Earnings Call Transcript - RCMT Q2 2023

Operator, Operator

Welcome to the RCM Technology Second Quarter Earnings Call. I will now turn the call over to Kevin Miller, you may begin.

Kevin Miller, CFO

Good morning. And thank you for joining us. This is Kevin Miller, Chief Financial Officer of RCM Technologies. I'm 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're subject, please see the periodic reports on forms 10-K and 10-Q and 8-K that we filed with the SEC, as well as our press releases that we issue from time to time. I will now turn over the call to Brad Vizi, Executive Chairman to provide an overview of RCM’s operating performance during the quarter.

Brad Vizi, Executive Chairman

Thanks, Kevin. Good morning, everyone. Consistent with our prior discussion, after starting the year off slow due to project timing and a key client's unexpected program loss impacting the first half, we made the decision to maintain stride in building what we believe to be a highly differentiated platform in the professional service and marketplace. Our secular growth markets and strong portfolio of capabilities made the decision to ignore the perpetual drumbeat of economic prognostications an easy one. In fact, as with any economic scare, we knew we would be in a position to take advantage of opportunities to further strengthen the business and enhance long-term returns while others taking a more short-term approach tap the brakes. Since we last spoke, progress has been made across each of our divisions, and I am excited to discuss in more detail starting with our healthcare division. RCM’s Healthcare Division continues to raise the bar in various aspects of the business. Our commitment to delivering best-in-class staffing services and solutions has led us to focus on several key areas. First and foremost, our steadfast dedication to improving the delivery of behavioral healthcare has seen very positive outcomes and growth in new school districts nationwide. By implementing innovative and evidence-based approaches, we have made significant strides in addressing the behavioral and mental health challenges facing children and their ability to learn and succeed in schools. Moreover, our effort to expand our school and healthcare facility clients has not only broadened our reach but also strengthened our ties with local communities and providers. These initiatives have bolstered client penetration and allowed us to serve more students and patients in need, making a sustainable impact. We have also invested significantly in technology to enhance the applicant user experience and optimize operational efficiency. This digital transformation, including the launch of our new app, has paved the way for expedited onboarding of service providers and an overall better candidate experience. Furthermore, our reinvigorated branding strategy has solidified our position as a trusted and forward-thinking healthcare staffing provider, setting us apart from the competition and opening new avenues of growth. As we look ahead, we remain committed to our pursuit of excellence and continuous improvement, embracing new technologies and staying attuned to emerging educational and behavioral healthcare trends will be pivotal in strengthening our continued success. With a strong foundation and a dedicated team, we are confident in our ability to navigate challenges and seize new opportunities, driving our business to new heights in the ever-evolving education and healthcare landscape. On the Life Sciences and IT front, we believe that division has reached a tipping point as we continue to grow our project and managed solutions business. Just 30 months ago, the division had less than 5% of its business in these areas, and in 2023, the number has grown to more than 33% in Q1 and 43% in Q2, with a much-improved revenue stream comes a more robust margin profile. Again, when analyzing the same sequential quarterly periods in 2023, we improved gross margin by 500 basis points on top of over 10% revenue growth. HCM continues to galvanize partnerships within its core clients becoming the number one partner in its flagship offering and securing a long-term contract within the client's second key offering. Our HCM team continues to raise the bar, and the rapid growth of our core clients has required increasing levels of support. We think the success of this group is in the early innings as we continue to grow our share within a fast-growing client base. Our Life Sciences practice has introduced several new service offerings including commercial operations, a key practice, and a series of target assessments to help clients quickly improve quality processes and data management. Our Life Sciences practice has also secured three new managed service clients and continues to strengthen its leadership and sales personnel. We continue to be optimistic for the remainder of 2023 and beyond. As mentioned earlier, I believe this group has reached a tipping point where it will serve as a strategic pillar within the RCM portfolio. Energy Services closed Q2 with strong results sustaining continuous growth through the first half of 2023. The team added a significant amount of backlog in Q2 for major contract wins and was selected to be the engineering firm for a large new substation project in the northeastern United States. This was made possible by delivering results as promised, and being a trusted partner to our major utility clients year after year. Across the globe, the energy transition is driving investment in new projects to strengthen the group’s future. And RCM is proud to expand its services to support our clients and communities' evolving electricity demands. Our European footprint has been developing well through Q2, and the team is building a strong foundation to serve our growing list of utility clients. Focus on developing a sturdy foundation across all engineering and project management disciplines has enabled energy services to take on more large complex projects to provide our clients with complete turnkey solutions. The second half of 2023 is expected to be consistently strong as the team continues to convert opportunities into backlog and expand our client list. Second quarter results in our process and industrial business were again in line with the plan. Focus over the past three months was on project execution and growing and strengthening our relationships. One important increase of the backlog came in the form of additional engineering for critical elements of an advanced ethanol facility to produce sustainable aviation fuel. We had a noticeable acceleration in pipeline throughout the quarter, stemming from projects with both new and established customers. Aside from the significant revenue potential expected in 2024, this expansion of the sales funnel is strong evidence that our growth and market diversification plans are being realized and strengthening RCM’s presence in the global energy transition. RCM Thermal Kinetics, a key unit within process industrial, continues to advance projects while performing engineering and lab testing for future demonstration and production scale facilities. It was rewarding to see the impact the RCM team is making to the community through the open house of our new 10,000 square foot office and lab held in July. Many members of local universities, vendors, clients, friends, and families joined us to learn from a variety of educational demonstrations. These demonstrations in our state-of-the-art lab highlight how our approach can provide clients with higher quality output, saving time and money while de-risking projects across the many markets that we serve. The team and company history was also featured by the local business journal Buffalo Business First. Aerospace and Defense is seeing a market recovery in the third quarter. After a key client experienced an unexpected program loss at the end of last year, the aerospace and defense team rose to the occasion, accelerating business development activity with new clients and deepening relationships with existing clients. Thus far in 2023, the division has already added eight new clients, well on the way to achieving our goal of 12 by the end of 2023. Also of note, we have almost tripled the number of hires across our client base in the second quarter compared to the first quarter of 2023. This expansion includes new clients in Defense specifically relevant vessels, a new vertical with customers, as well as new customers and aerospace component part manufacturers, assisting them on the production floor and within the aftermarket domain. The expansion of existing clients and new clients with our core expertise, and new arenas provides much desired depth and breadth to the organization and strongly positions us for 2024. We have also begun to see traction on one of our largest awards from our strongest OEM clients across the entire spectrum of engineering resources with potential opportunities spanning into 2026. In addition, we have been awarded a sole source contract for one of our space clients, where we are providing support from conceptual design through aftermarket services in hybrid and flexible scenarios. We now have a proven track record with our digital conversion expertise and methodology in the aftermarket, as well as our model-based definition prowess, which now expands across multiple clients throughout the United States. With the addition of our new Senior Vice President, our aftermarket group is now touting the S factor, which broadens our reach beyond S1000D publications into S2000M, material management, S3000L, logistic support analysis, S4000P, maintenance, S5000F, in-service data feedback. Once the realization of the support we have provided, our customers was apparent, we decided it was time to market the full solution and an offering that we believe is differentiated in the marketplace. I believe when we look back on 2023, RCM aerospace and defense will serve as a shining example of our culture at work, while continuous improvement, even in the face of adversity, day in and day out, and incessant focus on upgrading the quality of our business through value to create growth. Before turning the call to Kevin, who will cover our financial results in more detail, I will take a moment to touch on our progress on the capital allocation side. During the second quarter, we repurchased over 939,000 shares bringing our year-to-date share repurchase to nearly 1.6 million shares. Our clean balance sheet and high cash generating business model and dedicated culture committed to continuous improvement of our business has allowed us to repurchase approximately 40% of the company over the last three years at an average price of $7.50 per share. Consistent with our prior commentary, taking into account normal Q3 seasonality, the business continues to strengthen as we move through the year, setting up a healthy double-digit earnings increase in the fourth quarter, a trajectory consistent with our long-term objectives. Now I will return the call over to Kevin to discuss the Q2, 2023 financial results in more detail.

Kevin Miller, CFO

Thank you, Brad. Regarding our consolidated results, revenue for the second quarter was $67.0 million, flat with the first quarter of 2023. As we expected, the second quarter decline in healthcare was offset by sequential increases in engineering and our Life Sciences and Information Technology segments. The second quarter seasonal decline in Healthcare revenue was entirely due to several of our significant school clients closing in May, and all of our school clients closing by late June. We will still see greater seasonal declines in Q3. While we gear up for the 2023, 2024 school year that starts in August and September for various school clients. We're incredibly excited about this upcoming school year. I want to give some limited information on our non-COVID related school business. In fiscal 2022, we had about 60 active school clients with 22 exceeding $100k in revenue. That compares to fiscal 2019 when we had only six clients over $100k in revenue. For fiscal 2023, we expect at least 75 school clients with 30 over $100k in revenue. We saw a nice sequential uptick in engineering revenue in Q2 '23 driven mainly by the increase in energy services contract wins. We expect our engineering group to see sequential increases throughout the rest of 2023. As Brad discussed, our Life Sciences and Information Technology segment had a nice sequential increase as our managed service offerings continue to drive our growth. Gross margin in the second quarter was 28.0% also flat with the first quarter. We saw outstanding gross margin performance from our Life Sciences and IT segment at 39.4%. While this may be a high watermark, we do expect to see gross margins in the upper thirties going forward. Engineering gross margin saw a small sequential uptick as revenue increased. However, we expect better gross margin performance going forward. We are targeting the upper twenties. Healthcare gross margin performance was off in the second quarter, due primarily to June school closings, a mix shift and several discrete adjustments. We also expect better gross margins in healthcare going forward and target the upper twenties as well. As we look to the second half of 2023, we expect healthcare to continue to experience its underlying sequential growth trend. However, due to seasonal school closings, we will see a set sequential top-line decline in the third quarter as we do every year. We expect the fourth quarter to be our best quarter for 2023. With so many recently awarded school contracts, we're very excited to see the results. We expect both our Engineering and Life Sciences and Information Technology segments to see sequential increases in the third and fourth quarters. While there is always the risk of large projects sliding to the right, we expect a substantial uptick in the fourth quarter for all three of our engineering groups. In summary, we believe that Q3 ‘23 EBITDA will be similar to Q3, 2022. And we are lining up for an impressive fourth quarter and a nice run rate heading into 2024. In 2024, we expect to see at least double-digit growth in EBITDA as compared to fiscal 2023. This concludes our prepared remarks. At this time, we will open the call for questions.

Operator, Operator

And it looks like our first question is going to come from Alex Rygiel with B. Riley. Your line is open.

Alex Rygiel, Analyst

Good morning, gentlemen. Very nice quarter.

Kevin Miller, CFO

Thank you. Good morning.

Brad Vizi, Executive Chairman

Thanks, Alex.

Alex Rygiel, Analyst

First in the Healthcare business, as it relates to the third quarter, can you help us refine what normal seasonality what you mean by that? Obviously, a little bit difficult to look at that over the last two, three years, given that COVID.

Kevin Miller, CFO

Yeah, we typically see a pretty substantial decline, Q2 to Q3. An exact projection is difficult, especially with all the new schools that we have coming on, and some of them coming on in August when they've dipped. Typically most of our schools started in the past starting in September.

Alex Rygiel, Analyst

Okay, and then

Kevin Miller, CFO

But just to give you a little finer point, it will certainly be under $30 million in Q3. It's tough to give an exact number, but maybe $25 to $29 million, sort of in that range. We'll see where it comes in.

Alex Rygiel, Analyst

Helpful. And then your margin commentary in that segment would suggest high twenties. Last year, you were in the low thirties in the second half of the year. So, is the variance just sort of mix or is it something?

Kevin Miller, CFO

Yeah, we had a confluence of factors in Q2 that I think created a gross margin for healthcare that is not indicative of the actual margin. But I think the way that you should think about the gross margin in healthcare is, we did 28.8% year-to-date. And, I think that's a pretty good number on a go-forward basis, we're always looking to improve the margin. The thing that there's a fair amount of uncertainty around healthcare, just because we have a lot of new contracts. And we never know exactly how they're going to really start with a lot of these new schools. But certainly, I think that 28.8% indicates a pretty good range. I would be surprised if our margins in Q3 and Q4 are in the 28% to 29% area. And hopefully we're pushing up towards the top of that.

Alex Rygiel, Analyst

It’s good. Thank you very much.

Operator, Operator

Our next question is going to come from Bill Sutherland from Benchmark. Your line is open.

Bill Sutherland, Analyst

Thank you, hey guys. Great work. Things on Specialty Healthcare. Kevin, can you just tell me, or tell us I'm sorry, the revenue in the quarter from school clients?

Kevin Miller, CFO

I need to grab that. Actually don't have that open. Do you have another question?

Bill Sutherland, Analyst

Yeah, you kind of, when you were running through the clients this year, last year, and those over $100,000. I didn't quite get last year with 60 clients and how many? Over $100,000?

Kevin Miller, CFO

We had about 20, we had 22 to over $100k, and that compares with when we only had about six. Yes, so obviously, pick 2019. And that's a pre-COVID year. And, the business has changed quite a bit since 2019, as we've added so many new school clients.

Bill Sutherland, Analyst

Are you finding that the deals that you're winning in schools are broader in terms of the roles? And just, it sounds like it's given the sauces?

Kevin Miller, CFO

Every school is different. Sometimes we focus solely on nursing, and other times on behavioral health. We typically start with one service, but often we can introduce a second service in the following school year. There are many nuances in the different school systems, which makes it difficult to provide a general answer. Generally, when we enter a school, it's with one service, and we frequently expand to another service the next year.

Bill Sutherland, Analyst

And in Life Science, when you're seeing this nice expansion in gross margin, and I'd say assume it's tied to the expansion of Life Sci. Is that just pricing? Or is that something about? How you can optimally run those pieces of business?

Brad Vizi, Executive Chairman

Good question, Bill. It's not about pricing at all; it's primarily driven by our mix. The changes we initiated started about three years ago. When we looked at our Life Sciences and IT business, it mainly relied on staffing. We made a strategic decision to shift towards a solutions and managed service-based approach. This naturally comes with higher margins and can be more enduring as we provide more value to our clients. As this transition occurs, our team naturally evolves. We have observed this change across various parts of our portfolio, beyond just Life Sciences and IT. I believe we've reached a tipping point in the business lifecycle. Much of this change is driven by the talent involved. The skill sets required for staffing are different from those needed for solutions and managed services. This gives me increased confidence in the dynamics and drivers as we continue strengthening and expanding our team. This is just one segment of our portfolio, and we anticipate exciting developments ahead.

Bill Sutherland, Analyst

Yeah. Go ahead Kevin.

Kevin Miller, CFO

I was just going to give you the school stuff. But if you have some more questions on Life Sciences, go ahead.

Bill Sutherland, Analyst

Well, just, I was curious kind of where you've gotten managed services as a percent of revenue, ballpark?

Brad Vizi, Executive Chairman

Yeah. So, when you look at solutions and managed services, we're well under half at this point, over that a little under half or under, up from roughly 5%.

Kevin Miller, CFO

So, the school revenue in Q2 of 2023 was $26.5 million, and we were just a shade over $9 million for non-school.

Bill Sutherland, Analyst

You said 22. You meant this year?

Kevin Miller, CFO

I meant this year, Q2 of '23, sorry about that.

Bill Sutherland, Analyst

26.5.

Kevin Miller, CFO

Roughly 75% of our business in Q2 was school. So, it's pretty consistent with Q1.

Bill Sutherland, Analyst

Okay. I guess you saw on your non-school business kinds of same trend that the pure plays in that side were reported?

Kevin Miller, CFO

Yeah, I think it pretty much lines up. We expect to see growth there going forward. We had a slight sequential decline, but that was mainly due to one client reducing some of their expenses. We have plenty of room to grow our non-school business.

Bill Sutherland, Analyst

Okay. Last one on deployment, I guess you're going to continue with this very successful path you've had as opposed to anything related to a dividend, special dividend or tender or anything that might be outside of that. That tap to bid on?

Kevin Miller, CFO

All options are available, Bill, all options. However, we believe the stock is currently at a very attractive price. Let me check my screen quickly. Yes, it’s at 16.49, which simplifies the decision significantly.

Bill Sutherland, Analyst

Okay, guys, thanks a lot, for sure.

Operator, Operator

Our next question is going to come from Frank Kelly. Your line is open.

Unidentified Analyst, Analyst

Hello, guys. Hi, Kevin. Hi, Brad. How are you guys?

Kevin Miller, CFO

Good.

Brad Vizi, Executive Chairman

Very good.

Unidentified Analyst, Analyst

Good Life Science and IT are approaching almost 40%, which definitely needs to change significantly. That’s excellent, and hopefully, the other sectors will align as well. As we continue to add value, I have a question regarding the balance sheet. Can you explain why we experienced a 32% increase in accounts receivable over the quarter? Clearly, cash is crucial, and it also affects the profit and loss in terms of interest costs. Can you clarify this for us? What’s happening with accounts receivable?

Kevin Miller, CFO

Certainly. To be honest, the accounts receivable is simply too high in the second quarter. It's due to multiple factors rather than just one. We assess days sales outstanding alongside the dollar amounts, but the conclusion remains the same: the days sales outstanding in Q2 are elevated, and we plan to reduce them. I anticipate a significant drop in days sales outstanding in Q3, which is typically a low quarter for us. We should see a noticeable decline in receivables dollars. I also expect days sales outstanding to improve considerably in Q4, although it will depend on the revenue figures for that quarter. There may or may not be a reduction in accounts receivable, but I’m hopeful that days sales outstanding will decrease in Q4. I'm pleased you inquired about cash flow since we actually achieved very strong cash flow in Q2, despite the challenges in our trade receivables in Q4. For the year, cash flow from operating activities stands at $16.5 million, and overall, we're satisfied with our cash flow, though we recognize the need for improvement in managing receivables, and we are committed to making those improvements.

Unidentified Analyst, Analyst

Great, we're examining borrowings which impact interest and associated matters. It seems like an opportunity we aren't fully taking advantage of. But could you update me on the days sales outstanding in Q1 compared to Q2?

Kevin Miller, CFO

I don't have the exact numbers at hand, Frank, but they're definitely too high and they need to be reduced. However, I believe the more significant point is that, as I mentioned in the press release, we anticipate strong cash flow in the second half of this year, especially in Q3. Moreover, we are always focused on reducing our debt and interest costs. We are proud of our current debt situation in relation to the shares we've repurchased, but we recognize we can improve our receivables. If our debt increases, as long as our balance sheet remains strong, we are comfortable with that as it allows us to pay less interest.

Brad Vizi, Executive Chairman

I want to share two additional points. Since the end of the quarter, our collections have been strong. Furthermore, setting aside our capital allocation decisions, I expect our debt levels to remain relatively low, if we have any at all, in the upcoming quarters. We feel positive about our current balance sheet situation. The concern you raised is very pertinent.

Unidentified Analyst, Analyst

Great, no, I appreciate it understood. And I see where we're heading. And that sounds like a very good direction. That's all.

Brad Vizi, Executive Chairman

Thanks, Frank.

Operator, Operator

Okay, it appears there are no further questions. I will now hand it back to you for any closing comments.

Brad Vizi, Executive Chairman

Thanks, operator. Thank you for attending RCM second quarter conference call. We look forward to our next update in November.

Operator, Operator

This concludes your call. You may now disconnect.