RCM Technologies' (RCMT) CEO Rocco Campanelli on Q4 2017 Results - Earnings Call Transcript

RCM Technologies Inc. (NASDAQ:RCMT) Q4 2017 Earnings Conference Call March 7, 2018 10:00 AM ET

Executives

Rocco Campanelli - President and CEO

Kevin Miller - CFO

Analysts

Bill Sutherland - The Benchmark Company

Frank Kelly - Scopia Capital Management

Operator

Ladies and gentlemen, welcome to the 2017 Fourth Quarter Earnings Conference Call. Your host for today, President and CEO, Rocco Campanelli; and Chief Financial Officer, Kevin Miller. You may now begin.

Rocco Campanelli

Thank you. Good morning everyone. This is Rocco Campanelli, President and CEO. Welcome to the RCM Technologies 2017 fourth quarter earnings call. I'm joined today by Kevin Miller, our Chief Financial Officer. Kevin will begin with a legal disclaimer, and then I will summarize the operating results for each of our operating units. Then we will open it up for questions.

Kevin Miller

Good morning, everyone. Our presentation in this call will contain forward-looking statements. The information contained in the forward-looking statements is based on beliefs, estimates and assumptions and information currently available to us, and these matters may materially change in the future. Many of these beliefs, estimates and assumptions are subject to rapid changes. For more information on our forward-looking statements and the risks, uncertainties and other factors to which they are subject, please see the periodic reports on Forms 10-K, 10-Q and 8-K that we file with the SEC, as well as our press releases that we issue from time-to-time. Thank you.

Rocco Campanelli

Thanks Kevin. We are very pleased with our 2017 consolidated fourth quarter results. Our quarterly revenues of over $51 million are particularly respectable, since we had not exceeded $50 million in quarterly revenues since 2003. Our gross profit of $12.8 million in the fourth quarter of 2017 is by far our best quarterly amount in 2017 and our best since the fourth quarter of 2015. We are excited to head into fiscal 2018 with some strong momentum. I will discuss each division separately.

Our Specialty Healthcare Staffing Group again set new quarterly records with $22.1 million in revenue and $5.4 million in gross profit. Revenues and gross profit grew about 19% and 12% respectively in the fourth quarter of 2017, as compared to the fourth quarter of 2016.

Our healthcare growth was largely driven by our power professional contracts with both the New York City Board of Education and the Hawaii Department of Education. We ended the 2016-2017 school year in May-June timeframe with about 80 power professionals with Hawaii and about 150 with New York City. At the end of 2017, we had about 170 with Hawaii and 630 with New York City. Also, our therapists with New York City tripled, going from 32 to about 100 over the same timeframe. To put that in context, our revenues with New York City in the fourth quarter of 2017 were about $7.1 million versus the fourth quarter of 2016 of about $2.7 million. Revenues for Hawaii were about $3.9 million in the fourth quarter of 2017 versus about $2.4 million in the fourth quarter of 2016.

We also saw a nice growth in our HIM business in the fourth quarter of 2017, with revenues of $1.2 million as compared to revenues in the fourth quarter of 2016 of about $700,000. We are optimistic that we will see another record year from our Specialty Healthcare division in fiscal 2018, and believe our revenues will exceed $80 million.

With less than $35 million in revenues, as recently as 2014, the consistent annual performance of our Specialty Healthcare group is commendable.

Following three solid quarters, our Engineering division continued to perform well in the fourth quarter of 2017. Revenues grew about 18% as compared to the fourth quarter of 2016. All three of our Engineering groups contributed to the revenue growth in the fourth quarter.

Our Energy Services Group, which operates in the United States, Canada and now Serbia, posted revenues of $9.3 million in the fourth quarter of 2017, about 24% growth over the fourth quarter of 2016. The highlight of our quarter was the acquisition of PSR Engineering, which will provide the foundation for an Electrical Engineering Center of Excellence in Belgrade, Serbia. PSR was established in Serbia in 2006 and specializes in the design and Engineering associated with high voltage substations, design Engineering for electrical equipment and power plants, 3D modeling, testing and commissioning, site supervision and other Engineering Services for clients in Europe, North America, South America and the Middle East.

At the time of acquisition, PSR had a highly trained staff of approximately 30 engineers. We had been using PSR for subcontracted Engineering analysis for the past three years with excellent results, which led us to acquire them. We are very excited about this acquisition, as this will allow us to provide Engineering resources, that are very difficult to find in the U.S. and Canada. We are also looking at this acquisition as a platform to do more transmission and distribution work in Europe. We believe that over time, we can quadruple the number of engineers in Serbia, as we win more business.

We also added a senior IT resource in Serbia, just last month, and plan to develop on an expedited basis an offshore IT offering in Serbia out of our office in Niš. Niš is the third largest city in Serbia and a university city, where Engineering and IT talent are plentiful. An initial focus will be to look to offshore lifesciences validation and IT software application development projects.

Our Engineering Services group opened an office in Buffalo in the third quarter of 2017, and we are very pleased with its performance, as it is already accretive to the Energy Services operating income. We are excited about Energy Services' diversification strategy to drive our services deeper into the oil and gas processing, chemical manufacturing, and metals market sector.

Our transmission and distribution Engineering and testing and commissioning service area continues to expand every month. We are completing a multimillion dollar contract to perform the testing and conditioning for a high voltage DC facility in Canada in our Engineering work at AEP, Con Edison, FirstEnergy, Covanta, and We Energies are all doing very well. Energy Services expects to continue their solid performance with a strong backlog and pipeline, as we enter into fiscal 2018.

Our Canadian Power Systems Group which mainly services Bruce Power and Ontario Power Generation, slowed a bit in the fourth quarter of 2017, with $5.8 million in revenues. But still grew almost 11% as compared to the fourth quarter of 2016. Our Canadian Engineering Group's quarterly performance does have a tendency to be a bit erratic, as we start and complete projects. We are also getting off to a slow start in the first quarter of 2018, as we are waiting several anticipated purchase orders. However, we do expect to see improved performance in fiscal 2018 over the $23 million in revenue generated in fiscal 2017.

We are also optimistic that our recent diversification strategy to focus on commercial nuclear materials business will be successful in the near future.

Our Aerospace Group generated revenues of $6.1 million in the fourth quarter of 2017. A small increase of about 2% over the fourth quarter of 2016. Historically, our three biggest Aerospace clients have been Sikorsky, Pratt and Whitney, and United Technologies Aerospace Services, with a half dozen additional other small Aerospace clients we support.

In the fourth quarter of 2017, we added two new clients that we believe have the potential to become major clients over time. In 2017, we have also been working on developing an international Aerospace equipment and materials procurement business, that we have confidence will generate revenue in 2018. This service is a natural complement to our existing international trade compliance and jurisdiction and classification service area. Our primary goal in fiscal 2018 is to diversify and grow our revenue base, similar to what we have accomplished in Energy Services.

We are also happy that our Information Technology Group revenue has stabilized in fiscal 2017. Two developments are worth noting; first, after helping us with the turnaround plan, Bob Giorgio helped us with the transition plan to permanent leadership. We would like to welcome Mike Boyle to RCM as our new Senior Vice President of Information Technology, Consulting and Solutions Division. Mike is a senior executive with many years of experience in the IT staffing industry. Mike's most recent position was Chief Operating Officer of MTT Holdings, a $30 million IT staffing company. Mike has also held senior sales management positions with Therion [ph] and Kforce. We are looking forward to much better results in fiscal 2018 and thank you Bob Giorgio for your welcome efforts in the transition.

The second development, is that we sold our Microsoft Solutions practice for a nominal amount of cash. That group generated $1.8 million in 2017, but did not provide any contribution to operating income.

In summary, we have a strong backlog and pipeline, particularly in our healthcare and Engineering businesses, and are confident that will serve us well throughout 2018.

Thank you for attending RCM's fourth quarter conference call. We look forward to updating you on fiscal 2018 in a few months.

I'd like to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from Bill Sutherland. Please go ahead.

Bill Sutherland

Hi, thanks. Good morning guys. Nice year end. So I am curious, just a quick one here on the IT Group, you had a little lingering impact in Puerto Rico, and I know it's not a big issue. But just kind of curious how to think about the level you are at in the quarter, almost in line with the third quarter and looking ahead, is this kind of like the inflection point for some growth do you think?

Kevin Miller

I don't think you are going to -- we are not expecting any sort of immediate lift-off here Bill. Certainly, we believe that servers leveled off. Now Rocco mentioned that we sold off our Microsoft practice, which did about $1.8 million in revenues in 2017. So you got to back that out in total revenues of $32.7 million, to get to sort of a normalized number. And as you know, the second half, including Microsoft, was around $7.8 million in Q3 and about $7.7 million in Q4. So certainly, we think that, if you sort of take the second half run rate, minus the Microsoft revenues that we should see some growth in 2018 over that number.

We do have a number of initiatives in place to accelerate that growth, but we also need to invest in the business quite a bit, because we have a really good core group of people in that group that have been very successful with us, but we need to add more talent over time, to really get it on again.

Rocco Campanelli

Bob, while he was here, and will continue to support Mike. And Mike, just starting within the last month, has plans to do -- we have done some major organization changes, and we continue to plan more organization changes. And we need just a little time and Mike needs a little time to be successful.

Bill Sutherland

The impact from moving to Engineering, the impact from PSR, how much of the quarter was that impact?

Kevin Miller

I don't have the exact numbers in front of me. But you are probably looking at somewhere around $400,000 in revenues in the fourth quarter.

Bill Sutherland

Okay. So that was for the -- were they in the full quarter? I can't remember?

Kevin Miller

Yes. The effective date of that acquisition was on February 1.

Bill Sutherland

Okay. But there is -- just thinking about, with 30 engineers, it seems like you could -- I don't know what the rates are, but seems like it might have more impact over this year?

Kevin Miller

Yes. And bear in mind, that's the -- the sales number that we are generating out of Serbia. But probably prior to us buying them, about 25%, 30% of their revenues came from RCM. So we are billing them out at a higher rate, than what they are billing us obviously, internally. So I think that the impact there is -- can be pretty significant. It's not going to happen overnight obviously. But there is -- the guys who run that group for us, told us he could hire 100 engineers tomorrow if we had work for them. And the type of -- not only, are the engineers very talented there and very well educated, we can get a lot of engineers over there, that you just can't find here.

So we are going to really look to augment a lot of our projects with work done out of Serbia. So not only does it help us find resources there that are scarce here, but we can also get high quality and reasonably priced labor from this acquisition. And on top of that, they already have some inroads into some European clients, which we are going to look to expand. As you can imagine, a small firm like that in Serbia, can only take on so big of a project in Europe. But now, with a much larger company, we believe we can win much bigger projects over time, in Europe. And we will do some of the work out of Serbia, we will do some of the work out of Canada, we will do some of the work out of U.S., it's how importantly we may establish a presence, somewhere in Europe, we will see. Somewhere else in Europe.

Rocco Campanelli

And we are looking forward to the IT manager that we hired and he has been doing work in Europe for the past several years, and I guess, we are upwards of about three IT staff in Serbia at this point, and we think we are going to rapidly grow, as we are able to offshore the cost effective work in IT to Serbia. One of the things that we are really pleased is, with that their English language capability is really outstanding, and that's one of the big issues when you are outsourcing and interfacing between the U.S. or Canada, and other countries. So we are really looking forward to making something happen in not only IT, but also in lifesciences in Serbia.

Bill Sutherland

And then, just -- you alluded to the healthcare number was -- the revenue number was impressive, and clearly, you will get the full year impact of this big increase in the two contracts. What else do you see contributing to healthcare growth significantly in 2018?

Kevin Miller

We have high hopes for HIM, which had a real strong fourth quarter. We are continuing to look for more school contracts. We have about 17 or 18 school contracts, with three of them being sort of the bulk of the revenues. But we continue to look at -- most of our school clients are public schools. We do have some charter schools, but we are going to look to do more work with charter schools and private schools. We are very focused on the para-professional market and the behavioral health in general in schools. So those are some areas.

Our locum tenens business, we were real disappointed with the results in 2017, but we feel -- really like that market and think it's a good market to be in. So that's a nice area for potential growth. So just off the top of my head, those are some of the big areas to look into.

And we have other areas that we are interested in, focusing on new areas, which I am not ready to discuss right now, because we don't have any immediate plans for them. But there are some other areas as well.

Bill Sutherland

Well you got quite a bit on the plate already. Kevin, one question I had was the -- in terms of just the P&L, was the G&A; was of a much lower percent of revenue than I expected. Is that just -- is that a level which got anything particular in it? Or --

Kevin Miller

No, there is nothing. As you know, Bill, there is always going to be sort of ebbs and flows and accruals when you are trying to get them right each quarter, and we tend to sharpen them a little bit more in the fourth quarter, since its year end. But there is nothing in there, in terms of any, like out of the ordinary reductions or any out of the ordinary expenses in the fourth quarter. It just really kind of shows the leverageability of our income statement.

As you see, our gross profit growth, clearly, our SG&A will grow, because we need more people to put people out to work. We pay commissions and we pay bonuses. But we have so many fixed costs in terms of rent, utilities, management, that our income statement is very leverageable. So if you see good growth in gross profit, a really healthy portion of that drops to the bottom.

Bill Sutherland

And then finally, just talk a little bit about what's happening with the tax rate, after tax reform. [indiscernible] what's happening in 2018?

Kevin Miller

Yeah. I think on a GAAP basis, I think if you want to like assume a blended rate of about 28%, that's a pretty safe number. I don't -- it's hard for me to see us being over that, in terms of a GAAP rate. We could come in a little bit less than that. Obviously, it depends on the mix, taxes in Serbia are about 20%. Taxes in Canada are about 26.5%. But in both jurisdictions, if we pull cash out, we pay a 5% dividend tax on that -- excuse me, in Serbia, the 20% includes the 5% dividend tax. So it's 15% before the dividend tax. And most of the money we make in Serbia, we will be pulling out. So I just look at it as 20% anyway.

But I think a 28% GAAP tax rate is a good assumption for your model.

Bill Sutherland

Great. All right. I will catch up more offline. Thanks Kevin.

Kevin Miller

Great. Thank you, Bill.

Rocco Campanelli

Thanks Bill.

Operator

Our next question comes from Steve Bova [ph]. Please go ahead.

Unidentified Analyst

Hey, good morning guys.

Kevin Miller

Good morning Steve.

Unidentified Analyst

You appear to have a pretty significant deterioration in gross profit, both on a year-over-year and sequentially. What's that all about?

Kevin Miller

Well, I mean, each group is a little bit different, Steve. In terms of -- if you want to look at, say information technology, the major driver there is just doing less -- it's a combination of less project revenue and more competition in terms of the staffing. We used to get much higher margins than the lifesciences project work. A lot of lifesciences work we are doing now is staffing, and it's difficult, as you know, to get gross margins in the high 20s or low 30s when you are doing staffing.

So for IT, it's more of just a mix shift than anything else. If you flip through our healthcare, that's just a matter of where a lot of our growth is coming from, is just a little bit lower gross margin business. But, our contribution margins are up, but despite the fact that our gross margins in the healthcare space are down. So a lot of the growth that we are getting is just not -- is not accretive to the gross margin.

And as far as the Engineering is concerned, we are up a little bit year-over-year. We are about 27% for 2017. The biggest driver to -- and really, our Engineering gross margins have always been from quarter-to-quarter, pretty erratic, but the biggest driver there is utilization and success on fixed price contracts. I guess we will have years where we do fixed price contracts, where we get 50% gross margin on a fixed price contract, and then we will have other fixed price contracts, where they come in at 20%, just because of the nature of fixed price projects.

Unidentified Analyst

Okay.

Kevin Miller

Does that answer your question or?

Unidentified Analyst

Not fully, but that's okay. But you said Engineering was 27%, but what you published was -- for fourth quarter was 25% --

Kevin Miller

Well I thought you said year-over-year.

Unidentified Analyst

Yeah, year-over-year and sequentially. But so would you say, 25.9% is okay, it's just part of the range that you have set?

Kevin Miller

No. 25.9% in the fourth quarter for Engineering is low. I think that those margins should be somewhere -- the 25.9% is more of an example of what I was talking about, getting some quarter-to-quarter erraticness to the gross margins. I mean, I expect to see that every once in a while, I just don't know when it's going to happen. But I think if you look at the Engineering gross margin for the entire year of 27%, that's -- 26.5% to 27% is about where our business is right now, if things go steady state. In the fourth quarter we had some utilization issues, mainly in Canada, that sort of brought back down about 60 or 70 basis points from where I'd like to see it. We had some quarters in 2017 in Engineering, where particularly in, I believe Q3 is where we really had some significant gross margins in Engineering, and that was just because we had some projects that went really-really well, and we saw a nice little spike. We were at 28.45% in Q3, that's higher than what I would typically expect to see, whereas Q4 is definitely lower.

Unidentified Analyst

Okay. We are into -- we have got about, what 3.5 weeks to go in the first quarter to get a little color as to how the quarter is going?

Kevin Miller

Well, we think our first quarter this year is going to be better than our first quarter of last year. We think we will have a pretty solid quarter. Just keep in mind, that we see a big drop -- we typically see a pretty big drop in our gross margin from Q4 to Q1, just because of the resetting among the statutory taxes. But yeah, we expect to have a good quarter, not a great quarter; but we expect to have a good quarter in Q1 and certainly expect to beat last year.

Unidentified Analyst

Okay. On the 28% blended tax rate, how does that compare to what you have been paying?

Kevin Miller

Well, our GAAP tax rates have been -- on a blended basis, have typically been in the 40-ish range. So it's going to be much lower. But bear in mind, if you read my quote, we are not going to be paying a lot of federal taxes in -- certainly not in 2018, unless we really knocked the ball out of the park in 2018, which certainly hope we do, we probably won't bail out of federal taxes in 2019 either. But as you know, the GAAP tax rate versus what you actually pay, can be pretty different. In our case, because of some of the tax write-offs that we had in 2017, we are going to enjoy some nice cash flow in 2018 and 2019 as well, in terms of whatever pre-tax money that we make in the U.S., we should keep most of that.

Unidentified Analyst

Okay. That sounds good. Just one other question on your statement of income. What types of things are in change in contingent consideration?

Kevin Miller

It's just one thing, Steve. So when you buy a company, the way and the accounting rules, I don't know when they change. I want to say, it was like five years ago. But you have to estimate how much you are going to pay in an earnout. And if you estimate too high, you take it off your balance sheet as income decreased to contingent consideration and run through your income statement, and if you estimate too low, which we did on two of our Engineering acquisitions. One in particular, we estimated way low, it runs through your income statement. So you don't touch the goodwill, and once you get your projected earnout, projected contingent consideration, and it all runs through the income statement. Frankly, I think it's a really dumb accounting rule. In addition, they make you put it above operating income as opposed to below the operating income line. Doesn't make a lot of sense to me frankly, but that's GAAP.

Unidentified Analyst

So when you see a number there, it's good news, bad news, right?

Kevin Miller

Yeah essentially. That's right. Yes.

Unidentified Analyst

Okay. Thanks a lot.

Operator

[Operator Instructions]. Our next question comes from Anthony. Please go ahead.

Unidentified Analyst

Good morning. Hello?

Kevin Miller

Hello.

Unidentified Analyst

Good morning. So curious when your New York City contract expires?

Kevin Miller

Well, we don't know for sure, because it has options on it. But we have two more years on it, but probably more likely four more years on it.

Unidentified Analyst

That's good. Thank you.

Kevin Miller

Right.

Operator

Our next question comes from Frank Kelly. Please go ahead.

Rocco Campanelli

Hi Frank.

Frank Kelly

Good morning Rocco. Good morning Kevin. How are you?

Kevin Miller

Good. Good Frank.

Rocco Campanelli

Great.

Frank Kelly

Good. Great finish with the dividend at the end of 2017 and salutations to Michael and Mark over in healthcare, they are doing absolutely an outstanding job, and just need to be noted. My question was, was previously answered, is what does 2018 look like and it was covered off on, but I was in the queue, so they took the call. But looking forward to a real cash rich -- congratulations again on receivables coming down, if we can keep that, cash flow will be great in 2018 and even 2019 with these tax benefits as well. But that's all I had. Thanks again.

Kevin Miller

Great. Thanks Frank.

Operator

Our next question comes from Michael. Please go ahead.

Unidentified Analyst

Good morning guys. Good report. For the purpose of clarity, for the fourth quarter and the purpose of modeling going forward, we calculated about a $0.15 non-GAAP quarter. I know you guys don't provide it in the release, but just for the sake of clarity, for some potential new investors out there, did you guys calculate that internally, and would it be in that $0.15, $0.16 non-GAAP for the fourth quarter, like we calculated here?

Kevin Miller

Yeah. That's about in the range. It gets a little tricky, when you start trying to normalize the taxes frankly, and I thought about putting it in here, and I took it out for that reason, just because it's -- just because we have some funky stuff going on with the taxes.

Unidentified Analyst

Well generally speaking, I mean, you have an estimate out there, there is an analyst with an estimate out there, and for clarity, I don't know if something you would consider. But a non-GAAP number going forward, I know it can get complicated, but it might just provide a little bit of clarity for the -- to attract new investors to the story?

Kevin Miller

Well Bill's on the call, so he hears you. So --

Unidentified Analyst

Okay, great. The other question I had is, can you talk a little bit about, with the growth in the healthcare sector, and a sector that's doing obviously very well for you. How does it -- does that change at all the seasonality you guys had going quarter-to-quarter? I know your margin will go down a little bit in Q1. But can you talk a little bit about how the quarter has progressed? And if there is any change in the seasonality pattern?

Kevin Miller

Yeah. I mean, we are still getting about 60% of our revenues from schools. So we are going to continue to see a big drop in revenues in Q3. So we do have some -- still have significant seasonality for the revenues, and then as far as the seasonality concerning the gross margins, there is a little bit of that as well. But there actually isn't as much in healthcare as some of the other ones -- some of the people are a little bit lower paid, so they don't max out and there is the impact from the unemployment expense, but not necessarily for social security taxes.

Unidentified Analyst

Okay.

Kevin Miller

But yes. So there is some seasonality in the gross margin and there is a pretty heavy seasonality in the revenues.

Unidentified Analyst

Okay. And one more question if I can.

Kevin Miller

Sure

Unidentified Analyst

When you guys are dealing with, there is not a lot of news releases here on the company and between your earnings releases. Is that a function of -- is that an internal decision or is it the contracts that you sign and the business deals that you sign with, is that the companies not wanting that information to be made public?

Rocco Campanelli

Pretty much. When we win big projects at utilities, it's more difficult for us to mention our clients names in the press release that has RCM on top of it. So we pretty much don't issue press releases on projects for our big clients. A few times, the client will issue a press release and put our name in it. But generally, big utility clients really don't want to see their name in the press. [Indiscernible] don't know how much money they're spending.

Kevin Miller

And generally, we have a philosophy. We are going to put a press release out, make it something meaningful. In all times we win contracts, like, especially in healthcare, where we really don't know what that -- we win a lot of MSAs and we really don't know what the revenues are going to be; because it basically allows us to have a seat at the table and bid on work. But we don't necessarily know how much work we are going to win. So we are not going to put out press releases every time we win an MSA, which happens every month we win MSAs. But we generally only like to put out press releases, when it's something meaningful.

Unidentified Analyst

Yeah. I definitely know you guys are more conservative in that nature. But with the story that you have now, it looks like the future is bright for 2018, is there any effort internally to expand a little bit on the investor relations front, get the story out there, and maybe do a little bit more marketing to try to attract new investors to the company?

Kevin Miller

Yeah. That's definitely something we have discussed internally. So yes, that is something we are thinking about.

Unidentified Analyst

Okay. All right, great. Okay guys, thanks for taking the call.

Rocco Campanelli

Thank you.

Operator

[Operator Instructions]. There are no questions at this time.

Rocco Campanelli

Well thank you everyone for joining our conference call and we look forward to speaking with you in a couple of months.

Operator

Ladies and gentlemen, this concludes your conference call. You may disconnect at this time.