Earnings Call Transcript - RCMT Q4 2023

Kevin Miller, Chief Financial Officer

Good morning, and thank you for joining us. This is Kevin Miller, Chief Financial Officer of RCM Technologies. I am joined today by Brad Vizi, RCM's Executive Chairman. Our presentation in this call will contain forward-looking statements. The information contained in the forward-looking statements is based on our beliefs, estimates, 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. I will now turn the call over to Brad Vizi, Executive Chairman to provide an overview of RCM's operating performance during the quarter.

Bradley Vizi, Executive Chairman

Thanks, Kevin. Good morning, everyone. We concluded 2023 at the top end of our expectations. More importantly, we believe the fourth quarter reflects a clear picture of our progress under our smart growth strategy, with all three businesses showing healthy EBITDA growth. Our array of high-value capabilities in key end markets is clearly resonating. Our ability to foster collaboration among our teams continues to gain momentum, whether we are delivering facility design solutions for a major aerospace client or technical solutions for the K through 12 sector. This synergy is expanding as we provide increased value to our premier client base, further distinguishing ourselves in the market. Since our last discussion, we've made significant progress across each of our divisions, and I am eager to share more details, starting with health care. As many of you know, we take great pride in our leadership within the K through 12 market. One of our primary strategic goals is to leverage that leadership to grow our K through 12 client base. In health care, compassion is crucial. Given our dedication to our nation’s most valuable assets, we believe RCM has cultivated a unique asset that will allow us to grow our opportunities. Along with expanding our client roster nationwide, our success is evident in our ability to transform low-revenue new schools into greater economic opportunities. This progress speaks to our high-performance standards and our commitment to delivering exceptional care to students. Regarding overall business performance, we are pleased to report growth across all business units. This broad expansion highlights the resilience and adaptability of our business model. We are especially excited about the strong pipeline of opportunities, signaling a positive outlook for the health care group. As we move into the next year, we remain committed to innovation, client satisfaction, and sustainable growth. We are confident that our strategic initiatives will drive ongoing success in the Healthcare division. Turning now to Life Sciences, Data & Solutions, the results from 2023 showcase the power of our growth strategy focused on value and solution-based selling. Improvements are visible across all financial metrics—revenue, gross profit, gross profit percentage, net operating income, and net operating income percentage. Our gross profit percentage rose by 100 basis points, and our EBITDA contribution improved by over 375 basis points. Nearly $0.70 of each revenue dollar increased from 2022 to 2023 was converted to EBITDA. Managed services and turnkey software implementations led this growth. I take great pride in this team's unwavering commitment to operational excellence. Looking ahead to 2024, we anticipate strong growth, particularly in life sciences through our managed service commercialization and data integrity and quality improvement initiatives. Continued strength in our HCM practice will further enhance results. The Energy Services division had a year of strong performance, achieving revenue and profit goals that exceeded the previous year's profit contribution by 66%. Energy Services successfully developed grid modernization substation projects for major utilities and OEMs in North America and Europe. These projects included engineering services for a large-scale infrastructure project in the New York area, serving as a vital connection point for renewable energy from offshore wind initiatives. In 2023, Energy Services opened an office in Germany to broaden its global reach and position itself as a preferred partner for the energy transition in Europe. In its first year of operation in Germany, Energy Services secured two EPC projects from a leading German transmission system operator. This organization even sent a delegation to visit several projects we’ve executed in the U.S. The visit culminated in the awarding of a second project, further establishing a long-term partnership. Notably, Energy Services also enhanced its technical capabilities by offering a proprietary digital solution for 3D BIM and digital data management applications, aimed at assisting utilities and improving efficiencies from planning through construction and operation. The monetization of our application marks a significant advancement in our goal to position ourselves as thought leaders and strategic partners, widening our competitive advantage and delivering more value to our client relationships. RCM Thermal Kinetics is involved in several active equipment and engineering contracts for projects focused on zero-carbon chemical manufacturing, carbon capture, and sustainable fuels. These projects utilize a range of technologies developed by our engineering team, such as distillation, evaporation, and crystallization. Our contracts encompass dynamic clients who are becoming leaders in their respective industries and have standardized on RCM Thermal Kinetics’ process design and equipment supply. The new RCM Thermal Kinetics testing lab has been completely utilized in 2024 for customer testing, project support, and product profiling related to new equipment proposals. The lab has recently added a new glass crystallization system, which has been fully commissioned and is being used to support active crystallizer projects. Future expansion plans include a 30-gallon crystallization pilot plant, with engineering for the pilot plant scheduled for completion by the end of Q1. The Aerospace and Defense Group showed steady recovery in Q4 2023. Although we added clients and personnel during the quarter, it's important to note that our clients' focus is primarily on 2024. Nonetheless, we recognized additional workload from both existing and new clients to enhance our model-based expertise, digital conversion, and software and systems employee base in the upcoming year. Aerospace and Defense has now established itself as a trusted provider for a new offering focused on resolving quality and production issues within our clients' supply chains. Our approach and solutions reflect the extensive industry knowledge and background held by our management team. Given the supply chain challenges faced by many OEMs globally, such as part shortages and material availability, we are actively deploying teams to address these challenges and have garnered interest from various OEMs. We are continuing to expand our teams in workforce solutions, software, systems, and technical areas, particularly within the Air Mobility sector, which has attracted numerous candidates.

Kevin Miller, Chief Financial Officer

I will turn the call to Kevin to discuss the Q4 2023 financial results in more detail. Thank you, Brad. Regarding our consolidated results. Consolidated gross profit for the fourth quarter grew by 5.7% from $20.5 million to $21.6 million. Adjusted EBITDA for the fourth quarter grew by 18.5% from $7.5 million to $8.9 million. Adjusted diluted EPS grew by 37.5% from $0.52 to $0.71. As for segment performance in the fourth quarter of 2023, health care gross profit was essentially flat. If we remove the impact of COVID on the consolidated revenue and compared to the fourth quarter in 2022, we estimate that 2023 gross profit grew by 4.4%. However, our school revenue after normalizing for COVID, grew by over 28% Q4 to Q4. Life Sciences Data & Solutions gross profit grew by 19% in Q4 '23 compared to Q4 '22, largely behind the Energy Services Group. Engineering gross profit grew by 8.6% in Q4 '23 compared to Q4 '22. As for fiscal 2024, we anticipate that we will see at least low double-digit consolidated adjusted EBITDA growth as compared to fiscal 2023 with a similar quarterly cadence when compared to fiscal 2023. This concludes our prepared remarks. At this time, we will open the call for questions.

Operator, Operator

And our first question is going to come from Alex Rygiel with B. Riley.

Alexander Rygiel, Analyst

Nice quarter and nice year. First, if we could just touch on the balance sheet a little bit. Obviously, DSO has spiked a little bit. There's a lot of seasonality that occurs that probably, it's the majority of that. Can you talk about that increase and possibly the working capital improvements that you see coming in 2024?

Kevin Miller, Chief Financial Officer

Sure. I'd be happy to speak about that. We ended the quarter with a little over 90 DSOs, 90.7, which is similar to Q3, which was 90.1, both of which, frankly, Alex, are just much too high in terms of where we expect to be and where we believe we will be in the future. The thing that we see often with the schools is that they always pay, but sometimes we run into administrative issues that cause a bit of a blockage in terms of getting paid. And then all of a sudden, we'll get like four or five months of payments all at once. Now most of them pay pretty regularly, but every once in a while, we run into issues. Our second-largest client and the second-largest health care client, basically for administrative purposes, did not pay us from July through December, and we had about a $15 million balance at the end of the year. I expect that to be under $8 million by the end of this quarter. And most of that money has already come in. It may even be a little bit lower, we'll see. So we think we've got that client back on track. They've had a great record of paying us pretty timely over the last three or four years. So really, in terms of the receivables at the end of the year, just putting that one problem aside, that should be $63 million, $62 million. And frankly, there's a few other things that we need to work on. The WIP is a little bit high. That tends to be cyclical depending on where we are with projects. We have a couple of newer health care clients that we're still getting the rhythm with in terms of POs and getting everything approved and so on. But we believe the $70 million is too high. It's temporary, and we're going to get it down. I think the way that you should think about it, frankly, is we should have DSOs in the low to mid-70s, ideally in the low-70s, but it certainly should be below 75 and we probably won't get it to that level at the end of Q1, but will be much lower at the end of Q1. Over the next couple of quarters, we will get the DSOs down to a more acceptable level or in the low-70s.

Alexander Rygiel, Analyst

It's very helpful. And then, Brad, maybe you could talk a little bit about sort of the growth outlook by segment in 2024?

Bradley Vizi, Executive Chairman

Yes. Look, we expect all three of our segments to grow. We spent a lot of time doing strategic planning here in the last 90 to 120 days. And frankly, it's very encouraging. Pipelines are very strong and backlogs are stronger than they were last year. That being said, we're constantly balancing growth with investment. So growth in profitability today, productive revenue with investment in the future. So on a consolidated basis, we're comfortable where we sit today with the guidance we put forward. But underneath the surface, we anticipate all three segments growing as well.

Alexander Rygiel, Analyst

And then lastly, you've been very aggressive with your buyback through the year, strategically buying stock on opportunistic dips the market appears to be giving you. One of those right now. Can you talk about your view on repurchases right now and what your authorization stands at?

Bradley Vizi, Executive Chairman

Yes, we definitely have authorization, and it's likely to increase soon. In terms of overall capital allocation, we currently have less than 8 million shares outstanding, putting us in a strong position. When considering the purchase of additional shares, we need to balance liquidity to allow our investors the opportunity to buy and sell in the future. We see this as a chance to invest at a significant discount to intrinsic value. Share buybacks are always a part of our capital allocation strategy, and we plan to remain opportunistic. However, we are aware that each additional share can reduce float and liquidity. They are definitely still on the table and not off the table at all.

Operator, Operator

Our next question is going to come from Bill Sutherland with Benchmark.

William Sutherland, Analyst

The gross margin performance was very steady year-over-year. And you saw a nice pickup in the life science gross margin. Are you kind of at a steady-state level as you look forward into '24? Or are you expecting some improvement in any of the segments?

Kevin Miller, Chief Financial Officer

I would say it's probably steady state. You'll see some gyrations from quarter to quarter obviously, especially in engineering when we do have some projects stop and start. But I think we're steady state. Typically, we do see an increase in payroll taxes of somewhere between $1 million and $1.5 million when you go from Q4 to Q1. So obviously, that impacts gross margin and net margin. But that's just a seasonal thing, right? But yes, we like where the margins are, and we think we can maintain those or at least close to that.

William Sutherland, Analyst

Great. On health care, Kevin, do you have the breakout between education and the other segments?

Kevin Miller, Chief Financial Officer

Education revenue in Q4 was $29.812 million and our nonschool revenue was $6.876 million.

William Sutherland, Analyst

Okay. Do you have the comp just in case I don't just want to make sure I know that.

Kevin Miller, Chief Financial Officer

Yes. The comp quarter-to-quarter school revenue in 2022, Q4 was $24.644 and the nonschool was $11.166 million.

William Sutherland, Analyst

So that nonschool which includes HIM, I know is that kind of a run rate now that's been steady or even...

Kevin Miller, Chief Financial Officer

Yes. No, you can definitely look at that as a steady run rate. I mean we expect that to grow from there. When you look at Q4 '22, we had quite a bit of COVID revenue in there. And we also had a very big client that we scaled back a little bit just because, frankly, we don't like the way that they pay. So we scaled back the number of people that we're willing to stretch out payment on good clients that always pay, but we can only allocate so many dollars to use in high DSO clients. But we've got some pretty interesting things that we're working on to outside of the schools that we think can drive that a bit higher, including HIM, which is one of the ones that you mentioned.

William Sutherland, Analyst

Yes. Regarding capital deployment, Brad, how are you considering your current debt situation and the decision between share repurchase and reducing leverage?

Bradley Vizi, Executive Chairman

Yes. We've been pretty consistent with our framework we still are less than 1 turn of EBITDA of leverage, which is a pretty efficient capital structure. And we certainly have the ability to flex up from there significantly from a capacity perspective, but from a financial framework perspective, we have ample dry powder to do what we'd like to from a capital deployment perspective. In terms of potentially deleveraging and taking the balance sheet to a net cash position sometime over the next 12 months or so or potentially taking in more shares. Again, having less than 8 million shares outstanding, I think that gives us the opportunity to really be thoughtful and look at a lot of different options. So we would be happy to take it to 6%. Absolutely. But there's somewhere around $8 million; there's a trade-off associated with it that we just are mindful of.

William Sutherland, Analyst

Actually, let me add one more question about the deployment picture. How would you describe your M&A activity in terms of current opportunities?

Bradley Vizi, Executive Chairman

Yes. We're always looking. Primarily bolt-ons. We're very interested in capabilities and bolt-on acquisitions that we think we can grow and have significant value to. The reality is, I think the platform that we have, we've built over the years, is pretty unique to the marketplace. And we think we can leverage our existing client base relationships and our teams to add a lot of value to capabilities that we view as unique and scalable. So always looking very selective. And obviously, culture is a key component of that.

William Sutherland, Analyst

Brad, do you guys kind of look at the segments equally as far as opportunities? Or is there more emphasis on one or two of them?

Bradley Vizi, Executive Chairman

I'd say we look at them equally.

Operator, Operator

Our next question is going to come from William Duberstein with Stone Oak.

William Duberstein, Analyst

It's great to be on the call. Thank you for having me, and the performance has been impressive. I have a couple of questions, but first, I want to address the share count. I believe you mentioned having just under 7.8 million shares outstanding. However, on the income statement you presented, the diluted share count was closer to 8.1 million. I'm curious if this difference is related to your long-term incentive awards or what might explain the discrepancy.

Kevin Miller, Chief Financial Officer

Yes, those are the common stock equivalents, Bill. So when you have outstanding equity grants, those are computed into the diluted share count, right? So when Brad was giving his share count, he's talking about the shares that are actually outstanding as of today, which is under 8 million.

William Sutherland, Analyst

Got it. Perfect. Now onto some operational stuff. Just curious, the engineering, the top line was a little bit down year-over-year, but gross margin improved a lot, which is probably the most relevant metric. I know you had kind of the loss of that one contract early last year and that you expected that Aerospace segment to kind of improve through the year. I was just wondering if you consider it recovered and then sort of the different puts and takes between aerospace and engineering with the TransnetBW, if that's playing a factor and then Industrial, if you could just kind of dig in more granularly to the Engineering segment.

Kevin Miller, Chief Financial Officer

Yes. So before Brad speaks on this, just to correct you a little bit on one of these, we didn't lose a big contract. We had a big contract get reduced by about 30%, which was obviously a blow, but we didn't actually lose the contract. We still have it. But the contract that we spoke about on an earlier call, and I'm sure Brad would love to talk about expectations in terms of revenue going forward.

Bradley Vizi, Executive Chairman

Yes, further granularity on that point, we didn't lose share in the account. It was more a major end client did lose a program. It wasn't awarded a program that we anticipated and had some headcount reduction associated with that, just to clarify. With respect to the prospects for margin in engineering, I actually think there's upside. And when you look at it for the year and going into the future. And that's primarily going to come from aerospace. I think the other two businesses have room for improvement, certainly. But in Aerospace, it's primarily been a staffing orientation that I think you're going to see slowly migrate to a richer mix of services. So our outlook is net positive with respect to the margin profile of Engineering.

William Sutherland, Analyst

Great. Great. And then just one more quickly. The Life Sciences IT segment was clearly the star of 2023. I know you've been transitioning to more sort of project-based solutions rather than time plus. And then you also had the acquisition of talent hurter in Q4 of last year. I was just wondering, if the great performance this year, how much is organic and how much might be talent hurdle and if or if both were contributing?

Bradley Vizi, Executive Chairman

Yes. That's a great question, Bill. We have made significant investments in that business over the past couple of years, and we'll continue to do so. These investments are yielding results in terms of team development and enhanced capabilities. The main contributors to this are Life Sciences and HCM, and most of this growth is organic, with minimal inorganic growth. Additionally, I'd like to point out that our growth strategy focuses not just on adding new clients, but on collaborating with strategic clients to expand our core capabilities. This means increasing our share within existing clients by providing additional services, thereby delivering more value and becoming an essential partner for them, while also leveraging a strong client base that is experiencing its own growth. Essentially, we have multiple opportunities in this area. Regarding the acquisition of Talent Hurdle, its profit contribution was minimal, which aligns with our previous thoughts on the expected softening of the technology market. We've structured that deal with this in mind. Currently, we're noticing some positive trends in our core business and profit stream, which could lead to a more substantial contribution in 2024, although it was negligible in 2023. The synergies from the acquisition were spread across various segments. It's important to note that the acquisition was never aimed at establishing a foothold in technology; rather, we were focused on benefiting from their capital processes and some of their technologies. We believe this potential benefit will be seen in each segment and will continue to grow moving forward.

Operator, Operator

It looks like our next question is going to come from Frank Kelly.

Frank Kelly, Analyst

We had a strong quarter and a successful year. As all of Bill's comments highlighted, the life sciences sector is performing exceptionally well, with a gross margin exceeding 38 and continuing to grow. This will positively contribute to our top line moving forward. I believe we've overcome our challenges with accounts receivable, which has always been a concern for me. Looking at our current stock value, it's clear that investors are taking notice. We need to keep our focus on this area. Kevin mentioned that there's a $20 million projected free cash flow from operations in 2024, which I consider to be a conservative estimate, but I'm hopeful we can achieve it. Regarding capital deployment, many have discussed the importance of reducing debt and stock buybacks, which are beneficial, but as Brad pointed out, there are associated risks. One topic that hasn't been addressed is returning value to shareholders. A cash return to shareholders through a quarterly dividend of $0.25, considering our outstanding shares, is something we should discuss as well.

Bradley Vizi, Executive Chairman

Probably not this year, Frank. But again, we haven't taken it off the table. With fewer shares outstanding, when we do finally get that dividend, it's likely to be larger than it would be otherwise. I appreciate your patience on that front.

Frank Kelly, Analyst

Just one moment. Now that we are nearing the end of the first quarter, what can we expect and where are we headed for Q1?

Kevin Miller, Chief Financial Officer

Yes. Frank, we're hoping and planning on showing some growth each quarter over the prior quarter. So we'll see how the quarter comes in. But we like where we are today.

Frank Kelly, Analyst

Great. Great. I know in a previous call we were quite specific about some percentages, even drilling down into each of the segments. So, we're hearing that we're going to have a good or comfortable Q1.

Bradley Vizi, Executive Chairman

Yes. I think just generally speaking, Frank, I mean, if you look at 2023, I think that's pretty indicative of the typical year as far as cadence for us. Naturally, you have summer break for schools in Q3, right? Q4 is normally our strongest quarter. And naturally, as we start the year in January, you have to deal with things like snow days, reset of payroll taxes, sometimes a program will get delayed a couple of weeks or a project or a couple of schools will open a little bit lighter than expected, but you see an acceleration through the quarter and ultimately through the year. And until the schools start to taper off in the second half of June. So we don't see anything different from that cadence.

Operator, Operator

It doesn't seem like there are any more questions in queue. So I'll turn it back over for any closing remarks.

Bradley Vizi, Executive Chairman

Thank you for attending RCM's fourth-quarter conference call. We look forward to our next update in May.

Operator, Operator

This concludes your call. You may now disconnect.