, we made a decision to close our underperforming operations in Singapore and Ireland and to rationalize our operating cost structure in the U.K. Accordingly, we reserved $120,000 of severance expense related to these actions. Let me now turn the call over to Jack for a detailed review of our third quarter 2022 financial results.

Thanks, Vivek, and good morning, everyone. During the third quarter of 2022, revenues totaled $63.2 million, compared to $59.5 million in the corresponding quarter of 2021. This 6% year-over-year increase reflected an 8% increase in the IT staffing services segment and a 4% decrease in our data and analytics services segment. The 8% revenue improvement in IT staffing reflected a higher level of consultants on billing and a higher average bill rate during the 2022 third quarter, compared to the corresponding quarter a year ago. The 4% revenue decline in data and analytics comes after a 26% year-over-year improvement during the previous quarter and largely reflects the timing of workable orders available in the second quarter versus the third quarter of 2022. Gross profits in Q3 2022 totaled $16.3 million, compared to $16.6 million in the third quarter of 2021. Gross profit as a percent of revenues in Q3 2022 was 25.8% compared to 27.9% in the 2021 third quarter. The decline in Q3 2022 gross margins was largely due to lower utilization in the data and analytics services segment as we were unable to fully deploy the second quarter ramp-up of global resources. Additionally, we incurred a project overrun of approximately $300,000 on a fixed price assignment scheduled to complete at year-end. GAAP net income for the third quarter of 2022 was $2.4 million or $0.20 per diluted share, compared to $3.4 million or $0.28 per diluted share in Q3 2021. It should be noted that reserves for a cybersecurity breach and severance expense associated with the closure of our Singapore and Ireland operations, as well as the rationalization of our cost structure in the UK had a negative impact on GAAP diluted earnings per share of approximately $0.04. Non-GAAP net income for the third quarter of 2022 was $4 million or $0.33 per diluted share, compared to $4.6 million or $0.38 per diluted share in Q3 2021. SG&A expense items not included in Q3 non-GAAP financial measures, net of tax benefits, are detailed in our third quarter 2022 earnings release, which is available on our website. Addressing our financial position, on September 30, 2022, we had cash balances on hand of $3.5 million, outstanding term loan of $2.2 million, no borrowings under our revolving credit facility, and cash availability of $36.4 million in addition to term loan capacity of up to an additional $20 million under our revolving credit facility's accordion feature. During the third quarter, we elected to early pay $7.6 million of our outstanding term debt with excess cash balances on hand. Given our term loan repayment schedule, we expect to be debt-free in early January of 2023. I'll now turn the call back over to Vivek for his other comments.

Thank you, Jack. Clearly, we are not happy with the third quarter performance of our data and analytics services business segment and view the decline in year-over-year revenues and sizable gross margin shortfalls as unacceptable. Moving forward, we need to focus more on new business development activities, strengthen our relationships with existing clients, align our billing workforce with secured workable orders, which we believe will in turn improve utilization and proactively monitor all fixed price assignments. We will endeavor to focus on these issues immediately in an effort to avoid such occurrences in the future. Our IT staffing services segment continued to grow in the third quarter of 2022 at improved gross margins and at higher bill rates. We did however see some weakness in demand during the quarter, which resulted in a 30 billable consultant headcount decline. We will continue to monitor activity levels in Q4 to assess if this was an aberration or the beginning of a shift in market dynamics. Lastly, I would like to mention that during the 2022 third quarter, with the Central Bank continuing to increase interest rates, we made the decision to early pay $7.6 million of outstanding term loan in July. This action will lower our quarterly interest expense by approximately $100,000 as we continue to deleverage our balance sheet in today's uncertain environment. Operator, this concludes our prepared remarks. We can take questions now.

Thank you. Thank you. Our first question comes from the line of Lisa Thompson with Zacks. Please proceed with your question.

Good morning.

Hi, Lisa.

Hi there. You folks have certainly had a busy quarter.

Sure, sure.

Okay. So, I think, would be interested in getting a little bit more clarity on what you think might be happening at D&A? You certainly have a lot of cash to make an acquisition. Is that something you could do and then bring in that business to run your current business? And do you think that the weakness there is possibly the people reigning in their plans due to a recession, or is that just missteps? Can you elaborate a little more?

Can you just repeat the last part? I didn't quite get that part of the question.

Do you think that the pipeline drying up or whatever is due to your own missteps, or is that from a recession where customers are pulling back their plans?

Okay. So Lisa, let me try and answer the second one first. The second one is, I think the – when I mentioned about the demand reducing a bit, it's more on the IT staffing side. We have not seen evidence of that on the data and analytics side so far. It doesn't mean it may not be there, but we haven't seen evidence of that so far. Now, coming to the first part of the question, there is clearly some work to be done on the data analytics piece. As I mentioned, there are a bunch of things that we have identified that we need to focus on, including new business development, making sure that we are able to maximize what we can from our existing relationships with our existing clients. And then making sure that we align the workforce to actual orders. We did a bit of building up of resources in Q2, but we were not able to fully utilize them. And then the last one, which happened again coincidentally with the project overrun that we had in D&A. So, these things really contributed to what turned out to be a not-so-good quarter for data analytics in Q3, but we are pretty confident, I mean, we are confident, we remain confident in the long-term growth prospects of the segment, and the value of the solutions that we have delivered to our customers. And I'm confident that our team will effectively beat the current challenges and we will emerge as a better company as a result of these efforts. So, does that answer your question, Lisa?

Thank you. Did you book any new orders in that business this quarter? We needed 10 million last quarter.

Yes, I think it was for a similar order. Jack, you have the numbers?

Yes, I think it was a little bit over 8 million.

Okay, great. And I know that Q4 is typically weaker because of the holidays, can you give us a feel for what to expect going on in Q4?

So, Q4 indeed is always a seasonally lower quarter because there are lots of holidays and there is also a tendency for some customers to put folks on furloughs, and this actually impacts our IT staffing specifically. So, we do expect some amount of decline in Q4, but that's typically seasonal. And then also a lot of assignment ends happen in the IT staffing side, virtually on the last day or the last week of the quarter, which have a little bit of impact or carry forward into Q1, and this is the seasonal view. Jack, is there anything else that you want to add?

I just want to make one comment on D&A. There's no denying that the third quarter was a bit disappointing. We got revenues of 10.1 million, well below what we were hoping for, but you have to remember that in the second quarter, our revenues were 11.3 million, and in the first half of the year, we were averaging about 10 million. So, yes, the third quarter was a disappointment, but it's not like the business is falling off a cliff.

So, do you expect it to grow sequentially this quarter or not?

I would say that I think it would be flat to slightly up in Q4.

Okay. And I know you've been in this rodeo quite a while here, as far as recessions coming up. Is there any actions you take if you start seeing weakness globally?

Yes. So, Lisa, we are already beginning to tighten our operations, as they say, because we are seeing that almost all our clients, and I'm talking more on the IT staffing side, are being extra cautious in the current uncertain conditions and the likely possibility of a recession. Now, while the large-scale projects are not being cut or large-scale headcount reductions are not happening, our customers and partners are definitely tightening their cost structure and they are pushing out or shrinking or even canceling some IT projects. So, that's what we are seeing, but in anticipation of that happening, we are already starting to tighten our operations in terms of anything that can be deferred in terms of our costs, we are looking at ways of doing that.

Great. Thank you. That's all my questions.

Thanks, Lisa.

Thank you. Our next question comes from the line of Marc Riddick with Sidoti. Please proceed with your question.

Hi, good morning.

Hi, Marc.

So, I was wondering if you could talk a little bit about the decision as far as the closing of Singapore and Ireland and some of the financials or some of the details that we might need to address with that decision?

Sure, Marc. Jack has been personally driving that initiative. So, I'm going to let Jack talk to you about this.

Sure, Marc, about two plus years ago, we established Singapore, Ireland, and the UK subsidiaries on the expected strength of a global partnership that we had with a major client. And shortly thereafter, COVID hit, and the business really never took off as we expected. In 2021, we made some gains in the UK, but the other two entities continued to underperform. So, we entered 2022, and the Singapore operations and the Ireland operations continued to operate at a loss. And recently, we decided that it was really time to cut bait. We had other areas in the U.S. to spend our money rather than trying to grow a couple of subsidiaries that we just couldn't grow. The UK has gained some traction in both 2021 and 2022, but we really haven't been turning the profits that we expected. And that's why we made the decision to rationalize our cost structure in the UK as we go into 2023. So, that's sort of the short of it.

Okay. And then, could you sort of remind us, so the headcount was sort of growing going into the summer. There was a ramp up on staffing, so can you sort of bring us as to where we are at the end of the third quarter and where we might be as far as headcount and staff?

Sure, Marc. So, as I mentioned that we had a 30 billable consultant headcount decline in Q3, the point to be noted is that our assignment starts continue to be very high. I would say even in this Q3, it is probably one of the top five or six quarters since, I guess, last six, seven years. So, they are sort of not at the record level that were a couple of quarters ago, but they're still pretty high. The problem is in this equation when you are doing the net growth, it's just the number of starts minus the number of assignment ends. The assignment ends have been high. And I think that some of it is based on what I mentioned a little earlier as the customers are trying to tighten their budgets, they are really asking themselves the question, do we need some of the projects to continue? So, we've had an exceptionally high number of ends of assignments in the quarter. And so, very high starts, but very high-ends, sort of ended up making it into a negative 30 kind of number. But we are watching this closely to see if there's something, which is sort of a one-off kind of a thing or is this now going to be a pattern of the market dynamics going forward?

Okay. And then you made comments either – it might have been both in the press release and the prepared remarks around bill rates, can you sort of put a little more to what you're seeing there on bill rates and maybe how that sort of played out throughout the quarter?

So, the bill rates, we're happy that we've been able to steadily increase the bill rates over the last three, four quarters, and we've got the benefit of that. It's again, Marc a result of demand versus supply. When the supply was limited, demand has been much higher for these resources, which drives up the input price, the price that we pay or what we pay our consultants and in turn what the customers are willing to pay as well. So, that has been to our advantage. It's really again a function of how this dynamically demand versus supply changes over the next few quarters. That may sort of bring some kind of price pressure, but so far, it's been all very positive and we've got the benefit of it.

Okay. And then can you bring us up to speed on – if I remember correctly, sort of the timing of some technology spending in implementation that took place earlier in the year and sort of, could you sort of bring us up to speed, sort of where we are there? And what you might be expecting for the remainder of the year?

Yes, we – in our data and analytics services segment, we implemented earlier in the year. Our cloud system implementation concluded at the end of April. We spent a little bit of money to get the bugs out in the second quarter, but that's pretty much completed right now.

Okay. And so, what we might be looking at CapEx – sorry, yes, for CapEx for the year?

CapEx is going to go, I mean compared to what we spent over the last first half of the year, CapEx is going to go down.

Okay. Alright. So, it'll be a little less than or about the same as last year for this year?

Let me look at the statements real quick here. So, for the first nine months of 2022, we had CapEx of about 800,000. In 2021 nine months, it's about the same thing, it's about 900,000. So, I would expect that we end up the year about 1 million, 1.1 million, probably 1 million.

Okay. Got you. And just – so if we could go back to sort of the demand environment that you're looking at on IT staffing, can you sort of bring us up to speed on what you're seeing, as far as your customer verticals? And are there any sort of stand out by the positive or negative that you're seeing there as far as their activity? I mean, I understand you're seeing in general as far as folks are slowing down a bit, but are there any particular areas that are maybe more active in that behavior or vice versa that are noticeable?

Sure, Marc. Actually, the drop is virtually across the board. It's really a drop in demand that we are seeing or the tightening of the belt that I've been saying is across the board, it's really all customers, and it is virtually all verticals. So, there is no clear pattern emerging that it's one more than the other, although Financial Services, specifically at that vertical is showing a lot more concern and we're having a lot more conversations in that space. But every customer is being extra cautious in these conditions right now. And as I mentioned that no major large scale cutting is being seen so far in terms of huge headcount reduction, something that we saw in 2020 or large projects being canceled, but we are seeing that smaller actions such as pushing out projects, not canceling them, or shrinking the size of the projects or breaking up the projects into smaller phases. And then sort of committing to only one phase at a time, so they have the option of sort of pulling the plug if they need to halfway or through the whole process. There has been some cancellation of some IT projects, but those have been few and far between. That's what we are seeing at this point in time. So, there's no clear pattern. It is everybody is sort of waiting to see what actually happens, but based on conversations, I can see almost every organization has made their contingency plans that should things really get bad, what are the steps they will take?

Okay. And then the last one for me is, if you can sort of bring us up to speed on maybe what you're thinking about for data and analytics, as far as the acquisition side of things. And this was something that earlier in the year with the new leadership, I know you were sort of looking at the pipeline and looking at priorities, and obviously the news is very fresh, but maybe sort of give us some thoughts as to where you are as what your thoughts are with the potential acquisition pipeline, the health of it, and desirability or pricing maybe, sort of benefit to speed and maybe what your thoughts are there?

Sure, Marc. I mean, acquisition is definitely in our plan. We will, as I've said before, we would be doing the acquisition on the data analytics side. Specifically, what are the areas that is something that in some ways we will now want to wait for the new leader to be on board and make sure that the selection criteria for the acquisition aligns with the strategies of the new leader. So, I think what this really means is that for us, we have to put this on the back burner for a couple of quarters, and then we will at the first opportunity once the new leader settles down, we would want to reactivate our plan and go back to it. So, not much has changed, it's just the timeline has got extended a little bit.

Got you. Thank you.

Thanks Marc.

Our next question comes from the line of an analyst with Bennington Capital. Please proceed with your question.

Hi, good morning Vivek and Jack.

Hey, Ross.

Thanks. Hey, so I was curious if you could just talk a little bit more about data analytics specifically? And if I recall correctly, it seems like with Q2 results, you had ramped up some headcount and you alluded to sort of the underutilization of that increase in staff, if I understood you correctly for this quarter. I'm curious if you could elaborate on maybe what changed or, sort of how that maybe imbalance happened because it seemed like demand expectations were a little bit more robust in Q2 and it seems like maybe you expected some growth. And I'm curious what changed more specifically through the quarter that led to that shortfall, if you will?

In the second quarter, we increased our resources in preparation for several projects anticipated to start in the third quarter, but we didn't manage to get all the projects signed in time. As a result, we ended up with more resources than we were able to assign to active orders. It's a straightforward issue. We need to ensure that our order bookings moving forward align with the resources we have available. We're actively addressing this misstep to avoid a drop in utilization and to mitigate the fluctuations we've seen in revenue. Several factors contributed to our current situation in data analytics.

Fair. That's helpful. I mean, it sounds like you characterized it as a misstep, in retrospect, hindsight is of course 20/20, but do you feel like – it sounds like you feel like that you could have done better in terms of anticipation. Is that a fair takeaway of how you would characterize it?

I would actually say that's correct. Maybe we shouldn't have ramped up that much. And at the same time, we should have had our order book, or pipeline robust enough to be able to sustain that. So, we had an issue on both sides. And we've identified that and we are already working on addressing those.

Great. Thanks on that. And then I just wanted to ask about the fixed price overrun. Just to understand, kind of what high level, kind of leads to that overrun? And then is that – you said it was going to be expected to end at the end of the year. Is that something you continue to – you expect to recur? Any sort of like systemic thing you're watching related to that overrun?

So, Ross, the good news is that the overrun is over. We don't want to have that carrying forward.

Yeah. That's correct.

And the other thing I want to really stress, when we do fixed price projects, or any organization does fixed price projects, there's always the occasional project, which gives you a little bit of trouble where you underestimated some other reason you end up spending more resources on that project. One point which is really important is that this is the second project in the last five years since we acquired Info Trellis that has gone into an overrun. And I would say that if we – the last one was actually many years ago. So, I would say, while it's not good to have any project going into this overrun, having just had two in the last five years speaks volumes about the quality of delivery that we have in the organization. Of course, we will look at this closely. We are already looking at all fixed price projects very closely to see that we are able to spot and identify any other potential problem project way earlier, but this is where we are.

Great. That's helpful. Thanks. That's all I had. Appreciate it.

Thank you, Ross.

Thank you. We have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Thank you, operator. If there are no further questions, I would like to thank you all for joining our call today, and we look forward to sharing our fourth quarter 2022 results with you in early February. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.