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MASTECH HOLDINGS, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion in conjunction with our audited consolidated financial statements and accompanying notes for year ended December 31, 2010, included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission ("SEC") on March 17, 2011. 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 2010 Annual Report on Form 10-K. 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.mastech.com. The Company's 2010 Annual Report on Form 10-K, current reports on Form 8-K and all other reports filed with the SEC, are available free of charge on the Investor Relations page. The website is updated as soon as reasonably practical after such reports are filed electronically with the SEC. Overview: We are a provider of IT and specialized healthcare staffing services. From July 1986 through September 2008, we conducted our business as subsidiaries of iGATE. We do not sell, lease or otherwise market computer software or hardware, and 100% of our revenue is derived from the sale of staffing services. Our IT staffing business combines technical expertise with business process experience to deliver a broad range of services within business intelligence / data warehousing; web services; enterprise resource planning & customer resource management; and eBusiness solutions. We provide our services across various industry verticals including: automotive; consumer products; education; financial services; government; healthcare; manufacturing; retail; technology; telecommunications; transportation; and utilities. Our healthcare staffing unit provides specialized healthcare professionals to hospitals and other healthcare facilities. The Company aggregates its IT and healthcare operating segments based on the nature of services and accordingly, have one reportable segment. Thus, no segment related disclosures are presented. However, the Company tracks and evaluates its revenues and gross profits by four distinct sales channels: wholesale IT; retail IT; specialized healthcare and permanent placements / fees. Our wholesale IT channel consists of system integrators and other IT staffing firms with a need to supplement their abilities to attract highly-qualified temporary technical computer personnel. Our retail IT channel focuses on clients that are end-users of IT staffing services. Within the retail channel are end-user clients that have retained a third party to provide vendor management services, commonly known in the industry as Managed Service Providers ("MSP"). The specialized healthcare channel clients consist of hospitals and other healthcare facilities that utilize our staffing professionals. Permanent placement / fee revenues are incidental revenues derived as by-product opportunities of conducting our core contract staffing business. Critical Accounting Policies: Our critical accounting policies are described in Note 1 "Summary of Significant Accounting Policies" of the notes to our audited Consolidated Financial Statements, included in our 2010 Annual Report on Form 10-K. 10 -------------------------------------------------------------------------------- Table of Contents Economic Trends and Outlook: Generally, our business outlook is highly correlated to general U.S. 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 domestic economy, demand for our services tends to decline. As the economy slowed during the last half of 2007 and recessionary conditions emerged in 2008 and during much of 2009, we experienced less demand for our staffing services. During the second half of 2009, we began to see signs of market stabilization and a modest pick-up in activity levels within certain sales channels and technologies. In 2010, market conditions continued to strengthen over the course of the year and activity levels within most of our sales channels progressively improved. During the first half of 2011, activity levels have trended up at a modest and uneven pace. However, a challenging domestic job market and high levels of unemployment are concerning data points for the future. In addition to tracking general U.S. economic conditions, a large portion of our revenues are generated from a limited number of clients. Accordingly, our trends and outlook are 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 U.S. economic trends from time to time. In recent years, a larger portion of our revenues have come from our wholesale IT sales channel, which consists largely of strategic relationships with systems integrators and other staffing organizations. This channel tends to carry lower gross margins, but provides higher volume opportunities. Should this trend in our business mix continue, it is likely that our overall gross margins will decline. Within our retail IT sales channel, many larger users of IT staffing services are employing MSP's to manage their contractor spending in an effort to drive down overall costs. The impact of this shift towards the MSP model has been lower gross margins. Should this trend towards utilizing the MSP model continue it is likely that our gross margins will decline in the future. Results of Operations for the Three Months Ended June 30, 2011 as Compared to the Three Months Ended June 30, 2010: Revenues: Revenues for the three months ended June 30, 2011 totaled $22.1 million, compared to $16.9 million for the corresponding three month period in 2010. This 31% year-over-year organic revenue increase largely reflects a higher level of IT billable consultants during the 2011 period and the geographical expansion of our healthcare business. Billable IT headcount at June 30, 2011 totaled 530 consultants compared to 407 consultants, one-year earlier. For the three-months ended June 30, 2011 our billable IT headcount increased by 58 consultants. Below is a tabular presentation of revenues by sales channel for the three months ended June 30, 2011 and 2010: Three months Three months ended ended Revenues (Amounts in millions) June 30, 2011 June 30, 2010 Wholesale IT Channel $ 14.4 $ 10.7 Retail IT Channel 5.5 4.9 Specialized Healthcare 2.1 1.3 Permanent Placements / Fees 0.1 - Total revenues $ 22.1 $ 16.9 Revenues from our wholesale IT channel increased 35% in the three month period ended June 30, 2011 compared to the corresponding 2010 period. Higher revenue levels from both staffing clients (up 27%) and integrator clients (up 40%) were driven by stronger demand for IT services. Retail IT channel revenues were up approximately 13% during the three months ended June 30, 2011 compared to the period one-year earlier. Most of the increase came from higher demand at many of our MSP clients. Healthcare revenues increased by 55% for the three month period ended June 30, 2011 compared to the corresponding period a year earlier. This improvement reflects an expansion of our healthcare service offerings and the geographies in which we market such services. Permanent placement / fee revenues were approximately $0.1 million higher in the 2011 period compared to 2010. During the three months ended June 30, 2011, we had two clients that represented more than 10% of total revenues (IBM = 14.4% and TEK Systems = 11.5%). During the three months ended June 30, 2010, we had the same two clients that represented more than 10% of total revenue (IBM = 18.5% and TEK Systems = 10.7%). During the 2011 period, our top ten clients represented approximately 61% of total revenues compared to 56% of total revenue in the corresponding 2010 period. Gross Margin: Gross profits in the second quarter of 2011 were $4.4 million, or approximately $1.1 million higher than the second quarter of 2010. Gross profit as a percentage of revenue increased to 20.1% for the three months ended June 30, 2011 compared to 19.9% for the three month period a year earlier. The gross margin improvement reflected margin expansion in our specialized healthcare business and higher permanent placement revenues, partially offset by some margin weakness within our contract IT channels in the 2011 period compared to a year earlier. 11 -------------------------------------------------------------------------------- Table of Contents Below is a tabular presentation of gross margin by sales channel for the three months ended June 30, 2011 and 2010: Three months Three months ended ended Gross Margin June 30, 2011 June 30, 2010 Wholesale IT Channel 19.2 % 19.4 % Retail IT Channel 20.5 21.7 Specialized Healthcare 18.7 14.7 Permanent Placements / Fees 100.0 100.0 Total gross margin 20.1 % 19.9 % Wholesale IT channel gross margins declined by 20 basis points for the three months ended June 30, 2011 compared to 2010. This performance reflects a higher level of reimbursable expense revenues (revenues with no gross profit content) at our integrator clients and slightly lower margins at our staffing clients. Retail IT gross margins were down 120 basis points during the three months ended June 30, 2011 compared to 2010, due to a combination of lower pricing at end-user clients and an unfavorable mix of business between end-user and MSP clients. Specialized healthcare gross margins improved significantly in the 2011 quarter compared to a year earlier due to the expansion into higher valued service offerings. Selling, General and Administrative ("SG&A") Expenses: SG&A expenses for the three months ended June 30, 2011 totaled $3.8 million or 17.3% of revenues, compared to $3.2 million or 18.8% of revenues for the three months ended June 30, 2010. The increase in SG&A largely reflected investments made in our sales and recruiting organizations during the last twelve months. Fluctuations within SG&A expense components during the 2011 period compared to a year earlier included the following: • Sales expense was $0.3 million higher in the 2011 period due to an increase in sales staff and higher commission and bonus expenses. • Recruiting expense was up in the 2011 period by $0.2 million due to an increase in recruiting staff, higher commission and higher variable-type expenses, such as H1B processing and job board access fees. • General and administrative expense in the 2011 period was higher by $0.1 million and principally related to higher accrued bonus expense. Other Income / (Expense) Components: Other income / (expense) for the three months ended June 30, 2011 consisted of interest expense of $6,000 and foreign exchange losses of $1,000. For the three months ended June 30, 2010, other income / (expense) consisted of interest expense of $6,000 and foreign exchange losses of $2,000. Income Tax Expense: Income tax expense for the three months ended June 30, 2011 totaled $232,000, representing an effective tax rate on pre-tax income of 37.8%, compared to $72,000, which represented a 39.8% effective tax rate on pre-tax income for the three months ended June 30, 2010. A lower aggregate state tax rate in the 2011 period was responsible for the improvement. Results of Operations for the Six Months Ended June 30, 2011 as Compared to the Six Months Ended June 30, 2010: Revenues: Revenues for the six months ended June 30, 2011 totaled $42.0 million, compared to $32.6 million for the corresponding six month period in 2010. This 29% year-over-year organic revenue increase largely reflects a higher level of IT billable consultants on assignments during the 2011 period and the geographical expansion of our healthcare business. Below is a tabular presentation of revenues by sales channel for the six months ended June 30, 2011 and 2010: Six months Six months ended ended Revenues (Amounts in millions) June 30, 2011 June 30, 2010 Wholesale IT Channel $ 27.4 $ 19.8 Retail IT Channel 10.4 9.9 Specialized Healthcare 4.0 2.8 Permanent Placements / Fees 0.2 0.1 Total revenues $ 42.0 $ 32.6 12 -------------------------------------------------------------------------------- Table of Contents Revenues from our wholesale IT channel increased 38% in the six month period ended June 30, 2011 compared to the corresponding 2010 period. Higher revenue levels from both staffing clients (up 28%) and integrator clients (up 44%) were driven by stronger demand for IT services. Retail IT channel revenues were up approximately 5% during the six months ended June 30, 2011 compared to the period one-year earlier. A 17% increase in demand from MSP clients was partially offset by a decline in revenues from end-user clients. Healthcare revenues increased by 42% for the six month period ended June 30, 2011 compared to the corresponding period a year earlier. This improvement reflects an expansion of our healthcare service offerings and the geographies in which we market such services. Permanent placement / fee revenues were approximately $0.1 million higher in the 2011 period compared to 2010. During the six months ended June 30, 2011, we had two clients that represented more than 10% of total revenues (IBM = 15.2% and TEK Systems = 11.5%). During the six months ended June 30, 2010, the same two clients represented more than 10% of total revenue (IBM = 18.6% and TEK Systems = 10.2%). During the 2011 period, our top ten clients represented approximately 60% of total revenues compared to 54% of total revenue in the corresponding 2010 period. Gross Margin: Gross profits generated in the first six months of 2011 totaled $8.3 million, or approximately $1.8 million higher than during the corresponding six months of 2010. Gross profit as a percentage of revenue totaled 19.7% for both six month periods ended June 30, 2011 and 2010. Below is a tabular presentation of gross margin by sales channel for the six months ended June 30, 2011 and 2010: Six months Six months ended ended Gross Margin June 30, 2011 June 30, 2010 Wholesale IT Channel 18.7 % 19.4 % Retail IT Channel 21.0 20.4 Specialized Healthcare 17.9 16.0 Permanent Placements / Fees 100.0 100.0 Total gross margin 19.7 % 19.7 % Wholesale IT channel gross margins declined by 70 basis points for the six months ended June 30, 2011 compared to the corresponding 2010 period. This performance reflects lower skill-set assignments and a higher level of reimbursable expense revenues at our integrator clients and slightly lower margins at our staffing clients. Retail IT gross margins were up 60 basis points during the six months ended June 30, 2011 compared to 2010. This improvement was due to a combination of upgrades in consultant skill sets utilized on new MSP assignments, partially offset by lower pricing at end-user clients and an unfavorable mix of business between end-user and MSP clients. Specialized healthcare gross margins improved significantly in the first six months of 2011 compared to a year earlier largely due to the expansion into higher valued service offerings. Selling, General and Administrative ("SG&A") Expenses: SG&A expenses for the six months ended June 30, 2011 totaled $7.6 million or 18.1% of revenues, compared to $6.1 million or 18.8% of revenues for the six months ended June 30, 2010. The increase in SG&A largely reflected investments made in our sales and recruiting organizations during the last twelve months. Fluctuations within SG&A expense components during the 2011 period compared to a year earlier included the following: • Sales expense was $0.6 million higher in the 2011 period due to an increase in sales staff and higher commission and bonus expenses. • Recruiting expense was up in the 2011 period by $0.7 million due to an increase in recruiting staff, higher commissions and other variable type expenses and severance costs related to leadership changes made to our recruitment organization in March 2011. • General and administrative expense in the 2011 period was higher by $0.2 million and principally related to higher accrued bonus and employee relations expenses. 13 -------------------------------------------------------------------------------- Table of Contents Other Income / (Expense) Components: Other income / (expense) for the six months ended June 30, 2011 consisted of interest expense of $12,000 and foreign exchange losses of $2,000. For the six months ended June 30, 2010, other income / (expense) consisted of interest expense of $11,000 and foreign exchange losses of $3,000. Income Tax Expense: Income tax expense for the six months ended June 30, 2011 totaled $254,000, representing an effective tax rate on pre-tax income of 37.7%, compared to $116,000, which represented a 40.3% effective tax rate on pre-tax income for the six months ended June 30, 2010. A lower aggregate state tax rate in the 2011 period was responsible for the improvement. Liquidity and Capital Resources: At June 30, 2011, we had $5.3 million of cash and equivalents on hand. In addition to our cash balances, we have access to a revolving credit facility with $10 million of maximum availability, under which our borrowing base was $9.3 million as of June 30, 2011. Our credit facility expires on October 15, 2011. It is management's intention to replace this facility with a new agreement on or before its expiration. Historically, we have funded our 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, 2011, our accounts receivable "days sales outstanding" ("DSO's") measurement was 50-days compared to 52-days at March 31, 2011. We expect cash provided by operating activities and our cash balances on hand to adequately fund our business needs during 2011, exclusive of acquisitions and activities related to our share repurchase program, publicly announced on December 23, 2010. Cash flows provided by / (used in) operating activities: Cash used in operating activities during the six months ended June 30, 2011 totaled $0.8 million compared to $12,000 of cash provided by operating activities during the six months ended June 30, 2010. Elements of cash flows during the 2011 period were net income of $0.4 million, non-cash charges of $0.1 million and an offsetting increase in operating working capital levels of $1.3 million. This increase in working capital reflected higher accounts receivable balances in support of our revenue growth, offset by the impact of a 2-day improvement in our DSO measurement. During the three months ended June 30, 2010, elements of cash flows included net income of $0.2 million, non-cash charges of $0.2 million and increases in operating working capital of $0.4 million. Cash flows (used in) investing activities: Cash used in investing activities for the six months ended June 30, 2011 totaled $72,000 compared to $1.2 million for the six months ended a year earlier. In 2011, capital expenditures accounted for our entire cash needs. In the 2010 period, the acquisition of Curastat, Inc. was largely responsible for the use of cash in investing activities. Cash flows provided by / (used in) financing activities: Cash used in financing activities for the six months ended June 30, 2011 totaled $95,000 and largely related to common shares purchased under the Company's share repurchase program. In the 2010 period, $156,000 of cash was provided by financing activities and largely related to the proceeds from stock option exercises. Contractual Obligations and Off-Balance Sheet Arrangements: The Company rents certain office space and equipment under non-cancelable leases which provides for future minimum rental payments. Total lease commitments have not materially changed from the amounts disclosed in the Company's 2010 Annual Report on Form 10-K. 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. 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. 14 -------------------------------------------------------------------------------- Table of Contents Recently Issued Accounting Standards: In May, 2011 the Financial Accounting Standards Board ("FASB") issued ASU No. 2011-04 "Fair Value Measurement (Topic 820); Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs". The amendments in this Update change the wording used to describe the requirements in U.S. generally accepted accounting principles (GAAP) for measuring fair value and for disclosing information about fair value measurements and are the result of the work by the FASB and the International Accounting Standards Board (IASB) to develop common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and International Financial Reporting Standards (IFRSs). For public entities, the requirements of this Update are to be applied prospectively and are effective during interim and annual periods beginning after December 15, 2011. Early application is not permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements. |